The U.S. Chamber of Commerce filed suit Thursday to overturn federal regulators’ controversial new rule that mutual funds have independent chairmen.
The Securities and Exchange Commission approved the requirement by a 3-2 vote in June, and it is scheduled to take effect at the end of next year. The rule, passed in response to the scandals that have rocked the $7.4 trillion fund industry in recent months, also requires that 75 percent of directors on fund boards be independent.
“The SEC has overreached its authority, resulting in a rule that is bad for investors and contrary to the intent of Congress,” said Stephen Bokat, general counsel for the Chamber of Commerce, which filed suit in Washington, D.C.
The Investment Company Act of 1940 governing mutual funds requires that 40 percent of fund directors be independent, the chamber stressed. A subsequent SEC rule, however, already requires a majority independent board.
“Congress really considered this and has never suggested there has to be … an overwhelming majority,” Bokat said. “The SEC is going way beyond anything intended by Congress.”
The suit filed by the group, the world’s largest business federation, called the requirements “arbitrary” and “capricious.” It claimed the SEC ignored information about the potential costs and consequences of the rule and failed to consider evidence that independent chairmen could hurt fund performance.
The SEC, however, said it believes the rule is valid.
“The commission carefully complied with its legal obligations in adopting these rules, and we expect to defend them vigorously in court,” said SEC general counsel Giovanni Prezioso.
Several groups, including many fund companies, strongly opposed the requirement. Most of the nation’s funds, including those at Vanguard and Fidelity, have insiders as chairmen.
Bokat said investors ought to be able to decide what type of fund governance they want.
“It absolutely is a matter of investor choice,” he said. “If people feel companies ought to have an independent chair, then they can put their money in funds with independent chairmen.”
The rule generated significant controversy, with many investor advocates and the seven living former SEC chairmen supporting the plan, saying increased board independence was vital to ensure adequate scrutiny of fund operations.
When the rule was passed, influential House Financial Services Committee Chairman Michael Oxley (R-Ohio) called it “independence day for mutual fund investors,” saying, “Finally, mutual fund investors will have someone leading the board who is focused on earning returns for shareholders, rather than earning fees from shareholders.”
Separate proposals pending in Congress also would require independent chairmen and 75 percent independent directors.
But opponents, including Republican Commissioners Cynthia Glassman and Paul Atkins, said there was no proof such a rule would have any benefit.
When the rule was passed, Atkins said supporters were relying on “a hope and a prayer.”
Business groups increasingly are displaying a willingness to take on the SEC over its rulemaking.
For example, as commissioners debate a proposal to allow shareholders to directly nominate candidates for a company’s board of directors under certain circumstances, groups have signaled they will go to court to fight the plan if it is approved.
