How E*Trade Irked Citadel 

Capital One Financial Corp. COF -0.87% approached E*Trade Financial Corp. ETFC -5.50% last fall about a potential bid for the online brokerage, according to people familiar with the situation.
Though an offer never materialized, and Capital One ultimately didn't pursue it further, those discussions are a key reason hedge-fund manager Ken Griffin, who is on E*Trade's board, has lately been aggressively and publicly pushing E*Trade to sell itself.

The failure of the preliminary discussions to lead to a concrete offer represented a tipping point for Mr. Griffin, founder and chief executive of Citadel LLC, E*Trade's largest shareholder, according to a person familiar with the situation. Mr. Griffin felt the approach wasn't properly evaluated by the board, the person said.

The question of how E*Trade treated the discussions is a matter of contention. While Mr. Griffin wasn't satisfied with the process, people familiar with the matter said, some other people familiar said that E*Trade gave the Capital One approach the appropriate attention and that there is no indication otherwise.
Some other people familiar with the matter said E*Trade acted responsibly by not exploring a sale at the time since it probably would have been acquired at a relatively cheap price due mainly to its loan portfolio, which could have also angered investors.

In recent weeks, the fight over E*Trade's future has essentially become a battle between E*Trade, the iconic brand known by many consumers for its talking-baby TV commercials, and Mr. Griffin, one of the hedge-fund industry's most prominent managers.

Citadel has criticized the company's management in two separate letters to E*Trade CEO and interim Chairman Steven Freiberg over the past two weeks. In one letter, Citadel cited E*Trade's "catastrophic losses" for shareholders over the past four years—when the company's stock plummeted as it was rocked by souring mortgages in its banking arm.

Citadel is demanding a shareholder meeting to discuss a potential sale of the New York-based online brokerage. Citadel owns 9.8% of E*Trade's stock. E*Trade has not called such a meeting.
Capital One didn't hire an investment bank and a price wasn't discussed, the people familiar with the situation said.

The talks, however, were serious enough that E*Trade's board asked J.P. Morgan Chase & Co JPM -1.63% .—which it had already hired to perform a strategic review—to advise E*Trade on the matter, these people said. The strategic review focused on valuation of the company, including how the mortgage portfolio affected it, the sources said.

J.P. Morgan wasn't hired to explore a sale of E*Trade or to run an auction process for the company, but it didn't rule out that possibility if it were in the best interest of the company and shareholders, the people said.
E*Trade didn't feel the need to reach out to other potential buyers about a counteroffer, according to people familiar with the matter. Analysts have long counted TD Ameritrade Holding Corp. AMTD -2.24% and Charles Schwab Corp. SCHW -3.40% as E*Trade's most likely suitors.

Representatives for TD Ameritrade and Charles Schwab declined to comment.
One issue for E*Trade in sizing up the right time and price for a sale has been its loan portfolio. Chief Financial Officer Matthew Audette told investors during a conference call in January that losses from soured loans had declined for the sixth consecutive quarter, and improving delinquency trends were "exceeding our expectations." By Dec. 31, the company's loan portfolio had shrunk 21% from a year earlier, to $15 billion. Nevertheless, E*Trade at the time felt further improvements in the mortgage book would boost its value, according to a person familiar with the matter.

The Wall Street Journal recently said TD Ameritrade was scheduled to discuss a possible offer for E*Trade at its previously scheduled board meeting last Tuesday, citing people familiar with the situation. Ameritrade was lukewarm to a bid for E*Trade in recent days, given the possible price and the size of the company's mortgage portfolio, these people said.

During the discussions with Capital One, which hadn't become public knowledge until now, E*Trade's stock price rose, a factor in the McLean, Va., bank's decision to move on. Capital One later agreed to buy the ING Direct online-banking business from ING Groep NV ING -4.57% for $9 billion in cash and stock.
While Citadel rescued E*Trade with a big investment four years ago, it couldn't push for large changes until recent months. In 2008, the hedge fund received a waiver that prevented it from being regulated as a bank holding company as it accumulated a roughly 25% stake in E*Trade, which was regulated by the Office of Thrift Supervision. The agreement gave Citadel a seat on the board, but the firm couldn't exert control over the company or its management. Once Citadel's stake in E*Trade fell below 10%, that agreement was terminated.

The firm also likely saw an opportunity to push for new corporate governance, given the exit of E*Trade's former Chairman Robert Druskin in May and the decision by C. Cathleen Raffaeli not to seek re-election to the board.