Online Extra: A Conversation with Bill Donaldson
Since becoming chairman of the Securities & Exchange Commission on Feb. 18, William H. Donaldson, 72, has been a busy man: He found a high-profile chairman, William McDonough, for the Public Company Accounting Oversight Board, oversaw the $1.4 billion settlement of conflict-of-interest charges against 10 Wall Street firms, and began a review of hedge-fund operations.
Now, Donaldson is starting to lay out his own agenda for the securities agency. On June 5, he sat down to talk about the SEC's future -- and the imprint he hopes to leave -- with BusinessWeek Washington correspondents Amy Borrus, Paula Dwyer, and Mike McNamee. Edited excerpts of their conversation follow:
On the SEC:
The SEC is one of the great agencies of this government. I've dealt with the SEC all my business life, and it has always been extremely fair but tough. And the people are highly respected because of that. Insofar as it may have gotten off that track, I want to achieve an environment where it's better managed.
On what he hopes to accomplish:
I ask myself why I took this job at this stage in my life. It's because we're at a pivotal point in the reestablishment of faith in the business and financial communities. I would like to be remembered for having an effect on that, for bringing everybody back to a sense of business integrity.
There are a lot of people out there, not just businesspeople but also some of the gatekeepers -- accountants, lawyers -- where there has been a shift in ethics and morality, [thinking] that cutting corners a little bit is justified because "everybody else is doing it." I hope [to] have an impact in righting that.
On restoring investor confidence:
We've got to convince people that we're on the case. Real confidence won't come until people are convinced that [the scandals are] all gotten out, that real change has gone on. You don't gain confidence by burying [corporate fraud].
It isn't all solved yet. We're gilding the lily if we think it is. Unfortunate[ly] a lot of it is catch-up ball.
On corporate governance:
You've got to [have] boards that take a good hard look at how they're imbuing the corporate entity with a DNA that says "this is the kind of company we're going to be." There needs to be a whole new definition of what real performance is. The whole earning-per-share game, the straitjacket of trying to conform to the concept that things improve steadily quarter by quarter, is unnatural.
We still see -- witness this proxy season -- that a lot of compensation is not related to performance in the broadest sense of the word. I hope to use the bully pulpit to talk about that every chance I get.
On access to the proxy ballot:
It's very controversial. How can shareholders have more influence than they do now in terms of the election of directors? There are legitimate concerns [by] management to not have dissidents on the board. On the other hand, there's a very legitimate concern that if I'm a long-term shareholder in a company and own a lot of stock, and there are other likeminded people who own a lot of stock, why shouldn't we be able to put up our nominee?
On hedge funds:
There are conflicting trends. The little guy is saying, "How come I can't have this wonderful vehicle?" The presumption is [that] this guy is unsophisticated, [but] there are lots of little-guy investors who are sophisticated. On the other hand, [we] lack information on what's going on in this $600 billion pile of capital. It's just too much money for us to know as little as we do.
I'm not talking about making public the trading techniques that are proprietary to a hedge fund. It's about making sure there are enough safeguards, enough transparency so that a less-sophisticated investor is protected.
On mutual funds:
The mutual-fund industry is a vital industry, and it has had relatively few scandals. But it has to figure out how it can deliver what investors are looking for at a competitive price. People have to understand what the costs are of turning their money over to someone.
We [also] want to make sure that when brokers sell funds, there are no rules or laws being broken. We want to make sure that somebody buying a mutual fund knows why the broker is recommending it. We also want to know what inducements are coming from the mutual funds themselves to the brokerage firms. The role of the outside mutual-fund director is very difficult in terms of discharging the independence they should have, surrounded by directors with ties to the management company. It's an area that needs to be looked at.
On stock exchanges and market structure:
The issues of market structure have been handled piecemeal. We've had the rise of technology, we've had the tremendous introduction of new trading platforms -- the electronic communications networks -- we've had the whole package of Nasdaq separating itself and de facto going public and wanting to become an exchange.
We have the additional issue of the international, global markets seeking to be competitive. These are tremendously complex issues. I think we've got to try to do this thing as a whole [and] look at market structure to bring some of the forces into a coherent whole. Clearly, the market structure issue is the most complex and the one in which most caution is needed.
If you amass buyers and sellers together -- either electronically or physically -- that is in theory how you get price discovery. Insofar as you fractionate that into competition between market centers, you start to get imperfect discovery. One of the central features of our marketplace is that we have a price-discovery mechanism that's overwhelming in size, so that a lot of people can play off of that. I've always thought that the competition between buyers and sellers is the essential competition, not the competition between market centers.
I'm very conscious of the fact that we have the best-functioning markets in the world, and I don't want us to lose that.
On self-regulation by the exchanges:
We've had a long tradition, beginning in the 1930s, of self-regulation and embedding the regulatory operation inside the organization. That has been a concept that has stood us in very good stead here over a long period of time. There are other models where you could have the exchange, or the Nasdaq, be a separate operation, and have the regulatory mechanism outside. That's part of what we've got to examine.
If self-regulation is embedded in the exchange, it's very hard to think there should be public ownership. Now, if you take the self-regulation out...and let's say the market buys its regulation from somebody else, that's a new model, and I'm not sure how well that works. Every time you spend a dollar on regulation, it's a dollar out of stockholders' pockets.
On trading in decimals:
We've operated now with decimals for a couple of years. The theory was good, now let's look at what the impact has been. You've got a lot of different points of view being put forth. What I wasn't suggesting [in a recent interview] was in any way returning to fractions, but just simply looking at what the impact of pennies has been on the depth and liquidity of the market and on different shareholder groups.
[Five-cent increments] would be very tough to accomplish unless everybody did it.
On competing with New York Attorney General Eliot Spitzer:
We need all the help we can get to root out the bad things that are going on. The SEC was under [resource] constraints, and Spitzer came in and did something good. One of the strengths of the country is that we have a national regulatory mechanism, and I don't think we can have 50 states having their own solutions as to how markets should operate.
That doesn't mean that the states can't or shouldn't cooperate with investigations. But once malfeasance or fraud has been uncovered, we need a central authority, and that's the SEC.
On the risk of overregulating:
I'm terrifically conscious of the costs of regulation. But this is a regulated industry. And forget about the obvious frauds -- you have to look at the daily cases that come before the SEC, underneath the radar. Even with regulation, there's a constant stream of that stuff going on. Yes, it has [surprised me]. The bank fraud, the pyramids -- there's a certain rhythm to these schemes, and they go on and on. And a lot of money is at stake for innocent people.
Clearly, the net-net of Sarbanes-Oxley is positive. But we need some time to operate and see if there are some things that can't be cured by rule changes before we call for revisiting parts of the law.
On stock-option expensing:
There's an expense associated with the issuance of options, and as far as I'm concerned, it legitimately belongs on the P&L [profit-and-loss statement]. The question is, how do you arrive at it, not whether it should be there.
The issue is trying to come together on [how to value options]. That's what FASB [Financial Accounting Standards Board] is going to do -- come up with some sort of formula. Companies are making estimates on things all the time, and this would be a best estimate.
On his management style:
I'm a great believer in partnership. Extremely hierarchical organizations don't function too well. I don't believe in the screaming approach to management.
Unlike other agencies, the chairman of the SEC is the chief executive officer. I want to hear what people have to say. I know that if I ultimately disagree with them, I'm going to have to go the way I think is right. But I don't want to freeze anybody out from talking about how they feel.
On managing the SEC:
We've got to figure out how to organize the paperwork product so we can get a kind of cost-benefit analysis approach to it. We need to have more of a forward-looking unit...to look around corners and forecast what may be about to happen in the future, instead of just being reactive to problems.
Maybe we can prevent some things from happening. Our information systems are antiquated. We can save people who have to file with us a lot of time and effort.