The Federal Reserve's controversial approval last week of the Bank of Boston's application to acquire Multibank Financial Corp. has raised some important questions about how the Fed handles bank applications.

The Fed's initial denial of the application - reversed after a last-minute offer by the bank to raise new capital - has left the New England banking community baffled about the board's lack of confidence in the Bank of Boston's ability to successfully absorb two smaller companies.

"I'm surprised that the Fed would have any problems with it at all," said Robert J. Listfield, managing director of BEI Golembe, a bank consulting firm. "If I were Bank of Boston, I would not have thought this would be controversial."

The governors' rare reversal has also confused Fed watchers, who puzzle over the board's willingness to negotiate up to the last minute with Bank of Boston.

"It sets terrible precedents for future board conduct," said Robert E. Mannion, a partner at Arnold & Porter. "This potentially opens the door for other applicants to say: You allowed Bank of Boston to change their proposal - why not allow us to do the same?"

An Unusual Dissent

That three Fed governors would abstain from the final vote gives some indication of just how unusual this approval was. In an unusual display of dissent, they included a strongly worded complaint abou the process.

"We believe that it impairs the integrity of the board's decision-making process to permit an applicant to submit new information after the board has considered the record of the case and while the board is in the process of issuing its decision," wrote governors David W. Mullins, Lawrence B. Lindsey, Edward W. Kelley.

Applicants "should not have an opportunity or any incentive to attempt to negotiate each proposal with the board," they added.

Others Also Doubtful

And the three Fed governors are not alone in questioning the appropriateness of their reversal.

"It raises the question of fairness to other applicants," said Melanie L. Fein, a partner at Arnold & Porter. "And it does raise a question of, going forward, what is the board's procedure going to be?"

Several factors made the Bank of Boston application a particularly sticky process for both the bank and the Fed.

They included: the bank's submission of two expansion applications in quick succession, differences of opinion between the Boston Fed and the Washington staff, the bank's reluctance to heed warnings that their capital may be inadequate for board approval, and a leak of the decision before it was made public by the Fed.

On June 1, the Fed's board of governors took up Bank of Boston's application to acquire Multibank Financial. Facing contrary recommendations from the Boston Fed and the board's Washington staff,- with the Boston Fed recommending to approve the merger - the governors voted to deny the application.

Capital Looked Thin

They feard that Bank of Boston did not have enough capital to successfully absorb both Multibank and Society for Savings Bancorp, another institution the bank wanted to buy.

Board policy bars staff from notifying bank officials or anyone else of the decision until the Fed publishes the order. But in the week that the staff was drafting the order describing the denial, Bank of Boston learned of problems and approached the Fed staff with a last-minute proposal to raise new capital.

Meeting a second time, the Fed governors debated at length whether to review Bank of Boston's new proposal. Because the bank had already been warned of likely concern from the board about insufficient capital, and rebuffed suggestions that they propose raising more, sources said, several governors were angered at the bank's last-minute bargaining.

A Matter of Propriety

Some governors worried that the bank was negotiating inappropriately with the board, trying to get the best deal possible.

Such dealmaking would jeopardize the integrity of the applications process, they argued. The Fed rarely allows applicants to change their proposals once they reach the boardroom, unless governors raise problems the staff has missed.

The governors' debate came down to a vote on whether to consider the new bid at all, which passed. And in considering Bank of Boston's proposal to raise $170 million in capital, the governors unanimously agreed that the offer was sufficient to merit approval.

Three governors, though, abstained from the final vote, hoping their abstentions might send a stronger message than outright denials and draw attention to concerns with the process rather than the safety and soundness of Bank of Boston.

Others on the board say it is the outcome of the Fed's application review, not the process, that is important.

"I disagreed with the abstainers, who I think were more concerned with the process than substance," Governor John P. Laware said. "From a public policy point of view, the right decision was reached."

And while many observers question what the Fed will do to prevent the unusual circumstances from happening again, Fed governors are sending strong warnings against the industry construing the incident as a new era of flexible rules and negotiation.

"It would be a mistake for any observer to assume that the course of this particular transaction sets either a precedent or a change in guidelines as far as the board is concerned." Mr. LaWare said.

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