The Effect of Dodd-Frank on the Ability of Banks to Invest in CDVC Funds

Several of our member funds, as well as some bank investors, have asked us about the effect of the Financial Stability Act of 2010 (“Dodd-Frank”) on the ability of banks to invest in  CDVC funds.  This post answers that question and provides some background.

CDVCA worked closely with the bank regulatory agencies—with special thanks to the OCC!— to convince congress to insert language into the final Dodd-Frank legislation exempting so-called “Public Welfare” or “Part 24” investments from the general prohibition contained in the legislation against bank investments in private equity funds, including venture capital funds.  Investments in CDVC funds would be considered Public Welfare investments.

The following is the relevant section of Dodd-Frank, which adds a 13th section to the Bank Holding Company Act.  The most relevant language is marked in bold:

SEC. 619. PROHIBITIONS ON PROPRIETARY TRADING AND CERTAIN RELATIONSHIPS WITH HEDGE FUNDS AND PRIVATE EQUITY FUNDS.

The Bank Holding Company Act of 1956 (12 U.S.C. 1841 et seq.) is amended by adding at the end the following:

‘‘SEC. 13. PROHIBITIONS ON PROPRIETARY TRADING AND CERTAIN RELATIONSHIPS WITH HEDGE FUNDS AND PRIVATE EQUITY FUNDS.

‘‘(a) IN GENERAL.—

‘‘(1) PROHIBITION.—Unless otherwise provided in this section, a banking entity shall not—

‘‘(A) engage in proprietary trading; or

‘‘(B) acquire or retain any equity, partnership, or other ownership interest in or sponsor a hedge fund

or a private equity fund…

‘‘(d) PERMITTED ACTIVITIES.—

‘‘(1) IN GENERAL.—Notwithstanding the restrictions under subsection (a), to the extent permitted by any other provision of Federal or State law, and subject to the limitations under paragraph (2) and any restrictions or limitations that the appropriate Federal banking agencies, the Securities and Exchange Commission, and the Commodity Futures Trading Commission, may determine, the following activities (in this section referred to as ‘permitted activities’) are permitted:…

‘‘(E) Investments in one or more small business investment companies, as defined in section 102 of the Small Business Investment Act of 1958 (15 U.S.C. 662), investments designed primarily to promote the public welfare, of the type permitted under paragraph (11) of section 5136 of the Revised Statutes of the United States (12 U.S.C. 24), or investments that are qualified rehabilitation expenditures with respect to a qualified rehabilitated building or certified historic structure, as such terms are defined in section 47 of the Internal Revenue Code of 1986 or a similar State historic tax credit program.

 

In turn, paragraph (11) of Section 5136 of the Revised Statutes of the United States (12 U.S.C. 24)  reads as follows:

 

Eleventh. To make investments directly or indirectly, each of which is designed primarily to promote the public welfare, including the welfare of low- and moderate-income communities or families (such as by providing housing, services, or jobs).

 

These are basically investments, such as investments in CDVC funds, for which banks would receive credit under the Community Reinvestment Act.