Several banks are preparing to convert assets from common trust funds to proprietary mutual funds, indicating that a trend that began in 1996 is likely to continue unabated.

First Tennessee National Corp. and Colorado State Bank and Trust are both scheduled to convert assets from personal common trust funds to retail mutual funds today.

And Union Bank of California plans to convert $1.2 billion of common trust funds on April 24.

Since a change in the federal tax law in August 1996, converting personal trust assets held in common funds to mutual funds does not result in a capital gain. Before, trustees that converted the assets incurred additional taxes for their clients.

Several banks, large and small, made conversions last year. According to the Investment Company Institute, $18.1 billion of assets moved from common trusts to mutual funds in 1997.

"There are more coming," said David Huber, president of the fund services division of Bisys Group, based in Little Falls, N.J. Three-fourths of Bisys' trust department clients already converted, and most of the rest will do so this year.

Memphis-based First Tennessee is moving about $750 million of trust assets into its proprietary First Funds. After the conversion, more than $1.5 billion of assets will be managed in the bank's First Funds.

"We felt it is a superior form of investment," said Kelton Morris, executive vice president of the trust division. The First Funds "have daily values, liquidity, portability-the things mutual funds have that frankly aren't there with common trust funds."

The remainder of the bank's $6.5 billion in trust assets are in separate accounts.

Another trustee, however, suffered a setback when making the switch.

First Chicago NDB Corp., which converted $60 million of common trust funds into proprietary mutual funds last year, was sued last month by beneficiaries who claim that an earlier conversion cost them more in management fees and taxes. In 1995, First Chicago Corp. converted $1.3 billion of personal trust assets.

The plaintiffs contend that the conversion benefited the bank, not its personal trust clients.

"The banks need a critical mass to make these mutual funds work. That's really their motivation," said Jonah Orlofsky, a partner at Plotkin, Jacobs & Orlofsky, a Chicago law firm. "The most fundamental, principal fiduciary obligation is to act solely in the interest of your beneficiary-not in your interest."

Many proprietary mutual funds at banks were seeded by the conversion of assets from employee benefits plans, which were not affected by capital gains tax.

Mr. Huber said that Bisys has advised its trust department clients they have nothing to worry about if they follow "appropriate process and procedure." He said that would include notification, documentation of their thought process, and tax and legal opinions.

Several bankers maintain that mutual funds are better for clients than common trust funds.

Union Bank of California had a task force that included internal and external legal counsel, to "make sure this was something that was fair and beneficial to our clients," said Greg Knopf, managing director of its Highmark Funds. The bank's 16 proprietary Highmark mutual funds have about $6.3 billion under management.

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