Of 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.”

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