The unprecedented collapse of an $82 million-asset money market mutual fund for community banks has shaped up as an acutely embarrassing episode for all involved.

The planned liquidation of the fund, which came to light Tuesday in congressional testimony by Securities and Exchange Commission Chairman Arthur Levitt, is sure to intensify scrutiny of banks' derivative investments.

Some 94 institutional investors, all of which are believed to be community banks with between $50 million and $500 million of assets, stand to lose six cents on the dollar of their investments, for a collective loss of $5 million.

While the loss is likely to have only a minor impact on these banks' operations, it could lead to regulatory sanctions against the Community Assets Management Inc., the Denver firm that managed the fund. SEC officials have said an investigation of the matter is under way.

The company was founded in 1988 by a group of bankers led by B.F. "Chip" Backlund, a former president of the Independent Bankers Association of America. His son, John Backlund, a former Colorado bank executive, is president of Community Assets Management, and a number of banks are co-owners of the company.

Certainly the fund's meltdown will be noted by financial historians, as it marks the first time a money market fund has "broken the buck" - or dropped below a $1 share value - since the current money fund regulations were adopted more than a decade ago. It is also the first time that derivative losses have prompted the liquidation of a money fund.

But the effect of the fund's collapse on the attitudes of investors and regulators - perhaps the most important result - is hard to gauge.

Certainly, the episode proves to investors that money market funds can lose money. As for regulators and legislators, the failure adds grist to calls for more regulation.

One key player on this front, Rep. Jim Leach. R-Iowa, said Congress should not overreact to the failure of "one small money market mutual fund." At the same time. however, he called on banking regulators to tighten up derivatives regulation.

"It is impossible not to note that the failure is in the context of accumulating losses at very substantial, sophisticated institutions," Rep. Leach said Wednesday.

He appeared to be referring to money fund bailouts earlier this year by BankAmerica Corp., and spectacular derivative losses in bond funds managed by leading nonbanks, including Piper Jaffray Co. and Paine Webber Group Inc.

Rep, Leach has co-sponsored legislation that would direct bank regulators to establish guidelines for oversight of derivatives activities. No action is expected on the bill this year.

According to a press statement by Community Assets Management, the fund's problems stemmed from its holdings of agency-backed structured notes that fell in value when interest rates rose earlier this year.

The notes were of a variety that the SEC has called too risky for mutual funds. Such investments have caused losses at other money funds, including two portfolios in BankAmerica's Pacific Horizon family.

But unlike BankAmerica and the other money fund managers with similar problems, Community Assets Management was unable to reimburse the fund for the losses.

Nor was a Milwaukee firm called Prospect Hill Advisers Inc., which was an mvestment adviser for the Community Assets fund, able to help out. This company. which shut down on July 31, was headed by a former chief investment officer for Bank One Wisconsin Trust Co., Mark A. Elste.

Community Assets tried. without success, to get financial assistance from the agencies that issued the notes. The company also approached brokers who sold the notes to the fund, and service providers to the fund, to no avail.

As a result, Community Assets sent a memo to the fund shareholders on Monday, saying it would liquidate the fund at a loss of 4.2 cents per share on the securities, and 1.8 cents per share in administrative costs. Shareholders are to be left with 94 cents on the dollar, and whatever else is left over after the liquidation.

Ironically, the U.S. Government Money Market Fund was the top performer in its category in the period ending Sept. 16, according to money fund researcher IBC/Donoghue, of Ashland, Mass.

Richard Y. Roberts, an SEC commissioner. said he didn't know how a money fund with such deep troubles could have been a top performer so recently. He said that among other issues, the SEC is checking to see if its fund pricing rules were violated.

For Community Assets Management, the developments spell an uncertain future, since this was the company's only mutthal fund.

Most investors in the fund declined to comment. One who did, however, was Jerry Towns, chairman and chief; officer of Southern Michigan Bank and Trust, a $180 million-asset bank in Coldwater. Mich,

He said the bank had a munireal amount invested in the fund. and won't suffer any serious losses. He declined to be more specific. But he said the liquidation came as a shock.

"It's so unfortunate and fresh that we really don,t know what is happening," Mr. Towns said,

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