A lawyer for Virginia state Sen. Peter K. Babalas, one of the legislature's senior Democrats, told an ethics commission today that it is a "total impossibility" that the $3,000 the Norfolk Democrat received from a now-bankrupt second-mortgage firm was to pay him for killing legislation that would have placed the industry under state regulations.

The legislation, which would have placed a 10 percent cap on interest rates charged by second-mortgage firms, died in the Senate Commerce Committee on Feb. 11 by a vote of 7 to 5, with Babalas casting his own vote and two proxy votes against it.

Three days later, according to records disclosed this month, officials of Landbank Equity Corp. of Virginia Beach authorized the $3,000 payment to Babalas' law firm. A voucher initialed by Landbank officials filed in the bankruptcy case reads: "This was one we agreed to pay after he stopped legislation in Richmond."

"What that notation is all about can only be addressed by speculation . . . and speculation by this panel is not called for," Babalas' lawyer, Wayne Lustig, told the Senate's Advisory Ethics Commission today.

Lustig said Babalas had been paid by Landbank only for his legal work for the firm and that the legislator had billed Landbank for $3,000 for that work in December 1984.

Babalas' role as the firm's lawyer was proper and permitted both by the legislature and the state's conflict-of-interest laws, Lustig said.

"There have been suggestions, principally through the media, that the $3,000 retainer billed on Dec. 12, 1984, related to his vote on Feb. 11, 1985," Lustig said. Such a conclusion is a "total impossibility, based on this record . . . even by innuendo."

Until its collapse three months ago, Landbank was one of the largest second-mortgage companies on the East Coast. Babalas, the fourth-ranking member in seniority in the state Senate, served as its legal counsel, and his role in the firm and in the legislature has become a major issue in the bankruptcy proceedings.

The payment notation on the Landbank voucher was initialed "TCL," and a handwritten "OK" on it carried the initials "MLR." Lustig said that affidavits had been submitted to the ethics panel by Marika Lody Runnells, president and an owner of Landbank, and T.C. Lea Jr., a vice president, but they were not made public today.

There was "never any discussion [by either Runnells or Lea] with Sen. Babalas about the bill," Lustig said.

Bankruptcy Court records show that Babalas received a total of $61,480 in legal fees from Landmark, most of them while serving as Landbank's general counsel and as a member of the legislative subcommittee responsible for rewriting Virginia's interest rate laws.

Babalas sat stoically through today's 75-minute public hearing and did not speak. He submitted an affidavit to the commission detailing his defense.

Afterward, in answer to a reporter's question, Babalas said he did not believe he violated either the "letter or the spirit" of the conflict act. He has maintained he acted properly and asked for today's hearing, saying it would clear him of any allegations of wrongdoing.

The three-member panel, composed of two former governors and a retired judge, said it will make public its decision, and release all of the documents submitted in the investigation, after private deliberations that began immediately after the hearing.

It is the first Senate test of Virginia's Comprehensive Conflict of Interests Act, which took effect July 1, 1984, and affects legislators as well as other officials. "We are breaking new ground here," said the panel's chairman, Rayner Snead, a retired Rappahannock Circuit Court judge.

If the panel finds that Babalas willfully violated the act, it could recommend that he be prosecuted by the state attorney general. If it finds Babalas' action constituted an unwillful violation, his penalty would be determined by the Senate Privileges and Elections Committee.

After hearing the Babalas defense, Snead said he had "some feelings" about a need to tighten the regulation, but said he didn't know if his panel "will deal with that."

Although they gave no indication of how they might vote, all three panel member -- Snead and former governors Linwood Holton and Albertis S. Harrison -- sharply questioned Babalas' attorneys on why he felt no need to disqualify himself from voting on the mortgage regulation. Legislative rules prohibit legislators from voting on issues in which they have a personal interest.

"He Babalas had no interest in Landbank, but admittedly he had an interest in his professional corporation law firm ," Lustig said. "The law does not make it clear that lawyer fees are personal interest."

Lustig contended that Babalas was free to vote on the legislation because it applied to the more than 40 second-mortgage lenders in the state, rather than to a specific institution.

Further, Lustig said, "every single time" there was a discussion of the legislation, Babalas told his Senate colleagues: "I represent second mortgage companies."

"Suppose he did disclose and disclose and disclose," Holton said. "How would that affect the requirement that he disqualify himself?"

"Surely he didn't go into details of his representation sufficiently for other members of the committee to advise him, did he?" Snead asked. "Did he expect the committee to advise him?"

Lustig said Babalas did not.

Snead said that if Babalas were exercising "an abundance of caution, he would abstain."

"If he thought there were a conflict, yes," answered Lustig.

"Do you think there was any obligation on the part of the senator to disclose the depth of his involvement?" asked Harrison. Again, Lustig said no.

Babalas' other lawyer, R.D. (Bob) McIlwaine III of Petersburg, said there was no difference between what Babalas did and the "perfectly permissible" actions by lawyer-legislators with bank clients who voted for interstate banking "with utter serenity of spirit."

Holton responded, "I don't accept your analogy. I'm not interested in that banking legislation.