Morgan Stanley Chief Grappling With New Risk

John J. Mack stood before his board and shareholders at Morgan Stanley’s 2007 annual meeting and struck an aggressive tone. Coming off a year of record profits fueled by using the firm’s capital to take some highly lucrative risks — particularly by diving deeply into subprime mortgages, leveraged loans and complex derivatives — Mr. Mack had much to celebrate.

“Do we take a lot of risk? Yes,” he said forcefully, in response to a shareholder who questioned him about Morgan Stanley’s reliance on risky trades and increased debt to finance these positions. “I think this firm has the capacity to take a lot more risk than it has in the past.”

Next month, at Morgan Stanley’s annual meeting, Mr. Mack is unlikely to be so bold.

Having presided over close to $11 billion in write-offs and a wholesale revamping of Morgan Stanley’s risk management process, Mr. Mack faces an investor community that is raising questions about his ability to continue leading Morgan Stanley as he has.

The CtW Investment Group, a shareholder activist group representing union-sponsored pension funds with about $1.4 trillion, is weighing a campaign aimed at persuading Morgan Stanley investors to withhold their vote for Mr. Mack as chairman. The hope is to persuade Morgan Stanley’s board to appoint an independent chairman. An announcement of the effort could come as early as Wednesday.

In a statement, a spokesman for the board, Mark Lake, said, “We are comfortable with John Mack’s role as both C.E.O. and chairman of Morgan Stanley and also have a strong independent lead director.”

The proposal does not suggest that Mr. Mack leave the board or resign from his job as chief executive — nor is it binding, even if more than 50 percent of shareholders vote in its favor.

Moreover, Mr. Mack, who still enjoys plenty of support from directors and shareholders, is expected to preserve his dual status for now.

Nevertheless, the move strikes a wounding blow to Mr. Mack. And by forcing investors to contemplate the measure, it raises awkward questions for the Morgan Stanley board about Mr. Mack’s decision-making, strategy and succession plans.

“The argument for John Mack stepping down as chairman is pretty strong right now,” said William Patterson, executive director of CtW Investment Group. “Everything we have seen suggests that this board is excessively protective of its C.E.O. The losses that Morgan Stanley took and the risk were unwarranted.”

Mr. Patterson pointed out that among the chief executives of Wall Street firms that have taken major write-downs, Mr. Mack is the only one who remains in his post.

The campaign against Mr. Mack comes at a time of increasing investor fear over Wall Street’s prospects as the bite of the credit squeeze becomes more acute.

Yesterday, the stock of Bear Stearns plunged 11 percent, to close at $62.30, on rumors that the firm was experiencing a liquidity crisis. Alan D. Schwartz, the chief executive of Bear Stearns, said that the firm’s cash position and its capital “remain strong,” but the broader unease remained.

As for Morgan Stanley, “there is widespread belief that the Citigroup and Merrill Lynch boards have taken the right step and made leadership changes,” Mr. Patterson said, dismissing Mr. Mack’s move last year that forced out his former protégée who oversaw the firm’s trading operation. “The Morgan Stanley board needs to do more. Firing Zoe Cruz is not enough.”

Shares of Morgan Stanley fell $1.56 Monday, to $38.30, down almost half from their 52-week high of $75.49.

CtW is also weighing a call to withhold votes for C. Robert Kidder, Morgan Stanley’s lead director, and Howard J. Davies, the former head of the Financial Services Authority, Britain’s top financial regulator.

Both directors were on Morgan Stanley’s audit committee in 2005 when Mr. Mack took over as chairman and chief executive and allowed the top risk officer to report to Ms. Cruz instead of Mr. Mack.

The group has also sent letters to the boards of Merrill Lynch, Citigroup, Bank of America, Washington Mutual and Wachovia questioning the conduct of the audit committees of those financial institutions. Merrill Lynch, Bank of America and Wachovia all have chairmen that also hold the chief executive title.

To date, Mr. Mack has made the case to investors as well as his board that the firm’s $9.4 billion write-down was the unfortunate but isolated result of a group of traders who made a disastrous bet on the subprime market.

By doing so, Morgan Stanley has argued, they saddled the firm with an illiquid and ultimately worthless position in collateralized debt obligations, which are complex pools of securities tied to subprime mortgages.

Mr. Mack took full responsibility and asked his board not to pay him a bonus last year. He has also appointed a senior executive, Kenneth M. deRegt, to oversee risk and report to him.

In its talks with Mr. Patterson, Morgan Stanley has argued that the write-down, bad as it may have been, should not result in Mr. Mack’s losing his job as chairman.

Mr. Mack’s critics contend that it is not so much the faulty subprime trade that should be held against him as it has been a combination of other factors. Those include not only failed deals for Saxon Capital, a mortgage originator, and Goldfish, a credit card company, but more broadly, what they see as his failure to manage the firm’s capital position effectively.

Increased borrowing and an accumulation of risky assets put excessive strain on the firm’s equity position, they note, forcing Morgan Stanley to raise expensive funds from China when the trading losses arose, even though the firm made $2.3 billion in profit last year.

Mr. Patterson represents only 5.7 million of Morgan Stanley shares, under 1 percent, and he concedes that forcing a popular executive like Mr. Mack to give up his chairman title is a long shot. This week he plans to contact shareholders about the proposed action as well as the proxy advisory firms and he said that he would lobby investors before the annual meeting on April 8.

“There was a failure of Mr. Mack’s leadership when the board restructured the risk reporting structure,” he said. “Shareholders should review this and they will review this.”

How investors will react remains unclear. While many top Morgan Stanley investors said privately how unhappy they were with Mr. Mack’s performance last year, they have not pushed Morgan Stanley to replace him. Their refrain has been a consistent one: who better is there to succeed him?

Mr. Mack has appointed James P. Gorman and Walid A. Chammah as co-presidents. But the consensus, both within the firm and outside, is that these two executives are at least two years away from being seen as capable successors. Mr. Mack’s contract ends in 2010.

In fact, people who have spoken with board members about Mr. Mack say that directors share a similar view. While they too are unhappy with the losses, they see Mr. Mack, who is 63 and has spent 30 years at Morgan Stanley, as the person best placed to lead the firm to recovery.

Some disgruntled investors have begun to discuss names of outside executives who might be not only viable successors to Mr. Mack, but also would lend a degree of independent stature to a board that many investors say has become too beholden to its chairman and chief executive.

Topping this list is Robert K. Steel, under secretary of the Treasury for domestic finance, and a former top executive at Goldman Sachs.

Investors, speaking on condition they not be identified, say that the combination of his recent government work dealing with the fallout from the housing crisis and his time at Goldman make him an ideal candidate to become independent chairman.

Mr. Steel and Mr. Mack share a deep bond over Duke University, their alma mater. Mr. Steel is chairman of the university’s board; Mr. Mack is a former trustee himself. But there are no indications of talks between Mr. Steel and Morgan Stanley.