Bank mutual fund operations, one of the industry's most promising new businesses, are suddenly caught in a regulatory drumfire.
Regulators and lawmakers are issuing a barrage of questions and warnings. The big worry is that the bank mutual fund boom could go bust if stock and bond markets drop, hurting both consumers and banks.
Just last month, two powerful congressional committee chairmen -- Rep. John Dingell, D-Mich., and Rep. Henry Gonzalez, D-Tex. -- ordered the General Accounting Office to investigate the implications of the surge in bank fund sales.
Congressional hearings are likely as early as this fall, after the GAO reaches tentative conclusions. More hearings could follow in the spring, when GAO officials say their final report will be ready.
Dismay and Uncertainty
Few believe that regulators will force a rollback of the bank mutual fund business. But the heightened congressional interest and the possibility of tougher regulation have created consternation and uncertainty among banks that are pushing into investment products.
"If the regulatory environment is not clear, that makes planning difficult," said George Bernard, mutual fund chief at PNC Bank Corp., Pittsburgh. "Obviously, that's going to hurt people."
The heightened attention has prompted some banks to exercise greater care in choosing salespeople and disclosing investment risks. But so far, no banks have beat a retreat from the business.
Is the scrutiny dampening banks' enthusiasm for mutual funds? "I don't think so," said Kurt Cerulli, principal of Cerulli Associates, a Boston-based consulting fir. "Does it have the potential to become cumbersome? Yes."
Laundry List of Concerns
Among the worries on bankers' minds:
* Should banks let existing staff sell funds as well as traditional bank products -- or should they hire licensed brokers who deal strictly with investment-products customers? The latter approach would more readily pass muster with regulators.
* Will regulators crack down on the growing practice of adopting banklike names for proprietary mutual funds? If so, switching names could be costly and perhaps embarrassing for companies like NationsBank, First Union, and PNC, which use like-sounding names for their funds.
* Should banks reprint existing sales literature when they need more -- or wait to see if they will be required to disclose additional information about investment risks to customers?
The call to arms by Rep. Dingell and Rep. Gonzalez was the culmination of a war of words that has raged all year. Since January, federal banking, securities, and brokerage regulators, joined by state securities regulators, have been probing the bank mutual fund business.
Why the heightened interest? For one thing, the circumstances under which bank customers buy mutual funds have changed dramatically in the past three or four years, says W. Bruce McConnel, a partner in the Philadelphia law firm of Drinker, Biddle & Reath.
Today, mutual funds are frequently sold in bank lobbies. That is far cry from the prevailing practice of just a few years ago, when banks that offered mutual funds at all typically did so through a separate affiliate, such as a discount brokerage, Mr. McConnel said.
Consequently, "I think there's understandable concern among the regulators that bank customers may not be receiving proper disclosure," he said.
But Mr. McConnel added that there is more to it.
"Among some elected representatives, there is a legacy of suspicion when it comes to bank involvement in the securities industry," Mr. McConnel said.
Quiet Allies Expanded Powers
At the same time, he said, legislators feel "outflanked" by the courts and regulators, which have quietly expanded banks' mutual fund powers in recent years.
He expects the Office of the Comptroller of the Currency and the Securities and Exchange Commission in particular to keep the spotlight on bank practices.
"Both will bend over backwards to scrutinize banks' mutual fund practices, sensing the congressional concern," Mr. McConnel said.
Mr. Cerulli also sees the concerns as part of a long-running debate over the erosion of the Depression-era Glass-Steagall Act.
Scrutiny Called 'Reactionary'
"In reality, so much of Glass-Steagall has already broken down" Mr. Cerulli said. "A lot of this is just reactionary."
Congress, he said, quite rightly wants to make sure customers understand that mutual funds sold by banks aren't protected by the Federal Deposit Insurance Corp.
"But banks' investment representatives are well trained," he said. Increasingly, banks use full-fledged stockbrokers to sell their funds.
Bankers maintain that policy-makers are overlooking an important factor. Banks want to be in the mutual fund business for a long time, and they are taking pains to do things right.
"I do not want to sell a customer an inappropriate product, and I certainly don't want anyone leaving the bank believing they have purchased an insured product," said Deanna Belli, senior vice president and director of trust marketing at Riggs National Bank, Washington.
PNC's Mr. Bernard said he is convinced that mutual funds are good for investors, and that the business has potential to strengthen the banks by enabling them to build fee income.
"If you just paralyze the banks so they can do nothing but rely on traditional products, you're going to hamstring the banking system," Mr. Bernard said.
