By Mina Kimes
December 15, 2010

The battle between bond manager Jeffrey Gundlach and his former firm, TCW, is getting even more muddled after revelations of a government inquiry.

More than a year has passed since L.A. money management firm TCW fired its star investor, Jeffrey Gundlach, but their bitter feud, chronicled in Fortune earlier this year, shows no signs of cooling off. Both sides, who are still mired in a legal battle, said last week that they are also involved in a federal investigation — but they disagree about the reason for the probe, sparking yet another public dispute.

The TCW-Gundlach saga began last December, when the investment firm, which has about $110 billion in assets under management, fired Gundlach and announced that it was acquiring another L.A. investment firm, Metropolitan West Asset Management. The news stunned the mutual fund world: Gundlach, who is reputed in investing circles for both his mortgage bond expertise and his outsized personality, was overseeing more than half of TCW’s money at the time. He was also one of the nine fund managers picked by the U.S. Treasury to run a Public Private Investment Program (PPIP) fund, a venture in which TCW would purchase toxic securities on behalf of both the government and private investors.

After Gundlach was fired, about forty of his colleagues followed him out the door. Days later, he announced that they were starting a new fund company, DoubleLine Capital.

In early January, TCW sued Gundlach for more than $200 million, alleging that the fund manager had been plotting for months to leave the company and had stolen trade secrets. Around the same time, the company liquidated its PPIP fund, which the government had frozen, citing the key person provision that was triggered when Gundlach left.

Since then, both sides have been relatively quiet in advance of their court date next July. Gundlach’s new firm, DoubleLine, has accrued about $7 billion in assets, and TCW managed to stem the losses that occurred after he left. But the revelation of the government inquiry has revived their dispute and dredged up questions about the reason—and timing—behind TCW’s decision to fire Gundlach.

The government’s role

According to an SEC filing by DoubleLine, both the U.S. Attorney for the Southern District of New York and the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) are involved in the probe. The inquiries, according to the filing, pertained to both TCW’s charges that Gundlach and his colleagues stole proprietary information and the dissolved PPIP fund.

Both sides have confirmed the investigation, but they disagree about the nature of the inquiry. TCW’s lawyer, Steve Madison, says it solely concerns TCW’s allegations that DoubleLine stole proprietary information. “It relates to trade secret theft, and TCW has been informed that it is the victim,” he says.

The only reason that SIGTARP is involved, he says, is that information related to the PPIP fund was included in the alleged data theft.

But Robert Mintz, a lawyer at McCarter & English who specializes in government investigations, says it would be unusual for the DOJ and SIGTARP to take on the TCW case for reasons other than the PPIP fund. “Typically, federal prosecutors are not going to get involved in a trade secrets lawsuit that involves two well-heeled parties,” he says.

DoubleLine, meanwhile, says that it isn’t yet clear that TCW is the real victim of the investigation—and it stresses the involvement of SIGTARP and the PPIP fund, the very involvement that TCW downplays.

Spokesman Lew Phelps says officials from SIGTARP were present at every meeting held between DOJ investigators and DoubleLine staffers. The company issued a press release that focused on the PPIP fund, accusing TCW of making the decision to fire Gundlach before it accepted the award, thereby exploiting the fund manager’s name to “lure” the government into awarding them the mandate.

TCW was given the PPIP assignment in July of last year, and it was funded twice, in late September and November, according to DoubleLine. The company says it has evidence—sealed until the July trial—proving that TCW was planning on firing Gundlach long before then.

Indeed, in a December 2009 company-wide conference call reviewed by Fortune, TCW Chairman Robert Day insinuated that the company’s CEO, Marc Stern, made the decision to fire Gundlach earlier in the year: “This was something we didn’t bring on, we didn’t want to do,” he said of Gundlach’s firing. “And I guess Marc said in September we didn’t have any choices.”

Asked to respond to that quote, Madison would only say that TCW decided to fire Gundlach in December. “By the time Gundlach was terminated, he had already started his new firm,” he adds.

The office of SIGTARP did not respond to a request for comment. It’s unclear whether TCW would have violated its contract if it had it accepted funds after forging plans to fire Gundlach—or, by that same token, if Gundlach would have been in the wrong if he had been plotting to leave at the same time. Either scenario could be problematic in the eyes of the government, says Mintz.

“Any instance in which there is an allegation that an entity had made knowingly false statements in order to procure some from of government business is something that a U.S. Attorney’s office would be certainly interested in investigating,” he says.

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