SEC Reaffirms Independent Fund Oversight

Refusing to back down, a divided Securities and Exchange Commission on Wednesday passed for the second time a rule requiring independent stewardship of the nation’s mutual funds -- just one week after an appeals court had ordered the agency to reconsider the measure.

The SEC’s swift answer to the court came over the objections of business groups and was among the final official actions of Chairman William H. Donaldson, who is leaving the commission today after a tenure that earned respect from shareholder activists but angered industry lobbyists who viewed him as an overly zealous regulator.

“I think at this point, after 2 1/2 years, we’ve accomplished a lot,” Donaldson told reporters after the sometimes heated session. “There’s a lot that still needs to be done.”

Donaldson called the rule approved on a 3-2 vote Wednesday “the capstone” in a series of mutual fund reforms prompted by revelations of widespread trading abuses in 2003.

The rule requires mutual funds to have chairmen who are free of business ties to the fund company, and 75% of a fund’s directors must be similarly independent. It was originally approved last year over the objections of the U.S. Chamber of Commerce and other groups.

On June 21, the U.S. Court of Appeals for the District of Columbia Circuit affirmed that the SEC had the authority to pass the rule, but ordered regulators to review its potential costs and to consider the alternative measure of disclosing a fund chairman’s potential conflicts of interest.

The Chamber of Commerce asserted Wednesday that the SEC had defied the appellate court by failing to seriously examine the financial ramifications of the rule. The group vowed to continue its legal challenge.

“After a seven-day secret process, the SEC has recklessly readopted its flawed rule,” Thomas Donohue, the chamber’s president, said in a statement. “This attempt to circumvent our legal and regulatory process will not stand up in court.”

Donaldson, however, maintained that the SEC had already gathered the required information before it first passed the rule last year.

“I have the greatest respect for the court,” Donaldson said after the meeting. “Without question, we had the facts.”

The flap comes at a pivotal moment for the commission, which oversees the nation’s securities markets.

The White House has nominated Rep. Christopher Cox (R-Newport Beach) to succeed Donaldson, although his confirmation hearing has not yet been scheduled. Meanwhile, Democrat Harvey J. Goldschmid plans to leave the SEC this summer, and the term of Democrat Roel C. Campos is ending.

The Bush administration has not revealed whether it will go along with Democrats’ wishes to renominate Campos and name SEC staffer Annette Nazareth, a Goldschmid protege, to fill his seat.

Donaldson, a Republican appointee of President Bush, became controversial in some GOP and business circles for siding with Goldschmid and Campos on several high-profile votes, including the mutual fund independence rule.

The outgoing chairman said he had “no concern about Congressman Cox.” Donaldson said his goal for the mutual fund rules was to take “a 90-million-person investment vehicle and make it so it can grow as it should grow. Clearly, I would hope that Congressman Cox will agree with that.”

Critics of the mutual fund rule Wednesday accused Donaldson of rushing it through while the three-member majority remained in place.

Republican Commissioner Paul S. Atkins held up a multicolored poster of a timeline starting with the June 21 court ruling, mockingly titled “SEC’s Race to Beat the Clock.”

“The ink on the court’s opinion was not even dry when the die was cast for today’s preordained result,” Atkins said.

Critics also said the SEC should have solicited more public comment and further evidence to adequately meet the court’s demand.

“Today’s action is nothing more than window dressing,” Republican Commissioner Cynthia A. Glassman said. She added, “It strains all credibility to believe that the commission has mystically within the past week been able to conclusively estimate costs associated with the rule.”

When the SEC first passed the rule in July, Donaldson and others maintained that it would help reduce a conflict of interest now faced by board members of fund companies -- that is, the pressure to put the profits of the fund company ahead of the best interests of fund shareholders.

Making the fund company chairman independent was considered especially important because the chairman has the power to set the agenda at board meetings.

The U.S. Chamber of Commerce filed suit soon after the measure was passed, alleging that the SEC had overreached its regulatory authority and failed to consider sufficiently the costs and consequences of such a requirement.

The recent appeals court decision seemed to offer something to both sides, remanding the rule on certain technical grounds but affirming the SEC’s authority.

After a quick review, the SEC determined that it had all the cost information it needed on hand because of the initial rule-making effort.

In addition, its staff once again considered -- and rejected -- the notion that disclosure of potential conflicts of interest was a strong enough measure to safeguard the interests of mutual fund shareholders.

Eight in 10 of the nation’s mutual funds use insiders as chairmen and would have to replace them under the SEC rule. The requirement that 75% of board members be independent is an increase from the current 50%.

“The judgment was that costs were infinitesimal” in the context of an $8-trillion industry, Donaldson told reporters. “Costs were not important.”

But critics disputed that conclusion. Stephen Bokat, senior vice president and general counsel at the U.S. Chamber of Commerce, said it made no sense to compare compliance costs with the amount of money in mutual funds because that approach told nothing about the effect on particular funds.

“To me, it’s like comparing apples and oranges,” he said.

Atkins said the SEC should have conducted a survey of investment companies to learn about the real world costs of adding independent directors and sought further evidence.

But Donaldson maintained that action was preferable to further delay.

“Our failure to act would, I fear, throw the future of this rule making into an uncertain limbo until a new chairman is confirmed,” he said. “Today, however, we have intact the full complement of commissioners who have spent the last year and a half thinking about the issues raised in this rule making.”

Goldschmid accused the Republican dissidents of “crocodile tears” in their complaints about the SEC rule making.

“If we are wrong about being fully responsive, the court will certainly tell us so,” he said.

“But if we are right, we will have ensured an enormously better day for mutual fund shareholders.”