Bonds and Betrayal

Jeffrey Gundlach’s returns topped those of Bill Gross before he was fired by Societe Generale-owned TCW. Now, he faces allegations of stealing trade secrets and keeping drugs at the office.

By Edward Robinson and Sree Vidya Bhaktavatsalam Bloomberg Markets, April 2010

Jeffrey Gundlach has a black eye and a cut on the bridge of his nose, and he winces as he rubs his side.

“I think I cracked a rib,” Gundlach, 50, says as he gingerly takes a seat in a conference room in a Los Angeles high-rise in January.

Gundlach, a money manager who ran the second-largest mortgage bond fund worldwide, got hurt tripping over a computer cable in his office, not in a fist fight. But he is exchanging blows with his former investment firm, TCW Group Inc., in a brawl that has shocked the bond-trading world with allegations of double-dealing, drug use and workplace pornography, Bloomberg Markets magazine reports in its April issue.

The feud reaches from TCW’s headquarters in Los Angeles to Paris, where Societe Generale SA, the firm’s corporate parent, has been pummeled in the global credit crisis. France’s No. 2 bank has written down at least 11 billion euros ($15 billion) after losing additional billions in a 2008 trading scandal.

A relentless self-promoter who describes himself as a “money machine,” Gundlach outperformed 99 percent of his rival fixed-income money managers from 2005 to 2009, according to data compiled by Bloomberg. His lieutenants call him “the Godfather” for the loyalty he commands and the rich stream of asset management fees he brings in.

‘Amazingly Brilliant’

“I am amazingly brilliant analytically,” says Gundlach, a wiry man whose short brown hair hugs his skull like a helmet. “I’m the guy who makes it rain in the desert.”

TCW Chief Executive Officer Marc Stern fired his rainmaker on Dec. 4. Stern, 65, who former colleagues say is as hard- charging a figure as Gundlach, referred to the ousted money manager as a “prima donna” on a conference call with TCW employees on Dec. 7. A month later, TCW accused Gundlach in a lawsuit of stealing trading and contact data for thousands of clients so he could open his own firm, Los Angeles-based DoubleLine Capital LP.

Gundlach, who during 24 years rose from a junior analyst to manage about 70 percent of TCW’s $110 billion in assets, denies the allegations in the lawsuit. In a countersuit filed on Feb. 10, Gundlach contends TCW ousted him largely to take control of the 15 funds he ran and keep $600 million to $1.25 billion in fees his team was due to be paid over the next few years.

Bitter Divorce

The feud has wounded TCW, which in February took the unusual move of slashing its fees in two of Gundlach’s former funds to induce investors to keep their assets at TCW. With years of bad blood between Gundlach and Stern, this battle isn’t just business -- it’s personal.

“It’s a bitter divorce,” says Neil Rue, a managing director at Pension Consulting Alliance Inc., a Portland, Oregon-based firm that advises institutional investors.

This is a story rooted in old grudges over money and the perennial tension between the suits in the executive suite and the investment wizards on the trading floor. It begins in July 2001, when Societe Generale pushed into U.S. asset management by acquiring TCW. Originally known as Trust Company of the West, the firm went on to invest money for institutions such as the California State Teachers’ Retirement System and Cornell University and counted Henry Kissinger and Enron Corp. founder Kenneth Lay as directors in the 1980s and 1990s.

The French bank awarded fresh equity in TCW to its senior officers and skipped over the money managers, former TCW executives say. The move diluted Gundlach’s existing stake, and the money manager says he never forgot the snub.

Kerviel’s Losses

Paris-based SocGen, a 146-year-old retail bank that had long lagged behind rivals in mergers advice and underwriting, became one of the world’s top issuers of equity derivatives after 2000. Then in January 2008, as the credit crisis was picking up momentum, SocGen disclosed that it had lost 4.9 billion euros unwinding unauthorized bets that trader Jerome Kerviel had made on stock index futures.

Kerviel, 33, maintains he acted with the knowledge of his supervisors and hasn’t been accused of personally profiting from the trades. Following the scandal, CEO Daniel Bouton resigned and his successor, Frederic Oudea, moved to spin off far-flung asset management units such as TCW.

For Gundlach, who ran his investment team as a quasi- autonomous fiefdom and who has personally earned $134 million since 2005, Oudea’s course augured the end of his independence. Last September, the money manager, who specializes in mortgage- backed securities, threatened to lead a mass defection of his 65-member investment team to his own firm, Stern wrote in January in an e-mail to Bloomberg News.

Rocked Washington’s Boat

“This would have had an adverse and negative reaction on our fixed-income business,” said Stern, who declined to comment further. Gundlach denies the allegation, saying he wanted to protect his TCW business, not quit.

On the same day in December that Gundlach was sacked for allegedly stealing client information, TCW announced it was acquiring Metropolitan West Asset Management LLC, a crosstown rival, to take over his funds.

On a conference call with TCW’s 700 employees on Dec. 7, Robert Day, the firm’s founder and chairman, said terminating Gundlach was necessary for the good of the company, according to a recording of the meeting. Day, 66, had been a father figure to Gundlach early in the money manager’s career. Now, three days after Gundlach’s termination, Day likened his one-time protege to a soldier who rocked George Washington’s boat as it crossed the Delaware River in 1776.

‘Shoot The Soldier’

“Your choices are very simple,” Day told his employees. “You shoot the soldier and throw him overboard, otherwise everybody in the boat goes down.” Day declined to comment for this article.

Hours after he was fired, Gundlach returned to a private office he used in Santa Monica to find the lock on the front door removed. Inside, he says, about seven private investigators hired by TCW were searching through his desk and had broken open his filing cabinets. Gundlach says he protested the intrusion and one of the investigators told him to leave the office immediately.

The TCW men discovered marijuana stored in jars, drug paraphernalia, pornographic DVDs and a dozen “sexual devices,” according to the company’s lawsuit. TCW alleges that Gundlach’s possession of the material at an office it considered part of the firm’s workplace violated its employment rules and showed he wasn’t fit to manage money for clients or supervise employees as the chief investment officer of the company.

Drugs, Porn and Sex Toys

Gundlach says the drugs, porn and sex toys are relics from a closed chapter in his life and were stored in a crate. He says TCW disclosed their existence to damage his reputation with investors.

“It’s ancient stuff, like a box in an attic,” he says. “But they figured, ‘Let’s try and destroy the guy and throw some slander and sleaze on him.’”

Gundlach, who favors custom-made Brioni suits, is equally at home opining on the nuances of the yield curve or the geometry of Piet Mondrian’s gridlike paintings, which he collects. He’s also blunt and prone to pounding the table when making a point. On the trading floor, Gundlach openly chastises co-workers for mistakes or even their choice of necktie, former colleagues say.

“He’s a principled and honest guy, but sometimes he gets himself into trouble by speaking his mind without any sugarcoating,” says Frederick Horton, a money manager at TCW from 1993 to 2005 and now a managing director in New York at Strategos Capital Management LLC. “It can come off as arrogance, but I don’t think he means it that way; it’s just part of his makeup.”

Tops Bill Gross

Investors say Gundlach’s performance backs up his bluster. His former flagship mutual fund, the TCW Total Return Bond Fund, gained 20 percent in 2009, more than double his peers’ average of 8.6 percent, according to Bloomberg data. The portfolio’s 7.8 percent annual return during the decade ended on Dec. 4 beat the 7.6 percent performance of the PIMCO Total Return Fund run by Bill Gross, co-chief investment officer at Pacific Investment Management Co. in Newport Beach, California, according to Morningstar Inc.

In July, the U.S. Treasury selected TCW largely on the strength of Gundlach’s record as one of nine managers for its Public-Private Investment Program to buy distressed mortgage assets.

Theoretical Mathematics

Gundlach got into the investing business by chance. He was born in 1959, in Buffalo, New York, into a German-American family of scientists. His father, Arthur, was a chemist at a paint manufacturer, and his uncle Robert Gundlach, a physicist, was the primary inventor of the modern photocopier at Xerox Corp., according to the National Inventors Hall of Fame.

After graduating from Dartmouth College in New Hampshire with a bachelor’s degree in philosophy and mathematics, Gundlach enrolled in Yale University’s Ph.D. program in theoretical mathematics. His thesis, “The Probabilistic Implications of the Non-Existence of Infinity,” went against 20th-century mathematical canon, which is based on the assumption that infinity exists. He left Yale before completing his degree and moved to Los Angeles in 1983.

Gundlach led a carefree existence on the West Coast, playing drums for a rock band called Nuisance. One evening in 1985, he watched the TV program Lifestyles of the Rich and Famous and saw that investment bankers were the top-paid professionals in America. Inspired, he flipped through the Yellow Pages, calling investment firms. Gundlach, then 26, landed a 90-day probationary position as a quantitative analyst in the fixed-income unit at Trust Company of the West for $30,000 a year.

Inside the Yield Book

Day founded TCW in 1971. He’s the grandson of William Keck, the founder of Superior Oil Co. in Coalinga, California, which was sold to Mobil Corp. in 1984 for $5.7 billion.

Day structured TCW as a confederation of semiautonomous boutiques rather than a highly centralized firm, says a former TCW executive who knows him. Day played a paternal role at TCW by bestowing autonomy and generous fee-sharing agreements on his favored money managers, with some keeping more than half the revenue their teams generated, the executive says. Every Christmas, he threw a gala at his Beverly Hills home for his top people and their families. A 10-piece band and circus clowns entertained guests.

At TCW, Gundlach says he devoured the 1972 classic primer on bonds, Inside the Yield Book, and studied its formulas. He embraced mortgage bonds and set out to solve what he called “the conundrum of pre-payment risk.”

‘Scenario Analysis’

Many investors avoided mortgage bonds in those days because whenever interest rates fell, borrowers refinanced to settle home loans long before their terms expired. That wiped out gains, including those based on higher interest payments. Gundlach says most money managers erred by using past patterns to predict rate moves and prepayment levels. There are too many variables to make accurate forecasts, from Federal Reserve policy to the housing market, he says.

So working with fellow money manager Philip Barach, Gundlach developed a system called “scenario analysis.” It mixed bonds of varying credit risk and duration together to accommodate any rate move. Those bonds that underperformed when rates fell were offset by enough winners to produce profits, Gundlach says.

In March 1989, Day agreed to let Gundlach lead his own mortgage-backed securities investment team and retain about half of its asset management fees to distribute to his people as compensation, the money manager says. By late 1992, Gundlach had attracted $10 billion in investor assets and the following June unveiled the TCW Total Return Bond Fund.

Secretary of State Kissinger

Day offered Gundlach the option to buy an equity stake in TCW, which was coveted by money managers and senior executives. And the chairman sat his prized pupil next to former U.S. Secretary of State Kissinger, a TCW director from 1981 to 2003, at luncheons following periodic board meetings, Gundlach says.

“I was happy,” he says. “I believed.”

Across the Atlantic, Societe Generale CEO Bouton was moving in 2001 to become a global player after losing his bid to acquire rival Paribas SA to Banque Nationale de Paris SA. SocGen, which was privatized in 1987 following 42 years as a state-run institution, bought banks in the Czech Republic and Slovenia.

In July 2001, SocGen purchased 51 percent of TCW for $784 million and agreed to pay about $425 million to increase the stake to 70 percent over five years; Day and TCW retained the remaining 30 percent of equity.

Gundlach Diluted

Stern, a lawyer who joined TCW in 1990 after serving as president of life insurer SunAmerica Inc., played a key role in negotiating the deal, say two former TCW money man­agers. SocGen granted new equity stakes in TCW only to senior operating executives, the money managers say.

Gundlach says he was furious because the issuance of new equity diluted his existing stake by a quarter, decreasing its value by $15 million. Stern had violated a pledge to never diminish his holding, Gundlach says. “That’s absurd,” TCW spokeswoman Erin Freeman says. “Societe Generale’s acquisition of TCW did involve some dilution, and it was the same for each shareholder commensurate with the shares owned.”

In September 2005, the TCW board elevated Gundlach to chief investment officer as part of a move to bring the next generation to power at the firm. Day relinquished his CEO title to Robert Beyer, then 45, a former fixed-income money manager, and Stern stepped aside as president to become vice chairman.

SocGen’s AIG Exposure

When the Kerviel scandal hit SocGen in January 2008, TCW was immediately affected. French regulators opened an insider- trading probe of Day, then a SocGen director, after he and his foundation sold 148 million euros worth of the bank’s stock before SocGen publicly disclosed the trading losses on Jan. 24, according to regulatory records. Josh Pekarsky, a spokesman for Day, says Day used no inside information with respect to the stock sales and is cooperating with the investigation. Day resigned from SocGen’s board on Dec. 31.

Oudea, 46, SocGen’s former chief financial officer, took the helm in May 2008 with a mandate to staunch the bank’s losses. The carnage would have been far worse for SocGen had Washington failed to execute a $182 billion bailout of American International Group Inc. in 2008. SocGen held held $16.5 billion in credit-default swaps issued by AIG, the largest such exposure, according to filings with the Securities and Exchange Commission.

Backdoor Bailout

Under a deal arranged by the Federal Reserve Bank of New York, then led by Timothy F. Geithner, the insurer settled the swaps with SocGen and other AIG trading partners at 100 cents on the dollar. The decision spurred accusations from U.S. Congress members that Geithner, who is now the U.S. Treasury secretary, gave the banks a “backdoor bailout” at the expense of taxpayers.

Gundlach, too, was investing in the exotic instruments that helped fuel the crash. Under his direction, TCW became the No. 1 manager in collateralized debt obligations, with $41.3 billion under management as of Sept. 30, 2007, according to data from Standard & Poor’s. That included $35.1 billion of CDOs composed of asset-backed securities, including mortgages. Gundlach says his CDOs rotated out of high-risk home loans early in the credit crisis and escaped the worst of it.

In January 2009, Societe Generale said TCW would be spun off in a stock offering sometime in the next five years as part of a reorganization of its asset management division. Gundlach says he assumed the French would sell TCW if the right offer was made.

Gundlach Blows Up

At the end of May, Day summoned Gundlach to his home to meet with him and Stern. The two men told Gundlach that Beyer, TCW’s CEO, was about to announce his retirement at the age of 49 and Stern was to be named CEO. Gundlach blew up.

“I was like, ‘No! No! What do you mean you’re coming back? You turned this over to the next generation. This is all completely the opposite of what I was led to expect,’” Gundlach says. Beyer declined to comment.

The two men offered to make Gundlach president, which he says he rejected. Gundlach had never forgotten the dilution of his equity stake in 2001, and he says he accused Stern of stealing $15 million from him. The meeting ended badly.

“Gundlach’s claims are without merit,” TCW spokeswoman Freeman says.

In late August, Gundlach says, he heard rumors that Stern had convened a team of lawyers to fire him. On Sept. 3, the money manager asked Stern to join him and members of his team in a conference room off the trading floor to clear the air. The mood was tense as the money manager and the CEO faced one another, according to an account by Gundlach and Barach.

Threat to TCW

Gundlach asked Stern whether he was planning to fire him. Stern replied no. Gundlach asked whether SocGen was going to sell the firm. Stern again answered no. Gundlach then made an oral offer to buy 51 percent of TCW for $350 million. And several of his top lieutenants, including Barach and money manager Louis Lucido, voiced support for their boss.

“Just so you know, if anything happens to Jeffrey, we’re going with him,” Lucido, now executive vice president at DoubleLine, says he told Stern.

Stern considered Gundlach’s behavior confrontational and insubordinate and came away convinced the money manager now posed a threat to the welfare of the firm, says a TCW executive familiar with Stern’s views. Gundlach’s informal buyout bid was rejected, Jacques Ripoll, head of SocGen’s global investment group, wrote in a January e-mail to Bloomberg News.

TCW lawyers started reading Gundlach’s e-mails and allegedly found some in which he declared war on TCW and solicited his subordinates’ allegiance to him, according to the company’s lawsuit. TCW investigators monitored and recorded his team’s computer activity.

Firing Gundlach

Beginning in early September, members of Gundlach’s team allegedly started downloading data on every holding of every client in the mortgage-backed-securities group and contact information for more than 24,000 TCW clients firm-wide, according to the suit. Gundlach’s deputies also engaged a commercial real estate agent to find an office that could accommodate a 50-desk trading floor and registered the name DoubleLine on Nov. 22 in Delaware, the complaint says. At the end of the month, Stern briefed Ripoll and received his blessing to take the next step, the TCW executive says.

After lunch on Friday, Dec. 4, Gundlach was at his desk on the 16th floor when he got a call from Michael Cahill, TCW’s general counsel, asking him to come up one flight to the executive suite. Stern wasn’t there. Cahill told Gundlach his TCW career was over, the money manager says.

Stairwell Chase

The attorney tried to give Gundlach a legal document describing how he and his team took confidential information. Gundlach says he refused to take it and turned to go, saying he had trades to complete. Cahill told him he couldn’t return to his desk. Gundlach says he ducked into a stairwell and Cahill and another lawyer followed him down 17 flights to the street, demanding he take the papers. They gave up as Gundlach took off along Figueroa Street in downtown Los Angeles. Cahill declined to comment.

Gundlach says he did ask deputies to find office space and register DoubleLine in case TCW fired him. He denies directing employees to steal client data or any other trade secrets. In the two weeks after Gundlach was ousted, more than 40 members of his TCW team quit to join DoubleLine. Barach is now DoubleLine’s president. Oaktree Capital Management LP, a Los Angeles firm with $67 billion in assets, invested an undisclosed sum in DoubleLine for a 22 percent stake.

$500 Million in Fees

In his Feb. 10 answer to TCW’s lawsuit, Gundlach says DoubleLine has hired a firm to search computers belonging to former TCW employees and return any data that might be in their possession.

“DoubleLine’s establishment has not involved the use of any TCW information whatsoever,” Gundlach says.

Gundlach contends that TCW canned him largely to capture all of the fees from funds that he and Barach set up in 2007 to invest in distressed mortgage-backed securities, including two with $3 billion in assets. Gundlach says the strategy returned 60 percent in 2009. Along with revenue from his other funds, Gundlach says he was personally eyeing a payday of about $500 million over the next few years.

“They just wanted to broom-sweep me out and shanghai my business,” he says.

Freeman disputes that allegation. “He was let go because he stole from the company,” she says.

Investors Flee

TCW said it planned to start an equity-based compensation plan in the first quarter to retain employees. “The priority now is to concentrate on moving the business forward,” Ripoll wrote in an email on Feb. 11.

TCW’s standing with clients has been shaken by its firing of Gundlach: In December, TCW said it would liquidate its $1 billion PPIP fund for distressed assets after Gundlach’s dismissal triggered a so-called key-man clause and prompted the Treasury to freeze the firm’s participation in the program.

Investors pulled more than $6 billion in assets from the Total Return fund between Dec. 4 and Feb. 8, according to Morningstar. In January, pension funds in Colorado, Kansas and Texas withdrew a total of $1.2 billion from TCW.

“We decided to terminate because we’re no longer getting the team we signed up for,” says Robert Smith, chief investment officer at the Kansas Public Employees Retirement System.

Investors in TCW’s distressed funds are livid that their holdings have become pawns in the dispute, says Tania Modic, CEO of Western Investments Capital LLC in Incline Village, Nevada, which put $10 million in the funds. Clients asked TCW to permit them to make so-called in-kind transfers of assets to another firm so they don’t have to liquidate the securities into cash.

TCW Slashes Fees

TCW says it declined, offering an option to slash fees to 1 percent on assets and 5 percent on profits from 2 percent and 20 percent.

Modic says it appears TCW would rather alienate its clients than see them transfer their assets to DoubleLine, which is what she wants to do.

“Something happened to get their panties in a twist because their behavior is bizarre,” Modic says. “This shows gross disrespect for investors.”

Freeman says TCW is treating its investors fairly.

Gundlach is also feeling the fallout. TCW is seeking at least $200 million in damages from DoubleLine and wants it to relinquish its revenue. The lawsuit has hindered DoubleLine’s ability to raise assets beyond the $3 billion it has brought in so far, Gundlach says. Pension consultant Rue says he’s advised institutional investors not to commit capital to DoubleLine until the litigation plays out.

Starting Over

At DoubleLine’s offices, located a few blocks from TCW, Gundlach strides past electricians working on his half-completed trading floor and points to a spot where he plans to blow a hole in the ceiling and install a minimalist sculpture by the late artist Donald Judd. Gundlach, after more than two decades managing money, is now starting over. This time around, with a lawsuit threatening his new firm, he may find that repairing a career can be harder than building one.

Edward Robinson is a senior writer at Bloomberg Markets in San Francisco at; Sree Vidya Bhaktavatsalam is a reporter in Boston at

#<535521.2245115.># -0- Feb/25/2010 20:35 GMT

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