01 Dec 2004
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One-on-One with William H. Donaldson

by Roger Thompson

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When William Donaldson (MBA ’58) was sworn in as the 27th chairman of the Securities and Exchange Commission on February 18, 2003, Wall Street and the commission itself were in turmoil. A wave of corporate scandals that started with the collapse of Enron in December 2001 had severely eroded investor confidence and prompted Congress to legislate sweeping corporate reforms contained in the Sarbanes-Oxley Act. Donaldson’s predecessor, Harvey L. Pitt, had been forced to resign under pressure. And the agency was woefully understaffed to handle its task as chief regulator of America’s securities markets. To make matters worse, Donaldson hardly had time to settle into his new job before revelations surfaced of wrongdoing in the mutual-fund industry, triggering a new round of regulatory reforms.

Shortly after stepping into the SEC’s top job, Donaldson called upon Wall Street and corporate executives “to create a new environment of integrity and accountability.” He seemed uniquely suited to lead that effort. Donaldson was cofounder, with two HBS colleagues, chairman and CEO of the investment banking firm Donaldson, Lufkin & Jenrette; founding dean of the Yale School of Management; under-secretary of state during the Nixon administration; chairman and CEO of the New York Stock Exchange; and chairman and CEO of Aetna. Along with his impressive résumé, Donaldson brought a consensus-building leadership style and the political savvy needed to succeed in the nation’s capital. Donaldson, 73, recently took a break from his busy schedule to talk about why he took the job and what he has been able to accomplish.

Why did you agree to take on the job as the country’s chief securities cop?

First of all, it seemed to me that the malfeasance that emerged after the booming 1990s and the resulting public uproar that forced Congress to pass the Sarbanes-Oxley Act were eerily similar to the period leading up to the market crash of 1929. Coming out of that, the president of the New York Stock Exchange went to jail, and we subsequently saw enactment of major securities laws and the formation of the SEC.

We were in the same sort of turbulent period but with one major difference. In 1929, not that many people were invested in the stock market. This time around, well over half of the population owns stocks one way or another and is directly affected by the industry we regulate. So this was a historic moment to come into this job. In addition, the SEC itself recently had been through some tough times, so it seemed like the agency was in need of new leadership.

Not long after you arrived, the mutual-fund scandal broke. Did the magnitude of that industry’s problems surprise you?

What we found was absolutely shocking. First, we uncovered the so-called late-trading and market-timing issues. Beyond that, we have moved on a whole series of other issues, producing the greatest rule-making period for mutual funds that the commission has ever experienced.

Why did the SEC override strong industry opposition and require mutual-fund boards to appoint independent chairmen?

The commission felt, and I strongly agree, that there’s an unacceptable conflict of interest when the chairman of the mutual-fund management company wears two hats: he’s chairman of the management company and chairman of the company’s mutual funds. That means the chairman has a fiduciary obligation to both of those sets of shareholders. It’s impossible to wear those two hats.

You’ve been characterized as a quiet crusader. Is that how you see yourself as SEC chairman?

I don’t feel particularly comfortable with that characterization, except as follows. On the quiet side, I’ve always felt that one’s actions should speak louder than one’s words.

As for the crusader part, yes, when I came into this job I was upset by the fraudulent elements of the business and financial worlds. Even before that, I’d been upset with the gradual erosion of ethics in some of our best companies. This is not unheard of in ebullient market times when everything’s booming and people get sloppy in their ethical mandates.

A major contributor to this problem was the short-term mentality that comes from satisfying the Wall Street “beasts” quarterly-earnings estimates. If you don’t hit the number, your stock falls. This is an unfortunate game where Wall Street research had become the corrupt handmaiden of the investment banking business. The short-term mentality was further compounded by the fact that management was loaded up with stock options.

So you had this syndrome of short-term goals and lots of options, which was a perversion of what should be the long-term goals of corporate America — an evaluation of what is good management, a marketplace that’s focused on real research, and a real appraisal of what makes a good company.

How have new regulations addressed the problems you describe?

There was a need to tighten up the rules across the board, and that’s been done. In the accounting industry, we have the Public Company Accounting Oversight Board, which was mandated by Sarbanes-Oxley. We’ve also made changes in corporate governance — mandating independent audit committees, independent compensation committees, and independent nominating and corporate governance committees. All this has been part of a process of shifting the power from the omni-powerful chief executive back to the board, back to what should be the ultimate responsible body.

Is all this rule making enough?

You can go just so far with rules and regulations. It’s the spirit behind conforming with those rules that determines whether they will be successful. You can write all the rules you want to, but the act of rule writing by government is limited. People will find ways around the rules no matter how well-intentioned the authors are. I think history proves that.

So a major part of my job — and here I haven’t been so quiet — is urging management, and particularly boards of directors, to focus on what I call the DNA of their corporation. I want boards to answer the questions, What kind of company are we going to be? What is the moral fiber of this company? I want them to conclude that they are not going to skate up to the red line drawn by rules and regulations. Instead, they are going to stop well short of that line.

I believe it’s the company’s board that must establish that spirit, and I believe the board must pick a CEO who shares those beliefs and will implement them and make them part of everybody’s fiber and bones.

Does the SEC have enough personnel and resources to do its job?

After I arrived, we got an authorization for 840 new professional employees on the base of about 3,100. Is that enough? I would say that we are never going to have enough resources given the enormous scope of this agency’s task.

How do you best use the staff?

We have a whole new risk-management approach that is going to be revolutionary. It’s based on the assessment of where the problems are. I talk about looking around the corner and over the hill. We’re devising ways of uncovering current problems and learning more about potential areas where problems are bubbling. We’re redirecting our resources to use them in what I consider to be a cost-effective way.

What’s the role of business schools in training students to handle ethical conflicts that inevitably arise?

We used to talk at Yale about whether you can teach ethics to people in business school. We had big arguments with those who say ethics can’t be taught. I concluded that you can embed ethics in every course you’re teaching. There’s an ethical dimension to every decision that’s made, and that dimension can be an important point of discussion in everything that’s taught.

How much longer do you expect to lead the commission?

I’m going to do it as long as I think that I’m having an impact and doing what we started out to accomplish.

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