Legg Mason’s Mark Fetting riles up directors, sources say

Mark Fetting, chief executive officer of Legg Mason Inc., has disappointed the board of directors with the disclosure of costs that have delayed his goal of lifting profitability, said two people with knowledge of the matter.

Nelson Peltz and KKR & Co.’s Scott Nuttall, two directors whose firms own stakes in the Baltimore-based asset manager, have said they’re dissatisfied Fetting didn’t disclose until this month that expenses tied to bond division Western Asset Management will rise by $74 million this year, said the people, who asked not to be identified because the board’s deliberations aren’t public. The board is scheduled to meet today in New York, one of the people said.

Fetting, 55, has struggled to reverse client withdrawals after leading Legg Mason back to profitability from a $2 billion loss in fiscal 2009. Since Peltz, an activist investor and the biggest shareholder, joined the board in 2009, Fetting cut 350 jobs to lift operating margins to 30 percent, a goal the company said will be delayed because of the costs disclosed May 3.

“Anytime an executive has to go back on a promise, it’s a hit to credibility,” Mike Morris, a senior analyst at Atlanta-based Invesco Ltd., Legg Mason’s third-biggest shareholder, said in a telephone interview. “The turnaround is progressing nicely, but the process could have been managed better.”

Legg Mason has lost 11 percent in New York Stock Exchange composite trading since May 2, the day before the costs were reported. The shares are down 54 percent since Fetting was named CEO on Jan. 28, 2008, even after tripling from their March 9, 2009, lows.

Peltz’s ‘Standstill’

Fetting declined to comment, as did Anne Tarbell, a spokeswoman for Peltz. Nuttall didn’t return calls seeking comment. Kristi Huller, a spokeswoman for KKR, declined to comment.

Peltz’s Trian Fund Management LP, which owned 7.4 percent of Legg Mason’s shares as of March 31, is known for pushing companies to increase their value by cutting costs or merging. Peltz helped spur Cadbury Plc’s 2008 spinoff of Dr Pepper Snapple Group Inc.

He joined the Legg Mason board in October 2009, under an agreement that prevents him from raising his stake above 9.9 percent during a “standstill period” that could end as early as March 31, 2012. The accord prohibits him from forming syndicates or partnerships to amass more voting interests, or from forcing a sale or merger of any investment affiliates.

‘Patience Wears Out’

“If I were a board member, I would be encouraged with some signs of progress, but I couldn’t conclude that the turnaround has been completely successful,” Jeff Hopson, an analyst with Stifel, Nicolaus & Co. in St. Louis, said in an interview. “People’s patience wears out.”

Fetting told investors last year that he would expand the firm’s operating margin with job cuts that would save $130 million to $150 million a year.

He and Chief Financial Officer Pete Nachtwey told analysts and shareholders this month that its bond unit will keep a larger portion of its revenue, as performance rebounded and redemptions abated at Western Asset. The unit previously paid some of its quarterly revenue to the parent company to cover costs from a bailout of money funds it inherited through the December 2005 acquisition of Citigroup Inc.’s investment unit, which was integrated into the bond division.

‘Surprise to Most’

The change means Legg Mason won’t reach Fetting’s stated goal of expanding operating margins by March 2012 to 30 percent from 23 percent as of March 31. Nachtwey said on the call that while the company knew about the increase in compensation expenses “for quite some time,” it doesn’t discuss the impact on earnings until the start of the fiscal year.

“It came as a surprise to most of us,” Michael Kim, an analyst with Sandler O’Neill & Partners LP in New York, said in an interview. “While it’s going to be a headwind for margin expansion, because they are making this commitment to Western, it will allow them to retain their employees and improve growth prospects,” said Kim, who rates the shares a “buy.”

Fetting took over from Legg Mason’s founder, Raymond “Chip” Mason, in January 2008, after stock funds managed by Bill Miller trailed rivals for two years in a row and the firm started to see trouble signs in the former Citigroup money funds. The money funds had invested as much as $10 billion in structured investment vehicles that plunged as investors shunned mortgage-linked debt in 2008.

Capital Injection

Legg Mason sold $1.25 billion in notes to New York-based buyout firm KKR in January 2008 to increase its capital after spending cash to prop up its money funds. KKR’s Nuttall joined Legg Mason’s board as part of that transaction.

Mason started Mason & Co. in 1962 and eight years later merged it with Legg & Co., whose predecessor firm was founded as a regional brokerage in 1899. Mason expanded the asset- management side of the business by making acquisitions such as the 1986 purchase of bond investor Western Asset, the 2001 deal for small-cap manager Royce & Associates and the 2005 pickup of hedge-fund manager Permal Group Ltd.

Mason led the firm’s largest deal by swapping Legg Mason’s brokerage business for Citigroup’s investment unit. Citigroup’s bond and money funds were folded into Western Asset, while its stock funds were organized into a new unit called ClearBridge Advisors.

‘Fetting’s Tenacity’

Fetting, who was previously responsible for Legg Mason’s mutual funds and managed accounts, spent his first year as CEO bolstering the money funds, booking $1.69 billion in after-tax costs to remove the securities from the portfolios.

“Legg Mason was in the midst of integrating Citi and then came the catastrophic market, so it was a double-whammy,” Burton Greenwald, an independent consultant in Philadelphia, said in an interview. “The fact that the firm is alive, well and appears to be thriving is a tribute to Mark Fetting’s tenacity.”

After ridding the funds of the troubled debt in early 2009, Fetting said he would turn to reversing the redemptions that started in late 2007 and intensified with stock and bond fund losses amid the collapse of Lehman Brothers Holdings Inc. in September 2008. Assets tumbled from a peak of about $1 trillion at the end of 2007 to $672 billion at the end of April. After pulling a net $134 billion in 2008, investors withdrew $177.5 billion in 2009 and 2010 combined.

Redemptions Slow

Redemptions abated from a peak of $77 billion in the fourth quarter of 2008 to $8.7 billion in the three months ended March 31, the lowest amount in six quarters. Western Asset’s $6.7 billion in withdrawals was the smallest tally since December 2007, as 75 percent of the unit’s assets were in funds that beat benchmarks over the previous one, three, five and 10 years, according to the firm. As of March 31, about three-fourths of Legg Mason’s long-term U.S. assets were in funds beating their respective peers over the past three years, compared with 68 percent a year ago, the firm said.

Performance hasn’t picked up at the stock-fund division headed by Miller. His $3.9 billion Legg Mason Capital Management Value Trust fund, which beat the Standard & Poor’s 500 Index for a record 15 straight years through 2005, trailed the U.S. market benchmark in four of the last five years.

The fund averaged annual declines of 6.1 percent in the five years ended May 20, worse than 97 percent of its peers that invest in a blend of large-company stocks, according to data from Morningstar Inc. in Chicago.
–Bloomberg News–

Related Topics: Legg Mason Inc.