WASHINGTON - House Banking Committee Chairman Jim Leach lashed out Friday at the comptroller of the currency for allowing national banks to hold commercial stock for hedging equity derivative swaps.

In a scathing letter to Comptroller John D. Hawke Jr., Rep. Leach criticized "secret verbal approvals … communicated by bank examiners [that] are blatant attempts of the OCC to change the regulatory framework of Gramm-Leach-Bliley and more importantly represent a usurpation of the Congress' lawmaking powers."

Rep. Leach's ire was spurred after resident examiners told at least two major institutions it is legal to own equities to hedge equity derivative swaps with customers.

An OCC spokesman defended the agency's actions, saying, "We're not allowing banks to buy equity for investment or speculative purposes," he said. "We are allowing them to hold equity securities as part of a hedge in an equities derivatives contract."

He noted that the agency's lawyers issued a memo to examiners in July that explains how this activity is incidental to the business of banking. The agency refused to release the memo. It was the Federal Reserve Board that tipped Rep. Leach off to the OCC's decision, in a move suggesting that Round 2 has begun between the two agencies.

During debate over financial reform last year, the Fed bested the OCC by persuading Congress to restrict many new activities to holding company subsidiaries. Gramm-Leach-Bliley bars banks from merchant banking, or investing in commercial companies, until at least 2004.

"What the OCC is attempting to do in its secret approval process is change the law … to get by fiat even more than what it failed to achieve in advocacy before Congress - i.e., to grant powers directly to a bank rather than its subsidiary," Rep. Leach wrote in his three-page letter.

"The fact that the Fed had to tell us undercuts the position of the comptroller," Rep. Leach said Friday. "This guidance would still be secret if Fed examiners had not discovered it in the joint examination of a bank."

But industry observers disagreed with Rep. Leach. "If what they are actually doing is hedging equity swap positions, I don't see that this is merchant banking," said Hal S. Scott, a professor at Harvard School of Law who has testified before Congress on swaps regulations. "They will presumably be liquidating these positions as they liquidate the swaps."

John C. Dugan, partner with the Covington & Burling law firm in Washington, said: "Merchant banking doesn't have anything to do with a passive investment in a tiny percentage of shares of a company that is made for hedging purposes."

According to OCC data, U.S. commercial banks held swaps with $20.9 trillion in notional value on June 30. About 92% were executed by four banks: Chase Manhattan Bank, Morgan Guaranty Trust Co., Bank of America, and Citibank. Of the four, only Bank of America and Citibank are regulated by the OCC.

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