Charlie Johnston was skiing in Colorado on Christmas vacation when he got the call: Citigroup and Morgan Stanley were creating a $2.7 billion joint venture of their wealth management units. Johnston, president and chief executive officer of Smith Barney, had been at the company and legacy companies for 25 years and had witnessed his share of ups and downs. Now, he was to have a major role in this new deal that is destined to reshape the wealth management industry. Most analysts call this joint venture a smart business move, although more of a gamble than the other mega deal by its closest competitor, Bank of America/Merrill Lynch, which has the advantage of retail deposits for a capital base.

Morgan Stanley Smith Barney just needs to weather the current economic downturn, and handle the massive integration task just right-two major caveats-in order to reap the benefits as the premier brokerage of the future and dramatically change the landscape of the industry.

Wealth management is an expensive business model, so pooling resources is a natural way for firms to achieve the elusive optimal size that will balance the best combination of costs to the firm and still allow advisors to do their jobs well, say Gorman and Johnston, who gave an exclusive joint interview about the deal to On Wall Street.

The deal calls for a new joint venture; 51% owned by Morgan Stanley and 49% owned by Citigroup. Over the course of five years, Morgan has the right to buy more of the venture incrementally until it owns all of it. Meanwhile, Citigroup continues to benefit from an income stream, albeit a diminishing one, in addition to the $2.7 billion upfront cash payment.

The drive for more scale has prompted a number of the recent transactions in the industry, including this one, Gorman says. And with the economy in recession, revenues are likely to be down 10% to 20% this year across the industry, making scale even more important.

Moreover, Johnston notes that while cost cutting can help companies endure a rough patch; a strategy based on scale is more forward-thinking and is an investment in the future of the business as it prepares for brighter days ahead.

Despite the bombshell announcement in January, this joint venture did not happen as an immediate result of the turmoil in the financial marketplace, says Gorman. The deal was negotiated and worked out over a period of two months, but Morgan Stanley had been considering its various options for a big deal for a year and a half, he says. "We had taken a hard look at the industry and decided that consolidation was inevitable. We wanted to be one of the consolidators."

During the time it was looking at its options, Morgan Stanley was battling bad news on all fronts. In 2008, its shares fell 67%; it was hit with a downgrade from Standard & Poors (which added to the stock price decline), and in late September it sold off 21% of itself for $9 billion to Mitsubishi UFJ Financial Group, or $29 per share. At the time, that represented a premium over the $24.75 stock price. (The price has yo-yoed since then, ending the year at $16.06, but bouncing back to $23.56 by press time in mid-April.)

But all of that paled in comparison to the problem facing Smith Barney's parent, Citigroup. Like insurance giant, AIG, Citigroup was deemed "too big to fail" and received $45 billion from the government. Citigroup also received a $249 billion taxpayer guarantee from the government to cover bad assets. And the company's stock price fell 76% last year as quarterly losses mounted into the billions.

Analysts say that Citigroup did this joint venture with Morgan out of necessity. It simply needed the cash that badly. So it sold off one of the few valuable assets it owned, the retail brokerage. In fact, one analyst went so far as to say that the fact that Citigroup never really did a very good job integrating Smith Barney over the past 10 years into its operations might finally have been a blessing, as it was easier to hive it off when the parent needed the cash quickly.

So How Does This Affect Me?

News of the joint venture, understandably, sparked anxiety among the advisors, says Gorman. "The financial advisors are not here in the middle of the war room. For them not to be anxious, something would be wrong," he says.

After learning that the two firms had agreed to do the joint venture, advisors peppered management with questions.

How would the deal affect them? Would they get shortchanged on compensation? Would the new management fire their assistants?