WASHINGTON - In a decision that threatens two future sources of fee income for banks, a federal appeals court ruled that states can regulate bank insurance sales.

The U.S. Court of Appeals for the 11th Circuit, acting in a case involving Florida's Barnett Banks Inc., dismissed banking industry arguments that the National Bank Act supersedes state insurance law.

Instead, Judge Peter T. Fay wrote for a unanimous three-judge panel, the McCarran-Ferguson Act overrides other federal laws and gives states the right to regulate bank insurance sales.

The court said Florida, which allows independent state-chartered banks to sell insurance, can deny insurance licenses to national banks.

The decision, which affirmed the trial court's ruling, allows the Florida Department of Insurance to force Barnett to divest an insurance agency it bought in October 1993.

"Obviously, we are disappointed," Barnett spokesman David Palombi said. "Our position had been that we felt insurance sales were a natural extension of our product line, and that banks have a right to sell them."

Insurance advocates were elated. "It is great news for us," said Ann K. Kappler, an attorney who represents several national insurance groups. "In our view it is a confirmation that it is the states who regulate insurance."

"This ruling is a clear message that national banks shouldn't have special treatment," Independent Insurance Association of America spokesman Jeff Myers said.

The judges concluded that Section 92 of the bank act couldn't relate to insurance sales because Congress didn't believe it could regulate that industry when it passed the law in 1868.

Julie Williams, chief counsel to the Comptroller, said the court's argument doesn't make sense because Section 92 specifically mentions insurance sales in small towns.

"Unfortunately it . . . puts impediments in banks delivering the kinds of products that customers want to get," Ms. Williams said.

Banking lawyers said the eight-page decision also may allow states to ban annuity sales, despite last month's Supreme Court decision in NationsBank v. Valic.

Melanie Fein, a partner at Arnold & Porter, said the judicial panel left open the possibility that states could deem annuities as insurance for regulatory purposes. Under the Barnett decision, that means a state could regulate, and thus ban, bank annuity sales, she said.

"We could have won the battle in Valic, but lost the war if hostile states could prohibit the activity somehow," said David Roderer, a partner at Winston & Strawn.

"It is a whole other can of worms," he added.

The Barnett ruling is the second federal appeals court decision governing bank insurance sales. In the other case, involving Owensboro National Bank in Kentucky, the U.S. Court of Appeals for the Sixth Circuit said states cannot regulate bank insurance sales.

This split between the courts means the U.S. Supreme Court must step in and resolve the issue, said Tom Cardwell, outside counsel to the Florida Bankers Association.

But a Supreme Court appeal takes time, often lasting for more than a year. In the meantime, bankers will have to accept that the law is in flux, said Michael F. Crotty, the ABA's deputy general counsel.

"They can't know what's what at the moment," Mr. Crotty said. "It still needs to play itself out."

Michael D. White, president of the Financial Institutions Insurance Association, said bankers should see this as part of a broader battle between banks and insurers.

"It is a lot of time and money," Mr. White said of the battle. "It is a lot of wasted effort. Decisions like this run contrary to all the modernization efforts in all the industrialized nations of the world. It is unfortunate."

Bankers at some of the larger institutions said they were disappointed that the case may cut off a promising avenue of fee income.

"Yes, it is worrisome," Banc One Insurance Group President Glen J. Mikesko said. "But, there isn't any finality to any one case."

"It was an opportunity we hoped would be upheld," agreed Chase Manhattan Bank vice president Dennis Toivonen. "It had the potential to allow us to market all types of insurance in states where we presently cannot."

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