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News August 1, 2005 Issue

Chamber Asks Court for Emergency Stay and Reconsideration of Fund Governance Rules

Last week, the U.S. Chamber of Commerce asked the U.S. District Court of Appeals to not only stay the January 2006 compliance date of the SECís independent chairman and 75 percent independent director requirements, but also to rethink part of its June 21 decision.

As you may recall, the courtís decision basically upheld the SECís rules, but instructed the SEC to go back to school on its cost-benefit analysis and re-consider whether disclosure might serve as an alternative to the independent chair requirement. On June 29, the day before SEC Chairman William Donaldson left the SEC, the Commission held its now-infamous open meeting where it voted 3-2 to adopt a hastily-prepared cost-benefit analysis. On July 7, the Chamber filed a two-page "Petition for Review," which technically brought a new lawsuit against the SEC based on the inadequacy of the revised cost-benefit release. A few days later, the Chamber formally asked the SEC to stay the rules. On July 15, the Commission tied 2-2 on whether to grant the stay, and therefore the stay was not granted.

Which brings us to last week.

On July 26, the Chamber filed an "Emergency Motion" asking the court to impose the stay, and to do so no later than August 16.

Whatís the rush? If a stay is not granted, explained the Chamber, the rulesí January 2006 compliance date likely will have come and gone by the time the court reaches a decision on the Chamberís petition for review. A stay, said the group, is necessary to allow the court to review the SECís compliance with its remand "and to prevent the now-former majority of the Commission from entrenching the disputed provisions as a fait accompli in which the intended roles of the public, fellow Commissioners, and the court have all been foiled."

Even if the court ultimately decides to throw out the rules, said the Chamber, the fund industry would have already incurred the sunk costs of recruiting new independent directors. And, it argued, changes made to fund boards would, in many cases, be irreversible: "The Chamberís ultimate success in this lawsuit would neither remove the chairs and directors appointed as a consequence of the Commissionís new rule, nor restore those whom the rule ousted."

The Chamberís 28-page Emergency Motion slammed the SECís revised cost-benefit analysis, calling it the result of a "mad dash to a predetermined outcome." Among other things, the Chamber claimed that the SEC:

  • ignored the Investment Company Instituteís offer to gather data based on fund groupsí actual experience with the rulemaking;
  • improperly relied on a newsletter published by a "partisan" consultant, C. Merrick Payne. The Chamber asserted that Payneís income is tied to assisting funds with complying with the new independent director role. While Payneís newsletter was "publicly-available," and therefore part of the public record, the Chamber noted that being publicly-available does not translate into reliability (The National Enquirer, it noted, also is publicly-available);
  • underestimated the cost of an attorneyís time at $300 per hour, calling that "implausible"; and
  • improperly relied on the SEC staffís "experience," without specifying what, exactly, that "experience" consisted of.

On the last point, consider the following statement made by Division of Investment Management acting director Meyer Eisenberg during the SECís June 29 open meeting: "I have served as a staff member of the Commission for a total of over 16 years under seven chairmen; ten years from 1959 to 1970, under four chairmen, and six and a half years from December 1998 until now, under three chairmen. Much of that time, as well as my 28 years in private practice in between, was devoted to Investment Company and Investment Advisers Act issues."

Sounds like someone was trying to tell us a bit about his experience, eh?

In any event, itís likely that the SECís reply brief will echo statements made during the open meeting by the Division staff that worked on the cost-benefit analysis. Division assistant director Hunter Jones explained the staffís "basic approach" as using the information in the public record (namely, the comment letters filed on the rulemaking, supplemented "as we normally do" by publicly-available information) "as well as the other estimates and assumptions that we make when preparing a cost-benefit analysis."

During the meeting, SEC associate director Robert Plaze noted that the most difficult part of the staffís cost-benefit analysis "is the beginning," where the staff has to decide what assumptions to make. "Everything flows from those initial assumptions," said Plaze. The courtís instructions on remand actually helped the staff prepare the cost-benefit analysis. "Whatís really unique about this cost-benefit analysis is we have the benefit of the court that told us exactly how to do it in more detail than I, as a supervisor, can rarely give my staff," said Plaze. In fact, he added, it was the courtís guidance that made the quick day turnaround of the revised cost-benefit analysis possible.

Plaze also noted that typically only one or two staff attorneys are assigned to work on a cost-benefit analysis. "Here, we had five, six, seven people working practically full time for a week, including weekends," he said. "In my career, I have never spent as much time nor have I seen as many staff hours spent in analyzing cost-benefits." Like Jones, Plaze emphasized that the staffís reliance on data from both comments and public sources "is identical to what we would do for every normal adoption of rulemaking."

So: Why did the SEC initially insist that it had no basis for making certain estimates? In preparing the initial cost-benefit analysis, Plaze said that the staff concluded that it didnít "have a clue" as to what percentage of fund boards would appoint directors to meet the new requirements and what percentage would need to elect directors and potentially solicit proxies.

Despite that, Plaze said that the staff had "a good understanding" that in light of the $8 trillion size of the fund industry, "the whole governance system as it exists today is nary a line item on a financial statement for a mutual fund." Since, relatively speaking, the cost one way or the other was minimal, the staff decided it didnít need to guess. Because fund governance "costs so little," he explained, "we werenít going to attempt to make all those conjectures."

Added Plaze: "The court said we were wrong, obviously. And we listened to the court and we did exactly what the court said using the same exact tools we would use in any rulemaking of this significance, and we have always used before."

Under court rules, the SEC has until August 5 to file a response to the Chamberís motion, unless the Court orders a different schedule.

But wait, thereís more!

On July 28, the Chamber filed a separate "Petition for Rehearing," which continued the initial Chamber v. SEC lawsuit brought back in September 2005. In the 11-page petition, the Chamber asked the same three-judge panel that initially decided the case to reconsider the part of their decision that upheld the Commissionís judgment that the independent chair and 75 percent independent director requirements were reasonable prophylactic responses to perceived risks in the fund industry. The Chamber argued that the conduct governed by the various fund exemptive rules amended in the fund governance rulemaking were not at issue. "The sine qua non of the amendments was to use the exemptive rules collaterally to regulate matters that the rules themselves ó and the statutory authority on which they rest ó do not reach," said the Chamber. If allowed to stand, they argued, the courtís decision would enable the SEC "to leverage a narrow statutory grant of deregulatory authority to implement sweeping regulatory changes in a widely-noticed case." That, in turn, would either become "important precedent" for other agencies to expansively use their statutory authority, or would have to be "distinguished in the future in a way that produced confusion rather than clarity in the law."

Wait a minute . . . "clarity in the law" . . . where have we heard that before?

During his Senate Banking testimony, Christopher Cox said that one of his top priorities as new SEC chairman would be to "cultivate respect for the rule of law" by bringing "clarity" (as well as "continuity" and "consistency," we might add) to the SECís rulemaking process.