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90–929 PDF 2004

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

(

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah

WAYNE ALLARD, Colorado

MICHAEL B. ENZI, Wyoming

CHUCK HAGEL, Nebraska

RICK SANTORUM, Pennsylvania

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

JOHN E. SUNUNU, New Hampshire

ELIZABETH DOLE, North Carolina

LINCOLN D. CHAFEE, Rhode Island

PAUL S. SARBANES, Maryland

CHRISTOPHER J. DODD, Connecticut

TIM JOHNSON, South Dakota

JACK REED, Rhode Island

CHARLES E. SCHUMER, New York

EVAN BAYH, Indiana

ZELL MILLER, Georgia

THOMAS R. CARPER, Delaware

DEBBIE STABENOW, Michigan

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)

CONTENTS

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)

(1)

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.

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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 re ́sume ́ 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.

3

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

4

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

5

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.

6

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

7

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

8

industries, and there had to be a reaction to that. We have not repealed the business cycle. When over-investment produces overcapacity, 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 21⁄2 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,

9

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

10

Accounting Standards Board would not be the accounting standardsetting 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.

11

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.

12

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.

13

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

14

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 confidencebuilding, 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.

15

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 whistleblowers 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.

16

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 geopolitical risks, Iraq, the continuing war against terrorism, there is

17

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.

18

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

19

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

20

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.

21

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

22

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?

23

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?

24

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.

25

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.

26

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.

27

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.

28

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——

29

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.

30

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.

31

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

32

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 longhaul, 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.

33

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

34

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.

35

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

36

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.

37

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.

38

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 belowmarket 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.

39

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.

40

[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.

41

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

42

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 longterm 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 confidencebuilding 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 numVerDate 11-MAY-2000 10:00 Jan 14, 2004 Jkt 000000 PO 00000 Frm 00046 Fmt 6633 Sfmt 6633 90929.TXT SBANK4 PsN: SBANK4
43

ber 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

44

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 extraterritoriality 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.

45

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.

46

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.

47

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:]

48

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

49

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 SarbanesOxley. 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

50

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,

51

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 acVerDate 11-MAY-2000 10:00 Jan 14, 2004 Jkt 000000 PO 00000 Frm 00055 Fmt 6621 Sfmt 6621 90929.TXT SBANK4 PsN: SBANK4
52

counting 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

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vestor 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 re ́sume ́. 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.

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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 publiclytraded 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

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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 maVerDate 11-MAY-2000 10:00 Jan 14, 2004 Jkt 000000 PO 00000 Frm 00089 Fmt 6602 Sfmt 6602 90929.TXT SBANK4 PsN: SBANK4
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nipulation. 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

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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 broadbased 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

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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-thecounter (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

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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 ongoing 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?

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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 SarbanesOxley 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?

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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

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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.

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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

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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.

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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.