Contested SEC rule approved by panel

WASHINGTON — The Securities and Exchange Commission (SEC) narrowly voted yesterday to affirm a controversial rule requiring mutual funds to retain independent chairmen and increase the number of independent directors for their funds.

Departing SEC Chairman William Donaldson, whose resignation takes effect today, championed the move as a preventive measure against the mutual-fund abuses and scandals that have rocked the industry. Mutual-fund companies, however, said there was no proof that more independence would make mutual-fund governance more effective, and that the costs of the new personnel would be prohibitive.

Donaldson sided with the commission's two Democrats in the 3-2 vote that reconsidered the measure at the direction of the U.S. Court of Appeals for the District of Columbia. On June 21, the court questioned the high costs that would be incurred by fund companies and also ordered the SEC to consider alternatives to the rule.

The commission, however, simply affirmed its previous rules, stating that the costs involved with retaining independent chairmen and also raising the number of independent directors on a fund board to 75 percent from 50 percent were not onerous for the $8 trillion mutual-fund industry. The majority on the commission also decided that alternatives — such as simply having a given mutual fund disclose whether it had an independent chairman or not — would be ineffective.

"I believe that this is one of the most important things we've done over the past two and a half years," Donaldson said, referring to his term as chairman. "This really goes a long way to address the loss of confidence on the part of American investors over the years."

The measure, first passed by the commission in 2004, was designed to protect investors by ensuring that fund overseers would be insulated from the larger financial interests of the institution that owns them.

Research on the potential costs of the rule was contained in a new study, presented at the hearing, that concludes the financial burden would be minimal.

The rule, scheduled to take effect next year, could shake up the mutual-fund industry to which some 95 million Americans entrust their savings. The boards of 80 percent of U.S. funds — or about 3,700 funds — would have to replace their chairmen, according to SEC officials.

Opposition reiterated

Some industry experts say the new independent chairmen would replace chairmen who are more well-versed in fund operations, and therefore they would have to hire additional staffers to assist them.

The two Republicans on the commission reiterated their opposition to the measure and criticized Donaldson for calling for a vote just eight days after the court sent the rules back to the SEC for further consideration. Commissioner Cynthia Glassman called the hearing a mockery due to the short time frame for answering the court's concerns and Donaldson's impending departure.

President Bush appointed Rep. Christopher Cox of California, a free-market conservative, to replace Donaldson, a Bush appointee who often sided with the Democratic commissioners. Cox has yet to be confirmed by the Senate, and some Republicans felt Donaldson should have deferred to the new SEC chairman on the mutual-fund issue.

Donaldson dismissed those criticisms, however, saying the commission had been wrestling with the rules for more than a year.

"The staff and this commission have a strong foundation of experience with the fund governance rules, and that experience has enabled us to address these issues raised by the court within a relatively short period of time," Donaldson said, "albeit with the assistance of truly Herculean efforts on the part of our staff."

Vow to challenge rule

The U.S. Chamber of Commerce, which brought the suit against the SEC that put the mutual-fund rule before the U.S. Court of Appeals, said it will challenge yesterday's vote in court as well.

"The SEC didn't meet their legal requirements the first time around and today's effort is no different," said Thomas Donohue, chief executive of the Chamber. "It's outrageous that a regulatory agency would deliberately ignore the orders of a U.S. Court of Appeals and disregard calls for a reasoned rule making process."

On a far more harmonious issue, the SEC voted 5-0 to ease restrictions on executives' comments in the weeks before their company goes public in a stock sale. The change loosens restraints on the so-called quiet period preceding IPOs, part of a broader plan to ease regulation of new stock offerings.

Under the old rule, investors had trouble getting more information because companies weren't allowed to give them anything other than offering documents. Google found out just how serious the SEC was about enforcing the regulation when its $3.47 billion initial public offering in August was almost derailed after Playboy published an interview with the company's founders.

Now companies will be able to communicate with potential investors through means other than the typical prospectus, such as the use of Webcasts and other electronic means, to discuss new stock offerings.

"It's great," said Clay Corbus, the co-chief executive at investment bank WR Hambrecht + Co., which advised Google on its auction based-IPO. "It's good for the company, it's good for the investment bankers, it's good for the public as it seems there won't be an information vacuum."

Any public statement under the new rule must be accurate and not misleading, matching the legal standard that applies to a company's prospectus. Executives may speak to the media, as in Google's Playboy interview, provided they file a copy of the remarks with the SEC.

Information from Bloomberg News about the new pre-IPO communication rules is included in this report.