Answer can be worth billions and billions in revenues to Wall Street firms. 

The New York Federal Reserve has launched an investigation into whether the big firms and banks are misclassifying so-called proprietary trading activity - which eventually is to be banished under the Dodd-Frank Reform Act - according to Charlie Gasparino of Fox Business.  the recent financial reform legislation -- as trades they do on behalf of their customers, a move that could have major implications for the financial industry as it grapples with new law’s impact on their bottom line, FOX Business Network has learned.

Under Dodd-Frank - and specifically the Volcker Rule provisions - big banks and big Wall Street firms can no longer use firm capital to make bets in the stock and bond markets - i.e., prop trading.  One loophole is that firms can use their own capital to trade on behalf of clients, such as holding a position in a certain security that a client may eventually buy, and making money while that position is on its books.  In this regard, the NY Fed is asking: When does a client trade actually become a proprietary trade that is risking firm capital and threatens to impact its financial position if market conditions turn sour?  

The outcome of the investigation could have a significant impact on the bottom lines of banks and the remaining Wall Street firms. As banks like Goldman Sachs (NYSE:GS) and JPMorgan (NYSE:JPM) close down their proprietary trading desks, they are moving traders to other parts of the company such as asset management where they interact with customers, and under Wall Street’s interpretation of the rule, they can make their firms significant amounts of money trading stocks and bonds as long as a customer is involved.  

Should the Fed begin to reclassify many of these transactions as prop trading, Wall Street will no longer be able to count on customer trading as a major source of income.  Prop trading, as defined by the Volcker Rule is something that has the CEOs of the major firms worried, particularly if they have to scale back on their client-related trading.  “We’re talking about billions upon billions of revenues that may go away depending on how the Fed rules on this,” said one Wall Street CEO, who added:

“Holding an position for a customer for a week seems to be a legitimate use of firm capital.  But what about holding that position for a month or longer. That’s when it becomes more difficult to figure out if the firm is making a bet with its own capital, which is something the Volcker Rule was supposed to end."  --  CEO of a major firm with direct knowledge of the Fed’s activities. 

While a spokesperson for the New York Fed would neither confirm nor deny the inquiry, its understood that the Fed launched the inquiry about a week ago, seeking input from banks and Wall Street firms. In the meantime, Wall Street firms are experiencing a sharp slowdown in business activity, which has led them to lay off workers, slash bonuses and/or enact hiring freezes.  [Fox Business, 9/28]