Citigroup Inc. co-Chairman John Reed failed to take decisive action after several internal bank warnings in the mid-1990s showed the bank was ignoring its own safeguards against money laundering, Senate investigators said yesterday.

The revelations about Reed's handling of the money-laundering issue illustrate a broader problem faced by U.S. commercial banks as they try to balance aggressive pursuit of new business against the possibility that some clients may be using the bank to hide ill-gotten gains.

In 1995, Citibank became the subject of a Justice Department investigation into the bank's relationship with Raul Salinas, the brother of former Mexican president Carlos Salinas, and as much as $100 million in alleged drug money the bank secretly transferred on his behalf. The investigation continues, though sources say it has stalled for lack of proof that the money came from the sale of drugs.

Reed didn't begin aggressive action until either late 1996 or early 1997, after Robert B. Shapiro, chairman of Monsanto Corp. and then the head of the audit committee of Citicorp's board of directors, went to Reed and told him he had to be more responsive to the audits and take swift action to clean up the private banking unit, said investigators with the Senate's Permanent Subcommittee on Investigations.

Money laundering involves taking money from illegal activities, such as the sale of drugs, and sending it through a series of financial transactions that make the money and its true owners hard to trace and identify. Often these transactions are undertaken by bank divisions known in the industry as private banking units, which cater to rich individuals who wish to move money around in secret, often to avoid taxes or other encounters with governments.

Next week, the Senate panel plans to hold hearings on the arcane world of private banking and its relationship to criminal activity. The subcommittee will release a 64-page report summarizing a year-long investigation during which investigators examined tens of thousands of Citigroup documents and interviewed dozens of private bankers in the industry, as well as two dozen bank regulators from the Federal Reserve Board and the unit of the U.S. Treasury that regulates banks.

The report also will detail other suspicious foreign accounts handled by Citigroup's private banking unit.

"It's fair to say that John Reed was aware that Citibank's own internal audits of its private banking operations showed that the private bank was neglecting its internal controls and procedures, some of which were designed to protect the bank against money laundering," said a top investigator on the panel.

"We don't want to leave the impression that John Reed was asleep at the switch completely," the investigator said. "He was aware of a problem and didn't make changing the culture that allowed for that sloppiness a priority."

"Private banking has a legitimate function, but has too often been used to manage dirty money," said Sen. Carl Levin (D-Mich.), the senior Democrat on the subcommittee.

Reed, who will testify at the subcommittee's hearings, is expected to acknowledge that the bank did not do a good job monitoring possible money laundering in its private banking operations. "There is no question that in the mid-1990s, the control environment in the private bank was not satisfactory," according to a copy of Reed's prepared statement. "Our internal audits showed this."

Moreover, Reed's statement says, "The internal auditors were candid and specific in expressing their concerns. Senior management and the board's audit committees took note and took action. Of course, the changes did not occur overnight, and in retrospect one could take issue with whether they happened fast enough."

Citibank officials say they have learned from the past and now use up-to-date technology to track their private banking customers and their money flows.

"It takes long, hard work" to change a banking culture, Reed's statement says.

In 1994, 1995 and 1996, Citibank's internal audits showed its private banking unit was seriously vulnerable to money laundering because executives in the units were ignoring the bank's policy of knowing its customers and where their money came from, sources close to the investigation said.

Federal Reserve regulators were sufficiently concerned about Citigroup's private banking unit that at the beginning of 1998 the Fed told the bank's board of directors it wanted the head of the private bank to file a report to the audit committee directly every three months on its progress in cleaning up its operations.

Citigroup is the result of the merger last year of Citicorp and insurance giant Travelers Group. In mid-1998, when the Fed criticized Citigroup's management of its private banking operations, Fed officials were considering Citicorp's application to merge with Travelers. The Fed approved the merger in October 1998.

CAPTION: Citibank's John Reed failed to take decisive action after warnings, Senate investigators said.