The recently announced asset swap between Citigroup and Legg Mason could be a sign that the financial supermarket of yore is on its way out, to wit: the separation of asset management and distribution. It was once the goal of Wall Street to combine the two, and what a synergy that would make: asset management, a high-margined business, with a built in, but low-margin, sales force. Indeed, the present day Morgan Stanley (Morgan asset management combined with Dean Witter distribution) was a shining example of such synergies.
But times change and open architecture is the prevailing wisdom. That and regulatory heat. Firms are simply no longer able to push proprietary product through their own retail brokerage networks due to recent regulatory changes. In February of this year, New Hampshire state regulators filed a complaint against American Express Financial Advisors alleging that it offered its sales force illegal incentives to sell proprietary funds and seeking a fine and restitution of $17.5 million. And back in late 2003, Morgan Stanley paid a $2 million fine to the NASD for holding illegal sales contests for brokers selling proprietary products. Several other firms have been the subject of class-action suits for pushing their own products. And so now both Citigroup and Legg Mason decided marrying production to distribution is a bad idea.
In the current regulatory environment, financial advisors actually avoid selling proprietary products all together in order to sidestep any perception of conflict of interest, said Citigroup executives. Which means having both businesses under one roof actually becomes a liability. For Legg Mason, getting rid of its retail brokerage force also frees it to increase sales through third party distribution channels, as other brokerage firms are less likely to worry about giving business to a rival firm.
Greater scale will also help increase distribution, Legg executives said. With this transaction, Legg Mason more than doubles its assets under management to $830 billion, making it the fifth largest asset manager in the world, the firm said, citing Pensions & Invesments estimates.
Both Legg Mason and Citigroup executives predicted that the rest of the financial services industry would soon see the wisdom of their decision. “I don’t think this is a Citigroup-unique issue,” said Citigroup President Bob Willumstad. “This will come to be pretty widely perceived on the street over time.”
The $3.7 billion asset swap -- under which Citigroup will hand over most of its asset management business in exchange for Legg Mason’s 1,354 financial advisors -- includes a 3-year global agreement in which Citigroup will become the primary domestic provider of Legg Mason’s domestic equity funds. This adds some top performing funds to Citi’s product offering and should help to appease Legg Mason brokers, who have long prided themselves on the performance of Legg Mason funds like those run by Bill Miller.
“We think this will be an important retention tool for Legg Mason financial consultants,” said Citi chief financial officer Sally Krawcheck on a conference call. A big chunk of Legg advisor productivity -- in the double digits -- comes from Bill Miller and Legg Mason funds, she said. Legg Mason advisors will also get retention packages that “are in line with deals in past years in the industry” and training, she added.
At a time when competition for good advisors is fierce, the deal is a great way for Citi to pad its advisor force with a large number of productive advisors. Legg Mason has 1,354 financial advisors, which will bring Smith Barney’s total to just under 13,500, just short of rival Merrill Lynch’s 14,100 count. Legg also has 127 branch offices in 22 states, mostly in the mid-Atlantic and southern regions of the US, to add to Smith Barney’s 522.
Advisors at the two firms have very similar profiles in terms of assets managed, productivity, and fee-based business, according to Krawcheck. Combined assets per financial advisor at Legg Mason are around $69 million, versus $80 million at Smith Barney; Legg Mason advisors produce net revenue of about $546,000, in line with around $533,000 at Smith Barney; Meanwhile, around 53 percent of revenues at Legg Mason are fee-based, versus 55 percent at Smith Barney.
In addition to the asset swap, Citigroup will get approximately $1.5 billion of Legg Mason's common and convertible preferred shares, and Legg will receive approximately $550 million in the form of a five-year loan from Citigroup. The deal is expected to close in the fourth quarter. The transaction does not include Citigroup’s asset management business in Mexico, its retirement services business in Latin America or its interest in the CitiStreet joint venture.