Legg Mason/Citigroup ACAT battle
Looking to escape the perceived cultural problems of a huge national firm at New York-based Citigroup's Smith Barney unit and to work as an independent adviser, Jack Ditt decided to leave Legg Mason at the end of December. He had been a broker at the firm for 15 years.
OAS_RICH("Middle"); He registered as an investment adviser and by January opened an office about a block away from his old branch in Shreveport, La. Mr. Ditt joined Schwab Institutional as an RIA, christening his firm Eagle Financial Management Services LLC.
He said his move to Schwab went without a major problem until near the end of February, when executives from the former Legg Mason brokerage unit suddenly halted the transfer of Mr. Ditt's clients' accounts to Schwab Institutional. Up to that point, he said, he had transferred about $10 million in client assets with Legg Mason funds, about half the amount his clients had with the house funds.
By joining Schwab Institutional, Mr. Ditt believed he had found a loophole of sorts around the thorny issue of brokers carrying clients' Legg Mason funds outside the firm. Instead, he and some of his clients are in a bind.
'A thorn in their side'
"I'm going to pursue this until they do right by the clients," Mr. Ditt said in a telephone interview last Wednesday. "I will be a thorn in their side for years if I have to."
The Legg Mason-Citigroup deal closed Dec. 1.
In response, Baltimore-based Legg Mason said, "The distribution policy regarding the Legg Mason Funds has not changed with the transfer of our brokerage business to Smith Barney. This policy provides two options for investors to continue to hold Legg Mason Fund shares, through a firm with which the funds have a dealer agreement or directly with the funds.
"This policy has been in place for many years and has been disclosed to investors in our fund prospectuses and other documents," according to the company.
Legg Mason mutual funds are highly restricted. To that end, almost all other broker-dealers do not carry or sell the firm's funds.
San Francisco-based Schwab is an exception to the rule and offers at least 30 Legg Mason funds of various share classes through its platforms, according to the firm's website.
What's more, part of the deal between Legg Mason and Citigroup was that brokers leaving Smith Barney could not sell Legg Mason funds for three years, beginning in December.
Mr. Ditt, who said he returned his six-figure retention bonus to Citigroup with interest, thought that Schwab would be a natural fit for him and for his clients, as Legg Mason has a long-standing agreement for the discount broker to carry the funds. Mr. Ditt's clients had about $70 million in assets when he left Legg Mason and close to $20 million was invested in Legg Mason funds.
"At the moment, it's a stalemate," he said.
The issue of firms' interfering with the transfer of client accounts increasingly has drawn the scrutiny of securities regulators.
In December, Washington-based NASD adopted a new rule interpretation that prohibited any of its member firms from interfering with a customer's right to transfer accounts.
"It is a fundamental right of an investor to choose with whom he or she does business, and the fact that a broker changes firms should not affect an investor's ability to continue to access his or her account and to do business with that broker," said Robert H. Glauber, NASD's chairman and chief executive.
According to NASD, one common tactic broker-dealers have employed in the past to block account transfers has been to seek court orders to prevent clients from following one firm's registered representatives to another.
Smith Barney has said that it has an exclusive three-year agreement for its brokers and advisers to sell Legg Mason funds.
When Legg Mason and Citigroup last June announced the deal to swap their brokerage and asset management operations, respectively, the agreement was hailed - in part because the majority of Legg Mason's 1,300 brokers had their clients invested heavily in Legg Mason's proprietary funds.
In return, Legg Mason acquired Citigroup's huge asset management business, which has $437 billion in assets.
Legg Mason brokers, industry observers believed, could not jump ship and join another firm, because that would mean cashing out of Legg Mason funds and incurring hefty capital gains taxes for many of their clients.
If his clients sell their Legg funds and follow him, they will get hit with hefty capital gains taxes of close to $3 million, Mr. Ditt said.
He said he is considering filing an arbitration suit against Smith Barney and Legg Mason to pay for those taxes.
Smith Barney is fearful that Schwab Institutional will recruit brokers and advisers such as himself, he said.
And some of Mr. Ditt's clients also feel trapped, with one filing a lawsuit.
Earlier this month, John Settle, a client of Mr. Ditt's whose Legg Mason funds at the end of March were worth $45,676.93, sued Citigroup, Legg Mason and brokerage executives in U.S. District Court in Louisiana. Mr. Settle, a lawyer in Shreveport, claimed in the lawsuit that the firms are "arbitrary" and "capricious," because his account suddenly became frozen, and he was unable to move it to Schwab.
A Smith Barney spokesman, Alexander Samuelson, said the firm "believes the lawsuit is without merit."
Mary Athridge, a spokeswoman at Legg Mason, also said Mr. Settle's lawsuit was without merit.
Smith Barney days later in a letter told Mr. Settle he should "submit all controversies between yourself and Legg Mason to arbitration."
In correspondence with Mr. Ditt's attorney and clients, Legg Mason and Smith Barney executives have said that they stopped moving the accounts to Schwab in February because of a technical issue involving the funds' share designation, although it had made an "exception" to policy for the funds that already had moved, according to one letter.
"We are not willing to permit any of Mr. Ditt's former Legg Mason clients who still hold Primary shares of Legg Mason funds to convert their accounts to managed accounts," wrote Robert Patterson, deputy general counsel of Legg Mason, in a Feb. 27 letter to Mr. Ditt's attorney, Donald Wiener. Such a change would allow clients to move to "Mr. Ditt's new employer" or Schwab.
"That would not be a good-faith use of the Managed Account program, would be inconsistent with our long-standing policy and would result in harm to the clients and the firms involved," Mr. Patterson wrote.
Folks just don’t get it when we talk about why it’s so good to be free…they forget that this stuff happens all the time, and when it does it can literally destroy your business. Look at this poor guy, stuck potentially suing Citi…how do you think that’s going to work out?