Legg Mason Inc. agreed to swap its 1,400 stockbrokers for Citigroup Inc.'s mutual fund business, a $3.7 billion deal that would complete Legg Mason's transformation into one of the largest U.S. money managers.

With the deal announced yesterday, New York-based Citigroup would largely exit the mutual fund business in favor of selling such funds for others. The Baltimore-based Legg Mason would do the opposite, concentrating strictly on managing mutual funds and other investment products and getting out of the stock brokerage business.

The unusual transaction highlights the growing pressure on the investment industry to break up the combined retail brokerage and investment fund businesses that Citigroup, Legg Mason and many Wall Street firms built in the past decade. Executives at both companies said the deal was driven in part by concerns over the inherent conflict in stock brokers selling funds that are put together in-house when more appropriate or better-run funds managed by others are widely available.

"Given the more challenging regulatory environment, . . . we expect more deals to come," Banc of America Securities analyst Michael A. Hecht wrote in a note sent to investors yesterday.

By the end of the year, investors who have individual accounts at Legg Mason Wood Walker Inc., the company's retail brokerage subsidiary, are set to become customers of Citigroup brokerage unit Smith Barney. Neither firm would comment on possible job losses, though some cuts are inevitable as some administrative jobs will overlap.

Legg Mason officials said they would now be able to concentrate on advice and investment funds, the most profitable and fastest-growing part of their business.

"There's no question that we've worried the last few years on the regulatory side," said Legg Mason chief executive Raymond A. "Chip" Mason of his firm's brokers selling Legg Mason's own investment funds.

Now, Legg Mason's mutual funds and other investment products are sold through only its own network of brokers. With completion of the Citigroup deal, expected at the end of the year, those funds would be sold through Smith Barney, which would have nearly 14,000 brokers and 7.5 million clients. Legg Mason's 1,400 brokers in 135 East Coast offices would become Smith Barney employees.

Mason and Co. was founded as a stock brokerage by Mason and then-partner James W. Brinkley 43 years ago in southern Virginia, and it merged with Baltimore's Legg & Co. in 1970. Mason, 68, yesterday said it was a "very personal, difficult decision" to sell the brokerage.

Making phone calls to brokerage employees yesterday morning, he said, "was one of the hardest things I've ever had do. I just wanted to get through it."

The deal presents a new set of risks for Legg Mason, along with the potential benefits.

Citigroup's asset management business includes 80 funds with about $160 billion of mutual fund assets, most of which have not performed well and in recent months have been shrinking. It has not performed well relative to stand-alone mutual fund companies. "Our asset management business has not been what we had hoped," said Citigroup chief executive Charles O. Prince.

By taking on such a large bundle of assets -- and more than 2,600 employees around the world -- Mason is betting that his firm's prowess at managing money will turn that business around.

"Legg now must integrate a large asset management business with some centers of excellence, which is something Legg is very familiar with from past deals, but also a turn-around story, which is something that Legg is not really all that familiar with," analyst Hecht wrote.

Legg Mason's stock price shot up $13.01 yesterday on the news, closing at $98. Citigroup closed at $46.95, up 7 cents.

Legg Mason valued the entire Citigroup transaction at $3.7 billion, which includes the value of its brokerage unit, a $550 million loan from Citigroup and the sale of about $1.5 billion in Legg Mason stock to Citigroup.

Legg Mason would get $437 billion in Citigroup's managed assets, bringing Legg Mason's total managed assets to more than $830 billion, making it the fifth-biggest asset manager in the world.

Legg Mason yesterday said it was acquiring a hedge fund company with $20 billion in assets under management in a separate deal. In addition to more than doubling its asset management business, the Citigroup purchase and the purchase of Permal Group would significantly expand Legg Mason's presence among investors in Europe and Asia.

Legg Mason agreed to pay an initial $800 million for Permal, which has a predominantly non-U.S. clientele of wealthy and institutional investors. Permal invests in hedge funds -- loosely regulated, risky investment funds that seek high returns. The deal would be Legg Mason's first foray into the hedge fund business. If Permal performs well after the acquisition, Legg Mason could pay up to an additional $586 million to Permal's shareholders.

Both deals need regulatory and shareholder approval.

Legg Mason also agreed to acquire a hedge fund company.Under the deal, Citigroup would largely leave the mutual fund business.