Taking another step toward dismantling the Glass- Steagall Act, the Federal Reserve has proposed to scrap a rule that bars bank holding companies from sharing directors and employees with securities firms.
A key effect of the plan would be to permit bank holding companies to put their own representatives on the boards of the mutual funds they operate. Banks, which serve as investment advisers to more than $400 billion in fund assets, have long complained that this restriction puts them at a competitive disadvantage to nonbanks.
"It's one of a number of shackles that bank mutual fund complexes have to labor under and independent mutual fund companies don't," said Timothy J. Leach, president of U.S. Bancorp's Qualivest Capital Management subsidiary.
The Fed minimized the proposal's significance, approving its publication without discussion at a board meeting Wednesday. But industry lawyers described the move as another in a series the central bank has taken to gut the Glass-Steagall Act, the 1933 law that separated commercial and investment banking.
"This sends a signal that the Fed is going to move forward with Glass- Steagall reform at the regulatory level," said Melanie Fein, a partner in the Arnold & Porter law firm here.
James D. McLaughlin, director of regulatory and trust affairs at the American Bankers Association, said expanding the pool of bank fund directors to include bank investment advisers "would potentially create smoother, more efficient management of the bank mutual fund."
Section 32 of the Glass-Steagall Act bars bank directors, officers, and employees from working for a company involved in securities activities that banks are generally prohibited from conducting, such as equities underwriting.
In 1969, the Fed in its Regulation R expanded this restriction to cover bank holding company employees. Comments on the Fed's plan to eliminate this rule will be accepted through late July.
Observers said a handful of the 109 banking companies that operate mutual fund families have been able to work around Regulation R by housing their fund businesses in state-chartered bank subsidiaries that do not belong to the Fed system.
But most must heed the rule. For instance, Bisys Fund Services - which distributes 40 bank-managed fund families - said only two of its client banks currently have their own representatives on fund boards.
J. David Huber, president of the Columbus, Ohio, unit of Bisys Group Inc., predicted that many of his clients would seize the opportunity to gain a seat on fund boards if the Fed permitted it.
"Right now, senior bank management participates actively in mutual fund board meetings, and as long as things go smoothly, they're not excluded from anything," Mr. Huber said. "But there's a feeling they can influence policy and decision-making better if they're a member of the board."
The head of Banc One Corp.'s $13.5 billion-asset mutual fund family said his company would embrace "any kind of regulatory change that would allow us to approach the board the same way a nonbank would.
"If you're going to put a great amount of sponsorship and support behind a mutual fund family, it's helpful if you're not always at arm's length," said David J. Kundert, chief executive of Banc One Investment Advisers.
Experts said the change wouldn't permit banking companies to turn their mutual fund boards over to insiders. Under the Investment Company Act of 1940, at least 40% of the members of a mutual fund board must be disinterested parties, and these independent trustees have exclusive authority over some key decisions.