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Industry Pushes Back Against Fund Independent Chair Rule

The Investment Company Institute strongly urged the SEC to abandon its attempt to require mutual funds to have an independent chair in the wake of an appeals court ruling invalidating the SEC's independent chair rule. ICI said it could support a rule requiring fund boards to have two-thirds independent members, but not the 75% figure proposed by the Commission. The SEC, reacting to the federal appeals court order, reopened the comment period on its rules requiring the board of directors of most mutual funds to have an independent chair and 75% of independent directors. The comment period closed on August 21.

The governance rules were proposed in early 2004 and adopted in July of that year. Since that time, the U.S. Chamber of Commerce has twice successfully challenged the rules in lawsuits alleging that the SEC did not provide evidence supporting the need for the rule and did not adequately consider the cost of implementing it. The federal appeals court's latest decision gave the SEC a 90-day period to seek additional comment on implementation costs.

ICI believes the most compelling argument against the adoption of the independent chair rule is that the culture of the boardroom has evolved to the point that it is not needed. Through a variety of different means, the SEC's goals in proposing the independent chair requirement have already been accomplished, according to the ICI, diminishing the possibility of benefits flowing from the requirement. ICI noted that regular executive sessions have increased the cohesion among the independent directors, which has helped to foster a meaningful dialogue between independent directors and fund management.

Also, as a result of the annual board self-assessment requirement, directors continually revisit the effectiveness of how they operate. Apart from any specific regulations, ICI said that increased scrutiny, enforcement actions and private litigation stemming from the trading scandals have heightened the attention of fund directors and fund management to the importance of maintaining a culture of compliance, regardless of whether the chair is independent.

The existing requirements that the chief compliance officer meet at least annually in an executive session with the independent directors have created an opportunity for the chief compliance officer and the independent directors to speak freely about any sensitive compliance issues of concern to any of them. The requirement that independent directors meet in an executive session at least quarterly provides another opportunity for a frank and candid discussion regarding the management of the fund, including its strengths and weaknesses.

The discussions among the independent directors and with the chief compliance officer provide multiple opportunities for a board to assess management's performance and to demand high standards of compliance. These regulatory enhancements further strengthen the hand of independent directors who already must constitute at least a simple majority of the board and must approve key items such as a fund's advisory contract and any 12b-1 plans by a separate vote.

In ICI's view, the 75% requirement imposes additional costs on funds but no consistently evident benefits. In addition, the costs that would be incurred by having a two-thirds independent supermajority on the board would be amplified by adoption of the SEC's 75% independence requirement. ICI said the supermajority rule is not needed due to the continuing evolution of a culture of independence that has become well-entrenched as a result of a variety of factors, including the compliance rule, executive session requirements and increased regulatory scrutiny. ICI added that the culture of independence is further enhanced by the voluntary movement by many funds to increase the proportion of independent directors to at least two-thirds.