The U.S. Appeals Court for the District of Columbia today struck down an SEC rule requiring that 75% of mutual fund boards be made up of independent directors, up from 50%, and that board chairmen also be independent. The rule, adopted a year ago in an effort to curb sales and trading abuses, required mutual funds to comply by Jan. 6, 2006, said John D. Heine, SEC spokesman. The U.S. Chamber of Commerce had sued the SEC to ask for the court's review of the rule.
Chief Judge Douglas Ginsburg, writing for the court, agreed with the chamber that the SEC violated the Administrative Procedure Act "by failing adequately to consider the costs mutual funds would incur in order to comply" with the rule and for "failing adequately to consider a proposed alternative to the independent chairman condition." Mr. Ginsburg noted that "the commission did not exceed its statutory authority in adopting the two conditions, and the commission's rationales for the two conditions satisfy the APA."
The SEC should have considered an alternative to the independent chairman requirement, endorsed by two dissenting commissioners, "that each fund be required prominently to disclose whether it has an inside or an independent chairman and thereby allow investors to make an informed choice," Mr. Ginsburg wrote. The court ordered the SEC to "to address the deficiencies" in regard to the 75% independent director and the independent chairman provisions.
"We applaud the court's decision to stop regulatory overreach by the SEC," Stephen A. Bokat, executive vice president of the chamber's National Chamber Litigation Center, said in a statement. "Regulatory agencies must give serious consideration to public comments during rule makings and cannot ignore important information about the costs — and the consequences — of their rules."
The SEC's Mr. Heine said: "We are pleased that the court determined the commission acted within its authority and that the SEC rationale satisfied the requirements of the Administrative Procedure Act, and we will review how best to respond to concerns identified by the court regarding the analysis of costs and considerations of alternatives."
At Fidelity Investments, spokesman Vincent Loporchio said the mutual fund company hasn't reviewed the ruling. He noted, however, "our view is the rule limits substantial discretion of the board to exercise informed judgment to select any person of their choosing as chairman." Mr. Loporchio said he doesn't believe the 75% independent director requirement was an issue with Fidelity, noting that 71% of its mutual funds have independent directors.