Covington Takes On Volcker Rule for Bankers

, The Litigation Daily

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Covington & Burling has crafted the first court salvo in the battle over the newly-enacted Volcker Rule. On Tuesday the firm asked for an emergency injunction on behalf of the American Bankers Association and four community banks, claiming that a portion of the rule should be struck down for violating the Administrative Procedures Act.

The 25-page lawsuit asserts that the Volcker Rule would compel the plaintiffs and other banks to divest an obscure debt instrument called TruPS-backed CDOs, which are collateralized debt obligations backed by trust-preferred securities. This divestment would force them to recognize "significant and unexpected losses" by writing down the value of these investments by the end of this year, the plaintiffs claim. The lawsuit names as defendants three of the five entities that formulated the rule: the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency.

There are two main components to the Volcker Rule, which was enacted as part of the Dodd-Frank Act. One stops commercial banks from engaging in propriety trading. The other--which is the focus of the banks' lawsuit--prohibits these banks from having an ownership interest in a "covered fund." The plaintiffs allege that under the final implementing rules issued by the defendants Dec. 10, the definition of an ownership interest was "unexpectedly and dramatically expanded" to include the holding of these TruPS-backed CDOs.

The plaintiffs claim that this second portion of the Volcker Rule violates the Administrative Procedures Act for several reasons: The final rule as drafted is at odds with the language of Dodd-Frank; the plaintiffs weren't given adequate opportunity to comment on this version of the rule; and the rule is arbitrary and capricious.

While the lawsuit focuses on small banks, the ABA is asking the court to invalidate the rule for all banks, including large banks that hold the vast majority of these TruPS-backed CDOs. According to the complaint, the ABA estimates that banks with less than $500 million in assets collectively hold $210 million in TruPS-backed CDOs, and would suffer a loss of $78.6 million. Larger banks hold $3.29 billion in these securities, and face a potential write-down of $521 million.

Covington filed the lawsuit in both U.S. District Court for the District of Columbia and with the U.S. Court of Appeals for the District of Columbia Circuit. Covington partner Anthony Herman, who represents the plaintiffs, explained that the dual filing was made because the D.C. Circuit has exclusive jurisdiction over the Federal Reserve, and, ordinarily, the district court has jurisdiction over the other defendants. On Thursday the D.C. Circuit issued a briefing schedule that would put it in a position to decide the motion for emergency relief by the end of the year.  It's also possible that the district court could take up the issue by then, too.

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