When the Securities and Exchange Commission posts its independent chairman rule for a second time, it will do so amid an industry milieu that is greatly unlike the one it met two years ago. That fact, combined with a number of other developments on the regulatory front, could determine what fixes the regulator must make to the rule and perhaps whether the controversial mandate will ever see the light of day again.
To call the rule controversial, however, would be an understatement. First approved in 2004, it calls for 75% of a fund's board of directors, as well as its chairman, to be independent of the fund. It has drawn cheers from investor advocates, who claim that it would ensure that decisions are made in the best interests of shareholders and not the fund company. Critics assail the measure's costs, as well as the fact that it might take key decision making away from some of the industry's sharpest and most veteran minds.
Among its detractors are some of the industry's biggest players, which prompted the U.S. Chamber of Commerce to file suit against the rule last year. The court ruled in favor of the Washington lobbyist and bounced the rule back to the SEC for further cost analysis.
But eight days after the court's remand, then-SEC Chairman William Donaldson called a new vote just a few hours before his departure from the Commission. It passed by a 3-2 margin with significant dissent from Commissioners Cynthia Glassman and Paul Atkins, who complained that they weren't given sufficient time to reconsider the rule or offer additional input.
The Chamber filed suit again, arguing that the SEC rammed the rule through and ignored the court's order to perform additional analysis. The Chamber also won a stay of the rule, which was supposed to go into effect on Jan. 1. The most recent opinion from the court also sides with the Chamber. In the opinion, U.S. Court of Appeals Judge Judith Rogers threatened to vacate the rule entirely because the Commission relied on extra-record material in its second round of cost analysis that was not made available to the public. However, the court instead decided to give the regulator 90 days to solicit additional public comment on the rule's cost.
Now the Commission must decide whether to open the rule back up for public comment. Although SEC Chairman Christopher Cox said late last month that the regulator was "moving in that direction" and would "say something publicly" in the next few days, it had not been reopened prior to this issue's deadline. Reposting the rule for comment is a decision that could alter the measure dramatically, compel some minor tinkering, or leave it completely unchanged.
But there are other options. Since the court asked that the Commission report back within 90 days, the regulator could pursue a much more detailed, third-party cost/benefit analysis, experts say, or the Commission could hash out their differences behind closed doors and decide that the rule is no longer worth pursuing.
Either way, the industry is operating within a much different regulatory environment than it was in the months after the scandal broke and the independent chairman rule was conceived.
"That is the case both internally and externally," explained Margaret Sheehan, a partner at Alston & Bird in Washington. "Cox is not Donaldson, and the industry is not in the position of weakness that it was three years ago."
In fact, Sheehan observed, the court's opinion made a point of noting that when the rule was first proposed, nearly 60% of mutual funds already complied with the 75% independent director condition. That number, according to one recent survey, has grown to more than 78%. Critics of that study say the increase reflects a number of funds were preparing for implementation of the rule. The court, however, probably saw it as an indication that the industry is charting its own course, Sheehan said, a development that would further weaken arguments in the rule's favor.
The rule is also dragged down by the SEC's own admission that it would be difficult to perform a cost analysis that takes into consideration the countless number of different size fund firms that exist today, another key point raised by the court. In the original rule, the SEC said costs would be "minimal." Once it was bounced back after the first Chamber lawsuit, the regulator turned to existing third-party research that pegged the costs between $4,779 for large fund complexes or $37,500 for boards overseeing only one fund. But the court noted that even that research conceded a "wide divergence" in costs and Judge Rogers suggested that more reliable estimates might exist.
And then there's the rule's checkered past.
"It is rather tainted," said Sheehan, who doubts it will survive whatever the SEC decides. "It's been so beaten up, it might be time to take this rule out back and put it to sleep."
Colin Dodds, a senior analyst at New York consultant CCH Wall Street, isn't optimistic, either.
"People have had a lot of time to live with this rule," Dodds said. "It's going to be interesting to read the comment letters if the SEC does repost it."
Dodds thinks that Cox represents the greatest risk to the rule. If not for his conservative pedigree as a Republican Congressman, Dodds said, then just for the fact that he doesn't have a personal stake in its survival.
"The fact that they haven't jumped on it so far is interesting to me," Dodds explained. "This was Donaldson's baby, and obviously people are not pleased with it, but as far as it goes with Cox, this isn't his battle to fight. It will be interesting to see what sort of resources he throws at it. It might be wisest for him to cut it loose."
That doesn't mean it's a bad rule, though, Dodds offered. He pointed to the recent flap at Citigroup, where the New York bank received millions of dollars in illegal kickbacks from an in-house transfer agent, instead of passing those savings on to fund shareholders. Citigroup settled the charges by paying $208 million to affected shareholders.
"It could be argued that an independent board would have prevented that," Dodds remarked.
Plenty of others think it's a good rule, too. Allan Mostoff, president of the Mutual Fund Directors Forum in Washington, admits that the regulatory climate has changed and that the scandal is "no longer front and center in people's minds." But, he added, that doesn't diminish the importance of the rule to the SEC's entire package of reforms.
"Enhanced disclosure, chief compliance officers...the independent chairman rule is a crucial part of a total reform package. We'd like the rule adopted in its current form," said Mostoff, who thinks Donaldson was right to act quickly when the rule was first bounced back to the SEC.
"The SEC had the information it needed to examine the issue," he said, adding that he doesn't anticipate any watering down of the mandate if it is reposted.
The Chamber, which has not done its own cost analysis of the rule, would prefer otherwise. Absent throwing it out altogether, said Steve Bokat, general counsel at the Chamber in Washington, the rule should be changed to order funds to indicate in their prospectus whether or not independent directors are in charge.
"Then the public can decide for themselves if it's important that a fund have independent directors," Bokat said.
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