UPDATE 3-Citadel's Griffin joins troubled E*Trade's board

* Citadel exercises right under 2007 agreement

* Citadel is E*Trade's largest debt and equity holder

* E*Trade under regulatory pressure to raise capital

* Shares up 2.8 percent (Recasts, adds share rise, analyst comment, capital-raising plan, byline)

By Jonathan Spicer

NEW YORK, June 9 (Reuters) - Kenneth Griffin, the chief executive of Citadel Investment Group, has joined the board of E*Trade Financial Corp (ETFC.O) in a move that suggests the giant U.S. hedge fund wants a stronger hand in steering the troubled online brokerage.

Citadel, E*Trade's largest debt and equity holder, exercised its right under a 2007 investment agreement to appoint a member to the brokerage's board. E*Trade shares rose 2.8 percent in Tuesday morning trade.

"Citadel is deciding to become more pro-active ... and it also underlines the fact that it might be more difficult for an outside player to come in, given Citadel's interest," said Morningstar analyst Jason Ren, alluding to long-running speculation that E*Trade may be a takeover candidate.

"Citadel has considerable reach over the firm," Ren said.

E*Trade's core trading business has been sound, but bad bets in its mortgage business have brought on a string of sharp losses. Its regulator, the U.S. Office of Thrift Supervision (OTS), told the brokerage in April to quickly raise capital and reduce its leverage.

E*Trade's eight-month-old application for $800 million in funds under the U.S. government's Troubled Asset Relief Program has gone unanswered.

Griffin's appointment is effective immediately, E*Trade said in a statement on Tuesday. The executive, who will join the board's financial and risk oversight committee, said he would "help create and take advantage of the many market opportunities that these unique times provide."

E*Trade's stock dropped more than 90 percent in the second half of 2007 and has been relatively flat over the last 18 months. The shares were up 4 cents to $1.49 in morning Nasdaq trade.

E*Trade's stumble has hurt Citadel, which bought an 18 percent stake in the online brokerage and $3 billion in asset-backed securities in 2007. The hedge fund owns 15.6 percent of E*Trade's shares, according to a May regulatory filing.

E*Trade said in the May 8 filing that it had been in talks with Citadel and others over the last several months about its need to raise capital for its hobbled unit, E*Trade Bank. It said it had no commitment from any possible creditor.

It said in the filing that Citadel, which owned more than 70 percent of E*Trade's outstanding high-yield debt, had not agreed to reduce the debt.

"If we are unable to raise enough cash equity capital for E*Trade Bank or to reduce our debt in the near term, we would probably face negative regulatory consequences in the form of a public supervisory action, such as a written agreement or a cease-and-desist order, from the OTS," the New York-based company said in the filing.

Last month the online brokerage announced a $150 million common stock offering, to be sold periodically, in an effort to raise capital and shore up its balance sheet. But Standard & Poor's Ratings Services said the move "will not sufficiently improve the company's credit profile."

Griffin, who has headed Chicago-based Citadel since it was founded in 1990, will stand for reelection at E*Trade's annual meeting next year. (Reporting by Jonathan Spicer; editing by Maureen Bavdek and John Wallace)