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Who's Right, The SEC Or Ned Johnson?


Since 1946, a member of the founding Johnson family has sat at the head of the board table for every one of Fidelity Investments' mutual funds. The current chairman, Edward C. Johnson III, chairs all of Fidelity's 292 funds. And Fidelity-watchers have long assumed that when 73-year-old Ned Johnson retires from the No. 1 fund company, the fund chairmanships would pass to his daughter, Abigail P. Johnson, president of the management company that oversees Fidelity fund investments.

The Securities & Exchange Commission may be about to end that succession. In a landmark decision scheduled for June 23, the five-member commission is expected to require that three-quarters of mutual-fund directors -- including a fund's chairman -- come from outside the company. Ned Johnson won't be the only one losing his title: At 80% of funds the chairman is an executive affiliated with the fund's management. Under the rule, hundreds of insider chairmen would lose influence over such crucial matters as the level of the annual advisory fee that their funds pay the management companies.

The rule change will usher in a new era for the $7.4 trillion fund industry. Putting outsiders in the driver's seat should foster closer scrutiny of fund management companies -- their conflicts of interest and their sometimes mediocre performances. And a fund chairman who isn't beholden to the manager is more likely to press for the best deal for shareholders on fees. "If you want [the board] to be a watchdog, you shouldn't have the fox guarding the henhouse," says Christopher J. Traulsen, a mutual-fund analyst at Morningstar Inc.

But don't call Fidelity a den of foxes. The Johnsons take pride in their reputation for unassailable stewardship, and they have taken the lead in the industry's full-court press against the new rules. Ned and Abigail have personally phoned or visited SEC Chairman William H. Donaldson, Senate Banking Committee Chairman Richard C. Shelby (R-Ala.), and other key Washington players. Fidelity has deployed executives and lobbyists armed with studies and campaign contributions to drive home the message: Let fund directors choose whomever they want to be chairman. And the Johnsons are hardly alone in their quest. Other industry players, including Vanguard Group Chairman John J. Brennan and T. Rowe Price Group Vice-Chairman James S. Riepe, have also chimed in.

"A FUNDAMENTAL CONFLICT"

The tactics have scored on Capitol Hill. The industry has beaten back four attempts to pass an independent-chairman rule in the House. And Shelby says that for now he sees no reason to consider a fund reform bill. While that may seem like a big win for the industry, the fight is far from over.

Donaldson seems determined not to let fund managers sit on both sides of the table and is set to impose a regulatory fix where congressional action is falling short. "There's a fundamental conflict between the management company and the fund," says Donaldson. "It's impossible for someone to wear both hats."

Whether they agree or not, more funds are bowing to the inevitable, quietly electing independent chairmen. Not surprisingly, some of the recent converts are fund groups, including Janus and Massachusetts Financial Services Co., that have settled SEC and state charges of abusive trading. And given the pressure to improve governance, "most boards are close to appointing independent chairmen whether the SEC requires it or not," says C. Meyrick Payne, senior partner of Management Practice Inc., a consulting firm that advises independent fund directors.

Will investors be better off? Many fund experts think so. A board comprised of 75% outside directors and an outside chairman is more likely to demand a lower advisory fee, cut costs, and deliver better results. "There's a far greater likelihood that you will see fees come down and that advisers who are underperforming will get fired," says Morningstar fund analyst Jeffrey Ptak.

Fidelity contends, based on a study of large fund families, that funds with independent chairmen don't perform as well as those chaired by affiliated directors and don't always have lower expenses. Nor will outside chairman improve fund governance, according to the study. "Mandating an independent chairperson is akin to requiring that every ship have two captains," Chairman Johnson warned in a Wall Street Journal op-ed piece. Both Ned and Abigail Johnson declined to comment for this story.

Some experts dispute Fidelity's logic. They contend the size of the funds used in the Fidelity study -- not whether the chairmen were affiliated -- skewed the results in favor of Fidelity's argument. That's because the fund families led by affiliated chairmen in the study were, on average, twice as large as those that had independent chairs. And large funds, with their huge economies of scale, tend to have far lower costs than smaller funds. "When there are two clearly distinct corporate ships -- the management company and the fund, each with its own set of owners -- there ought to be two captains," says Vanguard Group Inc. founder John C. Bogle, a persistent industry critic.

Fidelity isn't depending on statistics alone to make its case. It has augmented the Johnsons' appeals with outside lobbying help. Last year, as a House panel was hammering out mutual-fund reform legislation, Fidelity paid $100,000 to the Federalist Group LLC, a lobbying shop whose principals include former aides to Republican congressional leaders.

FENWAY TICKETS

In mid-April, Fidelity hosted about a dozen congressional staffers for two days of seminars on the fund industry and its regulatory and legislative issues. But the highlight was an evening at Fenway Park watching the Red Sox beat the New York Yankees. David C. Weinstein, Fidelity's executive vice-president for government relations, says the purpose of the program was to help staffers "make better decisions on policy issues affecting us."

Fidelity isn't a heavyweight political donor, but it has made strategic use of campaign contributions. The company and its employees have given $654,000 to candidates this election cycle, 79% to Republicans. Its biggest Senate recipient is Banking Committee Chairman Shelby, with $31,250. That puts Fidelity at No. 20 on Shelby's list of donors. On Mar. 31, 14 Fidelity officials forked out $13,250 at a Shelby fund-raiser in Boston. Eight days later, Shelby announced he had decided to hold off on mutual-fund legislation. Shelby says campaign contributions played no part in his decision. "If you're going to demand that the board be 75% independent, the directors themselves ought to be able to vote to determine who the chairman will be," says Shelby.

With Congress unlikely to enact a law this year, the focus has turned to the SEC. Agency insiders believe Donaldson has the support of both Democratic commissioners, Harvey J. Goldschmid and Roel C. Campos. He may not win over his two fellow GOP commissioners, Paul S. Atkins and Cynthia A. Glassman. Both have expressed doubts about the value of requiring outside chairmen. Still, the rule change isn't a partisan issue. All seven living former SEC chairmen -- five Republicans and two Democrats -- publicly endorsed it in a June 15 letter to the agency.

The end of an era for Fidelity and scores of other fund complexes? No doubt about it. Now, along with numerous other new SEC rules requiring fund directors to take a more active role, the industry's 93 million fund shareholders may finally get a chance to see whether independent chairmen make a difference.

By Amy Borrus, with Paula Dwyer, in Washington


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