Traders on CitiGroup's (C) London bond desk were jubilant. On the morning of Aug. 2 they had just executed a daring coup: They dumped at least $13.3 billion worth of European government bonds onto the market, then bought a third of them back at lower prices within about a half-hour -- scooping profits that rivals say could be up to $24 million. As Citi traders high-fived each other in triumph, pandemonium broke out in the market. Citi's actions weren't illegal, but broke an unwritten understanding not to whipsaw markets or take advantage of the thin summer trading. When a rival trader called to ask what was up, the Citi crew laughed and hung up.
No one is laughing now, least of all Charles O. "Chuck" Prince III. Since becoming Citigroup chief executive a year ago, he has been telling his 275,000 troops worldwide in a welter of visits and messages that he doesn't want any more bad publicity. In fact, he wants the world's biggest bank, with $1.3 trillion in assets, off the front pages altogether. "We [won't] say we are never going to make a mistake, but we have a keen focus on not being in the headlines," he told money managers at a June 2 conference. "We're going to be judged on whether we meet that standard or not."
BANNED IN JAPAN
By Prince's own measure, he is failing. The bank is harvesting negative headlines galore and has regulators on its back on three continents. On Aug. 18, the British Financial Services Authority launched a formal investigation into the London bond coup. And Citi -- though it won't say who authorized the trades -- apologized for what had happened and promised not to repeat the behavior. "This is exactly what Chuck Prince said wasn't going to happen," says Howard K. Mason, senior financial analyst with Sanford C. Bernstein & Co.
Within weeks, Citi was back in the news. On Sept. 17, Japanese authorities ordered it to shut down its local private bank by next September. Regulators said an investigation, begun in August, 2001, had revealed extensive legal violations over seven years, including lax governance and money laundering controls and "numerous instances of unfair transactions...in which large profits were obtained through unsound means." Citi issued an apology, "with deep regret for its failure to comply with regulatory requirements," fired six bankers, slashed the salaries of eight other employees, and promised to improve its internal controls for all of Citi's operations in the country. Before the week was up, Japan's Finance Ministry banned Citi from participating in its government bond auctions.
Now BusinessWeek has learned that top Citi officials are among those the Securities & Exchange Commission and the National Association of Securities Dealers are investigating for failing to supervise analysts and investment bankers during the tech-stock boom -- and thus prevent conflicts of interest that harmed investors. The investigation follows the April, 2003, $1.4 billion global settlement between federal and state securities regulators and 10 Wall Street firms. Administrative charges could be brought within weeks, a source close to the matter says, but most likely before yearend. Citi declined to comment. Prince declined to be interviewed.
"CLAWS AND FANGS"
Rules and regulations are one thing. Getting people to follow them is quite another. And as CEO, Prince seems unable to drive a sense of universal integrity very deep into the bank. Some critics wonder whether this is even possible. "Every time you turn around, there's some other embarrassing thing that has happened," says Kathleen Shanley, senior credit analyst at Gimme Credit Finance in Chicago. "It raises a question of whether Citi is reaching the limits of its growth." Adds Bernstein's Mason: "Citi has become so large that it is simply not possible to mandate behavior. The challenge now is to create a culture, to inculcate a shared set of values that guide employee behavior."
On occasion Prince sends mixed signals. He regularly jawbones staff about the need for higher ethical standards, but at other times he also seems to underestimate the full extent of Citi's problems. For example, in a Sept. 20 message to employees, he said no matter how tight the bank's controls and how clearly the behavior in London and Tokyo deviates from its standards, "there will always be a small minority of people who will cross the line."
Prince's critics argue that the problems run deep and spring from the way Citi does business. "It's one of the most aggressive corporate cultures in banking, no doubt about it," says one Wall Street analyst. "These people grow up with claws and fangs." In a Sept. 20 report in which he downgraded the bank's shares to neutral from a buy, Merrill Lynch & Co. (MER) bank analyst Guy Moszkowski charged that Citi's "aggressive profit incentives [are] overriding judgment."
Those cultural flaws now risk damaging the bank, say critics. "Issues of ethical standards and control continue to compromise Citi's image with customers and governments, " says Moszkowski. In the worst case, they could stymie Prince's ambitions to build a much larger Citi empire abroad. Regulators may be less inclined to approve acquisitions or grant licenses. Corporate customers may be reluctant to do business with it -- and governments less eager to award it mandates to float billions in bond issues. "The constraint on Citi's growth is not its market size, nor its capital," says Bernstein's Mason. "It may well be that Citi can't achieve its growth ambitions because it cannot safeguard itself properly from regulatory and reputation risk."
Bankers in London, for example, say that the modest profits from the Citi trading brouhaha were not worth the damage to its reputation. Apart from attracting the attention of the FSA, Citi has angered governments in countries such as Belgium and Italy that rely on the international bond markets -- and often give Citi lucrative contracts to handle their deals. Why did the traders do it? "The Sollie spirit is still there," said one senior London banker, referring to the swashbuckling style of Salomon Brothers investment bank, which Citi bought in 1998. Regulators will no longer tolerate such behavior. Says Kathryn E. Dick, deputy controller for risk evaluation at the Office of the Comptroller of the Currency, a U.S. bank regulator: "[Banks] need to have an environment where people understand [that they can't] press the outer boundaries."
Prince, a lawyer by training, was drafted as CEO in part to draw -- and enforce -- such boundaries. Chairman and former CEO Sanford I. "Sandy" Weill handpicked him to guide the bank through rough legal and regulatory waters. Although Prince can be charming, he can also come across as abrasive.
In the wake of the analysts scandals and corporate blowups, Weill and Prince, who was then general counsel, took several measures mandated by enforcers. They separated stock research from investment banking and eliminated interlocking directorships between Citigroup execs and companies affiliated with the bank's directors. And they created stricter rules on the kind of complex financing that it handled for Enron Corp. and WorldCom.
UNIVERSAL ETHICS CODE
Now Prince has begun to overhaul the risk and compliance hierarchy in New York. He has given senior risk officer David C. Bushnell greater clout within the bank and ordered him to craft a set of compliance standards for the whole firm. Surprisingly, this didn't exist before. Also, audit committee members of Citi's board will get up to seven compliance reports a year compared with none before. A newly formed Policy Compliance Assessment Group will ensure new rules such as the separation of investment banking and research are enforced. And, starting in the fourth quarter, every Citi employee will receive ethics training. The bank's toll-free ethics hotline, in place for some time, will now be "aggressively marketed" to employees. Says Citi spokeswoman Leah C. Johnson: "This is the way that Chuck believes that you embed the change in the culture."
Although Prince has been grappling with one public relations nightmare after another, his tenure so far has been a financial success: The bank reported two record quarters, with profits reaching $5.27 billion in the first quarter this year. The growth culture he inherited from Weill evidently still lives on. Now Prince somehow has to temper the energy that drives Citi's culture without snuffing it out. He has pumped up his message to employees in recent weeks, and the bank's spokeswoman says he'll be attending more town hall meetings worldwide along with reviewing how he pays his bankers. "We have to have the moral compass to deliver those profits and growth responsibly and honestly," he said in his Sept. 20 message to staff. "Citigroup's culture must be synonymous with integrity,"
Beyond fine words, Prince has to transplant that culture of probity into the DNA of thousands of employees worldwide. The faster he does so, the less the bank's dealings will be the stuff of headlines.
By Mara Der Hovanesian in New York, Paula Dwyer in Washington, and Stanley Reed in London