On December 21, 2006, the SEC requested additional public comment on two papers prepared by the SEC’s Office of Economic Analysis (“OEA”) recently made public in connection with the SEC’s controversial 2006 independent chair and 75% board independence rules. The comment period ends on March 2, 2007.

You may recall that the SEC’s 2006 independence proposals required that mutual funds relying on any of the enumerated exemptive rules under the 1940 Act be required to have a board (1) constituted with no less than 75% disinterested directors and (2) with an independent chairperson. In 2006, the United States Court of Appeals for the District of Columbia vacated the independence rules on the grounds that the SEC violated the comment requirements of the Administrative Procedure Act (“APA”). In particular, the Court held that the SEC failed to comply with the APA because it relied for its cost estimates on materials not in the rulemaking record without affording the public an opportunity to comment on these materials. The APA requires that a government agency reveal for public evaluation the “technical studies and data” on which the agency relies in the rulemaking process.

The two papers issued by the OEA studied the costs and benefits of the SEC’s independence proposals. The first study1 indicates that existing data has failed to “consistently document a statistically significant relation between fund governance and performance, particularly with respect to board chair independence.” The paper suggests that there may not be reliable statistical methods available for measuring the relationship between fund governance and performance, although such a relationship could exist.

The second paper2 examined literature on financial economics related to fund governance and similarly concluded that empirical analysis did not provide consistent guidance on the best fund governance structure. For example, the report found that boards with a higher proportion of independent directors are more likely to negotiate lower fees, merge poorly performing funds sooner or provide greater protection to investors from abuses such as market timing and late trading. On the other hand, it also concluded that there is little consistent evidence that board composition is related to lower fees and better fund performance. In this regard, the report stated that there are several factors, other than fund governance, that can affect fund fees and performance and that it is not possible to isolate fund governance as a determining factor. This report also concludes that fund board structure may vary from fund to fund depending on business and other issues.

The SEC published these papers as part of the review it promised of the costs and benefits of the independence rules. The SEC published these papers as part of the review it promised of the costs and benefits of the independence rules.