The new plan, to go into effect in 18 months, forces mutual fund boards to appoint chairmen who are independent from the fund company's management. The new set of rules also increases the number of independent members on a board of directors to at least 75 percent, up from the current 50 percent.
The rule requiring an independent chairman is intended to avoid potential conflicts of interest on mutual fund boards. Board chairmen traditionally hold an influential role in establishing fund policy and management compensation. Investor advocates say fund chairmen and directors who are connected to management are inherently biased in favor of management's interests rather than those of investors.
After sharp disagreements during its public meeting, the SEC's commissioners voted 3-2 in favor of the rule, which was opposed by the mutual fund industry and is expected to result in the replacement of most chairmen now in place.
SEC Chairman William Donaldson and the two Democratic commissioners, Harvey Goldschmid and Roel Campos, championed the reform, despite opposition from two Republican members, Cynthia Glassman and Paul Atkins.
Donaldson, a Republican appointed by President Bush, said the agency received a flood of support from average investors when the SEC initially proposed the rule change in January.
"The proposal resonates strongly with individual mutual fund shareholders," Donaldson said following the open meeting Wednesday.
Those opposed to the SEC's new rule, including officials of large fund companies Fidelity Investments and T. Rowe Price Group, argue that it will not prevent abuses in the industry.
Fidelity Investments Chairman and Chief Executive Edward Johnson argued against the proposal in an op-ed column in the Wall Street Journal in February, contending that his dual roles of fund chairman and company executive ''mean that my personal, professional and financial interests are directly aligned with those of Fidelity shareholders."
Johnson furthermore pointed out that the independent chairman at Putnam Investments did not preclude that Boston mutual fund company from being hit with improper trading allegations, which Putnam paid $110 million to settle in April.
Nevertheless, the proposal for independent chairmen received a strong endorsement from all seven living former SEC chairman, who sent a letter of support to the SEC last week.
"We believe an independent board chairman would be better able to create conditions favoring the long-term interests of fund shareholders than would a chairman who is an executive of the adviser," wrote the former chairmen, who include five Republicans and two Democrats.