An U.S. Court found the U.S. Securities and Exchange Commission did not properly consider the costs mutual fund companies would face, or possible alternatives, when it voted to go ahead with a rule setting requirements for fund board independence: it has sent the rule back to the commission for further consideration.

The U.S. Chamber of Commerce petitioned the court seeking a review of the rule regarding the independence of mutual fund boards. The challenged provisions of the rule require that, in order to engage in certain transactions otherwise prohibited, a mutual fund must have a board with no less than 75% independent directors and an independent chairman. The rule was one of the controversial issues, which saw outgoing SEC chair Bill Donaldson side with the Democratic commissioners against the Republicans.

The Chamber argued the legislation does not give the commission authority to regulate “corporate governance” and that it adopted the rule without adhering to the requirements of the Administrative Procedure Act. In a decision released today, the D.C. Circuit Court of Appeal found the commission did not exceed its statutory authority in adopting the two conditions, and the commission’s rationales for the two conditions satisfy the APA.

However, it also notes the SEC did violate the APA by failing to consider the cost burden on mutual funds. “We agree with the Chamber, however, that the commission did violate the APA by failing adequately to consider the costs mutual funds would incur in order to comply with the conditions and by failing adequately to consider a proposed alternative to the independent chairman condition,” it says.

In addition to arguing that it didn’t properly consider the costs, the Chamber argued that the commission gave “inadequate consideration” to suggested alternatives to the independent chairman requirement, for example using disclosure as an alternative, as the dissenting commissioners preferred. The court agreed, saying, “The Commission’s failure to consider the disclosure alternative violated the APA.”

“The disclosure alternative was neither frivolous nor out of bounds and the commission therefore had an obligation to consider it,” it says. “The commission may ultimately decide the disclosure alternative will not sufficiently serve the interests of shareholders, but the commission–not its counsel and not this court–is charged by the Congress with bringing its expertise and its best judgment to bear upon that issue.”