SEC Chairman Mary Schapiro said on Tuesday her agency is exploring whether insurance companies can qualify for a coveted exemption in the proposed Volcker Rule that would protect them from having to scale back their investments in hedge funds.  Ms. Schapiro expressed her views, as follows:

"This is a really important issue, we understand that, and we are reviewing the comment letters carefully." ...  "We are looking at whether there could be flexibility on this point. We do have exemptive authority under the Volcker rule, but the standard is high." -- Mary Schapiro, SEC Chairman, speaking at Congressional hearing.

Basic Restrictions/Limitations Under the Volcker Rule. [The following is taken largely from the 3/5 speech by SEC Commissioner Daniel Gallagher.] Section 619 of the Dodd-Frank Act, commonly known as the “Volcker Rule,” has become one of the most controversial parts of the 2010 Dodd-Frank financial oversight law.  It seeks to add distance between the world of speculative trading and commercial banking.  Even though it is a statutory provision, the Rule imposes 2 significant prohibitions on banking entities and their affiliates.

1. The Rule generally prohibits banking entities that benefit from federal insurance on customer deposits or access to the discount window, as well as their affiliates, from engaging in proprietary trading.
2. The Rule prohibits those entities from sponsoring or investing in hedge funds or private equity funds.

It does so by identifying certain specified “permitted activities,” including underwriting, market making, and trading in certain government obligations, that are excepted from these prohibitions - but also establishes limitations on those excepted activities. The Volcker Rule defines - in expansive terms - key terms such as “proprietary trading” and “trading account” and grants the Federal Reserve Board, the FDIC, the OCC, the SEC, and the CFTC the rulemaking authority to further add to those definitions. The statute also charges the 3 Federal banking agencies, the SEC, and the CFTC with adopting rules to carry out the provisions of the Volcker Rule.  It requires the Federal banking agencies to issue their rules with respect to insured depositary institutions jointly and mandates that all of the affected agencies, including the SEC, “consult and coordinate” with each other in the rulemaking process.  In doing so, the agencies are required to ensure that the regulations are “comparable,” that they “provide for consistent application and implementation” in order to avoid providing advantages or imposing disadvantages to affected companies, and that they protect the “safety and soundness” of banking entities and nonbank financial companies supervised by the Fed. Impacted Financial Firms and Follow-Up Actions. The rule would mostly affect large banks - e.g., Goldman Sachs and Morgan Stanley.  Some insurance companies - e.g., Nationwide Mutual Insurance Co - have complained they would be hit by the Volcker rule because they are affiliated with a bank. Congress had attempted to avoid this scenario by exempting their insurance operations from the restrictions that banks will face.  But in October, U.S. banking regulators and the SEC unveiled a plan that caught insurance companies off guard by only extending the exemption to cover their proprietary trading activities, and not their private fund investments. Insurance companies were further spooked in January when during a House Financial Services Committee hearing, Schapiro told lawmakers she believed the law only exempted the proprietary trading activities of insurance companies.  After that hearing, a lobbying effort kicked into full gear and regulators were flooded with letters pushing for the fund investing exemption to be written into the final rule. Lawmakers and industry officials have contended that Schapiro is misreading the law and that the intent of Congress has always been to exempt insurance companies from the fund investing restrictions as well as the proprietary trading crackdown.  \ In a letter to SEC's Mary Schapiro and other regulators, dated 1/27/12, a bipartisan group of 17 lawmakers expressed the following:  "We believe it is imperative that, as the agencies move forward, they follow Congressional intent and permit insurance companies to continue investing in covered funds for their general accounts." Insurance companies argue that putting their operations under the under the Volcker Rule would greatly inhibit their ability to conduct business and that the type of trading and fund investing they do has little in common with the risky trading the rules seeks to curb. When asked about the issue on Tuesday during a hearing to review the agency's 2013 budget request, Schapiro said regulators followed the law closely when drafting the October proposal and deciding what insurance activities to exempt. Now, she said, the agency is reviewing comment letters and trying to decide how to proceed. While she was aware of the concerns, she warned that a high bar has been set for the exemption because under the law regulators would have to determine the reprieve would "promote the stability of the US financial system and the safety and soundness of the banking system."  She added that the SEC is "looking very carefully" at the possibility of granting an exemption to insurance companies.   [Reuters, 3/6/12]