(FORTUNE Magazine) – These days William Donaldson isn't exactly Mr. Popularity in Washington, D.C. Since taking over the Securities and Exchange Commission 19 months ago, Donaldson, 73, has tried to wrest the agency's mandate as corporate watchdog back from the exceedingly activist New York State attorney general, Eliot Spitzer. To that end Donaldson has gone on a rule-writing binge, introducing dozens of proposals. But it's the contentious battle involving two of his proposals that will determine Donaldson's legacy--especially if, as rumored, he steps down early next year.

On the surface both new rules seem fairly innocuous. One would give more power over corporate boards to shareholders, while the other would force hedge funds to register with the SEC. Yet both proposals divided the commission (with Donaldson jumping party lines and siding with the Democratic commissioners); have lobbyists, Congressmen, and investors clamoring to get their views heard; and even caused Alan Greenspan to question whether the SEC was overreaching, particularly on the issue of hedge fund regulation.

The debate will come to a head this fall. Whatever the outcome, Donaldson acknowledges that few are going to be happy. "In my experience in the big, wide world, when both extremes are not completely satisfied, you've probably reached a balance," says the founder of Wall Street firm Donaldson Lufkin & Jenrette and former head of the New York Stock Exchange and Aetna.

The fact is, Donaldson may be lucky to get any kind of compromise passed. Already some observers say his proxy-access initiative may not make it. Initially proposed last October, the rule would have given shareholders increased power to nominate company director candidates. The SEC received a record 16,000 comment letters on the proposal, with adamant support for and opposition to the measure. By late August proponents of the initiative were worried. "If Donaldson loses the [proxy access] proposal, it will be the first ball that hits the ground. But from an investor perspective, it's a very important ball," says Pat McGurn of Institutional Shareholder Services. "Ultimately, this may be the issue that defines his tenure."

It may also set the tone for Donaldson's other crusade--registering hedge funds, an area even Spitzer has decided to avoid. In August, Donaldson again sided with the Democratic commissioners to put the rule up for public comment. If enacted, it would force hedge fund advisors to open their books and records for examination. Donaldson says he worries about the huge numbers of investors and money flowing into the sector. To achieve the returns necessary to earn higher fees, hedge funds could be taking on bigger risks, he warns. He's right, but as Greenspan pointed out to the Senate Banking Committee this summer, even if the SEC detects trading irregularities, by the time they are discovered, "hedge funds will have certainly moved on to other strategies." Furthermore, don't forget, this is the same agency that totally missed the scandals in the mutual fund industry, which it monitors.

Now many are wondering how long Donaldson will stick around (he brushes off speculation that he'll step down in January) and whether there will be attempts to stall any final rulemaking before the presidential elections in November. Donaldson insists that he'll push forward: "The need for action," he says, "can't stop for partisan politics." --Julie Creswell