For Legg, deal would fit strategy

THE BALTIMORE SUN

Reports that Baltimore-based Legg Mason Inc. is in talks to swap parts of its business with financial services giant Citigroup Inc. reverberated from Wall Street to the Inner Harbor yesterday, pumped Legg's stock to an all-time high, and suggested a continued retreat from the "financial supermarket" era that bunched many services under a single corporate nameplate.

While neither company would confirm that a deal is in the works, the idea made sense to some experts in an industry that has been roiled by allegations of conflicts of interest involving companies in the position of serving as both financial advisers and sellers of their own mutual funds.

Possible scenarios include Legg Mason swapping its brokerage for part or all of Citigroup's $460 billion investment management division, which includes a suite of mutual funds that have $52 billion in assets. In return, Citigroup might get Legg's network of more than 1,500 brokers around the country, including about 250 in Baltimore, and possibly an ownership stake in Legg Mason.

Legg's shares rose $2.63, or 3 percent, to close at $86.92 on the New York Stock Exchange on a day when neither Legg nor Citigroup would discuss, or douse, the speculation. It's unclear how close the two sides are to a possible agreement or how it would be structured.

"At this point, it's really not something that anyone here is able to comment on," said Jeffrey Bukowski, a Legg Mason spokesman.

A swap also fits with the strategy of Legg Mason Chairman and Chief Executive Raymond A. "Chip" Mason. He has built one of the fastest-growing mutual fund firms in the nation, amassing $373 billion in assets under management from $25 billion just 10 years ago.

A deal with Citigroup could double those assets and burnish the 68-year-old executive's career. Rumors last year that Legg Mason would purchase a chunk of Merrill Lynch & Co. Inc. fizzled.

"We keep waiting for him to make his retirement announcement," Matt Snowling, an analyst at Friedman, Billings, Ramsey Group Inc., said of Mason. Snowling's firm doesn't own Legg Mason stock or have a business relationship with it.

"A deal like this would basically complete the transformation from broker to asset manager," he said. "That was his strategy over the last decade, and that would be his legacy."

Mason ascended to the head of Legg Mason in 1974, after his brokerage firm, Mason & Co., merged with Baltimore's Legg & Co., whose predecessors date to 1899. In recent years, Mason has made a series of acquisitions in money managers, from Western Asset Management Co. in Los Angeles to Royce & Associates Inc. in New York. He allowed both of the companies, known for picking winning investments in bonds and small companies, to operate almost autonomously from the brass in Baltimore.

Legg Mason's managers have also made a reputation for themselves. The company's star fund manager, William H. Miller III, has a record for managing money that no one else can match, having beaten the Standard & Poor's 500 stock index for 14 consecutive years.

While the Baltimore company has not been tainted by the scandals that have shadowed some of its peers, the possible swap could eliminate any perceived problems by ridding the firm of its brokers, experts said. Elsewhere, brokers have come under fire for steering clients to their own firm's funds even if those funds weren't the best choice.

Regulators, including New York Attorney General Eliot Spitzer and the outgoing Securities and Exchange Commission chairman, William H. Donaldson, turned their attention to mutual funds after accounting and other scandals of the late 1990s and as a broader swath of the public began investing in them. Mutual funds now invest $8 trillion on behalf of nearly half of all American households.

Among the problems uncovered, Morgan Stanley was found to be running contests to encourage its brokers to sell its own mutual funds, with prizes such as golf trips and Los Angeles Lakers tickets. Just this week, Citigroup agreed to pay $208 million in a settlement with the SEC, which had been investigating allegations it pocketed fees that should have gone to mutual fund investors.

Many of the interlocking relationships that led to conflicts of interest were spawned from the so-called "supermarket" model, in which firms offered a wide range of products from mutual funds to brokerage accounts to insurance and credit cards. In the wake of regulatory probes, industry observers are predicting the demise of that one-stop-shop approach.

"Whether it's empire-building or corporate ego, they have tried to be all things to all people financially," said Don Cassidy, senior research analyst for Lipper Analytical Services in Denver. "Then what they found out was that people like their privacy. People don't want someone to know everything about their finances, and they want to shop around. "

Citigroup had been creating such a financial supermarket under the leadership of its chairman, Sanford I. Weill, but recently has been shedding businesses. The New York-based company agreed to sell its insurance unit Travelers Life & Annuity and its truck-finance business earlier this year.

Other companies are taking the same route. American Express Co. is spinning off its brokerage and money management operations, while Morgan Stanley is spinning off its Discover credit card division.

The economies of scale are far smaller at Legg Mason. With annual revenue of $2.4 billion, it is the fourth-largest company in Maryland. Citigroup, with $86.2 billion in annual revenue, ranks as the fourth-largest corporation in the world.

A deal would help Citigroup expand its broker network of 12,000, while also ridding it of several mutual funds that have posted lackluster performances. Legg Mason, meanwhile, could streamline its business to focus on investment management, which typically makes more money than the brokerage side.

But while the possibility led Legg Mason shares to rise yesterday - reaching $88.42 in midday before settling back - Citigroup's stock barely budged, falling 1 cent to close at $47.71. That's partly because some investors felt that Citigroup would be exchanging a regular moneymaker for more brokers, whose business can be whip-lashed by market highs that draw clients and market lows that scare them away.

Investors weren't as fazed by the prospect of Legg Mason co-opting Citigroup's Smith Barney and Salomon Brothers fund families, though analysts said the logistics of such a deal would be difficult to iron out. Among the issues: how a Legg Mason might change its relatively simple fee structure.

"This is really a different kind of challenge than they've taken on in the past with acquisitions, and it's not a small operation they would be getting," said Chris Traulsen of Morningstar Inc., which tracks mutual funds."

Said Richard X. Bove, an analyst at Punk, Ziegel & Co., a research boutique: "It's a magnificent deal for Legg Mason. It's a horrendous deal for Citigroup. Clearly that's what the stock market is telling you."

Legg Mason history

1962: Raymond A. "Chip" Mason starts Mason & Co., a brokerage firm in Newport News, Va.

1970: Mason's company merges with Legg & Co. and moves its headquarters to Baltimore.

1974: Mason becomes chairman and CEO of Legg Mason Inc.

1983: Legg Mason goes public on the New York Stock Exchange.

1986-2001: Legg Mason makes five big acquisitions of investment managers.

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