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Crisis at Citi


On Wall Street they call Sanford I. Weill "the Postman" because he has been delivering impressive earnings growth with ruthless regularity for three decades. Investors flocked to Weill, who measured his success by a share price that rose as inexorably as did net income. Citigroup (C), the globe-girdling financial supermarket that is Weill's ultimate creation, returned a staggering 40.8% a year on average to its shareholders during the 1990s--outpacing Jack Welch's General Electric Co. (GE) and every other big U.S. corporation.

Citigroup, the world's largest and only true global bank, remains a paragon of profitability. In the second quarter, it reported record earnings of $4.1 billion, slightly topping analysts' estimates, as usual. Yet now, investors are deserting the Postman in droves. Citigroup's stock has plummeted from a high of 48.50 in January to 34, wiping out $74 billion in market capitalization. "There is no Weill premium in the stock anymore," says Anna M. Dopkin, portfolio manager of T. Rowe Price Financial Services fund, a Citigroup investor. If ever there was a bank too big to fail, it is Citigroup, with its $1 trillion in assets and 270,000 employees in 100 countries. But Weill's legacy as the supreme financial-company builder of his generation--if not his job as chairman and chief executive--is on the line.

Weill, who turns 70 in March, is a risk-averse manager who despises surprises. But for months now, he's been blindsided by one mishap after another. A platoon of state and federal investigators is homing in on the question of Citigroup's complicity in each of the defining business catastrophes of this post-bubble era: the fall of Enron Corp. and the great telecom meltdown. In South America, Weill is trying to stanch loan losses in Argentina that already have topped $1 billion while paring the bank's exposure to Brazil's shaky economy. Even Citi's consumer-lending operation, which generates half of its earnings, is afflicted by rising credit-card charge-offs and by conflicts with regulators over its marketing of loans to consumers with bad credit ratings.

These are all significant problems in their own right. But investors worry that they are symptoms of a deeper malaise. The fear is that Weill's unrelenting emphasis on opportunistic acquisitions and double-digit earnings growth has produced a behemoth so large and complex that it cannot be properly managed. Citigroup "had an aura of great deal-making and fast growth and better-than-peer-group performance, which was what supported a high multiple. That is gone," says Richard X. Bove, managing director of money manager Hoefer & Arnett Inc. "Now the aura is, `This company can't be trusted and has great problems and can't grow."'

The most pressing of these problems are the scandals rocking Wall Street. It's starting to look as though the very model of the financial conglomerate is fundamentally flawed. Sprawling institutions such as Citi, J.P. Morgan Chase, Merrill Lynch, and others are riddled with conflicts of interest, compounded by abuses by aggressive bankers. Consider how banks and brokers have used loans as loss leaders to win lucrative investment-banking assignments or how they have cobbled together dubious structured-finance deals that have helped corporate clients mask their true condition. Or how research analysts at some firms have hyped the stocks of banking clients to investors even as they disparaged them in private e-mails. In the latest revelation, Citi's Salomon Smith Barney (SSB) investment-banking subsidiary gave telecom CEOs preferential access to shares of hot initial public offerings that could be flipped in hours or days at great profit. All of these schemes were designed to lock in fees at the expense of smaller shareholders who, in many cases, were stuck holding worthless securities.

Not long ago, this long daisy chain of interlocking business was held up as a model of efficiency, but others see a much darker side to it all. "I don't think there is any question that bringing many elements of financial services together has created more complex relationships that need to be properly controlled," says New York Attorney General Eliot Spitzer, who has launched a sweeping investigation of SSB. He declined to comment on specifics of the SSB probe. "Many of the conflicts that we are trying to unravel ... come from the notion that the concentration of financial services would be a good and healthy thing for the economy."

Citi's stumbles strengthen the case of Representative John D. Dingell (D-Mich.), the ranking member of the House Energy & Commerce Committee, and other politicians and regulators who think financial liberation has gone too far. Wholesale reregulation is highly unlikely, but the combination of investor suspicion and stricter enforcement of existing laws could convince financial conglomerateurs that it's just not worth the trouble. Says Samuel L. Hayes III, professor of investment banking at Harvard Business School: "I've always felt the notion of a one-stop financial marketplace was more of a theoretical model than a practical one. I predict that these large financial conglomerates will redivide into components and will be spun off because they don't pay for themselves."

Weill has not renounced the financial supermarket concept, but Citi's exposure to Enron and the telecom bust has inspired much soul-searching inside the company. "Your whole frame of reference shifts when you have something dramatic happen like this, and [it] changes everyone's perception," says Charles O. "Chuck" Prince III, Citi's chief operating officer and one of Weill's most trusted trouble-shooters. "We're reflecting the new reality as quickly as possible."

In the last few weeks, Weill has announced that Citi will account for all options issued to employees as an expense and will create a new committee of independent directors to improve corporate governance. He also has toughened conflict-of-interest prohibitions and investor disclosure requirements at SSB. These may be just the beginning. Says Prince: "We are reviewing all our businesses.... We have to deal with people we can vouch for."

Hoefer & Arnett's Bove, like many professional investors, suspects that the sell-off in Citi's shares has gone too far. But that does not necessarily mean that they want to own the stock. David Ellison, a portfolio manager at Friedman, Billings, Ramsey & Co., says that he would rather "buy something with a clear sense of what's going on, as opposed to crossing my fingers and hoping. The last thing you want to do is bet other people's money on one person, even Sandy Weill."

Investors certainly would like to see a bona fide succession plan. After all, Weill has long epitomized the imperial CEO, from his well-documented aversion to power-sharing and famously explosive temper to his flouting of the conventions of succession planning and his gargantuan pay packets. During the 1990s, Weill's total compensation topped $1 billion, ranking him high on the list of history's highest-paid execs. He did pretty well for himself in 2001, too, raking in $28.2 million, $18 million of it in cash. But unlike many of his peers, Weill actually held on to the majority of his stock after exercising most of his options. He owns 32.6 million Citi shares, worth some $470 million less than in January.

No one has greater incentive to fix what ails Citigroup than Weill, but the question is whether the same man who built a company slavishly devoted to making its quarterly numbers is capable now of moderating its crasser impulses. Prince Alwaleed bin Talal, Citi's largest shareholder, is a believer. "Sandy's integrity should not be questioned at all, and I really want to emphasize that," says the Saudi Arabian royal, who owns 266 million shares, or a bit more than 5% of Citi. "He's a very honorable man." All the same, Weill's ability to inspire the troops has been progressively undermined over the years by his propensity for firing them if they don't make their numbers. "To say it is a difficult place to work is an understatement," says a former SSB executive. "Sandy's with you, win--or tie."

It is far too early to write off Weill, but his personal vulnerability to the reform movement now rolling over Corporate America was underscored recently when Spitzer broadened his investigation of SSB to include the Citi CEO. The immediate issue is whether Weill pressured star research analyst Jack Grubman to upgrade his rating on AT&T from "neutral" to "buy" to help SSB win a lucrative underwriting assignment from the telecom giant in 2000. Weill declined to be interviewed, but a Citigroup spokesman says that he never told any of SSB's research analysts what to do and that any suggestion to the contrary is "outrageous and untrue."

On the face of it, Salomon has come a long way since Citi acquired it in 1997. It was a dominant force in debt underwriting long before Weill bought the firm and combined it with Smith Barney's nationwide retail brokerage. But in recent years, SSB has muscled its way up the rankings in some of the Street's more lucrative specialties. Most important, it boosted its market share of global-equity underwriting from 5.4% in 1997 to 14.8% through the first eight months of 2002, behind only Goldman Sachs & Co., according to Thomson Financial.

Along with Attorney General Spitzer, New York City District Attorney Robert Morgenthau, several congressional committees, and various securities-industry regulators are all busily trying to determine whether, in its eagerness to move up in the world, SSB violated laws and regulations designed to enforce fair competition on Wall Street and to protect investors. No charges have been brought against the firm or any of its employees, but a great deal of unflattering and possibly incriminating information has surfaced.

To date, suspicion has fallen most heavily not on Weill nor on any of SSB's top brass but on Grubman (BW--Aug. 5). There is no question that Grubman gave investors bad advice, maintaining buy recommendations on WorldCom Inc., Global Crossing Ltd., and other failed telecoms to the bitter end. The crucial legal issue is whether Grubman's advice was tainted by self-interest--whether he deliberately misled investors to help SSB win banking assignments.

It has long been an open secret that the Chinese Wall that is supposed to insulate analysts from bankers is a myth. "There has not been an analyst of any note who has not been leaned on by the investment-banking division, which cares more about pleasing a potential or current client than about the overall objectivity of an analyst's rating," says John C. Coffee Jr., a securities law professor at Columbia University.

Grubman, however, was more than a pressured analyst. He styled himself as the avatar of a new hybrid of Wall Streeter--a "banking-intensive analyst," as he put it. He not only issued recommendations, but personally befriended many telecom CEOs, offered them business advice, and even sat in on board meetings.

Grubman's brashness did not endear him to competitors or even to many of his colleagues, but the big boss didn't mind. "Jack probably knows more about the business [telecom] than anybody I've ever met," Weill told BusinessWeek in 2001. "He's also, in my opinion, a tremendous team player."

Grubman's annual pay soared to $20 million a year as SSB became the investment banker of choice to the go-go telecom crowd. The firm has raised $190 billion in debt and equity for 81 telecom companies since 1996, when Congress deregulated the telephone industry. SSB owned WorldCom, lead-managing 65.8% of the $18.9 billion that the company raised on the Street, according to Thomson Financial. Citi was a large commercial lender to WorldCom until May, 2001, when the bank co-led an $11.8 billion bond issue. From the proceeds, the company paid back loans from Citi and others. "In hindsight, what we've learned is that separate from credit risk and execution risk, there is concentration risk," Prince says. "If you do so much business with someone, in the public's eye you end up essentially vouching for them."

On Aug. 15, the 48-year-old Grubman resigned from SSB, his passage eased by a $32 million severance package. In his resignation letter, Grubman seemed to veer between contrition and anger, apologizing only for failing, like most everybody else, to predict the telecom collapse. "I am nevertheless proud of the work I, and the analysts who worked with me, did," Grubman declared. "I always wrote what I believed." Prince Alaweed, who recently discussed Grubman's resignation with Weill, says that the Citi CEO was "relieved" to see Grubman go. The bet-ting is that other heads will roll at SSB as the poison drip of well-publicized revelations about its conduct continues.

Like most CEOs, Weill did not try to climb on the corporate reform bandwagon until it was well on its way. In a July 8 speech accepting Chief Executive magazine's 2001 CEO of the Year award, Weill called on his fellow corporate chieftains to take the lead in restoring faith in business post-Enron: "The responsibility starts at the top, and we must begin by asking what we, as CEOs, have to do, however challenging and uncomfortable it might be."

Weill did not begin to answer his own challenge publicly until after Citigroup was raked over the coals at a Senate hearing into Enron on July 23-24. Members of the Permanent Subcommittee on Investigations accused both Citi and J.P. Morgan Chase of helping Enron to mask its deteriorating finances by arranging $8 billion in "pre-pay" transactions--loans artfully contrived to look like commodity purchases. Internal e-mails obtained by the committee seemed to show that SSB bankers allowed Enron to improperly account for one such 1999 financing in order to keep $125 million off its books.

After the hearing, Weill sent a letter to Citi's employees in which he slipped on the mantle of reformer even as he denied that his company had done anything wrong. "From everything we know, our activities with Enron were legal, met accounting standards, and reflected industry practices," Weill declared. Even so, Weill said that Citi would voluntarily make changes in the way it did business. Investment bankers no longer would be allowed to screen research reports or have any say in how analysts are paid--a change already made by Merrill Lynch in settling a conflict-of-interest case brought by Spitzer earlier this year. Weill went beyond the so-called Spitzer principles in calling on regulators to pass new rules that would preclude analysts from accompanying bankers to pitch corporate clients or participating in investor roadshows. Meanwhile, analysts would have to formally certify that their reports "accurately reflect their personal views" and that they were not influenced by any kind of payment.

That was a substantive response, but it did not put Citi ahead of the reform curve for long. On Aug. 7, Weill announced more changes in a second employee letter in which he announced the expensing of options and the formation of a new board committee. Moreover, Weill continued, Citigroup will not countenance the use of arcane financing techniques to help clients hide debt: "Quite simply, if a company does not agree to record a material financing as debt on its balance sheet, Citigroup will only execute the transaction if the company agrees to publicly disclose its impact to investors," he wrote. Translation: We promise not to do again what we don't admit to having done for Enron.

By now, the story of Weill's rise and fall and late-career resurrection as the King of Capital is the stuff of Wall Street legend. He is the humbly born Brooklyn boy who built Shearson Loeb Rhodes from the parts of dozens of brokerages and then sold it to American Express. Weill aspired to the top job at AmEx but finally resigned in frustration, retreating to a tiny office accompanied only by number-crunching protege Jamie Dimon. In 1986, he acquired an obscure consumer-loan company and through one shrewd acquisition after another built it into Travelers. The capper came in 1998, when Weill merged Travelers into Citicorp, the nation's largest bank holding company, and became co-CEO of the combined entity with John Reed. In 2000, Reed withdrew, leaving Weill happily alone at the top.

The domineering Weill can be disarmingly casual. He prefers informal chats with employees to group meetings but keeps an eagle eye on the numbers. In repose, he can be affable and quite funny. But woe betide anyone who crosses him or who fails to perform to his demanding standards. It came as no great surprise that he has rid Citi's executive suite of Reed loyalists, but many members of his own inner circle have departed, as well. In 1998, Weill even turned on Dimon, demanding his resignation. Dimon, now CEO of Bank One Corp., committed the ultimate offense: He seemed capable of replacing Weill one day.

In June, Weill shuffled Citi's senior ranks. A trio of longtime Weill subalterns--Robert B. Willumstad, 56, Michael A. Carpenter, 55, and Thomas W. Jones, 53--now will run the consumer, investment-banking, and asset- management divisions, respectively, unencumbered by geographical areas. However, the Big Three's gains in influence were diluted by the promotion of Deryck C. Maughan, 54, to head a new international division. Citi's many regional chiefs around the world report to Maughan, who, like the Big Three, reports to Weill.

In effect, Maughan replaced Victor J. Menezes, the last of the Citibank Old Guard, whom Weill put in charge of Citi's emerging markets expansion drive in 2000. Menezes took the fall for Argentina, though Weill refrained from criticizing him by name, publicly conceding that Citi had screwed up in one of its most important foreign markets. "I believe that we didn't move fast enough in Argentina, and we didn't understand the risks as much as we might have," Weill said.

The latest shake-up was classic Weill: designed not only to boost bottom-line performance but to keep everyone guessing about who, if anyone, has the inside succession track. When Reed left, Citi's board extracted a promise from Weill to put a succession plan in place within two years. Weill elevated Willumstad to president in April, filling a post that had remained vacant since Dimon's ouster. Willumstad has an impressive record in consumer finance but has an utter lack of investment banking or international experience. In short, Dimon has departed, but he's not been replaced.

The wild card in Citi's managerial deck is Robert E. Rubin, who joined the company at Weill's behest in 1999 after stepping down as Treasury Secretary and serves as a kind of roving corporate ambassador. Like Prince Alwaleed, Rubin says that he still stands with Weill. "Obviously this is a difficult period ... but he's dealing with this in exactly the way that he should," says Rubin, a former CEO of Goldman Sachs. Rubin, 64, has said that he is not interested in running Citi. But if Weill were to leave in a hurry, it is likely that Citi's board would draft Rubin, at least on an interim basis.

Naturally, Weill has every intention of departing in his own time and on his own terms. One confidant says that Weill is likely to stay on for another one to five years, depending on his health, which is excellent, and "whether or not he's having a good time."

The damage control that now preoccupies Weill certainly does not qualify as fun. Above all, he is a dealmaker, and the punishing sell-off in Citi's stock has at least temporarily deprived him of his favorite deal currency. Weill would like to continue to build Citi's presence in consumer finance around the world and in retail banking in the U.S.--through mid-size acquisitions such as his recent $5.8 billion buyout of Golden State Bancorp, a California thrift.

Even if Citi were trading at its old premium, it is unlikely that Weill has another eye-popping mega-deal left in him. Citigroup is just too big to transform it in the way he reinvented Travelers by merging with Citi. Who knows? The Postman's final delivery may be a Citigroup that looks more like yesterday's Citibank than the scandal-plagued financial supermarket of today. By Anthony Bianco and Heather Timmons

With Emily Thornton and Mara Der Hovanesian in New York and John Rossant in Paris


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