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. Last Updated: 07/27/2016

Court Orders SEC to Reconsider Rule

WASHINGTON -- A federal appeals court ordered the U.S. Securities and Exchange Commission to reconsider a rule requiring mutual funds to be overseen by independent chairmen, a victory for Fidelity Investments and Vanguard Group, which spent more than a year fighting the provision.

The decision by a three-judge panel of the U.S. Court of Appeals for the District of Columbia Circuit in Washington said the SEC failed to properly consider the costs of the governance rule passed last June. About 80 percent of fund companies, including Fidelity and Vanguard, have boards run by insiders.

The SEC has a legal "obligation to determine as best it can the economic implications of the rule it has proposed," Chief Judge Douglas Ginsburg wrote in the unanimous decision.

Tuesday's ruling is a setback for departing SEC Chairman William Donaldson, who heralded the requirement as a central part of the agency's efforts to curb trading and sales abuses in the $7.9 trillion industry. Donaldson is leaving at the end of this month, and it is unclear if the SEC will respond to the court's concerns before he goes.

Republican Representative Christopher Cox of California has been named by President George W. Bush to replace Donaldson. His views on the case could be decisive since the rule passed on a 3- 2 vote, with Donaldson siding with the two Democratic commissioners, Harvey Goldschmid and Roel Campos.

While the decision calls for the SEC to re-evaluate the measure, it does not necessarily mean the rule will be scrapped. The requirement said 75 percent of fund board directors must be from outside the company.

Ginsburg, along with Judges Judith Rogers and David Tatel, also found the SEC had the legal authority to craft the requirement, which is slated to go into effect early next year.

The court said the SEC's failure to fully take into account the costs of the rule and to consider an alternative violated the Administrative Procedure Act, which gives federal agencies such as the SEC the power to write regulations.

There is "a good chance that the whole decision on whether to try to resuscitate this rule is going to be deferred," said Kathryn McGrath, a partner at Crowell & Moring in Washington and former head of the SEC's mutual fund division. "I seriously doubt that it's going to go in effect in January."

Former SEC Chairman Harvey Pitt, who supported the rule, said the decision "points up some of the serious weaknesses" at the SEC.

The SEC said it was reviewing the court's decision and considering how to proceed. "We are pleased that the court determined that the commission acted within its authority and that the commission's rationale satisfied the requirements of the Administrative Procedure Act," SEC spokesman John Nester said. "We will review how best to respond to the concerns identified by the court regarding the analysis of costs."