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updated 9/20/2004 4:28:18 PM ET 2004-09-20T20:28:18

The chief U.S. financial regulator has hit back at critics of "over-regulation" and accused many U.S. bosses of failing to provide "ethical" leadership for their companies.

William Donaldson, chairman of the Securities and Exchange Commission, said that while corporate governance had improved following the wave of financial scandals, senior executives had to set an example that went beyond the letter of the law.

The lack of progress in linking boardroom pay more closely to performance showed that many were failing to give such leadership, Mr. Donaldson said in an interview with the Financial Times.

"The tone is set at the top. You must have an internal code of ethics that goes beyond the letter of the law to also encompass the spirit of the law. Does that concept exist in all companies? No.

"All you have to do is look at executive compensation to recognize that we still have a way to go."

Mr. Donaldson's comments come as Citigroup, the U.S. financial services giant, is reeling from Friday's decision by the Japanese regulator to close its private banking operation in Japan after "serious violations" of banking laws. In a strongly worded memo to senior management, Chuck Prince, Citigroup's chief executive, said "we all must recognize that the success of our company requires each of us to maintain the highest standards of ethics".

Mr. Donaldson's criticism comes amid a mounting business backlash against a series of U.S. regulatory initiatives. The U.S. Chamber of Commerce recently launched a legal action in an effort to overturn the SEC's controversial new rule requiring mutual funds to have an independent chairman. Mr. Donaldson is also facing fierce opposition to a proposal to force all hedge funds to register with the agency.

In the interview, Mr. Donaldson signaled his determination to press ahead with the plan, which he says is necessary to enable regulators to protect hedge fund investors and the rest of the financial system.

"I think we would be severely criticized if in fact we did not do the most simple thing to get basic information so that we can get our arms around the industry and understand it better."

He said there was a "gold rush" of people entering the industry, many of whom had never managed funds, and there was a concern that the industry's deteriorating performance would encourage some managers to take big risks in an attempt to justify their high fees.

Opponents of the plan include Alan Greenspan, chairman of the Federal Reserve, who argues that hedge funds have an important role providing liquidity in the financial system.

"Concern about protecting hedge fund liquidity must be balanced against a simple question. 'How much fraud are you willing to tolerate for liquidity?' I think the answer is zero."

Mr. Donaldson denied claims that the pendulum had swung too far on regulation but said: "The danger of going too far is always there."

© The Financial Times Ltd 2013. "FT" and "Financial Times" are trademarks of the Financial Times.

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