UPDATE: E*Trade Complies With Citadel, Hires Goldman For Review

E*Trade Financial Corp. (ETFC) bowed to pressure from its largest shareholder, Citadel LLC, and said its board formed a new special committee of independent directors, which hired Goldman Sachs Group Inc. (GS) to conduct a review of strategic alternatives.

The move--for now--calms the heated battle for the future of the online brokerage, which began last month. Citadel, a hedge-fund manager and owner of 9.8% of the company's stock, has been pressuring E*Trade to call a special shareholder meeting to discuss options, including a potential sale of the company.

In a letter to E*Trade Chief Executive Steven Freiberg, Citadel Chief Legal Officer Adam Cooper wrote, "We trust this new process, involving all directors will be more transparent and objective."

Additionally, Cooper said, "we believe it is appropriate to suspend further shareholder action at this time, including our request for a special meeting of E*Trade's shareholders."

The news initially sent shares of E*Trade up 3.3% to $11.29 in after-hours trading as investors bet on the increased possibility of a possible sale of the company; later, shares dropped, and recently traded at $10.90, down 0.3%. Shares of E*Trade closed Monday down 13% at $10.93 amid a broad market selloff.

In a statement, E*Trade said independent board members Frederick Kanner, Joseph Sclafani and Joseph Velli would be on the new committee. All three joined the board in the last three years, after E*Trade's shares plunged in value and Citadel bought into the company.

E*Trade said the new committee would "facilitate and manage the strategic review process in collaboration with the full board of directors, which will act as a whole in making all decisions regarding the future direction of the company."

E*Trade said, "the decision and actions taken by the new special committee are unanimously supported by all independent members of the board."

The committee won't include Michael Parks, one of two board members--along with Donna Weaver--that Citadel demanded E*Trade replace with independent directors. Parks had been on an earlier committee set up to review strategic alternatives.

As part of Citadel's demands, E*Trade let go of Morgan Stanley (MS), which the online brokerage had hired last month to conduct a review of strategic alternatives, according to people familiar with the situation.

Citadel was unhappy E*Trade hired Morgan Stanley, which did previous work for E*Trade, and instead wanted Goldman Sachs to advise the company, these people said. The hedge fund had asked the online brokerage to retain an investment bank that had not previously advised the company or its board.

Citadel made that request, and leveled criticism at E* Trade's management, in two recent letters to Freiberg. In one letter, Citadel said E*Trade shareholders suffered "catastrophic losses" over the past four years, when the company's stock plummeted as it was rocked by souring mortgages in its banking arm.

Last month, Dow Jones Newswires, citing people familiar with the matter, said Capital One Financial Corp. (COF) approached E*Trade last fall about a potential bid for the online brokerage.

While an offer was never made, and Capital One ultimately didn't pursue the matter further, those fruitless discussions are a key reason Citadel founder Ken Griffin, who is on E*Trade's board, has aggressively and publicly pushed E*Trade to sell itself.

-By Brett Philbin, Dow Jones Newswires; 212-416-2173; [e-mail]

-By Gina Chon, The Wall Street Journal