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Federal regulators issued a blunt warning Monday to the banking industry: Think twice before propping up troubled hedge funds and mutual funds even if they share the bank’s name. “Banks are under no statutory requirement to provide financial support to the funds they advise,” said the Federal Reserve and the other three agencies that oversee the banking industry. The guidance Monday comes as prosecutors attack the mutual fund industry for allowing after-market trading by select customers and as the Securities and Exchange Commission weighs a registration requirement on hedge fund managers in response to a series of scandals, including the collapse of several funds. Regulators worry that banks will use their capital to prevent the failure of mutual and hedge funds that share their name, said banking consultant Bert Ely of Ely & Co. in Alexandria, Va. Using capital in this manner could threaten a financial institution’s viability, Ely said. “The concern is that they don’t want banks pumping money down a rat hole,” he said. “That may cause the bank to fail.” That worry is justified, said Gilbert Schwartz, a partner at Washington law firm Schwartz & Ballen. Historically, regulators were so concerned banks would use their capital to bail out failing mutual funds that for many years they barred mutual funds from sharing the same name as the bank, Schwartz said. While that rule was repealed in the 1990s, regulators remain uncomfortable with the close ties and have established numerous restrictions, including a requirement that banks extend credit at market rates to affiliates. A spokesman for the Office of the Comptroller of the Currency said the agencies first considered a policy statement during the year 2000 computer crisis. The agencies worry that banks would try to save their mutual funds if computer problems caused the financial markets to plunge in the new millennium. The issue came up again during the California power crisis and during the recent mutual fund scandal, the spokesman said. “This is an issue that has been alive for quite some time,” he said. The three-page policy paper demands that banks notify their regulators before extending financial support to funds they advise. Only in an emergency should the bank proceed without first contacting the government. The agencies said banks should establish alternatives sources for emergency credit for funds they advise, such as from other nonbank subsidiaries or from the parent company. Banks also should have procedures requiring bank directors to approve the financial support and establish controls to limit the situations in which an advised fund would seek financial support. Finally, the Fed, OCC, Federal Deposit Insurance Corp. and Office of Thrift Supervision reminded banks that advertising must warn that mutual funds are not guaranteed by the bank and not covered by federal deposit insurance. Copyright �2003 TDD, LLC. All rights reserved.

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