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Getting down to business
On a snowy February morning, his ninth day as chairman of the U.S. Securities and Exchange Commission, William Donaldson addressed the annual "SEC Speaks" conference of securities lawyers at the Washington Hilton Hotel. The grand ballroom was jammed. The veteran Wall Streeter would be making his first public remarks since President George W. Bush recruited him to take over the agency following the resignation in disgrace of the hapless Harvey Pitt.
The SEC, America's chief capital markets regulator, had been gravely wounded by the popular perception that it had fallen asleep at its post while CEOs were robbing shareholders and brokerage firms were gulling investors. Morale at the agency had sunk even lower than the Nasdaq composite index.
Donaldson greeted the attorneys then did something that caught them completely off guard. "I'd like to ask all of the SEC staffers present to stand up," he said. Surprised, some 200 agency employees around the room rose slowly to their feet.
"I want people to see who you are," Donaldson continued. "I think you deserve tremendous credit for the work you've done over the past year. It's been a difficult one, and rather than being distracted by the headlines and the enormity of the task before you, you demonstrated why the SEC staff is considered the best of the best. This is an incredible time in the SEC's history, and you are part of it." The chairman asked for a round of applause, and the rest of the room -- about 800 people -- erupted.
It was a simple act, but telling. By that afternoon Donaldson's comments were topic No. 1 of e-mails and corridor conversations at the agency. "Those kinds of things really make a difference to people," says Annette Nazareth, head of the SEC's market regulation division. "It's a gesture that gives you the feeling that we're all on the same team."
That Donaldson could engender such good will merely by acknowledging staffers attests to just how tough things have been at the agency. In fact, the SEC may be experiencing its most difficult period since President Franklin D. Roosevelt created it during the Great Depression. "Donaldson is facing the same kind of challenge that Joseph Kennedy did," points out Carla Rosati, executive director of the Securities and Exchange Commission Historical Society, referring to another Wall Streeter, who was the SEC's first chairman. "In that period, 1933'34, there was a real loss of confidence. No one was investing, and Kennedy had to start from scratch and say that, yes, there is an agency out there making it safe for you to participate in the markets."
Donaldson doesn't have to reinvent the SEC from scratch, but as a brokerage firm founder and former New York Stock Exchange chairman, he is well aware of the immensity of the task of restoring public trust in U.S. financial markets and in the agency that supervises them. "This is a rare time in American history when the chairman of the SEC is uniquely positioned to have a real impact," Donaldson told Institutional Investor during one of several interviews in his corner office in Washington (see page 36). "That's the reason I took this job."
The new chairman, who is 72 and whose term runs five years, appears to be in a hurry to remake the agency from wing tip to toe to bring it into the 21st century. Within days of taking office, he began the most sweeping reorganization of the SEC in its seven-decade history. His multiple goals: to enable the agency to anticipate and thus head off problems (like hedge fund excesses) before they become crises; to make sure that the SEC's long-overdue budget hikes -- a near doubling in two years -- aren't squandered; and to address the deep-seated alienation of some rank-and-file staff members who complain about a lack of vigilance and competence in management ranks.
"We don't have career civil servants writing the rules anymore -- Wall Street writes our rules," complains Michael Clampett, a 12-year veteran of the SEC's corporation finance division and president of the local chapter of the National Treasury Employees Union, which represents two thirds of the SEC's roughly 3,000 workers. "Instead of being the investor's advocate, we're the investment banker's advocate. We fell asleep on the job, and we're still asleep."
Donaldson found out early on that he needed to contend with sagging spirits at an agency that has been underfunded and understaffed for more than a decade. Investor complaints rose six times faster during the '90s than did the number of SEC employees assigned to look into them. And the agency's staff never even reviewed financial statements filed by Enron Corp. that contained buried clues to the massive fraud that brought the company down. Meanwhile, state regulators -- led by New York's ambitious attorney general, Eliot Spitzer -- have humiliated the SEC and its staff by repeatedly beating the agency to the punch in pursuing corporate wrongdoers and in compelling Wall Street to clean up its research and investment banking conflict.
Startling gaffes by Pitt further tarnished the SEC's reputation and worsened staff malaise. Once a top lawyer for big accounting firms, Pitt as SEC chairman met privately with former clients that were under investigation by the agency. He was effectively run out of office after nominating to head a new accounting industry oversight board a candidate who turned out to have chaired the audit committee of a company that was under investigation for questionable accounting.
Pitt's in-your-face micromanaging style terrorized many employees. "A lot of the staff really felt beat up by Harvey," says one senior SEC official. Pitt would aggressively drill staffers on legal minutiae, even footnotes, when considering new rules or enforcement cases. "He kind of suffered from smartest-man-in-the-room syndrome," adds the official. "He always had to prove to people that he knew it all. Even when you were getting a compliment, it was laced with blame or fault or some hint that you could have done a better job."
Donaldson couldn't be more different. The former diplomat has reached out to disenchanted staff and commissioners, soothing Pitt-era wounds and building collegiality. Underscoring the SEC chairman's top-cop role, he also has very publicly admonished Wall Street leaders -- including friends and former colleagues like Morgan Stanley CEO Philip Purcell and NYSE chairman Richard Grasso -- to adhere to the spirit, not merely the letter, of market reforms.
Unlike Pitt, Donaldson deftly handled the selection of a well-received accounting oversight board chief: former Federal Reserve Bank of New York chairman William McDonough. He also has stood up forthrightly to Spitzer by championing a congressional bill to prevent states from imposing industrywide settlements in securities cases. (Spitzer portrayed the bill and its backers as anti-investor, and Congress has postponed voting on it.)
Still, Donaldson's age, statesmanlike demeanor and sterling résumé -- Marine Corps, Yale University, Harvard Business School, Wall Street, State Department, academia, NYSE -- have prompted some to view him as no more than a blue-chip SEC caretaker. Donaldson, however, insists that "the farthest thing from my mind would be to be a caretaker." And his anything-but-passive performance thus far confounds this charge. His bold policy agenda includes, just for a start, aggressive probes of the mutual fund and hedge fund industries, adoption of a rule to make it easier for shareholders to elect independent candidates to corporate boards and a review of the status of exchanges as self-regulatory organizations.
BILL DONALDSON LOOKS WEARY. IT'S BARELY TWO o'clock on his 100th afternoon as head of the SEC, but already heavy bags hang under the lanky septuagenarian's pale blue eyes. He slumps into an armchair in his downtown Washington office, crosses his rumpled pant legs and starts -- well, to complain.
Since mid-February the Wall Street legend has retired to a lonely Washington hotel following his grueling, 12-hour workdays. Now it's a Thursday in late May, and instead of spending the upcoming weekend back home in New York playing tennis and enjoying meals with his wife and 13-year-old son, Donaldson will fly to California. There he'll preach good corporate governance to executives attending a director education program at Stanford Law School. He's clearly not enthusiastic about the prospect of spending more time away from home and family, and, if only for a moment, he lets it show.
"I'll be getting on an airplane and flying cross-country this weekend," he says, eyes rolling back ever so slightly before he recovers with a shrug and a tight smile. "It's just something I've got to do."
Donaldson's old-fashioned sense of duty is what keeps him away from home. Just last year, with nearly a half-century in finance, academia and public service behind him, the former Marine Corps rifle platoon commander contemplated retiring for good. At the time, he had his own private equity firm, Donaldson Enterprises, headed the Carnegie Endowment for International Peace and was chairman of the advisory board of Silvercrest Asset Management, another private equity firm.
Then, right around Thanksgiving, the White House came knocking. Pitt had just resigned. With financial scandals still raging and markets tanking, President Bush needed a savior at the SEC. Donaldson, however, was lukewarm about the idea. "It was not exactly what I had in mind," he confesses. "I was enjoying my life, enjoying my time with my family. I wasn't at all sure that I was interested in doing it if it were offered to me."
Donaldson has close ties with the Bush family. Both he and the president are members of Yale's influential Skull and Bones secret society. Donaldson's first job on Wall Street was working for the president's great-uncle Herbert Walker, at G.H. Walker & Co. Bush persuaded Donaldson to answer duty's call. "I decided that, given what was going on in the country, this was a period of time where I could really make a difference," he says.
The new chairman is a natural fit for the job. A Buffalo, New York, native whose father's machine-tool manufacturing business was wiped out in the Depression, Donaldson understands the struggles of investors. As a young man he sold lemonade, delivered newspapers and organized friends into a home-repair business to earn spending money, though he also attended the elite, private Nichols School.
Donaldson is deeply grounded in the ways of Wall Street. But unlike Pitt, he is nearly a decade removed from working in mainstream finance, so he faces fewer conflicts in the form of recent ex-clients seeking favors. And he has a more diverse background than his predecessor -- one that should equip him for the formidable challenge of reorganizing the SEC and professionalizing its management.
As a stock analyst in the early days of Donaldson, Lufkin & Jenrette, the pioneering research firm he co-founded in 1959, Donaldson paid close attention to the management of companies he evaluated. He and his co-founders also obsessed over their own firm's management, working hard to create a freewheeling culture at DLJ that made a job there one of the most coveted in finance. As the founding dean of the Yale School of Management, Donaldson taught a course on infusing large organizations with an entrepreneurial spirit, and he made the pursuit of public good through private enterprise a central tenet of the school. Upon taking over as CEO of troubled health insurer Aetna three years ago, he told this magazine: "This may be the last, best chance to prove that our health system can be run by the private sector" (Institutional Investor, July 2000). The company's stock has more than doubled.
But there was something more than an ideal CV or a sense of duty motivating Donaldson to take the SEC post. Something he doesn't like to talk about. He was ticked off. "One of the reasons Bill decided to take this job is that he felt a little disappointment, maybe even anger, at many of his quote-unquote colleagues that brought about the situation that occurred on Wall Street over the past few years," says Peter Derby, Donaldson's new operations chief (see box above). "There was an element of him looking at an industry that he was a part of for 50 years of his life that was being jeopardized. And he almost felt an ability to commit to rectify those situations and preserve its future."
No wonder, then, that Donaldson seethed when Morgan Stanley's Purcell publicly shrugged off his firm's inclusion in a $1.4 billion settlement with the SEC, Spitzer and other regulators of charges that the ten firms involved had issued misleading stock research to boost investment banking business. In early May, with the ink on the settlement barely dry, Purcell said at a conference in New York that he saw nothing in the pact that should trouble retail investors. The SEC chairman fired off a letter to Purcell chiding him for showing "a troubling lack of contrition" and reminding him that the firms had promised not to deny the allegations.
"It's hard for me to say that I'm proud of what I had to do with Phil Purcell," confides Donaldson, a friend of the Morgan Stanley chief, who suffered embarrassing press coverage after the incident. "But we had to nip in the bud very directly those that didn't seem to be conforming to the spirit of the settlement. We have to be direct and nonbureaucratic when we see something wrong. At least half of the job here is external -- a confidence-building aspect of the job. And I take that seriously."
That could be the impetus behind Donaldson's public put-down of Grasso and the NYSE. Amid controversy over cozy board relationships at the exchange and Grasso's exorbitant compensation -- he reportedly made more than $40 million over the past three years -- Donaldson in March publicly urged the Big Board to clean up its governance. He objects to top NYSE officials sitting on the boards of companies that list on the exchange, calling that a conflict of interest. (After being named NYSE chief in 1990, Donaldson himself remained on two listed-company boards to which he'd made long-term commitments, but he did not seek any more such appointments.) Grasso, who has pursued seats on the boards of NYSE-listed firms and encouraged other senior exchange officials to do the same, saying it helps them understand the needs of customers, currently sits on the board of one such company, Home Depot. He declined to comment.
Some see a veiled motive in the SEC chairman's actions. Grasso is believed to have been devastated when the NYSE board passed him over -- he was then president -- and named Donaldson, an outsider, as chairman. Before Donaldson's term expired in 1995, Grasso supporters orchestrated a coup d'exchange, sources say, convincing the board to promote Grasso rather than renominate Donaldson. Now Donaldson gets to hold Grasso's feet to the fire.
Following a talk at the New York Financial Writers' Association annual meeting in June, the SEC boss was asked what he thought of Grasso's pay package. "My reaction is I left too soon," he deadpanned.
"This is not a personal thing with Dick and me," says Donaldson now. "I have a lot of respect for Dick, and we have a professional responsibility to oversee the stock exchange. We're moving swiftly to make sure that those that are setting the rules for their listed companies have a proper governance structure of their own."
GIOVANNI PREZIOSO WAS A LAWYER AT A LOSS FOR words. After Prezioso got off a plane in Washington late last year, a friend had introduced him as the SEC's general counsel.
"The first thing this person said to me was, 'So where were you when Enron happened?' I didn't know what to say," says Prezioso, who joined the SEC in May 2002. "But people had to deal with a lot of that kind of thing, and it can get you down. This past winter was not an easy time to be at the SEC."
No wonder Donaldson was welcomed at the agency with open arms. Even before taking office he reached out to commissioners and staff, going out of his way to mend fences and motivate a downtrodden team. He listened to ideas and gripes, establishing rapport rather than dictating an agenda.
"He listens very hard and very carefully to what people say, which is exactly what you want in a leader," says Lori Richards, who heads the SEC's compliance inspections and examinations program.
"He's forceful, and he's determined, but he is a nice guy," adds enforcement chief Stephen Cutler. "You know how there are some people who are really good at saying no? He's one of those people. If he needs to say no, he'll do it. But you don't walk away from that conversation feeling bad. You feel like, okay, you've said your piece, got a fair hearing, and he did what he thought was right."
Donaldson restored the tradition, abandoned by Pitt, of speaking last during the commission's official meetings, allowing his colleagues to ask questions of the staff and air contrasting viewpoints before he weighs in. In private, he listened to his fellow commissioners' concerns and assured them that he would be straight with them. He's careful to achieve consensus through private give-and-take before critical votes.
"Just before he was officially nominated, he called each of us from the White House to say hello, introduce himself and say he was looking forward to working with us," says Democratic commissioner Harvey Goldschmid, who at times clashed bitterly with Pitt. "He has a very high intellect and a wonderful willingness to listen." Adds Republican commissioner Paul Atkins, "His demeanor and his ability to work with people has enabled the waters to calm down, basically."
Donaldson has gotten off to a good start in attacking the weighty issues facing the commission. One important early success: recruiting McDonough, his old friend and New York neighbor, to head the Public Company Accounting Oversight Board. The creation of the PCAOB, which will act as an independent watchdog over corporate audits, was the centerpiece of last summer's landmark Sarbanes-Oxley market-reform legislation. Pitt's selection of former Central Intelligence Agency director William Webster for the chairman's job, over the objections of Democrats who favored TIAA-CREF chief John Biggs, proved his undoing when it was disclosed that Webster had chaired the audit committee of U.S. Technologies, which was under investigation for questionable accounting tactics. Worse, Pitt had known of the blemish and failed to notify the four other SEC commissioners before they confirmed Webster in a partisan 3-2 vote. Webster stepped down. Pitt himself resigned in November but stayed on until Donaldson's inauguration in February.
Donaldson quickly established a process for selecting a new accounting board chairman that was transparent to commissioners but strictly closed to outsiders, to minimize media leaks. He assembled a confidential staff to identify candidates. Anyone who might engender strong opposition from a single commissioner was eliminated. Once the commission settled on McDonough, who'd already announced his plans to step down from the New York Fed, Donaldson faced a tough recruiting job. His quarry had just been appointed an NYSE director, was being touted to run the prestigious Council on Foreign Relations and was up for a number of private sector jobs.
"Bill called me and said he wanted to come over to the house to see me," recalls McDonough. "We've known each other a while, and usually we see each other socially with our loving spouses -- so when he said he wanted to see me alone, I knew it wasn't to talk about the weather." McDonough had no interest in the accounting board job, but he agreed to see his friend nonetheless. Donaldson made the trip across town on the morning of April 5, a Saturday. Just as the president had done with him four months earlier, Donaldson appealed to the former U.S. Navy officer's sense of duty and patriotism.
After an hour, McDonough told him, "I'm less negative about it than when we started, but I want to think about it." Donaldson left, thinking he'd have to keep looking. But by Sunday, says McDonough, "my wife, who knows me better than I do, said to me, 'I think you've got a glint in your eye.' I called him up and said, 'Okay, let's do it.'" Once McDonough was confirmed, Donaldson also fought to make the PCAOB chairmanship more powerful so that McDonough would have greater latitude to set policy.
Getting the right policy is as important to Donaldson as getting the right people. He has taken an aggressive stance toward hedge funds and mutual funds, breathing new life into ongoing SEC investigations of both industries. In May he invited hedge fund managers to participate in two days of discussions designed to help SEC commissioners and staff decide whether or not hedge funds should be more tightly regulated. Once its investigation is complete later this summer, the SEC is likely to require hedge funds to register with the agency, bringing them under the jurisdiction of its compliance examiners.
Moving the probe up on the agency's agenda is wise, given a rise in enforcement actions against hedge fund fraud in recent years and a perception that the lightly regulated, rapidly growing and highly secretive investment partnerships play fast and loose with the rules. The mutual fund investigation is likely to result in tougher disclosure: Funds will have to reveal various hidden fees. On this issue, Donaldson has managed to get Spitzer to follow the SEC for a change -- the state attorney general last month announced that he might investigate mutual fund fee disclosure.
Those are just two of the controversial and long-festering policy issues Donaldson has attacked. Some others: pushing for overhauling governance at the NYSE and other exchanges, which are faced with an increasingly difficult balancing act in policing the very companies from which they seek listing and trading revenues; passing rules so that shareholders can directly challenge management's candidates for board seats and policies, without having to launch costly and drawn-out proxy fights; getting companies to treat stock options as an expense; and fighting a House bankruptcy-bill provision that would allow investment banks to advise their underwriting and merger clients on Chapter 11 reorganization plans -- considered a conflict of interest.
In enforcement, Donaldson has continued Pitt's move toward taking action more quickly and devoting more attorneys to the highest-profile cases. In an unusual step he personally announced recent actions against Merrill Lynch & Co. and several of its former employees in connection with transactions the firm structured for Enron and against eight employees of telecommunications company Qwest Communications International who stand accused of a fraud that allegedly inflated revenues by $144 million in 2000 and 2001.
Under Donaldson the SEC also reached a long-in-the-works "global settlement" of research-related charges against Morgan Stanley and nine other major Wall Street firms. In that deal, the product mainly of Spitzer's investigation and struck in concert with his office, the firms have agreed to pay a total of $1.4 billion in fines, restitution and provisions for independent research and education for investors.
Donaldson's docket remains full of other hot-button issues. The SEC must oversee payments to what likely will be tens of thousands of investors from a $399 million restitution fund established as part of the research settlement, a gargantuan and thankless task. The SEC is recommending individuals to oversee the $85 million in "investor education" funds from the settlement, and Donaldson hopes to establish an internal outreach program that agency officials say will go even further than the considerable efforts of former SEC chairman Arthur Levitt Jr., who crisscrossed the country holding town hall meetings with investors. Democratic commissioner Goldschmid is pushing to draft comprehensive rules that would extend to the entire securities industry the strictures called for in the settlement and perhaps further reforms. And Donaldson asserts that the structure underlying U.S. stock trading, a rapidly evolving and long-neglected area that he calls "the biggest enchilada" policywise, needs a comprehensive review and update of aging rules.
"He's done far better than a lot of people thought he would when he took over," says Joel Seligman, dean of the school of law at Washington University in St. Louis and author of a history of the SEC. "It's very, very early to start making assessments. But there has been an enormous change for the better in leadership style."
NOW THAT HE HAS PATCHED UP THE SEC'S GAPING wounds and gotten it back on its feet, Donaldson faces a much bigger task -- overseeing the agency's long-term rehabilitation.
The SEC needs an overhaul. Founded in 1934 -- it's actually three years younger than its chairman -- its basic structure and methods of operation haven't changed a whole lot since then. But Wall Street sure has. Brokerage and asset management firms, once small private partnerships, since the 1980s have become publicly traded behemoths, often units of much larger financial conglomerates. The NYSE today handles an average of 1.5 billion shares daily, nearly 20 times the level of just 15 years ago. According to the Investment Company Institute, nearly half of U.S. households own shares in mutual funds, up from less than 10 percent in 1980. And although the lion's share of stock trading has historically taken place on the NYSE, Nasdaq and the American Stock Exchange, since 1998 the SEC has been regulating alternative trading systems. (There are approximately 70 that are gaining an increasing proportion of total stock market volume.)
According to a damning March 2002 report by the General Accounting Office, the SEC's workload has vastly outpaced staff increases over the past decade. Complaints and inquiries coming into the agency increased 100 percent in the 1990s, while the enforcement staff charged with following up on those reports grew by only 16 percent. Enforcement cases pending at the end of the year rose 77 percent, from 1,264 in 1991 to 2,240 in 2000, as stretched staff took longer to close cases. Investment company filings increased by 108 percent, but staff assigned to review them grew by just 9 percent. Filings from publicly traded corporations -- including the quarterly and annual reports that, if properly scrutinized, might have led the agency to discover the massive financial frauds exposed over the past two years -- grew by 60 percent, compared with a 29 percent rise in staff to review them. The backlog of rule filings from self-regulatory organizations like Nasdaq and the NYSE grew to 243 in 2001 from 174 in 1998 and is expected to continue rising as exchanges go public and competition gets more intense for trade-execution services.
Another problem: Since its creation, the SEC has been run by lawyers, who by necessity have dominated both the ranks of the top staff and commissioners. By and large they've done a good job writing and enforcing regulations, but they're not very big on management. That has only exacerbated the morale problems of the overworked and underpaid rank-and-file staff.
The local NTEU chapter has won concessions, such as casual dress and more flexible hours, since gaining recognition in 2000 but still harbors grievances toward management. Chief among these is what both NTEU national president Colleen Kelley and local chapter head Clampett call an uneven implementation of the so-called pay parity program, which Congress approved for the SEC in 2001 to bring its civil servants' compensation levels up to those of other financial regulators, like Fed officials. The union leaders charge that the SEC gave smaller raises -- of 10 percent or less -- to employees who have been supportive of the union, while rewarding management-friendly staff with increases of 30 to 40 percent.
"They chose to not distribute the money as we thought was appropriate," says Kelley. "They gave a lot of it to management officials. There were increases for front-line employees, but those increases did not close the gap on pay parity as intended." (An SEC spokeswoman points out that pay parity was implemented during Pitt's chairmanship.)
Operations chief Derby, whom Donaldson dispatched to meet with Clampett in March, after the union leader asked for a meeting with the chairman, says: "There's a cooperative working relationship with the union. It's certainly in the chairman's interest, and in mine, to have a good working relationship. Where there is input to get from them, we should seek it from them, and vice versa."
Donaldson, who has more zest for management than any previous SEC chairman, wants to address these problems. His sweeping reorganization seeks to maximize productivity, improve strategic planning and boost the quality of management. If it works, the regulator will be better able to anticipate trouble spots, attack them before they become crises and efficiently deploy the additional resources that will be arriving courtesy of Congress.
He began in February by bringing in Derby as a temporary consultant to assess the agency's strengths and weaknesses and make recommendations for the restructuring. In addition to gaining a full-time job, Derby has emerged from that process with two primary conclusions: "One, we have a tremendous group of really bright, very knowledgeable people. That's the main plus. The main minus is that management is not a pervasive skill. Some of it is just that attorneys don't like to manage, and attorneys don't like to be managed, and two thirds to three quarters of our people are attorneys."
After several weeks of talking to staff, Derby made his first recommendation -- that the job traditionally known as chief of staff to the chairman had grown too large and complex for just one person. Donaldson divided the position into three "managing executive" jobs -- one each to handle operations, policy and external affairs. For the operating post Donaldson picked Derby, a former investment banker who advised the Russian government on that country's transition from communism to capitalism. Handling policy and staff issues is Patrick Von Bargen, a former chief of staff for Democratic U.S. Senator Jeff Bingaman of New Mexico. Laura Cox, who comes from a stint in the Treasury Department's office of legislative affairs and has worked in communications jobs for electronic brokerage Instinet and Republican Senate Banking Committee chairman Richard Shelby of Alabama, is in charge of external affairs. Working closely with the three is James McConnell, the SEC's longtime executive director.
Next on the agenda: clearing the way to more quickly hire and deploy people with diverse skills, such as accountants, economists, examiners and other professionals. In May the SEC reached an agreement with the NTEU to exclude these hires from the civil service posting process, which can drag on for months. Congress subsequently passed a bill to extend the so-called excepted service privilege to cover these professions (the SEC already can hire attorneys outside the civil service process). Accountants are badly needed in the enforcement and corporation finance divisions. But hiring more people outside the civil service process might also attract more talented personnel, enabling the SEC to groom a future generation of managers from this pool. "Clearly, this would allow for us to have a broader, easier way to structure the organization to meet its overall managerial needs," says Derby.
Perhaps the biggest piece of the reorganization will be creating a strategic planning body. This group will be separate and distinct from the current operating divisions and offices. Its mission: enabling the commission to approach rulemaking and enforcement more comprehensively and proactively, rather than simply reacting to crises and issuing one-off decisions in a vacuum.
Says Donaldson, "We need a multidisciplinary approach to policy and planning that gives us the ability to look around corners and see what's coming down the pike, from a strategic point of view, with the end goal of being able to anticipate what the next problems are going to be and then to do something about them before they become too big."
In keeping with this goal, Donaldson also wants to foster more cooperation among the SEC's divisions and offices. True to his management style, he has begun delegating this to his subordinates, who already are talking about changing the old way of doing things. "We could probably do better in getting some of the things we find in front of enforcement," says Alan Beller, a veteran corporate lawyer whom Pitt recruited to head the SEC's corporation finance division in January 2001, at the height of the uproar over Enron. That kind of cooperation just might have led to a case against Enron before it blew up -- had corporation finance been reviewing all of the company's filings (which it wasn't) and had it possessed a more effective way of providing leads to enforcement chief Cutler and his litigators.
Others say that the problem is more complex than that. "Only 10 percent of our referrals to enforcement are acted upon," says Clampett, who works in Beller's division. "We give them stuff, and they don't follow up on it." Even getting a referral through is an overly bureaucratic process, he adds, requiring multiple approvals that discourage attempts. (SEC officials privately dispute the 10 percent figure but refuse to make public the actual number.)
Also likely, amid a rising chorus of industry gripes over extensive delays that are inhibiting competition in the financial markets, are changes that would impose some limits on the amount of time the SEC takes to complete regulatory reviews and enforcement actions. As with other aspects of the reorganization, this will require a change of attitude. Says Derby: "The SEC has many kinds of clients, internal and external. And we want the needs of those clients to be clear and paramount in the organization. There are requests and applications that come in for regulatory review. Are they outstanding for 30 days? Are they outstanding for three years? Does one sector get a response in 60 days and another in 100 days? You need to have a comprehensive solution instead of one-off decisions."
Most recently, Derby has been working with the staff on establishing performance benchmarks to serve as the basis for what he calls "dashboards" that top managers will monitor, like drivers keeping tabs on how an automobile is performing. Senior staff will hold biweekly assessment meetings with Derby and quarterly meetings with Donaldson, after which determinations will be made about any necessary reallocation of resources or strategy. Those meetings, he says, should begin by summer's end. In deploying this scientific-management-redux approach, the SEC is seeking to quantify how long particular tasks take to perform and therefore how many people to devote to them in order to achieve desired outcomes within set deadlines.
Also in the works: an office of risk assessment, which will seek to direct resources where there is the most risk of dislocation. Such an office, Derby says, might recommend that if stretched staff can review only 1,000 corporate filings per year, those filings should come from companies that represent a majority of stock market capitalization, for example.
Before Donaldson, few, if any, SEC chairmen took this kind of approach to managing the agency. "He has come out and asked whether the same old ways of doing things are necessarily the right ways," says Beller. "He is trying to run this place more like a pretty large corporation, and that's probably a good thing."
THIS COMBINATION OF SPIN and substance, of external and internal focus appears to be the defining characteristic of Donaldson's young chairmanship. He may well represent the perfect middle ground between Levitt, who has been criticized in some quarters for paying more attention to spin than substance, and Pitt, who was all substance but dangerously bereft of spin.
Consider the commission's closed meetings, at which new rules and enforcement cases are presented by the staff, debated and sometimes approved by the commissioners. Levitt, while an activist chairman, often tuned out when these discussions turned to technical and legal details. "Arthur hated these closed commission meetings," says one veteran SEC official. "They're incredibly legally oriented, and that's just not his style. He was much more comfortable in the public and trying to figure out how best to promote the agency's agenda with the public." Pitt represented the other extreme -- dominating closed meetings to the point of alienating staff and ignoring the external part of his job. But Donaldson has one foot planted firmly in both realms. "Donaldson performs very well in these meetings," says the official. "He is trying to learn the substance, the nuances of strategy and tactics, to the extent that it doesn't drown him."
So far, that has been a potent combination that has quieted critics who derided Donaldson, when he was nominated, as little more than a well-connected caretaker (his five-year term expires in February 2008). Instead, he has laid out an ambitious agenda that -- if he completes it -- will establish him as one of the more influential chairmen in the SEC's history.
"The reason I've taken this job on is because I want to do something," he says. "I hope that I can have an impact. And I hope that that will become apparent as we move along."
But however vigorously engaged he may be, and however much impact he hopes to have, don't expect Donaldson to stick around forever. He'll be four months shy of 77 if he serves out the rest of his term. To put that in context, Levitt -- the longest-serving SEC chairman ever -- was 69 when he retired after seven and a half years. Part of Donaldson clearly longs to slow down -- to spend more weekends at home, being a husband and a father. But first, duty calls.
The perspective from the bully pulpit
At 72, Wall Street veteran William Donaldson has taken on the challenge of leading the U.S. Securities and Exchange Commission through one of the most turbulent periods in American financial history. In a series of discussions with Institutional Investor Senior Writer Justin Schack, Donaldson talked about his reluctance to take the job, his disenchantment with the lapse in Wall Street ethics and his ideas for revamping the agency. Here are highlights.
Institutional Investor: How did you react when you were approached about the SEC job?
Donaldson: It was not exactly what I had in mind. I was enjoying my life, enjoying my time with my family. I came down and talked to a number of people in the White House, but I wasn't at all sure that I was interested in doing it.
What changed your mind?
At other times in my life, chairman of the SEC was not what I would have wanted to do. And when my nomination was announced [December 12, 2002], friends and others would call and say, "Congratulations -- or should I say condolences?" But I think that this is a rare time in American history when the chairman of the SEC is uniquely positioned to have a real impact.
As a former Wall Streeter yourself, how do you feel about the ethical transgressions of the past few years?
People are annoyed with Wall Street, and that goes beyond just the stockholders who have lost money. There's a general disenchantment. A gradual, imperceptible erosion of professional standards has taken place. That's not unusual in a bull market. It's not necessarily venal, either. But it's been slow and steady, and everyone has gotten in on it. That's troublesome. So I plan to continue to call for corporate America and Wall Street to do a real self-examination, to go beyond just complying with the letter of the law and fulfill the spirit of what's right. There has to be a culture of ethics that starts at the top.
You've compared the SEC to the military in the way the agency needs to restructure to adapt to a greatly changed world.
I've always admired the SEC, even though we had our share of battles over the years. It has always been very fair and very professional, and it continues to have that reputation. But the SEC has been deluged with work on an inadequate budget. That leaves very little time to go on the offensive -- anticipate problems and prevent them from happening. Overall, management of the SEC hasn't been that high a priority, given that there's hardly time to do anything other than process the business. The U.S. military did well to change its standard approach and get more mobile and fast moving. So can we.
We need more agility. We need people whose job it is to look into the future. That means drawing them from the SEC's various divisions to create a policy-planning function. And, as in any organization, there's a need to have more communication among the divisions. That implies a structural shift. Another thing to consider is that with so many new people about to join the SEC, you're not going to get much change -- there's going to be a temptation to do things the same old way -- if you just lay the newcomers on top of the existing organization and, if you will, on top of yesterday's budget. That's a huge potential pitfall, and it just screams for making sure we don't squander those resources.
What are you doing to buck up staff spirits?
Morale has been damaged by public embarrassment over a lot of the things that have gone on at the agency. So I've tried to talk a lot about the directions I hope to go in and to attempt not only by word but also by deed to build collegiality, first and foremost among the commissioners but also among the leaders here at the agency. We're trying to get the message out that -- No. 1 -- fresh troops are about to arrive. We're going to get some people in here to help out. But more important, we're trying to convey that we have an interest in making this a satisfying place to work. I've been pleasantly surprised to find that a lot of people are excited about the pace and the significance of the activity in the past several months. A lot of rules have been coming out of the SEC under intense deadline pressure in response to the Sarbanes-Oxley Act, and people here have been really turned on by that.
How critical is the external part of your job -- dealing with the public, Congress, the media?
It's extremely important. At least half the job is using the bully pulpit to talk about things that cause a lack of investor confidence. We've been going through a period of three or four years of bad markets and corporate scandals that's similar to 1929, when the stock market crashed. But back then there weren't really that many people investing. Now there are maybe 60 million investing directly and probably well over 100 million affected through their pension plans. So it's a huge challenge, but a very appealing one. In that respect I feel lucky to have the job.
How is the research settlement working out?
There was at least one instance where it didn't work at all -- I'm talking about Bear Stearns here. [An analyst for the firm was involved in a recent road show for an initial public offering, violating the spirit of a settlement intended to separate Wall Street research from investment banking. Bear Stearns apologized for the incident, delayed the IPO by a day and barred the analyst in question from covering the stock in the future.] Whether that was purposeful or just people needing to get accustomed to the new environment is not clear. But when you look at the influence of banking and other things on research, the settlement is working.
Is research improving?
It's probably too soon to measure that. I personally believe that there's a market out there for people who will pay for real research, as opposed to just reports on what earnings are expected to be or what management just said about the coming quarter. And this gets to a dream that I've had, which is that companies will level with the analyst community about how they really run and grow -- that there will be dips in the earnings pattern when they make reinvestments from time to time. That's a healthy way to run a company. I wish that corporations would tell the analyst community that, and that analysts would do their research accordingly. Nobody wants to be the first company to do that. But more and more institutional investors have the courage to look at companies as core holdings no matter what the quarter-to-quarter fluctuations in their stocks may be and to buy more of a company even if its earnings don't grow for a quarter or two as fast as they have in the past. That was the kind of research we tried to do at DLJ [Donaldson, Lufkin & Jenrette, the pioneering research firm Donaldson co-founded in 1959], and money managers appreciated it.
What other issues are high on your agenda?
One is proxy voting. It hasn't been looked at or changed in a long time. Giving shareholders access to the proxy statement comes with the shift of responsibility from CEOs and top executives to the board as a whole. That's a hot potato. But it needs to be done.
What else is really pressing?
The biggest enchilada is the whole issue of market structure. We have to look at how self- regulatory organizations and ECNs [electronic communications networks, which are alternatives to stock exchanges] are governed and regulated. We need to examine whether SROs should be embedded in stock exchanges. And we have to examine the rise of technology and globalization and what markets should look like in the future. We haven't had an overall philosophy here, so individual decisions are leading us in unintended directions. The time has come to do something about it.
Have exchanges been good regulators?
Yes, but we wouldn't be asking them to look at their own governance if we were totally satisfied. The issue is: Can you separate out regulation and not have it embedded [in the exchange]? The embedding of regulation [in exchanges themselves], as opposed to giving the whole thing to the SEC and creating a monster bureaucracy, goes back to the '33 and '34 securities acts and was probably a sound decision. That arrangement has stood the test of time. But now, what with all that has happened lately, we're reexamining it. Is there something fundamentally wrong with self-regulation?
How do you feel about banks tying corporate loans to companies using their investment banking services?
The Glass-Steagall Act [separating commercial and investment banking] had a reason for being. There has also been a business reason for agglomeration of financial institutions and the cross-selling of services to corporations. It's naive to think that banks that have a big balance sheet and a desire to get into the investment banking business won't use their market muscle in one place to get into other businesses. For me, it's very hard to say that if you're running a large company that needs to borrow, and you're having trouble borrowing, and the bank raises the possibility that you might do business with them in another place, that it's not some form of tying. It's an area that cuts across banking regulators and the SEC, and we need to talk about it.
But is tying an okay practice in your book?
Oh, I don't think it's okay at all. Ultimately, these businesses have got to stand on their own feet.
What are your plans for investor education, particularly with respect to the investor education fund being established by the research settlement?
We are about to suggest to the court [that must approve the settlement] a person to manage the process. And I might encourage a multifaceted investor education project that's supported not only by settlement funds but also by other monies, and create a permanent independent body to sustain that effort.
Why is investor education so important?
The preservation of the individual investor in the marketplace is important. And there's a class of people out there now -- the baby boomers -- who are hoping to retire soon and have some assets but who need to learn more about how to manage those assets. The go-go years of the 1990s demonstrated that there was a lack of knowledge about what investing really is.
What's your favorite part of the job?
The management challenge interests me a great deal professionally. The agency needs more attention paid to that aspect of its operations. I am intrigued by trying to bring what I would call an entrepreneurial focus to a government agency.
What do you like least?
Well, the job is extremely time-consuming. There's so much to do, and you're never done at the end of the day. So you have to have discipline, or it can just consume you. That discipline has to do with family. It has to do with health. There are so many demanding, interesting aspects to the job that you could literally keep at it all day every day.
Donaldson's Mr. Inside
In the 1990s he helped postSoviet Russia develop a free-market economy. Now Peter Derby is trying to imbue a stubborn 69-year-old government bureaucracy -- the U.S. Securities and Exchange Commission -- with a little private sector vigor. In just a few months, Derby, 42, has gone from being a would-be New York congressional candidate who settled for a seat on his town council to the second most powerful person at the nation's chief financial markets regulator.
The son of Russian immigrants, Derby spoke only his native language until learning English as a kindergarten student in Jamaica, Queens. After attending New York University, he became an investment banker with National Westminster Bank in New York. In 1990 Derby left the city for Russia, where he co-founded and became the CEO of DialogBank, the first private bank granted an international license by Moscow.
From this capitalist perch he was tapped by the Russian government to help write many of the laws and regulations that now govern the country's banks and financial markets. He also played a major role in establishing the Russian equivalent of the SEC -- the Federal Commission for Marketable Securities -- and helped finance the privatization of an economy that had been centrally planned since the days of Lenin almost 90 years earlier. After selling the bank in 2001, he returned to New York and set his sights on effecting a similar sort of free-market revitalization within American government.
"I wanted to make government more accountable, effective and efficient," says Derby, whom SEC chairman William Donaldson named the agency's managing executive for operations -- effectively, chief operating officer -- in April.
Derby had toyed with running for Congress, but a redistricting following the 2000 census threw a wrench into those plans. He instead ran for a trusteeship of his home village of Irvington-on-Hudson. He won the Democratic Party endorsement and the election and continues to serve in that post while overseeing operations at the beleaguered SEC.
Derby is Boy Scout earnest, almost to a fault -- he insists on splitting a modest lunch check with a reporter to eliminate even the appearance of a conflict of interest. And for a Democrat, he sounds a lot like a conservative Republican when describing the proper role of government. He says the SEC must be accountable to its "clients" (both investors and the firms it regulates), weigh the costs of regulation against the benefits, trim red tape and develop a "mission" that governs everything the agency does.
But Derby, a member of the centrist Democratic Leadership Council, is no apostle of dispensing with regulation altogether. Instead, he's a firm believer in correcting Washington's tendency toward bureaucratic gridlock by bringing the discipline of the private sector to government.
Donaldson himself has long been a staunch advocate of public-private symbiosis. He helped to organize the Yale School of Management around this very principle as its founding dean in 1975. He and Derby met in 1990, when Donaldson -- then chairman of the New York Stock Exchange -- visited Russia in search of companies to list someday on the Big Board. In 1995, Donaldson returned to Donaldson, Lufkin & Jenrette, the investment bank he had co-founded 36 years before, as a senior adviser on international issues. While there he worked with Derby on several investment banking and exchange matters, and Derby later retained DLJ to help sell DialogBank.
Last winter Derby called Donaldson to congratulate him on being nominated to lead the SEC. Donaldson promptly turned the courtesy call into a recruiting pitch: He knew that he would have to revamp the agency, which had endured years of neglect by the White House and Capitol Hill, and he was well aware of Derby's talents and zeal for efficient government. "'This place is so perfect for you, Peter,'" Derby recalls the chairman telling him.
Donaldson brought Derby on at the SEC first as a temporary consultant in late February, asking him to spend six weeks evaluating the agency's operations and to present recommendations for reorganizing them. "That's what I said yes to," sighs Derby.
But his first recommendation -- that the traditional position of chief of staff to the SEC chairman be split into three "managing executive" jobs -- wound up ensuring that Derby would be sticking around. By hiring him for one of the three new posts -- managing executive for operations -- Donaldson anointed Derby as his point man for what is perhaps the most important item on his ambitious agenda: remaking the SEC (story). The operations man has become one of the chairman's closest confidants within the agency. The two camp out at the same Washington hotel during the workweek and fly back and forth to New York together to visit their families on weekends.
Derby says he has met with "everyone from senior staff officials to secretaries, security guards and drivers" to gather input on how the agency can become more efficient and proactive. The SEC has suffered for years from underfunding, mismanagement and poor morale -- all of which no doubt contributed to its failing to uncover the Wall Street and corporate shenanigans that accompanied the 1990s bubble. The agency's reorganization should promote greater cooperation among divisions and offices and ensure that an injection of much-needed congressional funding this year and next is not frittered away.
"We need to look at the job of this agency and the way we go about doing that job in a different fashion, with an eye toward making the agency more efficient and accountable," says Derby. "More proactive and less reactive. Are we close to the end? No. Are we significantly down the road? Yes." -- J.S.