Business Analysis: Citigroup trips up on a series of corporate governance blunders

US banking giant's chief executive needs to steer the group away from controversy

If Citigroup was hoping the recent wrong-doing in its Japanese private banking business would fade away, it was disappointed. Yesterday, Japan's financial watchdog blamed the group's "corporate culture and governance" for a list of regulatory breaches which last month prompted it to order Citigroup to close down its entire private banking business in the Asian economic powerhouse.

If Citigroup was hoping the recent wrong-doing in its Japanese private banking business would fade away, it was disappointed. Yesterday, Japan's financial watchdog blamed the group's "corporate culture and governance" for a list of regulatory breaches which last month prompted it to order Citigroup to close down its entire private banking business in the Asian economic powerhouse.

Hirofumi Gomi, the commissioner of Japan's Financial Services Agency, said: "It was very regrettable to have regulatory violations of this sort at any bank, foreign or domestic".

It was an unwelcome pronouncement for Charles Prince, the chief executive of Citigroup, who celebrated his first year as the head of the world's largest financial services group last week.

Mr Prince, a trained lawyer, succeeded Citigroup's larger-than-life former chairman and chief executive, Sandy Weill. A veteran of Citigroup, Mr Prince was given the task of stamping out the lapses of judgement by employees which had led to the bank being entangled in almost every recent financial scandal, including the Enron and WorldCom collapses, and the allegations of biased equity research.

Mr Prince told a meeting of Citigroup's managers in June: "We have a keen focus on not being in the headlines".

Reality could not have turned out more differently. Just a few weeks later Citigroup was on the front page when it emerged that its London bond team had executed a controversial trade, rapidly selling off $13bn of bonds and buying them back for less.

The deal was not illegal but it was frowned upon by the Financial Services Authority and by fellow traders, who believed Citigroup's team had broken the unwritten rule that no one in the market takes advantage of thin summer trading in such a dramatic way to make a quick return.

Mr Prince himself said last week the trade was "a completely knuckle-headed thing to do" and promised that disciplinary action would be "felt stingingly" by those responsible.

Altogether more serious were the problems which emerged barely weeks later in Japan. On 17 September, the country's regulators ordered the bank to close its private banking business after an investigation revealed the group had committed extensive legal violations over seven years.

The financial impact on Citigroup's business - which has a market capitalisation of $228bn, and assets of $1.3trillion - is likely to be fairly small. Even the seemingly punitive charge Citigroup took in its second quarter of almost $5bn or possible lawsuit payouts over WorldCom and other cases was the equivalent of just three months' earnings.

Yet, even if Citigroup's deep pockets are not feeling the pinch, investors are worried that the seemingly endless stream of controversies will hurt the banking giant, whose empire includes investment and corporate banking, and financial services for personal customers.

Kathleen Shanley, a senior bond analyst at Gimme Credit Finance in Chicago, said: "I have not seen anything that threatens their financial stability. But it is a curse and a blessing that they are so large that they can write off a lot of these issues without endangering the cash flow because it could start endangering their reputation."

Guy Moszkowski, of Merrill Lynch, downgraded Citigroup from buy to neutral after the revelation of problems in Japan on the basis that it reflected a culture of focusing on relentless profit growth without much concern for how those earnings were made. Mr Moszkowski and others emphasise they believe Mr Prince and his senior managers are sincere in their attempts to stamp out all of the questionable practices within the group. But they argue Citigroup's sheer size makes the task either impossible, or in need or much longer than investors had initially hoped it would take to sanitise the business. Indeed, Mr Moszkowski said there could even be further problems on the horizon in the form of an ongoing "non-public" investigation by the Securities and Exchange Commission into accounting at Citigroup's Argentine business, which may have been extended to other regions.

Citigroup points to a string of actions it has taken to clamp down on regulatory breaches. When Mr Weill was still in charge and Mr Prince ran the investment banking business in spring 2003, they issued a report setting down the standards the business would meet.

One of the major steps taken was to create a separate entity to house Salomon Smith Barney, its research and private client brokerage business, under Sallie Krawcheck. Her task was to improve the quality of Citigroup's research and to ensure its content was completely independent of any corporate activity being carried out by Citigroup.

While 39-year-old Ms Krawcheck is considered by financiers to have done a very competent job, Citigroup made another announcement last week which unsettled investors. It said Ms Krawcheck would move over to become chief financial officer, while the current CFO, Todd Thomson, would take her job. Citigoup presented the swap as succession planning.

While acknowledging their importance, Mr Prince has sought to present the corporate governance issues as a sideshow to his main responsibility, which is to boost Citigroup's growth rates, both organically and by acquisition.

One of the main ways to do that, according to Mr Prince, is through international expansion. He will be under pressure to deliver when his competitors at home have opted for domestic mega-mergers to boost the bottom line, with JP Morgan buying Bank One and Bank of America swallowing Flee Boston this year. While Citigroup remains number one, Bank of America is catching up, with a market capitalisation of $180bn, and JP Morgan is now valued at $80bn.

Citigroup could yet be tempted to go down this route. In the meantime, it is hardly in a dire spot. It ranks in the top three in investment banking league tables in global underwriting, loans and merger and acquisitions and last week was involved in the massive cross-border acquisition of RMC of the UK by Mexico's Cemex.

Kevin McCloskey, a fund manager from Federated Investors, concludes that Mr Prince "has done a fair job" in his first year. His challenge is to find a way to keep Citigroup ahead of its competitors while staying away from the more swashbuckling practices of its past.