The SEC's man of the hour: just how serious is Bill Donaldson--and the Bush White House--about cracking down on Wall Street and corporate leaders?

The Washington parlor game of "Can he do it?" is in full swing, and the object this time is William H. Donaldson, the Wall Streeter who instantly became Washington's man of the hour when he took over the beleaguered Securities and Exchange Commission early this year.

Washington insiders, including current and former SEC officials, give Donaldson high marks for his moves thus far--particularly his appointment of William J. McDonough, president of the Federal Reserve Bank of New York, to head the Public Company Accounting Oversight Board.

Yet many question whether his role is meant to be aggressive, or whether the White House will be satisfied with the hand-slapping of a few prominent wrongdoers. Several recent high-profile enforcement actions including a $500 million penalty against MCI, the largest ever sought by the SEC, are viewed as good signs, but some experts worry that it is smoke, not real fire. Donaldson declined to be interviewed for this story.

Most SEC watchers now believe that the agency, which was understaffed and poorly managed through the 1980s and 1990s, is getting the resources and congressional authority it needs to begin clamping down on corporate shenanigans. The uncertainty that many inside and outside the agency have is whether the will exists--especially at the White House--to go beyond the high-profile settlements with the MCIs and major financial firms. "The real question is: Have we seen action that matches the rhetoric?" asks a former SEC official under Chairman Arthur Levitt. "No. You can have all the rhetoric you want on settlements, but that isn't going to solve the problem. Have these guys' attitudes on Wall Street changed? Not one iota."

More to the point, say SEC watchers, is whether Donaldson can forge enough consensus among the SEC commissioners to do what needs to be done. "He's taken a commission that wasn't in very good shape during the last few months of (Harvey) Pitt, terribly demoralized, and he's significantly improved morale and made real progress on the budget front," says Joel Seligman, a Washington University School of Law professor. "The question that's tougher is what will the commissioners do? You've got to build consensus with five commissioners, and how good the consensus will be as you face tougher issues is uncertain."

Much of the discussion comes squarely down to Donaldson himself and just how tough he wants to be. Even consumer advocates think the agency can no longer hide behind staffing and resource constraints. "I think the SEC at this point has significant authority and significant resources coming into play," says Barbara Roper, director of investor protection for the Consumer Federation of America. "What you have to look at is whether they have the will to regulate."

Donaldson, 71, who headed the New York Stock Exchange and was a co-founder of Donaldson, Lufkin & Jenrette, has taken over an agency whose culture has long been known as bureaucratic and sluggish. Even during the bull-market frenzy, many big cases were simply referred to the Justice Department, which sometimes acted and other times didn't.

Staffing was a major issue as SEC lawyers and accountants were routinely lured away for larger salaries by big New York and Washington firms. "The chairman of the SEC earned less than a second-year associate at (a big D.C. firm), That's crazy," says a former SEC official who now works for a big firm, often defending cases against the agency. "When you get that kind of distortion, it's crippling. You get an erosion of good leadership at the top levels. The good people bleed out of the agency."

Then came the scandals of the past few years. A weakened SEC was faced with a daily stream of headlines--Enron, Worldcom, Adelphi and others. Pitt tried, especially at the end of his regime, but most in the agency acknowledge he wasn't given enough authority by the White House and didn't have the political know-how or congressional authority to do more than slap wrists. "I don't have any doubt that Harvey had the will," said one former SEC official. "What he didn't have was good political sense."

His undoing came in the debacle of his attempted appointment of William Webster, the former CIA and FBI head who withdrew his nomination after questions were raised about his leadership of an Internet firm accused of fraud in a shareholder suit. Pitt took a hit from this, with the General Accounting Office chastising the agency for how it handled the Webster nomination. Morale inside the agency plummeted in the months surrounding this nomination.

Inspect this

Enter Donaldson, who took over the agency in February. He comes to the job with several strengths not enjoyed by his predecessors, especially Pitt. They are:

* Respect. Donaldson is a known quantity on Wall Street, but also has won over Washington insiders. Though he's low-key, hardly a fire-and-brimstone reformer type, his early speeches laid out plans or at least the rhetoric for trying to restore integrity to the markets. This has heartened many SEC watchers, even those who have been a thorn in the agency's side in the past. Robert Monks, a shareholder activist who started Institutional Shareholder Services, puts it this way: "I think Donaldson has the capacity to act independently. Donaldson is rich, he's over 70 years old; the possibility is if you appoint rich old men, you might find one with a conscience. Donaldson has the real potential to do this."

* Authority. The SEC had long labored under restrictions on its enforcement and even monitoring capabilities, especially in the accounting area. That changed significantly with the passage last summer of the Sarbanes-Oxley Act, which, among other things, essentially ends the practice of auditor self-regulation and broadened the agency's ability to set fines and monitor accounting practices. Most insiders say this legislation gives the agency most of the clout it needs to regulate, though some say it's still unclear how much authority the agency has with respect to broker-dealers.

And there are still question marks regarding inspection of the auditors. "They have the authority," says professor Seligman. "Clearly, so far at least, the Public Accounting Oversight Board is making some pretty wise decisions with inspection and oversight with the Big Four accounting firms." inspection and oversight with the Big Four accounting firms."

But he adds: "The question I cannot answer yet is the rigor of the inspection process; it's not spelled out very clearly in the Sarbanes-Oxley Act. What does inspection mean? How many inspections does someone do?"

* Staffing. The SEC has for decades been understaffed but help is on the way. Under Sarbanes-Oxley, the SEC received approval to hire 800 staffers this fiscal year. The agency, which currently has about 3,000 staffers, will grow to about 3,850 by the end of the fiscal year, says Jim McConnell, the SEC's executive director. Most insiders say this should be enough staff to get the job done, depending on how they are managed. And it's a good time to attract staff both because the SEC is in the limelight, and the private-sector job market isn't great.

One problem: streamlining the civil service process for getting accountants, examiners and economists on the job. "We're having a fairly rough time hiring accountants right now because of the procedures that are required," says McConnell.

Obvious targets alone?

But in March, the House Committee on Financial Services approved legislation that gives the agency the same speedup hiring powers that it now has for lawyers; the House and Senate are expected to approve that this summer.

Given Donaldson's strong hand, the question being batted around Washington now is: What's next? Will he go after just be the big, obvious targets, or will the SEC's crackdown spread to broker-dealers and smaller firms? Will it continue?

Many are worried that the broker-dealers, and mutual funds and others, will get off the hook. "In terms of broker-dealers, the huge question right now is what you do with respect to research analysis," says professor Seligman. "I don't know where they are going with this."

Others, especially consumer advocates, are worried that the Investment Company Institute, which lobbies on behalf of the fund industry, will be effective in protecting its members which are regulated fully by the SEC.

Another question is how the SEC will proceed with the huge backlog of examinations and enforcement actions. "It will take them five years just to get through the backlog of corporate fraud cases," says Dick Phillips, a former SEC assistant general counsel and a securities lawyer with Kirkpatrick & Lockhart in California. "I just argued a case that had been brought six years ago."

Several important chances for Donaldson and the SEC to answer these questions beckon in coming months. One of the most key is on proxy voting. The SEC staff must report, by July, on the barriers to putting shareholder issues before management and nominating directors from the shareholder advocate ranks. Donaldson has said he backs the review, but lobbying is fast and furious against any real changes.

By mid-June, Donaldson was also expected to report on several broker-dealer issues: how to reform fees, how to choose fund directors' and any changes on how fund managers should be paid.

And the real issue remains as to whether the Bush Administration, which initially fought the reforms that were passed under Sarbanes-Oxley but succumbed after last spring's WorldCom scandal, wants Donaldson to pursue an activist agenda for very long. "Donaldson himself may have the will," says one former SEC official, "but the thing people forget is that political appointees are appointed to carry out the will of their master. If Mr. Bush thinks that the SEC doesn't have a systemic problem, that there are some bad guys who should be locked up, none of this is going to go much further."

Agency at a Glance

The SEC has total staff of 3,041

Regional & District Offices      1,191
At Headquarters in Washington    1,850

Breakdown of Jobs

Projected staff by Sept. 30: 3,850

Attorneys      1,347
Accountants      645
Examiners        145
Economists        19
Other          1,694

Note: Table made from pie chart.

Source: Securities and Exchange Commission