Independent Directors and Mutual Fund Boards

The U.S. Court of Appeals for the District of Columbia Circuit released Chamber of Commerce v. SEC earlier this week. The case involved a challenge by the Chamber to SEC rules regarding governance of mutual funds under the Investment Company Act of 1940. The SEC's rules require that to be exempt from certain rules, the mutual fund must have a board with no fewer than 75% independent directors and an independent chairman. These SEC rules have had a tortured administrative life and were the subject of an earlier challenge by the Chamber (see Chamber of Commerce v. SEC, 413 F.3d 133 (D.C. Cir. 2005). Following that decision, the SEC modified the rules quickly without further notice and comment. The decision this week dealt with the Chamber's challenge to the SEC's process.

This week's opinion discusses the SEC's rulemaking processes in great detail. Rulemaking is governed by the Administrative Procedures Act requirements, such as providing a notice and comment period and the publication of studies and data upon with the agency relies. When an agency has gathered information and provided for a notice and comment period, "further notice and comment are not required when additional fact gathering merely supplements information in the rulemaking record. . . . " The crucial question is whether "at least the most critical factual material that is used to support the agency's position . . . has been made public. . . ." An agency can rely on extra-record information provided that the information simply clarifies or expands on information that is a part of the public record.

The court noted in the decision that the SEC's information on the costs of the rulemaking did not place interested parties on notice that the SEC would base cost estimates on extra-record information. Further, the information the SEC did have was stale by the time of the rulemaking. In light of these factors, the court determined that "the Chamber has been prejudiced by the Commission's reliance on materials not merely supplementary to the rulemaking record."