A federal appeals-court panel criticized the Securities and Exchange Commission (SEC) yesterday for failing to consider the costs of and...

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WASHINGTON — A federal appeals-court panel criticized the Securities and Exchange Commission (SEC) yesterday for failing to consider the costs of and alternatives to a key mutual-fund initiative, sending the rule back to the agency for more work and casting doubt on its future.

The U.S. Court of Appeals for the D.C. Circuit unanimously agreed with complaints by the U.S. Chamber of Commerce and two SEC commissioners, who argued that the agency failed to evaluate the rule’s expense and whether there were better ways to prevent conflicts of interest. The rule requires mutual-fund boards to appoint chairmen without ties to management.

In the 19-page ruling, Chief Judge Douglas Ginsburg directed the agency to analyze “the economic consequences of a proposed regulation before it decides whether to adopt the measure.” The judge added that the SEC was obliged to consider an alternative, supported by Republican Commissioners Paul Atkins and Cynthia Glassman, that would mandate that funds tell investors whether their board chairmen were independent.

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“The SEC failed to satisfy basic rule-making requirements by ignoring important information about the costs — and the consequences — of the rule,” said Stephen Bokat, executive vice president at the chamber’s litigation unit, which filed the case.

The measure, which affects about 80 percent of the $7.9 trillion industry, drew opposition from companies including Fidelity and Vanguard Group. A divided SEC passed the rule in a 3-2 vote last year. It had been scheduled to take effect in 2006.

Chairman William Donaldson, the rule’s biggest champion, exits next week. Under his watch, the agency passed more than a dozen measures related to mutual funds, as federal lawmakers and New York Attorney General Eliot Spitzer urged quick action to restore investor confidence after multiple trading abuses. The agency is expected to hold a public meeting before Donaldson’s June 30 departure, but it is unclear whether SEC staff members could complete their work on the rule in time for a vote.

The White House has nominated Rep. Christopher Cox, R-Calif., to replace Donaldson. Cox’s appointment requires Senate confirmation. He has not expressed a position on the issue.

Democratic Commissioner Harvey Goldschmid, who voted to support the rule last year, took comfort in the fact that the court affirmed the SEC’s authority over mutual-fund governance. He said the problems the appeals court cited “should be easy to remedy.”

Goldschmid is leaving the agency as early as this summer to return to a teaching position at Columbia University’s law school, though he told lawmakers last week that he might stay until the Senate confirms his successor.

The third commissioner who voted to support the rule, Democrat Roel Campos, is seeking renomination to the five-member panel. Senate Democrats have forwarded his name to the White House. Under the rules, Campos can remain at the SEC for up to 18 months.

Mercer Bullard, a law professor at the University of Mississippi, called the court decision “disappointing but not surprising,” since the SEC’s reasoning had been roundly criticized for months. Bullard, a former agency lawyer, said that mutual funds could decide on their own to appoint independent board chairmen as an investor-friendly move while the SEC reviews its options.

Bullard added that the court ruling could spell trouble for another controversial SEC rule requiring hedge funds to register with the agency, “because the analysis there is even weaker.”

The federal appeals court in Washington, D.C., is considering a separate lawsuit filed by a New York hedge-fund manager who argues that the SEC overstepped its authority in the registration rule. The court has not yet scheduled an oral argument in that case.