Federal prosecutors are investigating the back-office operation of

Citigroup's

(C) - Get Report

asset-management division, the nation's biggest bank disclosed late Tuesday.

At issue is a conflict that arose when Citigroup's mutual fund operation tried to break into the business of transfer agency in the late 1990s. A transfer agent is a Wall Street functionary that keeps records about shareholders in order to process the sale of shares to another party.

The press release announcing the probe was short on details, but implied executives of the asset-management unit overstepped their bounds when they hired an unnamed subcontractor to outsource the transfer agent business.

Among other things, the subcontractor guaranteed a minimum amount of revenue back to Citigroup. The deal, which resulted in $16 million of guaranteed revenue, was eventually scrapped when the transfer agent agreed to make a one-time payment back to the parent.

"Neither the agreement nor the amendment was disclosed to the boards of

Citigroup Asset Management's

proprietary funds at the time the boards were considering whether to approve the transfer agent arrangements," Citigroup Asset Management said in a release. "These errors never should have occurred and we deeply regret that they did."

Citigroup said the $16 million of guaranteed revenue would be paid back into the funds themselves.

Citigroup disclosed the investigation in a memorandum to the senior management of its asset-management group, which the bank also made available to the public.

The investigation by James Comey, U.S. Attorney for the Southern District of New York, centers around the transfer agent business for Citigroup Asset Management's family of mutual funds.

The details of the investigation are sketchy. But the activities under scrutiny appear to be unrelated to the fast-growing allegations of improper trading in the mutual fund industry.

In the memorandum, the bank said its "entry into the transfer agent business in the period 1997-99 was not done the way it should have been.''

The bank said it is taking actions to rectify the errors that were made. The bank is repaying $16 million to the funds and "making personnel changes."

A spokeswoman for the bank declined to elaborate on the memorandum, which was written by Thomas Jones, chairman and chief executive officer of Citigroup Global Investment Management. She declined to identify the subcontractor.

In the memo, Jones said the bank has briefed the

Securities and Exchange Commission

and New York Attorney General Eliot Spitzer on the matter. Jones said the bank learned of the problem while "reviewing documents requested by the SEC.''

Citigroup Asset Management is a large enterprise within the Citigroup empire. The division has 2,600 employees and $493 billion in assets under management. It sells mutual funds under three brand names:

Salomon Brothers

,

Smith Barney

and

Citi

.