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Plain Meaning of Sec. 619(d)(4)

Among the numerous exceptions to the Volcker Rule’s restriction on investments with hedge funds or private equity funds is the “de minimis investment” exception.  Originally derived from the latin de minimus non curat lex, which translates to “the law does not concern itself with trifles”, the term “de minimis” (which is latin for “the least”) operates in the modern parlance as something “minimal or trifling”.  As a de minimis amount is seen as less consequential, this exception therefore allows a banking entity to make and retain a nominal, “de minimis” investment in a hedge or private equity fund if the entity and/or investment meet a number of narrowly-tailored conditions.  

The primary condition to meet this exception is that the investment may only be with a fund that the banking entity “organizes and offers” its customers.  Unfortunately, the phrase “organizes and offers” is not defined within section 619, but it can be inferred from the rule that this exception is designed to limit a banking entity’s de minimis exception investments only to those funds in which it has a role in establishing.  This inference is supported by the next condition, which pertains to the purpose of the investment and mandates that in order to meet the de minimis exception, the investment must be made with the purpose of establishing the fund with sufficient initial equity for investment to permit the fund to attract unaffiliated investors, or making a de minimis investment.  Because the “establishment” of a new investment vehicle would conceivably benefit the markets by increasing investment volume and thereby promoting financial growth, a limited version of this specific action is allowed under the exception.

For such an investment to be considered “de minimis”, the investment must adhere to the following percentage limitations in section 691(d)(4)(B) – pertinent to both the size of the fund and the size of the banking entities assets.  As to the fund, the banking entity’s investment may initially (no later than one year after the establishment of the fund) exceed the de minimis amount, provided the banking entity actively seeks unaffiliated investors to reduce or dilute the banking entity’s investment to the de minimis amount.  To meet this de minimis amount, the banking entity’s investment must be reduced to an amount that is no more than 3% of the total ownership interests in the fund. Id.  Again, this reduction must occur no later than one year after the establishment of the fund and may occur through redemption (direct), sale (third party), or dilution (additional capital) of the investment amount.  Id.  However, the one-year period may be extended by up to an additional two years as determined by the Board of Governors.  

As to the banking entity itself, the banking entity’s investment must be deemed “immaterial to the banking entity” – a forthcoming rule-based definition as per section §691(b)(2)(A). Notwithstanding the promulgation of the “immaterial” rule, section 691(d)(4)(B)(ii)(I) requires that the aggregate amount of the banking entity’s investments in any private equity or hedge fund may not exceed 3% of the banking entity’s “Tier 1 capital” – a core measure of a bank’s financial strength from any regulatory perspective.  Tier 1 capital is required because this type of company capital is easily valued – thus allowing for a more transparent measurement on the effect such an investment will have on the banking entity.  Additionally, the aggregate amounts of the outstanding investments by a banking entity must be deducted from the total capital of the banking entity.  The amount of this deduction may be increased at a time that is commensurate with the leverage of the fund in which the banking entity has invested. Id. Although the term “commensurate” is not defined by the rule, this is presumably aimed at discouraging investments in highly-leveraged funds.