Strong at the precipice

MENOMONEE FALLS, Wis. — For Richard S. Strong, founder and CEO of Strong Capital Management Inc., winning is everything. And that might prove to be his downfall.

Accused by New York State Attorney General Eliot Spitzer of earning around $600,000 in profits from market timing his own mutual funds, Mr. Strong has stepped aside as chairman of Strong Mutual Funds, although he is continuing as chief executive of Strong Capital.

If Mr. Strong did, in fact, do what he is accused of doing, he did so out of "just the need to win," said a consultant who requested anonymity. After all, Mr. Strong ranks 388th on the prestigious Forbes list of the 400 richest Americans — with an estimated personal fortune of $800 million.

"He made a career out of pushing the envelope … he got a vicarious thrill out of pushing things to the limit," said one former high-ranking portfolio manager at Strong, who asked not to be identified.

Mr. Strong declined to comment about the allegations or to be interviewed for this article. His firm issued a statement, following disclosure of the charges, that Mr. Strong will reimburse Strong-advised funds for any financial losses resulting from his transactions in those funds.

In an industry not short on egos, Mr. Strong stood out as a hard-driving taskmaster and a control freak. Interviews with former employees and industry experts portray Mr. Strong as smart and competitive, but also as someone who refused to relinquish control. That reluctance to delegate impaired the firm's ability to grow. It also hindered installation of much-needed internal compliance, some observers said.

Werner F. M. De Bondt, the Richard Driehaus professor of behavioral finance at DePaul University, Chicago, who knows Mr. Strong, likened Mr. Strong's situation to a Greek tragedy.

Mr. Strong's "greatest strengths are also his greatest weaknesses," Mr. De Bondt said. "My impression when sitting in a room with him was that he had to be completely in charge, and even though there were other people around who were paid a lot to have opinions, those others didn't get to express their views. …"

"It's a mixture of wanting to be on top and feeling a little lonely once he got there, because there are few to contradict him. Entrepreneurs like him look for mastery. It's what drives them, to get control of the project, to experience the pure joy of doing it right," Mr. De Bondt said. "There is no logical reason for it. The money doesn't mean anything to him."

An industry consultant who knows the firm and its founder well, but preferred to be anonymous like many interviewed for this article, explained: "I think it's ego and arrogance that are behind this. … I don't know that he thought he was doing anything that risky or that wrong. …

"The notion of entitlement and winning is what drives Mr. Strong, who has a super A-type personality," the consultant continued.

"Super egos like his are great for starting a business, but can stifle its growth. Strong should be a $200 billion complex by now, but it's not. (It had $42 billion under management as of Sept. 30). It's been stuck at this level for a while, because it needs a broader set of skills, personality and culture to grow to the next level. A company can get just so big built around a single personality."

Another problem at Strong is the lack of people with operating backgrounds, observed Mark Esposito, managing partner at the New York office of executive recruiters Christian & Timbers.

"Their compliance and control infrastructure is way out of whack. It's either underutilized or underfunded, and they didn't take it seriously. None of these companies (cited in Mr. Spitzer's investigation into trading at mutual funds) did, and these investigations are just the beginning of a windstorm blowing across the industry. Everyone has been focused on returns. Companies didn't have these issues until the business grew so much in the last five or six years. A risk management infrastructure didn't exist. No one was accountable, because the leadership didn't understand this kind of thing can happen. Most people (in the industry) don't have operational backgrounds. They need to bring in people from outside the industry who have it."

Strong announced late last month that it was implementing more rigorous monitoring policies of its trading and enhancing its monitoring and compliance systems for associates trading in the mutual funds.

But others in the business defended Mr. Strong. "He's a great guy," said Doug Hanslip, managing director and senior client partner at executive recruiters Korn/Ferry International, New York. Mr. Hanslip believes if Mr. Strong had engaged in the trading, it was "because it was a profitable way to make money. In the end, he traded to make a profit, and now we've learned it's the standard industry norm." Korn/Ferry has done work for Strong Capital in the past.

"Dick is a hard, demanding manager," Mr. Hanslip said. "The industry is driven on absolute return now. Relative returns aren't enough any more, so managers like him are demanding more from their employees."

And Don Phillips, managing director at Morningstar Inc., Chicago, pointed out: "I don't believe he saw it as something that might be harmful to shareholders. He was always a very active trader, with high turnover, using a style where you move assets around quickly. It's not an issue if you do that with individual stocks. I think he thought it was better to do that through his own funds than through stocks.

"There is no way to defend his trading in excess of the rules laid out by his own firm's prospectus. But we don't know yet just what he's guilty of. Mr. Spitzer hasn't yet laid out the evidence, although he's declared him guilty. There is market timing where you're taking advantage of inefficiencies in the investment process, which is not the same as taking advantage of stale prices on international funds. If he was doing the latter, it's unforgivable. If he was only doing it to take advantage of investment inefficiencies, he should have been stopped by someone at the company."

Since formal charges have yet to be levied against Mr. Strong, the experts could only speculate about the future. "I don't see how the company would survive without him," Mr. De Bondt said.

"Maybe this will finally push him to sell the firm," observed the consultant quoted earlier. "There are firms out there looking to buy asset management companies, and he gets offers regularly."