PAUL SOLMAN: Last year, as corporate scandals continued to dominate the business news, the chairman of the Securities and Exchange Commission, Harvey Pitt, resigned. He was replaced this February by a distinguished veteran of Wall Street, William Donaldson. The "D" in the investment banking firm DLJ, former member of the Nixon and Ford administrations, founder and first dean of the Yale Graduate School of Management, and former head of the New York Stock Exchange.
The SEC has been accused of lax regulation. Donaldson, an ex-marine, has vowed to be more aggressive. But during his nine-month tenure, the scandals have kept on coming, most recently in the mutual fund industry, where New York State Attorney General Eliot Spitzer has uncovered abuses in which insider investors and fund managers themselves made money at the expense of the fund's every day shareholders. Spitzer has criticized the SEC for not being aggressive enough. I sat down with Chairman Donaldson at the SEC yesterday.
William Donaldson, thanks for being with us.
WILLIAM DONALDSON: Delighted to be here.
PAUL SOLMAN: One of your predecessors at the SEC, Arthur Levitt, has said of the mutual fund revelations, "This is far and away the most serious and pervasive scandal to hit America's markets in the past century. The ethical loss is cataclysmic." Is Arthur Levitt exaggerating?
WILLIAM DONALDSON: Well, I think that this is pretty serious stuff. "Cataclysmic" is a pretty strong word but I'm appalled by exactly what has gone on in terms of some of the issues such as, you know, involved with the late trading and market timing, and the fact that in some cases portfolio managers were actually breaking the law with the portfolios they were running themselves. That's pretty shocking.
PAUL SOLMAN: How could it have happened, though, in an industry that most of us, I think, felt was the safest place to put our money?
WILLIAM DONALDSON: Well, the industry has had a long and excellent record, and I think that during the times of the bull market, I think in particular when the performance has not been so good, i.e., in the bear market that we had a couple of years ago, that a lot of these companies maybe let their procedures down, and did some things that were caused by the circumstances of not such good performance.
PAUL SOLMAN: Why wasn't the SEC out in front on this and other issues? You told the Senate Banking Committee recently it was due to lagging resources and structural and organizational roadblocks -- such as?
WILLIAM DONALDSON: Well, I think that you have to put this in context. We have 350 or so people out there doing inspections in the mutual fund industry. There are 6,000-7,000 mutual funds, and another 6,000 investment advisors, so it's a big area to cover. And this doesn't excuse what's happened. And a further thing would be that the initial insight into what was going on was an illegal collusion between a hedge fund and a mutual fund, and that's when people want to collude and hide it, it's pretty easy to hide.
PAUL SOLMAN: On the other hand, it was the state attorney general of New York, Eliot Spitzer, who got a tip, pursued it.
WILLIAM DONALDSON: Absolutely.
PAUL SOLMAN: And when we talked to him, we said "how come it was you and not the SEC?" He said "well, the SEC is more like a World War I Army, digging trenches, inching forward. I'm fighting more of a guerrilla war."
WILLIAM DONALDSON: Well, I think the characterization of the SEC as a World War I Army is not pertinent at all. I mean, there are a whole series of things that the SEC has responsibility for, a whole series of things that we were looking at. You have to remember, during the bull market there were other things going on in the mutual funds that we were working on, and we've had a number of things that we've been working on well before Eliot Spitzer came along. But in terms of this specific issue of late trading and market timing, you know, we were not there.
PAUL SOLMAN: Arthur Levitt has said the pressure from Congress has kept the SEC off Wall Street's back, and Attorney General Spitzer has said the SEC has cow-towed to Capitol Hill. Has political pressure constrained the SEC?
WILLIAM DONALDSON: Not during my tenure.
PAUL SOLMAN: You think it had before?
WILLIAM DONALDSON: There were a lot of things going on in the past. I'm trying to look at what we're doing for the future as opposed to getting all tied up in what was wrong with the past.
PAUL SOLMAN: But so the SEC is now not under political pressure from Capitol Hill?
WILLIAM DONALDSON: Absolutely not. Absolutely not.
PAUL SOLMAN: Other people we've interviewed, Attorney General Spitzer, Nobel Laureate economist George Akerlof have blamed what you've called a gradual erosion of standards-- I think that's your phrase in the business community-- on deregulation. Do you agree with that?
WILLIAM DONALDSON: No, I don't think that's true. It's just a relaxation of standards, if you will, not unlike what happened back in 1929. After the huge bull market we had the same thing. We saw after the crash came, we saw these practices being brought out into the open. The difference this time, however, is that there are many more people involved, many more victims. You know, 90 million shareholders in mutual funds, 50 percent of the households having an interest in the equities market, that's different than it was back in 1929.
PAUL SOLMAN: Don't companies, and most of us perhaps, push the envelope to get away with essentially as much as the authorities will allow-- exceeding the speed limit when we're driving, for example, or if we're a mutual fund company, fudging the numbers for performance to make our fund look more successful than the other guy's? And if that's the case, then don't authorities need to really clamp down to set an example so that people won't push the envelope? Send people to jail, for example?
WILLIAM DONALDSON: Well, two things. Number one is that's exactly what we've been doing. I mean, you're absolutely right in terms of a tendency to, "perhaps fudge the figures" and so forth. You asked what the SEC was doing; that's what they were doing in putting that at a high priority. We maybe had missed a practice that was a lot harder to get to and find.
PAUL SOLMAN: But Eliot Spitzer has accused you guys, your administration specifically, of making too quick a deal with, too easy a settlement with Putnam, for example -- being too lenient and therefore not clamping down in a way that would discourage future malfeasance.
WILLIAM DONALDSON: Well, he's wrong on that. We believe the settlement we made with Putnam... you have to understand that the issue at Putnam was that they had at least two fund managers that were trading with their own fund and that the management... it was alleged that the management company should have found out about that, they knew about it, and they should have reported it to the boards of directors of the fund. They didn't. That's the issue, and we went in and we got a settlement with them, which will get the moneys that were involved, that is still open, they have admitted guilt to us in terms of the money penalties, which will still be coming down the pike.
The reason we settled with them was to try and prevent the continuation of these practices for the shareholders that are still in those Putnam funds. In other words we got immediate agreement from the Putnam people to change the structure of the oversight of their funds, the directors, et cetera, et cetera, et cetera. What we didn't do is close the door on further investigations that we have under way.
In other words, the door is totally open to go after other things if we find them at Putnam, and we will do that. The other point I'd like to make is that we do not have criminal authority. We cannot put people in jail, we are a civil agency. So the most we can do is to bring sanctions, monetary sanctions, to prevent people from becoming officers and directors and so forth. But as far as putting them in jail, Eliot Spitzer has that sort of authority in New York State. We don't.
PAUL SOLMAN: Finally, are investors safe now?
WILLIAM DONALDSON: I think that we're moving very swiftly now to install a number of rules and regulations that basically address some of the malfeasance that's gone on, and I think that people are going to see that the steps we're taking will go a long way toward having this sort of stuff not happen again.
PAUL SOLMAN: William Donaldson, thanks very much for being with us.
WILLIAM DONALDSON: Delighted to be with you.