In the Media

In the News

A Radical Act at the SEC?
By Carol E. Curtis
SECURITIES INDUSTRY NEWS
October 2, 2006

Sources tell Securities Industry News that Securities and Exchange Commission chairman Christopher Cox may be preparing the obituary for the mutual fund independent chairman rule, a centerpiece of the fund reform agenda that he inherited from his predecessor, William Donaldson.

As matters currently stand, if the SEC does nothing, the fund governance rule--which requires that the chairman of a mutual fund board and at least 75 percent of board members be independent from fund management--is in a state of suspended animation. "[The rule] is dead unless someone revives it," confirms John Nester, director of the SEC's office of public affairs.

When the U.S. Court of Appeals for the District of Columbia Circuit sent the rule back to the agency for further review in April, the court concluded that the SEC violated the Administrative Procedures Act by not affording enough time for public comment on the cost of complying with the rule. However, the court withheld for 90 days its order that the rule be vacated, giving the agency time to return and submit a proper justification.

On June 13, the SEC said it was putting the rule out for comment once again, and since the Aug. 21 deadline passed, the agency has been faced with three options. It can take no action, in which case the rule remains dead; it can vote on whether to adopt the rule as written; or it can vote on a modified version of the rule, taking into account the latest round of comments.

Insiders are betting on no action, in effect letting the rule die. "It will be way easier for Cox to let this die than getting any compromise in place, because [SEC commissioner] Paul Atkins is going to the mat on this," says one former SEC official with an inside track to the commission's thinking.

Reaction to Scandal

The fund governance rule, as initially approved by the SEC in June 2004, remains a critical component of the SEC's reform efforts. It was part of a package of reforms in response to a series of scandals involving late trading, market timing, directed brokerage and selective disclosure that rocked the fund industry beginning in 2003. "The independent chair rule is the capstone of our series of fund governance reforms that will help foster a culture ... based on transparency, arm's length dealing and, above all, protection of investors," said William Donaldson at a June 29, 2005 SEC meeting, the day before he officially stepped down.

The fund governance rule came before the SEC that day as the result of a court challenge brought by the U.S. Chamber of Commerce. The D.C. appeals court had decided to remand the rule to the commission for further consideration of certain potential costs and possible alternatives. In one of his final acts, Donaldson brought the rule up for a vote for a second time, where it passed 3-2, with Donaldson siding with the two Democrats against Republicans Paul Atkins and Cynthia Glassman, who has since left the commission (she was replaced in July by Kathleen Casey, a former Republican staffer on Capitol Hill).

Atkins has been a steadfast and increasingly vocal opponent of the rule. As recently as June 14, he reiterated his opposition to the governance reforms in a speech to the Mutual Fund Directors Forum members roundtable in Washington. "Investors do not seem to care about the contested provisions" of the governance rule, Atkins contended. "The Court of Appeals vacated the ... rule, so the fund governance slate is wiped clean. The old rule is dead and ... we can once again consider options that preserve investor choice."

However, not all fund experts agree with Atkins' take on the likely course of events. "The SEC is neglecting its foremost mission to protect investors by letting this rule die," says Jacob Zamansky, principal at Zamansky & Associates, a securities law firm in New York that represents individual investors. "The mutual fund scandal is a prime area of abuse that the SEC is just turning a blind eye to."

The SEC has received more than 13,000 comment letters on the rule since it was proposed over two years ago, many in the past few months. Lined up in favor of the rule are hundreds of individual investors and organizations that represent them, plus some heavy hitters including Vanguard Group founder John Bogle; Rep. Michael Oxley, R-Ohio, chairman of the House Financial Services Committee and co-author of the Sarbanes-Oxley Act; and executives at major asset management institutions including Morgan Stanley Funds and American Funds. Oxley wrote that the independent chair proposal "would eradicate the self-dealing by interested, management-affiliated chairmen and its harmful effects on mutual fund shareholders." Bogle maintained that "funds are operated largely in the interests of their management companies, rather than in the interest of their shareholders. To begin to redress that imbalance, I am strongly in favor of requiring the chairman of the fund board of directors to be independent of the management company."

The Opposition

Opponents of the governance reforms include the U.S. Chamber, which brought the lawsuit; Fidelity Investments, the largest fund complex in the world; and the Investment Company Institute, the main mutual fund trade association. Fidelity's chairman and member of its founding family, Edward C. "Ned" Johnson, has argued forcefully against the policy, saying that besides limiting the discretion of the board of directors, the rule has already served the purpose of stimulating industry reform. In fact, according to a study by the Mutual Fund Directors Forum, 78 percent of fund directors are now independent, and 43 percent of funds say they have an independent chair. Still, the forum joins many others in arguing that "adding the extra layer of protection that comes with independent voices can only serve to protect the millions of investors who have placed their trust in mutual funds."

One SEC comment letter stands out above the rest. It was submitted on June 15, 2004 and signed by all seven living former chairmen of the agency: Richard C. Breeden, G. Bradford Cook, Roderick Hills, Arthur Levitt, Harvey L. Pitt, David S. Ruder and Harold M. Williams. They wrote, "An independent mutual fund board chairman would provide necessary support and direction for independent fund directors in fulfilling their duties by setting the board's agenda, controlling the conduct of meetings and enhancing meaningful dialogue with the adviser."

Donaldson cited the letter at the June 2005 meeting, where he said that "any further delay or ambiguity surrounding implementation would disadvantage not only investors, but fund boards and management companies."

But it's a different SEC now, and Donaldson, who often sided against his fellow Republicans, has been replaced by Cox, a former California Republican congressman with a pro-business reputation who is more coalition-builder than reformer. In carefully crafted statements on the rule, Cox conveys respect for the process--but not necessarily support for the reform. For example, in putting the rule out for comment again in June, Cox said, "I have every confidence that the process we are announcing today will result in mutual fund governance that both protects investors and promotes their interests."

That "process" was soliciting comments, not putting the rule itself up for a vote. On that score, the die may well have been cast. As one source points out, at least one SEC member, Atkins, is willing to go to great lengths to defeat it, and strong support seems lacking.

There is one caveat--a possible political factor. With Donaldson having joined the ranks of former SEC chiefs who are solidly behind the proposal, Cox looks like an odd man out. "Cox should reconsider," says Zamansky. "By virtue of doing nothing, he is committing a radical act."