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Legg Mason, Citigroup agree to swap business

THE BALTIMORE SUN

Legg Mason Inc. agreed yesterday to trade its brokerage unit for the money management business of financial giant Citigroup Inc. in a $3.7 billion deal that transforms the Baltimore-based firm from a regional player into the world's fifth-largest money manager.

The deal remakes Legg Mason into a powerhouse in the business of investing money for wealthy families, institutions, workers and countries. It also frees Legg Mason from its historic moorings as a stock brokerage and the heightened regulatory scrutiny of potential conflicts of interest posed by brokers giving advice to clients while also selling their firm's mutual funds.

Raymond A. "Chip" Mason, Legg Mason's chairman and chief executive, broke the news to employees in an early-morning conference call. The company's offices had been abuzz for weeks about an impending deal that had been leaked to the media but about which Mason, by his own admission yesterday, had been wavering. At Citigroup's headquarters in New York, employees gathered for a town-hall-style meeting about the same time.

"This affords us an opportunity that is quite unique, and we looked at this long and hard," Mason said. "This transaction positions Legg Mason to be a formidable competitor."

The announcement crowned the career of the 68-year-old Mason, who said he will retire after the transaction is complete in two years. Mason founded a brokerage that bore his name in Virginia more than four decades ago, merged it with Legg & Co. a few years later and soon began running the entire firm. He said he thanked employees for helping him build the business.

"This was a very, very personal and difficult decision," he said in a conference call with analysts. "'Traumatic' would almost be an understatement, but it is in the long run probably the way it's going to have to be."

Legg Mason and Citigroup executives said they couldn't predict if any employees would lose their jobs while the two companies integrate their businesses. However, Mason said in an interview that he might expand his work force, as he expects the company to grow even bigger. He said the deal would boost the firm's earnings by 9 percent next year.

For Citigroup, which has been dogged by regulatory problems, the transaction enables it to focus on providing independent investment advice while gaining the ability to sell Legg Mason's mutual funds, many of which have out-performed their competition.

"Frankly, our performance in asset management has not been what we hoped for it to be," Citigroup Chief Executive Charles Prince said. "Devoting the resources needed to make that business a leader for us, we believe, would be better directed to our other franchises."

Possible harbinger

Industry observers said the transaction might be a harbinger of companies abandoning the "financial supermarket" model, in which firms tried to offer a range of services to investors as one-stop-shops. They also said it plays to the strengths of Legg Mason, which gains intellectual capital in addition to the investor accounts, and of Citigroup, whose Smith Barney business prizes brokers who have built personal relationships with clients.

The swap of assets and personnel is a huge and complicated undertaking. It involves Legg Mason's getting $437 billion that Citigroup manages. In return, Citigroup takes Legg Mason's regional network of 1,540 brokers, $1.5 billion in Legg Mason stock - a 14 percent stake - and $550 million through a five-year loan agreement.

Legg Mason also announced yesterday a separate, smaller agreement to buy Permal Group, one of the world's largest managers of funds that invest in hedge funds - private investment pools tailored to wealthy individuals. Legg would acquire an 80 percent stake and have the option to purchase the remaining 20 percent with the total price tag capped at $1.4 billion.

Permal, which has offices in New York, London and Singapore and sells its product mostly outside the United States, would operate independently of the Baltimore headquarters. It manages about $20 billion in assets and represents a new frontier for Legg Mason. Mason had previously said that he would not acquire hedge funds, which aren't regulated, but that he would consider a fund of funds - some of which disclose information to investors and vet the funds they invest in with background investigations.

Wall Street liked both deals, sending Legg Mason shares soaring 15 percent to an all-time high of $98 in trading on the New York Stock Exchange. Citigroup stock gained less than 1 percent to $46.95.

"The markets obviously approved of this from a Legg Mason standpoint," said Eric Fitzwater, an analyst at SNL Financial Corp., a financial services data provider. "As a business plan, it's nearly perfection."

Legg Mason, which ranks as the 21st-largest money manager, will more than double its assets while obtaining a global infrastructure that would have been too costly to build on its own. Legg also struck a three-year side arrangement in which Citigroup's brokerage force, which would number more than 13,500 after the swap, will sell Legg Mason mutual funds.

With wider distribution, Legg Mason's star fund manager, William H. Miller III, might be able to fulfill his goal of bringing in more assets to his shop. His Value Trust fund, which has beaten the Standard & Poor's 500 stock index for an unprecedented 14 consecutive years, is in high demand and has traditionally been sold primarily through Legg Mason brokers.

Most of the Citigroup assets would be steered to Western Asset Management, a Legg Mason subsidiary that invests in bonds. Citigroup's mutual funds, which are mostly sold under the Smith Barney brand, would operate as another subsidiary.

Citigroup's assets include "some centers of excellence" as well as businesses that present Legg with a "turnaround story," said Michael Heht, an analyst at Bank of America Securities. Analysts say that Richard A. Freeman is among the money managers regarded as Smith Barney's best, but that other fund managers have struggled to meet market averages.

Citigroup plans to woo Legg Mason's brokers with retention bonuses to persuade them to stay. "We're happy to have them as part of our family," said Citigroup's chief financial officer, Sallie Krawcheck.

But the future is unclear for Legg Mason's approximately 50 research analysts, 115 investment bankers and 280 office employees. Citigroup executives said they are working on a plan for them.

The deal is expected to close by the end of this year and is not subject to shareholder approval. The transition of employees switching companies might take longer, up to two years, Legg Mason and Citigroup officials said.

Talks between the two companies began six months ago, when Citigroup officials approached Legg Mason, according to CEO Mason. The meeting was a sign of the times, he said, as most major financial companies had begun to heed the changing regulatory headwinds.

From the 1970s to the 1990s, the trend was for companies to consolidate and offer more services to customers, until regulators decided that companies shouldn't "manufacture" financial products and "distribute" them at the same time, Mason said. "There is no question that we have worried in the last couple of years about the regulatory side," he said, adding that Citigroup "felt more pressure" to do a deal.

Minor brushes

Legg Mason has had relatively minor brushes with regulators in the midst of scandals that have roiled the industry - from brokers steering investors to funds for kickbacks to trading improprieties. Legg has responded to inquiries from New York Attorney General Eliot Spitzer and was part of a $21.5 million settlement among 15 companies over allegations they failed to give clients discounts due them.

Citigroup has faced harsher penalties. The company recently agreed to pay $208 million in a settlement with the Securities and Exchange Commission, which had been investigating allegations it pocketed fees that should have gone to investors.

The final details of the Legg-Citi transaction were presented to Legg Mason's board this week, and the directors approved the agreement unanimously.

Citigroup doesn't completely rid itself of potential conflicts because it will acquire a stake in Legg Mason, so theoretically the company could benefit from selling Legg funds, said Rachel Barnard, an analyst at Morningstar Inc., which tracks mutual funds. "It could be seen as a conflict of interest, but their current situation is more of a problem," she said. "Still, with Eliot Spitzer out there, you never know what's going to happen next."

Citigroup plans to gradually sell off its Legg Mason stock and has agreed not to acquire a bigger stake. Krawcheck, when asked about any continuing conflicts, said the brokers are not paid extra for selling Smith Barney funds, and the same would go for Legg Mason funds.

Analysts said the risks for Legg Mason lie in making the marriage with Citigroup assets work. Mason has a reputation for shrewdness in past acquisitions and might be just the man for the job, said Franklin L. Morton, a senior vice president at Ariel Capital Management in Chicago, who used to work at Alex. Brown in Baltimore.

"He's got a history of buying good people and good assets for the right price, and then he's managed them well once he gets them," he said. "This is a bigger challenge - a higher risk for a higher reward."

LEGG MASON GETS

Citigroup's $437 billion asset management businesses, excluding some Latin American units. This includes the Smith Barney and Salomon Brothers mutual fund families as well as funds managed for institutions, retirement accounts and wealthy individuals.

The ability to sell Legg Mason mutual funds through Citigroup's huge system, which includes the Smith Barney brokerage.

CITIGROUP GETS

Legg Mason's brokerage business, consisting primarily of 1,540 financial advisers who work in 127 offices. Assets in those accounts totaled $92.6 billion as of March 31.

Legg Mason's capital markets business, which arranges securities sales and transactions by corporations and municipalities and provides research on stocks.

Legg Mason stock worth about $1.5 billion.

About $550 million in cash, financed by a Citigroup loan. (Separately, Legg Mason is buying an 80 percent interest in The Permal Group, one of the world's largest investors in hedge funds with $20 billion in assets under management, mostly overseas.)

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