Many had expected Donaldson to be a caretaker who would do little more than restore the SEC's credibility and morale after the tumultuous reign of Harvey L. Pitt. Instead, he proved to be a strong reformer, turning up the heat on corporate and financial wrongdoers.
GOING "BACK TO SLEEP"? Donaldson's innovative strokes restored confidence in the markets and forced Corporate America and Wall Street to watch their step in keeping the books and managing conflicts of interest. And while his activism angered business and its GOP allies, he did George W. Bush an enormous favor: Corporate crime, the front-page news of 2003, barely featured in the 2004 campaign.
But Donaldson, 74, may have done his job too well. His departure comes amid a rising tide of resentment over what many executives view as regulatory overdrive and heavy-handed enforcement. Republicans are incensed that Donaldson has sided with the two Democratic commissioners on high-profile issues, including mutual-fund governance and hedge-fund regulation.
Investor advocates worry that Donaldson's successor could pull the plug on reforms still in the works and undo some controversial rules already in place. "The agency could just go back to sleep or actually roll back some hard-fought reforms," frets Barbara Roper, director of investor protection at the Consumer Federation of America.
EXTRAORDINARY OPENING. For months, Donaldson had made it plain that he wouldn't stay through Bush's second term. But in recent weeks, he has told confidants of growing pressure from his family to return to New York, where his wife and 15-year-old son have remained. With most of his agenda complete, and mounting business opposition to the rest of his to-do list, he had no compelling reasons to stick around.
"He has done a really excellent job at reestablishing confidence in the markets, so in a way his job was done," says Stephen A. Schwarzman, chairman and CEO of The Blackstone Group.
The new SEC chief will have an extraordinary opening to force changes at the five-member commission. Democratic Commissioner Harvey J. Goldschmid, an intellectual heavyweight and Donaldson's chief ally, plans to leave this summer to return to teaching at Columbia University Law School. But the two commissioners who have opposed the chairman again and again on key issues -- Republicans Paul S. Atkins and Cynthia A. Glassman -- are staying on.
COURT CHALLENGES. Senate Minority Leader Harry Reid (D-Nev.) has recommended that Annette L. Nazareth, the SEC's director of market regulation, replace Goldschmid. Her nomination has run into stiff opposition from execs, who would rather see a more business-friendly outsider. Oddly enough, Donaldson's departure may boost Nazareth's chances: If Corporate America gets a friendlier Republican in charge of the SEC, the Democratic commissioners won't matter as much.
A new chief could get to handpick key senior staffers, too. Donaldson has yet to name a new head of investment management, the division that oversees mutual and hedge funds. With business and Wall Street chafing at reform, a new chairman also could quietly derail some Donaldson initiatives that business finds particularly onerous. Those that require mutual funds to have independent chairmen and that force hedge-fund managers to register with the SEC have yet to take effect. The new chief could simply delay implementation.
The courts may take the issue out of the SEC's hands. A U.S. appeals court judge is expected to rule soon on the U.S. Chamber of Commerce's lawsuit to overturn the agency's requirement that mutual-fund boards be headed by outside chairmen.
In another court, Phillip Goldstein, president of hedge fund Opportunity Partners, has challenged the SEC's legal authority to regulate hedge funds. The SEC's legal staff is staunchly defending both cases -- and isn't likely to back down. But if the courts overturn either rule, a new SEC head might not push vigorous regulation.
OUTLASTING DONALDSON. Other initiatives are still vulnerable to concerted business lobbying -- or simple neglect. Take the chairman's push to give shareholders an easier process to replace errant directors -- a vital concern to both individual and institutional investors seeking better corporate governance.
The Business Roundtable, representing Corporate America's top CEOs, fought Donaldson's proposals vigorously. The SEC's plan was diluted to the point that dissidents would have to persuade a majority of shareholders to withhold their votes -- and would still have to run a two-year-long gauntlet to get their own candidate onto a proxy ballot. The agency hasn't yet passed that measure, and a new chairman would probably shelve the effort rather than expend precious political capital.
Executive pay is another area where corporate chiefs have outlasted Donaldson. He came to office with high hopes of forcing more sunshine into corner suites. But business lobbyists made it clear they would fight clearer disclosure of pay and perks, and that contentious issue never rose to the top of the SEC's agenda. With no rules pending, it could sink.
LESS BACKING FOR COPS? The SEC program with the most to lose could be enforcement. When former Enforcement Director Stephen M. Cutler left the agency on May 11, Donaldson generously said that the three years after Enron Corp. would be known as the "Cutler era," thanks to the megacases and record penalties won by the SEC. But without Donaldson's staunch support, the agency's haul -- $7.7 billion in penalties and disgorgements reaped from 1,716 cases over 212 years -- would have been far smaller.
Cutler's successor, Linda Chatman Thomsen, is a tough securities cop who shepherded the Enron probes. But business's chorus of complaints about hardball SEC tactics and stiff fines is rising -- and getting increasing attention from Commissioners Atkins and Glassman.
Atkins argues that fines -- such as the $250 million penalty against Qwest Communications International for accounting fraud -- merely punish investors whose stocks have already been hammered. If Bush's pick for chairman is swayed by such arguments, Thomsen and her securities cops will have less backing to force big settlements on companies, execs, and Wall Streeters who run afoul of the law.
ANTICIPATING PROBLEMS. The changes would be subtle: "You won't see an 'open season' sign go up," says a former top SEC staffer. And the commission will insist that it's not letting up.
"The SEC can't ever afford to be seen as not a tough enforcer," says Barry P. Barbash, the SEC's former top mutual-fund regulator, now a partner at the Washington law firm Shearman & Sterling. But any easing of enforcement -- in the vigor of investigations, the selection of cases, the defenses that offenders can claim, or the penalties that the SEC extracts -- could change the post-Enron climate.
For his part, Donaldson argues that the SEC is better equipped now to keep the heat on in executive suites. He believes his most important accomplishment has been creating a "risk-management structure" at the agency "to try and anticipate the [financial] problems coming down the pike instead of being reactive."
But investors now face a potential problem that's too big for the agency to manage alone. With the simultaneous loss of the SEC's two key reformers, it's up to President Bush to decide whether to give business the freer rein it wants or keep the aggressive financial cops on the beat. By Amy Borrus and Mike McNamee in Washington
With Emily Thornton in New York