How Purcell Lost His Way

An inside look at the strategic errors that led to the mess at Morgan Stanley

Philip J. Purcell had missed out on one blockbuster deal after another -- Chase Manhattan, JPMorgan, Bank One (ONE ). And with Morgan Stanley's share price down to barely half its 2000 peak, tensions inside the firm mounted as some of the firm's white-shoe bankers worried that CEO Purcell would grasp at any deal -- even a merger with a second-tier bank where they would never want to work.

At a meeting of Morgan Stanley's 14-person management committee in June, 2004, in Purchase, N.Y., some felt their fears were confirmed. The topic was Morgan Stanley's direction. The discussion, such as it was, soon erupted into blazing arguments. The fuse: an analysis of possible mergers presented by then-strategic officer Stephen S. Crawford that included a deal with Charlotte (N.C.)-based retail bank Wachovia Corp. (WB ). By the end of the meeting, many of the six investment bankers on the committee had beaten down the suggestions. But it was an uneasy peace. Before long, the long-simmering conflict over Morgan Stanley's direction would escalate into open warfare, pitting directors, ex-execs, bankers, and Purcell loyalists against one another -- ultimately leading to Purcell's resignation in June. Through spokesmen, none of the key players would speak on the record for this story.

A reconstruction of Purcell's last years in office, pieced together by BusinessWeek from dozens of interviews with former and current executives and others, shows that the most widely cited reason for his downfall -- his personality -- doesn't completely explain all the rifts inside the firm or its penchant for blowing big opportunities. By many accounts, Purcell favored one side of the firm over the other, brutally dismissed top execs who fell out of favor, and undermined Morgan Stanley's culture of meritocracy with some of his promotions. But it was his inability to develop a coherent strategy and sell it to the troops that led to his undoing. This former McKinsey & Co. consultant, who had won a reputation as a master strategist, found himself bereft of ideas when they were most needed.


That means simply replacing Purcell won't immediately fix Morgan Stanley. If ex-President John J. Mack makes a triumphant return, as is widely expected, he should be able to raise morale and defuse many of the personal antagonisms that plague the firm. But he will inherit all the strategic dilemmas that Purcell struggled with for most of his eight years at the helm.

One of the first signs of Purcell's strategic quagmire emerged in the late 1990s, when then-President Mack recommended that Morgan merge with Chase Manhattan. Purcell preferred JPMorgan. Nothing happened, largely because the bank's top execs couldn't agree on which deal to pursue, according to people familiar with the discussions. Chase ended the debate by buying JPMorgan in 2000. The next year, Mack quit after losing a fight with Purcell over who would lead the firm.

Purcell still didn't have a plan for Morgan Stanley when the board of directors met at the end of 2003, say several people briefed on the discussions. The financial-services industry was consolidating, but Purcell couldn't come up with a clear answer to directors' questions about how Morgan Stanley should respond. The board asked him to develop a blueprint in time for a two-day meeting in July, 2004, in London. Purcell charged a small team to work out strategic options, ranging from going it alone to a blockbuster merger.

The group had barely begun work in January, 2004, when Morgan Stanley was left out in the cold yet again as another banking megadeal got done. This time, it was JPMorgan Chase & Co.'s (JPM ) purchase of Bank One Corp. (ONE ). The news came as a shock in the executive suite at Morgan Stanley. Once more, the firm had been sizing up the two players as potential merger partners for months before they were snatched away. Adding insult to injury, Gary Parr, a former top Morgan Stanley banker who had recently defected to Lazard Frères & Co., had advised Bank One.

Purcell knew he had to do something and began openly talking with his managing directors about other potential mergers. One name that became an open secret early last year among some of Morgan Stanley's top brass was a real shocker: Wachovia Corp. (WB ). The regional bank had broken out of its Southern base only a few years earlier; New Yorkers were still learning how to pronounce its name. Wachovia CEO Ken Thompson had repeatedly said he didn't want to merge with an investment bank.

Still, Purcell thought the deal made a lot of sense, bankers who were close to the strategic team say. Wachovia only had a small investment bank, and Morgan Stanley would give the North Carolina bank's retail brokerage and credit-card operations far more heft. Moreover, because Wachovia's market cap was then roughly the same as Morgan Stanley's, there was a chance that Purcell could continue to play a role in the combined company, which some insiders say seemed important to him.

The debate over doing a deal -- especially with a bank such as Wachovia -- widened old fault lines in the firm. Executives began to blame each other for the firm's beaten-down stock price and lagging financial performance. Investment bankers said the poor results reflected the weakness of the old Dean Witter retail businesses, which Purcell continued to manage after Dean Witter bought Morgan Stanley in 1997. What's more, they complained that they didn't have enough capital to build up trading operations or to undertake highly lucrative transactions -- such as trading big blocks of shares with corporate clients, as Goldman, Sachs & Co. (GS ) did. Purcell and his loyalists often countered that the investment bank was sucking up most of the firm's capital. Some veteran Dean Witter executives griped that the bankers were taking too many risks.

By the time of the Purchase meeting in June, 2004, even Wachovia was becoming too expensive to buy. So some executives argued that if Purcell did want to do a deal, he should sell Morgan Stanley to a company able to pay a stiff premium, one with enough prestige to keep people on board, say some people familiar with what happened. Names tossed out by people in the meeting included Citigroup (C ) and Bank of America Corp. (BAC ) -- though mergers with them might have left no role for Purcell.


Unable to agree on a possible deal, the management committee resolved simply to try to improve the firm's operations by better integrating the Morgan Stanley and DeanWitter businesses. Purcell went along with the committee's decision. He told the July board meeting in London that he planned simply to manage Morgan Stanley's existing businesses better, according to several people briefed on the meeting. But the group failed to resolve how that would be achieved or what the firm's ultimate goal should be.

The truce lasted little more than four months. On Dec. 9, Scott Sipprelle, a former managing director who is now a hedge-fund manager, sent Purcell and the board a letter that called for breaking up the firm. Within four days, Purcell recruited his old boss at Sears Roebuck & Co., Edward A. Brennan, to rejoin the board, which was already packed with loyalists. Later the board removed the firm's takeover defenses and adopted a provision that entitled Purcell to a $62 million parachute if he quit or the firm was taken over. On Mar. 3, a separate Group of 8 former executives sent a letter calling on Purcell to resign, though this news didn't break until the end of the month.

Purcell was done arguing. He called some of his management committee to tell them about the letter. He said the board might think that the head of the investment bank, Vikram Pandit, was behind it. (Later, the Group of 8 repeatedly denied that he was involved.) Purcell also asked some committee members if they wanted to be considered as candidates for president and CEO. Until then, Pandit had been widely perceived as Purcell's most likely successor. Head of equities John P. Havens, a Pandit loyalist, declined the offer, according to several people familiar with the matter.


Word of Purcell's suspicions quickly made its way back to Pandit. He confronted the CEO, insisting that he had nothing to do with the letter, according to people familiar with the matter. Purcell said that he would clear up any impression that Pandit was involved -- provided that Pandit agreed to support Purcell. But Pandit replied he was loyal to the firm, not to any individual, the sources say.

Tensions between Purcell and Pandit continued to build. Then, on Mar. 28, Purcell dropped a bombshell: He showed Pandit a new leadership plan for melding Morgan Stanley's investment bank more closely with its retail brokerage, asset management, and credit-card operations. The cornerstone: Zoe Cruz, head of the bank's fixed income division, and chief administrator Crawford would be promoted to co-presidents. Two names were missing from the organizational chart: Pandit and Havens. After working at Morgan Stanley for two decades, Pandit was through. He left the building shortly after meeting with Purcell, say people who know him. He didn't say goodbye to his troops. He didn't clean out his office. He just walked out in a raincoat into New York's Times Square.

All hell broke loose as the full extent of the disarray inside Morgan Stanley's executive ranks became public that night. Purcell announced the promotions of Cruz and Crawford. The next morning, Havens followed Pandit out the door -- to a standing ovation on the trading floor. But that was just the beginning. Within two months, three other members of the management committee quit, along with more than 50 bankers, traders, and brokers. "For a lot of us, Pandit was the last hope for Morgan Stanley," says a former Morgan Stanley banker who asked not to be named.

As the Group of 8 was hammering him in newspaper ads and Morgan Stanley's stock kept sinking, Purcell was losing his grip on the firm. All the while, company spokesmen dismissed any talk of a lack of direction. "It is management's responsibility to continually evaluate all of the strategic alternatives," says a Morgan Stanley spokesman. "It has been the unanimous view of the management committee that organic growth is the best option."

Yet it was still not clear how Purcell's new management team would do business any differently. The only obvious change was that Cruz and Crawford were jointly put in charge of all of the firm's businesses. Previously, Pandit ran the investment bank, reporting directly to Purcell, who ran the retail brokerage, credit-card, and asset-management operations. "It's been less clear than with other brokerages where Morgan Stanley wanted to go," says Glenn Schorr, a financial-services analyst at UBS (UBS ).

Finally, on June 13, Purcell announced he would retire. At first, the market didn't take the news very seriously -- perhaps because Purcell had said he would stay until a successor was found or until the next annual meeting in March. But once word trickled out that the board was considering Mack for the job, the stock jumped 5%. Morgan Stanley may have found a leader who investors and employees can believe in. Now it just needs a plan to put it back at the head of the pack.

Whether it's Mack or someone else, whoever replaces Purcell will need to reverse the sharp slide in the firm's stock price, persuade star bankers and top execs who walked out this year to return, and get the storied bank firing on all cylinders again. Above all, the successor must put a strategic stamp on the place.

There are several ways to do that. Morgan Stanley could refocus on its distinctive businesses that cater to blue-chip corporations and super-rich individuals. That might mean selling its mediocre credit-card, asset-management, and brokerage units. It could still buy a small retail bank. Or Morgan could sell itself to a big bank such as Citigroup. But one of the many lessons of Purcell's downfall is that doing nothing is a recipe for failure.

By Emily Thornton in New York

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