No Respect

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NOVEMBER 3, 2003

No Respect

If Richard Grasso was the obvious villain in last month's upheaval
at the New York Stock Exchange (nyse), Securities and Exchange
Commission (SEC) Chair William Donaldson was the unsung hero. After
all, Grasso's obscene compensation package might never have come to
light if Donaldson had not requested in March that the heads of the
country's stock exchanges review their management structures. When
it emerged a few months later that, as nyse chair, Grasso had
received a $140 million compensation package in 2003, Donaldson let
it be known he was unhappy through a discreet but sharply worded
letter to the Exchange. What followed was straight out of The
Godfather: Within days, the nyse board was in revolt, and, a few
weeks later, Grasso was out. Donaldson then reportedly vetoed
several of the board's suggested replacements and even edged out a
few other board members, such as Daimler-Chrysler chief Jrgen
Schrempp, for good measure. When Grasso's interim successor, John
Reed, took over, the first thing he did was travel to Washington to
make sure he and Donaldson were on the same page.But, while editorialists licked their chops over Grasso's demise,
very few gave Donaldson credit for the deftly executed coup de
boardroom. Robert Kuttner, writing in The Boston Globe shortly
after Grasso resigned, told readers not to "hold your breath" on
future reform at the nyse, because, while "Donaldson may have been
disgusted by Grasso's pay, ... he is a longstanding member of the
same club." Donaldson, who led the nyse himself from 1991 until
Grasso took over in 1995, caught even more flak from the Toronto
Star, which argued that the whole thing was a personal attack by
Donaldson against his successor.

Such episodes are the story of Donaldson's eight-month tenure at the
SEC. Early this year, almost immediately after taking the reins
from Harvey Pitt-- whom the press had roundly vilified for taking a
soft approach on Enron and WorldCom--Donaldson began quietly but
forcefully reforming the agency and going after a whole range of
hitherto-ignored industries. "Given that Donaldson is a real
Republican, he's actually been remarkably strong," says Barbara
Roper, director of investor protection at the Consumer Federation
of America. But, for all that, the media still largely paints
Donaldson as a Bush insider, a political appointee of the same ilk
as Treasury's John Snow or former Office of Management and Budget
Director Mitch Daniels--Republican shills in nice suits. Editorial
boards continuously downplay or even ignore his achievements, even
while their business sections acknowledge his role in some of this
year's biggest reform successes. In fact, given the speed and
effectiveness with which Donaldson has turned around an ailing
agency, it's no small stretch to call him the only bright star in
the very dim galaxy of the Bush economic team--no matter what the
papers say.

When Bush announced in December that Donaldson would be taking over
the SEC, the country's papers and industry observers were almost
uniformly skeptical. The New York Post, which has since elevated
anti-Donaldson screeds to an almost regular feature, wrote that his
tenure would be "long on management and short on reforms." Or, as
one securities lawyer told TheStreet.com, "I guess [Bush] doesn't
want an effective SEC. ... [Donaldson]'s too wedded to the
industry." As if to reinforce the point, on the day Donaldson's
nomination was announced, the Dow jumped 100 points.

And the skepticism was understandable, given that Donaldson has what
may be the ultimate Wall Street insider's resum: a member of Skull
%amp% Bones at Yale; an MBA from Harvard; a founding member of
Donaldson, Lufkin %amp% Jenrette, a groundbreaking investment firm;
undersecretary of state under Richard Nixon; co-founder of the Yale
School of Management; and chair of the nyse, Aetna, and the
Carnegie Endowment. Nor did it help that Donaldson isn't just a
Wall Street insider, he's a Bush insider as well, having roomed
with Bush's uncle Jonathan Bush as an undergraduate and having
worked for Bush's great uncle in his first job after college. So,
not surprisingly, to many observers who watched Pitt and Bush
undermine the postEnron corporate reforms, Donaldson seemed simply
a smoother version of the same. "There was this assumption that
anyone who Bush brought in to take over the job would take a
similar approach," says Roper.

But, contrary to media expectations, Donaldson reversed the SEC's
course almost immediately. Appearing before Congress in March, he
requested an 18 percent boost in funding, an amount that exceeded
even Congress's record 2003 allocation of $711.7 million. The money
will help the SEC hire some 700 new lawyers and accountants, as
well as update the commission's woefully outdated computer systems.
The request was a decisive one, notes Joel Seligman, an SEC
historian and the dean of the Washington University Law School,
because, "in the long run, an adequately staffed SEC is more likely
to deter fraud than any rule the Commission can make." Indeed,
Seligman says, it's a rare occasion that an SEC chair can marshal
those sorts of resources. "Dwarfing everything he's done to date is
the budget. ... [I]n its history, there's only a minimum number of
years that you've seen this kind of support." Though it didn't sway
his critics, the request was the first solid evidence that
Donaldson was serious about reinvigorating the SEC.

Nor did Donaldson stop there. He also made it easier to hire new
accountants- -a surprisingly difficult process at an agency so
dependent on actuarial acumen- -and he is garnering support for
greater leeway from Congress for SEC regulators to hand down fines
without taking companies to court. He even used his insider status
to his advantage, bringing in an old ally, New York Federal Reserve
President William McDonough, to run the newly created Public
Company Accounting Oversight Board--a decision that was warmly
received within the investor-protection community. And, at a speech
before the National Association for Business Economics in March,
Donaldson raised the bar for his success even higher, telling the
audience that the corporate governance transgressions of the '90s
were responsible for the current economic malaise--a bold
statement, as it implied that economic growth depended at least in
part on his ability to clean house.

And, by and large, that is what he has done. With Congress's support
secure, Donaldson has proceeded to focus on issues that Pitt had
largely ignored: corporate governance, stock exchanges, executive
compensation, and hedge funds. He has already overseen a record
number of enforcement actions this year-- averaging an astonishing
twelve per week. And, while many saw April's $1.4 billion
settlement between the SEC and ten investment banks as insufficient
(Senator Charles Grassley called it "half a loaf"), Donaldson made
it clear that the deal was only the beginning of reform in the
investment community and that more enforcement actions would be
forthcoming if the banks didn't imbibe his reform message.

Indeed, it's that attitude that has proved Donaldson's best weapon.
One of the biggest complaints about Pitt was that, for all his
bluster (he infamously proposed the SEC chair be made a
Cabinet-level post, with a raise to match), he was ultimately
reactive, only going after corporate malfeasance when it made the
front page. Donaldson, on the other hand, has played a big part in
seeding press speculation about the nyse, hedge funds, and mutual
funds well before their respective irregularities became
well-known. What's more, former SEC officials note that Donaldson
often casts the swing vote toward tougher regulation on a
five-person commission otherwise evenly divided between Republicans
and Democrats. In the SEC's recent call for stronger control of the
hedge-fund industry, for example, Donaldson threw his support behind
the new measures despite opposition from the commission's
Republican members, Cynthia Glassman and Paul Atkins. "He's
behaving not like a Republican at all, in terms of rules and
enforcement," says David Martin, former director of the SEC's
corporate finance division who now runs the securities group at the
law firm Covington %amp% Burling.

Nevertheless, the media have continued to question Donaldson's
commitment to reform, a fact observers attribute to his low-key--at
times aloof--management style. Unlike the outspoken Pitt or Arthur
Levitt, President Clinton's media- friendly SEC chair, Donaldson is
understated. "I think his main problem is he's a quiet person; he's
got a quiet style," says Stephen Crimmins, former SEC deputy chief
litigation counsel. But, ironically, as Crimmins and others note,
it's exactly that quiet style that has proved Donaldson's most
successful trait- -as his behind-the-scenes maneuvering during the
nyse scandal demonstrated.

The White House seems pleased with Donaldson's performance to date,
if only because he's not as much of a lightning rod for bad
publicity as Pitt. But Donaldson's management style, combined with
the direction he has been taking the SEC, hint at a deeper and, in
this administration at least, more radical motivation than many
suspect. While Donaldson is hardly a fan of big government, he also
seems skeptical of the White House's overriding commitment to
deregulation, particularly when that commitment prevents the SEC and
others from cracking down on corporate malfeasance. Contrary to the
administration, he has come out in favor of stock-option expensing,
and he has repeatedly told reporters that the landmark
Sarbanes-Oxley corporate reforms were only a starting point.
"Lawyers, accountants, corporate and financial managers, and
financial regulators still have a lot of work to do," he said at his
February confirmation hearing.

Indeed, Donaldson is intent on fashioning an SEC potent enough to
force ethics back to the forefront of business. Granted, he has
often expressed a hope that the business sector can right its own
ship. "This is the beginning of a process in terms of the SEC being
willing to help," he told The New York Times. "The New York Stock
Exchange must come up with its own reforms." But Donaldson is no
hack, and, if it takes some arm-twisting from the SEC, then he'll
do it. His isn't a belief in big or small government but simply in
good, effective government, in harmony with the market.

Of course, even that may be too much for the Bushies. And, were
Donaldson to come out in favor of stricter rules regarding
board-of-directors responsibilities--something he has hinted at in
the past--Yale School of Management regulatory expert Paul MacAvoy
predicts it would cause an irreparable breach with the White House.
"He will go off into the horizon with flags waving," says MacAvoy,
"and you'll never hear from him again." Maybe then, at least, the
press would finally give Donaldson some credit.

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