A sharply divided Securities and Exchange Commission yesterday approved a rule forcing mutual fund boards to pick independent chairmen -- a move designed to stamp out conflicts of interest and to promote lower fees for investors.
SEC Chairman William H. Donaldson said the rule is the capstone of a broad slate of reforms the agency has imposed on the $7.5 trillion mutual fund industry, which has been bruised by disclosure of widespread trading abuses over the past 10 months.
Yesterday's 3 to 2 vote by the SEC, which also adopted a rule requiring at least 75 percent of directors on fund boards to be independent, constitutes the biggest and most controversial step the regulatory agency has taken in the mutual fund arena. And the board meeting marked one of the few times the agency's five commissioners have publicly clashed since Donaldson took the helm last year.
Supporters said the rule would foster stronger discussion in board meetings and ensure that fees are fully vetted by a mutual fund's board. They argued that most boards are led by chairmen who may be caught between their duties to shareholders and the interests of management.
SEC Division of Investment Management chief Paul F. Roye said that, in the past several years, the agency has brought cases against nine board chairmen with management ties who were actively involved in fraud at their funds.
"In case after case of abuse in the mutual fund area, it's the independent directors who have been shielded from knowledge," said Commissioner Harvey J. Goldschmid. "The reasons for that seem clear: They would have prevented abuses."
The move was opposed by the industry and by two of the SEC's five commissioners, Paul S. Atkins and Cynthia A. Glassman, who are Republican appointees. Both Atkins and Glassman decried what they said is a lack of empirical evidence to support the notion that independent board chairmen spur lower fees and better fund performance. Instead, they said, the commission was basing a crucial decision on conflicting anecdotes.
"We have entered the age of atmospherics," Atkins said. "We appear to be more concerned with doing something and going with gut feelings than we are concerned with making sure what we do is right."
For his part, Donaldson stressed that the commissioners had parted ways just 16 times since he arrived -- less than 1 percent of the 1,606 votes the agency had taken over that stretch. But yesterday's split vote may presage dissent on other thorny issues in the weeks to come, including whether to require the registration of hedge funds and whether to give dissatisfied shareholders more power to nominate board members at public companies.
During the normally genteel proceedings, commissioners threw out a few mildly barbed remarks. At one point Donaldson said, "There are no empirical studies that are worth much," saying results can be easily manipulated.
Glassman, who is trained as an economist, later replied, "Suggesting that empirical studies are not helpful I think undermines the whole field of economics, which concerns me."
Goldschmid attempted to lighten the atmosphere by saying, "This meeting demonstrates the extraordinary benefit of independent chairmen other than in the context of mutual funds." Donaldson, who was appointed by a Republican president, yesterday voted with the two Democratic commissioners, Goldschmid and Roel C. Campos, to form a majority.
The rule will have a widespread impact on the industry. Nearly 2,000 funds do not have boards on which 75 percent of directors are independent, Atkins said. And 80 percent of boards are led by chairmen who also are fund executives, including those of the funds controlled by Fidelity Investments and Vanguard Group Inc., according to the Investment Company Institute, an industry trade group.
Fidelity and Vanguard both issued statements yesterday saying that they would comply with the new rules and that they did not expect significant changes in the way their funds operated.
Prominent lawmakers, including House Financial Services Committee Chairman Michael G. Oxley (R-Ohio) and Peter Fitzgerald (R-Ill.), chairman of the Senate Governmental Affairs financial markets subcommittee, praised the vote. Donaldson said the measure also had the support of seven former SEC chairmen, the Council of Institutional Investors, AARP and TIAA-CREF, a retirement system that manages more than $300 billion in assets.
In other actions, the SEC voted 5 to 0 yesterday to require funds to disclose more information about their rationale for approving advisory contracts. The agency also unanimously approved a one-year pilot program that would remove short selling bans on some 1,000 stocks.
Staff writer Lauren Anderson contributed to this report.