Citi Slicker

By Daniel Kadlec

It was an awkward moment. Sandy Weill, the world's most powerful banker, came face-to-face with Eliot Spitzer, the toughest cop on Wall Street. Both were among the guests at a Sept. 10 lunch hosted by New York City Mayor Michael Bloomberg at Gracie Mansion. Their exchange was brief. But Weill, 69, CEO of Citigroup, indicated he was eager to talk about the ugly business that Spitzer, the ambitious New York State attorney general, has been finding in his probe of the financial behemoth. Within days a high-level session followed, and even Spitzer was impressed with Weill's sense of urgency.

The meeting that followed, at the attorney general's Manhattan office, between Spitzer and Charles Prince, the new head of Citi's subsidiary Salomon Smith Barney, marked the beginning of what is shaping up as a far-reaching peace treaty. Spitzer, who used a $100 million settlement with Merrill Lynch to reform stock research on Wall Street, wants a similar and more expensive pact with Citigroup to address systemic abuses in the way lucrative initial public offerings (IPOs) of stock have been showered on CEOs who sent investment-banking business to Citi. Spitzer is still digging for dirt, so any deal may be several weeks away. But the whole episode signaled a thaw in Weill's ice-age thinking. Playing to fat cats at the expense of retail investors was no longer defensible. Almost overnight, what had been de rigueur was deplored, and Weill's giant firm had been singled out as the poster child for big bad banks.

Weill, says a longtime friend, has become "horrified and embarrassed" by the mud-spattered image of Citi, which stands accused of unethical and illegal behavior on multiple fronts. Among the alleged transgressions: doling out shares of hot IPO shares to WorldCom executives in a bribelike manner to win banking business, devising complex financing to help Enron conceal debt and having stock analysts hype the shares of companies that were investment-banking clients. While Salomon Smith Barney was making the VIPs rich, another Citi subsidiary was charging consumers high fees and above-market interest rates on loans, according to charges Citi just settled with the Federal Trade Commission (FTC).

Citi, which denies doing anything illegal, remains under special scrutiny from at least five investigating bodies. Citi negotiators are now leading an effort to settle all matters regarding IPO allocations and analyst conflicts with all regulators and on behalf of all of Wall Street. The Citi team met with Spitzer last week and then had an initial "global" settlement session with the Securities and Exchange Commission (SEC). The National Association of Securities Dealers (NASD) and the New York Stock Exchange are in close contact with the discussions and will be part of any comprehensive deal. People close to those talks call them "preliminary." Under discussion is setting up stock research as a subsidiary company with no obligations to the firm's bankers.

Among the areas that Spitzer aims to reform is the IPO allocation process. One immediate goal, say sources close to him, is the disgorgement of profits that executives reaped through generous allotments of IPO shares in the late 1990s--a period during which those shares were virtually guaranteed to rise sharply. Spitzer is expected to file a legal action as early as this week. A likely target is former WorldCom CEO Bernard Ebbers, who made $11 million in trading profits over four years on IPO shares he bought through Salomon, according to documents obtained by Congress. Spitzer would like to prohibit IPO allocations to executives that can't be justified by the amount of business those executives provide their broker through personal accounts. "You cannot give shares in an effort to persuade the CEO of a big company to bring business to your investment bank," Spitzer told TIME. "That's commercial bribery." Spitzer also hopes to fully separate stock analysts from investment bankers--an area in which he came up short when dealing with Merrill Lynch but that remains on the table in talks with Citi. The SEC is expected to set new rules that will also require some separation.

Amid all the probing, Citi's stellar financial results--the company posted earnings of $8.9 billion in the first half of 2002, a 26% jump from the same period last year--are being seen in a different light. The stock has fallen 39% so far this year. Weill's 23million shares have lost more than $400 million in value. But just as grating to Weill is the threat to his legacy of bringing down the walls between banks, brokers and insurers. More than any other, it was Weill whose persistent lobbying persuaded Congress to deregulate the industry in 1999, a step that helped catapult U.S. financial-services firms to global prominence. Citigroup now has $1 trillion in assets and operates in 101 countries.

New York's John LaFalce, the House Banking Committee's top Democrat, has asked for broad hearings into whether "the expanded authority" banks have enjoyed since 1999 is leading them to take on too much risk and "whether further safeguards are needed." The prospect of new restrictions jars Citi's bankers, who believe they have a leg up on counterparts who have failed to move as boldly as Citi to become global financial supermarkets.

The collective magnitude of these problems eluded Weill during a summer of nasty headlines. Spitzer's investigation of Merrill Lynch was sure to spread, yet bankers inside Citi say the prevailing view there as recently as late August was that the main issue was people's losses in the market and that these problems would pass when the market rebounded.

Some trace Citi's ethical lapses to Weill's 1997 acquisition of Salomon Brothers, a rowdy bond-trading house notorious for bending rules, which in 1991 suffered the wrath of regulators for trying to corner the market in Treasury securities. "Salomon had a well-known cowboy culture, and he did not put in the controls that were needed," says Michael Mayo, a bank analyst at Prudential Financial. Weill has been personally taken to task on two fronts: for possibly asking former telecom analyst Jack Grubman to rethink his negative opinion of AT&T, on whose board Weill sits, and for directing some of Citi's charitable giving to his pet causes.

Since his chance encounter with Spitzer in early September, however, Weill has made it clear that he has resolved to clean up his shop. At a recent banking conference he told analysts, "We are not chicken. We will admit the things that we did wrong." Days later, in an internal memo, he apologized to employees, saying that "certain of our activities do not reflect the way business should be done," and in an overt nod to regulators seeking concrete change, Weill replaced Salomon's chief, Michael Carpenter, with Prince. If Prince, 52, hopes to succeed Weill one day, insiders say, he probably has just two or three months to clear up Salomon's troubles before they start to look like his own.

In rapid fashion, Weill has settled civil fraud charges with the NASD and the suit by the FTC accusing Citi of predatory lending. The NASD had charged that Grubman had recommended shares of Winstar Communications even though he privately harbored concerns about the telecom firm's prospects. While Salomon agreed to pay the NASD $5 million in fines, Grubman wants to fight the accusations and, according to the Wall Street Journal, has indicated that he wants to talk with investigators about the role Salomon's corporate culture played in the practices at the heart of the trouble. It may be difficult, though, for him to claim he was pressured into bogus stock ratings. He has publicly said his ratings reflected his convictions. Grubman could not be reached for comment, and his lawyer declined to discuss the issue.

The FTC settlement, meanwhile, will cost Citi $215 million. The charges were that a subsidiary, Associates First Capital, which Weill bought in 2000, used deceptive marketing to lure consumers into taking out loans with high rates and buying optional, pricey loan insurance without realizing it. Even before settling with the FTC, Citi stopped selling the insurance and lowered rates for 200,000 debtors. It was the first to voluntarily adopt the "Spitzer principles" imposed on Merrill Lynch, and now requires officers of public companies who get IPO shares through Citi to tell their shareholders about it. Citi says it will give its independent directors bigger roles, count stock options as a business expense and lower its assumed pension-plan rate of return to 8% from 9.5%--all hot buttons for watchdogs.

Citi still faces as much as $10 billion in potential costs stemming from settlements, fines and shareholder lawsuits, Mayo estimates. At the same time, the bank is dealing with souring investments in Argentina and Brazil and is under a cloud for lending practices in the Caribbean.

This should have been Weill's year. Citi's booming earnings have put it on track to unseat ExxonMobil as the most profitable corporation in the world. Earlier this year Euromoney named Citi the best bank on the planet, FORTUNE named Citi one of the world's most admired companies, and Chief Executive named Weill the best CEO. A proud business builder, Weill would like nothing better than to refocus the spotlight on what he's done right.--With reporting by Daren Fonda/New York and Eric Roston/Washington

With reporting by Daren Fonda/New York and Eric Roston/Washington