Court orders SEC to review independent-chairman rule

A federal appeals court yesterday ordered the Securities and Exchange Commission to reconsider its rule requiring fund company boards to be overseen by independent chairmen, a victory for Fidelity Investments and many other mutual fund companies.

A three-judge panel of the US Court of Appeals for the Washington, D.C., Circuit unanimously found that the SEC had authority to adopt the rule, but failed to adequately consider the potential costs to businesses. The lawsuit challenging the rule, which was set to go into effect in 2006, was filed by the US Chamber of Commerce.

The SEC ''will review how best to respond to the concerns identified by the court," it said in a statement.

The proposed rule galvanized Edward C. Johnson 3d, Fidelity's chairman and chief executive. A normally private man, he went public with his vehement opposition to such a change in board composition.

With the SEC due to get a new chairman, the fate of the rule seems uncertain. It was approved last year by a 3-2 vote of SEC commissioners, with current chairman William Donaldson on the winning side.

Donaldson is preparing to depart. President Bush's choice to replace him, US Representative Christopher Cox, a California Republican, has strongly supported the Chamber of Commerce in Congress.

Given those circumstances, yesterday's court decision could ''effectively kill the rule," said John C. Coffee, director of Columbia Law School's Center on Corporate Governance.

It's unlikely the SEC could address the court's concerns before Donaldson's departure, and Coffee said of Cox, ''I'd be surprised if he'd be sympathetic to the independent-chairman rule."

Still, the court decision simply calls for the SEC to reevaluate the rule and not necessarily to scrap it.

By one count, roughly 80 percent of fund companies have boards run by insiders, including Fidelity.

''We don't have an immediate comment," Fidelity spokesman Vincent Loporchio said yesterday.

But at Fidelity Investor, an independent newsletter, editor Jim Lowell said, ''It's certainly music to the Johnson family's ears if they can continue to maintain control over the company they built and not have the government tell them how to construct their board."

Amid investigations of trading abuses at fund companies, the SEC approved a rule that requires a majority of a fund company's directors, including its chairman, to be independent.

According to supporters, a director with company ties can be torn by divided loyalties; a director's interest in maximizing revenue by charging higher fees can be at odds with shareholder interests. Under this reasoning, shareholders are better served by independent directors.

''This is the most important reform in the mutual industry in 20 years," said John Hill, the independent chairman of the Putnam Funds board.

In a 2004 opinion piece in The Wall Street Journal, Johnson expressed opposition. An independent chairman, he wrote, could be a liability for shareholders because he might lack the hands-on experience of a seasoned insider.

''My personal, professional, and financial interests are directly aligned with those of Fidelity shareholders," Johnson wrote.

A study commissioned by Fidelity found that investors pay lower fees and get better performance in funds where a company executive serves as chairman.

As it seeks to address yesterday's ruling, the SEC has several options, including an appeal to the US Supreme Court.

Chris Reidy can be reached at reidy@globe.com. Material from Globe wire services was used in this report.