Among Vikram Pandit's last jobs as Citigroup Inc.'s chief executive officer was to decide the fate of the bank's hedge-fund unit, which employs some of his oldest colleagues. He agreed to give them most of it for free.
While Citigroup is keeping a 25 percent stake, managers at the Citi Capital Advisors unit will pay nothing for the remaining 75 percent of that business as it becomes a new firm managing as much as $2.5 billion of the bank's money, according to people with knowledge of the plan. The lender will pay the executives fees while gradually pulling out assets to comply with impending U.S. rules, said the people, who requested anonymity because the terms aren't public.
The deal was Citigroup's response to the Volcker rule, which seeks to protect the financial system by restricting banks' hedge-fund investments and proprietary trading. Instead of selling the funds or winding them down, the New York-based bank will give managers time to attract money from other investors while also granting them control of the business. CCA executives, who make bets on assets ranging from risky European loans to complex credit instruments, can wager with the lender's money until it's withdrawn.
"They're getting a couple of years to diversify the client base away from Citi and to build a stand-alone firm," said Craig Cognetti, a partner with Grail Partners LLC in New York. "If these efforts are successful, this could be very lucrative for the owners of the business."
Jonathan Dorfman, 50, and James O'Brien, 52, who once worked with Pandit at Morgan Stanley and are currently co-heads of CCA, will run the new entity, the people said. They will own about 25 percent of the firm. CCA portfolio managers and employees will share a 50 percent stake, the people said.
If the deal proceeds, Dorfman and O'Brien could end up in charge of a firm valued at more than $100 million, according to Cognetti and Ezra Zask, the head of New York-based SFC Associates, which consults on hedge funds. They based their estimates in part on internal CCA performance data in a report obtained by Bloomberg News.
"The details of this spin-out seem to me to be extremely generous to current employees," said Gerald Hanweck, a former Federal Reserve economist who's now a finance professor at George Mason University in Fairfax, Virginia. "It seems like an awfully good deal. The alternative is for Citi to sell it off. What's stopping them from doing that?"
The new firm, which has yet to be named, may include about 10 funds overseeing roughly $3.4 billion that use shareholders' cash for bets on everything from mortgage-backed securities to the debts of struggling companies, according to the CCA data, which, according to the internal report, is unaudited. Citigroup has as much as $2.5 billion invested in CCA hedge funds, one of the people said.
Citigroup explored other options in a "thorough process" for complying with the new regulation before deciding on the current plan, said Danielle Romero-Apsilos, a spokeswoman for the bank, who declined to comment on the deal's terms.
"The board and management both concluded that this transaction allows us to accomplish our objectives and balance the interests of the affected stakeholders," she said in an e- mailed statement. "It allows us to withdraw our proprietary capital in an orderly manner, mitigates risk for shareholders and provides a stable transition for investors."
James von Moltke, a senior Citigroup investment banker, helped design the deal, the people said. Pandit hired von Moltke from Morgan Stanley in 2009 to help him dispose of unwanted assets after the lender almost collapsed and took a $45 billion bailout from U.S. taxpayers. Von Moltke declined to comment.