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Morgan Stanley Strives to Coordinate 2 Departments, Often at Odds

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Several hundred Morgan Stanley retail branch managers descended on the JW Marriott Orlando Grande Lakes resort in Florida early this month for a retreat. They were greeted by an unlikely colleague, Colm Kelleher, who runs the company's sales and trading and investment banking departments.

Traditionally, traders and investment bankers think of themselves as the elite of Wall Street and look down on the retail business, seeing it as pedestrian. Yet Mr. Kelleher had a message for the branch managers: His group can work with retail brokers to increase profits at Morgan Stanley.

That message evokes the strategic emphasis that followed the 1997 merger of Morgan Stanley with Dean Witter, Discover & Co. The rationale for that deal was to create a financial supermarket where the retail brokerage and the investment banking businesses could complement each other.

But the company's swaggering traders wanted little to do with the financial advisers, creating tension and turmoil that would lead to upheaval at the top.

The company over the years has set up revenue sharing agreements between bankers and traders. But that, too, created strife, with bankers and traders accusing each other of deliberating misstating revenue to avoid splitting fees, which some traders called the investment banker tax.

"Morgan Stanley has a horrible history of getting these groups to work together," said Richard Bove, an analyst with Rafferty Capital Markets.

Yet since Morgan Stanley moved to acquire control of the Smith Barney brokerage business from Citigroup in 2009, the balance of power has shifted to wealth management, which now accounts for almost 52 percent of the company's earnings, up from roughly 16 percent in 2006.

Gregory J. Fleming, the chief of the brokerage business, and Mr. Kelleher have been under pressure from shareholders to coax greater profits from the low-margin brokerage business by finding ways for retail and investment banking to work better together. The two men are said to have a good working relationship, leading to renewed optimism that the company can finally find synergies among its various divisions.

That is a change from a few months ago, when cooperation was difficult, according to employees at the company, because of personality conflicts between Mr. Kelleher and the investment banker Paul Taubman, who were the two co-heads of the institutional securities business. The employees spoke on the condition of anonymity because of the policy against speaking to the news media without permission.

Mr. Taubman departed recently after a power struggle, leaving Mr. Kelleher solely in charge of sales and trading, and investment banking.

In recent months, the company has made changes intended to improve communication among divisions. Last fall, Morgan Stanley transferred Eric Benedict, an ally of Mr. Kelleher, to wealth management to run its capital markets operation. Previously Mr. Benedict worked for Mr. Kelleher on the equity syndicate desk.

A few months after Mr. Benedict moved to wealth management, the company created a bond, or fixed income, sales group to focus on middle-market clients. The company then transferred some of its smaller banking clients into wealth management to give them more attention. The fixed-income division will share revenue from this middle-market unit with wealth management.

James P. Gorman, the chief executive of Morgan Stanley, is hoping that its sales and trading unit will work more closely with wealth management to increase lending, better tailor structured products for retail clients and improve collaboration on events like public offerings, company insiders said.

For instance, Morgan Stanley may take a company public and the executives at that company may need advice managing their personal wealth. In such an instance, the bankers would alert wealth management, which could dispatch a broker to assess the situation.

In January, on a call with investors to discuss the company's fourth-quarter results, Mr. Gorman said 35 projects were under way to encourage collaboration between these businesses. One focus is how to increase lending to the firm's corporate and individual clients.

A lot is riding on Mr. Gorman's strategy. Morgan Stanley, which for years was best known for its high-flying trading operations and investment bank, was badly bruised in the financial crisis. Since then regulators have established rules that require banks to post more capital against riskier operations, compelling Morgan Stanley to scale back or get out of certain businesses. Morgan Stanley has shrunk its fixed income department, where most of its risk taking was embedded.

But, if Mr. Gorman can make it work, Mr. Bove predicted the chief could return Morgan Stanley to its former glory, "albeit in a different form." Mr. Bove has a buy rating on Morgan Stanley.

Morgan Stanley emerged from the financial crisis safer, but less profitable. In 2012 it posted a return on equity (excluding a charge related to its debt) of 5 percent. Return on equity is an important measure of how effectively shareholder money is being deployed. Goldman posted a return on equity for the same period of 10.7 percent. To simply cover its debt expenses and other capital costs, Morgan Stanley must achieve a return on equity closer to 10 percent.

Investors also focused on another number, from Morgan Stanley's wealth management unit. That division posted a pretax profit margin of 17 percent in the fourth quarter of 2012, exceeding most analysts' expectations.

The number was higher than expected, according to people briefed on the matter but not authorized to speak on the record, because the company deferred from the fourth quarter some major costs like compensation for certain executives.

As a result, some analysts and rivals are wondering how sustainable that level is. Morgan Stanley insiders say while some one-time items did help increase that number, it wasn't significant and they expect Mr. Fleming to produce a lower but still high pretax profit margin for the current quarter.

"Although the first-quarter margin is seasonally lower, we believe that we can drive margins to the high teens and above over time even with only with modest revenue growth and a low interest rate environment," said Ruth Porat, chief financial officer at Morgan Stanley, on a conference call last week with fixed-income investors.

For that number to rise significantly, Mr. Fleming must make some of recent initiatives work, analysts say.

"Everyone is watching that number," said an executive at a rival firm who was not authorized to speak on the record. "If they can increase, it will be a sign Gorman's strategy is working, but so far not everyone is convinced."

—Written by Susanne Craig for The New York Times

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