Independent Rule to Withstand Congress
December 13, 2004
Two attacks on the SEC's requirement for independent board chairmen are unlikely to topple the hotly contested rule, industry insiders say, and like it or not, funds run by outsiders could find their fees, and therefore their profits, reduced. But one ploy that could result would be a delay past the current Jan. 16, 2006 deadline for funds to install independent chairmen.
Congress has asked the Commission to deliver a report to it by May on what impact independent chairmen would have on fund fees and performance. On April 15, the U.S. Chamber of Commerce and the SEC will meet in court over the Chamber's lawsuit that the SEC overstepped its bounds by amending the Investment Company Act of 1940 to accommodate the new rule.
Congress' requirement is part of a new $388 billion omnibus spending bill that both of its houses have approved and President Bush is expected to sign following a roll call vote by legislators to remove an unrelated tax provision. The SEC will then be required to act on Congress's recommendations by the beginning of 2006, when the independent chair rule takes effect. By some estimates, the independent rule would force 80% of mutual funds, or 3,700 funds, to change their chairmen to an independent party.
Fidelity Investments and other heavyweights support the omnibus bill, in hopes that a report that funds with independent chairmen have higher fees or lower performance would give Congress the leverage to force the SEC to overturn the rule.
Anthony Sabino, an associate professor of securities law at St. John's University in New York, said neither Congress nor the courts are likely to win this fight with the SEC. "It is rare that the SEC overturns a new regulation before it goes into effect. It has only occurred when there is a big change in the law or the economy," he said.
And from the SEC's perspective, Commission spokesman Matt Well avowed, "We will not repeal the law." When asked whether the report the SEC will present to Congress could have any bearing, he said, "This is not about fees and performance. It's about good governance."
Certainly, however, there have been a number of studies in recent years that have made a case both for and against the efficacy of independent chairmen. Just last month, in fact, two professors from the University of Missouri said that an analysis of 448 fund families showed that funds with independent chairmen don't necessarily have lower fees. In fact, the professors said, a fund with an independent chairman might even suffer lower performance than its peers because of the chairman's unfamiliarity with the business.
Nonetheless, even the Investment Company Institute doesn't seem to believe a new report will force the SEC to overturn the rule. The SEC will have to fairly report both the pros and the cons of an independent chairman, said Chris Wloszczyna, a spokesman for the Investment Company Institute. If the study is inconclusive, the SEC will have to decide what to do about the new rule, he said.
"The SEC doesn't have to repeal the rule," Wloszczyna added. "It is their decision what to do after the study has been presented to Congress. Since the rule has already been adopted, the Investment Company Institute will help funds comply."
But one maneuver that could be in the industry's favor would be a delay. Because the SEC will have to report to the Senate Banking Committee and the House Financial Services Committee, even if the SEC doesn't repeal the rule, there could be a long delay before it's enforced, Sabino said. It could even take up to a year for the rule to get implemented, pushing it to mid 2006, he said.
"Congress controls the SEC budget and can exert pressure on regulators," he noted. "If Congress stalls this move, the SEC will do more studies. They [the SEC] may rethink their position."
Christopher Traulsen, an analyst with Morningstar of Chicago, said he would question the statistical validity of a report by the SEC or any other entity justifying independent board chairmen simply because there are only 14 funds with a track record with independent chairmen. Nine of those are bank-managed funds required by the Glass-Steagall Act to have independent boards, so it is not statistically valid to compare the returns of a large number of funds with such a small sample, he said.
Although Fidelity submitted a study to the SEC early this year protesting the rule, Traulsen maintained Fidelity's methodology was weak, again because there are not enough independently chaired funds to make a valid comparison to the large universe of management-chaired funds. "The Fidelity study is flawed. The sample size is too small," he said.
Fidelity noted in a footnote to the study that it might be somewhat flawed because it was "conducted under significant time constraints in order to meet the deadline for comments."