A U.S. district judge overruled the Federal Reserve Board yesterday and said that Bankers Trust Co., the big New York institution, is engaged in underwriting when it sells short-term securities on behalf of clients, and is prohibited from doing so under federal law.
Judge Joyce Hens Green said that Bankers Trust violated the 53-year-old Glass-Steagall Act that was "designed to preserve the integrity of the commercial banking industry by eliminating the potential conflicts of interest that arise when banks act as promoters of specific securities."
Bankers Trust, which has been selling commercial paper for clients since 1978, was challenged by the Securities Industry Association, a trade group of brokers and dealers.
The case already has been to the Supreme Court, which ruled in 1984 that commercial paper -- essentially short-term IOUs issued by companies to raise cash -- were securities under the terms of federal law. But the court made no decision on whether Bankers Trust was engaged in underwriting when it acted as agent in selling commercial paper on behalf of customers.
When a company engages in underwriting, it agrees to sell securities to the public for a fee. Most of the time the underwriter buys the securities from the issuing company and assumes the risk that they can be resold and at a price high enough that the underwriter will make a profit.
Bankers Trust was engaged in "best-efforts" underwriting, trying to sell commercial paper for its clients but assuming no risks that the commercial paper could not be sold.
After the Supreme Court remanded the case to the District Court, Judge Green asked the Federal Reserve, which regulates the activities of companies that own banks, to decide whether Bankers Trust was engaged in underwriting. The Fed said that it was not. Judge Green yesterday said the Federal Reserve was wrong.
A spokesman for Bankers Trust said the decision was "not consistent with the facts" and said the bank company would appeal Green's decision to the U.S. Circuit Court of Appeals for the District of Columbia. In the interim, the spokesman said, Bankers Trust would continue to sell commercial paper for its clients.
He said there is about $3 billion of outstanding commercial paper sold by Bankers Trust. All told, there is more than $200 billion of commercial paper outstanding, the bank spokesman said.
Bankers Trust has about 50 customers that use the bank as an agent in placing their commercial paper with buyers.
Bank companies long have sold their own commercial paper to raise short-term cash, and their ability to do so was not at issue in this case.