Upheaval in the Ranks at Morgan Stanley

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Joe Perella thought he could sidestep the pernicious culture-clash now consuming Morgan Stanley, where he's served as rainmaker and mentor for the firm's ťlite investment bankers for 12 years. But even Perella, a renowned dealmaker, couldn't find any middle ground in a family feud ignited the day the Ivy Leaguers at Morgan sold out to the hard-knocks brokers at Dean Witter Discover in 1997.

As the firm's internal troubles burst into the open, management pushed Perella to take its side. The vice chairman chose instead to take a hike, becoming the biggest name in a string of high-profile departures that have stunned Wall Street, leaving investors and clients to wonder whether more Morgan bankers will head for the hills.

At least eight bankers have left in a huff over the way the company is being managed, including president Stephan Newhouse; investment-banking boss Terry Meguid; and John Havens, head of stock trading. The fight has got so emotional that hundreds of employees on Morgan's vast New York City trading floor stood and applauded Havens for seven minutes on the day he left, which some saw as a repudiation of CEO Phil Purcell, the former Dean Witter boss who is running the show.

Morgan Stanley, split from J.P. Morgan's financial empire by regulators in 1935, has rarely seen such turmoil. For now, the brand remains strong. Stock and bond trading have been minting gold, and the firm has advised on seven of the 10 biggest takeovers in the world this year. But the increasingly bitter spat between Purcell, a master survivor, and eight former Morgan bankers led by another ex-president, Robert Scott, threatens all that.

The dissidents, who collectively own 11 million Morgan shares, or about 1% of the company, have asked the board to remove Purcell and put Scott in charge. Their broad plan is to re-Morganize Morgan in part by ditching the firmís moderate-income clients and focusing on the wealthy. But the proposals are short on specifics. "We're trying to figure out if this is anything more than a grudge match," says Richard Ferlauto, director of Pension and Benefit Policy at the American Federation of State, County and Municipal Employees, an activist shareholder. Such worries are weighing on the stock, which has been a woeful underperfomer, falling 22% in the past five years, while more focused firms like Bear Stearns and Lehman Bros. have doubled.

The damage to Morgan will only deepen. Says Bill Benedetto, an investment banker with the boutique firm Bendetto Gartland: "Every company in America that relies on Morgan for 100% of its banking business will be relying on it for just 50% going forward."

To understand how a venerable firm like Morgan got into this pickle, just do like they do on Wall Street and follow the money. When Chicago's Dean Witter bought New York City's Morgan for $10.4 billion and later adopted the Morgan name, Purcell became top dog. Morgan's John Mack became the No. 2. That didn't sit well with Morganites, but this was near the zenith of day trading and the rise of the individual investor. The blue bloods at Morgan needed an Everyman presence, and Dean Witter (once owned by Sears) fit the bill. They caved to Purcell's terms. Besides, on the Morgan side "it was an article of faith that Mack would take over within 12 months," says Benedetto.

Instead, Purcell consolidated power by building a loyal board and outmaneuvering Mack, who resigned in 2001. Chicago 1, New York 0. Since then, the Morgan side has had a serious case of sellerís remorse. Why? When the stock market turned down, the retail brokerage business hit the skids. The Ivy Leaguers had sold out for wampum.

Now institutional stock and bond trading is on a roll, and mergers and underwriting are picking up steam — all strengths of the old Morgan. No wonder the bankers want their firm back. This is a time when they should shine but feel hamstrung by Purcell, who is loyal to his underachieving brokers and keeps his bankers on a short leash. Purcell declined to be interviewed.

Will the Morgan bankers prevail? It's far from certain. Purcell has already proved a great infighter, and with a friendly board that has asked the dissidents to "desist," and another year before a new slate of directors could be voted in, he may outmaneuver his foes at Morgan again — if there are any left.