Last Tuesday, the Securities and Exchange Commission announced it would revisit a rule requiring that three-quarters of all a mutual fund's directors - including the board chairman - be independent.
Industry watchers suggested that the rule would come through a 60-day review easily and be reinstated. Then, on Wednesday, at a meeting of the Mutual Fund Directors Forum, a top SEC official suggested that the rule is as good as dead.
Considering that an independent board and chairman were key parts of the reform package that regulators pushed through after a series of trading scandals rocked the fund world in 2003, what happens next is no small matter. It may go a long way to deciding just how comfortable a lot of investors get owning funds as the scandals fade into the more-distant past.
When the scandals first came to light, reform took several meaningful courses. The problems stemmed from rapid trading that funds should not have allowed, and typically the trades were made on international funds, many of which calculated the share price using stale values for their foreign securities. (Stale prices reflect the close of trading in, say, Europe; hours of activity in U.S. markets may change that value, but only when the "fair value" price is calculated or the European market reopens.)
By insisting on a chief compliance officer, regulators made funds live up to their own rules. By helping to move funds toward a system of fair valuations, the stale pricing problem disappeared; the addition of short-term redemption fees made rapid trading too costly, and new sales disclosures ensured that customers would become aware of certain sales and marketing practices that had riled the regulators.
But former SEC Chairman William H. Donaldson went a step further to build the public trust and ensure quality governance, pushing through the 75 percent rule.
The action was challenged twice by the U.S. Chamber of Commerce. A federal appeals court decided in April that the SEC violated procedures by failing to seek comment on the rule's costs and potential flaws. The court said it would vacate the rule unless the SEC addressed that shortcoming within 90 days; SEC commissioners voted unanimously to reopen the issue about three weeks ahead of schedule.
When the rule was adopted in 2004 - and when it was revised last year - support was not unanimous; Donaldson voted with the two Democrats on the commission, and the Republicans dissented. Today, it still appears that Democrats favor the rule, while Republicans consider it an intrusion into the business affairs of fund companies.
Meanwhile, many firms have adopted the 75 percent standard, assuming it was not going to be shot down. Those firms will not backtrack, because it would make for bad press; that's the same reason why firms that have yet to go independent won't speak out too stridently.
The chamber will come out against the rule again, suggesting that implementing it is too costly for too little benefit, while the Mutual Fund Directors Forum will counter with a study showing that the costs for firms that made the change have been negligible.
The naysayers will write that the independent board doesn't change the way a fund is run; consumer advocates will say that an independent board can make life so untenable that management actually takes steps to make a poor fund better.
Ultimately, then, the decision will come down to SEC Chairman Christopher Cox and the commissioners, and they will most likely find a small compromise, setting some level of assets where a fund is allowed to have just three directors, so long as two of them are independent. It may also allow funds to keep an interested chairman, provided it names a lead trustee instead.
"The SEC was very clear a year ago that it would not back down, so I think they will try to show that they have gone through the right process so that the rule sticks this time," says Michael R. Rosella, who chairs the investment management practice group at Paul Hastings, an international law firm. "They might soften it a bit, but it stands."
But the real test will come in the future, and it won't be so much about rules as results, about whether an independent board can protect consumers from poor performance, high costs and bad management. After all, the SEC first required half the board to be independent back in 2000 (before that, just 40 percent of directors were unaffiliated), and the move certainly didn't stop the problems that were uncovered in 2003.
Says industry consultant Geoffrey H. Bobroff: "The acid test for any board, no matter the level of independence, is are they living up to what they are supposed to do. If not, you shouldn't care about the SEC rule, you should have your own, and it should be that you move on."
Charles Jaffe writes for MarketWatch. He can be reached by mail at Box 70, Cohasset, Mass. 02025-0070.