Can Sallie save Citi, restore Sandy’s reputation, and earn her $30 million paycheck?

She has filled seven 100-page spiral notebooks with scribbled questions that read variously as Zen koans (What do you do with an outperform stock in an underperform sector?), fortune-cookie aphorisms (Simplify financial planning), and to-do list fodder (Call client who is upset).

She has given out her cellphone number to hundreds of institutional investors. Three times she has been interrupted during speeches to take calls from her boss, Citigroup chairman and CEO Sandy Weill, who does not like to be put on hold. She has listened as one brokerage client after another has told her of losing money in WorldCom and Enron—each stock touted by the firm until the bitter end. She has nodded in sympathy to grumbles about IPO spinning and innumerable mentions of the name Jack Grubman, followed by sneers, scowls, and the occasional shout. She has said “sorry” to more people than she can begin to remember. “The public is like a jilted lover,” Krawcheck explains. “It’s going to take some time to win them back. We’ve got to start by saying we’re sorry.”

She has eaten at least 24 portions of chicken in a demi-glace. She has been honored by Columbia Business School and Governor George Pataki of New York. She has said good night to her husband and two children, ages 6 and 9, from hotel rooms in Sydney and Los Angeles and London and countless places in between.

It has been an impressive slog—but impressive in the way that anyone who begins her workday at 5 a.m. is impressive. Impressive as a synonym for “indefatigable” or “iron woman.” The achievements are that of a presidential candidate: crisscrossing the continent, retail politicking, winning votes one by one. Governing is a different matter. And Sallie Krawcheck, all of 38 years old, knows that. She knows that after seven months of a well-calibrated charm offensive, she hasn’t begun—oh, let’s be generous here—she has barely begun to govern Smith Barney. Her real job isn’t to make nice but to solve one of the most intractable problems on Wall Street and to patch up an embarrassing hole in the 70-year-old Weill’s legacy.

Already the sniping has begun. Some of her own analysts think the challenge is over her head, though none would snipe for the record. Nor is it a surprise that executives at rival firms are betting she won’t last. In several conversations with Fortune, veteran Wall Streeters drew on the same doubts: “[Weill] put someone in the job who was a great analyst but knows nothing about running this business,” says the well-regarded CEO of a large financial services company. “Smith Barney is a massive management job, and I don’t know if she can handle it. It’s almost unfair.”

Unfair…to be named chief executive of one of the most successful brokerages in history—a business (then called Salomon Smith Barney) that earned $722 million last year, in the throes of a bear market, nasty PR, and several regulatory investigations? Unfair to land a two-year compensation deal worth $30 million ($29.7 million, to be exact)? Unfair, you say, to find yourself suddenly mentioned, by some people anyway, as a possible successor to Weill—head of the most profitable company in the world.

Well, yeah.

But let’s back up for a moment. In the litany of Wall Street scandals last year, the most glaring scarlet letter of all seemed to be on Citi. When future historians review the excesses of the era, it will be Citi’s transgressions that loom largest—particularly the bizarre tale of star analyst Grubman allegedly selling a stock upgrade for nursery school recommendations for his children. In this year’s settlement between securities regulators and ten major Wall Street firms, it is Weill’s beloved Citi that was socked with the largest financial penalty, $400 million. Investigators described Citi’s stock research as “fraudulent,” an official humiliation only two other firms had to face.

Mending that tattered reputation would be hard enough for any seasoned, big-league manager. But to be perfectly frank, Krawcheck isn’t one of those. Before being chosen to run Smith Barney in October, the then-37-year-old former brokerage analyst had been CEO of boutique research firm Sanford C. Bernstein, a division of AXA’s Alliance Capital, for exactly one year and four months. Bernstein had 44 analysts covering 450 companies, plus 350 other traders, salesmen, and assistants. In 2002, its best year, its revenues were $295 million. Smith Barney, by contrast, has 23,000 employees, including 290 analysts covering 2,500 companies and 12,470 brokers spread across 530 branch offices (see sidebar below). Although it represents only 8% of Citigroup’s total revenues, were Smith Barney a stand-alone company, its 2002 revenues of $5.7 billion would rank it in the middle of the Fortune 500.

Fortune

This is the kind of spectacular career leap that tends not to happen in real life. It’s like telling the pitching coach of the Staten Island Yankees to catch the next bus to the Bronx to manage the New York Yankees, or maybe promoting a promising lieutenant, mid-battle, to commander of the Third Infantry. “She had a cushy job,” says Weill, with his usual bluntness. “She really demonstrates an entrepreneurial risk-taking ability to come into a business with lots of people she didn’t know and a huge challenge.”

That challenge, as big as it seems, is actually bigger than it seems. The behemoth that this bright, shining newbie now controls is busy changing its business model to the core—transforming in a way that competitors Merrill Lynch, Goldman Sachs, and Morgan Stanley are not. Under the terms of the $1.4 billion settlement, the big firms all agreed to separate analyst pay from investment banking, to prohibit spinning of IPOs, to provide retail clients with outside independent stock research paid for by the firms, and to publish ratings. Analysts can still be used to “vet” deals but cannot participate in road shows or even be alone in a room with an investment banker. The difference at Citi is that it’s the only one in the bunch that actually created a separate company to comply with the rules.

By marrying the research division and retail brokerage into a single corporate unit (separate from the company’s investment-banking, asset-management, and consumer-banking units), Citi has suddenly turned Smith Barney into something that looks more like Sallie’s old Sandy Bernstein than an integrated financial powerhouse.

The problem is, Smith Barney is a vastly more complex operation than her former research boutique, with exponentially higher operating costs and none of the gilded reputation. Its analysts will have to pay for themselves by bringing new, mostly retail stock-trading business to the firm’s brokers—in an era when individual investors are trading less and even commissions at the discount houses are falling rapidly. It’s a radical experiment that goes well beyond the requirements of the global settlement—and many doubt that it can work. “Anyone who can get a contract and get out is leaving,” one recently departed analyst says.

That characterization may be unfair. But then, so’s the job. It really is hard to look at Krawcheck and the task facing her and conjure any adjective other than “unfair.” To her credit, she seems to understand the risks, if not the odds. “I am not just betting my career on this,” she says, “I am betting my reputation.”

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“People used to say I was young and funny,” says Krawcheck, who is tucked into the seat of a Bombardier Global Express business jet headed for Philadelphia. She is smiling. She tends to smile when she talks. Her brown eyes light up. It’s hard not to be charmed. “I think every article about me used to have that line. Now they all say I’m ‘refreshing.’ I’m a ‘breath of fresh air.’ Does that mean I’m no longer young?”

It is just after 6 a.m., and she is skimming through the morning newspapers. The new CEO is starting a two-day trip to four cities that will include five presentations, five private meetings with investors and two group dinners. At times empathetic, even flirtatious, Krawcheck exudes the sense that she is entirely absorbed in the conversation at hand. Bill Clinton would admire her campaign skills (even if her rhetoric sounds more John McCain).

At every stop in her tour of retail brokerage offices she is mobbed by fans. People call her candid—an image enhanced by the fact that she tends to speak even to large groups without a microphone. She is animated onstage, using her hands for emphasis, brushing back her hair every few sentences, a tic she blames on nervousness.

None of her jitters are apparent, though, as she steps before a group of Smith Barneyites later that day in Atlanta. Within minutes of hello she is launching into her attack on the firm’s old ways. She mocks analysts who send out blast e-mails that do little more than review company earnings that have just been announced. “Do you think portfolio managers are sitting in their offices waiting for your take on the [quarterly] earnings IBM already reported?” she asks, before answering the question herself: “They don’t care!” She despises the reams of useless data that are sent to clients in morning notes, the endless parroting of management doublespeak that comes straight from investor-relations departments. “That has to stop,” she tells the assembled brokers. “The only goal of a research report is a target price. Just because Henry Blodget put a $400 target on Amazon does not mean target prices are bad. They are the end result of research.”

On this trip, though, Krawcheck is preaching to the choir. These are mostly brokers she’s talking to, after all. They had mistrusted their own firm’s research analysts long before the recent scandals and stock market collapse. The new CEO has spent months trying to woo Smith Barney’s brokers, who are the firm’s link to 7.5 million retail accounts. They like her. They seem to trust her from the get-go. But renewing their (let alone clients’) faith in research is, if not a mission impossible, a mission unlikely. Under Smith Barney’s new and improved model, analyst ratings will be simplified to “add,” “hold,” and “reduce.” Jargonistic terms like “outperform” and “market perform” have been purged from the system. Krawcheck says she wanted “thumbs up” or “thumbs down,” but was vetoed. Sector ratings, considered a wimpy way of downgrading companies, are being scrapped.

The new Smith Barney is a radical experiment that goes well beyond the requirements of the global settlement.

Eventually stocks in all categories will be combined into a single electronic list that ranks expectations, based on varying metrics, from favorite to least favorite. If a broker in St. Louis wants to find the top-rated stocks based on expected dividend growth, he will be able to access just such a list on his computer screen. The same will be true if he wants a list based on, say, return on equity. Research reports will also be required to offer a price target for each covered stock and clearly state the upside or downside potential in percentage terms.

But the most potent change is in how analysts are paid. In the old regime investment banking paid up to 40% of the firm’s research budget. Under the new model, most of Smith Barney’s research budget, which, incidentally, is down by more than a third, comes almost entirely from retail broker commissions. The firm also generates revenues by “selling” research (for an undisclosed fee) to Citi’s private bank, asset-management division, bank branches, and institutional trading arm. Citi’s investment bank—the remnants of Salomon—may also become a consumer of research. The money from all those purchases goes into Smith Barney’s overall budget, as opposed to directly into analysts’ pockets. The new structure, in short, takes away any financial incentive for analysts to inflate their ratings. The thinking is that great, unconflicted stock analysis will get retail clients, who normally pay up to 65 cents a share in commissions, to increase their assets under Smith Barney management. Institutional clients will also be more likely to trade through Citigroup rather than use a deep-discount electronic dealer if they think the research is worth reading.

At what point do those increases turn into Sallie’s victory lap? She has set a specific goal to double broker assets under management in five years, assuming a moderately rising stock market. As for trading revenues, if research can help brokers increase their commissions and fees from the current average of $430,000 a year to, say, $530,000, that would be success. “At the end of the day, it’s the numbers,” she says. “The ultimate arbiter of whether we are good at research will be our stock recommendations. I will know we are succeeding because we will be outgrowing and outearning the competition.”

In Krawcheck’s grand vision, the market wisdom from her research brain trust in lower Manhattan will propagate inexorably throughout the Citigroup cosmos. Private bankers, who heretofore have barely touched brokerage reports, will suddenly incorporate the advice into their strategies for the affluent. Insurance agents will bundle the research with annuities. Financial planners will turn to the brokerage analysts for guidance. It’ll be one giant, happy cross-selling bonanza.

But first she has to fix the research—a task she began in earnest this past January when she met for the first time with the entire U.S. research staff. By then she had gutted the old management. She promoted four analysts to serve as associate research directors and named a new U.S. research chief: Jon Joseph, a respected chip analyst who predicted a major drop in his sector’s stock prices in 2000 and received so many death threats that the firm had to assign him a bodyguard. Joseph and the others now review and debate the arguments made by analysts; a separate committee also examines reports.

Analyst compensation, meanwhile, has nosedived. One top-ranked researcher who earned $3 million at the market’s peak now takes home $1.2 million. Some big-name analysts who have balked at the pay cuts and felt demeaned by what they call “classroom treatment” have left for rival firms. (Others have had no choice: In late May the firm fired eight more analysts.)

Back on the plane home to New York, Krawcheck displays the blue pen she uses to mark up the status quo. She reads everything that Smith Barney publishes. Reports that meet her approval are often sent back to the analyst with a polite note. Others she dissects and bounces over to global research director Bill Kennedy.

Ripping through one report that lacks the decisive conclusions she wants, she exclaims, “I want controversies! Give me something that investors can use.” Weill says that impatience with indecision is one reason he hired her. “Sallie doesn’t dilly-dally,” he says. “I like that.” That, and her financial savvy: “Her understanding of numbers is great. As an analyst she was by far the most astute observer of our business. She can do what needs to be done better than anyone I know.”

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“I was so ugly,” says Krawcheck. “I had braces, glasses, and bad hair, and I was skinny. I wore corrective shoes because I had pigeon toes.” She was a seventh-grade student at the elite Ashley Hall school for girls in Charleston, S.C. Charleston is one of the more stratified cities in America, a place where you are not really accepted into society unless you were born (actually, unless your great-grandparents were born) south of Broad Street. Krawcheck was the product of a father who was well-off but Jewish, and a mother who was a less affluent WASP. She felt early on that she did not fit neatly into the culture. Kids laughed at her looks and her name, which was unusual in a city of Rutledges and Beaufains. (The brattiest little Charlestonians called her “Crotch-Check.”) Her childhood experience as a social outsider, Krawcheck says, “created this abject fear of failure for which I am grateful now but that was awful as a kid.”

By the time she transferred to coed prep school Porter-Gaud as a 14-year-old, the braces had come off. The thick glasses were replaced with contact lenses. She got rid of the corrective shoes, and the 5-foot-6 teenager discovered she could jump higher than almost any of the other girls. She became a track star in high school. Her peers voted her homecoming queen.

She found comfort in playing the underdog, which has proved to be a remarkable tool for success on Wall Street. Krawcheck claims that at Bernstein, where she quickly rose through the ranks, her insecurity made her work excessively long hours and ask lots of questions. By the time she had become widely recognized as the best brokerage analyst on the Street, she gave that up to become Bernstein’s research director. In 2001, when real investors rode momentum stocks and Bernstein’s value-focused research was unfashionable, she was promoted to the job of CEO. Instead of retrenching, Krawcheck somehow persuaded her bosses at Alliance Capital to triple the number of Bernstein analysts. Soon after, profits were through the roof. When the research scandals broke, it was Bernstein that became the poster shop of integrity on Wall Street. Fortune even put Krawcheck on its cover in June 2002 with the headline, “In search of the last honest analyst.”

Four months later, on a rainy Tuesday afternoon in October, Sandy Weill called. Though she had known Weill back when she was an analyst covering his company, the two hadn’t spoken in at least two years. Weill invited her to breakfast that Friday in Citigroup’s Park Avenue offices. She had an inkling that a job offer might be in the works, probably a research executive’s position. Seated in the windowless room, she could feel her heart thumping. The red blotches she gets when she is nervous were starting to show on her neck. Weill waited until the plates were cleared before he described his plan to combine research and the retail brokerage into a stand-alone company. When he asked if she’d like to run it, she says she momentarily stopped breathing. “Did I surprise you?” Weill asked as they left the dining room.

Weill offered her the two-year package worth $30 million—an amount that earned her the nickname “Sallie Paycheck” (a sobriquet she despises even more than the old “Sallie Crotch-Check”). What’s more, he made her one of nine direct reports and told her she could do whatever she wanted to fix research. That was the kicker, she says—the freedom to reinvent the company.

Weill told her to do whatever she wanted to fix research. That was the kicker: the freedom to reinvent the company.

That weekend a friend who knew Citigroup well tried to persuade her not to take the job. “Why would you want to take responsibility for Wall Street’s problems?” the friend asked. She didn’t need the money, having already earned millions at Bernstein. Her husband, Gary, a merchant banker, did not share her friend’s reservations. He saw it as a chance for her to make a difference. At dinner the following Sunday, Sallie and Gary met Sandy and sealed the deal over a bottle of extremely nice red wine.

In the past seven months her job has brought not only new fame and fortune but also plenty of hallway gossip speculating that she sees her high-profile assignment merely as a prelude to the corner office—a way to vault over established CEOs-in-waiting such as investment-banking chief Chuck Prince and Citigroup president Bob Willumstad. When asked about the chatter, she says, “I don’t know if I’m supposed to be flattered or offended when people ask me that. I have been here six months and 23 days and eight hours. At three o’clock I’m going to have my first staff meeting. There is no break. I am in a constant struggle to find the time to get the urgent out of the way and get to the important.”

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It is 4:15 a.m. Dallas time, and Krawcheck steps off an elevator into the grand marble lobby of the Mansion at Turtle Creek hotel. Remarkably spry given the hour, she is on her way to a nearby airport to fly back to Manhattan before the stock market opens. “Did you see Frontline?” she asks a nearby colleague. The PBS program ran a special on Wall Street the night before that highlighted Weill and Grubman.

A clerk hands her the Wall Street Journal as she exits the hotel and slides into a waiting minivan. In the paper is an article about securities regulators turning the spotlight on investment bankers at the old Salomon Smith Barney who pressured analysts to inflate their ratings. She finds a second article about a former Smith Barney broker who was an informer to securities regulators on the IPO-spinning case. The broker himself, the article claimed, is now being investigated by the New York Stock Exchange. “It’s like a hurricane, a hurricane of noise,” she says. “We’ve got to move beyond this.”

The odd thing, however, is how unflustered she seems when she says this. It’s her company now. Her good-God-what-have-I-gotten- myself-into challenge. And the smart money says Smith Barney and Citigroup and her boss Sandy have a ways to go before they win their credibility back.

But then, Krawcheck has a simple answer for such cherished pieces of collective wisdom. “In general, the consensus is just wrong,” she says. “Right now, in fact, the consensus is wrong that research is not worth anything.” And that would be a good thing for Sallie Krawcheck. If the consensus is wrong, she may just have a shot.

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The really fast track

Krawcheck’s gig at Smith Barney is a spectacular career leap. One day she’s running a research boutique, the next she’s CEO of one of Wall Street’s biggest brokerages. A before-and-after comparison.

Company

Then: Sanford C. Bernstein
Now: Smith Barney

Revenue

Then: $295 million
Now: $5.7 billion

Job title

Then: Chairman and CEO
Now: Chairman and CEO

Job description

Then: Run independent
Now: Run No. 2 retail research shop brokerage in the country

Employees

Then: 400
Now: 23,000

Time on the road

Then: 7 days per month
Now: 12 days per month

Corporate jet?

Then: No
Now: Yes

Best perk

Then: Free lunch
Now: Unlimited cookies and orange juice

Reporter associates: Julie Schlosser, Helen Kim