How's Donaldson Doing?

After a year, the SEC chief has accomplished more than many expected. But as resistance rises, will he be able to finish the job?

On the frigid morning of Jan. 30, Securities & Exchange Commission Chairman William H. Donaldson huddled with a dozen top staffers in Alexandria, Va. For four hours, they sat in a windowless room discussing what they thought the agency was doing right and wrong, and how it could do better. Over coffee and delivery pizza -- everyone anted up $4 -- the group batted around ideas on issues ranging from mutual funds to market regulation. The result: a long to-do list.

The off-site brainstorming session is the latest sign that Donaldson is kicking the 3,100-person agency into high gear. When the Wall Street veteran came out of retirement a year ago to head the SEC, many saw him as a caretaker who would keep the agency out of the headlines after the controversial reign of Harvey L. Pitt. Donaldson, 72, has indeed been low-key. But he has surprised backers and critics alike by emerging as a quiet crusader for reform and an able manager who has restored the battered agency's esprit de corps and unleashed the nation's securities cops in bold new ways.

Keeping up the momentum as he pushes the SEC to complete a pile of unfinished business will get harder. As memories of scandal fade, Corporate America and Wall Street are pushing back. To stay on his regulatory course -- one that's strikingly uncharacteristic of a pro-business Republican -- Donaldson will have to withstand enormous pressure from business. Already, CEOs are grousing about the rigors and costs imposed by the SEC under the 2002 Sarbanes-Oxley law.

Donaldson isn't moved by the argument. "Using Sarbanes-Oxley as an excuse for not taking risks -- that's a cop-out," he told BusinessWeek in an interview. And so far, the Administration hasn't weighed in. "There has been zero pressure" from the White House on any issue, Donaldson insists. But if stock markets stall before the election and business blames the new rules, that may change.

While the agency's five commissioners usually vote unanimously, insiders say a 3-2 split is emerging on key issues, such as shareholder democracy, hedge funds, mutual-fund governance, and even some enforcement matters. Increasingly, Donaldson is aligned with Democratic Commissioners Harvey J. Goldschmid and Roel C. Campos, while his fellow GOP commissioners -- Paul S. Atkins and Cynthia A. Glassman -- advocate a more hands-off approach.

SAVVY SILENCE. If Donaldson's reform efforts falter, Eliot Spitzer will be on his case. The New York attorney general's aggressive investigations of Wall Street analysts and mutual funds embarrassed the SEC, and the courtly Donaldson didn't do much to defend the agency in public. Some staffers wish he were feistier, but confidants say he's smart to turn the other cheek. "It does no good to get into a shouting match with Eliot Spitzer -- that's not a match you can win," says Dan W. Lufkin, co-founder of Donaldson's old firm, brokerage Donaldson, Lufkin & Jenrette Inc.

Rumors that Donaldson will step down after the elections aren't helping. Donaldson demurs, saying he hasn't even told his wife of his plans. "I came because I thought I could make a contribution," he says. "I'm going to stay here as long as I am."

Those contributions start with hefty budget hikes. The SEC is on track to hire nearly 900 new lawyers, accountants, and inspectors. The 12.5% increase Donaldson scored in President George W. Bush's 2005 budget, to $913 million, outstrips even the 9.7% boost in homeland security spending. "It's a truly signal achievement that will let the SEC keep up with the markets in a way it simply couldn't in the 1990s," says Joel Seligman, dean of Washington University School of Law.

Even more surprising is Donaldson's activism. The former chairman and CEO of the New York Stock Exchange forced the Big Board to disclose its exorbitant executive pay packages and overhaul its governance. He pushed for rules that would empower shareholders and, after a late start, ordered a raft of reforms to curb abuses in the mutual-fund industry. Donaldson has championed modest regulation of hedge funds, too, and plans to modernize the nation's stock markets.

Lawmakers give the SEC chief high marks. "William Donaldson is doing a good job under tough circumstances," says Senate Banking Committee Chairman Richard C. Shelby (R-Ala.). Many who had questioned Donaldson's commitment to good corporate governance are pleased, too. Says Nell Minow, editor of The Corporate Library LLC, a governance research service: "I'm delighted by his enthusiasm for addressing fundamental reforms."

Donaldson has his critics. Heads of some state pension funds were incensed that he didn't force the NYSE to separate its regulatory and commercial functions. And Spitzer has blasted the SEC for refusing to make fund companies cut their management fees in settlements over trading abuses.

Donaldson's most explosive issue is a plan to make it easier for shareholders to nominate directors to corporate boards. Says Donaldson: "If you are a shareholder and don't like what is going on, you can sell or start a proxy contest. Shouldn't there be something in between?" The Business Roundtable, whose members include some of President Bush's biggest backers, is fiercely opposed to the measure.

PINCHED PENNIES. There's less resistance -- but plenty to nail down -- on the mutual-fund front. The SEC is in the midst of a sweeping overhaul of rules aimed at halting trading abuses, shining a bright light on fees and costs, improving fund governance, and curbing unsavory sales practices. Some fund critics complain that the SEC's approach is scattershot and not bold enough. But most reformers say the agency is on the right track. "The SEC is hitting a lot of the most important abuses," says Roy Weitz, founder of FundAlarm.

Untangling knotty market issues will pitch the SEC into messy battles with the exchanges and their electronic rivals. The agency will soon unveil a series of initiatives, including a proposed ban on pricing stocks in fractions of a penny, which now occurs in 16% of NASDAQ's trading. The practice creates chaotic price quotes that can open the door to abusive trades. The SEC also will modify a rule that requires orders to go to the market that has the best price, rather than the fastest execution. "A lot of investors say it's worth more to me to get my order done immediately, unbroken-up, than it is to fight for a penny," says Donaldson. NASDAQ and electronic trading networks want the SEC to end the rule altogether.

The former U.S. Marine Corps platoon commander wants to weld the SEC's five disparate divisions into a rapid-response team that can tackle abuses before they explode into scandal. "We've got to look over the hills and around corners," he says. The SEC's recent crackdown on fees charged by index mutual funds is a prime example. After a few more brainstorming sessions, Donaldson may have even more marching orders for his troops.

By Amy Borrus, with Paula Dwyer, in Washington

— With assistance by Paula Dwyer

    Before it's here, it's on the Bloomberg Terminal.