Addressing an industry scandal, a deeply divided Securities and Exchange Commission decreed on Wednesday that mutual fund boards must have chairmen who are independent from the companies managing the funds.
In a rare public display of dissension, two of the panel’s three Republican members said they could not support the far-reaching rule change because they had seen no evidence that it would prevent abuses in the fund industry and it could have harmful effects on funds’ operations.
“The benefits are illusory but the costs are real,” Cynthia Glassman, one of the Republicans, said before the vote at the public meeting.
The vote to adopt the proposal was 3-2, as SEC Chairman William Donaldson and the two Democratic commissioners supported it in a politically unusual alignment.
Donaldson, a Bush appointee and former Wall Street executive, insisted that independent chairmen were needed as a way to avoid conflicts of interest that are built into the mutual fund system and to protect fund investors.
The new rule, to take effect in 18 months, could shake up the $7 trillion mutual fund industry. Some experts estimate that the boards of 80 percent of U.S. funds — or about 3,700 funds — will have to replace their chairmen.
Glassman and Paul Atkins, who also cast a dissenting vote, said they could not endorse an action that, while well-intentioned, would force a sweeping change of that magnitude through an entire industry.
The fund industry’s trade group and several big-name fund companies fiercely oppose the change and have been lobbying the SEC members against adopting it.
But Donaldson said an outpouring of support had come from ordinary investors since the agency proposed the rule change in January.
“The proposal resonates strongly with individual mutual fund shareholders,” he said, describing a deluge of letters received by the SEC, many of them handwritten.
The action was the latest in a monthslong series of changes to mutual fund operations that the agency has undertaken to bolster investor confidence. The rule change that was adopted — the first in the series to split the panel — also requires that three-quarters of the directors on a fund company board be independent, compared with half now.
Critics of the proposal, including officials of big fund companies Fidelity Investments and T. Rowe Price Group, contend that it would not prevent abuses in the scandal-tainted industry. Those companies are among several whose chairmen are senior executives of the firms that manage the funds and have been untouched by the trading scandal. At the same time, several fund companies cited for abuses by the authorities do have independent chairmen.
Other prominent Republicans — including Rep. Michael Oxley of Ohio, chairman of the House Financial Services Committee — vigorously support the proposal.
Buttressing Donaldson, all seven living former SEC chairmen — five Republicans and two Democrats stretching back to the Nixon administration — sent a letter to the agency last week endorsing the rule change.
“We believe an independent board chairman would be better able to create conditions favoring the long-term interests of fund shareholders than would a chairman who is an executive of the adviser,” they wrote.
Scores of investment complexes have been swept up in the scandal that began last fall, when New York Attorney General Eliot Spitzer accused a hedge fund of securing special trading privileges at several big-name mutual fund companies. Since then, several fund companies and executives have agreed to settlements worth hundreds of millions of dollars to resolve improper trading cases.