The troubles faced by one upstate New York bank underscore some of the difficulties that small banks can encounter in managing mutual funds.

Last November, Canandaigua (N.Y.) National Bank and Trust Co. ran afoul of the Securities and Exchange Commission when the regulator found discrepancies in its mutual fund accounting.

The accounting errors, revealed in Canandaigua's 1994 annual report, shortchanged shareholders in the bank's mutual fund family by $6,212. The bank's funds, a bond and an equity portfolio, are marketed solely to qualified retirement plans and do not have individual investors, bank officials said.

The bank also broke SEC regulations by investing the fund family's idle cash in an outside mutual fund and by putting more than 5% of its total bond portfolio in a single investment.

Shareholders have been reimbursed for the loss, bank officials said.

Canandaigua, with $317 million of assets, is one of the smallest banks managing its own mutual funds. The bank's total mutual fund assets at the end of 1994 stood at $6.3 million, ranking 113th of the 115 bank-managed mutual fund families, as tracked by Lipper Analytical Services for American Banker.

While the total lost due to management and accounting errors was small, some experts say the problems are fundamental and reveal a lack of expertise on the part of many small banks in money management.

"Those were basic (fund management) procedures that should have been followed to a T," said Glen Casey, a consultant at Cerulli Associates, Boston.

Unlike Canandaigua, which does all of its accounting in-house, many small banks leave their accounting work to outside firms that specialize in mutual funds "because it has the highest potential for shareholder impact and therefore the greatest liability," Mr. Casey said.

To be sure, Canandaigua isn't the only fund manager to have accounting problems. Mutual fund giant Fidelity Investments miscalculated the shareholder dividend for its Magellan Fund last year, forcing the company to send out revised yearend statements to investors.

But small banks do face particular problems in gathering the top-notch talent to manage funds. That's because of the competitive pressures put on banks and their funds' often slow movement toward achieving critical mass, bankers said.

"It's expensive to run these funds, and until you get to critical mass, it can be very difficult to manage," said Thomas K. O'Brien, a vice president at Sunburst Bank, Grenada, Miss.

Sunburst, which launched a single bond fund last August, is seeking permission from shareholders and regulators to get out of the mutual fund business by merging the bond fund with a similar portfolio run by Federated Investors, a financial services company based in Pittsburgh.

Mr. O'Brien blamed bad market timing for the hasty departure but acknowledged that, with more resources, the bank-run fund might have done better.

Des Moines banker Darrell H. Wright says that "for a smaller bank, it's harder to get the expertise to be in this business."

Mr. Wright, who helps manage Brenton Bank's four mutual funds, said it's essential for banks to partner with outside companies. Brenton uses Bisys Group, Little Falls, N.J., for accounting and shareholder servicing - areas in which the bank lacked expertise.

"We could not see staffing up in an area we knew nothing about," Mr. Wright said. "There's not much in the bank environment that can prepare you for the mutual fund business."

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