US court faults SEC again on mutual fund rule


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US court faults SEC again on mutual fund rule - April 7, 2006 - By Kevin Drawbaugh

WASHINGTON - A U.S. appeals court dealt another blow on Friday to a Securities and Exchange Commission rule aimed at making mutual fund directors more independent of funds' management after scandals embarrassed the $9.2 trillion industry.

In a win for a business lobbying group that has twice sued the SEC over the rule, the court found the commission last year made procedural errors in handling the measure and said it will be struck down if the SEC does not reconsider within 90 days.

The decision by the U.S. Court of Appeals in Washington sets up another round of debate over the contentious rule, which requires that the chairmen of fund boards and 75 percent of fund board directors have no direct ties to fund managers.

The court's ruling is "unfortunate and it's a terrible waste of energy since the industry has moved in this direction anyway," said Allan Mostoff, president of the Mutual Fund Directors Forum, which represents independent fund directors.

The fund industry saw its image tarnished starting in late 2003 when regulators found abusive trading, known as "market timing" and "late trading," being carried out mostly by hedge funds and sometimes with approval of mutual fund managers.

The SEC and New York Attorney General Eliot Spitzer slapped those involved with more than $2 billion in fines and the commission adopted a range of reforms for the fund business, including the fund director independence rule in July 2004.

Some fund management companies, including industry leader Fidelity Investments, have fiercely resisted the SEC measure. But many fund companies have moved to comply with it.

Over three-quarters of fund directors and nearly half of fund chairmen are already independent of management, Mostoff said, citing an industry study of fund governance in 2004.

On behalf of the independence rule's opponents, the U.S. Chamber of Commerce sued the SEC after the rule was adopted. Last June, the appeals court gave the chamber a partial win by finding flaws in how the rule was developed and sent it back to the SEC "to address the deficiencies."

The five-member SEC then reaffirmed the rule within days in a bitterly divided vote pushed through by then SEC Chairman William Donaldson during his final hours as chairman. The chamber sued again after that, alleging improper procedure.

In the latest legal development, the appeals court decided that the SEC did err in not seeking public comment on certain estimates of the cost of complying with the rule during its brief reconsideration of the measure last June.

The court said it was going to vacate the rule, but held back and gave the SEC 90 days to reconsider it first, with public comment, before the court's order takes effect. The 90-day deadline could be extended, the court said.

Chamber General Counsel Steve Bokat said the next step will be for the SEC to publish the rule again as a proposal and to take public comment on it.

"We fully intend to participate in that process. We thought this was a bad rule from the beginning. We continue to believe the commission should not issue the rule," Bokat said.

Afterward, the SEC would have to vote on the rule again and report to the court. If the rule is re-approved, Bokat said, the chamber would not rule out possibly suing the SEC again.

SEC Chairman Christopher Cox said on Friday the commission would comply with the court's decision in every respect.

"I am confident that the result ... will be final mutual fund governance rules that protect the interests of the funds and the fund shareholders they serve," he said in a statement.