SPECIAL REPORT:Divorce American style for French bank, bond star
NEW YORK (Reuters) - Jeffrey Gundlach, the prominent U.S. bond fund investor who refers to himself as "The Godfather," was storming around his office on September 3, 2009, red-faced and fuming. He was anxious about his future at TCW Group, the Los Angeles firm where he had worked for almost 25 years.
Gundlach, 50, gathered seven of his top lieutenants in a conference room dubbed "La Cienega" (or "the swamp") and phoned the firm's interim chief executive, Marc Stern, demanding that he appear immediately for a meeting.
Minutes later, Stern entered the room and Gundlach laid into him. "I am hearing that there's a floor full of lawyers and they are here to fire me," he recalled telling his boss.
Stern insisted he was not being let go, but Gundlach wasn't finished. After complaining about being frozen out of ongoing talks to sell TCW, he made Stern an offer: he wanted to buy a majority stake from the firm's owner, the struggling French bank Societe Generale, for about $350 million. That was less than half what the bank had paid for its controlling interest in 2001.
Gundlach and others at TCW told Stern they found the French bank inattentive, distracted by its staggering write-downs on subprime debt and by the embarrassing $7 billion loss caused by rogue trader Jerome Kerviel.
If the plan wasn't accepted, Gundlach told Stern, he might quit -- and take his entire team with him. To underline his threat, he asked for a show of hands: how many would walk out with him? With Stern looking on, all seven other senior managers in the room raised their hands.
Stern declined to be interviewed. A TCW spokeswoman confirmed the broad outline of the confrontation presented by Gundlach and others, as well as by court documents from a lawsuit filed by the firm against Gundlach on January 7.
The spokeswoman said Stern interpreted Gundlach's complaints as a direct threat to TCW and was appalled by the senior manager's behavior.
But Stern nevertheless told the group that he would speak with SocGen officials and get back to them, the spokeswoman and others close to the situation say.
Three months after the big showdown, on December 4, TCW did fire Gundlach, stating -- correctly, it turns out -- that he was about to start a rival firm staffed with his TCW team. On December 14, Gundlach announced he was opening DoubleLine Capital LP to be run by him and several former TCW officials. In response, TCW filed an explosive lawsuit on January 7 that has rocked the normally staid world of fixed-income investing.
The high-profile case underscores that when it comes to big firms and their stars, divorces are often messy -- not to mention costly. But few breakups have ever been quite this ugly.
In its lawsuit, TCW not only accuses Gundlach of stealing proprietary data and lying to potential clients but also claims that it found bags of marijuana, a collection of 12 sexual devices, 34 hardcore pornographic magazines and 36 sexually explicit DVDs and videocassettes in his former offices. It seeks damages of at least $200 million plus the rights to all revenue generated by Gundlach's new firm, DoubleLine, which calls the lawsuit without merit.
Since firing Gundlach, who oversaw $65 billion of the firm's $110 billion of assets, TCW has taken some hits. At least a dozen major institutional investors -- including the Teachers' Retirement System of Louisiana and the Fort Worth Employees' Retirement Fund -- have yanked or put up for review billions of dollars.
Small investors have jumped ship as well, and the $12 billion TCW Total Return Bond Fund Gundlach used to manage has shriveled to $5.9 billion.
Like it or not, observers say, the money management business revolves around star investors. SocGen may not have seen the problem coming, said Richard Lipstein, managing director at Boyden Global Executive Search in New York. "Many big firms, particularly European ones, don't want to create a star system, but then the real stars want to get paid and leave."
For Societe Generale, the timing of all this could hardly be worse. Over the past nine years, the bank plowed $2.2 billion in total into acquiring TCW. And last month, still ailing from bad mortgage investments, it spent another $200 million to $300 million to buy smaller rival Metropolitan West Asset Management, or MetWest, to replace Gundlach and his team, sources familiar with the deal said.
Jacques Ripoll, who oversees TCW and the rest of SocGen's money management businesses, declined to be interviewed. "The priority is now to concentrate on moving the business forward," a spokesman for Ripoll at SocGen said.
With all the turmoil at TCW, the unit may be worth $500 million today, according to one European analyst who follows SocGen. That's less than a quarter of what the bank has plowed into the firm. Although the bank had announced last year it would sell or spin-off TCW over the next few years, it now says flatly: "TCW is not for sale."
After the September 3 showdown, both sides secretly started preparing for a separation.
Stern considered Gundlach immensely talented, a brilliant fund manager and well-compensated -- earning $134 million the last five years, including $40 million in 2009, said the TCW spokeswoman. But he also found him utterly lacking the people skills and temperament to run the entire firm, she said. Stern and Robert Day, chairman and founder of TCW, declined to be interviewed.
True to his word, Stern brought up Gundlach's offer with SocGen officials, who had no interest in making the fund manager CEO or selling out for such a low price, TCW's spokeswoman said.
SocGen's Ripoll said in an emailed statement that Gundlach "never made any formal or realistic offer."
In any event, Stern was convinced Gundlach would bolt and started looking around for potential replacements such as MetWest shortly after the confrontation, his spokeswoman said.
His hunch proved right. According to TCW's lawsuit, on September 7, Gundlach's right-hand man, Cris Santa Ana, began downloading a huge volume of computer data about the firm's positions and analytic software.
The downloaded information also included a huge database known as "Saratoga," the lawsuit stated, with contact information, investing preferences and other closely guarded secrets about more than 24,000 TCW clients. Some of the copied data, TCW's lawsuit asserts, was hidden on a network computer drive in a folder titled "Disaster Recovery" that was itself stuffed in a folder labeled "MBSInterns."
Gundlach denies that the data cited in the lawsuit would be of much value and said he and his colleagues had returned TCW laptops and other gear. "Most of the things that were listed ... I wouldn't even know how to use to my benefit if I had them -- and I don't," he said.
According to the lawsuit, a few weeks after the flare-up another of Gundlach's colleagues, senior vice president Barbara VanEvery, began speaking with a real estate agent and architects to lease and design 24,000 square feet of office space elsewhere in downtown Los Angeles with a huge trading floor. In October, Gundlach's group registered a limited liability corporation in Delaware called Able Grape LLC. Within days after Gundlach's firing, Able Grape's name was changed to DoubleLine Capital.
With the new firm up and running, Gundlach filed to open three mutual funds with the Securities and Exchange Commission on January 12. One focuses on mortgage-backed securities like Gundlach's old fund, another on emerging market debt and another invests across the fixed-income markets. Gundlach or another member of his former TCW team runs each of the funds.
The relationship between SocGen and TCW had grown increasingly troubled as the French bank's problems mounted, according to Gundlach and other former TCW officials.
For two decades, Stern worked closely with founder Robert Day to build TCW into an industry leader. Stern, now 65, and Day, who is a year older, made hundreds of millions of dollars each selling TCW to SocGen in several stages. In 2001, the bank paid over $800 million for a 51 percent stake.
By 2005, the two and other elders of the firm were looking to step back and handed power to a new team of executives led by Robert Beyer, whom they named chief executive, and Gundlach, who was made chief investment officer.
The firm's old guard -- including Day and Stern -- owned most of the 30 percent stake in TCW that did not belong to SocGen, according to former senior TCW officials. To "recirculate" more of that stake among the new leadership such as Beyer and Gundlach, SocGen agreed to buy it back from the old guard, the former officials said.
But negotiations over how to distribute the equity to the new leadership group went nowhere. TCW executives at the time proposed to SocGen various deal structures "but they just weren't receptive," said one former official. "They weren't opposed but they were so distracted it was always at the bottom of the list of priorities." SocGen would not comment on this, but few dispute that the bank had a lot on its plate.
In June 2009, Beyer, 49, suddenly quit, saying in a press release from the firm that he wished to retire. That started a chain of events that would soon throw Stern back into daily management as interim CEO. Another former official says Beyer left because he was frustrated with SocGen. Beyer did not return several calls for comment.
TCW and SocGen declined to comment on any of the ownership or management issues. "TCW and SocGen are not the issue here," the spokeswoman for TCW said.
SocGen has spent much of the past two years dealing with fallout from the $7 billion loss run up by Kerviel-- whose fraud was discovered in early 2008 -- as well billions of dollars of losses from toxic mortgage securities.
Last January, SocGen announced that it was spinning off its entire European and Asian money management businesses into a joint venture with Credit Agricole called Amundi. The press release disclosed the new venture would hold a 20 percent stake in TCW and, in a footnote, said that its remaining ownership would be spun-off sometime over the next five years. A spokesman for Amundi declined to comment.
SocGen's press release prompted howls of protest across TCW's trading floor. "Everything changed," Gundlach said in a recent interview. "Pretty clearly, they were no longer committed to the business."
Around that time Gundlach began openly criticizing management in front of employees and clients, behavior that continued throughout 2009, TCW said in its lawsuit and through the spokeswoman. Gundlach makes no apologies and defends his views.
He also dismisses the lawsuit as frivolous and a personal attack on his reputation. In an interview with Morningstar just after the lawsuit was filed, he said cleaners left the drugs in his offices. But in a letter to clients sent on January 11 he dropped that defense, acknowledging that some of the materials were "vestiges of closed chapters of my life."
DAVID VS GOLIATH
Born near Buffalo, New York, Gundlach graduated summa cum laude from Dartmouth with a bachelor's degree in mathematics and philosophy and attended Yale University as a Ph.D. candidate in mathematics. A former drummer in a rock and roll band, he said he was inspired to work in financial services in the 1980s by an episode of the TV show "Lifestyles of the Rich and Famous" hosted by Robin Leach and featuring the 10 top-paying careers.
"I think, great! I'll just listen to that and figure out what I am going to do," he recalled. The No. 1 highest-paying profession at the time was investment banker. "The show said you need to have worked very hard -- not like I don't do that already -- and the show said you need to have an analytical mind -- and I said, I've got an 11 on a scale of 10 -- and I said that's what I am going to do."
Back then, there were no yellow page ads for investment bankers, only investment managers, Gundlach noted. "I thought, well, that was close enough," he said. He started at TCW in 1985 as a bond analyst on a 90-day probation and starting salary of $30,000.
Gundlach began managing money for TCW in 1986 and became its chief investment officer in 2005. By the time he was fired, he oversaw 59 percent of the firm's assets. He also specialized in mortgage-backed securities, and was chosen last year as one of nine portfolio managers in Treasury Secretary Timothy Geithner's Public-Private Investment Plan -- an effort to help get toxic assets off bank balance sheets using a mix of government and private funding.
One thing is clear: Gundlach's overall results are difficult to challenge. The TCW Total Return Bond Fund returned an average of 7.05 percent annually in the past five years, beating similarly managed funds by more than a quarter-percentage point per month, Lipper data shows. The fund gained 7.54 percent in the past 10 years, beating even the 7.15 percent return of Pacific Investment Management Co.'s Total Return Fund, managed by bond fund superstar Bill Gross.
Throughout the past decade, news stories have portrayed Gundlach and Gross as the David and Goliath of the bond world. Gundlach oversaw a fraction of Gross' more than $1 trillion in assets at Pimco.
Gundlach was not above self-promotion. Morningstar bond fund analyst Eric Jacobson recalled in a recent interview hearing increasingly bitter complaints from Gundlach in 2002 and 2003 about not being nominated for its fixed-income fund manager of the year award.
As 2004 was winding to a close, Jacobson, who was telecommuting from his home in Kansas City at the time, says he told Gundlach that Morningstar analysts were uncomfortable because they had never met any other members of Gundlach's team.
Gundlach chartered a private jet and flew to Kansas City with some colleagues and met with Jacobson at a hotel conference room by the airport for several hours.
Gundlach was a runner-up for manager of the year in 2004 and 2005 before ultimately winning in 2006. At the end of 2009, he was nominated, along with his rival Bill Gross, as Morningstar's bond fund manager of the decade. Gross won. (The two say they have never met.)
"It's an asset to have that level of confidence but it may have something to do with the predicament he's now in," Jacobson says now.
Former colleagues recall Gundlach as brilliant but arrogant. One recalls shortly after he joined TCW having lunch with Gundlach and being asked: "What's it like having lunch with a genius?"
Gundlach acknowledges that he frequently refers to himself in email as "The Godfather" or "The Pope" and occasionally sends reprimands to those who fail to use the monikers in addressing him. Still, a number of former TCW executives agree that Beyer and his team knew how to handle Gundlach. "You could manage Jeffrey with facts," one executive said. "You could appeal to his logical and analytical side."
Most of Gundlach's underlings call him a tough boss but say they appreciated working for such a talented manager. "Jeffrey isn't a touchy-feely guy," said Loren Fleckenstein, who worked under Gundlach at TCW for four years and, like others, followed the boss to his new firm. "He's a results guy."
Still, several former colleagues say Gundlach's arrogance was a turn-off for many institutional investors and kept him from building a fund as big as Bill Gross's Pimco. "It's entirely related to this issue of arrogance and his tendency to be rude," one former colleague said.
Perhaps not surprisingly, Gross is benefiting from the TCW fallout. Clients have pulled nearly $3 billion out of the firm and shifted it to Pimco, sources familiar with the matter told Reuters.
CALLING THE TOP
Gundlach was among the few investors who saw early signs of the coming real estate meltdown and managed to steer his fund clear of the damage. But he has also made a few bad investment decisions along the way.
He oversaw TCW's collateralized debt obligation products that have suffered billions of dollars in losses and contributed to the failure of AIG. In fact, before the credit crisis, TCW was among the biggest managers of CDOs, pools of asset-backed securities that frequently included subprime mortgages.
At least 11 deals TCW managed were among those insured by AIG, including those issued under the names Davis Square and Porter Square. A December 11 Fitch Investors report on one of the deals, Davis Square Funding II Ltd., noted that fully 24 percent of the securities backing the deal had defaulted. A November 19 Fitch report cited a 27 percent default rate for securities backing another TCW-managed deal called Porter Square CDO I.
Gundlach says AIG's relationship with TCW CDOs was "extremely small." A CDO equity fund he personally oversaw gained 28 percent, he says. And TCW moved away from using the weakest types of mortgage securities in 2006, he says.
Despite the CDO problems, most investors remember Gundlach's impressive track record running more typical bond funds, says financial adviser Larry Glazer, managing partner at Mayflower Advisors in Boston. "Investors believe he'll have a smaller asset base so he'll be even more agile and nimble buying his best ideas," Glazer said. "He may be quirky but if he can still perform, people will flock to him."
Tim Schlindwein, managing principal at Schlindwein Associates, thinks some big investors may be more cautious. Schlindwein, who used to run money manager Stein Roe & Farnham, now offers proprietary research on mutual funds. The burdens of setting up DoubleLine and fighting TCW's lawsuit are obvious distractions, he says. "Can somebody in that situation have their full focus on managing the assets? I'd take a pass," he says.
But as Gundlach pointed out to Stern during their September 3 showdown, SocGen has its share of distractions, too.
(Additional reporting by Sudip Kar Gupta, Joe Giannone, editing by Jim Impoco, Claudia Parsons )