Fight likely to continue over independent chairs

July 10, 2005|By CHARLES JAFFE

IN TRYING to get more mutual fund reform done before he walked out the door at the Securities and Exchange Commission, Bill Donaldson might have inadvertently slammed the lid shut on what he clearly considered a key change for investors.

Donaldson, who left his post as SEC chairman last month, pressed for his agency to reintroduce a rule - first passed last year - that requires funds to put an independent chairman of the board in place by January.

The rule was shot down June 21 by a federal appeals court review, the result of a U.S. Chamber of Commerce lawsuit that argued regulators had not taken enough time to study alternatives or the financial impact the new rules would have on funds and shareholders.

But Donaldson rushed a new vote - supposedly based on new estimates that the cost of the rule would be minimal and that disclosure would be an ineffectual alternative - and so the change is back on track.

For now.

California representative Christopher Cox has been tabbed by President Bush to succeed Donaldson, a change awaiting approval from the Senate. To get the independent chairman's rule passed, Donaldson crossed party lines and voted with two Democratic SEC commissioners; the two Republican commissioners voted against the rule.

If the rule again gets beaten down in court - and the Chamber of Commerce is not giving up easily - it will come back to an SEC where party politics suggests it will be defeated.

Moreover, observers on Capitol Hill suggest that Cox is less regulation-minded than Donaldson; one way for him to signal that there's a new sheriff in town would be for him to step in and pull the agency back from Donaldson's pet cause.

Here's where things get a bit goofy. A number of media members have suggested the fund industry is fighting the change tooth and nail. Consumer advocates have hinted that the rule is necessary to make sure that investors are adequately protected against future scandals. And if Cox steps in to help the change go down, he will be painted as anti-investor.

It makes for good sound bites, but there's just no proof that investors will notice the difference.

The few studies done on the issue have suggested that having an independent chairman makes no drastic difference in the two areas that matter most to a shareholder: performance and costs. In fact, the tiny difference that does exist actually shows that funds with insiders as chairmen come out on top.

That might change in the future, as the sample of funds with independent chairs grows.

But the bottom line is that an ordinary investor can't tell the difference between a fund with an independent chairman and one with an insider at the helm. It's hard to suggest that with three-quarters of a board being independent, the chairman has enough power to railroad the other directors into making decisions that were not in the best interest of shareholders.

Here's where Donaldson messed up. Had he made the independent chairman's rule voluntary, it would have become the industry's "best practice" over time, without much fanfare. Instead, the rule is now a political football Cox will punt.

Indeed, 12 of the 20 largest fund group already have boards with an independent chair, including the American, Janus, AIM, Putnam and Oppenheimer funds. The remaining members of the top 20 - including Fidelity, Vanguard, T. Rowe Price and Franklin Templeton - have taken a wait-and-see posture, mostly hoping that the Chamber would win its case and the rule would be struck down.

"An investor won't notice an independent chairperson in the least," says Geoff Bobroff, an industry consultant who has studied the impact independence has on performance and costs. "Generally, the chairman doesn't sign the letter to shareholders in the annual report, and it's not like an investor has much interaction with the board at all. The dynamics of the board room have really changed in the last 12 to 18 months, and there's no going back on that. In those ways - which are more important to the day-to-day operations of a fund - the change has been made."

The point is investors have seen a huge change in corporate governance. Directors clearly are providing safeguards on issues they might have let slide in the past. While the independent chair would be an additional protection, it's a bit like wearing two raincoats; the basic barrier to trouble already was erected. While an independent chairman is the right way to go, Donaldson pursued it the wrong way and investors should expect the rule to go down. It will be a disappointment when it happens.

Charles Jaffe is senior columnist for MarketWatch. He can be reached at or Box 70, Cohasset, Mass. 02025-0070.

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