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U.S. Court of Appeals Vacates Board Independence Requirements

On Friday, April 7, 2006 the U.S. Court of Appeals for the District of Columbia vacated the conditions of the fund governance rules requiring that mutual fund boards be comprised of 75 percent independent directors and have an independent chairman. However, the Court of Appeals withheld issuing a mandate for 90 days to allow the Commission the opportunity to reopen the record for comment on the cost of implementing the two conditions. Within the 90 days, the Commission must file a status report with the Court of Appeals, after which the Court may issue a mandate, rescind the order vacating the two conditions, or modify its ruling.

The U.S. Chamber of Commerce originally filed suit against the Commission on September 2, 2004, alleging that the governance requirements exceeded the Commission’s statutory authority and infringed upon state law. On June 21, 2005, the U.S. District Court for the District of Columbia, in a unanimous decision, remanded the matter to the SEC to reconsider the cost of compliance with the independent chairman and 75 percent independent director requirements, and to give consideration to a proposed alternative to the independent chairman requirement. On June 29, 2005, the Commission met and re-approved the rules, without modification, by a 3 to 2 vote. On July 7, 2005, the U.S. Chamber of Commerce filed a petition with the Court of Appeals for review of the final rule. The Chamber’s petition asked the Court to (i) hold the independent chairman and 75 percent independent director requirements unlawful under the Investment Company Act, the Administrative Procedures Act and the terms of the June 21, 2005 remand, (ii) vacate the requirements; and (iii) issue a permanent injunction prohibiting  the Commission from implementing and enforcing the requirements  On August 10, 2005 the Court issued an order staying the compliance date of the fund governance standards pending judicial review.

In its decision, the Court of Appeals found that the Commission had violated Section 553(c) of the Administrative Procedures Act when it re-approved the rules because it relied extensively upon “extra-record materials” in arriving at cost estimates without providing an opportunity for public comment. Specifically, the Court found that the Commission relied on “privately produced Management Practice Inc. Bulletin[s] and a nonpublic survey of compensation and governance practices in the mutual fund industry”, neither of which were part of the rulemaking record.

For More Information

Please contact Donald S. Mendelsohn, JoAnn M. Strasser, or Michael V. Wible or any member of our Corporate Transactions & Securities practice group for more information.

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