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SEC to compel ouster of most fund chairmen

WASHINGTON — WASHINGTON - Overcoming strong opposition from the mutual fund industry, the Securities and Exchange Commission will approve a regulation tomorrow forcing most fund companies to replace their board chairmen with outsiders who are independent, commission officials said yesterday.

The new regulation, which is expected to take effect in 18 months, will apply not just to fund companies that have figured in recent investigations, but also giant firms that have not been named, including Fidelity Investments and T. Rowe Price Associates Inc.

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Industry analysts estimate that 80 percent of the nation's fund companies have chairmen who are also senior executives and who will have to be replaced under the new rule.

The new set of rules also will require 75 percent of the directors to be independent, up from 50 percent. The outside directors will have to hold quarterly meetings without fund executives, and each board will have to justify the fund managers it retains.

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The changes in fund governance are a significant and controversial part of an overhaul of rules by the commission in recent months in response to the industry's woes. The agency has revised significant disclosure rules and forced the funds to adopt new ethics codes and appoint compliance officers.

Officials said the agency is also planning rules limiting after-hours trading, imposing greater disclosure of some fees and regulating more closely the payments and other compensation from funds to brokerage firms that execute their trades.

'Primary advocate'

The agency has moved ahead of Congress, where a similar measure has sailed through the House of Representatives and other bills on the subject have been introduced in the Senate.

In a speech Sunday at Stanford Law School, William H. Donaldson, the SEC chairman, said the proposal "solidifies the role of the fund board as the primary advocate for fund shareholders."

He said the new requirement for an independent board leader was needed to eliminate "the inherent conflict of interest" when a mutual fund chairman is also a senior manager. That person, he said, must serve as steward for both the fund's investors and for the shareholders of the fund's investment adviser.

"It is easy to see that these two duties are often in conflict," Donaldson said. "For example, consider the conflict that necessarily arises when it comes to setting the level of fees the fund will pay the adviser."

Bipartisan support

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Last week, seven former Republican and Democratic chairmen of the agency wrote a letter to the commission urging the adoption of the rule. But the provision has sharply divided the commission, with Donaldson, a Republican, siding with the two Democratic commissioners who have supported the rule.

The agency's two Republican commissioners, Cynthia A. Glassman and Paul S. Atkins, have not said how they will vote. But in both public and private settings, they have expressed strong reservations about the plan.

Glassman, an economist, has said she has found little empirical data to support the changes or that the costs of the measure outweigh its benefits.

Atkins has said that the funds could reduce conflicts by giving a greater role to lead outside directors.

Donaldson and his two Democratic allies - Harvey J. Goldschmid and Roel C. Campos - say the changes in governance combined with other reforms will go a long way toward restoring investor confidence in the industry.

"This is the pivotal proposal to make the board effective, and with the other things we've done, should provide for more protection for investors," Goldschmid said. "Overall, this package will make a large difference."

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The industry's once powerful trade association, the Investment Company Institute, has raised objections to the plan, and industry executives have noted that some of the abuses have occurred at fund companies, like Putnam Investments and Bank of America, whose boards were led by independent chairmen.

Paul S. Stevens, the new president of the institute, said yesterday that the industry had not opposed independent chairmen, but had sought to give each fund company the discretion to pick inside or outside candidates.

"We prefer the issue be left to the directors," he said.

Stevens said it was "not apparent" to him why publicly traded companies would continue to have the flexibility of having a chairman from the senior ranks of management, while a mutual fund company would not.

Two other major proposals that are headed for final votes have divided the SEC. The agency has plans to vote in mid-July on a requirement that hedge funds file registration statements with the agency. That proposal has been questioned by Glassman and Atkins, but has had the support of Donaldson and the two Democratic commissioners.

Less clear is how the commission will complete its work on a proposal to open proxy contests to candidates proposed by large shareholders as alternatives to the board's nominees.


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