The publicly-held, full-service investment banking and brokerage firm (fiscal 2002 revenues: $32.4 billion) was also facing investigations from the U.S. Securities and Exchange Commission (SEC), New York Attorney General Eliot Spitzer and others. In fact, the very same October day the "All-America" results were published, Morgan Stanley went public about a subpoena it had received in July from Spitzer's office for alleged violations of mutual fund trading rules. In addition, the SEC was weighing legal sanctions against the firm for allegedly using secret incentives with brokers who represented Morgan Stanley mutual funds. (Morgan Stanley declined requests for information or comment about any of its business units or the allegations against it.)

To be sure, Morgan Stanley is far from alone in being investigated by the regulatory authorities. And it has not been found guilty of anything, to date. The notorious triumvirate of recent Wall Street scandals -- Henry Blodget, Jack Grubman and Frank Quattrone -- came from Merrill Lynch & Co., Citigroup's Smith Barney and Credit Suisse First Boston, respectively, not Morgan Stanley. Nevertheless, many industry watchers are expressing grave concern about management's strategy and, more significantly, the firm's very future.

CLIENT CASUALITIES

"In the past two years, it's become apparent that [Chairman and CEO Philip] Purcell is much more interested in building the profit margins than maintaining or expanding the company's reach," says Richard Bové, an analyst at Hoefer & Arnett, a brokerage based in San Francisco. While that may not sound so bad at first, the implications over the long term are considerable. To Bové, the emphasis on profit margins means management is unwilling to spend extra money to build up lackluster departments, and cut prices -- and consequently eat into profits -- to retain corporate clients and entice new ones.

For the firm that was for many years among the top three advisers to the lucrative mergers-and-acquisition market, severing client relationships can have profound repercussions. Though it lags only Merrill Lynch in the amount of capital it wields (total capital is in excess of $78 billion), Morgan Stanley has fallen behind Merrill, Citigroup and J.P. Morgan Chase in its M&A business, according to a Bloomberg analysis. Its market share of M&As fell from 30.5% in 2000 to 17.1% in 2002 -- and it's expected to drop to 12.9% this year. Goldman Sachs, which currently boasts the largest market share, has nearly twice as big a portion as Morgan Stanley's now.

Indeed, Morgan Stanley has missed out on many large-scale M&A deals this year -- eight of the 10 biggest, according to Bloomberg. What's worse, some of them involved former Morgan Stanley clients. In March, for instance, one-time Morgan Stanley client Olivetti, the Italian typewriter maker turned information technology provider, rejected Morgan Stanley in favor of Merrill Lynch and J.P. Morgan to handle its $28 billion purchase of Telecom Italia. The telecommunications company, also a former Morgan Stanley client, was advised by Goldman Sachs and Lazard. Other ex-Morgan Stanley clients who recently chose rival banks for their acquisitions include American Express, First Data Corp., France Telecom, Harrah's Entertainment, Microsoft Corp. and Siemens, Bloomberg reports.

On the other hand, Morgan Stanley has been an active adviser for some 162 deals this year with an aggregate value of $98.7 billion. Nonetheless, Moody's Investors Service notes with concern the firm's dwindling share of M&A deals. Moody's Peter Nerby wrote in a late-September report, "Recently, Morgan Stanley's league table share in mergers and acquisitions appears weaker than its more typical top three position.... We will be watching closely to see whether MWD can demonstrate strong advisory fee momentum when activity recovers."

This isn't the same as questioning the firm's creditworthiness. Morgan Stanley's debt remains top-rated. Yet the fees it collects from advisory work have plunged 90% since 2000. While a decline may not be surprising, given the past two years' grueling economic slowdown, rival J.P. Morgan has somehow managed to grow its share of the M&A market to 15.4%, the second-largest piece of the pie.

REVEALING RESULTS

"The investment banking business, where Morgan Stanley was perennially a No. 1 participant in many different league tables, is stagnant," insists Bové, of Hoefer & Arnett. "It's dropped to the middle of the pack." Management, he says, "indicates it will continue doing business with a core group of clients. If those clients are active, Morgan Stanley will benefit. But while those clients are quiet, Morgan Stanley's banking operations are quiet, too. That's like saying it's no longer even trying to build market share, no longer competing with Goldman, Merrill and the rest for new clients."

That's just one man's opinion, to be sure. Morgan Stanley's Chief Financial Officer Stephen Crawford isn't buying it. In a late-September conference call, he reportedly told analysts, "We don't like our current position. It's something that we will be forced to talk about until the market share numbers are somewhat different." Crawford's reaction was prompted by recent performance figures, which show investment-banking revenues slipping. In 2002, they fell 26% to $2.5 billion. That was just half the number posted in 2000. But in the nine months ended August 31, 2003, revenues from all banking fees were down just four percent from the corresponding period a year earlier.

Other results were decidedly more promising. For the quarter ended August 31, overall net income surged an impressive 108% year-over-year and 112% sequentially to $1.3 billion or $1.15 per share, handily beating expectations which averaged $0.69 a share, as measured by Reuters. These results were helped by a new accounting procedure that allowed the firm to change the way it expenses equity-based compensation. The change boosted net income by some $350 million or $0.32 a share.

Much of the profitability came from fixed-income sales and trading, where net revenues more than doubled from the same three-month period a year earlier to $1.5 billion. Net revenues from equity sales and trading, however, declined 21% from a year ago to $830 million.

Not surprisingly, given this strong income statement, Morgan Stanley stock surged 34.3% this year through mid-October. It outstripped the Standard & Poor's 500 benchmark by 15.3 percentage points, though lagged shares of rival Merrill Lynch by 18.74 percentage points.

POWERHOUSE PURCELL

The man at the helm, Philip Purcell, 60, isn't easily fazed by such comparisons, or seemingly much else. A member of the board of the New York Stock Exchange that famously rewarded and then ousted Richard Grasso, Purcell publicly declared last April that Morgan Stanley's part in a 10-firm, $1.4 billion settlement related to the conflict-of-interest charges against analysts was not an admission of guilt. Moreover, he said, Morgan Stanley's $125 million share of that settlement should not discourage investors -- and by implication, shouldn't be used as a basis for private lawsuits. SEC chairman William Donaldson reproached Purcell for his unrepentant bravura.

Undaunted, Purcell issued a separate statement in May that his company would prosper because of its "intellectual capital." The University of Notre Dame graduate who earned an MBA from the University of Chicago knows something about utilizing intellectual capital. He worked at management consultant group McKinsey & Co. before joining Sears Roebuck & Co. in the late 1970s. By the early 1980s he was CEO of Sears' Dean Witter, Discover financial services unit. Purcell was instrumental in that division's spin-off in 1993. Four years later he spearheaded Dean Witter, Discover & Co.'s takeover of the Morgan Stanley Group. "At that time, he was one of the most, if not the most, exciting CEOs in the brokerage sector," recalls Hoefer & Arnett's Bové. "These were brilliant, innovative moves that defined Purcell as a unique powerhouse in the industry."

The original Dean Witter company opened its first office in San Francisco in 1924, 11 years before Henry Morgan and Harold Stanley quit J.P. Morgan & Co. and Drexel & Co., respectively, to form their own independent investment-banking firm in New York: Morgan Stanley & Co. The marriage of these two divergent, longstanding organizations 62 years later created a combined firm that was touted to benefit from Dean Witter, Discover's widespread, well-known retail network and Morgan Stanley's top-notch reputation with corporate customers -- the best of both worlds.

Today the firm maintains more than 600 offices spread across 28 countries.

FACING LEGAL SCRUTINY

Lately, Morgan Stanley's asset management and retail brokerage units appeared to be under almost as much pressure as its investment-banking operations. Regulatory pressure, that is. In July, securities regulators in New York and Massachusetts accused the firm of secretly holding illegal contests and other soft-dollar incentives to reward brokers who pushed Morgan Stanley mutual funds harder than other funds. Then a few shareholders personally sued the company for not disclosing such practices. In September, Morgan Stanley agreed to pay $2 million to the National Association of Securities Dealers, the oversight agency for the Nasdaq and AMEX markets, as a settlement. But the matter was reopened by the SEC, which is weighing sanctions against the brokerage.

At the same time, the SEC was reportedly investigating allegations that two Morgan Stanley funds, the Strategist Fund and the 21st Century Trend Fund, had engaged in insider trading back in the spring of 2001. These funds allegedly had foreknowledge of Dallas-based Suiza Foods Corp.'s plans to acquire Chicago-based Dean Foods -- both distributors of dairy and other processed foods -- before buying shares of the latter. The merger, completed in December 2001, was co-managed by Morgan Stanley.

In fairness, its own internal review concluded in September that the funds only purchased shares of the former Dean Foods after analysts at other firms had openly predicted such a deal was imminent. And the firm has not been found guilty of any wrongdoing. But with Attorney General Spitzer and the SEC joining forces to probe into alleged after-hours trading of mutual funds -- that is, charges that certain mutual funds allowed high-roller clients such as hedge funds to engage in market timing and other aggressive trading practices off-limits to individual investors -- these and other unflattering headlines came at a difficult time.

REDUCING RETAIL

Also in September, Morgan Stanley's money management division, which has $433 billion under management and some 400 professionals worldwide, sacked dozens of money managers, traders, analysts and others throughout the U.S. The entire equity operations in a Philadelphia suburb were wiped out, reports say. Job losses were also felt at Morgan Stanley's Van Kampen mutual funds operations in Houston. "Investment management is a core business," notes Bové, the analyst at Hoefer & Arnett. "By reducing its investment management operations, Morgan Stanley has made it clear it's not fighting hard for market share."

Reductions have been felt in other areas as well. Over the past year, more than 2,200 financial advisers from the global individual investor group were let go. The retail brokerage, with five million customer accounts, lost $3 million in the first half of this year. Compare that to rival Merrill Lynch, whose brokers earned more than $600 million in profits over the same period.

Yet nothing may be more emblematic of retail finances than the credit card. When Dean Witter, Discover got hold of Morgan Stanley in 1997, it brought the Discover card with it. But the marriage of bulge-bracket investment banking and plastic has been stormy. In August, when CEO Purcell commented that the card unit needed something "imaginative" done with it, Crain's New York Business observed that the Discover card has been "losing market share for years. With 46 million accounts, it now ranks as the sixth-most-popular credit card.... That's down from No. 2 in 1995."

Rumors spread that Purcell was planning to sell off the Discover business. The rumors were promptly denied. But, Analyst Bové points out, Purcell "doesn't want to build the Discover business either." Considering it's a hefty contributor to profits despite its declining market share, Bové considers this attitude "shocking." Credit card margins, he adds, are "so wide they blow everything else away."

Still, Moody's Nerby observed in his September report that intense competition, high levels of consumer bankruptcies and high unemployment made the Discover card's "defensive approach to account growth...prudent," given the current "challenging operating environment."

A FIRM FUTURE?

Notwithstanding such moderate views -- and the accolades flowing to the firm's team of analysts -- critics like Bové maintain that Morgan Stanley's focus on profit margins over all else, reluctance to expand shrinking business units and blatant downsizing of core operations are shortsighted at best. But clearly, it depends on whom management is trying to please. Some observers suggest Purcell and team's aim is to attract a buyer. "The emphasis on profit margins only makes sense if Purcell is dressing up the company for sale," Bové postulates.

He's so convinced of this he's got a Strong Buy on Morgan Stanley stock as a likely takeover target. Again, Morgan Stanley declined to comment, but Bové says the company disputes his conclusion. Who would be Morgan Stanley's ideal suitor? Bové says Bank of America Corp., though it denies any such intention, has several strategic interests that "line up perfectly." Morgan Stanley's sizable sales force would be an asset to the Charlotte, North Carolina-based commercial bank. The Discover card would be a boost to Bank of America's card business, too. And Bank of America's corporate client base of "tens of thousands of middle-market companies" could use the power of a major investment bank to expand; in turn, Morgan Stanley could use that base to lift itself back up the league tables. "The fit between the two couldn't conceivably be better," Bové insists. "If these two don't merge, it's almost a crime!"

Of course, only time will tell. If Bové is right -- if Morgan Stanley no longer wants to expand its businesses, and Bank of America does -- such a marriage could very well happen. One thing at least is clear: If this sort of prediction sells more Morgan Stanley stock, CEO Purcell certainly won't complain, no matter how much he may protest.