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SEC votes to change mutual fund governance

THE BALTIMORE SUN

WASHINGTON - A divided Securities and Exchange Commission passed yesterday, for the second time, a rule requiring independent stewardship of the nation's mutual funds - just one week after an appeals court had ordered the agency to reconsider the measure.

The SEC's swift answer to the court came over the objections of business groups and was among the final official actions of Chairman William H. Donaldson, who is leaving the commission today after a tenure that earned respect from shareholder activists but angered industry lobbyists who viewed him as an overly zealous regulator.

"I think at this point, after 2 1/2 years, we've accomplished a lot," Donaldson told reporters after the sometimes-heated session. "There's a lot that still needs to be done."

Donaldson called the rule, approved on a 3-2 vote yesterday, "the capstone" in a series of mutual fund reforms prompted by revelations of widespread trading abuses in 2003.

The rule requires mutual funds to be chaired by people who are free of business ties to the fund company; 75 percent of a fund's directors must be similarly independent. The SEC originally approved the rule last year over the objections of the U.S. Chamber of Commerce and other groups.

On June 21, the U.S. Court of Appeals for the District of Columbia Circuit affirmed that the SEC had the authority to pass the rule but ordered regulators to review its potential costs and to consider the alternative measure of disclosing a fund chairman's potential conflicts of interest.

The Chamber of Commerce asserted yesterday that the SEC had defied the appellate court by failing to seriously examine the financial impact of the rule. The group vowed to continue its legal challenge.

"After a seven-day secret process, the SEC has recklessly re-adopted its flawed rule," Thomas Donohue, the chamber's president, said in a statement issued 30 minutes after the commission meeting. "This attempt to circumvent our legal and regulatory process will not stand up in court."

Donaldson, however, maintained that the SEC had already gathered the required information before it first passed the rule last year.

"I have the greatest respect for the court," Donaldson said after the meeting. "Without question, we had the facts."

The flap comes at a pivotal moment for the commission, which oversees the nation's securities markets.

The White House has nominated Rep. Christopher Cox, a California Republican, to succeed Donaldson, although his confirmation hearing is not yet scheduled. Meanwhile, Democrat Harvey J. Goldschmid has plans to leave the SEC this summer, and the term of Democrat Roel C. Campos is ending.

The Bush administration has not revealed whether it will go along with Democrats' wishes to re-nominate Campos and name SEC staff member Annette Nazareth, a Goldschmid protege, to fill his seat.

Donaldson, a Republican and appointee of President Bush, became controversial in some GOP and business circles for siding with the two Democrats on several high-profile votes, including the mutual fund independence rule.

The outgoing chairman said he has "no concern about Congressman Cox." Donaldson said his goal for the mutual fund rules was to take "a 90-million-person investment vehicle and make it so it can grow as it should grow. Clearly, I would hope that Congressman Cox will agree with that."

Critics of the mutual fund rule yesterday accused Donaldson of rushing it through while the three-member majority remained in place.

"The ink on the court's opinion was not even dry when the die was cast for today's pre-ordained result," said Republican Commissioner Paul S. Atkins.

Critics also said the SEC should have solicited more public comment and further evidence to adequately meet the court's demand.

"Today's action is nothing more than window dressing," said Republican Commissioner Cynthia A. Glassman. "It strains all credibility to believe that the commission has mystically, within the past week, been able to conclusively estimate costs associated with the rule."

When the SEC first passed the rule in July 2004, Donaldson and others maintained that it would help reduce a conflict of interest now faced by board members of fund companies - that is, the pressure to put the profits of the fund company ahead of the best interests of fund shareholders.

Making the fund company chairman independent was considered especially important, because the chairman has the power to set the agenda at board meetings.

The chamber filed suit soon after the measure was passed, charging that the SEC had overreached its regulatory authority and had failed to consider sufficiently the costs and consequences of such a requirement.

The recent appeals court decision seemed to offer something to both sides, remanding the rule on certain technical grounds but affirming the SEC's authority.

After a quick review, the SEC determined that it had all the cost information it needed, due to the initial rulemaking effort.

In addition, its staff once again considered - and rejected - the notion that disclosure was a strong enough measure to safeguard the interests of mutual fund shareholders. Eight in 10 of the nation's mutual funds use insiders as chairmen and would have to replace them.

The requirement that 75 percent of a board's members be independent is an increase from the current 50 percent.

"The judgment was that costs were infinitesimal" in the context of an $8 trillion industry, Donaldson told reporters. "Costs were not important."

But critics disputed that conclusion. Stephen Bokat, senior vice president and general counsel at the Chamber of Commerce, said it made no sense to compare compliance costs with the amount of money in mutual funds, because that approach tells nothing about the impact on particular funds.

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

Companies will be able to communicate with potential investors through means other than the typical prospectus, such as Webcasts, to discuss new stock offerings.

The Los Angeles Times is a Tribune Publishing newspaper. The Associated Press contributed to this article.

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