Banks will have to wait at least a while longer for a federal law that could boost their mutual fund assets by billions.

The proposed legislation would allow the conversion of common trust funds into mutual funds without exposing trust customers to a big tax bite.

As the law now stands, common trust customers would have to pay taxes on any gains in their portions at the time of conversions into mutual funds. The pending measure would change the law so that customers would be taxed only when they sold, at a gain, shares in a mutual fund formed from a trust.

Common Trust Funds Targeted

The measure targets common trust funds, like those set up for estates and minors.

Some 473 financial institutions oversee 1,770 common trust funds with $136.7 billion in assets, according to the Federal Financial Institutions Examination Council.

James McLaughlin, director for trusts and securities at the American. Bankers Association, said that perhaps a third of these funds would convert to mutual funds if the law were passed. But others think the conversion rate could be much higher.

Victim of Circumstances

The measure has drawn little or no opposition since first proposed in 1991 but has repeatedly fallen victim to circumstances.

It was included in a tax plan President Bush twice vetoed for other reasons last year. This y,ear, the measure was part of HR 13, a tax simplification bill introduced in January by Rep. Dan Rostenkowski, D-Ill., chairman of the House Ways and Means Committee.

Could Ride on Tax Bill

But Congress shelved that initiative while working on President Clinton's economic package. The way things stand now, banks and other supporters of the measure probably will have to wait until next year.

"My guess is Congress won't be able to tackle that this year," said Pat Jones, a spokesman for Rep. Rostenkowski.

Some supporters hold out hope for the measure to be attached to a miscellaneous tax bill that Congress may consider before breaking for the year.

This could allow time for a modification sought by smaller banks. They want the proposal broadened to allow common trust conversions into one or more mutual funds; the current bill limits them to one fund.

More Choices for Customers

But Mr. Jones isn't optimistic the measure will pass in any form before yearend because Congress will be "consumed" by matters like health care reform and the North American Free Trade Agreement once it returns from summer recess.

Still, many believe it's just a matter of time. The current administration does not oppose conversion, said Kathy Anderson, national director of tax services for mutual funds at KPMG Peat Marwick. "They just have to get it into a less controversial bill."

Bank trade groups say the bill would benefit trust customers by giving them additional investment choices and will help banks hold onto customers who are asking for mutual funds.

Big banks appear to be the biggest beneficiaries, earmarking the assets for mutual funds they already manage. Many of these were started by converting employee benefit, IRA, and 401(k) accounts, which are not subject to immediate tax consequences.

Banks Must Tread Softly

Other banks could use the assets as seed money to help launch their own funds, or to arrange a private label agreement with an outside fund company.

But banks have to tread softly to avoid trampling on their fiduciary duty to customers.

Banks will need customers' permission to convert the accounts and must also make sure that customers know the funds are managed by the bank.

"Banks have to be very careful about this," said Lee Cross, a spokeswoman for the Office of the Comptroller of the Currency. "There's a real potential for customers who don't feel banks have been acting in their best interest to sue them."

OCC Permission Unnecessary

Banks apparently would not need Comptroller's office permission for the conversion.

First Chicago Corp. is among the banks planning to go the conversion route while keeping their responsibilities to customers in mind, said Michael Traba, vice president for mutual funds.

First Chicago expects the measure to pass, and has already filed with the Securities and Exchange Commission to convert its 16 common trust funds into bank-managed mutual funds.

Other banks will seriously consider diving in if the proposal becomes law.

"We would absolutely take a very hard look," said Judy Rudnick, product manager for the Harris Insight funds offered by Chicago's Harris Bankcorp.

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