Brooklyn Law Prof Blasts Indy Chair Rule

By pushing through its controversial independent chairman rule in the final hours of former chairman William H. Donaldson's tenure last month, the Securities and Exchange Commission jeopardized its power going forward, according to a leading law scholar.

The U.S. Chamber of Commerce has filed two lawsuits against the SEC over the rule. In the first suit, the Chamber argued that the SEC overstepped its authority by ordering the rule, which calls for mutual funds to have boards composed of 75% independent directors and a chairman of the board who is an independent director. The courts ruled in favor of the SEC, but also found that it didn't conduct sufficient cost/benefit analysis and ordered the regulator to further examine whether the governance benefits of the rule truly outweighed the costs mutual fund companies would have to bear.

But just a few days after the court order was issued, Donaldson called an eleventh hour meeting of the commission and pushed the rule into effect by a 3-2 vote, despite strong objections from republican commissioners Cynthia A. Glassman and Paul S. Atkins. The Chamber followed suit a second time, claiming that the SEC acted without fulfilling the court's cost/benefit analysis. Arguments in that case will be heard this fall, but in the meantime the Chamber won a stay delaying the rule's enactment. 

In the Aug. 18 issue of the New York Law Review, Brooklyn Law School Professor and former SEC Commissioner Roberta S. Karmel argues that even if the court upholds the rule as a legal matter, "by acting in such a political manner, the Commission majority exhibited disrespect for the minority commissioners and for legal process, which can only weaken the agency over time."

Karmel further argues in the opinion that the court's decision that the SEC acted within its authority by crafting such a rule is "troubling," because it suggests that the regulator can intrude upon the business of an investment company "based on some notion, however fanciful, that a new rule will guard against some conflict of interest." And besides, Karmel notes, a conflict of interest is not in violation of the law.

"Mutual funds and the securities industry generally are rife with conflicts of interest because funds and other securities firms are intermediaries between parties with opposing interests," she said.

Mutual fund investors, Karmel adds, are seeking honest, competent and professional management, "not some ideologically pure corporate structure." In its zeal to pass the independent chairman rule, the SEC "made no effort to study the track record" of companies with such structures. And such a "penchant for command and control regulation of investment companies, as opposed to reliance on disclosure of fund governance structures and conflicts of interest," is likely a major factor driving mutual fund investors into hedge funds.