The Glass-Steagall Act, the law that supposedly separates commercial from investment banking, is dead-or so it would seem. Regulatory actions and business developments over the past several years make it quite easy to reach this conclusion.

The principal issue in the financial service reform debate is now bank insurance, not bank securities activities. Many banking organizations, in particular larger ones, have concluded that they don't need Glass-Steagall reform anymore, because they now can engage in significant-and profitable- securities dealing and underwriting activities without the need for legislation.

The Federal Reserve Board has reduced its percentage and operational limitations on bank section 20 affiliates, and regulatory agencies have continued to approve bank securities brokerage and investment management activities.

It also seems that the securities and investment management industries are focusing upon legislative and regulatory efforts to ensure that banks in the securities business are subject to the same rules and requirements as nonbank securities firms. Securities firms also want to be allowed to acquire banks to the same extent that banks can acquire securities firms.

But Glass-Steagall, if not in vibrant good health, is still alive.

Banks cannot engage in unlimited securities dealing, and underwriting and securities firms generally cannot buy full-service banks. The law also continues to impose artificial, cumbersome, and expensive regulatory requirements in a variety of securities-related areas.

Occasionally, in response to evolving business practices, regulatory agency action to loosen the act's constraints can still happen.

One prime example of Glass-Steagall's continuing effects-and a potential object of expansive regulatory action-is in the bank mutual fund business, where banks seeking to organize or sponsor their own mutual funds must retain-and pay for-the services of an independent fund distributor to act as principal underwriter of a bank's mutual funds shares.

The traditionally accepted view among industry observers and regulators is that because the basic business of a mutual fund is the distribution of securities, to avoid violating Glass-Steagall banks must use a securities firm to act as fund organizer, sponsor, and distributor. The securities firm must fund, or "seed," a new mutual fund; enter into the basic underwriting agreement with a mutual fund; and execute the necessary selling agreement with brokers, dealers, and other selling agents for the fund.

But a pair of late 1997 regulatory decisions-one by the Office of the Comptroller of the Currency and one by the Federal Reserve Board-may have opened a path for banking organizations to reexamine the need for independent distributors for their proprietary mutual funds.

The two regulatory decisions, read separately, were mildly interesting regulatory actions. They provoked brief comment in the trade press, which perceived them as providing banks with increased flexibility in the marketing and servicing of their mutual funds.

The OCC letter, which was issued in the fall but publicly released several months later, expanded on a prior interpretive ruling which allowed banks to extend credit to fund distributors to finance the payment of commissions and other sales compensation for the sale of B-class mutual fund shares-shares carrying a rear-end or contingent deferred sales charge.

In the first letter, published in 1996, the OCC had little difficulty concluding that bank financing of B-class share sales was not a "distribution" or "underwriting" activity prohibited under Glass-Steagall. In its 1997 letter, the OCC carried this principle one step further. It concluded that a national bank could advance sales compensation to selling agents on their sales of B-class shares without going through the burdensome and potentially costly step of extending credit to an intermediary distributor.

Instead, the OCC concluded that the direct payment by a national bank of sales commissions to selling agents was the "functional equivalent of, or logical outgrowth of, a permissible lending or marketing activity." Equally significant, however, was the OCC's conclusion, stated in a footnote, that the direct payment of marketing expenses in the form of retail commissions to selling brokers did not amount to a "covered transaction." Therefore, it is not subject to the significant financial restrictions of the affiliate transaction requirements of Sections 23A and 23B of the Federal Reserve Act.

The contemporaneous but unrelated Federal Reserve Board action consisted of an approval of a Bank Holding Company Act notice filed by England's Lloyds PSB Group seeking permission to retain its ownership of a mutual fund advisory and administrative services firm. With one important distinction, the Lloyds notification was one in a long line of Federal Reserve Board decisions allowing bank holding companies to provide advisory and administrative services to mutual funds.

Unlike the previous regulatory actions, however, the mutual funds advised and serviced by the Lloyds subsidiary did not have an independent third-party distributor. Instead, they were "distributorless" and sold by unaffiliated agents.

The Federal Reserve Board nonetheless concluded that the provision of advisory and administrative services by a bank holding company to such a "distributorless" mutual fund did not cause it to engage in impermissible securities dealing and underwriting activities under Glass-Steagall. Though the Fed Board reiterated its long-held conclusion that the "distribution" of mutual fund shares is prohibited by Glass-Steagall, it noted that the mutual funds in question entered directly into selling agreements with unaffiliated brokers and would rely upon independent sources for advertising.

The Fed Board also relied upon commitments by Lloyds that it would not act as an underwriter of the firm's shares under the federal securities law, nor enter into any distribution agreement with a mutual fund or be identified as the fund's distributor in prospectuses and other sales materials. Further, Lloyds committed that neither it nor any affiliate would engage in any activity with respect to the funds that would cause it to act as a securities broker under federal law or receive any transaction- based compensation in connection with mutual fund sales.

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