Betting the Bank

The ousting of Morgan Stanley CEO Phillip Purcell.

John MackEager to seal their $10 billion merger, Morgan Stanley C.E.O. John Mack handed Dean Witter’s Philip Purcell the reins of the combined nancial behemoth in 1997. A few years later, or so the plan went, Purcell would hand them back. Instead, he tightened his grip, while the company hemorrhaged top talent, saw its stock plummet, and reeled from a series of high-prole lawsuits. VICKY WARD gets the bitter blow-by-blow of how a band of former Morgan Stanley executives known as “the Group of Eight”-with an unintended assist from Ronald Perelman-nally ousted Purcell in June, and returned Mack to the throne.

Though he didn’t know it, the beginning of the end for Morgan Stanley chairman and C.E.O. Philip Purcell, 61, came on January 12, 2005, at a memorial service at Riverside Church, on Manhattan’s Upper West Side. The service was held to celebrate the life of Richard “Dick” Fisher, the beloved former chairman of the investment-banking firm, who had died suddenly of prostate cancer at age 68. The church was crowded, since Fisher’s interests extended well beyond the realm of finance. Chairman of the boards of Rockefeller University, the Urban Institute, and Bard College, he was often described as a Renaissance man. Even that description, according to Robert “Scottie” Scott, 59, a former Morgan Stanley president, “does not do him justice.”

At the front of the church, a section was roped off for V.I.P.’s, who included New York City mayor Michael Bloomberg and philanthropist and former Chase president David Rockefeller. Purcell, who is six feet five, arrived early and sat in the front row. The other 10 members of the Morgan Stanley board were not present, however, something that many firm veterans found shocking. “It was completely inappropriate for the board not to come,” says Scott.

It was Fisher, along with Morgan Stanley’s then C.E.O., John Mack, who in 1997 had stepped aside to let Purcell run the firm, after a $10 billion merger of Morgan Stanley and the retail brokerage company Dean Witter, where Purcell had been C.E.O. Mack, now 60, was a charismatic former bond trader who had risen through Morgan Stanley’s ranks over 29 years to become Fisher’s protege and obvious successor. At the time of the merger he agreed-against Fisher’s advice-to take the number-two job of president. Meanwhile, Purcell, a former management consultant who had spent much of his career in Chicago and had far less Wall Street experience than Mack, became C.E.O. of the combined company.

Mack explained to his disappointed troops that he felt that the good of the firm ought to outweigh his personal ambition. And, in any event, according to Mack’s inner circle of colleagues, Purcell had agreed on a handshake (witnessed by Fisher) that in a few years Mack would succeed to the top spot. (Purcell now insists that there was no handshake deal. “There was, however, a succession plan,” he says, “and John knew that he was my recommended successor.”) One story that made the rounds at the time, which offended many of the Dean Witter people, had a senior executive at a rival firm telling Mack, “Don’t worry, you’ll have Purcell out within three weeks.”

But after the merger Purcell steadily tightened his grip on the firm that he, in his management-consultant idiom, preferred to call “the company.” Eventually, he forced out Fisher, Mack, many of Mack’s senior allies, and most of the board members chosen by Fisher and Mack, until only 2 of the 11-member board were seen as not connected to him-although Purcell and some of the directors would often insist this was not so. (Mack went on to run competitor Credit Suisse First Boston and in 2005 accepted the chairmanship of Pequot Capital, a $6.5 billion hedge fund. On June 30, it was announced that he will return to Morgan Stanley as chairman and C.E.O.)

During this reshuffling Morgan Stanley’s stock price plummeted from a high of $110 in 2000 to $49 by the early summer of 2005, and the company’s “white shoe” reputation had been gravely scuffed in a series of discrimination lawsuits and costly tussles with regulators. But that was not the worst of it. The rift between the Morgan Stanley side and the Dean Witter side did not close. The Morgan Stanley people believed that Purcell had transformed a meritocratic culture, described by one former top executive as “Camelot before Arthur lost his way,” into one of fear and anxiety. “You are either with me or against me,” Purcell reportedly told a departing senior executive, echoing both President Bush and Darth Vader. (Purcell says he “would never make things so personal.”) The Dean Witter people, however, thought the old Morgan Stanley culture so cutthroat that it was “more akin to Renaissance Florence than a meritocracy,” says a colleague of Purcell’s.

Current and former employees said that they feared losing stock options because of the Draconian enforcement of contracts, and also that phone calls were monitored for disloyalty. One person who left the firm says he was told that if he or even his wife spoke ill of Morgan Stanley he’d “lose everything.”

When, recently, another executive wanted to question a decision made by the board, he was too nervous to raise his hand during the presentation. “I’d have been fired,” he says. According to a former employee, Purcell let it be known he did not want feedback even from clients. In fact, in his eight years at the helm of Morgan Stanley he rarely visited clients and then only reluctantly. (Purcell says this is not true.) He would tell people that his job was to strategize (though his detractors nicknamed his management style “analysis/paralysis”).

It was in this charged climate that Morgan Stanley employees, past and present, paused in January to remember Fisher: a man who’d regularly visited clients, who was known for listening rather than talking, who’d invited argument and even considered it an intrinsic part of the culture. “Morgan Stanley was never at a loss for talkers, so maybe that’s how he became a good listener- he got lots of practice,” Robert Scott told the assembled mourners, in one of four eulogies. Significantly, Fisher’s widow, Jeanne, who once ran Morgan Stanley’s P.R. department, had not asked Purcell to speak at the service.

After the memorial, in the reception area outside the church, Scott and many other senior Morgan managers stopped to talk about Fisher’s death and what it meant. “We reflected on how much the firm had changed … that people were no longer having the experiences that we had all had and benefited from,” Scott says. “The regret most often expressed was the fact that there had been this transition from a meritocracy to an organization that seemed to be based on other things. Now, suddenly, political skill seemed more valuable than financial acumen.”

S. Parker Gilbert, a former Morgan Stanley chairman, Scott, and six other former senior employees, who among them owned 11 million Morgan Stanley shares, decided then and there it was time to speak up. “The company” seemed to them to be in chaos; the Dean Witter and Morgan Stanley businesses had never been properly integrated, and though analysts debated it, the general consensus on Wall Street was that the Dean Witter retail-brokerage and Discover credit-card businesses were hampering the old Morgan Stanley investment-banking-and-securities arm of the firm.

According to a Merrill Lynch presentation last May, the Morgan Stanley brokers were far behind Merrill’s and Citigroup’s. Another survey ranked the Dean Witter brokerage last out of a group of seven. Also looming was a lawsuit by the financier and Revlon chief Ronald Perelman. Perelman alleged that he’d been fraudulently misled on the 1998 sale of camping-equipment maker Coleman (in which he owned an 82 percent stake) to Sunbeam, which went bankrupt in 2001-costing Perelman $680 million, since part of the transaction had been in Sunbeam stock. In May a Florida jury ruled that Morgan Stanley was guilty of fraud and, pending an appeal, would have to pay at least $1.45 billion, plus, it emerged in June, $130 million in interest.

To the Group of Eight, as Scott, Gilbert, and their fellows were soon called-or “the grumpy old men”-there was a simple solution to the problems. Philip Purcell had brought them on, and Philip Purcell had to go. They believed it was the only hope of saving the firm they had worked so hard to build.

After meeting again in early March and enlisting the help of Morgan Stanley’s erstwhile investment-banking chief Robert Greenhill, the Group of Eight wrote a private letter to the board, complaining about the firm’s decline in reputation and performance. They requested the removal of Purcell as C.E.O. and the insertion on the board of three outside directors with experience in financial services, including one in institutional securities and another in the retail-securities business.

On the 39th floor at Morgan Stanley, on Broadway in Times Square, Purcell went into overdrive after he received the letter. According to a former employee, Purcell, chief administrative officer Stephen Crawford, chief legal counsel Don Kempf, and Marty Lipton, the veteran Wall Street lawyer who was retained by both the Morgan Stanley board and Purcell personally, “disappeared into a black hole for the next day.”

“That Friday we got the impression Purcell was meeting with his closest allies on the management committee-the men he’d brought over from Dean Witter in the 1997 merger,” says a source. Then, over the weekend, Purcell called the rest of the management team-those who had worked for Morgan Stanley pre-merger and whose support he was less sure of. First he called John Havens, head of the institutional-equities division and a Morgan Stanley employee since 1986, at his home on Long Island. “I have received a letter,” Purcell allegedly said. “It looks like Pandit is right in the middle of this. Would you like to be a candidate for C.E.O.?” According to a source, Havens apparently was taken aback. He supposedly replied, “Phil, I’m flattered. I can’t answer you. I would have to think about that and what’s best for the firm.” He put the phone down, bewildered, say sources. (According to someone close to Purcell, Purcell denies saying Pandit was in the middle, but sources close to Havens say he did.)

Vikram Pandit, 48, the man whom Purcell allegedly mentioned in the telephone call, had been widely considered to be Purcell’s successor at the firm only 18 months before. A Morgan Stanley veteran of 22 years, he is a mild- mannered but fiercely intelligent businessman, and a trustee of Columbia Business School. As head of institutional securities since 2001, he has generated most of the bank’s profits. Pandit had come to believe he was Purcell’s “chosen one.” But, starting in the spring of 2004, relations between the two men soured. Pandit, say sources, had proposed a strategy to integrate the firm’s businesses, with the idea they should all report to one person: him. Though Purcell told Pandit to develop the scheme, there were signs the C.E.O. was unsettled by it. Suddenly, Pandit no longer appeared to be the “chosen one.” Instead, Steve Crawford, 41, seemed to succeed to that role. (Purcell, however, says, “Vikram was certainly a candidate, but I was always careful never to tell anyone they were the successor.”)

“People assumed that, being younger, Crawford was less of a threat to Phil,” says one person. Crawford was far less popular than Pandit, but, unlike Pandit, he had had a close relationship with Purcell for years-and therefore, according to some, he was virtually alone among Morgan Stanley senior employees in having a relationship with the board. (A source claims, “Plenty of others on the management committee got the chance to meet with the board.”)

“To win respect in this business you have to be seen to have produced revenue,” says a former Morgan Stanley senior executive. Crawford, say people who worked closely with him, had never done that; he was more a strategist and number cruncher who had briefly been the C.F.O. before becoming chief administrative officer in 2004. (Purcell defends him, however: “In the last five years Steve has substantially improved Morgan Stanley’s financial capability, control environment, and risk management. He is enormously talented.”)

Tensions were further exacerbated when Scott Sipprelle, chairman and founder of Copper Arch Capital and a Morgan Stanley client responsible for millions of dollars’ worth of business, wrote a letter dated December 9, 2004, to the board, calling for the firm to undo the merger-in other words, spin off the Dean Witter and Discover Card businesses from the old Morgan Stanley. (The letter wasn’t passed on to the 14-member management committee until December 16, insiders say.) Sipprelle wrote that the “current stewards are blind to the root causes of the affliction,” and he enclosed a chart illustrating the ties that various members of the board had to one another, including overlapping country-club memberships.

A former senior executive said Purcell asked his management team to deride Sipprelle publicly. (Purcell denies doing so.) Several proceeded to point out to the financial press the flaws they saw in Sipprelle’s arguments. Zoe Cruz, 50, then head of the fixed-income unit and the most senior woman at the firm, went furthest, calling Sipprelle an “ass” in a meeting. (A source close to Purcell says she did this on her own.)

It seemed to count for little that Sipprelle (and his brother Dwight) used to work at the firm, or that Sipprelle currently owns 1.3 million shares of its stock. In the week between receiving Sipprelle’s letter and sending it out to the management committee, Morgan Stanley announced that Purcell’s old boss Ed Brennan, 71, the former chairman of Sears, had joined the board. (A source says Brennan’s appointment was unrelated to the letter and was decided weeks before, when Brennan announced he was stepping down as chairman of American Airlines.)

On January 6, 2005, Sipprelle’s letter was leaked to The Wall Street Journal.

In February, Sipprelle complained publicly again-this time over the issue of Purcell’s pay, which was $22 million. Sipprelle noted that while Morgan Stanley’s stock declined 4 percent last year, the C.E.O.’s pay increased by 57 percent.

Thus, when Purcell received the Group of Eight’s letter, on March 3, it did not come in isolation, and he started looking for treachery among his lieutenants. “We knew the Group of Eight would not have written that letter if they had not felt they’d get a result-and to get a result they had to have internal support,” a board member told V.F. Another senior executive, who left Morgan Stanley in 2001, says it was known on the Street that Pandit had begun stirring up dissent once he realized it was unlikely he would be made C.E.O. (Pandit denied this.)

That weekend Purcell called Zoe Cruz. Cruz is generally viewed as candid-so much so that she has been nicknamed “Cruz Missile.” Reportedly, she and Pandit, her direct boss, did not always get along, and, unlike Havens, Cruz told Purcell she would be willing to be considered for the job of C.E.O.

Finally, after he’d called most of the management committee, Purcell called Pandit. Sources familiar with both men say that Purcell accused him of collaborating with the Group of Eight. (According to a source close to Purcell, Purcell denies doing so.) Supposedly, Purcell promised Pandit that if he “locked arms” and fully supported him the issues in the Group of Eight’s letter could be easily resolved. Pandit allegedly said he felt that the letter had to go to the board because the trust between the two men had been broken. (A source close to Purcell says this is nonsense, as the board already had the letter.) Though Pandit said he would support Purcell, he refused to stand up in public and deride the Group of Eight’s letter.

Purcell then acted on Marty Lipton’s advice about how to proceed. Lipton, Purcell knew, is an expert on how to protect boards under attack; in 1991 he had advised the Sears board, then assailed by disgruntled shareholders, after the company had stumbled badly under Purcell’s mentor, Ed Brennan. A crisis was avoided temporarily, although Brennan ultimately had to resign in 1995. Lipton now told Purcell to set up a formal process, which he did: the board interviewed the firm’s management committee about who should succeed Purcell.

In her interview, Cruz reportedly said she would leave if Pandit were chosen as a successor. The Dean Witter people also chose not to endorse Pandit. Morgan Stanley president Stephan Newhouse, a veteran of 26 years, who was woken up in the middle of the night in China, said that he wanted what was best for the firm, and that he didn’t want to get into specifics about individuals; Pandit said the same thing. John Havens was never reached. Everyone the board spoke to believed that whatever they said would be kept confidential and would have no impact whatsoever on their careers.

That didn’t turn out to be the case.

On March 28, following a meeting with Marty Lipton, Purcell told Pandit his job had been eliminated-but he did not say he was fired, and no paperwork was exchanged. Purcell also informed him there were two new co-presidents: Cruz and Steve Crawford, both of whom would shortly be elected to the board. (Cruz, when it happened, according to several colleagues, didn’t know she’d been elected for just one year and Crawford for three.) John Havens was later summoned and told of the new co-president appointments. Given no words of encouragement to stay, he went to see a lawyer and called Purcell from his lawyer’s offices, saying, “I feel like I’ve been fired.”

“You’ve seen a lawyer. We’ll talk in the morning,” said Purcell. The next thing Havens knew, Jerker Johansson, head of European equities, was given his job.

Soon, when it was clear he’d also been replaced in his job, Stephan Newhouse followed Havens out the door.

Then came a flood of departures of high-level executives, led by head of global trading Guru Ramakrishnan, 40, who had worked closely with Pandit. Many were prepared to leave all their money on the table rather than stay on in the new regime. (Generally, Morgan Stanley policy says you are fully vested only after 20 years.) This, despite a rushed internal decision to pay retention bonuses (something at first denied by the firm, then admitted) and an announcement that seemed to many analysts like an ill-prepared last-minute flip-flop, which stated that the firm would look at spinning off the Discover Card business and set about fully integrating the securities businesses-in other words, the same strategy proposed by Pandit.

But it didn’t close the floodgates.

By the end of June more than 50 senior figures, including well-known investment banker Joe Perella, had left. Besides the key executives, hordes of brokers-whose departures were not chronicled in the press-also quit. The Group of Eight was appalled-as indeed were most on Wall Street. In protest, T. Rowe Price temporarily stopped trading with Morgan Stanley. Headhunters’ phones were ringing off the hook. Goldman Sachs, Morgan’s main competitor, offered its employees $10,000 for every Morgan Stanley person they could hire away from the firm.

The Group of Eight wrote two more letters to the board, asking for a meeting; the first complained furiously at what was happening, calling it a “crisis”: “The loss of several key executives … because they were unwilling to swear loyalty to an ineffective CEO is an outrage,” they wrote. In their next letter, in early April, the group suggested that all the dissenters be reinstated and that Robert Scott, who felt he’d been sidelined by Purcell in 2003 and subsequently left, come back to run the bank. By this point, the stakes had gotten so high that the letters were sent to the press at the same time they were sent to the board.

A source close to Purcell claims that if the Group of Eight had asked civilly for a meeting, instead of leaking their letters to the press, it would have made all the difference. But Andrew Merrill, a spokesman for the Group of Eight, retorts that their first letter was utterly private, and that the board chose not to reply, and shortly afterward the three management executives found themselves out in the cold.

In early June it was reported that the Group of Eight had retained the services of a proxy firm, meaning that they were considering the option of a proxy vote among shareholders at the next annual meeting, in February 2006. Succumbing to pressure, the board had changed certain rules in its governance: a 75 percent super-majority was no longer needed to fire the C.E.O.; rather, it was now 50 percent. The retirement age was made 72, instead of 70. Also, a universal term limit of one year for board members was instituted, thus bringing Cruz’s and Crawford’s tenures in line.

Other than this, though, the board remained mute, for which it received heavy criticism both in the media and among shareholders. A board member later explained to V.F., “We were in a no-win situation. Vikram Pandit was a very popular guy internally, so the board didn’t want to do a public character assassination and explain why they’d chosen others to be promoted above him. It would be wrong to think we were doing Purcell’s bidding. The board was pushing him hard.”

In April, the Council of Institutional Investors, a group of pension funds which owns a huge amount of Morgan Stanley shares, asked for a meeting with Purcell. It was later reported that Calpers, a giant California pension fund, also contacted the board, expressing concern. But by late May-a pre-earnings-report “quiet period”-no meeting with either had occurred. (Purcell and others say every effort was made to meet with every major institutional investor in this period.)

Then the bombshell of the Perelman case hit, with Florida state judge Elizabeth Maass ruling that Morgan Stanley was guilty of fraud and owed the Revlon chief $1.58 billion. Her rulings criticized the bank in strong language, saying it had shown “willful and gross abuse of its discovery obligations.” In early June it was clear that the company’s earnings, announced on June 22, were going to be lower than its competitors’. (They were, falling 24 percent.) According to one board member, the pressure from shareholders became overwhelming. “We could have held out until the next annual meeting,” says this person, “but that would not have been the right thing to do.”

On the evening of Wednesday, June 8, the board called an emergency meeting in Chicago. Though reports vary as to who was the first to stick his neck out and urge action, several sources say it was Laura D’Andrea Tyson, dean of the London Business School, who apparently said she had had enough. A former Clinton-administration economist who hopes to work in the White House again someday, she had always felt like a fish out of water on this mostly white, male, conservative board, colleagues say. Despite Marty Lipton’s admonitions to stick together, she allegedly said she could see lawsuits ahead if they didn’t act. Still, there was no announcement.

On Friday, June 10, a team of nine people in the equities-derivatives unit-the same team which, according to the bank’s March manifesto, was to play the key role in Morgan Stanley’s “new” strategy of integration-walked out to more lucrative pay packages at Wachovia. By the end of the weekend, Purcell had quit-but not before holding out for some control. In a meeting in Chicago, he asked the board to make a statement that neither Pandit nor his followers, nor any of the Group of Eight, nor any people they’d suggested, nor John Mack, be considered for C.E.O. The board agreed, even though to do so was unprecedented-and was to cause further unhappiness among shareholders. “What Morgan Stanley needs most is someone who knows the organization inside out and can come in and fix it,” says a former senior executive. “To rule out most of the people who could do that is totally irresponsible.”

On Monday, June 13, Purcell announced his resignation at the morning meeting. Charles “Chuck” Knight, the former chairman of Emerson Electric and the head of the new search committee on the board, immediately followed with an announcement about who would not be considered for C.E.O.

When Purcell gave his speech, he was emotional. He blamed the media and a “jihad,” consisting of personal attacks, rather than the internal discord and fallen stock price. At the end, applause occurred, but outside the organization there was no such support. One of the people who’d quit the previous Friday left a euphoric voice mail on a former colleague’s machine. “I just heard the news: the Evil Empire has fallen. I’d like to think that in some small way we were part of the straw that broke the camel’s back-or these jackasses’ back, as the case may be.”

The question that many people now ask themselves is: How could one man bring one of America’s premier financial-services franchises to its knees, single-handedly? This was echoed over and over during the reporting of this piece. (A source close to Purcell says any Dean Witter person filling the role of C.E.O. would have had difficulties with Morgan Stanley, and Purcell points out that the market capitalization of Morgan Stanley went from $22 billion to $58 billion after the merger.)

In hindsight, say many people, it’s easy to see how, but it wasn’t so easy at the time. Purcell, after all, is a strategist who thinks long-term. In his Dean Witter days he had a 10-year plan. “I don’t know if I ever met anyone who put a 10-year plan together,” one of his former colleagues reportedly remarked.

Purcell grew up in Salt Lake City, the son of an insurance executive. An avid athlete, he attended Notre Dame (where he is now on the board) and got master’s degrees at both the University of Chicago and the London School of Economics. In 1964 he married his high-school sweetheart, Anne, with whom he has seven sons, all grown. The couple moved to the Chicago suburb of Wilmette, and he rose through the ranks of McKinsey & Company, a management-consulting firm, where one of his clients was the mid-market retailer Sears.

Sears, under Edward Telling, hired Purcell to become head of planning. In 1981, Sears acquired Dean Witter, which sold stocks to a growing affluent middle class. In 1985, Purcell came up with what is generally considered to be the triumph of his career: Discover-a credit card for customers that earned them a rebate on purchases. The card had a rocky beginning, but soon became a great success. Dean Witter, Discover & Co. was spun off from Sears in 1993, with Purcell as its C.E.O. and chairman. Morgan Stanley advised on the transaction.

Thus began the relationship between the two companies. By the late 1990s the idea of the financial supermarket was coming into vogue (the Citigroup behemoth formed in 1998), and Dick Fisher and John Mack felt that if they added a retail outlet to their advisory business they’d have far greater distribution. “The advantage of merging with Dean Witter Discover was that it would mean relatively little bloodletting, since there was relatively little overlap,” says someone familiar with the talks.

Both men were so entranced with the idea that they didn’t balk at Purcell’s demands, including the installation of the Dean Witter chief legal officer, Christine Edwards, over the more qualified and more experienced Wall Street lawyer Jonathan Clark, who’d been Morgan Stanley’s chief legal officer for three years. “I’m sure Christine is good at compliance and things that are important to a retail business,” says a former senior management executive from the Morgan Stanley side, “but a global institutional-securities firm, where the legal issues are really complicated? John Clark is a lot more experienced, and he’s a great businessman.” Edwards and Purcell had a close friendship. “Her entire career she had followed him around until that point,” says a former high-ranking Dean Witter employee. Another Dean Witter person says, “They both had family in Chicago, but had apartments in New York City. They traveled back and forth together.” A former, very senior Morgan Stanley person points out, “She was the only person allowed to answer him back in meetings with him.”

But Mack took the view that the deal needed to be done, and if there were a few personnel concessions, so what? It was a price he was willing to pay-and he set the example, stepping aside for what he thought would be just three years or so. Wall Street colleagues were astonished at the sacrifice. One source says that KKR co-founder Henry Kravis called Mack to say, “I don’t know any C.E.O. who’d do what you did.”

Fisher allegedly told his protege before the merger was completed that he had misgivings, but Mack convinced him to proceed. (A Fisher family member says that he did not have doubts until after the merger.) Why didn’t Mack get the so-called handshake agreement with Purcell written down? “Mack is a former bond salesman who grew up through the ranks at Morgan Stanley,” says a former colleague of his. “He lives by a code that says your handshake is worth something. That’s how the old Morgan Stanley was.”

But it wasn’t too long before some in the Morgan Stanley camp began thinking that Purcell was not their kind of people, as they say. Soon after the merger, Purcell came to an informal meeting at the clubhouse of the Muirfield Village Golf Club, in Dublin, Ohio. Mack and Peter Karches, then the head of institutional securities and perhaps Mack’s closest friend within the organization, were having breakfast when Purcell joined them. Purcell’s clothing, according to someone who was there, stood out: a Panama hat, bright-red shirt, and ill-fitting shorts. Karches, who is renowned for being blunt, turned to Mack and said, “John, this is not going to work.”

The incident characterized the deep cultural rift that would tear apart Morgan Stanley for the next few years. “Hatfields and McCoys” and “White shoe meets white belt” were phrases bandied about to describe the incongruity between the consumer-oriented Dean Witter employees and the Morgan Stanley elite. The Dean Witter crowd regarded the Morgan Stanley employees as arrogant snobs.

Shortly after the merger, Mack became the head of the retail side of the firm-theoretically, so he could gain the requisite experience for when he took over. In retrospect many saw it as a move to sideline him, since some of Mack’s underlings-including, reportedly, Jim Higgins, head of Morgan Stanley’s private-client group-tended to go around Mack and report directly to Purcell. Higgins went so far as to complain to Purcell when Mack dropped in unannounced on the brokers in Hayward, California, to see how they were doing. Purcell told him not to do this. “They (the brokers) want to be prepared … put on a coat and tie,” a source says he told Mack.

But formality-and adherence to hierarchy-was Purcell’s style. He built a lavish executive floor, but left the office of Dick Fisher, then chairman of the executive committee of the board, on the old executive floor, which many saw as a snub (although, evidently, Fisher did not). What was wounding to Fisher, however, was when he went to see the board as they were discussing Mack’s resignation, and Purcell popped his head out the door to say the board didn’t want to see him.

Purcell did not have an open-door policy and insisted that people make appointments with him, and he rarely visited clients-or, indeed, anyone except his own lieutenants. Even though Morgan Stanley prided itself on being a “horizontal” institution-in other words a place that was swarming with talent-Purcell would choose the top 50 employees and take them to an off-site meeting each year, as he’d done at Dean Witter. “He didn’t seem to get that at Morgan Stanley a single individual could make or break a quarter; it just wasn’t like Dean Witter, where it was all about volume,” says Robert Scott.

The Dean Witter faction, however, remained steadfast in its loyalty to Purcell. A posting on the job-search Web site, dated April 2005, reads, “Purcell made a lot of people a lot of money-I was at the firm when we went public in 1993 and were allowed to buy shares at $17. It has split twice and is in the 50s. Many of those brokers have been with the firm 20+ years and Phil helped pay for those beach houses. They will lay down in traffic.”

At the time of the merger, Purcell wanted to pay himself, Mack, and senior executives incentive bonuses; Karches, an outspoken character, thought this ludicrous, even though he was a beneficiary. “We had all this stock; that should have been incentive enough,” he said. (Purcell doesn’t recall the incident.) Karches was not the kind of man to keep his opinions to himself. He felt that Purcell was out of his depth-and he was not afraid to tell him so on an ongoing basis. At one point he said to him, “Just leave… You are the most incompetent manager I’ve been around.” (Purcell, according to sources, did not feel Karches’s opinions were representative of a meritocracy, since Karches had worked for only one person, John Mack, all his career.)

Purcell, in turn, was thought to be afraid of Karches and eventually got rid of him. Mack, at the behest of Robert Scott, had asked for Jim Higgins, head of Morgan Stanley’s private-client group, to be removed. “You gotta make a change with Higgins. Make him vice-chairman. Let’s put someone else in retail,” Mack supposedly said. Purcell took a trip to Hawaii. On his return he told Mack, according to a source, that Higgins could go, but Karches had to as well-because of poor performance in technology. Mack was astonished. “Peter is one of the best managers we have. How can you tie him to Higgins?” he allegedly said.

Purcell then reportedly told a senior Morgan Stanley executive that Goldman Sachs C.E.O. Henry Paulson and then Merrill Lynch C.E.O. David Komansky felt that Karches had performed poorly in meetings with other investment banks-something that Paulson and Komansky subsequently denied ever having said. Purcell paid off Karches handsomely-$50 million over three years, according to a source. “He gave me all this extra money which I didn’t expect or deserve,” Karches says. In return, Karches was not to disparage the company for a set term. At their final meeting Karches, in his typically blunt style, said to Purcell, “Phil, you don’t have the game for this business.” Purcell is said to have replied, “Don’t tell anybody.”

As the months went by, Mack grew increasingly frustrated as the members of the board who’d been elected by the Morgan Stanley side of the merger resigned either because of age, such as Dick Fisher, or because of unforeseen circumstances, as was the case with Diana “DeDe” Brooks, the former C.E.O. of Sotheby’s, who pleaded guilty to price-fixing. Michael Miles, former C.E.O. of Philip Morris Companies and a friend and ally of Purcell’s, was the head of the board’s nominating committee, and under his leadership the new board came to be made up of those perceived to have ties to Sears or McKinsey or Chicago, the hometown of Phil Purcell. By 2001 the ratio of Dean Witter to Morgan Stanley board members stood at eight to three.

By then Mack realized he was outpositioned, and in January 2001 he resigned. By this point he’d met with Purcell several times to discuss the issue of succession, and each time Purcell had stonewalled. (A source close to Purcell says this was the third time Mack had threatened to resign and this time the board decided to accept it.) According to a source, when the board met to discuss Mack’s resignation, it set a time when Purcell knew that Laura D’Andrea Tyson, Mack’s biggest ally, would be on a plane, unavailable. (Purcell says that the board was gathered as quickly as possible because the resignation occurred suddenly, and that every effort was made to include everyone.)

After Fisher tried unsuccessfully to speak to the board about Mack, he washed his hands of the place, say people close to him. Mack’s departure was not the only thing that troubled Fisher. By this time the firm had been on the front page of the newspapers off and on for two years because of a high-profile racial-discrimination suit filed by an African-American former employee named Christian Curry. The case caused immense damage to the firm’s reputation and an even bigger problem internally.

Curry had been a 23-year-old junior analyst at Morgan Stanley for less than a year in 1998 when it was discovered that he had posed nude for a photographer who then sold the pictures to a gay-porn magazine. The son of a Manhattan surgeon, he was a first-rate athlete, a serious pianist, and a Columbia graduate. Morgan Stanley fired him shortly afterward, claiming he’d abused expenses; Curry turned around and sued for $1.35 billion.

During the legal proceedings that unfolded, the D.A. learned that Morgan Stanley had paid a former friend of Curry’s, Charles Joseph Luethke, to set up a sting operation, in which Curry was arrested for plotting to plant racially charged messages in the Morgan Stanley e-mail system. In the ensuing brouhaha both Monroe Sonnenborn, a head securities lawyer, and Christine Edwards took the fall.

Few tears were shed within the company over Edwards’s departure. A stunningly attractive woman, she was widely resented for what some saw as her imperious attitude and her close relationship with Purcell. Several sources said that a high-ranking executive had spoken to Purcell about the problem and how it was affecting morale.

After Morgan Stanley, Edwards spent three years at Bank One, and is currently a partner in the firm Winston & Strawn, in Chicago. She was replaced by Donald Kempf, who was a senior partner in the Chicago office of the firm Kirkland & Ellis. “He was hired for one reason-to get Purcell out of that (Christian Curry) mess,” says someone involved with the legal proceedings at the time. Kempf obliged. The case was settled one week before Purcell and other Morgan Stanley executives were due to be deposed. Someone familiar with the matter has stated that Kempf was looking into setting up parameters so that questioning under oath would not include details of the executives’ private lives. Another source says that Curry suddenly became eager to settle because of events extraneous to the case that neither side will now talk about. Morgan Stanley paid $1 million to the National Urban League and stated that Curry was never paid a dime by them in the settlement.

What the board did and did not know over the past eight years is now a key question. Certainly, some critics ask why it did not push Purcell harder in the last three years as the stock plummeted and the bank’s reputation was severely diminished.

On top of the Curry case, it has paid a series of fines to regulators, as well as settling a class-action discrimination lawsuit stemming from a complaint filed by former Morgan Stanley bond saleswoman Allison Schieffelin, 44, who claimed she had been passed over for promotion. Several former senior female executives said that Morgan Stanley under Purcell had been a terrible place for women to work. (Purcell says he prides himself on the number of senior-level women employed by Discover.)

Last year Morgan Stanley settled with the Equal Employment Opportunity Commission, which brought the suit on behalf of Schieffelin and other female employees, for $54 million, rather than stand trial. This was the second-largest settlement the commission had ever reached with a company (the highest was $81 million, with Publix Super Markets, in 1997), and the first with a major securities firm.

Yet Purcell publicly remained unbowed, going so far as to remark to the attendees of an institutional-investor conference-which included a New York Times reporter-that retail investors need not be concerned by Morgan Stanley’s involvement in a $1.4 billion settlement the firm, along with nine other financial companies, paid to the Securities and Exchange Commission. (The case was based on claims that the firm’s reports misled investors.) S.E.C. chief William Donaldson responded by saying that Purcell’s remarks showed “a troubling lack of contrition.”

Over the years Purcell’s thick-skinned attitude has won him few friends and many detractors. Under him, the company ran through presidents-the number-two job-at a record pace: there were five in eight years. The day Mack left, in 2001, Purcell allegedly went to Robert Scott and said, “John’s quit. I would like you to become president, and you need to say yes right now because John will put out a press release, and I need to issue one, too.” Scott had little choice but to agree. (Purcell says there was no pressure on Scott to make a quick decision.)

But about a year into Scott’s tenure as president, he, like Karches before him, began telling Purcell to his face that he had lost his grip on the firm. Scott eventually found himself off to the side on an organizational chart in Purcell’s office. “Does this mean I’m fired?” he asked. “I guess so,” said Purcell. Two months later, Scott resigned. He was replaced by Stephan Newhouse, who was thought to be more client-friendly than Purcell and thus a good complement. He lasted in the job less than two years.

As it happened, the Perelman case turned out to be Purcell’s final blunder. “It’s quite clear that here was a C.E.O. who did not even know that the ball was in play and did not set up a system where disputes involving significant amounts of money reached him,” says the head of one of the bank’s bigger private equity clients.

In 2003, Donald Kempf told then investment-banking division head Tarek Abdel-Meguid that Perelman was filing a suit for fraud. Kempf’s recommendation-uncharacteristic, according to many sources-was to settle, for $20 million. But several people on the institutional side of the bank said they didn’t want to do so. “Part of the problem was that no one felt like they wanted to give a man like Ronald Perelman $20 million,” says a high-ranking source.

Time after time during the discovery process Morgan Stanley failed to produce requested e-mails and relevant documentation it said it didn’t have-only to find them later. In June 2004, a Morgan Stanley technology executive signed a document certifying that the company had turned over all e-mails ordered by the court. However, the firm later revealed that an employee had stumbled upon 1,423 additional e-mail storage tapes. In February, even more tapes were unearthed.

By March 2005 the judge in the case, Elizabeth Maass, was fed up; she took the extremely unusual step of telling the jury that Morgan Stanley had helped to defraud Perelman. Now all the jurors had to do was decide whether Perelman had relied on Morgan Stanley’s faulty information and lost money because of it, as he claimed. From the perspective of someone close to Perelman’s legal team, the behavior of Morgan Stanley was a “classic case of the bully in the schoolyard … they behaved with astonishing arrogance.”

Toward the end of the trial, which took place in West Palm Beach, Florida, people saw Kempf huddled with journalists in what seemed, in retrospect, an attempt to save Morgan Stanley’s reputation. It was too late. On June 3, Kempf announced his retirement after Shearman & Sterling senior partner David Heleniak was hired in May to report directly to Purcell. Lawyers all over Wall Street shook their heads at such an ignominious end for a lawyer that even former adversaries consider one of the best. “It’s a sad day that that guy had to take the fall for something he’d never even believed in,” commented a friend of his.

Meanwhile, for Purcell, too, the end was drawing near, though he remained determined to tough it out. “He still believes the firm was on the right course under him,” says a person close to him. “He took the board’s decision badly.”

No sooner had Purcell resigned than a close associate of Cruz’s began to campaign for her to be C.E.O., it was reported in The New York Times, and she told people that she would have “some say” in the board’s selection process. Names came up and were dismissed: Robert Diamond, president of Barclays; Citigroup’s executive-committee chairman, Robert Rubin; and Laurence Fink, the chairman of Black Rock, who told the board they’d be better off considering Mack.

“Really, to fix this problem, all the divisions and scars, it has to be someone who knows the firm, who knows the business,” said a veteran. “There’s really only one person who can do it.”

And so, five years after he’d walked out, John Mack, nicknamed “Mack the Knife,” got the call many felt he should have gotten years earlier. Eventually, Charles Knight, the head of the search committee, had to reverse his position because of the overwhelming support for Mack both inside and outside the bank.

As the news seeped out that he might come back, the stock price immediately rose. “He’s one of the most challenging people I’ve ever worked for. He’s terrific with regulators, clients, the employees; he’s passionate, he’s disciplined, he’s there for everybody. If you looked up the antonym to Phil Purcell in the dictionary, you’d see John Mack’s face,” says one of his most senior former executives.

During negotiations, Mack hung tough. “If he’s going to do this, he’s got to replace some of that board,” says a friend of his. It was unclear at the time of this writing precisely how Mack was going to restore harmony and stability. According to a source, he made offers to Pandit, Havens, and Newhouse, but it was not clear who had accepted. In part, this was because, on July 11, Zoe Cruz was appointed acting president, and co-president Steve Crawford announced he’d be resigning-along with a $32 million package, previously agreed to by the board. Purcell’s severance package was an estimated $106 million, including a $44 million bonus and retirement pay, as well as some previously granted stock and options. Many people both inside and outside the company were appalled at the board for signing off on these. “I can’t believe that someone’s not going to do something (about it), like (New York State attorney general Eliot) Spitzer,” said one former senior executive. “The Morgan Stanley board of directors continues to give capitalism a bad name,” Neil Barsky, a former Morgan Stanley analyst and now a hedge-fund manager, told The Wall Street Journal. (Mack quickly agreed to invoke a merit-pay standard for himself.)

When asked recently how he felt about his tenure at Morgan Stanley, Purcell replied: “I’m proud of what we’ve done. We’ve built enormous value for shareholders. And I have every confidence that this will continue.” Meanwhile, there was a feeling of excitement and optimism inside the Morgan Stanley building for the first time in years. Except, that is, in one corner of the 39th floor, where Philip Purcell’s belongings had already been packed in boxes.V

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