E-Trade ousts CEO, gets hedge fund cash

Online brokerage and bank E-Trade Financial Corp. said Thursday that it was getting a $2.55-billion infusion from a hedge fund firm and ousting its chief executive after the company’s shares plunged because of losses on securities linked to sub-prime mortgages.

Chief Operating Officer Jarrett Lilien took over as acting CEO, replacing Mitchell Caplan, E-Trade said. Citadel, a Chicago-based hedge fund manager, will get a 17% stake in the company, plus notes issued by E-Trade, for $1.75 billion and will pay about $800 million, or 27 cents on the dollar, for asset-backed securities with a face value of $3 billion.

E-Trade shares fell 46 cents, or 8.7%, to $4.82. The stock is down 79% this year.

The company joins lenders Citigroup Inc. and Countrywide Financial Corp. in turning to outside investors for capital amid a plunge in the value of securities tied to sub-prime mortgages. Earlier this month, a Citigroup analyst said losses from bad debts might lead E-Trade into bankruptcy, spurring customers to withdraw about $6 billion, or 15% of the cash in client accounts at the end of September, Lilien said Thursday.

“The company was getting awfully close to violating their regulatory capital ratios,” said Jaime Peters, an analyst at Morningstar Inc. in Chicago who covers E-Trade and doesn’t have a rating on the stock. “They needed an infusion of cash and they needed it fast.”

E-Trade’s $2.2-billion loss on the sale of the debt to Citadel will wipe out almost five years of profit for the New York-based firm. The company faces a formal inquiry by the Securities and Exchange Commission into “matters related to the company’s loan and securities portfolios,” according to a Nov. 9 regulatory filing.

Citigroup analyst Prashant Bhatia said in a Nov. 11 report that there was a 15% chance that E-Trade would be forced to seek protection from creditors if mortgage losses prompted customer defections. Smaller brokerage rivals have taken out ads alluding to E-Trade’s mortgage losses.

“Our expectation is that the money will move back now that people see that there is this strong deal, this strong investment led by Citadel,” Lilien, 45, said in an interview. “We feel it takes concerns off the table.”

After reviewing the transaction, Standard & Poor’s kept E-Trade’s rating on review for a possible downgrade, saying the deal “does not provide a full resolution for long-term stability.”

Caplan, 50, is the second E-Trade CEO forced out on the heels of a falling market. He joined E-Trade as chief of financial products in 2000 when the company, then headed by Christos Cotsakos, bought the online bank run by Caplan for $1.9 billion.

E-Trade stock, which climbed as high as $62.75 in 1998 amid the frenzy for day trading and dot-com shares, tumbled as low as $3.40 in 2002 as the stock market swooned. Cotsakos resigned in January 2003 after two straight years of losses, and Caplan took over.

He reduced reliance on trading commissions by tripling loans at the company’s online bank.

But the mortgage-market losses this year have made E-Trade the S&P; 500 index’s worst performer this year, and the stock is barely 10% higher than when Caplan started.