Oct. 31 (Bloomberg) -- House Financial Services Committee Chairman Barney Frank said banks using cash from the $700 billion U.S. rescue plan for bonuses, acquisitions and other purposes unrelated to lending are in ``violation'' of the law.

``I am deeply disappointed that a number of financial institutions are distorting the legislation,'' Frank, a Massachusetts Democrat, said in a statement today. ``Any use of these funds for any purpose other than lending -- for bonuses, for severance pay, for dividends, for acquisitions of other institutions, etc. -- is a violation of the terms of the act.''

Lawmakers are faulting Treasury Secretary Henry Paulson for letting financial institutions use the $250 billion set aside to buy banks' preferred shares to make acquisitions. PNC Financial Services Group Inc. agreed to buy Cleveland-based National City Corp. on Oct. 24 after getting $7.7 billion from the government.

Senator Sherrod Brown, an Ohio Democrat, urged Paulson yesterday to ``insist that participants in the capital-purchase program not use taxpayer dollars to buy healthy banks.''

Year-end bonus payments at nine banks that received $125 billion from the U.S. are being investigated by House Oversight and Government Reform Committee Chairman Henry Waxman and New York Attorney General Andrew Cuomo, who are demanding details on compensation plans. Goldman Sachs Group Inc., Morgan Stanley and Merrill Lynch & Co. have already set aside $20 billion to pay bonuses this year.

Frank today said Paulson ``must make it absolutely clear to any participating entity that the federal government will insist on compliance'' with the law. Frank's committee will hold hearings Nov. 12 and 18 on the response to the financial crisis.

White House Objects

``If the capital injections were used to pay for dividends, I think that is something we would object to,'' White House spokesman Tony Fratto said responding to Frank. ``What we're trying to do is to have a healthy banking industry that can get back to the business of lending.''

Odds that Wall Street will give up bonuses are ``slim to none,'' John Gutfreund, 79, president of New York-based Gutfreund & Co. and the former chief executive officer of Salomon Brothers Inc., said yesterday. ``They're going to have to be a little bit sensitive because politicians, whether they like it or not, are part of their lives now.''

Bush administration officials and lawmakers disagree over the scope of the legislation Congress passed Oct. 3 to buy toxic assets now being implemented by Treasury as a way to inject capital into banks.

`Prudent Acquisitions'

``We have to be very careful about not discouraging prudent acquisitions because that can actually help us get through this troubled time that we're in right now,'' said Neel Kashkari, the interim Treasury assistant secretary who heads the office overseeing the bailout, in congressional testimony Oct. 23.

Bankers complain that Paulson's program has strayed from its original goal: to purchase assets from financial firms to shore up their balance sheets. The Troubled Asset Relief Program is being used to buy stakes after markets deteriorated faster than policy makers anticipated.

``When you invite the government into your living room, which is what you're doing with the TARP program, I can't guarantee you they're going to be a good guest in your house,'' said Gerard Comizio, senior partner at Paul, Hastings, Janofsky & Walker LLP and former deputy counsel at the Office of Thrift Supervision. ``This program is basically a work in progress.''

The American Bankers Association, which represents institutions with more than $13 trillion in assets, said the Treasury's program is forcing banks to accept cash, in some cases where assistance is unnecessary.

``It is completely unfair to ask thousands of banks across the country -- and they are being explicitly asked by their regulators -- to participate in a program when the impact of the program on those banks is unknown,'' Ed Yingling, ABA executive director, wrote in a letter yesterday to Paulson.

ABA member banks are concerned they ``run the risk of being labeled -- falsely --as needing government support, or of appearing to be asking for a handout,'' Yingling wrote. ``This is not a program the banking industry sought.''

To contact the reporter on this story: Ian Katz in Washington at ikatz2@bloomberg.net.

Last Updated: October 31, 2008 16:54 EDT