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In June a federal appeals court in Washington, D.C., handed a significant victory to the nation’s largest business lobby with a decision that affects who sits on mutual fund boards and how independent they should be from the fund managers. The U.S. Court of Appeals for the D.C. Circuit directed the Securities and Exchange Commission to reconsider rules passed in June 2004 requiring the chairman and 75 percent of most mutual fund boards to be independent of fund managers. In a unanimous decision, the three-judge panel found that the SEC violated rule-making procedures by failing to take into account how much the reforms would cost the industry. Furthermore, the court criticized the agency for improperly rejecting an alternative proposal from two of its commissioners. The court, however, took no position on whether the rules governing independence were proper. It all started when the U.S. Chamber of Commerce sued the SEC last September, claiming that Congress did not give the commission the authority to mandate mutual fund board composition. Further, the Chamber of Commerce argued that the rules were arbitrary and capricious. The 19-page opinion was authored by Chief Judge Douglas Ginsburg and joined by judges Judith Rogers and David Tatel. The appellate panel heard oral arguments on April 15. Eugene Scalia of Gibson, Dunn & Crutcher represented the chamber; SEC general counsel Giovanni Prezioso argued on behalf of the government. The SEC rules, scheduled to go into effect in January 2006, were drafted in response to discoveries of misconduct in the more than $7 trillion mutual fund industry. The problems included late trading and market timing that benefited fund companies and brokerages but could have hurt the shareholders of the funds. Securities and Exchange spokesperson John Nester says the commission is reviewing “how best to respond to the concerns identified by the court regarding the analysis of costs and the consideration of alternatives.” While the SEC could try to replace the rejected rule with something similar, industry lawyers say that is unlikely to happen, given a June 30 leadership change at the commission. Earlier in June, President George Bush nominated Representative Christopher Cox (R-California) to replace outgoing chairman William Donaldson. Cox, who as a member of Congress authored legislation that sought to curb shareholder lawsuits, is widely expected to be more pro-business than his predecessor was. Mutual fund companies that opposed the rules, such as The Vanguard Group, Inc., could see a more favorable result the second time around, according to Stephen Bokat, senior vice president and general counsel of the Chamber of Commerce. “There are already two dissenters,” Bokat points out, referring to the two commissioners who voted against the rules in 2004. “If [Cox's] view is different from [Donaldson's], this could certainly result in a very different outcome.” A version of this story originally appeared in Legal Times.

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