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The departure of Legg Mason's CEO raises questions about its future

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The second CEO in Legg Mason's history announced last week he was stepping down, raising the question: What's next for the Baltimore-based money manager?

Only the board — or more precisely, activist shareholder and Legg director Nelson Peltz — may know. And for now, Peltz isn't talking, at least publicly.

But the abrupt resignation of CEO Mark R. Fetting after fewer than five years at the helm has fueled speculation that Legg is headed for a breakup.

Legg has nine major money-management affiliates, some of which would be attractive acquisitions for other asset managers needing to fill out their lineup, analysts said. And the sale or spinoff of some of those affiliates would be a way for Peltz to quickly boost shareholders' value.

"He's certainly a major decision maker," said Richard Cripps, chief investment officer of EquityCompass Strategies in Baltimore, who previously worked 26 years at Legg. "He no doubt will have to consider the alternatives, which includes the breakup."

Legg has struggled to recover from the 2008 financial crisis. Compounding its difficulties were its ill-fated takeover of Citigroup's asset-management business in 2005 and weak performances by some of its funds. Its stock has languished, down more than 60 percent from when Fetting became CEO in early 2008.

The company also has been unable to stem withdrawals from its funds, largely by institutional investors. In early 2008, Legg managed nearly $1 trillion of clients' money. According to the latest figures released Thursday, assets under management rose by $3.4 billion in August to $639.2 billion.

A report by Stifel, Nicolaus & Co., however, said the August asset growth was below expectations, and money has continued to flow out.

Typically, the CEO and other top executives set the company's strategy and direction, and the board signs off on that, said Greggory Warren, senior stock analyst with Morningstar. But Fetting's resignation, which takes effect Oct. 1, signals that the board is steering the company now, he said.

At the wheel, some analysts say, is 70-year-old Peltz, a founding partner of the Trian Fund Management. The New York-based company owns 10.9 percent of Legg, making it the largest shareholder. A spokesman said Trian declines to comment on Legg.

Peltz took a big stake in Legg in 2009, when the stock market was down along with the shares of many financial services companies, said James Hardesty, chairman of Hardesty Capital Management in Baltimore. Peltz likely figured the hard-hit financial sector would rebound the most once the markets improved, which historically has been the case, he said. But that didn't happen.

Fetting had been making progress, Hardesty said, likening the CEO's job to undertaking a major construction project.

"A lot of work has to be done on the foundation before you see the results come to the surface," he said.

But the rebuilding of Legg's fortunes might not have been fast enough for Peltz or the board.

In exchange for a board seat in 2009, Peltz agreed to not amass more shares, gripe publicly or push for the sale of Legg's affiliates for about three years. That promise expires at the end of November. And, Hardesty said, Peltz isn't afraid to step in if he thinks he can unlock value.

"I think he lost patience right before the sun was coming up," Hardesty said. "He wants to exercise more control. I don't know what he wants to do with that control — and he may not."

Morningstar's Warren said Peltz is not a corporate raider who strips down a company and lays off employees. Peltz is an activist shareholder — and not a shy one, he said.

"He has a sense of how things should be done," Warren said. "He's not going to sit back quietly if things aren't going the way he thinks" they should.

The billionaire investor, who never finished college, has agitated for change at many companies that Trian has bought into, including Kraft Foods and Tiffany & Co. He is the non-executive chairman of Wendy's Co. and has muscled his way into director seats on the boards of H. J. Heinz Co. and, just last month, Ingersoll-Rand.

Many analysts speculate that what Peltz has in mind at Legg is to sell or spin off some of the money-management subsidiaries it acquired over the years. Rather than absorbing them, Legg has allowed the affiliates to operate largely independent of the parent company.

"It's such a loose confederation of different affiliates," Warren said. "It would be easier to split up than it would be [to break up] a more integrated collection of asset managers or businesses."

A likely candidate for sale or a spinoff is Legg's largest subsidiary, Pasadena, Calif.-based Western Asset Management, which is the third-largest fixed-income manager in the world, analysts said.

Other affiliates that analysts say could be placed on the block are international money manager Batterymarch Financial Management in Boston; New York-based Permal Group, which runs a group of hedge funds; and small-cap manager Royce & Associates in New York.

Likely buyers would be other major money managers that need to plug holes in their portfolios, analysts said.

But Daniel McHugh, president of Lombard Securities in Baltimore, predicted that rather than selling off select pieces, Legg would put the entire company up for sale.

"In this case, I see the whole as greater than the sum of the parts," he said.

The 5 percent jump in Legg's stock price on Tuesday's news of Fetting's resignation means "the market sees this as a step closer to a sale," McHugh said.

The stock closed Friday at $26.95 per share, up $1.48 — 5.8 percent — since the day before Fetting's announcement.

Any of the big money managers, such as Vanguard, Fidelity Investments and even Baltimore-based T. Rowe Price, would be interested, he said.

T. Rowe, through its mutual funds, is Legg's second-largest shareholder with a 9.75 percent stake. The company declined to comment.

But some analysts said that while T. Rowe would be happy to have Legg's assets, the companies' business models are so different that a merger is highly unlikely.

"The only similarity between T. Rowe and Legg Mason is they are both in Baltimore," Warren said.

Baltimore also has a stake in the future of Legg, which employs 3,000 workers, including 430 at its headquarters, a flagship tower in Harbor East.

It won't be clear what's in store for Legg until Peltz announces his plans or a new CEO is hired, Warren said.

If the new CEO comes from a company with a similar business model to Legg's, that would signal the company would continue in its current form, Warren said. Or, if the chief executive has experience with acquisitions, that could mean Legg plans to buy — or sell — subsidiaries.

Legg's chief financial officer told analysts last week the search for a CEO hasn't begun. In the meantime, Joseph A. Sullivan, head of global distribution, will serve as interim CEO and W. Allen Reed, Legg's lead independent director, will become non-executive chairman.

Meanwhile the 57-year-old Fetting, who joined Legg in 2000, will be leaving after fewer than five years as CEO.

That's not far off the average tenure of CEOs, which traditionally has been four years, according to Rhonda Reger, an associate professor of strategic management at the University of Maryland's Robert H. Smith School of Business.

Managers have little time to prove themselves, Reger said.

"You have to show early wins, whether you are a new middle manager in your division or you're the new CEO," she said. "You need to show some kind of progress within a year, or eyebrows start to go up."

Fetting shouldn't have been expected to meet that standard, given that he took the helm early in 2008, just before the financial crisis and Wall Street's meltdown, said Cripps of EquityCompass.

"There was a financial crisis that was certainly bigger than Legg Mason," he said.

Nevertheless, Cripps added, "It's not been a successful company for the last few years."

One of Legg's big problems was recovering from the 2005 takeover of Citigroup's asset management business. With that deal, Legg acquired money market funds larded with toxic securities. Legg ended up spending more than $1 billion to shore up the funds.

"The Citi acquisition turned out to be a terrible mistake and made during the prior administration," Hardesty said.

But, Cripps added, active money managers like Legg that hand-pick securities for their funds have been underperforming. Investors instead are moving into passively managed funds that simply mimic a benchmark by holding similar securities.

Jeff Tjornehoj, a senior research analyst at fund tracker Lipper, said Legg will have to keep trying to find ways to jump-start its weaker performers, such as one-time star fund Value Trust.

"Just like a professional team that has lost far too many games to make the playoffs, something is not right in the organization," he said. "Something has to change. The coach, the players or the playbook."

eileen.ambrose@baltsun.com

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