Chase Manhattan Corp., the nation's third-largest bank, will reduce pretax earnings by $60 million this year after an internal investigation found an employee overstated the value of some of the bank's trading in financial contracts known as over-the-counter derivatives, bank sources said.

The disclosure comes as the White House prepares to recommend as early as this week that the $80 trillion OTC derivatives market does not need to be regulated, in part because the banks and securities firms that create the OTC market already are regulated by the U.S. Treasury, the Federal Reserve Board, and the Securities and Exchange Commission.

Chase has fired the employee responsible for the overstated values but has not determined whether his actions were unintended mistakes or a deliberate effort to pad trade values so that his end-of-the-year bonus would be bigger, sources said.

An internal bank audit two weeks ago uncovered the inflated values on foreign exchange forward contracts and interest-rate swap contracts. The bank has reported the problem to regulators at the Federal Reserve Board, sources said.

The inflated values mean that the bank will reduce pretax earnings in the fourth quarter by $60 million before taxes, or $40 million (5 cents a share) after tax. Wall Street analysts have estimated the bank's per-share earnings in the fourth quarter will be $1.31.

The bank for the first nine months of 1999 has reported $2.2 billion in trading revenue. Sources at the bank say bank officials are confident the employee's conduct is an "isolated event" and that the reduction in earnings, while significant, will not seriously hurt the bank or its profitability.

The White House's recommendation will come in a report by the President's Working Group on Financial Markets, which has been studying derivatives of all types in the wake of the near-collapse of a giant hedge fund in Connecticut a year ago whose troubles regulators feared could cause a meltdown of the entire U.S. financial system.

The regulators will recommend that Congress formally declare that the Commodity Futures Trading Commission should not regulate these instruments, people familiar with the recommendation say. The CFTC, the SEC, the Treasury, the Federal Reserve Board and other federal financial regulators are part of the group.