Signet Banking Corp. has added an unusual disclosure to its mutual fund sales materials to address a potential conflict of interest that is unique to bank-managed funds.
In a revised prospectus issued last month, the Richmond, Va., regional banking company said its lending relationships will not be a factor in the selection of securities for its mutual fund portfolios.
Such disclosures are not required by the Securities and Exchange Commission. But some securities regulators have raised concerns that banks could pressure their fund units to buy securities of companies they lend to, putting the banks' interests ahead of those of fund shareholders.
One fear expressed by regulators is that a bank, through its mutual fund arm, might invest in a weak company to help bolster its ability to pay back a loan in the future.
Signet's fund manager, Virtus Capital Management, did not rule out the possibility that its Virtus Funds would invest in companies that owe money to the bank. However, the three-sentence explanation made clear that Signet is paying careful attention to possible conflicts of interest.
Signet vice president Leslie Hunter said the language represented "an overabundance of caution on our part."
And he believes other banks will follow suit. He said Signet included the disclosure because it lends money to publicly traded companies and the Virtus Funds may invest in some of those businesses.
Geoff Bobroff, a mutual fund consultant based in East Greenwich, R.I., said Signet's move shows how banks are being mindful of even the appearance of conflict.
"Banks have been very much under the scrutiny of regulators over everything and anything, so they are being very cautious," Mr. Bobroff said.
Signet's move caught the eye of Lipper Analytical Services, a Summit, N.J., firm that carefully tracks the mutual fund industry. In a March report to its clients, the firm said it was "the first example we have seen that addresses the possible conflict of interest for banks ultimately acting as lenders to and investors in the same companies."
Reached by phone, A. Michael Lipper, the firm's president, said, "While the Glass-Steagall Act of 1933 is effectively riddled, it is not dead at the moment. Someone at Signet is being wise to put this in."
Other observers said Signet seems to have come up with a new twist on disclosure.
"It does seem to be unusual language from my experience. I never recall seeing that in a brokerage firm prospectus," said John Rekenthaler, publisher of Chicago-based Morningstar Mutual Funds.
Signet's fund distributor, Federated Investors, Pittsburgh, said it has encouraged its bank clients to include such disclosures in prospectuses for some time, but was unable to say how many are currently doing so.
Mutual fund experts were divided over how much good the disclosure would do for Signet.
"I don't know how much extra protection this really gives the bank," said Joseph Goldberg, a lawyer with Shereff, Friedman, Hoffman & Goodman, New York.
Mr. Goldman said he was "not aware" of any bank that has been sued for pressuring a portfolio to buy the securities of a bank borrower. A bank that broke securities law in this way couldn't use promises to the contrary made in a prospectus as a defense, he said.
Observers said the money center banks would have more potential conflicts to worry about than a regional bank like Signet because their commercial banking operations are so much larger.
The way banks avoid the problem now is by separating their commercial operations from their brokerage units.
Current law allows a portfolio manager to know about the bank's lending relationship as long as the manager invests with the interest of shareholders in mind, Mr. Goldberg said.
SEC commissioner Richard Y. Roberts has argued that all bank-advised funds should, with few exceptions, be excluded from purchasing securities in an underwriting where the issuer owes money to the bank.
Beyond that potential conflict, banks are also open to lending officers giving insider information about a company to portfolio managers, Mr. Bobroff added.
