WASHINGTON — Rules governing the mutual fund industry, designed to protect investors from abuses, were overturned by a federal appeals court Friday and sent back to the Securities and Exchange Commission for the second time in less than a year.
In a 3-0 ruling, the U.S. Court of Appeals for the District of Columbia Circuit decided to void the SEC regulations mandating that chairmen of mutual funds be independent from the companies managing the funds. The court said the agency violated the Administrative Procedures Act by failing to adequately examine the potential costs to the mutual fund industry before adopting the rules, which require that at least 75 percent of the directors on fund boards be independent — up from the current mandatory minimum of 50 percent.
The court also decided, however, to hold off for 90 days on invalidating the rules to give the SEC another chance to make its case after opening the proposals to public comment a second time to garner better information about the costs.
SEC Chairman Christopher Cox said the agency "will comply with the court's decision in every respect."
It was a victory for the U.S. Chamber of Commerce, which brought the case against the SEC. "The court had a simple message for the SEC today: You can't run roughshod over the rulemaking process," Steve Bokat, an executive vice president of the business group, said in a statement. "The SEC rushed to reissue the mutual fund rule without conducting the thorough review requested by the court."
The rules, meant to protect investors by ensuring that mutual fund directors, as overseers, are insulated from the financial interests of the institution that owns the funds, were proposed by a divided SEC in 2004 in response to widespread trading abuses in the fund industry. They were adopted on June 29, 2005, one day before Cox's predecessor, William Donaldson, resigned. The rules already have had an impact on the sprawling $8 trillion mutual fund industry to which some 95 million Americans entrust their savings.
The fund industry had fiercely opposed the independent chairman requirement.
"A significant portion of the mutual fund industry appears to have come into substantial compliance" with the rules, the appeals court said in its ruling, explaining its decision not to void them immediately.
That would risk "substantial disruption to the mutual fund industry because of the resultant inconsistent governance practices that would arise within the industry, which also might sow confusion in the investing public," the court's ruling said.
The court ruled in June 2005 that the regulations must get new scrutiny from the agency. The court questioned whether high costs could be incurred by fund companies and ordered the SEC to consider alternatives to the rule.
The SEC, however, simply affirmed its previous rules in the June 29 meeting, stating that the costs involved would not be onerous for the fund industry. The three-person majority of the five-member commission also decided that alternatives — such as simply having a given mutual fund disclose whether it had an independent chairman — would be ineffective.
In the 33-page ruling issued Friday, written by Appeals Court Judge Judith Rogers, the court said the SEC relied on incomplete data for its estimates of the potential costs of the rules — which the agency said would likely be "minimal."
In a statement, Cox said the SEC takes seriously "our responsibility to subject all of (its) proposed rules to public notice and comment, and to apprise ourselves, the public and the Congress of the economic consequences of proposals before we decide whether to adopt them."
"I am confident that the result of the process that the court has prescribed will be final mutual-fund governance rules that protect the interests of the funds and the fund shareholders they serve," he said.