<DOC>
[108 Senate Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:90929.wais]
S. Hrg. 108 - 231
NOMINATION OF WILLIAM H. DONALDSON
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
ON
NOMINATION OF WILLIAM H. DONALDSON, OF NEW YORK, TO BE A MEMBER OF THE
U.S. SECURITIES AND EXCHANGE COMMISSION
__________
FEBRUARY 5, 2003
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
RICHARD C. SHELBY, Alabama, Chairman
ROBERT F. BENNETT, Utah PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky EVAN BAYH, Indiana
MIKE CRAPO, Idaho ZELL MILLER, Georgia
JOHN E. SUNUNU, New Hampshire THOMAS R. CARPER, Delaware
ELIZABETH DOLE, North Carolina DEBBIE STABENOW, Michigan
LINCOLN D. CHAFEE, Rhode Island JON S. CORZINE, New Jersey
Kathleen L. Casey, Staff Director and Counsel
Steven B. Harris, Democratic Staff Director and Chief Counsel
Douglas R. Nappi, Chief Counsel
Dean V. Shahinian, Democratic Counsel
Vincent Meehan, Democratic Counsel
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
(ii)
C O N T E N T S
----------
WEDNESDAY, FEBRUARY 5, 2003
Page
Opening statement of Chairman Shelby............................. 1
Opening statements, comments, or prepared statements of:
Senator Sarbanes............................................. 2
Senator Schumer.............................................. 4
Senator Clinton.............................................. 6
Senator Bennett.............................................. 7
Senator Johnson.............................................. 8
Prepared statement....................................... 48
Senator Enzi................................................. 9
Prepared statement....................................... 48
Senator Corzine.............................................. 10
Prepared statement....................................... 49
Senator Dole................................................. 12
Prepared statement....................................... 50
Senator Carper............................................... 12
Senator Dodd................................................. 13
Senator Chafee............................................... 14
Senator Stabenow............................................. 14
Prepared statement....................................... 51
Senator Allard............................................... 15
Prepared statement....................................... 52
Senator Bayh................................................. 16
Senator Crapo................................................ 29
Senator Santorum............................................. 52
Senator Bunning.............................................. 53
NOMINEE
William H. Donaldson, of New York, to be a Member of the U.S.
Securities and Exchange Commission............................. 18
Prepared statement........................................... 54
Biographical sketch of nominee............................... 55
Response to written questions of:
Senator Bunning.......................................... 84
Senator Hagel............................................ 85
Senator Enzi............................................. 86
Senator Crapo............................................ 88
Senator Miller........................................... 88
Senator Stabenow......................................... 89
Senator Reed............................................. 90
Senator Corzine.......................................... 91
Senator Dodd............................................. 92
Senator Santorum......................................... 94
Senator Bennett.......................................... 95
(iii)
NOMINATION OF WILLIAM H. DONALDSON
OF NEW YORK, TO BE A MEMBER OF THE
U.S. SECURITIES AND EXCHANGE COMMISSION
----------
WEDNESDAY, FEBRUARY 5, 2003
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:03 a.m., in room SD-538 of the
Dirksen Senate Office Building, Senator Richard C. Shelby
(Chairman of the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY
Chairman Shelby. The Committee will come to order.
Today, we are here to consider the nomination of Mr.
William H. Donaldson, to be Chairman of the U.S. Securities and
Exchange Commission.
Mr. Donaldson, we welcome you to the Committee.
Mr. Donaldson. Thank you, Senator.
Chairman Shelby. It is my intention to follow the same
procedure that this Committee has used in the past. I will make
my opening statement. I will then recognize the Chairman--
former Chairman Sarbanes--I still call him that.
[Laughter.]
For his opening statement. I will then recognize any of our
other colleagues who wish to make their opening statements.
After Mr. Donaldson is sworn in and makes his statement, we
will proceed to questions. I would ask my colleagues to limit
their questioning to 5 minutes, and then have additional rounds
of questioning, as necessary.
We stand at a critical time in the history of America's
capital markets. Our capital markets, which are the envy of the
world, have been shaken by scandal and corporate malfeasance.
We have all suffered accordingly. Investors have seen trillions
of dollars of market capital evaporate.
Despite the swift reaction of this Committee, led by my
colleague, Senator Sarbanes, the Congress and the
Administration, in passing the reforms embodied in the
Sarbanes-Oxley Act, investor confidence continues to flag. And
the reverberations of this crisis of confidence are felt beyond
Wall Street. Its impact is felt throughout our Nation's economy
and continues to impede a strong economic recovery.
We describe our capital markets with words like
``efficient'' or ``transparent.'' And it is true we have the
most efficient and transparent markets in the world. But the
bedrock of our capital markets is integrity. Without integrity,
there can be no such thing as rational investor confidence.
Since our capital markets fuel the engine of economic growth in
this country, the growth and strength of our economy relies on
investor confidence in the integrity of our markets. And few
people have as important a role to play in safeguarding the
integrity of our markets as the Chairman of the SEC.
As the agency charged with investor protection, the SEC has
always played a crucial role in ensuring the integrity of our
capital markets. By and large, it has been highly successful in
that role. Ours is the first society in history where equity
ownership is commonplace among ordinary citizens.
But recent events have left investors nervous and morale
flagging at the SEC. Rebuilding morale, I believe, Mr.
Donaldson, must be a top priority of the next Chairman of the
SEC. Today's SEC must be more nimble, more proactive, more
efficient than ever before. This will require strength and
take-charge leadership at the top. As Wall Street's ``Top
Cop,'' Mr. Donaldson, you will have to ensure that our
securities laws are enforced zealously and without regard for
wealth, position, or power.
As Chairman, Mr. Donaldson, you will be undertaking a
tremendous public trust. We live in a world where technology is
constantly reshaping the marketplace. The Commission must
jealously guard the integrity of our capital markets in order
to ensure that in an increasingly global economy, these markets
maintain their preeminent position. This will require a firm
hand, but also patience, determination, and resolve.
Mr. Donaldson, your leadership will be key to rebuilding
the faith of investors in our markets. The next Chairman of the
SEC will have an incredible opportunity.
Mr. Donaldson, your resume speaks for itself. Your
background and experience give you a unique perspective into
the challenges that we face today. You have the credibility and
standing in corporate America and on Wall Street to demand the
high standards of professional conduct. Indeed, you have an
opportunity to set a new tone for corporate governance and
responsibility.
It could be a new day for our capital markets, a new day
based on integrity and best practices, rather than cynicism and
manipulation of loopholes.
I know that my colleagues on our Committee and I support
the SEC in achieving its mission, but the SEC requires strong
leadership from within. We will expect you, Mr. Donaldson, to
provide that leadership.
Senator Sarbanes.
STATEMENT OF SENATOR PAUL S. SARBANES
Senator Sarbanes. Thank you very much, Mr. Chairman, I am
pleased to join with you in welcoming Mr. William Donaldson
this morning to the Committee. President Bush has nominated Mr.
Donaldson to be a Member of the Securities and Exchange
Commission and to serve as its Chairman.
As you have indicated, the United States securities markets
have been an economic asset, a very important economic asset,
not only of our own economy, but, indeed, of the world economy.
The Chairman of the SEC plays a critical role in promoting the
integrity, the strength, and the efficiency of these markets
and inspiring trust and confidence among investors. In my view,
protecting investors, ensuring the fairness and integrity of
our securities markets, and aggressively enforcing the
securities laws are the primary functions of the Securities and
Exchange Commission.
Unfortunately, in the last few years, the securities
markets have experienced a significant erosion in public
confidence. Investors have seen too many instances of public
companies with faulty
accounting and inadequate or misleading disclosures, unreliable
auditor certifications, and analysts giving misleading stock
recommendations. As Fortune magazine observed, there were, and
I quote them: ``Rampant conflicts of interest on Wall Street.
Wildly creative accounting. Auditors who didn't audit. Money
managers who didn't manage. A stunning lack of oversight by
regulators.''
The consequences for American families, for American
workers, and for investors have been profound. The aggregate
value of the publicly-traded stocks has declined by trillions
of dollars over the past 3 years. State pension plans have been
really hard hit. The retirees have seen their retirement
savings dry up, while millions of working Americans have had to
put their retirement plans on hold. Tens of thousands of
working men and working women have lost their jobs--at Enron
and WorldCom alone, just those two, more than 30,000.
It was precisely to address these and other related urgent
problems that the Congress last summer overwhelmingly approved
the Public Company Accounting Oversight and Investor Protection
Act, which the President signed into law and noting it as being
the most far-reaching changes in our securities laws since the
1930's.
Now it is the responsibility of the SEC to promulgate
regulations that fully implement the letter and spirit of the
new law, to engage in strong oversight of the securities market
participants and to vigorously enforce the laws. Clearly, the
SEC needs to take decisive actions to restore public
confidence.
In addition, the SEC must appoint for the new Public
Company Accounting Oversight Board a Chairman, selecting
someone, as the statute provides, ``of integrity and reputation
who have a demonstrated commitment to the interests of
investors and the public, and an understanding of the
responsibilities for and nature of the financial disclosures
required of issuers . . . and the obligations of accountants
with respect to the preparation and issuance of audit reports.
. . .'' The naming of this Chairman awaits the arrival of the
new Chairman of the SEC. It is a very important decision and,
in my judgment, will be the first clear definition of the new
Chairman of the SEC and the Commission.
Further, the morale of the Commission and its staff must be
restored. It now appears that increased funding for the SEC
will be forthcoming. The Omnibus Appropriation bill passed by
the Senate, contains a significant increase, but not quite up
to the level that was in the legislation. The President, in his
budget request, not for this year, but for next year, has
called for a further significant
increase. And if we can implement those increases, there will
be significant resources available to the SEC.
But leadership--at the SEC, that traditionally has meant
from the Chairman--will be required to restore the SEC to its
historic place as the crown jewel among the Federal regulatory
agencies.
These are all challenges that the new Chairman will
confront. This morning, I hope to review with Mr. Donaldson a
number of the key issues that confront the Commission and our
financial markets, including, of course, the need for the SEC
to reestablish its role as a strong, independent regulatory
body.
Mr. Chairman, I join with you in welcoming Mr. Donaldson
before the Committee and I look forward to the hearing to
follow.
Thank you.
Chairman Shelby. Thank you.
Before we go to the other Members' opening statements, I am
going to recognize Senator Schumer and then Senator Clinton for
any remarks that they want to make about Mr. Donaldson.
STATEMENT OF SENATOR CHARLES E. SCHUMER
Senator Schumer. Thank you, Mr. Chairman.
First, let me say that this is my first meeting of the
Banking Committee with you as Chairman. I want to congratulate
you on that and say that we have known each other for 20 years.
You are somebody who has a great mind, and who I think will
lead this Committee extremely well, and I look forward to
working with you.
Before I begin, I should note that among Mr. Donaldson's
qualifications is that he is a life-long New Yorker. He was
born and raised at one end of the State in Buffalo, and has
lived and worked for almost his whole life at the other end of
the State in New York City. And I must point out, Mr. Chairman,
that his experience has spanned two of the greatest cities in
this country.
[Laughter.]
Now, Mr. Chairman, I believe, and I am sure you and my
distinguished colleagues will agree, that today's hearing is
likely to be the most important hearing this Committee will
hold this year.
For today, we are not only nominating the next Chairman of
the Securities and Exchange Commission, but we--the Members of
the Senate Banking Committee--are taking the first steps to get
our Nation's economy back up and running again.
I have long believed that much of the current economic
downturn is due to a crisis of confidence. People have lost
faith in trusted institutions. That trust must be restored
before we see any meaningful growth in our markets, and before
any of the other measures we are considering at the Federal
level will have effect. As James Madison observed, ``The
circulation of confidence is better than the circulation of
money.'' And nothing is more damaging to the confidence of
investors than a leaderless and rudderless SEC. I know the SEC
can, and I believe that our nominee will, play an active role
in restoring investors' faith in the integrity of their
markets.
As I think of many of the challenges facing the new head of
the SEC, I am reminded of the famous Chinese curse, ``May you
live in interesting times.'' As we well know, these are
interesting times. And Mr. Donaldson, I certainly do not have
to tell you, in regard to the securities markets of this
country, these are the most interesting of times.
On the one hand, we need to rapidly conclude the
investigation and reforms of the securities industry that have
resulted in the ``global settlement'' amongst brokerage firms,
the SEC, and the States Attorneys General.
At the same time, I feel strongly that it is time we
recognize the importance of our capital markets and financial
services firms to our Nation's economic success. I believe our
markets are truly national assets. I know that our financial
services firms lead the world in innovation and excellence. The
SEC has a vital role to play in ensuring that they remain a
major competitive advantage of the United States and, of
course, of New York.
The new head of the SEC must also reckon with the enormous,
new complexity of our financial markets. Today, billions of
shares trade hands daily on the major markets in the United
States. In a short period of time, as this Committee well
knows, we have gone from largely a single equities market, the
New York Stock Exchange, with a few dominant firms trading on
regular hours, to many new markets, after-hours trading, online
trading, and an enormous array of players. More Americans are
exposed to these markets, with, for the first time, over 50
percent of Americans now owning stock in some form or another.
These statistics speak to the magnitude of the challenges
before the new head of the SEC.
Finally, as we all know, the SEC itself is undergoing
enormous change. As it attempts to reckon with the changes in
its markets and the companies it oversees, it is also
determining its own mission and mandate for the future. Given
an expanding mandate, I join my colleague, Senator Sarbanes, in
saying that I am delighted the SEC's funding has been increased
substantially in the Administration's new budget. Simply put,
the SEC cannot enforce the law without the quality and quantity
of professionals it requires. Those funds are also critical to
ensuring that the SEC can effectively enforce the governance
mandates set forth in Sarbanes-Oxley.
With these challenges in mind, Mr. Chairman, I believe that
Bill Donaldson's background ably qualifies him for the job. Mr.
Donaldson has started and has run a major Wall Street firm--
Donaldson, Lufkin & Jenrette--one, I might add, that was known
for being ahead of the curve of changes in the financial
industry.
Mr. Donaldson also served as Chairman of a major exchange,
the New York Stock Exchange, during a period of tremendous
market growth. But he has also been on the other side of the
table. He understands the risks, responsibilities, and
challenges of an executive, a Board member, and an investment
professional. He has a perspective grounded in reality, and he
is aware of the unpredictable, fallible and, at times, flawed
human factor in our markets.
Finally, Mr. Chairman, Mr. Donaldson is known as a man of
professional integrity. He is a straight shooter, who, I
believe, will work well with both political parties. Those are
personal qualities required of the head of the SEC.
In summary, he has the seasoned perspective of an issuer,
underwriter, exchange operator, and investor. The very
constituencies the SEC must consider in all of its work.
There is no doubt, Mr. Donaldson will live in interesting
times. The challenges of the industry will be one thing. My
hope is that the challenges of the political process will not
outweigh the important work that the SEC needs to do. Our
financial markets need to move forward. Our securities firms
need to move forward. And the SEC needs to move forward.
I am very confident that Bill Donaldson's life-long
involvement in the financial industry, coupled with his
demonstrated service to
his country, has adequately prepared him for the role of SEC
Chairman.
I should conclude by saying that I have had the pleasure of
knowing Mr. Donaldson for a long time. I am happy to see that
the Committee has not disqualified him for service based on
that fact.
Senator Sarbanes. Not yet, at least.
[Laughter.]
Senator Schumer. I am delighted, Mr. Chairman, to join with
my colleague, Senator Clinton, to introduce Bill Donaldson, and
I support his nomination to be the Chairman of the Securities
and Exchange Commission.
Thank you.
Chairman Shelby. Senator Clinton.
STATEMENT OF HILLARY RODHAM CLINTON
A U.S. SENATOR FROM THE STATE OF NEW YORK
Senator Clinton. Thank you, Mr. Chairman.
I join with my colleague, Senator Schumer, in not only
introducing Bill Donaldson, but also in endorsing the
opportunity we have as a Senate to put into such a critical
position a man of his experience and background.
It is not only that he was born in Buffalo and lives in New
York City, but also his background and experience has uniquely
qualified him for this position at this point in our history.
I would certainly associate myself with the comments of the
Chairman and the Ranking Member, as well as my colleague from
New York, in pointing out all of the reasons why this
appointment at this time could not be more crucial and
essential for the confidence and integrity of our markets.
I would also just add that on September 11, the financial
capital of the world in lower Manhattan was attacked. There was
a reason for that--because of what it represented, because of
what it meant, not just to New York and America, but, indeed,
to the entire global trading system.
The firms that are located there and, indeed, even the SEC
office, which is downtown, have made heroic efforts in the
immediate aftermath and in the months since, to make sure that
America and the world were once again open for business.
It is essential to the conduct of that business that we
have the rule of law and that we have confidence in the systems
that we have established here in the United States.
You can find rich people and you can find traders trading
nearly anything anywhere in the world. What you cannot find,
and what no nation has ever constructed, is the unique public-
private partnership to ensure the smooth operation and the
integrity of our capital markets. That is one of the great
attributes of 20th Century America.
In the 21st Century, we have to ensure that the SEC and its
Commissioner, who really epitomize and personalize that
commitment, demonstrate to our investors and to the world,
indeed, that we are not only open for business, but also for
business that is well-intentioned, well-regulated, and
extraordinarily successful.
So this is, as Senator Schumer said, an extraordinarily
important hearing to nominate someone who I think was certainly
meant for this position at this point in our time. And I look
forward to working with him and with this Committee as we do
what all of you know we must do, which is to restore confidence
and integrity in the minds of our investors and in the reality
of the investment
atmosphere.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Bennett, any opening statement?
STATEMENT OF SENATOR ROBERT F. BENNETT
Senator Bennett. Thank you, Mr. Chairman.
I, too, want to congratulate you on assuming the
Chairmanship of this Committee. I think your stewardship will
be marked with a calm and even hand. And I think we will be
well-served by your leadership.
I also want to thank Senator Sarbanes for his leadership as
Chairman, and I appreciate the time and effort that he put in,
not only on the Sarbanes-Oxley bill, but also the management of
the Committee.
One of the nice things about service on this Committee is
that it has been free of some of the more bitter partisanship
that we have found on other committees, and I think the two of
you are a demonstration of that, and I appreciate it.
I want to welcome Senator Dole and the other new Members of
the Committee that bring us a little fresh blood and a little
fresh outlook, which we need.
Mr. Donaldson, I will not go through all of the paeans of
praise that my colleagues have heaped upon you, all of which is
deserved. I simply want to thank you for your willingness, at
an age when people think about taking time off to put time in.
Your service, your experience, and your background are very
much needed and very much appreciated, not only by this
Committee, but also by the country as a whole.
We have a remarkably resilient economy. It has sustained
four major shocks in the relatively recent past. During the
collapse of the dot-com era, companies would come on to the
marketplace and not triple or quadruple, but exceed by 10, 20,
or 30 times their offering price in a matter of days.
And anyone who remembers tulip time in Holland understands
that those kinds of P/E ratios--there was no E, there was only
a P--would come back down to earth, and the inevitable collapse
of some of that bubble that hit the stock market and brought,
as Senator Sarbanes has said, the loss of paper value at least
of trillions of dollars, is a shock to the economy.
Then there was the over-capacity that was built into the
worldwide economy as investments were made in a number of basic
industries, and there had to be a reaction to that. We have not
repealed the business cycle. When over-investment produces
over-
capacity, it will produce ultimately a contraction. And that
came at about the same time that the high-tech bubble burst.
Then we had the corporate governance scandal hitting us at
the same time with the challenge of confidence in the markets
and confidence in market information--a tremendous shock to the
system.
On top of that, we have the geo-political risks that we are
currently facing, the uncertainty of what will happen in the
Middle East, the uncertainty in Venezuela, and the spike in oil
prices that come as a result of that.
A fourth shock to the economy occurred. And yet, through
all of this, last year, the GDP grew in excess of 2\1/2\
percent.
Now that is anemic growth, but it is growth, in the face of
these four areas of tremendous shock.
So, as I say, we have a tremendously resilient economy. But
it is still struggling. It is still in what Chairman Greenspan
calls ``the soft patch.''
Your confirmation and your stewardship at the SEC can
address one of those four shock areas and remove it from the
table. The confidence in corporate governance will go up when
you raise your right hand and take the oath. That is a
tremendous responsibility for your country to put on you, but I
do not know of anybody who is better equipped to shoulder that
responsibility than you are.
So again, I thank you for your willingness at this time in
your career, when you could just disappear and enjoy the many
fruits of a tremendously productive life, to share the
knowledge and the understanding that came out of that
productive life with your fellow citizens.
I look forward to supporting with enthusiasm your
nomination.
Mr. Donaldson. Thank you, Senator Bennett.
Senator Bennett. With that, Mr. Chairman, I have to be
excused because I have another hearing that I have to go to
where Secretary Chao will be reporting on what she is doing to
help small business, which is another underpinning of the
economy.
Chairman Shelby. Senator Johnson.
STATEMENT OF SENATOR TIM JOHNSON
Senator Johnson. Thank you, Mr. Chairman.
Our Nation continues to confront a crisis of confidence in
the markets that was precipitated by outrageous fraud in
companies and their auditors, from WorldCom to Enron to Arthur
Andersen. It is my hope that new leadership at the SEC will
help to move America forward. Ever since Mr. Pitt announced his
resignation on Election Night, we have been waiting for
President Bush to show leadership in this area. I know I join
my colleagues in welcoming a strong new head of the SEC, and we
look forward to hearing Mr. Donaldson's thoughts on his vision
for this critical position.
I would like to note to this panel the importance of
setting the tone for the future of the SEC. As I am sure most
recognize now, it is clear that Mr. Pitt made a grave error in
the tone he set at the start of his tenure by declaring his
intention to create a kinder and gentler SEC. As we have all
learned since, most of us the hard way through a steep decline
in the value of our retirement savings, we must work to create
a formidable SEC, a trustworthy SEC, and most important, an SEC
that places the interests of investors above all else.
However, if the SEC is to become kinder and gentler, I
believe it should be toward investors, who are now negotiating
the difficult maze of arbitration to seek justice over the
outrageous fraud that has gutted their life savings. I look
forward to hearing Mr. Donaldson's views about the arbitration
process, and how he might take steps to protect the rights of
investors.
Companies must understand that in the long-term, an SEC
that is trusted by investors will work to their ultimate
benefit. Until we restore confidence in investors, we cannot
get our economy back on track. Investors have not pulled out of
the market because they want to avoid paying taxes on their
dividends. They have pulled out because they do not trust
corporate leadership and they do not trust the SEC.
I would like to note for the record that the SEC under
Harvey Pitt has taken some very important steps toward
implementing the Sarbanes-Oxley Act. And I would especially
like to acknowledge the extraordinary leadership of Senator
Sarbanes, along with Senators Dodd and Corzine, on that effort.
We need to keep the pressure on implementation of this law, and
I look forward to working with Chairman Shelby and this
Committee to conduct strong oversight.
I would ask, Mr. Chairman, that a complete statement and
some additional questions be submitted into the record. And I
once again thank the Chairman for convening the hearing and
congratulate Mr. Donaldson on his nomination.
Chairman Shelby. Without objection, your complete statement
will be made part of the record.
Senator Enzi.
STATEMENT OF SENATOR MICHAEL B. ENZI
Senator Enzi. Thank you, Mr. Chairman. I, too, would like
for my complete statement to be made a part of the record.
Chairman Shelby. Without objection, so ordered.
Senator Enzi. I am pleased that you are holding this
hearing. I appreciated the opportunity to meet with Mr.
Donaldson last week.
Of course, you are coming at a time of tremendous turmoil,
as the previous speeches have pointed out. I particularly
appreciate the strong endorsement and recommendation you
received from the two Senators from New York, who do a good job
of keeping an eye on this particular sector, since it
originates in New York.
I do believe that part of accomplishing the goals of the
SEC come from penalizing the wrong-doers to the fullest extent
possible. That has made the biggest difference so far. The
purveyors of corporate fraud must be punished swiftly and
severely. And the only way to punish these criminals is to
deliver real sentences and harsh monetary penalties.
We provided the legislation that will allow that. Now, we
need the action by the Commission.
In addition, I want you as the new Chairman to closely
examine the Congressional intent during the Commission's
rulemakings on Sarbanes-Oxley. I do not believe that anyone who
was involved in the development of Sarbanes-Oxley believed that
the Financial
Accounting Standards Board would not be the accounting
standard-setting body described in Section 108. However, the
SEC has yet to officially notify FASB that they are that body.
It is my understanding that while naming the standard-setting
body, that we would be giving the FASB more independence. By
giving them an
independent funding source and statutory authority, they would
have a better ability to make independent decisions on
accounting matters.
This section was not intended to give the SEC significantly
more authority over accounting standard setting. The Commission
does not have the expertise to set the accounting standards.
This lack of acknowledgement by the Commission has left FASB in
a funding crisis. Private companies are no longer supplying the
funds to FASB because they were intended to have the mandatory
funding mechanism outlined in Sarbanes-Oxley.
The Commission, I think, should immediately name FASB as
the standard-setting body in Section 108, or at least make
clear what is going to happen on it.
This point brings us to, I think, a bigger issue, and that
is throughout the rulemaking, the SEC has gone beyond the
statutory requirements of last year's legislation, whether it
is the auditor independence rule, the Section 307 lawyer
provision, or the naming of FASB, which I mentioned.
The Commission seems determined to go beyond these
statutory requirements. Some of these issues, in particular,
the nonaudit services provision, went well beyond the statute.
However, I am really glad there is some clarification on the
cascading down to the smaller bodies.
A large part of Sarbanes-Oxley was the construction of the
new Public Company Accounting and Oversight Board. It was
designed to be the front-line regulator of the accounting
industry, including the establishment of nonaudit service
prohibitions. It was unnecessary for the Commission to go as
far as the proposed rule did when we were a few months from
having the PCAOB operational. They, not the Commission, will be
in the best position to make the determination regarding what
is and is not a conflict.
I also know the salary levels of the members of that Board
have received a lot of attention, particularly from the members
of the Commission. This Board was constructed to be private and
not a Government agency and part of this was to ensure it would
attract and retain qualified members of the Board by offering
competitive salaries. I think we need to ensure that that Board
is able to continue to attract those people.
I thank you for the opportunity to have you here today, to
get to meet your family, and to move this process along.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Corzine.
STATEMENT OF SENATOR JON S. CORZINE
Senator Corzine. Thank you, Mr. Chairman. Let me begin by
congratulating you on your role as Chairman. I look forward to
working with you. I know you have the interest of making sure
that our financial markets are the best in the world, the
deepest, strongest, most committed to integrity.
I also want to compliment the Ranking Member on his
leadership and commitment to the same principles. And I do
believe that we have the capacity to be a positive oversight
element in the construction and execution of these markets.
Last, I have a longer statement for the record that I will
include. I, too, am one that respects the President's choice
with regard to the individual selected for the SEC. Not only
did he visit with me last week, but also I have had more than
ample opportunity in my own personal experience to spend time
with Mr. Donaldson. I respect his vast knowledge, character,
independence, and ability with regard to the issues that the
SEC will have to deal with.
I want my colleagues to know that I both respect him as an
individual and also I think he can bring to the SEC his
leadership.
The agenda is an enormous one, and the challenges of
restoring confidence and clarity to the marketplace's sense of
integrity, those hurdles are very high. And so, the challenges,
even for an innovator and an honorable person who has this
experience, I think, are going to be quite serious.
The first place we start, in my view, is making sure that
this Public Accounting Oversight Board is independently staffed
and resourced. I concur entirely with Senator Enzi that we need
to make sure that FASB is in that same position, gets the
resources to make sure that it is representing investor
interests as opposed to any other presumptions, not necessarily
other interests-dominant. But we need to make sure that it is
independently financed, and that process needs to get going
forward.
These two institutions ultimately will be responsible for
making sure that the auditing of our public accounting firms,
of our public companies, is done in a way that the public will
develop trust over time and FASB needs to be able to write
rules in an independent way, that has not always been clear in
the public's mind.
I think there is also the issue of making sure that we use
these resources, and I think we are all very pleased that both
the President and the Congress are now on one page with regard
to providing the SEC, are soundly used and managed. Your
experience will be great in that.
But there is a need for a national market. And if the SEC
is not strong in its voice with regard to how our markets are
integrated and work together, I fear that we will see a
deterioration of the quality, depth, and breadth of those
markets.
I think it is absolutely essential that the SEC be the
leader in this. And I look forward to your efforts along those
lines.
There are a whole host of fairness issues, the arbitration
issue, which was already mentioned by Senator Johnson, the
interpretation of the rules and making sure that they are
administered fairly and consistently across all elements of the
industry, are important.
I know you are an individual who cares deeply about this
and I endorse completely what I know to be a strong and
experienced leadership who will do a great job at the SEC.
Chairman Shelby. Senator Corzine, your complete statement
will be made part of there record, without objection.
Senator Dole.
COMMENTS OF SENATOR ELIZABETH DOLE
Senator Dole. Yes, Mr. Chairman. As a new Member of the
Banking Committee, let me say how much I look forward to
working with you as Chairman.
Chairman Shelby. Thank you.
Senator Dole. And with former Chairman Sarbanes. I
appreciate your leadership on the Sarbanes-Oxley Act.
It was my great pleasure to get to know Bill Donaldson on a
trip to Poland when I was a leader of that delegation, during
my time as Secretary of Labor.
I certainly look forward to strongly supporting your
nomination.
I do have some questions, Mr. Chairman. I have another
committee hearing that was scheduled at the same hour, and so,
I will submit my statement for the record and look forward to a
couple of questions before I have to leave.
Chairman Shelby. We will see that that is done. Thank you.
Senator Carper.
STATEMENT OF SENATOR THOMAS R. CARPER
Senator Carper. My statement was so strong, I broke the
microphone.
[Laughter.]
Senator Carper. Mr. Chairman, thanks very much.
Chairman Shelby. Thank you.
Senator Carper. Mr. Donaldson, welcome to you and to your
family this morning.
I just want to say for the record that the Chairman and I
served together on the House Banking Committee a number of
years ago. And as I look around the audience, I see some people
with whom we served, either in that capacity or in a staff
capacity.
I remember saying to people, some day, Richard Shelby will
be Chairman of the Banking Committee, but I thought it would be
the House Banking Committee.
[Laughter.]
I thought he would be a Democrat.
[Laughter.]
But I knew from the outset that he would be Chairman and I
am happy to be here with him.
Chairman Shelby. I loved the House, but I am glad to be in
the Senate.
[Laughter.]
Senator Carper. Thank you for being here. Thank you for
your willingness to serve. The others who have known you longer
and better than I have have spoken to your credentials and I
won't go over those again.
I want to thank your family for their willingness to share
you with us and with the people of this country.
The President is interested, as we all are, in getting the
economy moving; and he has proposed an economic stimulus
package, to help do that.
In my own conversations with business leaders in Delaware
and around the country, my sense is what we need maybe more
than an economic growth package is some certainty in a variety
of areas, and I just want to mention a few of those.
One of those is certainty with respect to who is going to
be in the majority here? Who is going to be in the majority in
the Senate? Who is going to be the leader of the majority?
Certainty with respect to the situation in Iraq, the Middle
East, the availability of oil, the price of oil, energy, what
kind of impact are we going to see there?
Certainty with respect to North Korea. Certainly with
respect to the stock market--can people really trust and
believe the numbers that are presented to them by the companies
whose stocks they are investing in, whose bonds they are
buying?
You in this new role won't be dealing all that much with
Iraq or North Korea. The die is cast there and it is what it is
for now.
But you will have a whole lot of say, and those who you
will lead will have a whole lot to say about whether or not
people are willing to put any stock or confidence in the
Sarbanes-Oxley bill, to make sure that it, as passed, is not
just well-funded, but also well-implemented.
It is a very heavy burden to carry, but I am encouraged by
what others have said about you and the brief conversations
that we have had, that the President has found a very good
person for this job. And as we head down the road toward
greater certainty and economic recovery and growth, that you
just very well may be the right person to help move us along
that road.
Good luck. We are here to be of support.
Mr. Donaldson. Thank you.
Chairman Shelby. Senator Dodd.
STATEMENT OF SENATOR CHRISTOPHER J. DODD
Senator Dodd. Thank you very much, Mr. Chairman. Let me
echo the comments that have been made by others in
congratulating you on your assumption of the Chair of this
Committee.
Chairman Shelby. Thank you.
Senator Dodd. And we commend as well our colleague from
Maryland for the terrific job he did as Chairman. We sat next
to each other for years on this Committee and the Foreign
Relations Committee. We served together in the House, as I did
with the Chairman. So it is a pleasure to see you taking on
this role.
Let me join as well, Mr. Donaldson, in congratulating you
and thanking you for your willingness to do this. There are
times when you certainly wonder whether or not it is worth all
the effort.
But I appreciate intensely your desire to once again serve
in the public sector. I thank you. I thank Jane, your wife, who
I have known for a long time as well, and your involvement in
my State, Connecticut, with Aetna, is certainly one that we
appreciated during some very difficult days.
I just have a couple of thoughts, and I appreciate you
coming by the office the other day.
In addition to thanking you for doing this, I thank the
President for choosing someone who is as knowledgeable as you
are. I fully endorse the notion that we need bright, young
people at the SEC; but I have also felt that we need not only
bright people, but also we need people with wisdom.
The fact that you have the age and experience is not a
value that is appreciated enough, in my view. And the fact that
you bring such a wealth of experience over so many years, both
in and out of public life, success in the private financial
market areas, is going to be of great value to the SEC and to
the country.
So, I thank you.
All the things said by my colleagues, Tim Johnson, Jon
Corzine, Paul Sarbanes, and Mike Enzi, I would endorse
thoroughly. The importance of restoring confidence in our
markets is the critical job that you face.
The one piece of advice that I offer, having sat on this
Committee now for 22 years, and I have been through a variety
of Commissioners and Chairs of the SEC, is the independence of
the SEC.
The toughest moment you are going to arrive at is when you
are going to have a slew of people up here, possibly including
this Member, who will be browbeating you about trying to get
you to do something that you do not think is right. It is those
moments that will really determine whether or not your tenure
is a success or not. The independence of the SEC, staying away
from the political agendas.
The idea that this will be a Cabinet officer is ridiculous.
We need to keep the SEC as far removed from the political life,
if you will, of this city as much as we can.
So, I have confidence that you have reached a point in your
life when the attractiveness of being associated with the
political swirl is beyond you, and I think that is encouraging
and it is confidence-building, in my view. I urge you to really
insist upon that independence and I am confident that you will
do that.
Those are the only parting words I have as we begin the
process of a confirmation hearing this morning. Again, thank
you. Thank your family. And I look forward to working with you.
I think you are going to do a great job and we are lucky to
have you.
Mr. Donaldson. Thank you.
Chairman Shelby. Senator Chafee.
COMMENTS OF SENATOR LINCOLN D. CHAFEE
Senator Chafee. Thank you, Mr. Chairman.
Mr. Donaldson, I want to thank you for stepping forward and
agreeing to be nominated to this hot seat and I look forward to
your testimony.
Chairman Shelby. Thank you.
Senator Stabenow.
STATEMENT OF SENATOR DEBBIE STABENOW
Senator Stabenow. Thank you, Mr. Chairman. I want to first
congratulate you on the Chairmanship as well.
Chairman Shelby. Thank you.
Senator Stabenow. And thank Senator Sarbanes for his
incredible leadership and producing a very important piece of
legislation that I think will have a real impact on investors
and consumers and the country as a whole.
Welcome, Mr. Donaldson. It was a pleasure to speak with you
in my office yesterday. And welcome to your family. Thank you
for being willing to serve.
I think it is incredibly important, as we all do, that we
have a strong, confident, independent leader at the SEC. There
have been tremendous problems that my colleagues have
articulated and that we are all aware of. And so, we are
looking forward to very strong leadership.
When I was talking with you yesterday, I spoke specifically
about the amendment that I authored that relates to corporate
whistle-blowers and the importance of having a system through
corporations and a process through the SEC for employees and
others to come forward in a confidential manner, to be able to
share information, hopefully, before we find the disasters that
we have seen. Hopefully, that provision will be implemented in
a way that is helpful.
I would also concur with what Senator Dodd said in terms of
the independence of the SEC. And as I mentioned to you
yesterday, I believe that relates to the funding mechanism.
The SEC is one of the only financial regulatory agencies
whose funding goes through the appropriations process. It is
not separate. I hope that is an issue that we will address in
the Committee thoughtfully, looking at whether or not that is
in the best interest of the ongoing operations, of being able
to function in the independence of the SEC.
I would also share the comments and concerns that my
colleagues have expressed about the fairness in the securities
arbitration process.
We have been hearing from many people about the concerns of
who serve in judgment on that process and the transparency, or
lack of transparency, in that process. I will be anxious to
hear your comments regarding your willingness to look at that
arbitration process and the concerns that have been raised
about those who have gone before the arbitration panels.
Finally, I would just urge that although the Enrons and the
WorldComs of the world are not in the daily news, we are now
certainly still in a process that involves thorough examination
of the wrong-doing, and the people and the companies who have
committed crimes must be held accountable.
I hope that we will be vigilant and be fair as we look at
those, some receiving right now more scrutiny than others. And
when we look at the WorldCom situation, for instance, very
serious, systemic problems that still need to be addressed and
people that still need to be held accountable.
I am looking forward to hearing your thoughts on that as
well.
Thank you, Mr. Chairman. I would like to submit my full
opening statement for the record.
Chairman Shelby. Without objection, it is so ordered.
Senator Allard.
STATEMENT OF SENATOR WAYNE ALLARD
Senator Allard. Mr. Chairman, I would like to make a few
brief comments at this time, but have a full statement that I
would like to make a part of the record.
Chairman Shelby. Without objection, it will be made a part
of the record.
Senator Allard. Mr. Donaldson, I want to wish you well as
you assume your new duties here at the SEC, assuming that you
get confirmed, and I believe that you will.
I would just second many of the comments that you have
heard from the Committee. I think it is important if we are
going to expect recovery of the stock market, that the
consumer--the person who buys the stock--has confidence in the
value of the company, and that it truly reflects the
liabilities and assets of that particular company.
I think consumer confidence is an important factor in order
to help our stock market. You are part of the team that
restores that confidence; Congress has that responsibility; the
SEC has that responsibility. I think the accounting profession
also has a responsibility there that they have to face up to.
The sooner we can get that done, I think the better; and
the sooner we can expect some results considering the bursting
of the bubble that we have just been through.
I also ask that you stay in touch with this Congress and
hope that you will take time to keep us informed as to what is
going on. There is a lot of interest on this Committee and I
personally have a lot of interest.
One of the things that I personally have an interest in is
the Government Performance and Results Act. It is something I
bring up to nearly everybody that appears before the Committee
because Congress is working to implement it so that we can
measure the results of what is happening in the various areas
of the budget.
We do not measure performance based upon how much money
Federal Government agencies receive, but we measure performace
based upon what really happens, and what really makes a
difference in the lives of Americans.
When you spend taxpayer dollars, what actually happens as a
result of that?
That is something that is important to me and I hope you
will pay particular attention to that.
Thank you, Mr. Chairman.
One more thing, Mr. Chairman.
Chairman Shelby. Okay.
Senator Allard. I probably won't be here for the full
hearing, but I will hopefully be here for your full statement.
I apologize in advance if I have to walk out while you are
speaking.
Chairman Shelby. Senator Bayh.
STATEMENT OF SENATOR EVAN BAYH
Senator Bayh. Thank you, Mr. Chairman. I want to compliment
you for moving this nomination so expeditiously. We are getting
off to a good start under your leadership.
Mr. Donaldson, I want to congratulate you. I appreciated
your visit in my office. As I indicated at that time, I will
reiterate publicly today, I intend to support your nomination.
I think you are well-qualified for this position. And I would
urge you in two areas.
First, as my colleagues have indicated, the vigorous
enforcement of the new law. As others have commented, along
with the geo-
political risks, Iraq, the continuing war against terrorism,
there is
little doubt that the uncertainty about these accounting issues
has helped to hold the economy back.
Through the right kind of leadership from you and your
organization, we can help to alleviate that cloud, and
hopefully, get some additional momentum behind this economy.
I would urge you in that respect.
Our whole system of free market capitalism is based on the
efficient ``functioning of markets'' theory. But that all
breaks down when the information provided to the markets is
fraudulent. And so, we need to work to try and remove that
element. Also, it undermines the confidence that people have in
market-based solutions of any kind. If the public gets the idea
that markets are essentially just a large confidence game where
the insiders reap all the profits and leave everybody else
holding the bag, that is not very helpful to good public
policymaking in other areas as well.
So, I would urge you in terms of vigorous enforcement of
the new statutes.
The other thing I would say is that we need to start the
right balance. We need to vigorously enforce the interests of
shareholders. But at the same time, it would be an irony if we
imposed undue costs on those very shareholders by not going
about protecting their interests in the most efficient way
possible.
If you have recommendations about how to most effectively
and efficiently implement the new statutes and other actions we
might take to refine what has already been done, I think we
would all be most interested in that because at the end of the
day, that is what it takes to protect the rights of
shareholders.
I wish you well. I know you will be back testifying before
us on many occasions. I will apologize in advance for that. But
we look forward to hearing from you then as we do today.
Good luck.
Chairman Shelby. Mr. Donaldson, at this time, if you will
stand, I would like to administer the oath to you.
Do you swear or affirm that the testimony that you are
about to give is the truth, the whole truth, and nothing but
the truth, so help you God?
Mr. Donaldson. I do.
Chairman Shelby. Do you agree to appear and testify before
any duly-constituted committee of the Senate?
Mr. Donaldson. I do.
Chairman Shelby. I note that you have family members here.
If you want to introduce them to the Committee at this point,
you can do that.
Mr. Donaldson. I am delighted to do so. Right behind me is
my wife, Jane Donaldson. My two sons, Adam Donaldson; and
sitting behind him, Matt Donaldson. My daughter, Kim McKowski,
and her husband. And an unviewable, but also present, first
grandchild.
[Laughter.]
Chairman Shelby. I understand that.
[Laughter.]
Thank you. Your written statement will be made part of the
record in its entirety. You proceed as you wish.
STATEMENT OF WILLIAM H. DONALDSON
OF NEW YORK, TO BE A MEMBER OF THE
U.S. SECURITIES AND EXCHANGE COMMISSION
Mr. Donaldson. Thank you.
Chairman Shelby, Ranking Member Sarbanes, and Members of
the Committee, it is my distinct honor to come before you today
as President Bush's nominee to be Chairman of the Securities
and Exchange Commission. I thank you for this opportunity, and
I thank you for your comments. I want to especially thank both
Senator Schumer and Senator Clinton for their warm
introductions.
The U.S. capital markets have long been the most
intelligently regulated, efficiently functioning, and widely-
admired markets in the world. Because of this strength,
America's financial system has become synonymous with an
entrepreneurial spirit and free flow of capital that is
unparalleled throughout the world.
Over the past year and a half, our Nation and its financial
systems have been faced with extraordinarily new challenges.
The evil of global terrorism attacked a great symbol of our
financial strength. Soon thereafter, we witnessed revelations
of corporate and financial corruption that accompanied the
market's retreat from the boom of the 1990's.
Many Americans' individual savings, accrued over a
lifetime, were devastated. This loss was more than simply
monetary--it was the loss of their hopes, their dreams, their
futures, and, in many cases, their security. The reports of
fraud and manipulation only fanned the flames of their distrust
and outrage with corporate America and Wall Street. Their loss
was profound; and, in many cases, the violation of trust was
great. Such circumstances required a response just as serious.
The groundbreaking Sarbanes-Oxley legislation, passed by
the Congress and signed by President Bush responded with the
most sweeping reforms of American business since the New Deal.
But just as the war on terrorism cannot be won overnight,
neither can investor confidence be completely restored so
quickly. Corporate America, Wall Street, and their professional
stewards--lawyers, accountants, corporate and financial
managers, and financial regulators--still have a lot of work to
do.
If confirmed, I will vigorously enforce Sarbanes-Oxley and
the rules and regulations already put forth by the SEC. I will
demand accountability from all responsible parties. I will
aggressively enforce civil penalties and work cooperatively
with State and Federal law enforcement agencies and the
President's Corporate Fraud Task Force to bring those who break
the law to justice.
While Sarbanes-Oxley has laid the foundation for best
practices, legislation, and vigorous regulation can accomplish
only so much. In my view, there must be a conscious decision to
make honesty, integrity, and regard for the good of
shareholders the motivation for all business decisions. If
confirmed, I will call on corporate America and on Wall Street
to restore these principles to their proper place.
The SEC has been through a trying time as well. The SEC
staff, in my view, is superb, with knowledge and commitment
that are unsurpassed. The recent scandals have depleted their
morale and taxed their resources like never before. If
confirmed, I will work closely with the agency staff to enhance
their sense of dedication and pride and restore the stature of
this agency.
I have great respect for the critical role of the Congress
and of this Committee in particular. I hope to work closely
with each of you. If you choose to affirm my nomination, I
pledge to take on the task ahead with every ounce of
experience, judgment, and energy that I have.
Thank you, Mr. Chairman. I would be glad to take any
questions.
Chairman Shelby. Thank you.
Mr. Donaldson, you are named in a class-action lawsuit
against Aetna. The plaintiffs allege that you ignored
operational problems that led to an understatement of Aetna's
medical expenses, reserves, and therefore, an understatement of
losses that occurred to the company. What can you tell us about
the allegations made in this lawsuit? I realize it is
litigation pending and I do not know how free you are to talk
about it.
Mr. Donaldson. Thank you, Mr. Chairman.
I took some strong measures when I was the CEO of Aetna to
strengthen and to improve Aetna's performance. Aetna sold its
financial services and international businesses to ING for some
$7.7 billion. We created a new Aetna, with a new management
team that focused exclusively----
Chairman Shelby. Did they sell when you were Chairman?
Mr. Donaldson. Chairman?
Chairman Shelby. Did they sell to AIG?
Mr. Donaldson. I was Chairman and CEO then, and we sold the
divisions to ING.
Chairman Shelby. Okay, ING.
Mr. Donaldson. We created a new Aetna with a new management
team that I helped to recruit to focus exclusively on improving
customer satisfaction and on ensuring the long-term success of
the health care business. In total, the value of Aetna has
almost doubled, including cash and stock, from the day that I
joined the company.
Now as far as the litigation goes, during the course of
turning the company around, we had a hiccup, a hiccup that we
did not expect. We addressed that hiccup. We informed our
shareholders as soon as we knew about it. And as I say, over
the years since then, with a management team that I helped to
hire, the record of the company has been outstanding.
Chairman Shelby. Some have criticized Aetna's use of poison
pills and other anti-takeover devices during your tenure. Such
devices are often viewed as benefiting management at the
expense of shareholders. It has been alleged that minority
shareholders had no voice in Aetna's strategic planning or
operations. How would you address these criticisms?
Mr. Donaldson. Well, when I became Chairman, and I should
say that the Aetna Board of Directors asked me to become CEO
and to put new management into the company, the Board decided,
with my concurrence, that we would institute a shareholder
protection device because we felt that we could turn this
company around for our own shareholders, that we wanted to
protect our shareholders from somebody coming in, swooping in,
in the process of turning the company around and taking it over
for some other group of shareholders.
So when we put the shareholder device, a so-called poison
pill, in, we also pledged that we would take it out within 2
years. And I am glad to report that the company has done just
that. It no longer has a poison pill.
Chairman Shelby. Okay. Mr. Donaldson, you were a co-founder
of DLJ--Donaldson, Lufkin & Jenrette--a firm that has been
referred to as ``the house that research built.''
We have all been shocked by the revelations over the past
year regarding analyst reports that literally were prepared to
order in to capture investment banking business.
Given your roots in qualitative research, your background,
I would be highly interested in your views regarding the recent
revelations concerning analysts' conflicts of interest. Do you
believe that the SEC needs to invest greater resources to its
compliance program in this regard? And what could the SEC do to
improve its ability to detect systemic problems like the ones
that came to light this past year?
Mr. Donaldson. Mr. Chairman, you bring up a couple of
issues there. Number one----
Chairman Shelby. My time is limited up here, even as the
Chairman.
[Laughter.]
Mr. Donaldson. --is the simple issue of the quality of
research itself.
If I might say, when we formed our business many years ago,
we intended to do real research. We intended to do analysis of
companies that would be much closer to what a management
consulting firm would do to evaluate directions, management, et
cetera, and the issue of earnings per share the next quarter
was insignificant to us.
I deplore the denigration of research that has gone on,
particularly during the boom time of the 1990's, where earnings
per share and quarterly growth----
Chairman Shelby. It became a sham in a lot of ways, didn't
it?
Mr. Donaldson. I beg your pardon?
Chairman Shelby. It became a sham, rather than real
qualitative research.
Mr. Donaldson. Exactly. And as an aside, I might say that
the imperative that that was put on managements to attempt to
run their companies on a quarter-to-quarter basis has caused,
in my view, a very disturbing short-term orientation.
Nothing grows like that--human beings, plants, whatever. We
grow in stages. Companies grow in stages, or they should. They
should make the investments do that.
In terms of the other part of your question, the conflict
of interest inherent in analysts becoming hand-maidens for the
investment banking side of the business, clearly, this is
wrong. Compensation for doing that is highly suspect. Clearly,
the SEC needs to assure that there is no linkage between the
investment banking side of the business and the research side
of the business. And there are a number of things that I think
can be done in that line.
Chairman Shelby. Will you pledge to continue to this
Committee here, assuming you are confirmed, which I predict you
will be, as the Chairman, that the SEC will push enforcement
efforts in this area? And that culpable individuals who are
involved in this controversy regarding research analysts are
sanctioned? Because I think we can afford to do no less.
Mr. Donaldson. Right. I think there are two issues there.
First is the separation, the iron curtain, the bamboo wall,
whatever you want to call it, between research and the
investment part of the business. There is a second thing there,
which is the analyst's having a different view, an inside view
and an outside view. Absolutely unacceptable, as far as I am
concerned.
Chairman Shelby. Thank you.
Senator Sarbanes.
Senator Sarbanes. Thank you, Mr. Chairman.
Mr. Donaldson, in the first round, I want to focus on the
SEC itself as an institution and your role, potentially, as its
Chairman. There are lots of other areas that will be covered in
the course of the hearing and, presumably, we will come back to
a second round, if Members deem it necessary.
I am prompted to do this because I recognize that if we
have the SEC really functioning at top level, it just makes an
enormous difference. As you indicated, there are people of
tremendous ability and quality at the SEC and its reputation
traditionally has been as the outstanding independent
regulatory agency of the Federal Government.
Speaking about the SEC, an observer recently was quoted as
saying: ``Morale is at its lowest point. This place is a
shambles of what it was 10 or 12 years ago.''
I would like to put some very specific questions to you.
We indicated earlier the increase in the budget. Part of
the motivation for that is to provide parity of employee
benefits. The other financial regulators have the authority to
raise salaries in order to retain able people, and hopefully,
keep them from going into the private sector, although they can
make far more money in the private sector. But it is an effort
to give the employees a little more breathing room.
The SEC has not implemented full pay parity, and I am
interested in your view about it. Parity of benefits, as well
as parity of pay. And also, whether you calculate the parity
with reference to all Federal bank regulators and not just
those paying at the lower compensation levels.
At the moment, other Federal financial regulators can pay
their people more than the SEC. So the SEC is losing people not
only to the private sector, but they are losing them to other
public sector agencies as well.
Mr. Donaldson. Right.
Senator Sarbanes. What is your view on this pay parity
issue?
Mr. Donaldson. Let me begin by saying that I am terribly
concerned about the morale situation at the SEC. This is a
group of professionals that have been working very, very hard
with inadequate resources and, in many cases, inadequate
compensation.
As far as pay parity, I have not been inside the SEC. But,
just as soon as I get there, you can be sure that I will pay
attention to the issue of pay parity and pay attention to the
issue of not only the reason that many of the people are there,
which is the work they are doing, but also the compensation for
that work.
I am not familiar yet with what is being done in other
agencies. However, I assure you I will get into that issue just
as soon as I get there.
Senator Sarbanes. So, you see pay parity as embracing
parity of benefits, as well as salary pay?
Mr. Donaldson. Well, there is a whole package. I think pay
is not the only issue. I think it is the whole package of
benefits. But, as I say, I really want to get in and understand
what is being done now and what is being done in other
comparable Government organizations.
Senator Sarbanes. The Congress, in voting higher levels,
was very clear that one purpose of those higher levels of money
was to achieve pay parity, and I think it is very important for
the morale of the agency.
The GAO, in a report, ``SEC Operations--Increased Workload
Creates Challenges,'' in March of last year, recommended, and I
quote, ``That the Chairman of the SEC identify ways to involve
human capital leaders in decisionmaking and establish a
practice that requires management to continually ensure the
effectiveness of SEC's human capital approaches in addressing
employees' needs, including working with the national Treasury
employees union.''
Now, we have been informed that there is a strained
relationship with the employee union at the SEC. What is your
view of this?
Mr. Donaldson. If there is a strained relationship, that is
something that I would like to address. I am very concerned
with the management of the agency. I am very concerned with the
efficiency and effectiveness of that management. If I am
approved by your Committee and by the Senate, I see a danger of
the massive hiring that we have to do, of a large chunk of
money coming into the agency.
I want to make sure that we are not just spending the money
to hire the best people we can find, but that we are managing
the place in an efficient way. And I pledge that that again
will be high on my agenda.
Senator Sarbanes. To draw a close on this, the SEC has a
long and important tradition of allowing its Enforcement
Division to pursue its investigations wherever they may lead.
In other words, the Commissioners have not interfered with the
judgments of the Enforcement Division. Are you committed to
ensuring that the
Enforcement Division can continue to conduct its investigations
free of political considerations or other improper concerns or
interference?
Mr. Donaldson. Absolutely. I believe the Enforcement
Division is at the core of what the SEC does; and they will go,
as I think they always have, where they should go.
Senator Sarbanes. All right. Traditionally, the SEC
Chairmen were careful not to meet with persons under
investigation, in part, because such meetings suggest the
possibility of interfering with or improperly influencing the
investigation. Will you follow this tradition and decline to
meet with persons under investigation?
Mr. Donaldson. I will abide by the letter of the law in
terms of doing that. I will do everything in my power to not
meet with anyone under investigation and to follow the general
guidance of the General Counsel of the SEC in terms of people
that I do meet with.
Senator Sarbanes. Thank you, Mr. Chairman.
Chairman Shelby. Senator Dole.
Senator Dole. Mr. Donaldson, as we work to restore
confidence in our markets, I think we may need to do more to
restore investor confidence in financial statements.
I would like to visit with you a moment on something that I
feel still needs to be focused on, and that is the fact that
auditors face a real conflict of interest because they are paid
by the company that they are going to be auditing. And so, in a
sense, then, they are beholden to that company which is paying
the bills.
I am intrigued by an idea that Professor Joshua Ronen,
Stern School of Business, New York University, put forward just
a few months ago.
He would require that there be Financial Statement
Insurance. In other words, that companies would buy insurance
on the quality of their audit reports. And the liability for
false or misleading statements in those reports would then run
with the insurance company rather than with the Board of
Directors. This would provide independence because the
insurance company would then hire the auditors rather than the
company.
This idea I find to be very interesting because I think
just switching incentives could make a real difference here.
This would mean, in Professor Ronen's view, that the SEC would
require that this Financial Statement Insurance be provided.
And then the SEC would require that the results be made public.
In other words, in the quarterly reports, in the annual
statement, financial report, the companies would report the
amount of insurance and what the premiums are.
This would enable investors then to compare between
companies and would I think do a lot to restore confidence, to
obviously take care of the incentive issue, and to provide a
comparison which could be very useful, and to give more
protection to employees and to stockholders.
So my question to you is, would you be willing as Chairman
of the SEC to take a look at this idea and to determine the
feasibility and the possible effectiveness of such an idea?
Mr. Donaldson. Senator Dole, I would be absolutely willing
to do that. I hope that you will encourage Professor Williams
to send his paper in.
Senator Dole. Professor Ronen.
Mr. Donaldson. And let us take a look at it. I might just
say, parenthetically, that the concept of having some new
ideas, ways of approaching some of the problems, is very
appealing to me. I would welcome having us discuss that.
Senator Dole. Right. Well, it seems that the insurance
company, by hiring the auditor, as the incentives are changed,
then the loyalty is to accuracy rather than to the company that
is hiring the auditor.
I would also like to ask you for your views on how much you
feel eliminating the double taxation of dividends will help the
economy?
Mr. Donaldson. I think the elimination of double taxation
of dividends is part of a total package that the President has
put forward. I think it is a very important part of that
package. I think that it could have far-ranging effects in a
number of ways on corporate governance itself.
Clearly, there is an advantage of getting away from the
double taxation of dividends themselves. That goes without
saying. But beyond that, I think that it could change, perhaps
gradually, the way companies are structured, the use of
excessive debt, the whole investor attitude toward real
earnings and real dividends as opposed to futures.
So, I think this puts a new burden on corporate governance
and management in terms of determining how they get a return to
shareholders. Not all use of futures. The idea that they cannot
just build up a piggybank there, that they have to share that
with the shareholders.
I believe that it is a very positive suggestion by the
President.
Senator Dole. Good.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Schumer.
Senator Schumer. Thank you, Mr. Chairman. I have a few
questions. Are we going to have a second round, Mr. Chairman?
Chairman Shelby. Sure. Go ahead.
Senator Schumer. Great. Thanks.
Mr. Donaldson, one of the issues that has been of great
concern to me and many others has been the movement of U.S.
corporations to off-shore tax havens.
Often, these businesses maintain the bulk of their
operations, as you know, in the United States, but set up
largely a shell operation in a low- or no-tax country. I think
this is a short-sighted view on the part of those business
managements because they are failing to support the very
economy that is sustaining their business.
What I propose, is to introduce legislation that would set
standards for U.S. corporations to get shareholder approval
before they can relocate off-shore.
My view is they say they are doing this for the company,
but the owners of the company, the shareholders, would not
really be for it because they are patriotic Americans.
Would you support this type of legislation? And can you
comment on the practice of corporations moving off-shore?
Mr. Donaldson. I have a similar concern to your's in terms
of the abusive, or perhaps abusive, use of off-shore havens by
corporate America. I think each individual case requires an
examination, according to the law.
In terms of putting that up to the shareholders, I think
that that is something that we should examine within the
context of what other things should be brought up for
shareholder vote. In other words, there are a number of issues
where shareholders now are not allowed to vote, and I would
consider this area one that----
Senator Schumer. Would your initial reaction be favorable?
I am not asking for a commitment. Obviously, you have to study
the bill. But to the general concept.
Mr. Donaldson. Yes. Again, it is one of those things that
is out there, and my initial reaction is that we should take a
look at that.
Senator Schumer. Would your initial reaction be favorable?
[Laughter.]
Mr. Donaldson. Well, I do not mean to waffle, Senator. I
really do not.
Senator Schumer. I just said that you were a straight-
shooter!
[Laughter.]
Mr. Donaldson. I really want to----
Chairman Shelby. He gave you a good introduction earlier.
[Laughter.]
Senator Schumer. Exactly.
Chairman Shelby. That doesn't mean you should join, though.
[Laughter.]
Mr. Donaldson. I am a great believer in listening to both
sides of an argument.
Senator Schumer. Thank you. Next question. As you know,
U.S. policies in securities laws reflected in the 1933, 1934
Acts, the 1975 amendments to those Acts, and many Federal laws
relating to investment and market participants, promotes a
national, uniform system of regulation for nationally-traded
securities and national broker-dealers, and it has served to
safeguard both consumers and develop capital markets that set
the world standard.
You know that better than anybody else.
Recently, however, the SEC has been much less visible in
its role of setting Federal securities policies, and States
have stepped in to fill the void.
Rather than discuss what happened in the past, I would like
to discuss what will be in the future. I have related questions
which I will ask you and then you can answer them all at once.
Do you currently see a risk to our national system, and
consequently, a risk to national competitiveness, from a
balkanization of securities markets? Meaning many different
regulations, each by the different States, rather than one
national regulation.
How do you propose to work with State prosecutors currently
pursuing reform of the securities industry as it operates
within their respective States?
How can the SEC reestablish the Federal nature of
securities law?
Should the SEC request additional legislative authority to
achieve truly national regulation of markets?
And how will you assure that the SEC has a place, and a
prominent place, in future discussions of industry practices?
Mr. Donaldson. A series of very good questions, Senator.
Let me begin by saying that I think that one of the great
strengths of our market system is that it is a national market
system and has not been balkanized, and we see the effects in
other countries of systems that are not firmly regulated at a
Federal level.
Having said that, some of the instances in recent weeks and
months where local or State-level regulators and/or attorneys
general and so forth, have stepped in on a fraud basis, I
believe have been constructive, up to a point. And that is that
they have been constructive in terms of bringing all the
resources we can bring at a time when perhaps the SEC has been
short of resources. But up to a point.
The point is where the solution comes. I believe that the
solution should come from the Federal regulators.
So, I hope that, if you do confirm me, I will be able to
speak with State attorneys general and State regulators and
talk this out with them and make sure that they are stopping
where they should stop and put the responsibility back to where
it should be.
If that doesn't work, and if I receive no response there,
then I think we have to turn to you all to help redefine
regulatory authority because the balkanization you talk about
is a terrible threat if it should happen.
Senator Schumer. The next question. The press has reported
that you are opposed to something your predecessor once removed
supported very strongly, the regulation of fair disclosure,
which was intended to safeguard investors against selective
disclosure of business and financial information. You stated at
one point that it was, ``a terrible rule.'' What is your
current view on Regulation FD? Is it adequate? Does it need to
be strengthened? Should it, in fact, be reconsidered?
Mr. Donaldson. Thank you. I have seen the quote in the
press. I have to say up front, it was a quote taken out of
context. I was a private citizen having a private meeting and
was asked, what did I think of FD?
My initial reaction was I thought it was crazy because, at
that time, I was Chairman of a major U.S. corporation that was
trying to deal with the implementation of it. I was in the
throes of, at that time, thinking that there were some
unintended consequences. I am totally for the intention of the
law. But at that time, there were some unintended consequences
of having just the reverse effect--shutting down information
flow.
My present attitude toward it is that it is working better.
From all I can see, FD is working better. And my attitude, as
Chairman of the SEC, if I become Chairman, would be to
constantly monitor the implementation of FD and to make sure
that we are not having unintended consequences. But the concept
of FD is right.
Senator Schumer. So, your initial reaction would not be to
propose any changes one way or the other.
Mr. Donaldson. Absolutely not.
Senator Schumer. But rather, look at it.
Chairman Shelby. Your time is up.
Senator Schumer. I have some more, but I will wait for a
second round.
Chairman Shelby. Senator Chafee.
Senator Chafee. Thank you, Mr. Chairman.
It seems to me that the effective working of the SEC
depends on how successfully everybody works together. And it
seems to have been recognized in your opening statement that
morale was low within the SEC.
So, I am curious, with everything that you have learned in
the Marines and your career, what is your basic philosophy for
motivating employees? Could you be as specific as possible?
Mr. Donaldson. Your question is what is my philosophy on
motivating people?
Senator Chafee. Yes.
Mr. Donaldson. I believe very strongly that the motivation
of people comes from the quality of the assignments they are
given, from the freedom to pursue ideas, to have an openness
within the organization, to have not a command and control
structure, but, rather, to have a flatter structure that allows
for individuals to say what they think.
I think that there is nothing more motivating than to have
an ability to say what you think within an organization without
fear of retribution. I think that is at the core of the esprit
de corps of an organization.
To me, probably a bad analogy, but the SEC has been the
Marine Corps of the regulatory agencies. I say that with great
admiration for the Marine Corps. I have served in the Marine
Corps, and I really hope that we can bring some of that spirit
to the SEC in terms of the motivation.
Senator Chafee. I am referring back to what Senator
Sarbanes said about some of the problems of the bargaining unit
employees as well. This general philosophy I am sure extends to
the professionals and to everybody within the organization.
Mr. Donaldson. Yes. Clearly, the SEC is a very professional
organization, with a very high percentage of employees that are
professionally trained, lawyers and accountants and so forth,
who have professional ethics.
I believe that the pride in the profession, if you will, is
a kind of strong motivating force, as well as being paid
adequately and rewarded adequately for what you are doing.
Senator Chafee. Well, thank you, and good luck.
Chairman Shelby. Senator Corzine.
Senator Corzine. Thank you, Mr. Chairman. We are going to
have two rounds, so I have a whole series of smaller, more
specific questions.
But there are issues with regard to investor confidence,
how we rebuild that, and the independence of the SEC, which I
believe are broad subject matters. As it relates to investor
confidence, I cannot personally believe that there is anything
more important than the SEC demonstrating this independence
that a number of my colleagues have spoken about on both sides
of the aisle.
And with respect to that issue, I cannot think that there
is a more important place to demonstrate that than the
implementation of the Public Company Accounting Oversight
Board, making sure that a transparent, independent process of
selecting the membership and the implementation of Sarbanes-
Oxley and auditing of auditors, if you will, to short-form it.
Have you considered the process that you intend to take
since there was unfortunate, I think, and damaging elements to
the credibility of the SEC and to potentially even the
Oversight Board itself, given that it got off to such a rocky
start? Have you thought about how you reestablish that
integrity and independence of that process?
Mr. Donaldson. Well, I have read the GAO report, which
examines the process. I think the report speaks for itself in
terms of finding an imperfect process that resulted in an
imperfect answer.
I believe that the selection of the leadership, of a
Chairman for the independent board, is the number-one priority
that I have going into office, should I go into office.
We are behind the eight ball given the fact that a Chairman
has not been seated.
The day I get to the SEC, I will examine whatever process
has been put in place since the time of the report, I would
hope that a process has been put in place.
I will take a look at that process. I would intend to
modify it if it needs modification. Then I would hope to,
through an organized process, spread as big a net as we
possibly can in terms of persons who might be qualified to run
this agency.
In my view, there have to be people out there who are
eminently qualified to do this job. I would hope to narrow that
universe just as quickly as we can and get to the point of
selection.
I will, in the final analysis, consult with everyone I can.
I will consult, as required by law, I believe, with the
Secretary of the Treasury and with the Chairman of the Federal
Reserve. I also will consult with anybody and everybody who
wants to throw a name into the hat. But in the final analysis,
the decision will be up to my fellow Commissioners.
Senator Corzine. I can only suggest that I think both
markets, those of us responsible for oversight, and ultimately,
the investors, will look to this kind of decision as one of
those foundation points for restoring investor confidence.
On another subject with regard to investor confidence, I
think
it is very difficult for small investors to understand how they
are
fairly represented in the marketplace, particularly when they
feel that they have been wronged--this whole arbitration
process, which a number of my colleagues talked about earlier.
Have you considered whether you think, from your own
experiences and knowledge, that the issue of securities
arbitration where representatives from the exchanges and
generally lawyers that are close to the industry, are basically
the arbiters, where the proceedings are secret, whether there
is the kind of fair review of individual investor's response,
arbitration, a good process, keeping it out of the courts,
potentially.
But have you reviewed whether you think we have a
satisfactory arbitration process that protects the interests of
small investors as they face off with large firms like ones
that you and I are quite familiar with and work their way
through a process that is basically established in conjunction
with the industry?
Mr. Donaldson. Well, I am intimately familiar with the
arbitration process at the New York Stock Exchange when I was
there. And I believe that it was working pretty well. I have
not been intimately involved in the changes in the arbitration
process, both at the Exchange and at the Nasdaq, since I left.
I have been away from it for 8 or 9 years.
I think it is a very legitimate question to examine the
arbitration practice, as it is being practiced today, and I
would do that. I would do just that.
I have no idea whether there has been examination within
the SEC. So the first thing I would do----
Senator Corzine. I would make just one point. The global
settlements with regard to a number of the research functions
go through the arbitration process. And one statistic that I
wasn't aware of when I was in another seat in another point in
time.
According to the General Accounting Office, 64 percent of
arbitration awards go unpaid. So even the execution of the
process, whether it is a fair judicial or review process is one
question. Whether it actually works is another.
Mr. Donaldson. That is an interesting statistic. I am
reminded of similar statistics in other areas where legal
payments are due the Government that aren't being made.
I think bill collection, if you will, is an important
issue, and it certainly would be one for me--if that statistic
is correct.
Senator Corzine. For investor confidence, I believe that
this is another area where, particularly so-called investor
class or small investors, need to get a fair shake, an
observation here.
Mr. Donaldson. If I understand you correctly, judgments
that have been made by an arbitration panel should be paid. And
if they are not, we should know why.
Chairman Shelby. Senator Crapo.
STATEMENT OF SENATOR MIKE CRAPO
Senator Crapo. Thank you, Mr. Chairman.
Mr. Donaldson, first of all, I want to congratulate you on
your willingness to step forward and provide public service in
this capacity. And I am confident, as is the Chairman, that
your nomination will be confirmed by the Senate.
I just want to cover a couple of issues if I have time with
you today. The first one is derivatives transactions. As you
know, last year, we had some proposals in the Senate to change
the way in which over-the-counter derivatives transactions are
regulated. Namely, by requiring that they be on-exchange or
that they be done through an exchange rather than an off-
exchange transaction.
I strongly opposed that and frankly, last year, we received
letters from the Department of the Treasury, from Alan
Greenspan of the Federal Reserve, from the Chairman of the U.S.
Commodities Futures Trading Commission, and from Harvey Pitt,
the Chairman of the SEC, indicating that they all unanimously
felt that we should not change the manner in which we regulate
the over-the-counter derivatives transactions and that, in
fact, I think Alan Greenspan said several times that it was the
flexibility that these instruments provide to us that gave us
some significant strength in the economy when we saw some of
the softening occurring in the last years.
The obvious question I have for you is, I expect that we
will be dealing with this issue again. I would like to know
what your feeling is about the issue? Do you agree with your
predecessor and with others in the financial community, or do
you have a position at this point on whether we should maintain
our current regulatory posture with derivatives?
Mr. Donaldson. Yes. Derivatives are extremely complex, as
you know better than I. I believe that they cross, in terms of
responsibility, between the Federal Reserve, the Treasury
Department, the SEC, and certain of the other exchanges that
deal in marketable derivatives.
First, I hope to understand what work has been done in the
SEC.
Second, I would hope, through the working group with the
Chairman of the Fed and the Secretary of the Treasury, that we
would get together and talk about this issue.
I believe that there is the potential for risk out there
somewhere. Risk gets passed via derivatives, and somewhere out
there there is risk. Somebody's holding the bag. And I think we
have to make every effort to find out where that is.
Chairman Shelby. It is passing on the risk, in a way. You
are passing the risk on.
Mr. Donaldson. Exactly. It is a little bit like a hot
potato, and somebody is holding that potato. And we have to
find out who is holding it and whether we are adequately
anticipating what might eventuate from that.
Senator Crapo. As I understand it, one of the ways that was
explained in one of our hearings by one of the experts--it may
have been Alan Greenspan--was that the derivatives are actually
utilized in our market to allocate risk better to those areas
or those entities that can handle it, and it is a very strong,
stabilizing influence in the markets. Do you agree with that?
Mr. Donaldson. I think a very good case can be made for
that. I think that is one of their positives. There is a
negative case that could be made, as we have seen in a couple
of the blow-ups where derivatives were being used and
unexpected things happened.
So, I think, as a positive tool, putting your risk in the
hands of people who are willing to accept it and must be paid
for it, is not a bad idea. It is just that we have to make sure
the way it is being done is appropriate and that we know that
there is not something hidden out there that is going to hit us
when we do not expect it.
Senator Crapo. In that context, I think that I probably
would agree with you. Some of the discussions we have had
focused more on reporting and make sure that adequate
information was available, as opposed to requiring that the
transactions be handled through an exchange.
Mr. Donaldson. Right. I think disclosure, transparency is
the first line of regulation. And I do not disagree with that.
Senator Crapo. Thank you. How am I on time? Out?
Chairman Shelby. You are in summing-up time now.
Senator Crapo. All right. I have some other questions for
you, but more lengthy than that. And so what I will probably do
is just discuss them with you privately.
Mr. Donaldson. Thank you.
Chairman Shelby. Mr. Donaldson, just to pick up on Senator
Crapo's question on derivatives.
Sooner or later, somebody's holding the bag on a
derivatives. Derivatives are very complex instruments and they
manifest themselves in many, many ways. We have talked about
this before the Banking Committee on many occasions. But if you
are getting into derivatives, you are getting into some complex
financial transactions that it would be hard for the layman to
understand. Is that correct? Is that fair?
Mr. Donaldson. Absolutely. I think many of them are hard
for the professionals to really understand.
Chairman Shelby. Absolutely. They are used in just about
every financial--not every financial transaction--but they are
used in financial markets every day now, everywhere in the
world. Wouldn't you think?
Mr. Donaldson. Yes, they are. They are being increasingly
used.
Chairman Shelby. Now, I was intrigued with your statement,
and I tend to agree with that. I do not know how we can
regulate, or should regulate, derivatives. But there is no
substitute for transparency, for openness and who might
ultimately hold this risk, the ultimate risk. And are they
financially able to cope with that risk?
Mr. Donaldson. Right.
Chairman Shelby. Because if the risk is passed on, and that
is the idea, isn't it, one of the ideas of a derivative is that
it is passed on to someone else. Ultimately, it might be
interesting to know if whoever is holding that risk at the end
of the day is capable of holding it very long, financially. I
do not know the answer to that. But we know that that is a
complex world that you will be dealing with, and we should not
ignore it. So openness is probably the first step, isn't it?
Mr. Donaldson. Absolutely. It is a fertile area to
investigate, in my view.
Chairman Shelby. It is. Mr. Donaldson, what are the biggest
challenges that you would face in maintaining the preeminence
of the SEC as the regulator of our national markets in an
increasingly global marketplace, because that has to be a
challenge there, too. You have the London Exchange. You have
all the others around the world. You know them all.
Mr. Donaldson. Right.
Chairman Shelby. What is your biggest challenge to maintain
our preeminence in that area?
Mr. Donaldson. Well, what we have now, in my view, is an
increasing interest by American investors in markets outside
the United States.
The figure I would quote, and do not hold me to it, is
something like two-thirds of the world's earning power is
coming from outside the United States, with only a third coming
from the United States.
So investor attention is being directed toward purchasing
shares in companies that are not resident in the United States.
That percentage of portfolios in foreign securities is
growing rapidly from a very small percentage to 5 percent to 10
percent and so forth. Theoretically, it could some day get up
to two-thirds if it matched where earnings were coming from.
I think we have to be terribly concerned with how American
investors are treated in terms of making purchases in foreign
markets, if I am addressing your question. And I think the way
foreign markets operate is of importance to us. But even more
important, I believe, is making sure that our markets can be
competitive in trading foreign securities and give investors
the protections that we have in our market, as opposed to
forcing them to go and do their buying in less regulated
markets.
Chairman Shelby. This just begs the question. How do we
harmonize the international accounting standards? Because if we
are going to invest in their markets, we need to know what is
going on there.
Mr. Donaldson. Right.
Chairman Shelby. The Europeans have basically principal-
based accounting as opposed to rule-based accounting. So that
is a challenge in itself, is it not?
Mr. Donaldson. Absolutely.
Chairman Shelby. But it goes right to the heart of what you
are talking about. For an investor to invest wisely, they have
to know what they are investing in. Correct?
Mr. Donaldson. Right.
Chairman Shelby. And if you do not have basic standard
accounting terms and some rules for the market, how do you do
it? It is a big risk, is it not?
Mr. Donaldson. Yes. I think that one of the great benefits
of the Sarbanes-Oxley legislation and the formation of the
Accounting Oversight Board is the focus and attention that will
come from that sort of a regulatory umbrella still passing
through the SEC, but able to focus on just the issues that you
are talking about.
I believe that for the long-haul and, hopefully, shorter
than long- haul, we have to get at a reconciliation or
harmonization between principal-based accounting and rule-based
accounting.
I suspect that the best thing is going to be a combination
of both. I do not think it is going to be one or the other. I
think we are behind the times in resolving that. It has been an
agenda item too long. It has been debated year after year after
year. So, we have to get to it.
Chairman Shelby. I believe that one of the most important
things that you will be involved in after you are confirmed,
and I assume you will be confirmed soon, is the Chairman of the
Accounting Oversight Board.
I have no candidates, or wouldn't have any. But I think you
realize how important that position is, not only for investor
confidence, but also for the working of the Board itself.
Mr. Donaldson. I could not agree with you more. If you have
a candidate, or anybody has a candidate, we would like to hear
about it. We will have a process to----
Chairman Shelby. I do not have a candidate. But I hope you
are going to have one or two and you are going to select one
with the wisdom and experience that you bring to this table.
Mr. Donaldson. Top priority, Senator.
Chairman Shelby. Last, I continue to believe always that
you cannot legislate or by regulation impose ethics. You cannot
do this.
But, clearly, the problems that our markets face are beyond
isolated incidents of outright fraud and malfeasance. I would
like to think that they were not, but they keep coming up from
time to time.
I think we are suffering from a broad cultural crisis of
professionalism and values there. So how would you as the
Chairman of the SEC demand the highest standards of ethical
conduct in dealing with our capital markets, our accounting
profession, to try to restore investor confidence in our
capital markets?
Mr. Donaldson. Well, that is an excellent question. That is
one I have thought a lot about.
I believe that, number one, we must have laws and we must
strictly enforce them. But in the final analysis, moving up to
just conformity with a redline law is not going to get the job
done.
So as Chairman of the SEC, I would see as a major part of
my job speaking to the corporate community and talking to
anybody that will listen to me and from any forum that will
allow me to speak about the responsibilities of the corporate
manager, about the responsibility of the corporate board of
directors, about instilling in their organizations in any way
they choose a code of ethics, esprit de corps, a way of doing
business that is understood up and down the ranks.
There will be different approaches to that. But what I hope
that we can do by talking a lot about it, and urging action on
it, and actually, commending those that are actually doing a
good job and showing different ways of doing that, is that we
can recreate an environment where simple conformity to the law
is not enough.
Chairman Shelby. Although you come out of Wall Street, you
have been very successful there, and this I think adds to your
credibility for the job that you have been nominated for.
I think that now is the time to put some fear into people.
You mentioned earlier the Marine Corps. You were a Marine
officer. And there is always a little fear there, fear of not
doing something right. Fear of not being on time. Fear that I
believe that some people that have cheated and stolen and
committed fraud, and might do it in the future, that they need
to fear you as the Chairman of the SEC, that although you come
out of Wall Street, you are not one of them right now.
You will be the Chairman of the SEC looking over what they
do or what they fail to do.
Mr. Donaldson. Right. Well, I surely understand the concept
of the independence of this agency. I also understand the
independence of my role as Chairman, no matter where I have
come from. I think my past history----
Chairman Shelby. I think it is good that you are coming off
the street, as we say, because you know the system. You have
experienced the system. You have unique qualifications. But
your role is different, or will be different when you become
the SEC Chairman. No one knows that better than you. You then
will have the obligation to the American people, period. Won't
you?
Mr. Donaldson. I think that I understand that, Mr.
Chairman. Thank you.
Chairman Shelby. Thank you.
Senator Sarbanes.
Senator Sarbanes. Thank you, Mr. Chairman.
Before I turn to the questions that I have reserved for my
second round, there are some questions I want to put on the
basis of the first round.
First of all, I want to join Senator Corzine and Senator
Shelby in underscoring the importance of the decision you will
have to make in fairly short order to put in place a Chairman
of the Public Oversight Board.
Newspapers that have been following this issue very
closely--The New York Times, The Washington Post, The Los
Angeles Times, The Wall Street Journal, USA Today, The
Financial Times, and others, Business Week--have all
underscored the importance of this.
The Financial Times had an article just a day ago: ``New
Chief Must Show Recruiting Skills At SEC.'' It talks about the
appointment of the new head of the accountancy regulator. The
Public Company Accounting Oversight Board is the cornerstone of
legislative efforts to restore integrity to corporate America
and replace the accountancy profession's failed system of self-
regulation.
A creditable replacement and clean selection process should
see Mr. Donaldson off to a good start.
Also in another article it said: ``The first test of
Donaldson's skills will come when he helps decide who should
replace Webster as head of the Accounting Oversight Board.''
And then references the GAO report, which found just this
breakdown in the process at the SEC on this very question. In
fact, it was that breakdown in large part that brings you to
the witness table today in terms of the Chairmanship opening
up.
So, I do not have a question. I just want to underscore the
importance of this decision and the absolute necessity of
putting into place someone whose very naming must command
confidence and send a strong message that we really mean
business about cleaning up these practices.
I think it is of critical importance and I just want to
leave that with you.
I want to clear up a couple of things on the SEC. There
have been all these references to your Marine Corps experience,
and I commend that. I have enormous respect for the Marines.
But I do hope that in running the agency, you will recognize
the place of the employees union and the necessity as the
Chairman to consult with them in a respectful and reasonable
fashion. Can you give us some assurance on that point?
Mr. Donaldson. I will give you absolute assurance on that
point, Senator.
I have no experience with whatever the problems or the
alleged problems are. But I assure you that that will be,
again, one of the first things that I will want to take a look
at.
Senator Sarbanes. The other thing that I want to get
assurance about is that you have to fight for the SEC budget.
We have been through this process. Senator Corzine has taken a
very keen interest in it and now, if we can bring it to success
in the two budget decisions about to be made for this year and
then for the next year, we will have a significant increase in
the SEC resources, approximating almost doubling. But it took a
lot of effort to bring that about. And the SEC needs a Chairman
who will fight for its budget within the Administration and
with the Congress.
You have to really be prepared, I think, to put yourself on
the line to try to get the resources that your agency needs in
order to do the job. That is going to have to require a lot of
skillful in-fighting and almost a fierce determination on your
part. Do you have such a commitment to assuring your agency its
resources?
Mr. Donaldson. Indeed, I do. I believe that the President's
budget for 2004--I have one ally there to begin with. Clearly,
I will do everything in my power to help convince the
appropriate committees that that is a needed budget.
I also am aware of the timeliness now of resolving the
interim appropriations for the year we are in right now.
We have a lot of promises out there. But right now, the SEC
doesn't have much money and we really do not have much money as
we are loaning money to the Oversight Board.
So, we need to get this through. And again, if I can be of
help--I guess it is in conference right now. But if I can help
in any way of convincing people that it should be done quickly,
I will do so.
Senator Sarbanes. I want to ask a couple of questions about
some of your past performance.
An article in The Washington Post only a few days ago
states that when you served as Chairman of the New York Stock
Exchange when senior officials there looked the other way while
four brokers reaped millions of dollars in illegal stock
trades.
And Business Week reported that the SEC censured the big
board for failing to catch illegal trading by floor traders in
part during your watch.
Of course, that leads to the question, were you aware of
these activities? Some have alleged that, as the Chairman of
the Stock Exchange, you simply passed it over. What was the
situation?
Mr. Donaldson. Let me, if I can, elaborate on that. I am
glad that you asked that question because there has been a lot
of misunderstanding and misquotation in the press from a number
of very prominent organizations who basically have not done a
very good job of reporting.
First of all, during my tenure at the Stock Exchange,
enforcement and protection of investors was always my top
priority.
The New York Stock Exchange's first line of defense . . .
We went back in and looked at the numbers. Enforcement actions
increased by 80 percent during the years that I was Chairman of
the Stock Exchange because I had put a lot of emphasis on that,
80 percent over the prior 3 or 4 years.
One of the issues that arose was an issue associated with a
practice called flipping. Flipping is kind of a day trading
operation carried on by floor brokers where profits accrue to
their customers.
The practice while I was there raised some very important
questions--is this good for the overall market, and is it being
done in accordance with the rules and regulations? And if it is
being done in accordance with the rules and regulations of the
Stock Exchange, should those be changed?
So in the early years of my tenure, there were a couple of
committees that were put together, a couple of standing
committees that looked at the process, examined it, and came
away saying that they thought that the Exchange should re-
remind the practitioners of the rules and regulations and take
a good, hard look at infractions that may be going on because
people did not realize the rule.
Having done that, I was not satisfied with the conclusion
of those two committees. And therefore, I caused a third
committee to be formed, made up of directors of the Stock
Exchange, representatives of the directors of the Stock
Exchange, and others who were not intimately involved with the
practice, and charged them with another look at this whole
situation. And they did just that. They came up with some
recommendations for changes. Those changes were submitted to
the SEC and approved by the SEC. That was during the period,
let's say 1992, and I left the Exchange in 1995.
Later on, and all I know now is what I read in the press,
the New York Stock Exchange, in conjunction with the U.S.
Attorney in New York, opened up an unrelated investigation. And
that investigation was caused by the allegation of criminal
actions, not flipping actions, but criminal actions--false
accounts, false time stamps, devious ways of sharing in the
profits, et cetera, backdating orders, and so forth.
This was addressed by the Exchange. It was addressed by the
U.S. Attorney. And this had to do with a criminal investigation
that was undertaken.
If I can go one step further, the allegations that these
criminal activities were going on during my tenure. . . . The
allegations are something that is being promoted by lawyers
defending a particular individual, and the very misleading
statements have been released to the press and just picked up
and used.
Senator Sarbanes. Mr. Chairman, I am way over the time.
Chairman Shelby. As former Chairman, I was indulging you.
You used to indulge me. Thank you so much.
Senator Sarbanes. Well, I appreciate the indulgence.
Chairman Shelby. Senator Corzine.
Senator Corzine. Thank you.
Let me go quickly through a series of things. First, the
oversight and scope of view of derivatives. And I would like to
talk about kissing cousin users of derivatives. Hedge funds are
an area that I do not know whether you have verbalized to the
public how you feel about being involved in oversight by the
SEC. But many of us are concerned about both the connection
between derivatives and hedge funds and whether there is some
need for supervision there. I would like to hear your view on
that.
If I could go ahead and just tick off these issues, I would
like to get them on the record.
The harmonization of global accounting issues which you
spoke to raises an issue which we have had a lot of
conversation here in the Congress about, one that I hope we do
not regulate, or one, we do not write rules on, but it is
important to be addressed. And that is the expensing of
options.
As you know, the International Accounting Standards Board
has already recommended that that be the case. We could get
into a harmonization problem pretty quickly if they take one
approach, and we do not others. And certainly you have some
element of relationship to FASB.
I would love to hear a little bit of your philosophy with
regard to enforcement. Being on the other side of the fear
quotient that the Chairman talked about, I just think that firm
enforcement is a good idea.
I wonder if you have a philosophy that you bring with
regard to enforcement considerations. You know, a number of the
fall-out questions of the scandals that we have seen in the
last several years raise this issue, WorldCom probably being
the most extensive. But you can say that on Enron and other
places. When does a corporate action dictate how you think
about that? I would love to hear.
And if there were time, I would love to hear some
impressions about the oligopoly of credit agencies and the
economy.
Mr. Donaldson. Let me see if I can hit those.
First of all, on hedge funds, I believe that there is a
tremendous growth in hedge funds, pretty much totally
unregulated. A lot of money. There is a distressing move toward
what I would call the REITization of hedge funds, making them
available to smaller and smaller investors and aggregating
their money. It is of serious concern to me. Not the hedge fund
concept itself, but the possibility of, A, less sophisticated
investors not realizing the risks inherent in the vehicle and--
--
Senator Corzine. My question wasn't formulated under the
view that hedge funds necessarily are bad. They can greatly
positive.
Mr. Donaldson. Absolutely. And the allegations that concern
me is what are possible manipulative aspects to hedge fund
management. So, I am not against hedge funds per se. I think we
need to know more about how they are operating. I believe that
the SEC has already started to look into this and I would
encourage that investigation.
In terms of expensing of options, I believe in
oversimplified terms that there is an expense associated with
options, and that that expense should be reflected in the
operating statements of a company. The devil is in the details
as to how you do it. We are about to get a report from FASB
which I look forward to, if I am Chairman of the SEC, in terms
of their approach to the details of how you do it.
And we, I hope, will be looking at anybody else's ideas
with the end result desired that we have a common, an
acceptable approximation of the best way to reflect the costs
and it becomes a standard within the industry.
As far as enforcement is concerned, again, if I understand
the thrust of your statement, as I said earlier, I believe that
enforcement is at the core of the SEC.
I think that there may be some issues out there where
people are impatient with the pace of enforcement. And I would
simply say that I think we have to be very careful that we do
not violate the ethics of review and process and so forth when
we go to make very serious charges.
We cannot afford to make mistakes. So it is a slow,
deliberate process. I am not saying that we cannot do it
faster. But we cannot do it so fast that we harm the justice
system that is so meaningful to all of us.
Senator Corzine. Mr. Donaldson, the thrust of my question
was not face. It is trying to get a sense of your balancing of
the weight of individuals versus the corporate entity.
Mr. Donaldson. Yes, the individual versus the corporate.
Senator Corzine. It is a tough call. I am not trying to say
that there is a How-You-Do-It book here. But there are
certainly needs sometimes when the entity has so been infected
with what the violation is, that it needs to be recognized as a
choice that I think enforcement agencies and officials need to
take a look at.
Mr. Donaldson. I think that, clearly, individuals in many
cases have broken the rules within their organization and are
guilty and should get the penalties due that.
If there is such a pervasive atmosphere within an
organization itself, that it is not an isolated individual
breaking of the rules, but it is breaking of the rules
throughout the whole organization and the organization is,
``corrupt,'' then I think, if I am addressing your question,
the organization becomes guilty.
That is a tough call. And it is quite dangerous, I think,
to condemn a whole organization for the sins of outliers within
that organization. But it is a tough call.
You also asked about what I think of the oligopoly of the
rating agencies, of which there are three, or perhaps four,
prominent ones. There is an oligopoly, and we depend so much on
these agencies for the ratings that they give. There are a
number of issues there as far as I am concerned.
One is that the rating agencies are paid by the very
entities that they rate to give those ratings. That is an
interesting fact and it has gone on for years. It is very tough
to become a rating agency now, given the laws and the practice
we have.
So, I think the area of rating agencies, the way they go
about their business, the conflicts they face, how we bring
more competition into that business, as well as allegations of
delinquency and uncovering ratings that should have changed,
that should have been quite obvious, but weren't quite obvious
to the agencies. All of this, I think, justifies a hard look at
the rating agencies.
Chairman Shelby. Senator Schumer.
Senator Schumer. Thank you, Mr. Chairman.
And thank you for being here for a while, Mr. Donaldson.
These are very important issues, and this is our first chance
publicly to ask you these questions. We all appreciate it.
My next question is not about the transparency between
investment bankers and research analysts. There has already
been a lot of talk about that transparency. However, more and
more firms are offering an array of products under the same
roof to their corporate clients, particularly since the
Financial Services Reform Act.
I would ask you to comment on another side of transparency,
the relationship between loans to a corporation that may or may
not be subsidized by the promise of future additional
investment banking business.
I believe this practice has the potential to alter credit
markets, and it certainly disguises the true cost of credit--
can disguise. Let's not say it does.
It may also price out many firms that cannot subsidize
below-market loans through fees from other businesses. It also,
frankly, has the potential to hurt many banks. I think we have
seen in the last year, that banks find themselves drawn into
loans that they otherwise wouldn't make to maintain corporate
relationships.
Now this is a question we have all debated on this
Committee for a long time. But since the Financial Services Act
of 1999--Gramm-Leach-Bliley--we have seen a lot of new changes,
and we have seen a lot of write-downs of loans that may well
have been made, or certainly were made alongside investment
banking relationships, and there may have been a relationship
among those.
I am thinking specifically of recent experiences of firms
who have lost more in loan value from recent large-scale
bankruptcies than they ever made in investment banking fees.
What is your experience as an executive with this practice?
As head of the SEC, would you push for disclosure of any of
these agreements? And can you give us a general view of how you
feel about it.
Mr. Donaldson. Well, if you go way back in history and the
enactment of the Glass-Steagall Act, the reason for that Act
was basically to separate banking and brokerage or
underwriting, and there was a purpose for that given the
problems that existed back then.
Obviously, the Financial Services Act has basically
abrogated Glass-Steagall and set in motion a conglomeratization
in the financial services business that already has changed the
face of Wall Street. All the acquisitions by banks of
investment banking firms and, conversely, investment banking
firms acquiring banks, has changed the whole face of Wall
Street dramatically in the last decade, and even more
dramatically in the last 5 years. And within that context,
there are whole new sets, as you bring up, of conflicts of
interest existing in a one-stop-shopping concept.
The banks that have acquired investment banks have been
after the generally higher profit margin business associated
with investment banking. And clearly, the issue of whether
making soft loans in order to get the more profitable business
is an issue that, in my view, rivals in importance the use of
research to be a handmaiden to investment banking and the
securities industry.
Senator Schumer. So that is something that you would
examine as Chairman of the SEC.
Mr. Donaldson. Absolutely.
Senator Schumer. Good. My next question is about WorldCom.
This has been characterized as the biggest corporate fraud
in American history. As you know, billions of dollars of wealth
were wiped out. Confidence of business management was
substantially undermined, to the detriment, not only of the
shareholders and employees of WorldCom, but also to all U.S.
businesses.
I still get complaints from other businesses whose phone
service is all tangled up in this mess.
What do you see as the role of the SEC in prosecuting the
individuals responsible for this fraud? As you know, as of now,
there have been no official actions by the SEC.
Mr. Donaldson. Well, if you confirm me as the Chairman of
the SEC, I certainly will look into whatever work is going on
inside the SEC in terms of this problem you cite.
Senator Schumer. Anything else?
Mr. Donaldson. I would go on to say that if there have been
violations of law, they should be punished, and that punishment
should come as quickly as we can, doing it fairly.
Senator Schumer. Do you have any thoughts of how good a job
the SEC has been doing in this regard in this case up to now?
Mr. Donaldson. I do not, Senator. I wouldn't comment on
that.
Senator Schumer. Okay. Thank you. Final question, do I have
time for one or should I wait?
Chairman Shelby. Go ahead, finish it.
Senator Schumer. Thank you. Is there a clock?
Chairman Shelby. We have been very generous with----
Senator Schumer. You have.
Chairman Shelby. --Senator Sarbanes' time.
[Laughter.]
Senator Schumer. Paul, if you would like to go, I can wait.
I have one more question.
Senator Sarbanes. For the sake of friendly relations, I
urge you to go ahead with your next question.
[Laughter.]
Senator Schumer. Paul, we will always be friendly, as far
as I am concerned.
Senator Sarbanes. Would the Reporter please note that for
the record.
[Laughter.]
Chairman Shelby. Strike that.
[Laughter.]
Senator Schumer. Okay. All of us in the Senate, in this
Committee in particular, are very concerned about the current
state of the economy. As you know, the stock market has lost
almost $5 trillion in the last 2 years, a mind-boggling sum.
Last year, it showed its worst performance since 1974. And I am
told that the stock market is down more in the last 2 years,
the first 2 years of President Bush's Administration, than any
modern President, including Herbert Hoover. What is your
assessment of the current market? How much do you see the
threat of war weighing on stock prices and investor confidence?
What is your view of the relationship between deficits and
interest rates? And in turn, interest rates and stock prices?
Mr. Donaldson. Well, let me----
Senator Schumer. I can go over each one of them separately.
Mr. Donaldson. Let me talk a little bit about the market
itself.
Clearly, the economy has been in a recession. It is coming
out of a recession, I believe. I believe that the pace of
recovery has taken a little side tick here. It appeared that it
was on a much more sustained track and that now there is
evidence that perhaps that is moderating a bit.
To me, it is amazing that it hasn't moderated sooner, given
the events that are worrying investors, to wit, that the
earnings of corporations have been a little disappointing, that
recovery earnings have been a little disappointing.
The escalation of the possibility of war is overhanging the
entire situation. And of course, the constant daily reminder of
the malfeasance that has gone on in the securities markets and
corporations and so forth, the undermining of the confidence,
just general confidence, is there and has not been dissipated.
I would hope that the SEC could have some influence on the
confidence factor.
I think that until the international situation is resolved,
at least the immediate possibility of action in Iraq, it is
going to be a very nervous market. And of course, we have other
worries that may be triggered by that action, terrorist
worries, North Korea, and so forth.
Frankly, that is beginning to reflect itself in consumer
confidence and that again flows back into earnings estimates,
business not being as good as people expected it to be. So, we
are in a very uncertain period.
I do believe that the President's program, as proposed, is
a good program. I am sure it will be argued about. But I think,
essentially, as to the deficit implications of that, my own
personal view is that nobody likes deficits. Deficits do count.
But also, we have to take remedial action. We have to have an
insurance policy. We have to take steps that we might not take
in normal times to make sure that we do not go over the cliff.
And in that sense, the risk of larger deficits is justified, I
believe, in terms of even greater risk that the economy rolls
over.
As far as the long-term impact of deficits on the economy,
clearly, borrowing does have an effect. Deficits do affect the
economy.
The hope is that the best way of addressing those deficits
and meeting our other obligations is that the tax policy will
get the economy going again and the tax revenues will come in
and that we will help to pay down that deficit by these
actions.
Senator Schumer. I had asked you also about the
relationship between deficits and interest rates and interest
rates and stock prices.
Mr. Donaldson. Well, there is a definite relationship
between interest rates and stock prices. As a matter of fact,
the take-off for pricing of stocks, of price earnings
multiples, is a simple measure, and definitely has something to
do with the rates of return available in other forms of
investments.
If interest rates were at 10 or 15 or 20 percent, or ever
where they were years ago, that becomes a pretty attractive
investment relative to the stock market and vice versa. So
there is a definite correlation, not over a short period of
time, but over a long period of time.
In terms of the effect of deficits on interest rates,
again, there is a lot of debate on this. There is the theory,
as you know better than I, of a crowding out, the financing of
the deficit by the Government crowding out the private
borrowers. I do not see that as an immediate problem here. I do
not believe that the cost of capital right now, which is very
low, is what is impeding industrial investment. I believe it is
confidence that is impeding. If I am running a company and I am
facing some of the things that we were just talking about a
minute ago, war, et cetera, and somebody comes in and says,
let's build a new plant, I am going to say, why don't we wait?
Why don't we wait for a couple of months?
Senator Schumer. Right.
Mr. Donaldson. So the dissipation of that is what the
problem is right now.
Senator Schumer. And regardless of one's overall views in
terms of your earlier comments----
Mr. Donaldson. I should preface this--excuse me--by saying
I am not an economist. These are my own personal----
Senator Schumer. We understand that. But you have a lot of
experience, practical, good experience.
Wouldn't it make more sense if we were using the deficit to
prime the pump a little bit, or using deficit spending, to do a
good deal of it this year and next year, rather than in 2006,
2007, 2008, and 2009?
As you know, the President's plan does a very small
percentage in this fiscal year and a rather small amount in the
next fiscal year. It really comes hitting later on. Maybe if
and when you become Chairman of the SEC, you will have done
such a good job, that by then the economy will be going on all
cylinders.
But one of the things I think that makes people scratch
their heads a little bit is how backloaded the President's so-
called stimulus plan is. Some even say it is not even a
stimulus plan, but rather, tax reform, whether you are for it
or against it.
Would you care to comment? Would it be better in terms of
getting the economy going, getting the markets going, to do a
little more in this first and second year to prime the pump?
Mr. Donaldson. This business of confidence, confidence is a
very evasive concept. It is my own personal belief that one-
shot tax reform is not nearly as effective in gaining
confidence as is a long-term program that you can count on.
And having a few dollars in hand or a depreciation
deduction that goes on 1 year, off another year, that is a lot
less confidence-building than surety that, over the long haul,
things are going to kick in on a programmatic basis.
I think we have so many expenditures now that we need to
make in connection with all of the things that we are trying to
do--Medicare, domestic spending, military spending, et cetera--
that I do not think we have to go out and build new roads or
stimulate the economy in any other way than just addressing
some of the real problems we have.
Senator Schumer. Thank you, Mr. Chairman. I appreciate
Senator Sarbanes letting me ask that last question.
Chairman Shelby. Senator Sarbanes.
Senator Sarbanes. Thank you, Mr. Chairman.
Mr. Donaldson, The Washington Post, in an article when you
were first named, said, and I am quoting them now: ``As New
York Stock Exchange Chairman, he argued that foreign companies
should be allowed to sell stock to U.S. investors with
financial disclosure rules weaker than those required of U.S.
companies.''
``The SEC Chairman at the time, Richard Breeden, who was
appointed by Bush's father, refused to allow that despite
Donaldson's lobbying of the White House and Congress.''
I am interested in this issue of listing standards for non-
U.S. companies. Actually, we tried to address it to some extent
in the legislation. And I would like to know your view on this
question. Particularly as you move from being head of the New
York Stock Exchange toward the prospect of being Chairman of
the SEC.
Mr. Donaldson. Right. As I touched on before, the issue
back then, 1990 through 1995 or so, was the amount of money
that was going overseas, going through many intermediaries, and
being invested by individual investors overseas, in markets
where there were not the regulatory safeguards that we have in
our market.
At that time I felt very strongly that somehow we should
give--and at that time I was wearing a partisan hat of the New
York Stock Exchange--investors the protection of the New York
Stock Exchange's rules and regulations by somehow getting these
foreign companies to list on the New York Stock Exchange.
The main inhibition for that was the absolute insistence of
conformity to U.S. accounting GAAP standards that we attempted
to force on foreign companies. And I can remember talking to a
number of foreign companies--as an example, in Germany, where
no German company had ever listed on the New York Stock
Exchange, and listening to their arguments about why their
accounting was better than ours.
I obviously disagreed with that, but it became very
apparent to me in subsequent events that there was an element
of truth to that, that our accounting did not look so good in
hindsight. And perhaps some of their accounting looked a little
better.
So what I was calling for was not a diminution of
accounting standards, but, rather, a harmonization of somehow
getting the best of both with a view toward transparency and
disclosure, but gotten at in a different way.
The fact of the matter is that, during that period of time,
gradually, the SEC's posture changed a bit under Chairman
Breeden and finally, when Daimler-Benz wanted to list on the
Stock Exchange, the rules were changed. We let Daimler-Benz
list without making them report their earnings back over 3
years, which they could not do. So, in fact, the rules were
modified to allow the largest German company to list on the
Stock Exchange.
Senator Sarbanes. Well, now, if we achieve harmonization
between FASB and the International Accounting Standards Board,
so that there is a uniform set of accounting principles, we
wouldn't have this issue, then, would we?
Mr. Donaldson. Correct.
Senator Sarbanes. It is important, though, it seems to me
to achieve harmonization at the highest level, not at the
lowest level. In other words, that we take the best out of both
systems in the course of doing that and FASB and the IASB are
in discussions about doing this, as I understand it right now.
Until that is achieved, though, I think it is important
that we not relax the standards for listing in the United
States of foreign companies in such a way that we are not
protecting our investors or creating a nonlevel playing field
for American companies. Would you agree with that?
Mr. Donaldson. I would agree with that. I believe that
there should not be, in areas other than pure accounting,
things that foreign companies can do that a U.S. company cannot
do. However, there are certain things having to do with foreign
companies where our current laws, are impossible for them to
conform to.
And again, I am referring now to the dual boards and
directors by their laws who must be termed to come from the
company and be insiders and who cannot be outsiders on their
audit committee.
It is a matter of law, and I think that the interpretation,
as I understand it, of the Sarbanes-Oxley law, the rules that
are coming out now, are taking that into consideration. I think
that that is probably an unintended consequence.
Senator Sarbanes. Now the SEC has made some accommodations,
which, upon review, seem to be fairly reasonable. For instance,
the German, the Swedish companies have, given the way they are
structured corporately, they have employee representatives on
the Board who also usually have an employee representative on
the audit committee.
It is arguable that they do not constitute an independent
director. The SEC has made an accommodation for that purpose.
But it seems to me that we still have to be pretty rigorous in
ensuring that the companies being listed meet our standards.
The only penalty for not doing so is they do not get listed.
And of course, we are anxious to protect our capital markets
and to assure investors that they can rely on the disclosures
and the corporate governance that lies behind it.
So, I would be very concerned about some effort that said,
we are getting this argument from abroad that we are trying to
do extra-territoriality by imposing our standards on foreign
companies.
It is only if they seek to become listed on our exchanges
that these standards apply.
Mr. Donaldson. Right.
Senator Sarbanes. If they do not seek listing on our
exchanges, they can govern themselves any way they want. But it
is once they want to get that entry into the American exchanges
that we then have to be concerned about providing assurances to
investors in terms of the information that has been flowed to
them.
Mr. Donaldson. Well, several responses. One, I basically
agree with you. I think that the transparency of our accounting
cannot be fiddled with, if you will, in terms of foreign
listings. The individual investor has to have the protection of
our accounting system as we try to harmonize it.
I also think that there is an element here of U.S.
competitiveness that we cannot disregard. To wit, if we have
such a high fence around our markets and we force foreign
companies not to trade here, not to be listed on our exchanges,
the market will move from the United States to other countries.
Senator Sarbanes. The way to deal with that high fence is
to achieve this harmonization between FASB and the
International Accounting Standards Board.
Mr. Donaldson. I agree with you, Senator.
Senator Sarbanes. Then the problem becomes moot. Assuming
that the harmonization is achieved at a high level and not down
at some low level.
But if we have learned any lesson out of what we have been
through, it is the necessity to sustain the integrity of our
markets in a way that people can repose confidence in them.
In that regard, I was encouraged to hear your response to
Senator Schumer about examining the WorldCom situation. They
overstated their earnings by $10 billion. By $10 billion. And
it seems to me that it is worth looking into. I don't know that
they should simply take a bankruptcy bath and everything is
forgotten and forgiven. I think of all the companies, their
impact in terms of lost employment, the hits to pension funds,
to retirement plans, is by far the greatest.
Let me ask you, do you regard State securities regulators
and State attorney generals as prospective partners for the SEC
in enforcement of the securities laws?
Mr. Donaldson. Absolutely. I absolutely believe that, and I
also believe that the President's Corporate Fraud Task Force
with the Justice Department is another partner. I think that
the law enforcement agencies, whether they be Federal or local
or State, should be partners in pursuing securities crime.
Having said that, I think there has to be a primacy in
terms of the solutions to these things that rests with the
Securities and Exchange Commission.
Senator Sarbanes. I think Attorney General Spitzer was
pretty sensitive to that, actually. I think he moved into a
vacuum that was not being filled by the SEC and they called for
some action. And he has been very clear himself in the
necessity to have national standards with respect to the
securities markets.
I think it is very important for the SEC to see the State
securities regulators and the State attorneys general as
partners in their effort to sustain the integrity of these
markets.
Even the increase in resources that you are getting, you
have nowhere near enough to do what has to be done and, in many
instances, they have contributed to it.
A couple more questions, if the Chairman will indulge me.
Chairman Shelby. You go right ahead.
Senator Sarbanes. There have been a number of newspaper
articles about your compensation package at Aetna. I am sure
you have seen those. They talk about your share options and
your own direct pay package and so forth. Your bonus on top of
your salary. I would like to hear your response to that. But I
would also like to couple it with another question.
The Council of Institutional Investors has said that it is
time for the SEC to review the current rules and to consider
updating and improving the disclosure requirements. This is on
executive compensation. And I would like to know your view on
this suggestion from the Council of Institutional Investors
that we need to have improvements in the disclosure
requirements of executive compensation.
Mr. Donaldson. Yes. Let me address the first question
first, which is my compensation for my role as the CEO of
Aetna.
I believe that my compensation was strongly aligned with
shareholder interest. I received substantial compensation from
Aetna. However, the majority of that package was contingent
upon my achievement of six stated goals. When I became CEO of
Aetna, the independent compensation committee hired an outside
consultant and they developed a compensation package with six
goals. And the equity portion of that was staggered. In other
words, it wasn't all granted at the existing price. There were
ever-increasing prices which would make the options worth
something only if the stock price went up.
By the way, the value created since the day I took over
Aetna as CEO until today, for the shareholders, was, according
to my calculations, $4.3 billion of new value that was created
for Aetna shareholders.
My compensation package was tied to the six goals and it
was tied to what the rest of the shareholders were going to
get.
And this relates to the second part of your question. It
was fully disclosed in all of our proxy materials; they spelled
out exactly the compensation I received, the procedure as to
how it was awarded, the fact that it was independent directors
who determined it, the fact that they use outside independent
consultants to verify their judgments. So, I feel that that was
the way it should work.
Now at the time I took on the job, and this has to do with
the duration of my employment, part of my arrangement with the
directors of Aetna was that I was there to achieve certain
goals. Those goals were to restrategize the company, to sell
off properties, to bring in new management, and so forth. I had
no idea, nor did the directors, how long that was going to
take.
Frankly, we got it done in a lot shorter period of time
than might have been expected. And when, in my view, it was
done, I resigned my position, turned the whole thing over to
the current CEO. By the way, they are doing a terrific job
right now, if I might say that.
Senator Sarbanes. Let me put one final question to you.
The SEC has just approved a final rule requiring mutual
funds to make public how they vote the proxies of the companies
they
invest in. This regulation responded to investor complaints
that
mutual funds were voting against investor interests on issues
like Bermuda reincorporation, board independence, the whole
list of things. Do you support the implementation of this rule?
Mr. Donaldson. Yes, I do. I believe that there are lots of
arguments pro and con. But I think that this is a good start in
terms of transparency. And inducing large shareholders, in this
case, mutual funds, to exercise their rights of ownership, and
obligations of ownership. So, I do support the bill.
Senator Sarbanes. Mr. Chairman, I want to thank you for
holding this hearing promptly. After all, Mr. Donaldson's
papers only arrived last week. And I know of your own
commitment to try to move the nomination forward, which I
share.
I intend to support this nomination. We have had a Chairman
of the SEC who resigned the first week in November. It is now
the first week in February and he is still on the job.
We do not have a Chairman of the Public Oversight Board. We
need to get moving. And I have the hope and the expectation
that Mr. Donaldson will prove to be the kind of committed
Chairman of the SEC who will bring about these changes that are
so essential.
You face a tremendous challenge, and a tremendous
opportunity. This Committee obviously will be watching closely.
I know the Chairman has indicated his own intention to have a
very active oversight agenda.
There is a chance here now to raise in a very significant,
substantial and hopefully, a lasting way the whole level of
corporate governance, corporate behavior, accounting standards,
the accountability of the accountants. But it very much depends
on the new Chairman of the SEC providing that kind of
leadership. We look forward to working with you on that and we
wish you the very best as you undertake these very significant
responsibilities.
Thank you, Mr. Chairman.
Chairman Shelby. Thank you, Senator Sarbanes.
I just want to add, Mr. Donaldson, I believe that you bring
more than the requisite experience, your educational
background, your commitment to this country. That you could,
and I hope you will, be one of the outstanding Chairmen of the
SEC. Otherwise, I do not believe you would have taken the job.
I want to work with you. And of course, I intend to support
your nomination. I told you that earlier.
There are some Senators who have submitted some questions
for the record. I would hope that you would answer those
questions expeditiously. And Senator Sarbanes and I will get
together and try to have a Committee hearing as soon as
possible, if you get those questions in and report your
nomination to the floor, and ultimately, the Senate will vote
on it.
Thank you for your appearance. I wish you well.
Mr. Donaldson. Thank you very much, Mr. Chairman.
Chairman Shelby. The hearing is adjourned.
[Whereupon, at 12:50 p.m., the Committee was adjourned.]
[Prepared statements, biographical sketch of the nominee,
and response to written questions follow:]
PREPARED STATEMENT OF SENATOR TIM JOHNSON
Mr. Chairman and Ranking Member Sarbanes, thank you for convening
today's hearing to consider the nomination of Mr. William Donaldson to
become Chairman of the Securities and Exchange Commission. I would like
to take a moment to welcome the new Members of the Senate Banking
Committee. I look forward to working with Senators Chafee, Dole, and
Sununu on so many issues of importance to this country.
Mr. Chairman, our Nation continues to confront a crisis of
confidence in the markets that was precipitated by outrageous fraud in
companies and their auditors, from WorldCom to Enron to Arthur
Andersen. It is my hope that new leadership at the SEC will help to
move America forward. Ever since Mr. Pitt announced his resignation on
election night, we have been waiting for President Bush to show
leadership in this area. I know I join my colleagues in welcoming a
strong new head of the SEC, and we look forward to hearing Mr.
Donaldson's thoughts on his vision for this critical position.
I would like to note to this panel the importance of setting the
tone for the future of the SEC. As I am sure most recognize now, it is
clear that Mr. Pitt made a grave error in the tone he set at the start
of his tenure by declaring his intention to create a ``kinder and
gentler'' SEC. As we have all learned since, most of us the hard way
through a steep decline in the value of our retirement savings, we must
work to create a formidable SEC, a trustworthy SEC, and most important,
an SEC that places the interests of investors above all else.
If the SEC is to become kinder and gentler, I believe it should be
toward investors, who are now negotiating the difficult maze of
arbitration to seek justice over the outrageous fraud that has gutted
their life savings. I look forward to hearing Mr. Donaldson's views
about the arbitration process, and how we might take steps to protect
the rights of investors in this area.
Companies must understand that in the long-term, an SEC that is
trusted by investors will work to their ultimate benefit. Until we
restore confidence in investors, we cannot get our economy back on
track. Investors have not pulled out of the market because they want to
avoid paying tax on their dividends. They have pulled out because they
do not trust corporate leadership, and they do not trust the SEC.
Now, I would like to note for the record that the SEC under Harvey
Pitt has taken some important steps toward implementing the Sarbanes-
Oxley Act, and I would especially like to acknowledge the extraordinary
leadership of Senator Sarbanes, along with Senators Dodd and Corzine on
this effort. We need to keep the pressure on implementation of this
law, and I look forward to working with Chairman Shelby and this
Committee to conduct strong oversight.
----------
PREPARED STATEMENT OF SENATOR MICHAEL B. ENZI
It is nice to be back at the Committee after the recess, and I look
forward to working with the Committee on issues affecting the financial
services sector.
I want to welcome Bill Donaldson to the Committee. I certainly
appreciate his willingness to take on this role and to help restore
investor confidence in our capital markets.
This is not an easy time to become the head of the SEC. The markets
have recently gone through more turmoil than since the 1930's.
Corporate fraud and the bursting of the internet bubble has cost
investors large portions of their personal savings and retirements. In
my opinion, the job of the next SEC Chairman will be to restore this
confidence and to renew Americans' willingness to participate in
our capital formation process. This will be an incredible challenge for
the new
Chairman.
I believe part of accomplishing this includes penalizing the
wrongdoers to the fullest extent possible. The purveyors of corporate
fraud must be punished swiftly and severely. The only way to punish
these criminals is to deliver real sentences and harsh monetary
penalties. The victims of these crimes demand justice and they deserve
to receive it. Class-action lawsuits that allow the trial lawyers to
reap millions of dollars while the investors receive pennies will not
bring justice to the victims. To accomplish this, I am glad that during
last year's passage of Sarbanes-Oxley we significantly strengthened
white collar crime penalties. I know that Congress did this with the
expectation that the law enforcement community would utilize the
authority.
I also want the new Chairman to closely examine and follow
Congressional intent during the Commission's rulemakings. For instance,
I do not believe that anyone who was involved in the development of
Sarbanes-Oxley believed that the Financial Accounting Standards Board
should not be the accounting standard-setting body
described in Section 108. However, the SEC has yet to officially notify
the FASB they are that body.
It was my understanding that while naming this standard-setting
body that we would be giving FASB more independence.
By giving them an independent funding source and statutory
authority, they would have a better ability to make independent
decisions on accounting matters. This Section was not intended to give
the Commission significantly more authority over accounting standard
setting. The Commission does not have the expertise to set accounting
standards.
This lack of acknowledgment by the Commission has left the FASB in
a funding crisis. Private companies are no longer supplying funds to
the FASB because they were intended to have the mandatory funding
mechanism outlined in Sarbanes-Oxley. The Commission should immediately
name the FASB as the standard-setting body in Section 108.
This point brings us to, I think, a bigger issue. Throughout the
recent rulemakings, the SEC has gone beyond the statutory requirements
of last year's legislation. Whether it is the auditor independence
rule, the Section 307 lawyer provision, or the naming of the FASB which
I mentioned, the Commission seems determined to go beyond the statutory
requirements. Some of these issues, in particular the nonaudit services
provision, went well beyond the statute.
A large part of Sarbanes-Oxley was the construction of a new Public
Company Accounting and Oversight Board or PCAOB. This Board is designed
to be the frontline regulator of the accounting industry, including the
establishment of nonaudit service prohibitions. It was unnecessary for
the Commission to go as far as the proposed rule did when we are a few
months from the PCAOB operational. They, not the Commission, will be in
the best position to make the determination regarding what is, and is
not, a conflict.
Also, I know that the salary levels of the Members of the PCAOB has
received a lot of attention, particularly from Members of the
Commission. This Board was constructed to be private and not a
Government agency. Part of this was to ensure it could attract and
retain qualified Members of the Board by offering competitive salaries.
I think we need to ensure that the Board is able to continue to attract
these people.
I know that I have put a lot on your plate, Mr. Donaldson. I want
you to know that I have complete faith in your abilities and the
direction which you will lead the Commission and our securities
markets. If, at any time, you feel you need more authority or resources
to help weed out corporate wrongdoers, I hope that you will feel
comfortable calling on this Committee before we encounter these types
of problems again.
Mr. Chairman, I thank you for your efforts on this matter. I look
forward to working with you, the Members of the Committee, and the
Commission in the future.
----------
PREPARED STATEMENT OF SENATOR JON S. CORZINE
Thank you, Mr. Chairman, for holding this hearing. I want to
welcome Mr. Donaldson before the Committee and congratulate him on his
nomination.
Mr. Chairman, though Mr. Donaldson was kind enough to pay me a
courtesy visit last week, I did not need that meeting to become
convinced of his vast knowledge of our Nation's financial markets. I
have known Mr. Donaldson for quite some time, and he has always been an
innovator and a leading thinker within the securities community.
Those characteristics and the skills acquired from years spent at
the company he co-founded--Donaldson, Lufkin & Jenrette--his tenure at
the New York Stock Exchange and his time as a public company CEO give
Mr. Donaldson a wide array of experiences from which to tap into should
he move forward to become the next Chairman of the Securities and
Exchange Commission.
If confirmed, Mr. Donaldson would take the helm of an embattled
agency. His first task will be to restore investor confidence after a
year plagued by corporate fraud and accounting scandals. The efforts he
will immediately undertake at the agency will go a long way toward
determining his success or failure at restoring that confidence.
Those include finding a strong, credible individual to lead the new
Public Company Accounting Oversight Board and overseeing the rulemaking
process for implementation of the Sarbanes-Oxley Act. Mr. Donaldson
will also need to devote considerable attention to restoring the morale
amongst SEC employees and fighting to make sure that the agency
receives the funding it has been promised by President Bush in his
fiscal year 2004 budget and by the Congress.
Over the long run, I look forward to seeing how Mr. Donaldson seeks
to turn his vision of a new SEC into a reality. That vision will play a
significant role toward ensuring whether America's capital markets--in
the face of growing global competition--remain the heart of global
capital formation.
Mr. Chairman, the U.S. capital markets have, in many ways, provided
the fuel for the expansion of the global marketplace. Domestically and
abroad, they have driven the economic growth that has been at the heart
of technological, economic and cultural change throughout the world. In
doing so, our capital markets have grown stronger, more liquid, and
more adaptable to ever-changing and dynamic
global economic conditions.
To remain strong U.S. markets must pursue innovative thinking and
risk-taking which, coupled with transparency and effective regulation,
will ensure the integrity of a system that investors will continue to
view as a fair and reliable place to do
business.
To be certain, the challenges facing the SEC are enormous.
Fortunately, Mr. Donaldson will be equipped with considerably more
human and technological resources than those before him have had. The
Sarbanes-Oxley legislation provides a statutory framework that should
enable his success, as will new funding for the agency. The rest, as
they say, will be up to him.
Mr. Chairman, I look forward to Mr. Donaldson's testimony before
the Committee, and should he be confirmed, to assisting him in any way
I can. And Mr. Donaldson, I again congratulate you.
Thank you, Mr. Chairman.
----------
PREPARED STATEMENT OF SENATOR ELIZABETH DOLE
Thank you, Mr. Chairman. I look forward to working with you and the
other Members of the Senate Banking, Housing, and Urban Affairs
Committee, and I join you this morning in welcoming William H.
Donaldson, who has been nominated by the President to serve as the next
Chairman of the U.S. Securities and Exchange Commission.
Economic growth and job creation, the very health of the American
economy, all depend on the honesty of American business, the integrity
of our securities markets, and the faith of the American people in our
financial institutions. Over the past year, this faith has been badly
shaken--a fact that is further compounded by the global uncertainty
surrounding the war on terror and the unpredictability of Saddam
Hussein.
The vast majority of American businessmen and women obey the laws
and uphold the rules. However, those that refuse to play by the rules,
and threaten to undermine the integrity of our financial markets in the
process, deserve tough penalties.
Last July, President Bush signed the Sarbanes-Oxley Act, which
adopts tough new provisions to deter and punish corporate and
accounting fraud and corruption. It ensures justice for wrongdoers, and
protects the interests of workers and shareholders. There are a lot of
very good things in this new law--like requiring companies to disclose
more information and then having CEO's and CFO's personally vouch for
the truth and fairness of their company's disclosures.
This law takes much needed steps to help expose and punish
corporate corruption, improve disclosure, and increase protections for
those that invest, including pension funds. Now, we need to focus on
strengthening the SEC's structure and ensure the ability of the agency
to fight fraud and by fully implementing the Sarbanes-Oxley
legislation.
And there is more we can do to restore investor confidence.
Auditors currently face a real conflict of interest--as The Wall
Street Journal
recently pointed out, they are paid by the people they are asked to
police. And there is no doubt that at least some of the scandals we
have seen over the past year
occurred because auditors were hoodwinked by management.
So it comes down to a matter of incentives. What incentive does an
auditor have to report something displeasing to those who foot the
bill? Wouldn't it be in their best interest to make the client happy,
thereby guaranteeing more work from that client in the future?
I like an idea put forward by New York University Stern School of
Business
Accounting Professor Joshua Ronen, to change the incentive structure
for auditing companies. The proposal would require that companies buy
Financial Statement
Insurance in much the same way they now buy officers and directors
insurance,
offering a solution to help improve the integrity of audited financial
statements at publicly-traded companies.
I believe Professor Ronen has hit the nail on the head. Again,
according to the Journal, his idea ``not only attacks the incentive
problem, but along the way it brings market discipline into corporate
accounting via stock prices, offers better
protection to shareholders in the case of fraud than does directors-
and-officers insurance, and avoids more Government regulation.''
It is a matter of changing the incentives.
Let's look quickly at the problem: Auditors face a real conflict of
interest. Right now, an auditor is hired by the corporation, and
therefore is, to some extent, beholden to the corporation that is
paying the bill. But if corporations are required to buy Financial
Statement Insurance, and the insurer hires the auditor, it changes the
incentive.
The insurance company has every incentive to hire the most
competent auditor, and the auditor has every reason to ensure an
accurate audit. Under such a system, the loyalty is to accuracy, not to
the corporation being audited.
Financial Statement Insurance attacks the incentive problem, brings
market discipline into corporate accounting and offers better
protection to employees and shareholders. But making the leap to
Financial Statement Insurance is unknown, thus less comfortable and
businesses are unlikely to make the jump unless pushed. That is where
the Federal Government comes in. By requiring this by the SEC, the
natural reluctance to change, even for the better, can be overcome. And
requiring companies to have Financial Statement Insurance enables
investors to accurately judge the quality of financial statements and
make sound choices with their money.
It just makes good sense--it will not cost the companies much more,
and if their audits are very reliable, maybe even less. It will not
cost the Government much since it is only adding some additional lines
to already required quarterly and
annual statements. And since it does not create a new cause of action,
it will not
create new lawsuits and the insurance companies already know the risks.
Mr. Donaldson, I look forward to working with you on this issue and
others to ensure that investors have fair and accurate information to
make sound investment decisions. I appreciate your commitment to
service, and I am confident that you will work hard to vigorously
enforce our Nation's laws against corporate corruption and help bring
confidence back to our markets.
Thank you.
----------
PREPARED STATEMENT OF SENATOR DEBBIE STABENOW
Thank you, Mr. Chairman. Let me take a moment--since I have not yet
had the chance--to congratulate you publicly on taking over the
Chairmanship of our Committee. I am looking forward to working with you
on important legislation in the 108th Congress and I think there are a
number of important issues where we will find a great deal of common
ground.
Today, we are going to be hearing from Mr. William Donaldson, the
President's choice to replace Harvey Pitt as head of the Securities and
Exchange Commission.
I believe it is absolutely essential that we have a strong and
effective leader running the SEC.
I was the first Member of this Committee to call for Mr. Pitt to
step down from his role at the SEC. With the ever-intensifying concerns
from many about his decisions and priorities and with the profound
problems in the markets and with investor confidence, it was clear to
me that we needed new leadership.
The sooner we have a strong leader in place at the SEC, the sooner
we can assure consumers that the Sarbanes-Oxley Act will be implemented
effectively.
I look forward to hearing more from Mr. Donaldson about how he
intends to make sure the law is fully implemented as intended by
Congress. I also look forward to learning more about his plans to
restore investor confidence. I know that people remain scared of the
markets. Many people lost huge portions of their life savings over the
last 3 years and are holding back on future investments. In addition, I
do not believe that we can guarantee to the public that all of our
accounting concerns have been allayed. The work of the Public
Accounting Oversight Board, after all, is just getting underway.
Mr. Donaldson came by my office yesterday and we had a chance to
talk briefly about a number of issues of concern to me. In particular,
I indicated to him that it is extremely important to me that the
corporate whistle-blower amendment that I offered to the accounting
reform bill is effectively implemented. I want to make sure that
employees can confidentially and anonymously report concerns about
accounting wrongdoing directly to their company's audit committees. In
this way, I believe we can stop some of these corporate implosions
early on--rather than after millions of dollars invested in these
companies are lost and thousands of jobs are gone forever.
I will remain actively engaged on this issue of corporate whistle-
blowing, and I want to work with the SEC to make sure the new whistle-
blower mechanism is working well.
It is also important to me that the public understand the new law.
I have encouraged Mr. Donaldson, upon confirmation, to update the SEC's
website and to engage in a public relations campaign to make sure that
the employees of publicly-traded companies understand that they have a
means of reporting questionable accounting procedures to those that
have a responsibility to do something about it.
Mr. Donaldson and I also had the chance to talk about the
challenges the SEC has faced in remaining an independent regulator. Too
often, political influences have tried to alter sound policy decisions.
Sometime it has been Members of Congress. Sometimes it has been an
Administration. Sometimes it has been various industry groups. I want a
strong independent SEC that will work in the best interests of
investors. I have told Mr. Donaldson that, to the extent that I can
help insulate the SEC from political interference that affects sound
decisionmaking, I will be an active and supportive ally.
This is especially critical now, as the SEC gets ready for one of
the most significant budget and staffing increases in quite some time.
It is so important that the SEC get sufficient funding in the fiscal
year 2004 funding cycle and beyond.
We tend to forget about Enron and WorldCom and the other companies
since they are not in the news everyday. But the SEC, as I am sure Mr.
Donaldson would agree, cannot ignore the wrongdoing that occurred in
those various companies and its investigations must continue and those
guilty of crimes will need to be punished.
Thank you, Chairman Shelby. I appreciate the chance to share some
of my thoughts today and I look forward to learning more about Mr.
Donaldson, his vision for the SEC, and how he will help restore
investor confidence in America's markets.
------------
PREPARED STATEMENT OF SENATOR WAYNE ALLARD
Mr. Chairman, I would like to thank you for holding this hearing to
consider the nomination of Bill Donaldson to head the SEC. I especially
appreciate that you scheduled it so promptly after the Committee
received his paperwork. This is a critical position in our Government,
and I look forward to working with you and the rest of the Committee to
get Mr. Donaldson confirmed.
As we all know, the SEC has been the subject of many headlines over
the last year. With the revelations of corporate scandals and passage
of Sarbanes-Oxley, the agency has received a mandate for change. As the
nominee to lead the SEC through this transition, Bill Donaldson has a
daunting challenge before him.
Mr. Donaldson, as I do for all nominees before this Committee I
would like to take this opportunity to bring to your attention the
Government Performance and Results Act. The Results Act requires
Government agencies to focus on results and outcomes rather than
processes. I would urge you to carefully study the Results Act and
apply it to your decisionmaking at the SEC.
Finally, I would also urge you to communicate regularly with
Congress and keep us informed of your work. We all have a common goal
of wanting to provide effective and efficient service for American
taxpayers and investors, and good communication will help us both.
Again, Mr. Chairman, thank you for convening this hearing. I look
forward to hearing from Mr. Donaldson.
----------
PREPARED STATEMENT OF SENATOR RICK SANTORUM
Mr. Chairman, as you may know, the Finance Committee, of which I am
a new Member, is marking up a key legislative priority for the
Administration at the same time as this confirmation hearing for Mr.
Donaldson. In addition, I am the lead Republican sponsor of the
legislation, the Charity Aid, Recovery, and Empowerment (CARE) Act. I
regret that I will have to leave shortly.
Mr. Donaldson, you are being considered to take leadership
responsibility at a challenging time for the Securities and Exchange
Commission, investors and Wall Street. The drop of the stock market and
various financial scandals, some of which involve criminal wrongdoing,
have taken their toll on the U.S. financial sector, investor
confidence, and the economy at-large. In response to the scandals,
Congress last year passed the Sarbanes-Oxley Act, the most sweeping
securities legislation in a generation.
Yet at the same time, it is important to remember that the U.S.
financial markets are the most fair and efficient in the world and play
a key role in the economic strength of our Nation and the standard of
living Americans enjoy. The preeminence of U.S. financial markets,
however, is not automatic and there are competitors around the world
who would eagerly replace the position of the United States in world
financial markets.
Innovation, competition, and the trustworthiness of our processes
and our people have produced all the positive characteristics found in
our financial markets today. Yet events of recent years prove that
there are still standards to tighten, and unfortunately, crooks to
punish. The Commission must therefore regulate with the
utmost care while balancing competing needs to provide for necessary
safeguards, particularly for average investors, as well as maintaining
our competitiveness. If done well, the safeguards of a sensibly
regulated national market system can be an asset to U.S. financial
markets that will allow Americans to continue to benefit from favorable
capital inflows from around the world to U.S. markets.
Your experience in various roles in the financial world will bring
an important perspective as you lead the Commission in the coming years
in evaluating complicated issues and making significant decisions for
which there will be no absence of critics or scrutiny. I look forward
to working with you as this Committee continues its work to ensure that
the SEC has the necessary resources and legislative authority from
Congress to perform its mission with excellence and to reinvigorate
confidence on the part of all investors in U.S. financial markets.
----------
PREPARED STATEMENT OF SENATOR JIM BUNNING
Mr. Chairman, I would like to thank you for holding this very
important hearing and congratulate you on becoming the newest Chairman
of the Senate Committee on Banking, Housing, and Urban Affairs. I look
forward to working with you in your new capacity.
This is obviously a very important nomination. Mr. Donaldson has a
long and impressive resume. He has extensive experience both on Wall
Street and in academia. He is going to need it. Everyone knows the
Securities Exchange Commission (SEC) faces extensive challenges as we
recover from the corporate scandals that have plagued our country. Mr.
Donaldson has a very tough job in front of him. I hope he is up to it.
We do not have to recap what has happened to our markets over the
past few years. It has not just affected the rich, but almost everyone
from seniors on a fixed pension, to union members, to ordinary workers
with 401(k)'s, to employee stockholders, to Wall Street investors to
Government employees. We have seen over the past few years how many
people the capital markets really affect.
Last year's Sarbanes-Oxley bill, which I proudly supported, was a
big step in restoring trust in the markets. But as hard as it was to
pass that bill, and let me reiterate my admiration for everyone on this
Committee who worked so hard on that bill, the implementation of
Sarbanes-Oxley may be even tougher. And believe me, this Committee will
be watching the implementation of Sarbanes-Oxley very closely.
However, as everyone here knows, there are many other issues facing
the SEC. The former Chairman started hearings on market structure.
There are applications before the SEC that have been there for over 2
years, and there are countless other proposals that the SEC needs to
study. I am not taking a side in any of the business before the SEC, I
am just pointing out that many of the noncorporate responsibility
issues have been put on the back burner. That is not a criticism of the
SEC. The SEC has limited resources, we are trying to correct that, and
corporate responsibility had to be its first priority. But it is time
to start looking at the other issues before the Commission.
Once again, Mr. Chairman, I thank you for holding this hearing and
congratulate you on your ascension to the Chairmanship.
PREPARED STATEMENT OF WILLIAM H. DONALDSON
Member-Designate of the U.S. Securities and Exchange Commission
February 5, 2003
Chairman Shelby, Ranking Member Sarbanes, and Members of the
Committee, it is my distinct honor to come before you today as
President Bush's nominee to be Chairman of the Securities and Exchange
Commission, and I thank you for this opportunity. I want to especially
thank Senators Schumer and Clinton for their warm introductions.
The U.S. capital markets have long been the most intelligently
regulated, efficiently functioning, and widely admired markets in the
world. Because of this strength, America's financial system has become
synonymous with an entrepreneurial spirit and free flow of capital that
is unparalleled throughout the world.
Over the past year and a half, our Nation and its financial systems
have been faced with extraordinary new challenges. The evil of global
terrorism attacked a great symbol of our financial strength. Soon
thereafter, we witnessed revelations of corporate and financial
corruption that accompanied the market's retreat from the boom of the
nineties.
Many Americans' individual savings, accrued over a lifetime, were
devastated. This loss was more than simply monetary--it was the loss of
their hopes, their dreams, their futures, and their security. The
reports of fraud and manipulation only fanned the flames of their
distrust and outrage with corporate America and Wall Street. Their loss
was profound, and, in many cases, the violation of trust was great.
Such circumstances required a response just as serious.
The groundbreaking Sarbanes-Oxley legislation, passed by Congress
and signed by President Bush responded with the most sweeping reforms
of American business since the New Deal. But just as the war on
terrorism cannot be won overnight, neither can investor confidence be
completely restored so quickly. Corporate America, Wall Street, and
their professional stewards--lawyers, accountants, corporate and
financial managers, and financial regulators--still have much work to
do.
If confirmed, I will vigorously enforce Sarbanes-Oxley and the
rules and regulations already put forth by the SEC. I will demand
accountability from all responsible parties. I will aggressively
enforce civil penalties and work cooperatively with State and Federal
law enforcement agencies and the President's Corporate Fraud Task Force
to bring those who break the law to justice.
While Sarbanes-Oxley has laid the foundation for best practices,
legislation and vigorous regulation can accomplish only so much. There
must be a conscious decision to make honesty, integrity, and regard for
the good of shareholders the motivation for all business decisions. If
confirmed, I will call on corporate America and Wall Street to restore
these principles to their proper place.
The SEC has been through a trying time as well. The SEC staff is
superb, with knowledge and commitment that are unsurpassed. The recent
scandals have depleted their morale and taxed their resources like
never before. If confirmed I will work closely with the agency staff to
enhance their sense of dedication and pride and restore the stature of
the agency.
I have great respect for the critical role of the Congress and of
this Committee in particular. I hope to work closely with each of you.
If you choose to affirm my nomination, I pledge to take on the task
ahead with every ounce of experience, judgment, and energy that I have.
Thank you. I would be glad to take any questions.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM WILLIAM
H. DONALDSON
Q.1. As you know, there are a great deal of market issues
facing the SEC. The former Chairman started hearings on market
structure. There are applications before the SEC that have been
there for over 2 years, and there are countless other proposals
that the SEC needs to study. I am not taking a side in any of
the business before the SEC, I am just pointing out that many
of the noncorporate responsibility issues have been put on the
back burner. That is not a criticism of the SEC. The SEC has
limited resources, we are trying to correct that, and corporate
responsibility had to be its first priority. Will you, if
confirmed by the Senate, start to take a look at these issues
that have not been a priority lately?
A.1. Over the past several years, as you recognize, advances in
technology and globalization have given rise to many new
challenges for our securities markets. I understand that the
SEC has begun the process of addressing a number of critical
issues affecting market structure and the regulation and
control of exchanges. I believe it is important to continue to
move expeditiously to address these issues, with a view to
assuring competitive and vibrant markets that meet the needs of
U.S. investors.
Q.2. Earlier this week, the SEC, Treasury, and OFHEO put out a
report calling for more disclosure of Mortgage Backed
Securities by Government Sponsored Enterprises (GSE's). As you
may know, the Tennessee Valley Authority (TVA) has over $20
billion in publicly-traded debt and does not disclose with the
SEC. Do you think that they should?
A.2. In my view, it is important to provide investors, wherever
possible and appropriate, with disclosure that meets the high
standards that they have rightly come to expect in our
securities markets. I understand that there is the potential
for tension between TVA's exempt status under Federal
securities laws and the need for disclosure to investors that
serves investors' interests. While TVA is an agency and
authority of the United States, its debt is not backed by the
full faith and credit of the United States. It is my
understanding that the Commission staff has had preliminary
discussions with TVA regarding potential means of meeting
Commission disclosure standards, such as voluntary compliance
or registration under the Exchange Act, and that TVA has
expressed interest in enhanced disclosure. I expect to work
with the staff in this area and to support efforts that achieve
improved disclosure.
Q.3. Do you believe the Chairman of the Federal Reserve should
get involved in trying to affect the capital markets when the
Fed Chairman believes the markets are inflated or depressed? Or
do you believe the markets should be left to sort themselves
out?
A.3. The Federal Reserve has a clear mission: To conduct
monetary policy and regulate certain banks and affiliated
institutions. The Federal Reserve is an independent agency, and
I believe that the Federal Reserve Board, under the leadership
of its Chairman, should make his own judgments about how the
Federal Reserve fulfills its mission. Generally, though, I
believe that our markets are strong and resilient, and market
forces should determine market levels.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR HAGEL FROM WILLIAM H.
DONALDSON
Q.1. Do you see a problem with current disclosure rules for the
Federal Home Loan Banks? I have heard from my small community
banks back home that they are worried the proposed structure,
where the FHLBanks must register their stock with the SEC,
could potentially harm or slow-down the availability of funds
to member banks. Do you think FHLBanks need to be regulated by
both the Federal Housing Finance Board (FHFB), as they are
currently, and the SEC?
A.1. My understanding is that the Federal Home Loan Banks, like
other Government Sponsored Enterprises, publicly offer debt
securities that are not backed by the full faith and credit of
the United States. I support what I believe is the Commission's
view and the view of the Administration that Government
Sponsored Enterprises should be role models for disclosure. As
such, I believe that they should comply with the ``gold
standard'' of disclosure--the disclosure requirements of the
Federal securities laws. Until further study, I am not prepared
to determine the exact manner in which that compliance should
be achieved.
Q.2. As you know, there are a number of market structure issues
facing the SEC, and the Commission has indicated it intends to
take action on some of these critical issues this year. What do
you see as the key market structure issues?
A.2. The U.S. markets have long been the most efficient, well-
regulated, transparent, and accessible markets in the world.
Our Nation's securities markets have uniquely encouraged
investment by a broad range of public investors. I consider it
essential to maintain the preeminent position of our markets
and to assure that all categories of U.S. investors continue to
have confidence in their
efficiency and integrity.
Over the past several years, as you know, advances in
technology and globalization have given rise to many new
challenges for our securities markets. I understand that the
Commission has begun the process of addressing a number of
critical issues affecting market structure and the regulation
and control of exchanges. These issues include important
questions about the basic obligations of regulated exchanges,
access to information and trading opportunities, market
linkages, the quality of investor trade execution, and
incentives for innovation and competition. I believe it is
important to continue to move expeditiously to address these
issues, with a view to assuring competitive and vibrant markets
that meet the needs of U.S. investors.
Q.3. What are your thoughts on Nasdaq's pending application to
become a national securities exchange and the length of time it
has taken the SEC to consider it?
A.3. Under our system of self-regulation, exchanges play a
very, very important role. They ensure that their members
comply with securities laws. They also help maintain markets
that instill investor confidence and protection, while being
free from fraud and manipulation. At the same time, it is
important that the SEC's review of exchange applications not
impede the entrance of additional competitors to our
marketplace. Applications that are consistent with the statute
and do not jeopardize the integrity of our securities market
should be approved. I understand that substantial progress has
been made to address the complicated, but more technical,
issues related to Nasdaq's application. I am committed to
working with the Nasdaq to resolve the significant outstanding
issues that remain.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR ENZI
FROM WILLIAM H. DONALDSON
Q.1. Some companies seem to be using bankruptcy protections to
eliminate their debt and return to the marketplace. I am not
sure that I support companies who engage in fraud on a wide
scale and mislead their shareholders and then are able to
reemerge as competitors to companies that have been legitimate.
What I see happening in these cases is that a company's stock
essentially goes to zero when they declare bankruptcy. Then the
company brings in new executives with large compensation
packages. The company then reemerges from bankruptcy in much
better financial condition than their competitors who did not
engage in fraud. Do you believe that this method of utilizing
the bankruptcy code has occurred and do you believe it should
be allowed to continue in future cases of widespread fraud?
A.1. The bankruptcy laws, as you mention, can be used to permit
failing companies to restructure their debts and return to the
marketplace in a financially stronger position. In cases where
large public companies file for bankruptcy under a cloud of
fraud, as has occurred several times in the past few years,
shareholders and competitors often have concerns regarding the
appropriate use of the bankruptcy process.
It is essential, in my view, that those who commit fraud be
punished for their actions. It is also necessary, in cases
where a company's viability has been put at risk through
fraudulent conduct, to consider whether a bankruptcy filing is
the most effective way of preventing further harm to public
investors and creditors, as well as to preserve jobs that are
lost when businesses liquidate. In addition, Chapter 11
provides a mechanism to replace old management who operated the
company when the misconduct occurred with new management that
can more effectively and appropriately maximize value for those
who did not participate in the wrongdoing.
Q.2. Payment for order flow seems to have reemerged as an issue
affecting certain options exchanges recently. In December 2000,
the SEC released a study on internalization and payment for
order flow in the options industry and was very critical of the
practice. Can you tell me what your opinion is of paying for
orders even through broker-dealers are already supposed to send
order flow to the market with the best execution?
A.2. Payment for order flow and other forms of internalization
can discourage competition. These arrangements also can pose a
conflict of interest for broker-dealers because of the tension
between the firms' interest in generating profits from routing
orders and its fiduciary duty to customers to seek best
execution. Some brokers also ``internalize'' retail option
orders by trading as counterparties to their customer orders.
Like payment for order flow, internalization can discourage
markets from competing on the basis of price and pose a
conflict of interest for broker-dealers.
I understand that on January 24, 2003, Chairman Pitt wrote
to each of the five options exchanges to express his belief
that all exchange-sponsored payment for order flow programs
should be eliminated. I agree that these programs may
discourage competition for orders among market makers and may
encourage firms to consider their own economic interests over
those of their customers. I recognize, however, that these
issues are complicated and the Commission has struggled with
them for many years. If confirmed, I will give them my close
attention to ensure customers receive the best execution
possible.
Q.3. Chairman Pitt has been very outspoken about his
frustration with the State bar associations not fully
disciplining attorneys the Commission refers to them. I, too,
believe that attorneys have escaped much of the blame, which I
believe they deserve in some of these corporate frauds. Do you
believe that the Commission has the needed authority to
discipline attorneys who assist in corporate fraud?
A.3. Attorneys and other professionals play a critical role in
our capital markets--and I consider it important to hold them
fully accountable for their actions. I understand that the
Commission has extensive authority to sanction attorneys when
they participate in, or assist others in carrying out,
fraudulent or similar illegal activities under the securities
laws. In addition, Congress recently clarified and expanded the
Commission's authority to discipline attorneys in the Sarbanes-
Oxley Act. I believe that the Commission should enforce that
new authority vigorously. If the Commission's newly expanded
authority does not prove adequate to establish an appropriate
level of attorney accountability, I would actively consider
whether additional authority is needed.
Q.4. I understand that a number of exchange rule changes are
pending before the SEC that would permit implementation of a
pilot program for portfolio margining in the account of a
customer with an account equity of at least $5 million for
positions in broad-based index options, and futures. This pilot
program, which was developed nearly 4 years ago, is an
important first step in introducing state of the art, risk-
sensitive portfolio margining for securities customers. What
steps need to be taken by the SEC or others before the
portfolio margining pilot can be implemented? What is the SEC
doing to ensure that these steps are completed in the near
future so that the portfolio margining pilot can finally be
implemented? When does the SEC expect that the portfolio
margining pilot will be implemented?
A.4. I understand that the Commission staff is working to
resolve issues relating to the portfolio margin proposals as
submitted to it by the New York Stock Exchange and the Chicago
Board Options Exchange. If confirmed, I will work with the
staff in coordination with the exchanges, the market
participants, and other financial regulators to resolve this
and any other issues that may arise in connection with the
portfolio margining pilot program.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM WILLIAM H.
DONALDSON
Q.1. Do you believe that off-exchange derivatives are important
tools which contribute to the economy? Is regulation of over-
the-counter (OTC) derivatives adequate?
A.1. I share the views of Chairman Greenspan that derivatives
have come to play a very important role in our financial system
and economy. Companies have successfully employed derivatives
as an important part of their risk capital allocations. If
confirmed, I look forward to reviewing the existing regulatory
framework involving derivatives and discussing the views of the
CFTC, the FERC, and the Treasury Department on this important
issue.
Q.2. Do you support additional disclosure requirements for the
Government Sponsored Enterprises?
Q.3. In light of the existing exemption for FHLBanks'
securities from SEC registration, do you believe the FHLBanks
should register their capital stock with the Commission under
the Securities Exchange Act of 1934 (1934 Act)?
Q.4. Along the same lines, do you believe the FHLBank System
should register its debt to conform to the requirements of the
Securities Act of 1933 (1933 Act)?
Q.5. What is the benefit of additional regulatory oversight by
the SEC over the Federal Home Loan Bank System?
Q.6. I have heard from community banks back in Idaho that they
are worried that registration of FHLBank's capital stock could
potentially harm or slow-down the availability of funds from
the Bank System. As Chairman of the SEC how can you assure me
this will not be a problem?
A.2 - 6. In my view, it is important to provide investors,
wherever possible and appropriate, with disclosure that meets
the standards that they have rightly come to expect in our
securities markets. My understanding is that the Federal Home
Loan Banks, like other Government Sponsored Enterprises,
publicly offer securities that are not backed by the full faith
and credit of the United States. I support what I believe is
the view of the Commission, and of the Administration that
Government Sponsored Enterprises should be the role models for
disclosure. As such, I believe that they should comply with the
``gold standard'' of disclosure--the disclosure requirements of
the Federal securities laws. Until further study, I am not
prepared to determine the exact manner in which that compliance
is achieved.
RESPONSE TO WRITTEN QUESTION OF SENATOR MILLER FROM WILLIAM H.
DONALDSON
Q.1. The Nasdaq Stock Market has an application to become an
exchange that has been pending before the Commission for more
than 2 years. Admittedly, the Commission has had its plate full
lately with the September 11 crisis and the implementation of
the Sarbanes-Oxley Act. I hope you will look into the status of
the Nasdaq application and the issues the application raises
when you get to the Commission and address the application in a
timely manner.
A.1. I am aware of the length of time that the Nasdaq's
exchange application has been pending before the Commission,
and, if confirmed, I will assure that sufficient resources are
committed to allow for timely consideration of the application.
There are complex issues of market structure inherent in the
Nasdaq application. I understand that the Commission and Nasdaq
have been working closely to resolve all outstanding matters
related to the Nasdaq's operation as an independent self-
regulatory organization. In this regard, it is important that
the Commission and Nasdaq continue to work together with all
deliberate speed to thoroughly consider and resolve the
complicated issues raised by the Nasdaq's exchange application.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR STABENOW FROM WILLIAM
H. DONALDSON
Q.1. Mr. Donaldson, as I mentioned in my opening remarks, I am
concerned about the on-going lack of confidence among
investors. Although the Enrons and WorldComs of the world are
not receiving daily news coverage, these two and a lot of other
companies like them need a thorough examination of what went
wrong, and people who have committed crimes must be punished.
This is essential to ensuring that the American people believe
that the Government is protecting their interests and fighting
to make sure that these sort of accounting outrages won't
happen again. Would you please confirm for the Committee that,
even though there is less public attention, you are committed
to pursuing all of the allegations of corporate malfeasance and
accounting fraud against these companies and doing everything
you can, within the jurisdiction of the SEC, to ensure that
those guilty of defrauding investors and running these
companies into the ground are brought to justice?
A.1. Combating financial fraud has been a priority for the
President's Corporate Fraud Task Force and the SEC. If
confirmed, I pledge to make strong enforcement of securities
laws among my chief priorities. I share your view that
restoring investor confidence is essential to maintaining the
vitality of our markets. Vigorous and tough enforcement actions
against corporate wrongdoers must be the cornerstone of that
effort.
Q.2. When a company engages in fraudulent activities that have
hurt its employees and shareholders, I think the Government
should not reward them with Government contracts. Recently, it
was brought to my attention that the GSA and the GAO have on-
going Government contracts with WorldCom even though the
information that WorldCom provided to get those contracts has
been questioned. Do you think, as a general rule, it is
appropriate for the Government to continue to have contracts
with companies that have been found to have engaged in
corporate malfeasance or misrepresentation of their accounts?
What do you think the SEC should do in regard to this issue and
what, if anything, should it do specifically about WorldCom?
A.2. As I testified before the Committee, I believe that
companies and individuals who engage in fraudulent activities
that harm employees or shareholders should be punished, and I
will make tough enforcement of the securities laws among my top
priorities, if confirmed. In principle, I agree that the
Government should not reward in any manner those found guilty
of corporate wrongdoing. I do not believe it would be
appropriate for me to comment on the specific circumstances of
any case pending before the SEC.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
FROM WILLIAM H. DONALDSON
Q.1. What would you do with the new Sarbanes-Oxley regulations
to go beyond what Commissioner Pitt has proposed to protect
investors and restore confidence in the capital markets and
corporate financial statements?
A.1. If confirmed, I will continue the work that has already
been done by the SEC to ensure swift and effective
implementation of the Sarbanes-Oxley Act. This landmark
legislation gives the SEC a broad new mandate for action, and I
intend to pursue these important reforms vigorously.
In areas where the Commission has taken final action to
implement new rules under Sarbanes-Oxley, I will work hard if
confirmed to ensure strong enforcement of the rules, while
monitoring their implementation over time. In other areas that
are yet to be resolved, I will work with my fellow
Commissioners to accomplish this goal expeditiously, taking
into account the extensive public input that is part of the
rulemaking process.
In general, I believe that improving protection for
investors and restoring investor confidence requires sustained
and tough action by the SEC in all areas, including rulemaking
under Sarbanes-Oxley as well also tough enforcement of the laws
and rules.
Q.2. Under the Sarbanes-Oxley Act of 2002, all insiders,
defined as officers, directors, and 10 percent shareholders,
are required to file reports with the SEC of their trades of
employer stock before the end of the second business day on
which the trade occurred or at such other time if the SEC
determines that the 2-day period is not feasible. However,
contributing to swap funds is not currently defined as trading
and is therefore exempt from disclosure rules. Thus, executives
who may be acting on insider information may contribute stocks
to these funds in order to diversify, make a profit, or avoid a
loss without having to disclose their actions to public
investors. Do you think that these kinds of transactions should
be disclosed to the SEC?
A.2. I strongly support requiring prompt public disclosure of
transactions by insiders. I have not discussed with the SEC
staff the current treatment of these transactions that you
referenced. If confirmed, however, I will explore whether
transactions of this type are covered by existing law and
whether additional regulation or guidance on the requirements
of the insider-reporting provisions is necessary.
Q.3. In light of your experience as Chairman for several
companies, do you feel that the executive compensation
disclosure rules are adequate and what improvements would you
propose?
A.3. I believe that easy-to-understand disclosure of executive
compensation is critical to improving investor confidence in
the integrity of financial statements. I understand that the
SEC has been reviewing the quality and quantity of executive
compensation disclosure, and I look forward to discussing these
issues with them. If the SEC can refine its executive
compensation disclosure to improve investors' understanding of
companies, I would consider that a positive development.
Q.4. What steps do you anticipate taking to clarify the
specific actions public companies, auditors, and others must
take to preserve and to protect data once they are informed of
a possible SEC investigation?
For example, there were significant issues related to the
destruction of evidence in recent Commission investigations. Do
you agree that clear guidelines should be put in place to
instruct companies that are the subject of an informal
investigation to ``throw the switch'' and stop the routine
deletion of electronic data and the recycling of backup tapes
to keep evidence in useable form?
In addition to putting clear guidelines in place that
articulate the document retention responsibilities of corporate
information specialists, should ``whistle-blower'' protection
be extended to information specialists and others that observe
these procedures and resist activities that could result in the
destruction of evidence?
A.4. As illustrated by the criminal conviction of Arthur
Andersen for obstruction of justice, existing laws make clear
that companies are not permitted to destroy documents or other
evidence to avoid producing it in an SEC investigation.
Continued SEC cooperation with the criminal authorities through
the President's Corporate Fraud Task Force will go a long way
toward impressing upon companies their obligation not to
improperly destroy documents.
In addition, the Commission recently adopted new rules
pursuant to the Sarbanes-Oxley Act that require auditors to
retain audit workpapers and other relevant documents for 7
years. These strong new record retention rules should provide
significant benefits to the SEC's investigative efforts.
My understanding is that the Sarbanes-Oxley Act provides
whistle-blower protections for employees of public companies
who assist in an investigation regarding any securities law
violations or violation of other Federal laws relating to fraud
against shareholders. While the whistle-blowers you refer to
may be within the scope of this protection under certain
circumstances, it is my understanding that this section of the
Sarbanes-Oxley Act is being administered by the Department of
Justice and the Department of Labor. Therefore, I would, of
course, defer to those agencies' interpretation.
RESPONSE TO WRITTEN QUESTION OF SENATOR CORZINE FROM WILLIAM H.
DONALDSON
Q.1. Mr. Donaldson, one area that I think there has been a
deficiency in regarding the SEC's diligence toward enforcing
rules requiring companies to report all material financial and
nonfinancial information is in the area of disclosure of
environmental activities, liabilities, trends, and
uncertainties. SEC Regulation S-K, Item 103, requires companies
to disclose any material environmentally-related legal actions
contemplated or initiated by a governmental agency. Item 101 of
Regulation S-K instructs that a ``description of business''
includes appropriate disclosure of the material effects of
compliance with Federal, State, and local environmental laws,
including estimated expenditures for environmental control
facilities. Also, the Management's Discussion & Analysis Rule,
Regulation
S-K, Item 303, requires disclosure of any known trends or
uncertainties that have had or could have a material impact on
business.
I have heard from several groups that environmental
liabilities are regularly under-reported under these
regulations. For example, in 1998 the U.S. Environmental
Protection Agency completed a
report that I understand indicated that 74 percent of companies
facing environmentally-related legal actions initiated by a
governmental agency seeking $100,000 or more, failed to
adequately disclose these liabilities as required under the SEC
rules that I just mentioned.
Knowing your interest in ensuring transparency in financial
reports, what steps will you take as the SEC Chairman to
measure and improve compliance in the area of environmental
disclosure requirements? Several interest groups have suggested
changes to current SEC environmental disclosure requirements.
On March 8, 2002, the Social Investment Forum wrote then-SEC
Chairman Pitt requesting that the SEC convene a roundtable to
examine recent proposals to expand financial disclosure and
auditor oversight of material environmental and social
liabilities, obligations, and impairments. Additionally, the
Rose Foundation for Communities and the Environment has
recently filed a rulemaking petition (SEC File #4- 463)
recommending changes to material disclosure requirements with
respect to financially significant environmental liabilities.
Both bring into question the adequacy of existing standards. As
Chairman will you scrutinize the adequacy of the existing
environmental disclosure requirements and involve the full
range of stakeholders in considering whether changes should be
made to those requirements?
A.1. As you know, the Federal securities laws require fair and
accurate financial disclosure of information to investors. The
fact that a company may have environmental expenses triggers
disclosure if regulatory compliance or remediation costs are
material to its overall financial results or condition.
Similarly, other types of exposure to potential expense or
exposure in connection with environmental matters trigger a
disclosure obligation where they are material. Therefore, not
all environmental expenses or exposures require disclosure.
That being said, if confirmed, I will work with the SEC's
Division of Corporation Finance to consider the full range of
views on such matters.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR DODD FROM WILLIAM H.
DONALDSON
Q.1. One of the most important characteristics of quality
accounting standard setting is that the standard-setting body
must have the ability to make independent decisions on
financial accounting and reporting matters. As you know, the
Financial Accounting Standards Board (FASB) has been
establishing ``generally accepted accounting principles'' for
nearly 30 years.
The Sarbanes-Oxley Act, to further the goals of improving
and providing greater independence in the accounting standard-
setting process, created statutory criteria for the SEC to use
to renew its recognition of the FASB. However, that recognition
has yet to occur. This may be the result of the significant
workload that the SEC is currently engaged in, as part of the
implementation of the Sarbanes-Oxley Act.
The fact that this recognition has not yet occurred may
pose very serious budgetary problems at the FASB. As you know,
Section 109 of the Sarbanes-Oxley Act establishes an
independent funding mechanism for the private sector standard-
setting body envisioned in Section 108. The absence of formal
recognition has left the FASB without the statutorily
prescribed funding.
If confirmed as Chairman, will you pay immediate attention
to the recognition of the FASB?
A.1. My understanding is that representatives of the FASB and
its trustees, the Financial Accounting Foundation (FAF), have
written to the SEC requesting that FASB be designated as the
organization in the private sector for establishing standards
of financial accounting and reporting. I further understand
that the SEC staff has been engaged in a dialogue with
representatives of the FAF and FASB concerning the designation.
If confirmed, I will make this a priority and work with my
fellow Commissioners and the SEC staff to make the designation
contemplated by the Sarbanes-Oxley Act.
Q.2. Last week, the SEC approved a final rule which required
mutual funds to make public, on their website, how they vote
proxies of the companies in which they invest. What are your
views on this recent SEC rulemaking?
A.2. While I support the Commission's decision to increase
transparency in this area, I understand that the Commission's
recent rulemaking on this issue attracted a significant amount
of interest. On the one hand, many individual investors
supported the proposed disclosure requirements on the grounds
that the rule would enable fund shareholders to monitor their
funds' involvement in the governance activities of portfolio
companies and prevent possible conflicts of interest. On the
other hand, I understand that members of the fund industry
raised concerns that these requirements would deprive funds of
the ability to vote confidentially that other investors have,
would politicize the proxy voting process, and would result in
significant costs to funds and their shareholders. I understand
that the Commission weighed these concerns and decided to adopt
the rule with certain modifications to address some of the fund
industry's concerns. If confirmed, I will ask the staff to
monitor the implementation of this rule to ensure that it is
functioning as intended.
Q.3. The Intermarket Trading System (ITS) is generally
considered to be antiquated and in need of an overhaul as soon
as practicable. Could you please share with the Committee any
thoughts that you may have on the issues facing the ITS, and
the future of market linkages?
A.3. The Intermarket Trading System is clearly an important
part of the current market structure. I understand that its
operations are being looked at as part of the Commission's
ongoing market structure review. In light of technological
advances and of other market developments, I believe it is
critical for the Commission to continue this review. If
confirmed, I will work with my fellow Commissioners and the
staff to evaluate the issue of market linkages and other
important market structure issues with the goal of making our
markets as efficient, well-regulated, transparent, and
accessible as possible.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SANTORUM FROM WILLIAM
H. DONALDSON
Q.1. One of the issues this Committee often wrestles with is
the desirability of the uniformity of national regulatory
structures for various industries and the efficiencies and
competitive advantages a single set of standards entails with
the need to respect States rights and the appropriateness of
States having the flexibility to address unique local problems.
In the case of financial market regulation, however, there is a
strong case to be made that a national market system is an
important factor in keeping U.S. financial markets globally
competitive. As you know, some States are quite active in
addressing many of the issues currently being addressed by the
SEC in conjunction with last year's Sarbanes-Oxley Act. What is
your view on the appropriate role and function of securities
regulators at the State and Federal levels?
A.1. State securities authorities play an essential role in the
regulation of the U.S. securities industry, particularly as it
relates to investor fraud. At the same time, I believe it is
critical that the SEC serve as primary regulator responsible
for upholding national standards and uniform enforcement
related to our securities markets. The States' enforcement
efforts should be complementary.
Q.2. The Biotechnology Industry Organization (BIO), whose
membership includes some Pennsylvania companies, and has
brought to my attention their concerns with the Commission's
proposed Rule 3a-8 under the Investment Company Act of 1940.
BIO is concerned that this rule, which is intended to allow
research and development companies flexibility in raising and
investing research capital, is not flexible enough in its
current form and does not create the best framework for
allowing the research-oriented companies to invest funds where
they can obtain the best return. It is my understanding that
the BIO has filed a petition detailing its concerns. What is
your evaluation of the BIO's concerns and position on the
proposed rule?
A.2. I understand that the Commission proposed this rule, which
would provide relief from the Investment Company Act to
research and development companies, in response, in part, to a
rule petition filed by the Biotechnology Industry Organization
(BIO). I understand that the comment period on the proposed
rule has closed and that the staff is analyzing the comments,
including comments submitted by the biotechnology industry. If
confirmed, I look forward to considering those comments with a
view toward a final rule that provides biotechnology firms and
other research and development companies with sufficient
flexibility without compromising the goals and the investor
protection objectives of the Investment Company Act.
RESPONSE TO WRITTEN QUESTION OF SENATOR BENNETT FROM WILLIAM H.
DONALDSON
Q.1. Mr. Donaldson there is some concern that companies that
own and operate distributed generation in small onsite
applications in multiple States may qualify as holding
companies under PUHCA. Recognizing the obvious fact that the
law was not written in 1935 to apply to such companies, which
have no market power, would you support an SEC exemption from
PUHCA for the DG companies?
A.1. My understanding is that the Act has an exemptive
provision that deals with similar types of situations. The
Commission has historically tried to respond to the changing
face of the utility industry in a way that preserves the core
purposes of the statute, which, as you note, dates to the
1930's. If confirmed, and working together with my fellow
Commissioners, I would be open to exploring the issues raised
by the development of distributed generation to determine
whether an exemption would be in the public interest.