The five SEC commissioners gave a thumbs up to new rules that require mutual funds to have independent chairs. While the outcome of the vote has been predicted for days, what was less expected was division among the commissioners revealed in this morning's meeting.

In a Wednesday morning meeting, SEC commissioners voted 3 to 2 to approve the controversial independent chairman proposal. Chairman William Donaldson called the approval of the independent chair proposal a "keystone" of the new wave of fund reform.

The commissioners also voted to require disclosure of advisory contract proposals. Unlike the independent director vote, the vote on advisor contract disclosure was 5-0.

The split vote on the proposal requiring that fund board directors be independent marks one of the few times the five commissioners split their votes. Indeed, all but 16 of the 1,606 votes that have been held since Donaldson took over for Harvey Pitt have been 5-0. Although today's vote marks only the seventeenth split vote, it may indicate the split in the commissioners on the issue of fund reform.

Donaldson acknowledge the attention now being paid to a possible partisan divide among the Commissioners and stressed the Commissioners track record of unanimous votes under his leadership.

"[M]uch has been made about the division within the Commission on the recommendation before us...While we may not always agree on every issue, I have nothing but respect for the opinions that have been expressed, and the people who are expressing them," said Donaldson.

The two Republican Commissioners Cynthia Glassman and Paul Atkins voted against the measure, while Donaldson and Democratic Commissioners Harvey Goldschmid and Roel Campos voted in favor of the governance proposal.

While Donaldson is a Republican and was appointed by President Bush, the remaining four seats must be split between the two parties by law.

During the meeting the four commissioners' comments reflected classic party beliefs. The Republican commissioners, among other criticisms, said that the agency was overreaching and ignoring competition in the marketplace. Glassman called approval of the proposal a "regulatory fiat," while Atkins said that the commission was not considering that investors had walked away from scandal-tainted firms -- "we completely ignore market power."

For their part, Democrats emphasized the benefits of the regulation to investors, the inherent conflict of interest in inside director-chaired funds, and investor constraints. Campos said that investors in 401(k) plans may find it difficult to easily withdraw from funds, especially losses.

The governance proposal also includes three less-controversial measures to improve fund governance: requiring directors to conduct self evaluations annually, requiring independent directors to hold meetings without fund management, and allowing directors to hire their own staff to carry out their duties.

But the two that have received the most attention are the proposal to require that three quarters of a fund's board of directors be made up of independent directors, and that an independent chairman head a fund's board.

The lack of empirical evidence was a major theme throughout the debate. Glassman and Atkins criticized the proposal for lack of empirical evidence supporting that independent chairmen correlate with lower fees or higher fund performance, and that alternatives to the mandate were not considered.

The governance proposal was drafted "with the best possible intentions," said Glassman. Revealing dissatisfaction with the agency itself, Glassman said the commission "did not commit resources" to meet the challenge of empirical proof. She also added that the 75 percent supermajority seemed to be an arbitrary number that "may do no harm, but it will accomplish little."

"In sum, the benefits are illusory, but the costs are real," concluded Glassman.

Atkins commented against the proposal at length, criticizing at several times the SEC's own proposing release. Later in his speech, Atkins said he was not criticizing the staff of the Division of Investment Management, the division responsible for analysis of the proposal.

Atkins also questioned the staff about whether the proposals would lead to barriers to entry and heavier burdens on smaller fund firms. The staff responded that technology costs are the main barrier to entry. Paul Roye, head of the Division of Investment Management, countered that the nature of the business -- "managing people's money" -- requires a certain level of compliance.

Donaldson stressed experience over empirical studies, saying "you can do anything you want with numbers...as we have seen that in submissions."

Highlighting an issue none of the commissioners brought up, Donaldson spelled out the "interpersonal dynamic" between independent directors and the very managment that hired them. He concluded that expecting independent directors to fire the very person that hired them a "breach [of] personal relationship."

It was widely reported that the commissioners would approve the controversial governance measures earlier this week. Chairman William Donaldson hinted at his position in a Sunday speech at Stanford University: "[w]hen the Chairman or CEO of a mutual fund's adviser is simultaneously serving as the Chairman of the mutual fund itself, this individual is put in the untenable position of having to serve two masters."

Prefacing the issue, Donaldson summarized the commentators by highlighting the more than 180 comments submitted, most by fund shareholders, "in a number of cases handwritten," that galvanized in support of the governance proposal. Donaldson said 85 percent of individual shareholder comments supported the measure.

Prior to their vote on the governance proposal, the commissioners approved a proposal to require disclosure of specific factors in a board's decision to grant advisory contracts.

The only commissioner that expressed reservations about the advisory proposal was Glassman, who said she was concerned with "information overload" from the perspective of an investor. She asked the staff to consider streamlining and prioritizing shareholder information.

Roye's response gave SEC-watchers a hint of what's coming next: "after we get through this wave of rulemaking, we will be focusing on these issues."  

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