Federal officials who monitored the D.C. Department of Employment Services marveled at Ivanhoe Donaldson's success in retrieving the agency from the administrative chaos that for years had hobbled it. Even as Donaldson was bringing the agency into the computer age, however, he was stamping Employment Services in his own likeness, promoting those who did his bidding and shoving aside those who didn't.

The result was a Jekyll-and-Hyde creation, a bureaucracy that was efficient by some measures but vulnerable to corruption and cronyism.

Under Donaldson's directorship, between the fall of 1980 and the spring of 1982, job placements increased, unemployment compensation checks were speeded to the jobless, and training programs improved. At the same time, Donaldson blocked attempts to establish safeguards over the agency's funds and elevated persons who proved willing, as he was, to flout existing financial controls.

Joyce Blalock, who as D.C. inspector general investigated improprieties in the agency, said poor management practices that continued long after Donaldson left the agency created "a climate" conducive to law-breaking. She concluded that Mayor Marion Barry should now "take a very close look at staffing" at the agency and consider "different personnel."

Donaldson, for years the top political adviser to Barry, pleaded guilty last month to obtaining illegally more than $190,000 in city funds between 1981 and 1984, mostly from Employment Services. He is to be sentenced in U.S. District Court on Jan. 27 and faces a maximum penalty of 23 years in prison and a $360,000 fine.

His inner circle at the agency, as detailed by federal prosecutors, included three officials who hold high positions there: Matthew Shannon, Donaldson's hand-picked successor as Employment Services director; James George, deputy director for finance, described by some co-workers as Donaldson's "yes man," and Lillian Manson-Neal, associate director for contracts and support services.

The three prospered professionally under Donaldson, but others who challenged the powerful official -- especially on the crucial question of financial controls -- found the climate at Employment Services not so favorable.

In early 1981, Carl Bergman resigned as Employment Services deputy director for finance after Donaldson denied him access to internal reports on contract expenditures. "Consistently, Ivanhoe made it difficult for me," Bergman said recently.

Donaldson also successfully resisted efforts by Alphonse G. Hill, who at the time was D.C. controller, to allow the tracking of expenditures from a special Employment Services discretionary fund through the city's Financial Management System. The fund became the source of many checks that Donaldson converted to his own use.

In Shannon, George and Manson-Neal, Donaldson found subordinates who would follow his lead on how to handle funds without question -- even after Donaldson left the department to become deputy mayor and later when he became a vice president with E.F. Hutton & Co. in November 1983.

According to a statement of evidence filed by prosecutors, the three repeatedly violated the agency's contracting regulations while obeying Donaldson's instructions to issue payments to associates who funneled the money back to him.

George either personally authorized or gave instructions on how to handle seven checks totaling $42,000 issued to Donaldson's friends and associates, despite the lack of any written justification for the expenditures, according to the prosecutors' statement. When his subordinates voiced concerns, George told them to list the payments as expenses of the agency, the statement said.

Shannon was involved in unjustified payments to two contractors who served as middlemen for Donaldson. He personally pushed through a $20,000 addition to a contract at the request of then-deputy mayor Donaldson -- even though the contract had been set for a fixed price and there was no evidence that additional work had been done, according to the statement.

According to George and another agency employe who was not identified by prosecutors, Shannon also gave detailed orders on awarding a $65,000 sham contract to Cornbread Givens of the Poor People's Development Foundation Inc. at the behest of Donaldson. Shannon denied the allegations in conversations with prosecutors.

Manson-Neal, now the agency's contracting officer, put the contract in motion and handled the payments, including a $32,500 advance that violated agency procedures. She set up the contract, purportedly for a survey of the chronically unemployed, without ever discussing Givens' qualifications and despite the fact that most of the information the survey would have provided "already existed in DOES computer files and records," the prosecutors said. The survey was never finished.

George and Manson-Neal declined to be interviewed for this story. Shannon would not comment on his role in the Donaldson case but said in an interview Friday that the documented improprieties in the agency demonstrate that "an administrator can never be so focused on their program performance that they don't keep their minds forever vigilant on all aspects of the public trust."

None of Donaldson's three former associates has been charged in the case.

The paradox of the department, which has an annual budget of $71 million, is that even as funds were being siphoned off, Donaldson and Shannon were whipping programs into shape. Employment Services, a major trouble spot during the early years of the Barry administration, took "a quantum leap" forward under Donaldson and has continued to make "steady progress" under Shannon, according to William Haltigan, a regional administrator with the U.S. Department of Labor.

The agency's summer youth program, which was a model for "everything bad you could say about a summer youth program," is now "really quite good," Haltigan said. Job placement services have also improved, with a total of 27,128 unemployed individuals getting jobs through the agency in 1985 -- about 8,000 more than in 1981. And the agency, once among the slowest in the country to process unemployment compensation claims, now surpasses the federal standard, according to Labor Department records.

The management changes that upgraded the agency included computerization of department records and, during Donaldson's tenure, extraordinarily close supervision of high-level Employment Services staff. As former inspector general Blalock noted, however, there was a dark side to Donaldson's relationships with his key lieutenants.

Donaldson, who at one time was widely considered to be the second most powerful man in District government, was able to rely on his trusted aides to override government safeguards after years of nurturing their allegiance.

His ties to Manson-Neal were partly personal. She is a close friend of Donaldson's wife Winifred, who, according to two sources, served as matron of honor at Manson-Neal's wedding.

Shannon, though he resists the label of a Donaldson protege, has been essentially a deputy of Donaldson for most of his tenure in the District government.

After serving as Barry's Ward 5 campaign coordinator in 1978, Shannon was appointed special assistant to the mayor for labor and religious affairs, under Donaldson, the mayor's general assistant. Shannon moved on to be acting Employment Services director in February 1979, but he returned to his post as special assistant within six months after running into problems with the summer youth program.

Shannon went back to Employment Services in October 1980 as a deputy director under Donaldson and became director in the spring of 1982 on Donaldson's recommendation.

The title of agency head in no way loosened Shannon's ties to his patron. Though Shannon was technically in charge, Donaldson, then deputy mayor for economic development, "was a strong figure in running the department," said Blalock. "I think it was very clear that he didn't really leave managing the department to Shannon."

Herbert O. Reid Sr., legal counsel to the mayor, put it more bluntly: "The only reason Shannon is still alive is because Ivanhoe didn't tell him to jump out the window."

As acting director of Employment Services in 1979, Shannon shocked agency employes by giving oral authorization to Mary Treadwell, former wife of Barry and founder of Youth Pride Inc., to continue a job training program after her contract ran out.

Bud Clatanoff, former assistant deputy director for finance under Shannon, said that allowing her to run up a substantial bill on nothing but a spoken agreement violated "everything in the book" on contracting regulations.

"I called him up and said, 'Here's this wild claim being made that you promised Mary Treadwell this money,' and he said, 'Oh yeah, I did,' " Clatanoff said. "I nearly fell off my chair. We just couldn't believe anybody in government would do that."

Shannon said in an interview that he had "no recollection" of the contract.

In late 1980, Shannon, then a special assistant to the mayor, was embarrassed by newspaper reports that he owned a Capitol Hill flophouse where rooms were rented by the hour.

A $48,000 contract to provide T-shirts to participants in the summer youth program in 1984 put Shannon at odds with an agency contracting official again, according to a former Employment Services employe. Employment Services contract specialist John Saunders protested the fact that the agency awarded the contract to Mary Payne of Payne Associates after soliciting an informal "price quotation" from one other firm.

According to agency documents, officials justified awarding the contract without further competition by declaring that an "emergency" need existed for the T-shirts.

Shannon refused to comment on the contract, saying, "That file has been subpoenaed by the grand jury."

In the summer of 1984, Shannon was in the news again for awarding a contract to Clarence Wade, the boyfriend of his sister, despite Wade's apparent lack of qualifications for the work.

Wade and a former participant in the youth training program said Shannon accorded Wade favors on the basis of their relationship, including use of an Employment Services van as his personal vehicle.

Wade also said Shannon gave him a beige carpet from an agency storeroom, and a former program participant confirmed that he helped Wade load the carpet. In return, Wade said, he put up lights, installed a new water pump and did other odd jobs at Shannon's beach house, working largely on government time.

Shannon said Friday that Wade's allegations were fully investigated and discounted by federal prosecutors and by Blalock after Wade and two midlevel department employes were discovered to be misusing agency funds.

"All this was considered," he said. "No further comment is necessary or appropriate."

Blalock, however, said she never followed up on Wade's allegations because she was focusing on gathering evidence on Donaldson and because she believed other continuing investigations would cover them.

George enjoyed a relationship with Donaldson that rivaled Shannon's. According to Blalock, it was Donaldson's sponsorship that accounted for George's swift climb in the District government from a $27,453-a-year program analyst in 1979 to a $61,879-a-year job in 1983 as Employment Services deputy director.

"The reason Jim George rose so fast was that George was doing what Ivanhoe wanted done," Blalock said. "Ivanhoe was pushing George's career."

To some former Employment Services employes, it appeared that Donaldson played his proteges off one another. One ex-employe recalled that George was able to reverse decisions of Shannon's by appealing directly to Donaldson. The relationship was such that George felt free to issue a $26,000 check on Donaldson's instructions without checking with Shannon, even though Donaldson was not a government official at the time, according to the prosecutors' statement.

*"That is how he [George] was so powerful," one ex-employe said. "Because he had the backing of Ivanhoe, he knew he could do what he wanted to do. Shannon knew it too."

Whether the careers of Shannon, George and Manson-Neal will suffer because of their attention to Donaldson's wishes is unclear.

Barry has declined to say whether he will take action against any of the officials implicated in the Donaldson case other than to say that he has a "plan."

Many D.C. City Council members have been reluctant to press the question. "I can't imagine your boss telling you to do something and you don't do it," said council member Nadine P. Winter (D-Ward 6). "I have a problem with this constant witch-hunting . . . . I understand that [Shannon] is running the department very well."

However, council member Charlene Drew Jarvis (D-Ward 4), chairman of a committee that oversees Employment Services, said she has asked the mayor about the roles of Donaldson's subordinates and expects to receive a report from him.

And D.C. Auditor Otis H. Troupe said he is planning "an intensive review" of Employment Services. One of his biggest concerns, he said, is "the quality of decision-making that would allow these occurrences.