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Deal would free Legg from hassles of also running brokerage


At first glance, a potential deal to swap Legg Mason Inc.'s 1,540 brokers for Citigroup Inc.'s low-rated mutual fund business would seem to conflict with the Baltimore financial firm's historic practice of buying small, high-performing fund managers and letting them operate autonomously.

But analysts say the proposed deal makes sense because it would get the asset management firm out of the brokerage business - a relationship that has attracted greater scrutiny from regulators - and open more opportunities to distribute the company's funds through other brokerage companies.

With neither Legg nor Citigroup confirming a possible trade in the works, industry analysts were left to ponder the reasons such a deal would make sense for both - or why it wouldn't. The proposal would dovetail with Legg Mason's stated plans to expand its asset management business, which provides a more stable revenue stream than the smaller brokerage division that launched the company 43 years ago.

With substantial capital to spend after years of explosive growth, Legg has been in the market to make a substantial purchase to complete the transformation to a pure asset manager. Rumors of a deal have surfaced before, with Legg previously linked to a possible deal with Merrill Lynch.

"Asset management is much more stable than the brokerage business," said Eric Fitzwater, an analyst with SNL Financial in Charlottesville, Va., which does not own Legg shares or have a business relationship with the firm. "It simplifies their business ... and it's more aligned with their core competency."

In the deal, first reported Wednesday night on The New York Times Web site, Legg would trade its brokers for Citigroup's asset-management business, which would include the bank's $50 billion mutual fund division. Neither company would comment yesterday.

Citigroup's Smith Barney funds lag in performance compared with the Legg family of funds, which includes money manager Bill Miller's celebrated Legg Mason Value Trust. The fund has beaten the Standard & Poor's 500 index for a record 14 straight years.

"On the surface, it's not quite consistent with their history of buying just 'best of breed,'" said Jeffrey J. Hopson, an analyst who follows Legg for A.G. Edwards & Sons, which doesn't own the company's shares.

However, Legg could put under-performing Citigroup assets under its own managers or add them to existing Legg funds in a bid to boost returns, Hopson and other analysts said. That would be a departure from Legg's usual hands-off approach with funds it acquires.

More importantly, Hopson said, the deal would free Legg of regulatory hassles associated with being in the brokerage and asset management businesses.

The Securities and Exchange Commission has cracked down on firms that have rewarded brokers who sell their firm's funds to clients instead of better-performing funds managed by other companies. Morgan Stanley was fined $50 million last year for questionable sales practices.

"[Legg Chairman] Chip Mason has said that in the new regulatory world, they [regulators] are making it hard to own both distribution and manufacturing," Hopson said.

Analysts say the deal would provide Legg with opportunities to sell its funds in more outlets. Historically, Legg has used its own brokers as the primary outlet for sales of its mutual funds - particularly the highly sought Bill Miller funds. With the company's brokers gone, other much larger financial firms could step up to sell the funds, greatly expanding Legg's retail presence. Among them would be Citigroup, which has about 12,000 brokers who would likely carry Legg funds if a deal is struck between the two companies.

"It would give them a whole new stable of assets to sell through third parties," said David Haas, an analyst with Fox-Pitt, Kelton, which does not own Legg shares or have a business relationship with the company.

Haas said this could be one of a few large deals Legg is considering. "Legg has been on the prowl for deal opportunities," he said. "They have the capital to do it. This is probably not the only thing they are looking at."

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