March 22 (Bloomberg) -- Ten years ago, John Mack tried to turn Morgan Stanley into Merrill Lynch & Co. Now the firm's chairman and chief executive officer is chasing Goldman Sachs Group Inc.

Mack was president of Morgan Stanley in 1997 when he and then-CEO Richard Fisher sold it to Dean Witter, Discover & Co., seeking to blend their investment banking prowess with Dean Witter's herd of stockbrokers. At the time, New York-based Merrill Lynch, the biggest brokerage, was the top U.S. securities firm.

Today's Wall Street titan is Goldman Sachs, which last year produced a record $9.54 billion in profit through bigger trading bets and by building divisions in private equity and hedge fund investing. Mack, 62, drove a 70 percent jump in first-quarter earnings by increasing trading risks, profiting from investments and adding hedge funds of his own.

``He's trying to copy Goldman, but that's what he knows and what he does best,'' said Jon Fisher, who helps manage $22 billion, including Morgan Stanley shares, at Fifth Third Asset Management in Minneapolis. ``If Goldman is putting up the best numbers, then if you're a competitor why wouldn't you do what they're doing?''

Some investors say it's too late to catch Goldman at its own game. Mack's Dean Witter strategy worked at first. In 1998, Morgan Stanley became the biggest U.S. securities firm by market value. It reported the highest profits in the industry for the years 1998 through 2002.

Meeker Era

Its star Internet analyst, Mary Meeker, gave Morgan Stanley unequaled cachet during the dot-com era. Meanwhile, Goldman suffered from its association with Long-Term Capital Management LP, the hedge fund that collapsed in 1998. Even Goldman's initial public offering was conceived during a power struggle that resulted in the ouster of co-CEO Jon Corzine, now the governor of New Jersey.

Then it was Goldman's turn to shine. In 2004, Goldman's earnings surpassed Morgan Stanley by less than $100 million --in 2005 the gap grew, and last year Goldman's profit was $2.1 billion higher. Morgan Stanley's profit grew 51 percent in 2006 and its shares climbed 43 percent; Goldman's earnings advanced 70 percent and its stock gained 56 percent.

The Dean Witter plan faltered under Philip Purcell, who ran the brokerage before taking the helm at Morgan Stanley after the $11 billion sale in 1997. Mack, who joined Morgan Stanley's bond department in 1972, left in 2001 because Purcell refused to turn over power. He returned four years later after Purcell was forced out by shareholders unhappy with a stock price that lagged peers and the defections of top bankers such as Joseph Perella and Terry Meguid.

`Blue-Chip'

``The blue-chip in the group is Goldman Sachs now,'' said Richard Moroney, chief investment officer of Horizon Investment Services LLC, which has about $110 million under management. ``Morgan Stanley was that five or 10 years ago -- it is trying to compete for that label again.''

Mack is unwinding Purcell's mistakes and copying Goldman's key strategies. In December he said Morgan Stanley will spin off the Discover credit-card division inherited from Dean Witter, freeing up capital and boosting return on equity. He also is relying on lieutenants who have either worked at Goldman or have similar experience to Goldman's senior management.

Neal Shear, 52, runs Morgan Stanley's fixed-income trading division, where revenue rocketed 31 percent in the first quarter. Before joining Morgan Stanley in 1982, Shear worked at J. Aron & Co. -- the same commodities trading company where Goldman Chairman and CEO Lloyd Blankfein got his start.

``The firm's strong performance this quarter was in large part the result of effective, disciplined risk-taking,'' Mack said in a memo to employees yesterday.

Risk Measures

Morgan Stanley's average value-at-risk, a measure of how much the firm could lose in a single day of trading, surged in the first quarter to $90 million from $58 million a year earlier. At Goldman, the same ``VaR'' measure leapt to $127 million in the quarter from $92 million a year earlier.

``Shear does seem to be turning Morgan Stanley into a Goldman Sachs on the trading side,'' said Brad Hintz, an analyst at Sanford C. Bernstein & Co. who rates both companies ``market perform.'' ``The trading side looks very good -- increasing VaR, and the return on VaR, looks very good.''

In equities trading, where Goldman's 2006 revenue was 34 percent higher than Morgan Stanley's, Shear and co-head of trading Jerker Johansson in February recruited Jay Dweck, a 13- year Goldman veteran, to help build and manage software programs. Goldman's Blankfein said in November that technology played an important role in the equity division's revenue growth.

Private Equity

In September, Morgan Stanley hired Stephen Trevor from Goldman Sachs to help oversee the firm's return to private equity investing, two years after it left the business because of concern about conflicts with clients. That decision came almost 18 months after Goldman's private equity team, led by Richard Friedman, raised $8.5 billion for what was then the world's biggest buyout fund.

Morgan Stanley's fund division had $478 billion under management at the end of November and produced $2.8 billion in revenue last year. Goldman's $676 billion in assets produced $4.29 billion of revenue in the same period.

Goldman was the top-ranked firm in 2005 for the amount of hedge fund assets it managed until it was surpassed last year by JPMorgan Chase & Co. Last year Mack started adding to Morgan Stanley's suite of hedge funds, buying FrontPoint Partners LLC and stakes in Avenue Capital Group and Lansdowne Partners LP. Last week, Morgan Stanley agreed to buy a stake in Abax Global Capital Ltd., a new hedge fund investing in Asia.

Coach K

Still, it will be difficult for Mack, who motivates his troops with outside speakers such as Duke University basketball coach Mike Krzyzewski, to knock Goldman from its perch. His best hope is a market shock, like a recession, some investors said.

``I don't have delusions they're going to be able to catch up with the type of numbers that Goldman's putting up, they're starting too late in the cycle,'' said Fifth Third's Fisher. ``Morgan Stanley's are good and will continue to get better, but they were starting from too far behind.''

Goldman's strategy is best suited for a bull market, said Fisher and James Ellman, president of San Francisco-based SeaCliff Capital LLC. Big trading risks and private equity investments will probably cause losses whenever stock prices fall and credit spreads widen, they said.

``As long as markets remain healthy, Goldman might stay on top,'' said Ellman, who has about $100 million under management and owns more Morgan Stanley than Goldman shares. ``When markets turn down, the retail business isn't hurt'' so Morgan Stanley can better withstand a downturn.

To contact the reporter on this story: Christine Harper in New York at charper@bloomberg.net.

Last Updated: March 22, 2007 00:15 EDT