Jan. 9 (Bloomberg) -- Morgan Stanley is in advanced talks with Citigroup Inc. to form a joint venture that would combine the brokerage units of both banks and give Morgan Stanley a 51 percent stake, said a person familiar with the matter.

An agreement may be announced as soon as Jan. 11, said the person, who declined to be identified because the deal isn’t complete. Morgan Stanley would pay cash for control of the venture and would have an option to increase its ownership to as much as 100 percent in coming years, the person said.

The combined brokerage, which would be managed by Morgan Stanley Co-President James Gorman, would be the world’s largest with more than 20,000 financial advisers, ahead of the new combination of Bank of America Corp. and Merrill Lynch & Co. The deal would give Citigroup cash in exchange for its Smith Barney brokerage while giving Morgan Stanley a bigger presence in the business of providing financial services to individuals, an area where the firm has been trying to expand.

The sale of Smith Barney “is a first step in Citigroup’s dismantling,” said William Smith, CEO and founder of Smith Asset Management Inc., a Citigroup shareholder. “This is positive news.”

Rubin Quits

The news came as Citigroup announced that former U.S. Treasury Secretary Robert Rubin plans to quit its board. Spokeswomen at Citigroup and Morgan Stanley, both based in New York, declined to comment.

After the worst financial crisis since the 1930s forced U.S. taxpayers to support the nation’s biggest banks, regulators may seek to break up some companies or restrict activities that could threaten the system’s stability, analysts say.

Morgan Stanley, the second-biggest U.S. securities firm before converting to a bank holding company in September, would make the payment from its existing resources and wouldn’t raise new money to pay for the deal, the person said.

Morgan Stanley received $10 billion from the U.S. Treasury last year. The firm, which lost 70 percent of its market value last year, has been trying to attract retail deposits to help reduce its reliance on debt markets for funding.

Citigroup, which is expected to announce a fifth consecutive quarterly loss when it reports fourth-quarter results later this month, has received $25 billion from the U.S. Treasury and $306 billion of government guarantees for troubled mortgages and toxic assets. The bank suffered a 77 percent decline in its stock price last year.

Sandy Weill

Citigroup was formed in 1998 by the $37.4 billion merger of Travelers Group Inc., led by Sanford “Sandy’ Weill, and Citicorp, led by John Reed. Travelers, which owned brokerage Smith Barney Holdings Inc., had a year earlier paid about $9 billion for Salomon Inc., the parent of Salomon Brothers Inc., to form Salomon Smith Barney Inc.

Vikram Pandit, who has been Citigroup’s CEO for more than a year, told employees on a conference call in November that he didn’t plan to break up the company and that he didn’t want to sell Smith Barney.

He and Chief Financial Officer Gary Crittenden instead said they wanted to sell businesses that weren’t crucial to the bank’s main operations. In July the bank agreed to sell its German retail bank, Citibank Privatkunden AG & Co., for $6.6 billion, and last month it sold a processing business in India with about 12,000 employees for $512 million.

Global Wealth Management

In a memo this week, Crittenden said that the bank had sold 21 businesses over the past year and that divestitures would “again be critical in 2009.”

Citigroup’s wealth-management division, which includes Smith Barney, is headed by Michael Corbat, a 25-year veteran of the bank who was named to succeed Sallie Krawcheck in September.

Smith Barney has 13,500 financial advisers in about 600 offices in the U.S., according to Alex Samuelson, a Citigroup spokesman. Global wealth management business had about 9 million U.S. client accounts as of Nov. 3, oversaw $1.32 trillion of client assets, and generated $7.94 billion in revenue during the first nine months of 2008.

Morgan Stanley gained its retail brokerage in the company’s 1997 combination with Dean Witter, Discover & Co. The business had 8,426 financial advisers at the end of November, $546 billion in total client assets, and generated $6.3 billion in revenue during 2008 when the gain from an asset sale was excluded, according to a company report last month.

CNBC reported the plans for the combination earlier today.

To contact the reporter on this story: Christine Harper in New York at charper@bloomberg.net; Bradley Keoun in New York at bkeoun@bloomberg.net.

Last Updated: January 9, 2009 18:49 EST