(Reuters) - Money manager Legg Mason Inc (>> Legg Mason, Inc.), struggling to boost its stock price and stem 19 straight quarters of net withdrawals from its funds, said Chief Executive Mark Fetting will step down effective October 1.

Investors applauded the news, sending Legg Mason shares up 5.6 percent to $26.90 in mid-day trading on expectations the move will clear the way for activist investor and board member Nelson Peltz to further shake up the company.

Legg Mason sales chief Joseph Sullivan will become interim CEO during a search for a replacement. Fetting, 57 years old, took over the Baltimore-based fund giant as the financial crisis intensified in early 2008, and tried to fix the company's troubles with deep job cuts and by restructuring its debt.

But the performance of Legg Mason's funds has been mixed since then and its shares have not come back like those of some competitors. Earlier this year, Legg Mason's star fund manager, Bill Miller, gave up management of his main fund after a string of sub-par results.

Fetting has also had to deal with Peltz, who often presses for changes at companies in which he invests and who joined Legg Mason's board in 2009. Peltz has not objected publicly to Fetting's policies -- so far.

Peltz's Trian Fund Management firm also agreed to refrain from buying shares beyond a current stake around 10 percent. But that agreement expires in November, giving Peltz room to ramp up pressure on the money manager.

Expectations Trian will press for big shifts at Legg Mason, such as selling off pieces, drove up the shares, said Stifel Nicolaus analyst Jeffrey Hopson in a telephone interview. Of Peltz, Hopson said "He's an instigator. People expect something to happen."

But it may prove hard for Trian to find a buyer willing to pay a high price for parts of Legg Mason since there are other asset managers also on the market and buyers are cautious, Hopson said in a research note to investors.

A spokeswoman for Peltz's firm, Anne Tarbell, said on Tuesday it would not comment on the changes. Trian has consistently declined to discuss its views of Legg Mason, citing Peltz's board role.

NO BUM'S RUSH

Pete Nachtwey, Legg Mason's chief financial officer, said the board and Fetting had agreed that "this is an appropriate time to transition leadership of the firm."

Speaking at a financial services conference that was webcast, Nachtwey did not mention Peltz or Trian but denied the change in leadership was hasty.

When a conference participant said that "it seems like Mark (Fetting) is being run out the door pretty quickly," Nachtwey responded that there was "no bum's rush whatsoever."

Legg Mason said Sullivan, the company's global distribution head, will become interim CEO when Fetting steps down. The firm is among the largest fund companies in the United States; as of the end of July it managed $636 billion of assets.

In a press release, the company said the board had formed a search committee to review internal and external candidates for CEO.

Fetting will remain a consultant through the end of the year, it said.

At the conference, Nachtwey said one possibility was that Sullivan, age 54, would become permanent CEO. "This is not a caretaker," he said, but added that "sometimes fresh blood is helpful."

Nachtwey said Legg Mason's turnaround was continuing.

Lead independent director W. Allen Reed will become Legg Mason's non-executive chairman, a post Fetting also holds.

None of the executives were available for interviews, a spokeswoman said. Asked about the timing of the change, the company said in an emailed statement that "This is about a fresh look at growth, within our affiliate model."

Affiliates like Legg Mason's Western Asset Management bond unit and smaller equity divisions like Legg Mason Capital Management and Clearbridge operate with more independence than do units of big Legg Mason competitors. The statement seemed to affirm that arrangement and left room for acquisitions.

The new CEO, and Sullivan in the interim, "will work closely with the affiliates to build on our core capabilities and to develop new products and capabilities that best serve clients.

PATIENCE WEARS THIN

In July Legg Mason reported its 19th straight quarter of net withdrawals from its funds, leaving investors frustrated waiting for Fetting to improve the performance of the funds after losses during the financial crisis.

Legg Mason's stock trades at about one-quarter of its price of around $100 in mid-2007 before the crisis hit. Shares of rivals like BlackRock Inc (>> BlackRock, Inc.) and T. Rowe Price Group Inc (>> T. Rowe Price Group, Inc.) have already recouped all their losses and more.

Legg Mason's board cut Fetting's compensation 17 percent to $4.94 million in the company's latest fiscal year, to reflect a lagging stock price and lackluster returns.

For years, Legg Mason was best known as the home of Bill Miller, whose fund outperformed the Standard & Poor's 500 index 15 years in a row. But Miller's performance tailed off starting in 2006. He stepped down from his best-known fund earlier this year.

(This story has been repeated to remove extraneous characters from headline)

(Additional reporting by Jochelle Mendonca in Bangalore; Editing by Akshay Lodaya, John Wallace and Steve Orlofsky)

By Ross Kerber