Insider sources told Bloomberg that the plan is one of several options being explored by Citigroup as it looks to comply with the new legislation, which requires banks to stop wagering their own money on markets and securities.
As a result, preliminary talks are said to be ongoing about moving traders from the Citi Principal Strategies unit to Citi Capital Investors, which mostly oversees money for external investors.
The plan is to reassign the proprietary traders as hedge fund managers and seed their current funds before redeeming their stakes with new investments from outside sources.
David Hendler, a senior analyst at research firm CreditSights, said the Citigroup proposal could turn out to be a good one.
"This may be a way of keeping a high-margin capital-markets business in the fold, within the language of the law," he said.
"They would be transforming it from an-interest-plus-capital-gain business into a fee business."
Another potential option for Citigroup is to reassign the Principal Strategies team across the bank's various trading operations, with employees moving to the unit most closely related to their specialism.
However, there is some concern about this strategy, as the proprietary traders may be unwilling to deal with clients after being independent from them in their unit.
The insiders said that although full compliance with the new legislation may not be required until 2017, Citigroup is anxious to sort the problem out before its traders start to look elsewhere for employment.
Earlier this month, President Barack Obama signed the financial reform bill into law, which also includes provisions to allow regulators to break up any bank deemed too 'big to fail'.
He said it will mean that "the American people will never again be asked to foot the bill for Wall Street's mistakes".
By Gary Cooper