(MONEY Magazine) – Typically, you can't call a government official a success (or failure) after only six months on the job. But there's nothing typical about William Donaldson, the new head of the Securities and Exchange Commission. Already, Chairman Donaldson has surpassed the expectations of his strongest supporters and won respect from his toughest skeptics.

Donaldson took over the SEC in February, following more than a year of unprecedented and even shocking corporate and Wall Street scandals and the resignation of his controversial predecessor, Harvey Pitt. In that short time he has overseen a $1.4 billion conflict-of-interest settlement with investment banks, appointed William McDonough to head the new Public Company Accounting Oversight Board and begun an inquiry into how brokerage firms are paid for selling mutual funds. Donaldson and I talked recently about the SEC's progress and its plans for the future.

DOBBS: Let's start with what appears to be a rising level of investor confidence in this market. Do you think that confidence is the result of improved regulation?

DONALDSON: I think that people invest in the market when they think they can make some money. So I don't think that the fact that the market is going up is solely the result of improving regulation. Having said that, I think an element of market confidence can come from people seeing a very firm policeman on the beat--knowing that people will be held accountable for their illegal behavior, sensing the general change in the attitude toward responsibilities of boards of directors. I think all those factors are beginning to have an effect.

Q. You have undertaken several initiatives, one of which is to give shareholders access to the corporate proxy and the power to nominate directors. Will that proposal go through?

A. Absolutely. This issue has come up several times through the years and nothing was done. This is a necessary companion piece, if you will, to the change in corporate governance that's come out of the Sarbanes-Oxley corporate reform legislation. There's been a proper shift of responsibility from the imperial CEO to the board. That puts new burdens and responsibilities right where they should be: with the board. Direct shareholder access to the nomination of directors is a companion piece to this shift.

Q. How would it work?

A. There would have to be indications that the board was not being responsive to shareholder concerns. For example, when a proxy suggestion receives some 40% or 50% vote and the company doesn't do anything to respond. That's an indication that the company is not listening. Or if there are increasing numbers of shareholder abstentions in voting for directors nominated by management, that increase would be a sign that things are not all well.

At that point, a shareholder or group of shareholders would be able to get together and put forward a candidate. That candidate couldn't be an employee of the proposing group and would go through the normal conflict-of-interest screening required of any director on the management-proposed slate. If those criteria are met, I think they would address many of the concerns the business community has had as to the idea of shareholders nominating directors.

EXPENSING OPTIONS

Q. The Business Roundtable has opposed requiring companies to treat the cost of stock options as an expense; you've said straightforwardly that you believe options should be expensed. How can that become a reality?

A. I believe the main objective is that we get some uniformity in the way that companies account for options. The issue is how do you do it. What kind of formula can you use? The Financial Accounting Standards Board and its chairman, Bob Hertz, who is a good man, are working very hard to come up with a formula that works, and I believe they will. It may not be perfect, but it will be no less perfect than some of the other estimates that are inherent in regular accounting, whether they be bad debts, depreciation, valuation of derivatives or other places where there is a judgment factor.

CONTROLLING CEO PAY

Q. You've approved rules requiring shareholder approval for stock-based compensation. That's a big step toward dealing with the issue of egregiously excessive executive compensation. What more do you think can and should be done?

A. The next step is that corporate America has to take a good hard look at the way it evaluates performance. This goes to the whole syndrome of earnings per share as the only measure of performance. Corporate America and compensation committees have to realize that there are other critical performance measures that matter too.

This syndrome is reinforced by the compensation consultants the boards hire. I've used the Lake Wobegon analogy to describe this process. You know, where all the children are above average. There has been an ever-increasing tendency for compensation advisers to come in and say, "Where do you want to be?" and the CEO or the board says, "We're a top-quarter company and we want top-quarter compensation." So all awards are set in the top quarter, and the next year they end up in the top quarter again.

BOARDS IN CHARGE

Q. How long do you think it will take to bring back strong independent boards with real authority over the CEO?

A. Well, I feel very strongly that in addition to being the purveyor of rules, regulations and enforcement, we have to use the bully pulpit of the SEC to commend those boards that are taking positive actions, such as more clearly defining performance measures, setting realistic goals and continuing to take legitimate, honest business risks. I want to be clear. The SEC is very serious about enforcing the rules but expects honest companies to continue to engage in honest business practices.

Q. Do you think enough has been done to increase the independence of the general counsel and the auditor?

A. Yes. It remains to be seen just how well the audit committees handle what they are supposed to do, in terms of changing the whole tenor of their meetings with auditors. They must foster an open dialogue that allows them to talk about areas in which the auditors disagreed with management. And you know that will only come from a clear recognition that the...auditor works for the audit committee, not the company management. I think the newly created Accounting Oversight Board and its chairman, Bill McDonough, will heighten the auditors' responsibility too.

Q. When will we see real results from the Accounting Oversight Board?

A. Well, I think that Bill is off to a great start. He's gained the confidence of his colleagues, and they are now moving on to the important business, which is to begin registering public company accountants and auditors. He will also have to address problems overseas, with the required registration of the international accounting firms and the pressures inherent in this.

WORKING WITH THE STATES

Q. I'd like to hear your thoughts on the relationship between the SEC and the state attorneys general, like Eliot Spitzer, who were early in dealing with the Wall Street scandals.

A. The SEC has a long history with the state regulators, and it's been a good one. They've picked up local violations that we haven't had the time or the resources to uncover. The SEC is going to continue to partner with the state regulators. We need all the help we can get in targeting people who break the law. But we can't have 50 different sets of securities laws and rules. When it comes to affecting market structure, in my view there must be a single, federal rule-making body, and that is the Securities and Exchange Commission.

Q. How pervasive is the corruption in corporate America?

A. There are clearly some real bad people out there who have done bad things, but there are also 15,000 companies out there, the great majority of which are run by honest people. Having said that, there has been a general erosion of professional standards [fueled by] an attitude that "everybody else is doing it" [and] a perceived need to meet quarterly earnings numbers. We've got to get back to an honest approach and a broad-gauged concept of what we really mean by management performance.

ON THE RIGHT PATH

It is that very commitment to honesty and common sense that has me unabashedly cheering for Chairman Donaldson as he charges ahead with his duties as Wall Street's watchdog. Give 'em hell, Mr. Chairman.

Lou Dobbs is the anchor and managing editor of CNN's Lou Dobbs Tonight.