WASHINGTON -- House Banking Committee leaders may propose overhauling a suitability provision in their pending derivatives bill when a subcommittee votes on the measure next week, congressional aides said yesterday.

The bill, which was introduced in May by Rep. Henry Gonzalez, D-Tex., the committee chairman, and Rep. Jim Leach, R-Iowa, the committee's ranking Republican, calls for federal regulators to establish comprehensive and consistent standards for the derivatives activities of banks, federal credit unions, and government-sponsored housing agencies.

It is scheduled to be voted on next Wednesday by the Banking Committee's subcommittee on financial institutions supervision, regulation, and deposit insurance, which is chaired by Rep. Stephen Neal, D-N.C., a co-sponsor of the measure.

Sponsors of the bill are expected later this week to consider possible amendments to the measure, including one that would modify the suitability provision so that it is more in line with guidance issued by bank regulators and focuses on dealers rather than investors, the aides said.

The aides stressed that no decisions have been made yet on any possible amendments.

The bill currently calls for federal regulators to establish "suitability" standards that provide "assurance that a financial institution does not recommend or engage in derivative activities that the institution knows, or has reason to believe, would be inappropriate for the customer."

Derivatives market participants and bank regulators wince at the bill's use of the term "suitability" and complain that suitability standards are inappropriate for derivatives dealers.

Suitability standards, they say, have been imposed by the National Association of Securities Dealers to protect retail investors from unscrupulous dealers who try to sell them unsuitable financial products.

Such standards are inappropriate for derivatives, they say, because most transactions involve institutional rather than retail investors.

Bank officials worry also that suitability standards would prompt customers to sue them whenever they suffer derivatives-related losses.

Bank regulators say they specifically refrained from imposing suitability standards on banks' derivatives activities.

Instead, they say they adopted an "appropriateness standard" that is geared more toward protecting the dealer than the investor.

The Office of the Comptroller of the Currency, for example, issued guidance earlier this year calling for banks to determine if a derivatives transaction is consistent with the counterparty's derivatives policies and procedures, to the extent the bank is familiar with those policies and procedures.

The aim of the standard, an official with the comptroller's office says, is to try to ensure that a derivatives dealer only engages in derivatives transactions with investors that both have the authority to enter into them and understand the risks.

The appropriateness standard does not require a bank dealer to conduct an investigation of the counterparty's derivatives policies and procedures, the official says.

The Treasury's Office of Thrift Supervision, in a recent letter to Neal, suggested that the bill's suitability provision "should be altered to focus on the appropriateness of the derivatives activity for the financial institutions engaging in the activity, rather than on customer protection."

The International Swaps and Derivatives Association, the Public Securities Association, and seven other financial trade groups told Neal in a recent letter that the bill's suitability provision imposes "customer suitability standards on banks and their affiliates" that are "unnecessary and inappropriate."

The suitability provision, they said, "is fundamentally different than existing regulation" and tougher than guidance issued by the comptroller's office "because it would require a bank to make decisions for its customers."

It "would subject banks and their affiliates to heightened compliance costs and likely lead to frivolous litigation," the groups said.

The nine groups said they strongly oppose the derivatives bill proposed by. Gonzalez and Leach because it "will reduce the availability and increase the costs of important risk management transactions involving derivatives.

"The bill would also unnecessarily reduce the flexibility of financial supervisors who have testified on many occasions that they already have and are using the powers they need," the groups said.

They said the bill is "flawed in significant respects."

The groups complained, for example, that the bill's definition of a derivative "may be broader than generally realized" because it appears to include repurchase agreements and mortgage-backed securities.

"The effects of the bill on these markets have not been studied and are not fully understood," the groups said.

The bill's definition of a financial institution may also be overly broad because it appears to include banks and bank affiliates whether or not they have the benefits of federal insurance.

"The breadth of this definition would subject a variety of institutions to federal banking regulation that are not subject to that regulation today," they said.

Banking committee aides say they believe the derivatives bill and possible amendments will be adopted by the subcommittee next week with possible amendments.

But there is little chance the bill will go much further this year because so little time remains in this session and the committee's plate is already full. In addition, Rep. John Dingell, D-Mich., and other members of Congress would probably want to weigh in on any derivatives legislation, and there is no comparable measure pending in the Senate, the aides said.

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