If the ongoing legal fracas between the U.S. Chamber of Commerce and the Securities and Exchange Commission over the controversial independent chairman rule illustrates anything, experts say, it's that the mutual fund industry has entered an entirely new era in rulemaking.
"This is the first step of a very large, mature industry," said Frank Coates, founder of Coates Analytics Group and Board Alert Systems of Conshohocken, Pa., which specializes in providing governance tools to the fund industry.
"Until recently, the mutual fund industry has been a relatively small, growth-oriented industry, and now it's this huge industry, one where nearly every American owns a mutual fund. So now it must operate like a large, mature industry, and that means having big political action committees that stand up to the regulators," said Coates, a onetime head of wholesaling at Strong Capital, who compares this debate to the perpetual courtroom wrangling between the automotive industry and environmentalists over emissions and fuel economy standards.
Coates' remarks came on the heels of yet another successful legal ploy by critics of the independent chairman rule, which demands that fund companies install an independent chairman of the board and that the board of directors itself be 75% independent, both by Jan. 16, 2006.
Opposition to the rule began earlier this spring when the Chamber filed a lawsuit against the SEC, saying the rule is overreaching and much too costly for smaller companies. The court ruled that the SEC was indeed within its jurisdiction, although it also determined that the regulator was in violation of the Administrative Procedures Act (APA) and ordered it to conduct further cost/benefit analysis.
A scant eight days later, as the rule's champion and former SEC Chairman William Donaldson approached his final hours at the helm, he used a little-known "duty officer's" provision to call a special vote and the rule was pushed through by a 3-2, margin.
Opposition to the rule has now arguably hit its apex, as the Chamber has filed suit yet again, this time alleging that the SEC acted without sufficiently fulfilling the court's request for further cost/benefit analysis. It's a criticism that dissenting members within the Commission raised just prior to Donaldson's 11th-hour proceeding.
"I disagree with this rush [to vote]," said Commissioner Cynthia Glassman, a Republican who opposed the rule form the outset. "In my view, a prudent response to the court's mandate would be for the Commission to seek public comment on the issues identified by the court as violating the APA."
Fellow Republican Commissioner Paul Atkins concurred by saying, "The ink on the court decision was not even dry when the die was cast." He added that the 11th hour vote was "a profound disrespect for the rule of law."
Democratic Commissioners Roel Campos and Harvey Goldschmid called the accusations of their colleagues "absurd" and said that any further analysis would carry a heavy cost burden to the SEC itself and lead to "a period of great uncertainty."
But that seems to be exactly where the industry finds itself today.
Two weeks ago, in what most experts regard as a matter of legal procedure, the Chamber added to its second lawsuit a request that the court order the enacting of the independent chairman rule delayed until the cost/benefit analysis lawsuit is heard in its entirety. The court agreed with the Chamber's position and according to a copy of the order obtained by MME, final arguments over whether the SEC acted without sufficient cost/benefit analysis won't be heard until Nov. 14 - a mere eight weeks before the rule's scheduled implementation date.
Steve Bokat, an attorney with the U.S. Chamber, speculated that a ruling from the court wouldn't arrive until sometime in the first quarter of 2006.
Left to Speculate
Until that time, it seems, fund companies are left to speculate on the rule's final outcome.
"Fund companies taking a wait-and-see attitude are in a tough spot right now," Coates observed. "From an SEC enforcement viewpoint, always taking the conservative side of regulation and doing more than what is absolutely required is always helpful. The SEC likes to see you doing everything you can to identify problems and remediate those problems."
As for fund companies that have already taken steps to meet the rule's implementation deadline next year, problems could arise further down the road, Coates warned.
Should They Stay,
Or Should They Go?
"If this rule gets repealed in some way, I think the boards that are already independent will remain that way as long as the relationship between the fund board and the fund company is good," he offered. "But if that relationship becomes contentious, there is a real risk that, at a time when we need boards to be their most aggressive, the companies may choose to move their boards away from independence."
Such a move would likely raise flags at the SEC and among shareholders, Coates said, "so repealing the rule creates a bigger risk to the industry than keeping it alive."
What impact the Chamber's massive legal opposition to the independent chairman rule might have on future SEC rulemaking, such as the proposed 4 p.m. hard close to the trading day, has also been brought into question.
Chink in the Armour
Margaret Sheehan, co-leader of the financial services and product practice at the Washington law firm of Alston & Bird, said the Chamber might have exposed a chink in the SEC's armor.
"The one thing this whole independent chairman fight points out is that the cost/benefit analysis is actually a real requirement," said Sheehan, who thinks fund companies shouldn't rush to meet the independent chairman rule's implementation date, as the lawsuit's briefing schedule would likely push it as far ahead as 2007.
"This case seems to be saying, yes, you have to do a cost/benefit analysis, it has to be real, it has to be reasonable and it has to be consistent," Sheehan said.
"The 4 p.m. close has some very, very significant costs associated with it," she continued. "The industry knows that and the SEC, to some extent, knows that. So this new emphasis on the cost/benefit analysis could torpedo the 4 p.m. hard close, [and] it gives potential plaintiffs another arrow in their quiver with respect to rules they don't like."
That fact isn't lost on Paul Schott Stevens, president of the Investment Company Institute in Washington. Stevens, who heads the mutual fund industry's principal trade group, said, in a recent statement directed at incoming SEC Chairman Christopher Cox, that the ultimate impact of the Chamber's lawsuit could prove to be more important than the independent chairman rule, whatever its outcome.
"Careful attention to economic consequences, greater concern for identifying and quantifying compliance costs, openness to alternative approaches - all this would have a salient and highly beneficial effect on the way the SEC goes about its business," he said. "Future SEC chairmen would do well to pay heed to these larger implications of the court's decision."
In a motion opposing the Chamber's request for a delay that was filed with the U.S. Court of Appeals on Aug. 5 - two days after the business-friendly Cox was officially installed as SEC Chairman - the SEC defended Donaldson's 11th-hour vote by citing the Supreme Court's "deliberative decision-making" procedures, where appeal cases are assigned to the same panel that previously considered it because of their familiarity with its details.
While the court ultimately sided with the Chamber, Sheehan said it's noteworthy that it was filed under Cox's watch, because if the court does bounce the rule back to the SEC for more analysis and a third vote, it doesn't look like he'll side with Glassman and Atkins and overturn the rule.
"Ultimately, it's about whether or not his agency has the authority to adopt a particular rule, and I don't think that he is going to want that limited. Just because someone is known as pro-business, it doesn't mean they'll come down on one side or the other of a rule," she said.
And if the court sides with the Commission, Chamber officials have left the door open for additional legal action.
"We'll make that decision at that time," Bokat said.
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