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Citigroup Separates Operations, Hoping to End Regulatory Woes

Oct 31, 2002 | Wall Street Journal Since it became entangled in regulatory weeds earlier this year, Citigroup Inc. has tried several high-profile moves to get out of the mess. Its latest effort will help, but the nation's largest financial services firm still won't be free and clear.

Citigroup, as expected, named Sallie Krawcheck, chief executive of Sanford C. Bernstein, as head of a new stock-brokerage and research unit, reporting directly to Citigroup Chairman Sanford I. Weill. The unit will be separated from Citigroup's corporate and investment-banking operations and, under the name Smith Barney, will include "retail" brokerage services for individual clients as well as stock research.

The move was designed to show that Citigroup is willing to make big changes in its corporate and investment-banking business in response to criticism over alleged conflicts of interest among its analysts and over its allocation of shares in hot initial-public offerings to executives of client firms.

New York Attorney General Eliot Spitzer has been investigating those issues for months and Citigroup, along with several Wall Street firms, is now part of settlement talks with both Mr. Spitzer and the Securities and Exchange Commission that revolve around establishing greater independence for research operations. Indeed, Citigroup's action now could put pressure on other Wall Street firms to take action to more thoroughly ensure the independence of their research analysts.

"This organizational change, with Sallie at the helm, is a giant step forward for Citigroup's continuing effort to rebuild investor confidence and provide our clients with the highest quality service," Mr. Weill said in a statement. "Over the last several weeks, we have been working closely with our regulators and have been considering a number of ways to address the issues challenging the industry."

In effect, Citigroup is trying to adopt reforms itself rather than have them imposed by regulators or legislators. It has good reason to do so because the stakes are so high: Its business model, in which virtually all financial services, from stock underwriting to banking to credit cards, are held under one roof, has been viewed as potentially in jeopardy as its regulatory woes mounted.

"How can anyone tell them what to do when they've already done it?" said Karen Petrou, managing partner at Federal Financial Analytics, a Washington consulting firm.

But this may not be Citigroup's final move. The broader settlement being discussed with Mr. Spitzer and the SEC could ultimately force the firm to make further changes that establish even more of a distance between research and investment banking.

"What this really is all about is to influence what the outcome might be on the industry structure to be in control of the structure and not have it done to them," said Tanya Azarchs, analyst at Standard & Poor's. "I doubt it will be enough to affect what is already in the works."

One risk for Citigroup is that by taking unilateral action, it could alienate other Wall Street firms that it needs to sign on to a broad settlement with regulators. Some officials from other institutions involved in the regulatory talks said they weren't bothered by Citigroup's move to separate out its brokerage and research operations as long as Citigroup's model didn't become a blueprint for what other firms would have to do.

But that seemed to be a secondary concern for Citigroup. "In a very difficult game in which their franchise is vulnerable, if you have to pick who you're going to annoy, the competitors aren't holding the power hand," Ms. Petrou added.

Citigroup officials said the new model would be flexible enough to adapt to whatever reforms ultimately come out of the settlement talks with regulators.

Other Wall Street firms already have taken some steps to allay regulators' concerns, but they haven't gone as far as Citigroup. Merrill Lynch & Co., for instance, earlier this year agreed to wall off bankers' influence over how analysts are paid and to introduce a monitor to oversee research practices as part of a $100 million settlement with Mr. Spitzer over its research practices.

Steps taken by Goldman Sachs Group Inc. included the appointment of a former president of the Federal Reserve Bank of New York as a research ombudsman and prohibited analysts from owning shares in companies they cover.

Citigroup's move "appears to be an affirmative step but we have to review the proposal," said a spokeswoman for Mr. Spitzer's office. "Such actions could complement the broader reforms we are hoping to achieve."

A spokesman for the SEC declined to comment.

Citigroup has made bold moves in the past that it had hoped would end its woes. Yet it still found itself under intense scrutiny from regulators and shareholders.

In early August, company officials told Jack Grubman, the former star telecommunications-stock analyst at Salomon Smith Barney, Citigroup's investment bank, that he should resign. The analyst had been at the center of a firestorm over whether Wall Street analysts' recommendations were compromised by pressure to bring in investment-banking business from companies that were the subject of research analysis. Citigroup later agreed to pay $5 million to settle an action by the National Association of Securities Dealers that accused Mr. Grubman of setting an unrealistic price target on shares of Winstar Communications. Mr. Grubman is contesting an individual NASD action against him.

Then, in September, Mr. Weill reassigned Michael Carpenter, head of corporate and investment banking, who had once been viewed as a possible heir apparent to the 69-year-old chairman. Insiders say Mr. Weill, even then, was frustrated by the inability of the bank to move beyond the issues that were sullying its reputation with investors and hurting its stock price. In 4 p.m. New York Stock Exchange composite trading Wednesday, Citigroup shares were up 58 cents at $37.08, but still well below their 52-week high of $48.69.

Mr. Weill replaced Mr. Carpenter with Charles O. Prince, one of his most-trusted aides and, significantly, a lawyer, not an investment banker. Mr. Prince has extensive experience dealing with regulators.

But the regulatory pressure only mounted, with Mr. Spitzer taking a look at Mr. Weill himself and his possible role in a 1999 recommendation Mr. Grubman made on AT&T Corp., of which Mr. Weill was a director at the time. Mr. Weill isn't currently a target of Mr. Spitzer's investigation, Mr. Spitzer's office has said, and Mr. Weill recently announced that he will resign his AT&T board seat. But it put yet another question mark over Citigroup's reputation, even though the firm continued to post strong financial results.

Exactly how the new Smith Barney unit will function hasn't been set in stone because Citigroup is waiting to see what changes emerge from the settlement talks with regulators. But Citigroup officials noted that Citigroup already has agreed that investment-banking revenue shouldn't be used to pay analysts. And they said Ms. Krawcheck would be responsible for signing off on analysts' compensation and will put policies in place to ensure their independence.

Just having Ms. Krawcheck there will, in itself, make a difference, some observers said.

"If she walks out in six months saying they wanted me to do something that I didn't want to do, it will be an open invitation to Mr. Spitzer," said Michael Holland, chairman of New York investment firm Holland & Co.

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