Nov. 29 (Bloomberg) -- E*Trade Financial Corp., the online bank and brokerage, got a $2.55 billion infusion from Citadel Investment Group LLC and ousted its chief executive officer after the shares sank almost 80 percent and customers withdrew cash.

Chief Operating Officer Jarrett Lilien took over as acting CEO, replacing Mitchell Caplan, E*Trade said in a statement. Citadel, the Chicago-based hedge-fund manager run by Kenneth Griffin, will get a 17 percent stake in the company and pay about $800 million, or 27 cents on the dollar, for asset-backed securities with a face value of $3 billion. E*Trade fell 8.7 percent today in Nasdaq Stock Market trading.

The company joins lenders Citigroup Inc. and Countrywide Financial Corp. in turning to outside investors for capital amid a plunge in the value of asset-backed securities linked to subprime mortgages. Earlier this month, a Citigroup analyst said losses from bad debts might lead E*Trade into bankruptcy, spurring customers to pull about $6 billion, or 15 percent of the cash in client accounts at the end of September, Lilien said today in an interview.

``The company was getting awfully close to violating their regulatory capital ratios,'' said Jaime Peters, an analyst at Morningstar Inc. in Chicago who covers E*Trade and doesn't have a rating on the stock. ``They needed an infusion of cash and they needed it fast.''

Caplan's plan of expanding the company's banking business by tripling loans backfired, sending E*Trade shares to a five- year low earlier this month.

Wiped Out

E*Trade will take a $2.2 billion charge for the sale of the debt to Citadel, wiping out almost five years of profit for the New York-based company. E*Trade also faces a formal inquiry from the U.S. Securities and Exchange Commission into ``matters related to the company's loan and securities portfolios,'' according to a Nov. 9 regulatory filing.

E*Trade dropped 46 cents to $4.82 at 4 p.m. in Nasdaq trading. The stock has declined 79 percent this year, the worst performer in the Standard & Poor's 500 Index, followed by Countrywide.

Citigroup analyst Prashant Bhatia said in a Nov. 11 report that there was a 15 percent chance E*Trade would be forced to seek protection from creditors if mortgage losses prompted customer defections. Smaller rivals including OptionsXpress Holdings Inc. have ramped up advertising alluding to E*Trade's mortgage losses.

S&P Monitoring

``Our expectation is that the money will move back now that people see that there is this strong deal, this strong investment led by Citadel,'' Lilien, 45, said in an interview. ``We feel it takes concerns off the table.''

After reviewing the transaction, Standard & Poor's kept E*Trade's rating on ``creditwatch'' for a possible downgrade.

The deal ``does not provide a full resolution for long-term stability to capital, liquidity and franchise health,'' S&P analyst Helene De Luca said in a statement. ``We will be monitoring whether the net client asset outflows were just a spike or a systematic weakening of the franchise.''

Citadel and investment funds managed by New York-based BlackRock Inc. will pay $1.6 billion in return for E*Trade stock and senior unsecured notes paying 12.5 percent. Citadel will spend an additional $150 million for bonds and shares in January and get a seat on E*Trade's board of directors, which will now be headed by Donald Layton, a former vice chairman of JPMorgan Chase & Co. In total, the group will get shares worth 19.99 percent of the common stock currently outstanding.

Second Casualty

``We stepped in to buy the piece of the business that causes angst,'' said Joe Russell, head of Citadel's U.S. and European credit business, referring to E*Trade's asset-backed securities. ``By removing this issue and showing that as one of the largest stock and bondholders we're stepping up to the plate, we're making a statement.''

The world's biggest banks have written down more than $50 billion in bad debts and trading losses after increasing defaults on U.S. home loans by borrowers with poor credit histories caused credit costs to surge in August. The losses led to the resignations of the CEOs at New York-based Citigroup and Merrill Lynch & Co. and Zurich-based UBS AG.

Caplan, 50, is the second E*Trade CEO forced out on the heels of a falling market. He joined E*Trade as chief of financial products in 2000 when the company, then headed by Christos Cotsakos, bought the online bank Caplan headed for $1.9 billion.

Caplan's Legacy

E*Trade stock, which climbed as high as $62.75 in 1998 amid the frenzy for day-trading and dot-com shares, tumbled as low as $3.40 in 2002 as the stock market swooned. Cotsakos resigned in January 2003 following two straight years of losses, and Caplan took over.

He reduced reliance on trading commissions by tripling loans at the company's online bank. In 2005, Caplan acquired two rival brokerages, Harrisdirect and Brownco, for $2.31 billion, helping to drive profit to a record $628.9 million last year.

From Jan. 24, 2003, Caplan's first day as CEO, until the end of last year, E*Trade shares quintupled, outperforming the 11 other brokerage stocks tracked by the Amex Securities Broker/Dealer Index.

The mortgage-market losses have made E*Trade the index's worst performer this year, and the stock is barely 10 percent higher than when Caplan started.

Citadel, which manages about $17 billion, has thrived by buying distressed assets. Under Griffin, 39, Citadel took over the energy trades of Amaranth Advisors LLC after the Greenwich, Connecticut-based hedge fund collapsed in September 2006.

Dilution

In June, Citadel paid $180 million in a bankruptcy auction for the assets of subprime lender ResMae Mortgage Corp. A month later, Citadel bought most of the assets of Sowood Capital Management LP after two of its funds lost more than 50 percent from credit investments.

The E*Trade transaction diluted existing shareholders' stake by more than 40 percent, wrote Bank of America analyst Michael Hecht in a report today titled: ``Christmas Comes Early for Citadel, Existing Shareholders Get a Lump of Coal.''

``Citadel is the clear winner in this transaction,'' said Hecht, who has a ``neutral'' rating on E*Trade shares.

To contact the reporters on this story: Bradley Keoun in New York at bkeoun@bloomberg.net; Sebastian Boyd in London on sboyd9@bloomberg.net or

Last Updated: November 29, 2007 19:06 EST