Up Against The Wall Dick Strong runs his mutual fund firm with a raging passion. And passion can get you into a lot of trouble.
(FORTUNE Magazine) – "I didn't sleep for 53 days straight," Dick Strong says, gripping the wheel of his Lexus, eyes fixed grimly on the road ahead. He's driving around Milwaukee talking about the trouble he and the mutual fund company that bears his name, Strong Capital Management, have suddenly found themselves in. "Maybe an hour or so a night. I've been working all day. That and working out, five days a week. Spinning classes. I've been grieving. It's like losing someone. Grieving. But six days ago I just stopped. I got over it. Time to move on. I had to go through the grieving, but now that's done."
Stopping at a diner, Strong takes a table near the door. Seconds later he changes his mind and calls for a table toward the back. He orders a club sandwich--cancel that, a roast beef sandwich--no, make that a turkey club. "Please, when you are writing, I ask you to consider our company," he says, leaning in close and affecting a stage whisper, "and consider our dreams."
This is, clearly, a man besieged, although it can be hard to separate what is distraught behavior and what is his own deep quirkiness, for which Strong is famous. His face is drawn, and his crazy, high-pitched hyena laugh comes infrequently now. His life's work--the mutual fund complex he built in Menomonee Falls, Wis.--is at stake. Strong Capital Management is his Siamese twin. Losing the business would be agonizing. But unfortunately for him, it's not outside the realm of possibility.
As the mutual fund scandal erupts into public view, Dick Strong finds himself at its center. Strong and his firm stand accused of unethical, and possibly illegal, activity. What's more, when you start to ask questions about Dick Strong, a pattern emerges of personal and professional behavior that not only is idiosyncratic but pushes the limits of acceptability. There are the tantrums. The revolving door for senior executives. The previous run-ins with regulators. When asked whether he was surprised that Strong was being accused of underhanded behavior, his former longstanding business partner, Bill Corneliuson, replies in a heartbeat, "No, not at all. Dick always pushes the envelope."
We don't yet know the full story behind Strong's legal woes, but here's what we know as of presstime. In early September, New York attorney general Eliot Spitzer alleged that Strong Capital and three other mutual fund companies had engaged in illicit trades with Canary Capital Partners, a New Jersey hedge fund. Spitzer accused Strong of allowing Canary to quickly jump in and out of its mutual funds to make a quick buck, a practice known as "market timing." While not necessarily illegal, market timing is frowned upon by fund management as it siphons money out at the expense of other shareholders.
Then, on Oct. 30, came a bigger bombshell. Strong's board of directors announced that it had "become aware of active trading of the Strong Funds by employees of Strong Capital Management, including Richard Strong." It was reported that Strong's market timing, which took place over several years, netted him a profit of some $600,000.
In addition, FORTUNE has learned that Spitzer's investigators have uncovered evidence suggesting that the compliance officials at Strong were told by other Strong executives to avert their eyes from the boss's market timing. Spitzer's office is now weighing the possibility of filing criminal charges against Strong, sources say. In a recent appearance before a congressional committee, Spitzer described Strong's alleged wrongdoing as a "case of gross malfeasance." Strong himself has vowed to reimburse the funds for any investor losses caused by his actions, and the firm has retained former SEC chief David Ruder to review its compliance procedures.
Why would a man who is said to be worth $800 million--who owns no fancy yachts or designer suits and who lives in the same stone house he built 30 years ago--risk it all on a six-figure pittance? The question is baffling to Strong's friends and foes alike.
"I don't care about money," says Dick Strong. That may sound far-fetched, but it is a sentiment one hears again and again from people who know Strong well. What has driven the 61-year-old is the ambition to build a dominant fund complex. "Dick is somebody who wants to build a company that will last for the next 100 years," says Kiril Sokoloff, an investment strategist who has known Strong for two decades. A fund consultant who once worked for Strong adds, "He wants to out-Schwab Schwab and out-Fidelity Fidelity." In 1996 his rallying cry to employees was "No. 2 in 2002."
Strong has few interests beyond his work. "If he asks you to play golf, you know it's because he wants to talk to you about something," says Steve Hannah, a former newspaperman who serves as his outside public relations consultant. "You'll be on the fourth hole when he's finished whatever he wanted to talk about, and he'll say, 'Okay, I think we're done here, right?'" Jody Lowe, Strong's former communications head, adds that Strong would always invite his wife, Donna, to business dinners because "that was the only time he would see her." Byron Wein, the former Morgan Stanley strategist, says that one of Strong's associates once told him, "Dick is the only man he knew who finds work, rather than rest, to be the perfect remedy for exhaustion."
For all that, Strong has largely failed to build the kind of company he dreams about. Today, although Strong markets 66 funds and has around $40 billion in assets, it is a far cry from Fidelity (more than $700 billion in assets), Vanguard (more than $450 billion), or even Janus ($96 billion). It has never come close to being No. 2; it currently ranks 43rd among the major fund families. Its overall fund performance during the past decade has been mediocre at best. According to Lipper, 65% of Strong's funds have underperformed during the past three years. The company has never been a serious contender in the all-important 401(k) business, which has been the growth engine for the fund industry at least since the early 1990s.
"Dick will never understand this about himself," says a former top Strong manager, "but he has always been the limiting factor." Dick Strong's own personality has consistently sabotaged his ambitions. In many ways his involvement in the current mutual fund scandal is simply the latest example of the flaws that have held back Strong--both the man and the company.
Strong founded his current company in 1974 and was soon joined by Bill Corneliuson, his now estranged partner. Strong had grown up in North Dakota, the son of a farm agent who died when he was 17. His mother died of leukemia six months later. He moved to Wisconsin to enroll in the University of Wisconsin law school--which he soon abandoned for the business school. He got fired from every job he had out of business school--"I'm impossible," he conceded to FORTUNE in a 1996 article--and his first attempt at running his own show also ended in failure. He co-founded a firm with Ab Nicholas--who is also now a well-known fund manager--but the firm got hammered during the 1973 bear market. The two men parted enemies and haven't spoken since.
With Corneliuson, though, Strong found both the right partner and the right moment. Strong was "highly energetic, bright, and creative," Corneliuson says now. "I'm the one who would say about Dick's ideas, 'Wait a minute, let's think this through.' I'm good at strategy and implementing the ideas." Corneliuson also managed money--though, he says, "Dick had the ultimate say."
The new firm had the wind at its back. In the late 1970s and early 1980s, as interest rates rocketed into the double digits--while bank interest rates remained regulated at less than 6%--companies such as Fidelity and Strong marketed a newfangled financial instrument called a money market fund. Those funds, which primarily traded in short-term commercial paper, allowed small investors to get far higher returns on their savings than they could get at the bank. Money market funds also wound up serving as the foundation for the modern mutual fund industry.
Money flowed into Strong/Corneliuson Capital Management. It had accumulated $40 million by 1980. Three years later--by which time the bull market was in full swing and investors were pouring money into equity funds--the number stood at $1 billion. Strong and Corneliuson flew the entire firm to England to celebrate. "We were like a rocket ship," Corneliuson recalls. "Dick was in seventh heaven."
By all accounts, Strong was an extremely aggressive money manager, and there was little he wouldn't do to generate good performance numbers for his fund. (In the early years his primary funds were the Strong Investment Fund and the Strong Total Return Fund; later he helped run Strong Discovery, among others.) He liked to make giant macro bets. "At times he'd be in domestic stocks, then he'd move into Russian stocks, then into junk bonds," says industry consultant Geoff Bobroff. "His fund was a microcosm of what he thought was going to happen in the world."
Back then, no one questioned his approach. Why would they? Strong was posting great numbers, which the firm would then trumpet in advertisements, which in turn would cause assets to pour in. That's how the fund industry worked in those days. Fund managers didn't worry about having to stick to certain investing styles. Swing-for-the-fences fund managers like Strong--not to mention Peter Lynch, who operated pretty much the same way at Fidelity Magellan--were celebrated in the press for their willingness to take outsized risks.
In the late 1980s and early 1990s Strong's penchant for taking excessive risk caught up with him. He had bought large quantities of junk bonds, both for his mutual funds and for the pension fund accounts Strong managed. But in 1989, a proposed LBO of United Airlines that would have been largely financed with junk bonds collapsed, and with it the junk bond market.
In the aftermath of that collapse, both the SEC and the Department of Labor accused Strong of conducting a series of "cross trades"--that is, trades between various Strong funds and pension accounts, without any intermediary. According to the Department of Labor complaint, Strong had made close to 1,600 such trades--and Corneliuson says today that Dick Strong himself was directing the Strong trading desk to make those trades. Such cross trades are forbidden by the SEC and the Department of Labor because they violate one of Wall Street's cardinal rules: the same entity can't be on both sides of a trade. Indeed, among the reasons Strong gave the Labor Department for the cross trades was that "the account which held the security, having already experienced a loss, should not risk further losses in that security...."
In 1994, Strong agreed to reimburse its funds $444,000 to settle the SEC investigation--without admitting or denying guilt--and agreed to set guidelines for personal trading. (Some of the cross trades were conducted with funds Strong ran for himself.) Two years later Strong settled the Department of Labor complaint by paying $5.9 million to reimburse pension funds that had been the victims of the cross trades. Most of the pension funds first learned of the Labor Department action when the checks from Strong arrived on their desks.
In later years Strong and his allies would characterize the junk bond scandal as a tempest in a teapot--merely an example of a good man who made a mistake because he was stretched too thin at a company that was growing too fast. Most reporters covering Strong bought it. But Corneliuson never saw the scandal that way. "I remember when the junk bond scandal broke, Dick called me and asked, 'So, Bill, what's your scheme?' And I said, 'Scheme? I don't have a scheme.'" Corneliuson continues, "I wasn't comfortable working with him. For Dick, the end justifies the means. I thought it was likely we would see this kind of thing again. I didn't want to go through another scandal like that." By the middle of 1993, Strong had bought Corneliuson out, and the two men had parted ways. Like Ab Nicholas, Corneliuson no longer speaks to Dick Strong.
The junk bond affair should have been a turning point for both Strong and his firm. Largely because of the scandal, Strong hired Thomas Lemke, a former SEC attorney with a sterling reputation, as the firm's general counsel. Strong also brought in a talented, outspoken woman named Rochelle Lamm to, among other things, push the firm into the 401(k) business, where the mutual fund industry was increasingly headed. He hired a high-profile marketer named Jay DeMartine from Fidelity Investments. And he had in place a handful of well-known fund managers, including Dick Weiss, who managed (and still co-manages) Strong's largest equity fund, Strong Opportunity, and Bradley Tank, who headed up Strong's bond funds (and was widely viewed as Dick Strong's heir apparent). If ever there was a moment when Strong could have catapulted into the upper ranks of fund families, this was it. But it never happened. By the end of 1998, after just three years at Strong, Lemke was gone. The other key managers brought in from the outside didn't last much longer. Never again would Dick Strong have a management team as strong as the one he put together in the mid-1990s.
In truth, what needed changing most was Strong himself, and that never happened. His staff would craft long-term strategies, which he would agree to implement--and then would ignore. "He just can't think long term," says John Dragisic, who was his second-in-command during the mid-1990s. Strong's family of funds had no overarching theme or vision; he preferred to jump on whatever was hot and trendy and ride it as hard as he could. Thus, when small-cap stocks were roaring in the mid-1990s, he hired Mary Lisanti, the hottest small-cap manager around, and reportedly paid her $1 million a year, at the time an eye-popping sum for a fund manager. Within two years, after she failed to produce the performance he had hoped for, she was gone. He launched Strong Emerging Growth when emerging growth was hot. And, perhaps most ignominiously, in early 2000, at the very top of the Internet bubble, Strong rolled out an Internet fund. Says Morningstar analyst Russ Kinnel: "Dick didn't have the patience to build a real fund company."
He also had a habit of becoming infatuated with a new hire and then turning on him or her. "We called it the shiny-new-car thing," says a former aide. "He would make a big splash when he hired someone. He would talk to that person all the time, and he'd insist that everyone listen to his wisdom. But it took very little time before the shine was off. When that happened, you didn't exist in his eyes."
It was the same with strategies. He would become wildly enthusiastic about starting, say, a fund supermarket or a discount brokerage, but then lose interest. "He just doesn't like to get out of his comfort zone," says another former top manager. As ever, his comfort zone was managing money and pushing for the kind of glittering performance numbers that the company could advertise. So that's what he did, even though the fund business had left that model behind.
And the push for yields that Strong could advertise continued to cause trouble for the firm. In 1997, for instance, Strong's three money market funds did the unthinkable--they "broke the buck," as they say in the business, meaning they suffered losses, which is simply not supposed to happen with money-market funds. It happened because the Strong funds had loaded up on the corporate paper of Mercury Finance, a scandal-tainted used-car lender whose paper was yielding higher-than-normal returns. Most fund companies avoided Mercury Finance's paper because of its subpar credit rating. But not Strong. The firm had to put up $30 million to make the money funds whole and keep Strong's investors from having to take the losses.
A few years later Strong's bond funds began to crater for much the same reason. The funds had loaded up with bonds from such highfliers as Enron and WorldCom, which of course had helped their performance in the 1990s. When the post-bubble scandals hit, those funds were hit far harder than many competitors' bond funds. In the summer of 2002, Strong fired the two men who had built the firm's bond department, including Bradley Tank.
Strong's willingness to fire people has long been cited by his defenders as one of his strengths. "Dick sets high expectations," says his ex-p.r. head Lowe. "And when they don't perform, he doesn't wait around." But he hasn't held himself, or his loyalists, to the same exacting standards. His own performance as a fund manager dropped steeply during the 1990s, but, says someone who worked closely with him, "he always had an excuse." (Strong finally stepped down as co-manager of Strong Discovery in August 2000.)
Strong's temper is also legendary. One person who worked closely with him recalls meetings in which Strong would react to questions and criticism by "gasping and weeping and throwing chairs." The most famous such meeting took place in 1999 when several of his senior management team were demanding both more autonomy and a small stake in the firm. According to an account in the Wall Street Journal, Strong brought one of the firm's long-time maintenance workers to the meeting in which he confronted the rebels. "You greedy bastards," he reportedly said. "Where were you when I started this firm? This is the type of loyal person you should want to be like." According to Rochelle Lamm, "the language he used was horrible, terrible. I couldn't take it. I was the only person to say to Dick, 'You don't have to melt down like this.'" Another person who was at that meeting remembers it as "awful. He humiliated the janitor, but Dick didn't care about that. It was a brutal display of his own power."
The year before, his senior staff had witnessed another display of Strong's power. He told his top aides that he was negotiating to sell the firm to a large British money-management company--and that he had negotiated huge retention bonuses for each of them. In private meetings he laid out how much each executive would be getting. "It was millions of dollars," recalls one aide. Not long afterward Strong broke off the negotiations and told the press that he didn't want to sell the firm after all. Of course the retention bonuses vanished as well. "It just seemed to me," says this same aide, "that he put us through the entire exercise just to show us who was boss."
Not that there has ever been any doubt about that. Strong is a neatness fanatic, so the lawn at the firm's suburban Milwaukee headquarters is cut as closely as a golf-course green. He once took a Money magazine reporter to the basement of the building to show him how clean it was. ("Look at that floor! You could eat off that floor!") For years facial hair was taboo at Strong, and very few of his employees dare to wear shirts of any color besides white. At the headquarters complex, he insists that the slots in the heads of all horizontally driven screws be aligned up and down, former employees say. Why? Because dust could accumulate in them otherwise.
One former Strong aide says, "He wants you to know that he came from North Dakota and he's better than you." Jody Lowe says Strong has tended to recruit people out of Midwestern universities because they were more likely to stay with the company than people from either coast. "A lot of them were like Dick--farm kids," she says. Last year Strong said to a Money magazine reporter, as they walked past a group of his employees, "Germans and Poles get things done."
"I gave a speech there once," recalls Don Phillips, managing director of Morningstar, "and I was talking about what a diverse company Morningstar is, full of people with different backgrounds. Then I looked out into the audience and realized that everyone in the room was young and white, and they were all wearing the same crisp white shirt." This hiring pattern means that Strong has created a company full of people where there is little independent thought. And a company where no one is willing to say no to Dick Strong. Which has now helped cause this terrible fix he finds himself in.
"I was born in North Dakota. The soil is terrible," Dick Strong says softly. "We came out of the Depression; there wasn't any money. We really had to work." We are back in the diner; Strong is talking with the aid of a script he has taken from his briefcase. "I found out early on I was different. I loved to read history, about leaders. I loved business. I sold honey, recycled papers, and cardboard. I was different, that's hard...I would like to be like everyone else, but the more I tried to be normal, the more difficult it became."
Strong won't talk about the allegations made against his company and himself. He will, however, talk about building his company. "We have recruited young people out of school who are good at sports and activities, who like competition," he says. "Peter Drucker told me, 'America was built by the kids from the plains who came to the city. They were hardworking and got knocked around by the weather.' We are loaded with talent."
That last comment is, at best, debatable. Over the years Strong has driven away much of his top talent--alienating them forever. It's not just Nicholas and Corneliuson who no longer speak with Strong. Rochelle Lamm says that in 1999 the firm threw a gala 25th-anniversary party for itself. "All the people Dick had hired and trained and helped and paid big salaries to ... there should have been dozens of well-wishers at the party. Not a single person came back. Not one."
If Dick Strong is charged with any crimes--or even if he winds up in settlement talks--it is quite possible that the government will force him to resign from the firm and agree to a ban on any future employment in the financial services industry. Certainly, that has been Spitzer's pattern with the likes of Henry Blodget and Jack Grubman. But unlike them, Strong owns about 85% of his firm, and because of his own dominant personality, there is really no one at Strong who can step in to replace him.
"They are a classic example of a midsized no-load fund family that is neither here nor there," says Morningstar's Russ Kinnel. "Can Strong survive?" he asks. "That's a good question." Says industry consultant Bobroff: "He is in a terrible space. I've seen other money-management companies get into trouble before, and they end up with nothing."
Over the years, Dick Strong has had plenty of offers to sell his firm and cash out; in 1998, he had an offer for $1.2 billion. Perhaps he should have taken it. But he was never in it for the money, and he's not like other fund executives. "Can you understand someone who is different?" he asks plaintively. "It is difficult. I ask you please to try."
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