Regression Analysis and Strengthening the SEC’s Efforts to Regulate Mutual Funds

Early in 2004 the Securities and Exchange Commission (SEC) proposed new conditions that Mutual Funds would need to satisfy in order to engage in otherwise prohibited transactions, i.e. those that the fund’s advisor would also benefit. In particular, the fund would be required to have a Chairman and at least 75% of its Directors independent of its advisors and sponsors. The Commission adopted this and other new conditions in light of recent abuses in the mutual fund industry and felt that more independent directors would provide greater oversight of activities that involve inherent conflicts of interest between the funds and their managers in order to protect shareholders. The industry challenged the new proposal. In Chamber of Commerce of the United States of America v. Securities and Exchange Commission 3 the Court of Appeals of the D.C. Circuit held that while the Commission had the legal authority to establish additional conditions on the funds, its deliberations did not fully comply with the Administrative Procedures Act. In particular, the Commission had not considered the potential costs of more independent directors versus those of a proposed alternative involving fuller disclosure by investment companies. Within days after this decision was issued, the SEC published a Response Release stating that it was unnecessary to reopen the rulemaking record for additional comments as the information in the existing record together with other publically available information was sufficient to remedy the deficiencies noted by the court. The Chamber of Commerce again challenged this procedure, in part because when an agency determines that additional fact gathering is needed, public notice and comments are typically required. In Chamber of Commerce of the United States of America v. Securities and Exchange Commission II 5 the court vacated the rule and gave the SEC time to reopen the record. The decision noted that the SEC estimated the cost of requiring an independent chair on the increased compensation for the chair and the cost of extra staff using information obtained from “extra record” summaries of two surveys, one of which was not even available during the previous comment period.