funds assets they manage generate profits from lending out securities. In what is being viewed as an important test case, the Securities and Exchange Commission has given Norwest Corp. and Keycorp the green light to lend securities held by their proprietary mutual funds. The SEC decision, issued in a May 25 letter, means that other banking companies that have both proprietary mutual fund families and custody operations that administer the funds can lend securities for profit. The only condition is that lending programs for these banking companies must be structured in the same way outlined by Norwest and Keycorp. "This could enhance the funds' overall performance in a tough market," said Joseph A. Randazzo, vice president of institutional asset services at Key Trust Co., Ohio, a unit of Keycorp. The enhanced returns would result from the bank's investment of collateral paid by the borrower of the security. The collateral is set at a slight premium to the value of the security, usually 102%. The SEC rendered its decision by agreeing in a letter that it would take no action against the two banking companies if they engaged in securities lending on propriety fund assets. Norwest is a Minneapolis-based banking company with $61.8 billion in assets, and Keycorp is a Cleveland-based banking company with $67.7 billion in assets. Prior to the SEC ruling, the lending of securities by a custody bank that only managed its mutual funds was a gray area of the law. Many believed the Investment Company Act of 1940 prohibited this activity to prevent self-dealing by funds in their transactions with affiliates. The fear was that a custodian might, for example, be over-compensated for the lending and the funds could be short-changed. In 1993 the SEC had refused to grant a request from United Services Funds, an affiliate of Bankers Trust Co., to permit securities lending of its funds The permission sought would have let the custodian and the mutual fund share the revenue derived from the securities lending. Currently, bank custody units are allowed to lend securities from funds that are not managed by the banks' investment units. In a typical case, a broker borrows a security from a custodian or a broker-dealer for a short time to cover a short sale or a failed trade. The broker gives the custodian collateral at a slight premium of the value of the security, usually 102%. The collateral is often in the form of U.S. government bonds, cash, or letters of credit. The custody bank invests the collateral. The broker repays the security, usually within a day or two. The collateral is returned to the broker, and the investment income and any fees are divided between the custodian and the customer account that owns the securities. However, in the structure that Norwest and Keycorp outlined in their request to the SEC, the investment adviser dictates which brokers may borrow securities and what the terms of such arrangements may be. The custodian acts purely in a "ministerial" capacity, performing the transactions.

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