WASHINGTON -- Bank-America Corp.'s recent bailout of a proprietary mutual fund managed by its lead bank set off no alarm bells at the Federal Reserve, according to Fed Governor John LaWare.

In an interview this week, Mr. LaWare characterized the bailout as an "unusual circumstance" that raises no concerns about the safety and soundness of the banking system.

"They had the integrity of the whole corporation to defend because a serious problem with an affiliate could affect the confidence of the bank, even though there were no bank funds involved," Mr. LaWare told the American Banker.

"But it doesn't concern me from the standpoint of the safety and soundness of the banking system," he said.

Some Lawyers Disagree

Industry lawyers, by contrast, say the incident reveals the real risk that banks face in this business, namely exposure to losses by proprietary funds, and argue that regulators should pay more attention to that area.

Mr. Laware said that although the amount of the bailout was "peanuts," the episode nonetheless has probably caused the bank to reevaluate the appropriateness of the instruments used and the fund's risk management system.

But at the Fed the incident has raised no questions about the use of derivatives by bank-managed mutual funds.

Repeating an argument he has made on the use of derivatives generally by banks, Mr. LaWare said the critical issue is not whether derivatives are used, but how their risk is managed.

Strong Response

Responding to a question about a recent meeting of the Fed's Consumer Advisory Council at which several members supported bank testing by federal regulators, Mr. LaWare repeated the Fed's opposition to the proposal.

"The underlying assumption that banks are trying to hoodwink consumers, I think, is totally wrong. No banker in his right mind wants to break the law," Mr. LaWare said.

"I think it's immoral [and] unethical" for the federal government to send in testers posing as customers looking for investment products at banks, he added.

He agreed that oral disclosures are key to a bank's effort to make clear to consumers the distinnction between insured CDs and mutual funds.

But he said the best way to monitor those disclosures are self-testing programs by banks and examinations where staff members from the Fed observe how such products are sold and determine whether bank sales-people have been properly trained.

Mr. LaWare agreed with consumer advocates that elderly, long-time bank customers are particularly vulnerable to confusion when they are sold investment products at a bank.

Such customers have "a special feeling about banks," and, being in the habit of buying CDs, believe that all bank products are insured, he said.

But, he added "we have to assume some level of intelligence on the part of the investor and some level of responsibility."

Comparing consumer protection in banks to another hot issue, Mr. LaWare said, "Pick up a cigarette package. It says this is dangerous to your health, and people puff away ignoring the warning.

"You can't protect everybody from every kind of risk," he added.

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