ARTICLES MODERN

By Christine Harper

Nov. 30 (Bloomberg) — Zoe Cruz, co-president of Morgan Stanley and Wall Street’s highest-paid female executive, was ousted three weeks after the firm disclosed $3.7 billion of losses on mortgage-related securities at the division she oversaw.

Cruz, 52, was viewed by analysts as a leading candidate to succeed Chief Executive Officer John Mack. Her departure adds to the list of banking executives who have lost their jobs amid more than $50 billion of credit losses tied to subprime home loans. Warren Spector, the former co-president of Bear Stearns Cos., was forced out in August, followed by Merrill Lynch & Co. CEO Stan O’Neal and Citigroup Inc. chief Charles O. “Chuck” Prince III.

“In this environment, if things happen on your watch, then the door is where you are pointed,” said Ken Crawford, who helps oversee $950 million at St. Louis-based Argent Capital Management, which holds Morgan Stanley shares. “At investment banks of late, it’s hard to say that big heads have not rolled.”

Morgan Stanley, the second-biggest U.S. securities firm by market value, also demoted Neal Shear, the top trading executive under Cruz. Walid Chammah, 53, and James Gorman, 49, will replace Cruz, who worked at New York-based Morgan Stanley for 25 years, and Robert Scully as co-presidents, the firm said yesterday in a statement. Scully, 57, will join a newly created office of the chairman.

Morgan Stanley has tumbled 23 percent this year to $52.34 in composite trading on the New York Stock Exchange, the steepest annual decline since 2002. While the stock trails the 13 percent gain by Goldman Sachs Group Inc., the biggest U.S. securities firm, it has outperformed Merrill’s 38 percent drop and Bear Stearns’s 39 percent slump.

Promoted by Purcell

Cruz, who was promoted to co-president in 2005 by Morgan Stanley’s then-CEO Philip Purcell, received about $30 million in compensation last year. Sallie Krawcheck, chairman of Citigroup’s wealth management unit, earned about $9.9 million, company filings show.

Cruz held on to the president role after Purcell was forced to resign amid investor discontent in 2005. After Mack took over later that year, he made Cruz responsible for overseeing institutional securities and the brokerage division managed by Gorman, while Scully was tasked with supervising the asset management unit and private equity.

“I’m surprised, she’s been a big disciple of John Mack,” said Douglas Ciocca, who helps manage $1.6 billion, including Morgan Stanley stock, at Renaissance Financial Corp. in Leawood, Kansas. “It may well be to satisfy the public’s need for scapegoats.”

Divisive Figure

Cruz, who was born in Greece and received undergraduate and MBA degrees from Harvard University, started her Morgan Stanley career in 1982 as a bond trader. She became a managing director in 1990 and helped run foreign exchange before taking charge of fixed income, commodities and foreign exchange in 2000.

Under Purcell’s leadership, Cruz clashed with her then-boss Vikram Pandit, who oversaw institutional securities, according to “Blue Blood & Mutiny: The Fight for the Soul of Morgan Stanley” by Patricia Beard (William Morrow, 2007). Cruz thought Pandit should allow her to take bigger trading risks to improve revenue, while Pandit thought any blame for the unit’s underperformance should lie with Cruz, according to the book.

Cruz became a more divisive figure at the firm after she accepted the promotion to co-president along with then-Chief Financial Officer Stephen Crawford. The action caused senior executives including Pandit, John Havens, Joseph Perella and Terry Meguid to quit the firm in protest. None was willing to return to Morgan Stanley, even after Purcell’s departure, because Mack didn’t replace Cruz, people familiar with the situation said at the time.

Trading Risk

Morgan Stanley spokesman Mark Lake said Cruz and Mack declined to comment.

Under Mack, Morgan Stanley has taken bigger trading risks and expanded its mortgage securities business.

Value-at-risk, an estimate of the potential losses that the firm’s trading division could sustain in one day, jumped to an average of $87 million in the third quarter from $56 million a year earlier. The firm paid $705 million in December to buy Saxon Capital Inc., a mortgage provider that also services home loans to people with patchy credit histories.

Fixed-income trading revenue surged in the second quarter to $2.9 billion from $1.3 billion two years earlier. In the third quarter, which ended in August, revenue dropped to $2.2 billion on “significantly lower” profit from credit products, the firm said on Sept. 19.

September and October proved worse, as rising defaults on home loans reduced the value of debt products linked to mortgages. Morgan Stanley said Nov. 7 that it lost $3.7 billion in the two months on trades related to subprime mortgages, cutting fourth- quarter profit by an estimated $2.5 billion.

`Feet to the Fire’

Maximum potential losses from subprime-related assets stood at $6 billion at the end of October, down from $10.4 billion at the end of August, the company said at the time.

The losses “offset most of the gains that Mack made in fixed income,” said Brad Hintz, an analyst at Sanford C. Bernstein & Co. who rates the stock “outperform.” “Zoe is accepting responsibility. Mack holding people’s feet to the fire is par for the course.”

Morgan Stanley said in yesterday’s statement that it plans to announce fourth-quarter earnings during the week of Dec. 17.

“Disclosures in early November reflect the full extent of the firm’s direct subprime-related exposure, as of October 31,” the statement said. “The company noted at the time that the actual impact on the firm’s fourth quarter financial results would fluctuate based on market conditions in November.”

Rising Losses?

Fourth-quarter profit probably will fall 87 percent to $297 million, based on the average estimate of nine analysts surveyed by Bloomberg.

Cruz’s departure and Shear’s demotion may spur speculation that the firm’s losses increased in November, said Gary Goldstein, CEO of Whitney Group, a recruitment firm based in New York.

“Morgan Stanley’s likely to take some bigger write-offs again,” he said. “Ahead of that announcement she is stepping down, and they’re making changes in anticipation.”

Shear, a former commodities executive who rose through the ranks to run the entire securities trading operation overseen by Cruz, will now return to the commodities unit as chairman. Michael “Mitch” Petrick, 45, will take over trading, assuming Shear’s responsibilities as co-head of institutional securities sales and trading with Jerker Johansson, 51, the firm said.

Tufariello Exits

“We’re putting in place a leadership team that is ideally suited to help Morgan Stanley realize the opportunities ahead, while continuing to navigate the current challenging conditions,” Mack, 63, said in the statement.

Tony Tufariello, global head of securitized products at Morgan Stanley, is also leaving amid the management changes, said a person familiar with the situation. Tufariello, who was a member of the firm’s management committee, oversaw the mortgage businesses. He didn’t immediately respond to a voicemail left at his Morgan Stanley office.

Chammah, based in London, was most recently chairman of Morgan Stanley’s business in Europe. Gorman, who is in New York, joined the firm in 2006 to oversee the wealth management division. He previously ran the brokerage unit at Merrill Lynch.

Mack’s decision to promote Chammah, who joined Morgan Stanley’s debt underwriting division in 1993, is “no surprise,” said Whitney Group’s Goldstein. Chammah is “well known and well liked inside the organization,” Goldstein said.

`Pregnant Question’

“He’s very close to John Mack, they are very loyal to each other,” Goldstein said. “What’s interesting is that he’s pairing him with Gorman, but I guess that they’re making a commitment to their retail business as well.”

Institutional securities, Morgan Stanley’s largest division by revenue, will report to Chammah, the statement said. Gorman will oversee the brokerage division, which he was already running, as well as asset management, which is led by Owen Thomas.

“The most pregnant question related to these moves is the firm’s attitude to putting the firm’s capital at risk,” Richard Bove, an analyst at Punk, Ziegel & Co. in Lutz, Florida, wrote in a note to investors. Purcell was ousted “in part due to an unwillingness to do this. Mr. Mack aggressively pursued this policy. Will Mr. Mack now revert to Mr. Purcell’s strategy?”

To contact the reporter on this story: Christine Harper in New York at charper@bloomberg.net .

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