Commentary: Just a Minute, Mr. Donaldson

TO: Senate Banking Committee

FROM: Gary Weiss

SUBJECT: William Donaldson, SEC nominee

I am sure you are anxious to confirm Bill Donaldson as chairman of the Securities & Exchange Commission. The word out of Washington is that this old Bush family friend, fellow Yalie and Skull & Bones member, is going to glide smoothly to confirmation. His résumé is, of course, superb--Under Secretary of State, New York Stock Exchange chairman, co-founder of Donaldson, Lufkin & Jenrette Inc. (CSR ) His personality is as calm and serene as the Tidal Basin. And above all, he is not you-know-who. It doesn't do his prospects any harm at all that Harvey L. Pitt, arguably the least popular SEC chairman in modern times, has made good on his threat to stay on the job until his successor arrives.

But even though haste is understandable, your committee should take some time in its deliberations. Chew the fat with Donaldson a little. As a matter of fact, I have some questions that you might want to ask him at his confirmation hearings on Feb. 5. I tried to ask them myself but had no luck. The nominee was "traveling," according to an aide at Donaldson Enterprises, a private investment firm in New York where Donaldson hangs his hat nowadays, and he did not respond to my request for an interview. Maybe you'll do better:

When you were chairman of the NYSE, did you know about, sanction, or cover up illegal trading by floor brokers?

Unlike his predecessor, Bill Donaldson actually has a track record as head of a regulatory body. And there is one aspect of his term as chairman of the Big Board, a post he held from 1991 to 1995, that your committee may want to explore. It has to do with an obscure breed of Wall Streeter called the floor broker. These people handle orders on the stock exchange floors from large customers, and are strictly prohibited from trading for their own profit because of their unique access to customer order-flow information. In 1998, a federal grand jury indicted 10 floor brokers for doing just that. Nine of them pleaded guilty and were sentenced to prison terms.

The available evidence suggests pretty strongly that Donaldson either knew or should have known about the illegal trading--and failed to do anything to stop it. The NYSE was soundly thrashed in a 1999 settlement of an enforcement action that the SEC lodged against it. The SEC found that the NYSE had turned its back on a widespread problem. Neither Donaldson nor any other NYSE official was named, but the SEC found that the NYSE--"without reasonable justification or excuse"--failed to supervise its floor brokers adequately during the entire time that Donaldson was chairman, and for two years afterwards. The NYSE neither admitted nor denied the charges.

Be sure to get ahold of the internal NYSE documents that were produced as evidence in legal proceedings involving a former floor broker named John D'Alessio. Read them carefully. You might want to ask Donaldson to explain a memorandum that was sent to him dated Jan. 16, 1992, providing the "highlights" of the NYSE's Market Performance Committee, including an ad hoc committee on "trading for eighths"--NYSE-speak for floor brokers illegally trading for their own profit. The ad hoc committee found that existing trading rules were adequate, and that the issue should not be put in writing to avoid "unwarranted media attention." Sure enough, not a word found its way to the public or the SEC at the time.

Did Donaldson agree with that memo's view of the public's right to know? And did he know about or sanction efforts to hide the issue from the SEC? According to notes produced in a D'Alessio lawsuit, one high-level NYSE official instructed another: "DO NOT DISCUSS WITH SEC." There's no evidence Donaldson saw those notes. Even so, D'Alessio's attorney, Dominic Amorosa, alleged in a December, 2002, letter to the SEC that Donaldson "was deeply involved in the wrongdoing that is at the root" of D'Alessio's appeal of NYSE charges related to the trading scandal. Is that legal grandstanding--or is there a germ of truth to the charge?

Why did you try to charge the Henry Ford II estate $1 million a year for acting as part-time trustee?

Executive compensation is a hot issue. So is the attitude of the next SEC chairman toward individual investors--the proverbial "widows and orphans." Donaldson has a reputation for not being overly solicitous in that regard. Is that a bum rap? You might find a clue in a long-forgotten dispute involving Donaldson, a fortune, and a widow.

In 1988, Donaldson became trustee of the $350 million estate of Henry Ford II. Trustees' salaries are not set by law, so Donaldson came up with a nice round number--a million dollars a year. The primary beneficiary, Kathleen DuRoss Ford, asked a judge in Palm Beach, Fla., to bar Donaldson from collecting. Mrs. Ford's lawyer angrily asserted at the time that Donaldson was trying to "extort from the trust" a huge sum of money for doing "no work." Donaldson just as angrily replied he would indeed have to do work, and that the money was justified. The case dragged on for some months, ending in a settlement in which Donaldson would earn $1 million the first year, $550,000 the next two, and then resign.

A million dollars for a part-time job? That's as much as Donaldson was paid when he was chairman of Aetna Inc. (AET ) (not counting the controversial $6 million bonus he was also paid by the insurer). Why did he charge the trust so much? What does this say about his attitude toward executive compensation?

Other questions come easily to mind. Obvious things, such as one of his more interesting recent public comments:

Why do you believe that Regulation Fair Disclosure is "crazy"?

Advocates of this rule believe that by requiring that market-sensitive info is made available to everyone at the same time, the public benefits. Does he have a problem with that?

And don't forget another position he took as NYSE chairman:

Do you still believe that accounting rules for U.S.-listed foreign companies should be softened?

Likewise, be sure to have Donaldson walk you through his 14 months in 2000 and 2001 at Aetna. By all accounts, his record showed a callous disregard of investor interests. Maybe that's a mistaken impression--let's hear from him on that. The company ran deep into red ink on his watch, rejected a handsome merger offer just before shares of Aetna stock tanked, and is the target of shareholder lawsuits that he and the company are fighting.

I also hope you'll ask him if he was aware that another company in which he was a board member, EasyLink Services Corp. (EASY ), was paying for ostensibly independent analyst research (BW--Jan. 13). Does he think that kind of thing is a good idea? He was on EasyLink's compensation committee when it voted to forgive a $200,000 loan to the chief executive even though the company was mired in red ink. Why did he do that?

I hope Donaldson has good answers for all of these questions. Investors are in no mood for another Harvey Pitt, and the public needs somebody who can restore confidence to the markets. But if Donaldson doesn't give satisfactory answers, your duty is clear. Forget about his résumé, the public's fatigue with bad news--and even the ever-lingering Pitt. Don't confirm his nomination.

Weiss covered the NYSE floor brokers scandal.

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