ITEM 1. BUSINESS
Throughout this Annual Report, unless the context otherwise requires, the terms “GFI”, “Company”, “we”, “us” and “our” refer to GFI Group Inc. and its consolidated subsidiaries.
Our Business
Introduction
We are a leading provider of wholesale brokerage services, clearing services and electronic execution and trading support products for global financial markets. We founded our business in 1987 and were incorporated under the laws of the State of Delaware in 2001 to be a holding company for our subsidiaries. We provide brokerage and trade execution services, clearing services, market data and trading platform and other software products to institutional customers in markets for a range of fixed income, financial, equity and commodity instruments. We provide execution services for our institutional wholesale customers by either matching their trading needs with counterparties having reciprocal interests or directing their orders to an exchange or other trading venue. We have focused historically on more complex, and often less commoditized, markets for sophisticated financial instruments, primarily over-the-counter (“OTC”) derivatives, that offer an opportunity for higher commissions per transaction than the markets for more standardized financial instruments. In recent years, we have developed other businesses that complement our brokerage of OTC derivatives, such as cash bond and futures contracts brokerage services, clearing services and analytical and trading software businesses. We have been recognized by various industry publications as a leading provider of institutional brokerage and other services for a broad range of products in the fixed income, financial, equity and commodity markets on which we focus.
We offer our customers a hybrid brokerage approach, combining a range of telephonic and electronic trade execution services, depending on the nature of the products and the specific needs of our customers. We complement our hybrid brokerage capabilities with decision support services, such as value-added data and analytics products, real-time auctions, fixing and matching sessions and post-transaction services, such as straight-through processing (“STP”), clearing links and trade and portfolio management services.
Headquartered in New York, GFI was founded in 1987 and employs more than 2,000 people with additional offices in London, Paris, Nyon, Madrid, Hong Kong, Seoul, Singapore, Manila, Sydney, Cape Town, Santiago, Bogota, Buenos Aires, Lima, Dubai, Dublin, Tel Aviv, Los Angeles and Sugar Land (TX). We have more than 2,600 brokerage, software and market data customers, including commercial and investment banks, corporations, insurance companies, asset managers and hedge funds.
During 2012, many of the financial markets in which we provide our services continued to be subject to major regulatory overhaul, as regulators and legislators in the United States and abroad have proposed and, in some instances, already adopted, a slate of regulatory changes that call for, among other things, central clearing of certain derivatives, greater transparency and reporting of derivatives transactions, mandatory trading of certain derivatives transactions on regulated exchanges or swap execution facilities and the required or increased use of electronic trading system technologies. In the United States, The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law in July 2010. We are still in the midst of the rulemaking process mandated by the Dodd-Frank Act, with many rules yet to be finalized. The Dodd-Frank Act creates a new form of regulated entity known as a Swap Execution Facility (referred to herein as a “SEF”) and mandates that all cleared swaps trade on either an exchange or a SEF. We intend to apply to become a SEF and this process, including the regulatory implications and risks associated with it, are discussed throughout this Form 10-K, including under the heading “Recent Derivative Market Developments” below and under “Item 1A
ITEM 1A. RISK FACTORS
Risks Related to Our Business and Competitive Environments.
Economic, political and market factors beyond our control could reduce trading volumes, securities and commodities prices and demand for our brokerage and clearing services, which could harm our business and our profitability.
Difficult market conditions, economic conditions and geopolitical uncertainties have in the past adversely affected and may in the future adversely affect our business and profitability. Our business and the brokerage and financial services industry in general are directly affected by national and international economic and political conditions, broad trends in business and finance, the level and volatility of interest rates, substantial fluctuations in the volume and price levels of securities, commodities and financial transactions and changes in and uncertainty regarding tax and other laws. In each of the three years in the period ended December 31, 2012, over 75% of our revenues were generated by our brokerage operations. As a result, our revenues and profitability are likely to decline significantly during periods of low trading volume in the financial markets in which we offer our services. The financial markets and the global financial services business are, by their nature, risky and volatile and are directly affected by many national and international factors that are beyond our control. Any one of the following factors, among others, may cause a substantial decline in the United States and global financial markets in which we offer our services, resulting in reduced trading volumes. These factors include:
· economic and political conditions in the United States, Europe and elsewhere in the world;
· concerns over inflation and wavering institutional and consumer confidence levels;
· the availability of cash for investment by our customers and their clients;
· concerns over the credit default or bankruptcy of one or more sovereign nations or corporate entities;
· the level and volatility of interest rates and foreign currency exchange rates;
· the level and volatility of trading in certain equity and commodity markets;
· the level and volatility of the difference between the yields on corporate securities being traded and those on related benchmark securities (which difference we refer to as credit spreads); and
· concerns about terrorism and war;
Declines in the volume of trading in the markets in which we operate generally result in lower revenue from our brokerage and clearing businesses. In addition, although less common, some of our brokerage revenues are determined on the basis of the value of transactions or on credit spreads. Therefore, declines in the value of instruments traded in certain market sectors or the tightening of credit spreads could result in lower revenue for our brokerage business. Our profitability is adversely affected by a decline in revenue because a portion of our costs are fixed. For these reasons, decreases in trading volume or declining prices or credit spreads are likely to have an adverse effect on our business, financial condition or results of operations.
Because competition for the services of highly qualified and skilled brokers is intense, we may not be able to attract and retain the brokers we need to support our business or we may be required to incur additional expenses to do so.
We strive to provide high-quality brokerage services that allow us to establish and maintain long-term relationships with our customers. Our ability to continue to provide these services and maintain these relationships depends, in large part, upon our brokers. As a result, we must attract and retain highly qualified brokerage personnel. Competition for the services of brokers is intense, especially for brokers with extensive experience in the specialized markets in which we participate or may seek to enter. If we are unable to hire highly qualified brokers, we may not be able to enter new brokerage markets or develop
new products. If we lose one or more of our brokers in a particular market in which we participate, our revenues may decrease and we may lose market share in that particular market.
We may not be successful in our efforts to recruit and retain highly qualified and skilled brokerage personnel. If we fail to attract new personnel or to retain and motivate our current personnel, or if we incur increased costs associated with attracting and retaining personnel (such as sign-on or guaranteed bonuses to attract new personnel or retain existing personnel), our business, financial condition and results of operations may suffer.
In addition, recruitment and retention of qualified staff could result in substantial additional costs. We pursue our rights through litigation when competitors hire our employees who are under contract with us. We are currently involved in legal proceedings with our competitors relating to the recruitment of employees. An adverse settlement or judgment related to these or similar types of claims could have a material adverse effect on our financial condition or results of operations. Regardless of the outcome of these claims, we generally incur significant expense and management time dealing with these claims.
We operate in a rapidly evolving business and technological environment and we must adapt our business and keep up with technological innovation in order to compete effectively.
The pace of change in our industry is extremely rapid. Operating in such a fast paced business environment involves a high degree of risk. Our ability to succeed and compete effectively will depend on our ability to adapt effectively to these changing market conditions and to keep up with technological innovation.
To remain competitive, we must continue to enhance and improve the responsiveness, functionality, accessibility and other features of our hybrid brokerage systems, network distribution systems and other technologies and functionalities. The financial services industry is characterized by rapid technological change, changes in use and client requirements and preferences, frequent product and service introductions employing new technologies and the emergence of new and complex regulatory requirements, industry standards and practices that could render our existing practices, technology and systems obsolete. In more liquid markets, development by our competitors of new electronic or hybrid trade execution, STP, affirmation, confirmation or clearing functionalities or products that gain acceptance in the market could give those competitors a “first mover” advantage that may be difficult for us to overcome. Our success will depend, in part, on our ability to:
· develop, test and implement hybrid or electronic brokerage systems that meet regulatory and customer requirements, are desired and adopted by our customers and/or increase the productivity of our brokers;
· enhance our existing services;
· develop or acquire new services and technologies that address the increasingly sophisticated and varied needs of our existing and prospective customers; and
· respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis.
The development of proprietary brokerage systems and other technology to support our business entails significant technological, financial and business risks. Changes in existing laws and regulations, including those being proposed and implemented under the Dodd-Frank Act, may require us to develop and maintain new brokerage systems, services or functionalities in order to meet the standards set forth in such regulations or as may be required by regulators, such as the CFTC or SEC. Further, the adoption of new Internet, networking or telecommunications technologies may require us to devote substantial resources to modify, adapt and defend our services. We may not successfully implement new technologies or adapt our hybrid brokerage systems and transaction-processing systems to meet our clients’ requirements or emerging regulatory or industry standards.
We may not be able to respond in a timely manner to changing market conditions or client requirements or successfully defend any challenges to any technology we develop. If we are unable to anticipate and respond to the demand for new services, functionalities, products and technologies on a timely and cost-effective basis, and to adapt to technological advancements and changing standards, we may be unable to compete effectively, which could negatively affect our business, financial condition or results of operations.
We face substantial competition that could negatively impact our market share and our profitability.
The financial services industry generally, and the wholesale and inter-dealer brokerage businesses in which we are engaged in particular, is very competitive, and we expect competition to continue to intensify in the future. Our current and prospective competitors include:
· other large inter-dealer brokerage firms;
· small brokerage firms that focus on specific products or regional markets;
· securities, futures and derivatives exchanges, swap execution facilities and electronic communications networks;
· in certain equity and corporate fixed income markets, traditional cash product broker-dealers, including large, medium and smaller sized financial service firms;
· with regard to our Kyte business, futures commissions merchants and other firms providing settlement and clearing services; and
· other providers of data and analytics products, including those that offer varying forms of electronic trading of the types of financial instruments in which we specialize.
Some of our competitors offer a wider range of services, have broader name recognition, have greater financial, technical, marketing and other resources than we have and have larger client bases than we do. Some of them may be able to respond more quickly to new or evolving opportunities, technologies and client requirements than we can, and may be able to undertake more extensive marketing activities. Our competitors often seek to hire our brokers, which could result in a loss of brokers by us or in increased costs to retain our brokers. In addition to the competitors described above, our large institutional clients may increase the amount of trading they do directly with each other rather than through us, or they may decrease their trading of certain OTC products in favor of exchange-traded products, such as futures contracts. In either case, our revenues could be adversely affected. If we are not able to compete successfully in the future, our business, financial condition and results of operations would be adversely affected.
We have experienced intense price competition in our brokerage business and clearing services in recent years. Some competitors may offer brokerage or clearing services to clients at lower prices than we are offering, which may force us to reduce our prices or to lose market share and revenue. In addition, we focus primarily on providing brokerage services in markets for less commoditized financial instruments. As the markets for these instruments become more commoditized, we could lose market share to other inter-dealer brokers, exchanges and electronic multi-dealer brokers who specialize in providing brokerage services in more commoditized markets.
We increasingly compete with exchanges for the execution of trades in certain products. If a financial instrument for which we provide brokerage services becomes listed on an exchange or if an exchange introduces a competing product to the products we broker in the OTC market, the need for our services in relation to that instrument could be significantly reduced and our business, financial condition and results of operations could be adversely affected.
For example, during 2012, derivatives exchanges and other market participants began migrating toward alternatives to swaps that are more widely used, such as futures contracts, and there was a general market move in the U.S. commodities markets towards futures contracts instead of OTC swaps.
The migration of OTC swaps to exchange-traded markets may impact volumes, liquidity and demand for our services in certain markets.
New regulation in the United States and abroad, including the Dodd-Frank Act, has resulted in a convergence of the traditional OTC market and the exchange traded futures market, as certain OTC products are required to and become centrally cleared and traded via an exchange or SEF. As the convergence of the OTC and exchange traded markets continues, the resulting OTC or SEF market for these products may be less robust, there may be less volume and liquidity in these markets and there may be less demand for our services. In those cases where an OTC swaps market migrates to an exchange
traded futures market, such as what occurred during 2012 in many U.S. commodities markets, our ability to continue to provide brokerage services for the resultant futures markets will be subject to the block-trade and other rules of the applicable exchanges. If a significant number of the OTC swaps markets in which we provide brokerage services transition to an exchange traded futures market or if the block-trade and other rules of the applicable exchanges are too restrictive, our business could be significantly reduced and our business, financial condition and results of operations could be adversely affected.
Consolidation and layoffs in the banking and financial services industries could materially adversely affect our business, financial condition and results of operations.
In recent years, there has been substantial consolidation and convergence among companies in the banking and financial services industries. Continued consolidation or significant layoffs in the financial services industry could result in a decrease in the number of traders for whom we are able to provide brokerage services, which may reduce our trading volumes. In addition, continued consolidation could lead to the exertion of additional pricing pressure by our customers and our competitors, impacting the commissions we generate from our brokerage services. Following the enactment of the Dodd-Frank Act in the United States, many banks have reduced, spun off or are in the process of spinning off their proprietary trading operations due to the increased regulations, costs and uncertainty involved with such operations. It is not yet clear what affect this will have on our transaction volumes, revenues and business or whether we will be able to successfully compete for the business of any new entities created as a result of these spinoffs.
Further, the recent consolidation among regulated exchanges, and expansion by these firms into derivative and other non-equity trading markets, will increase competition for customer trades and place additional pricing pressure on commissions and spreads. These developments have increased competition from firms with potentially greater access to capital resources than us. Finally, consolidation among our competitors other than exchange firms could result in increased resources and product or service offerings for our competitors. If we are not able to compete successfully in the future, our business, financial condition and results of operations could be materially adversely affected.
If we are unable to continue to identify and exploit new market opportunities, our ability to maintain and grow our business may be adversely affected.
When a new intermediary enters our markets or the markets become more liquid, the resulting competition or increased liquidity may lead to lower commissions. This may result in a decrease in revenue in a particular market even if the volume of trades we handle in that market has increased. As a result, we seek to broker more trades and increase market share in existing markets and to seek out new markets in which we can charge higher commissions. Pursuing this strategy requires significant management attention and broker expense. We may not be able to attract new clients or successfully enter new markets. If we are unable to continue to identify and exploit new market opportunities on a timely and cost-effective basis, our revenues may decline, which would adversely affect our profitability.
Financial or other problems experienced by our clients or third parties could affect the markets in which we provide brokerage services. In addition, any disruption in the key derivatives markets in which we provide services could affect our brokerage revenues.
Problems experienced by third parties could also affect the markets in which we provide brokerage services. In recent years, an increasing number of financial institutions have reported losses or significant exposures tied to write-downs of mortgage and asset backed securities, government securities, structured credit products and other derivative instruments and investments. As a result, there is an increased risk that one of our clients, counterparties, third-party clearing firms or reference entities whose securities we broker could fail, shut down, file for bankruptcy or be unable to satisfy their obligations under certain derivative contracts. The failure of a significant number of counterparties or a counterparty that holds a significant amount of derivatives exposure, or which has significant financial exposure to, or reliance on, the mortgage, asset backed, sovereign debt or related markets, could have a material adverse effect on the trading volume and liquidity in a particular market for which we provide brokerage services or on the broader financial markets. The occurrence of any of these events or failures by our customers, clearing firms or reference entities could adversely affect our financial condition and results of operations. In addition, in recent years, a significant percentage of our business, directly or indirectly, results from trading activity by hedge funds. Hedge funds typically employ a significant amount of leverage to achieve their results and, in the past, certain hedge funds have had difficulty managing this leverage, which has resulted in market-wide disruptions. During the economic turmoil of the last few years, many hedge funds have significantly decreased their leverage
or have gone out of business. If this deleveraging continues or one or more hedge funds that was a significant participant in a derivatives market experiences problems in the future, that derivatives market could be adversely affected and, accordingly, our brokerage revenues in that market will likely decrease.
Our brokerage, clearing and execution business exposes us to certain client and counterparty credit risks.
We generally provide brokerage services to our clients in the form of either agency or matched principal transactions. In agency transactions, we charge a commission for connecting buyers and sellers and assisting in the negotiation of the price and other material terms of the transaction. After all of the material terms of a transaction are agreed upon, we identify the buyer and seller to each other and leave them to settle the trade directly. We are exposed to credit risk for commissions we bill to clients for our agency brokerage services. In executing matched principal transactions, we are exposed to the risk that one of the counterparties to a transaction may fail to fulfill its obligations, as described in further detail in the Risk Factor captioned “The securities settlement process exposes us to risks that may impact our liquidity and profitability. In addition, liability for unmatched principal trades could adversely affect our results of operations and statement of financial condition.” Our clients may default on their obligations to us arising from either agency or principal transactions due to disputes, bankruptcy, lack of liquidity, operational failure or other reasons. Any losses arising from such defaults could have a material adverse effect on our financial condition or results of operations.
We also have credit and counterparty risk in certain situations where we provide clearing and execution services. We provide agency clearing services through our relationships with general clearing member firms and/or exchanges. In these instances, our accounts at such institutions are used, in our name, to provide access to clearing services for our customers. Credit risk arises from the possibility that we may suffer losses due to the failure of our customers or other counterparties to satisfy their financial obligations to us or in a timely manner. We may be materially and adversely affected in the event of a significant default by our customers or counterparties. Credit risks we face include, among others:
· exposure to a customer’s inability or unwillingness to meet obligations, including when adverse market movements result in a trading loss and the customer’s posted margin is insufficient to satisfy the deficit. Such margin deficiencies may be caused by a failure to monitor client positions and accurately evaluate risk exposures, which may lead to our failure to require clients to post adequate initial margin or to increase variation margin, as necessary, to keep pace with market movements and subsequent account deficits;
· exposure to counterparties with whom we place funds, including those of our customers, such as when we post margin with exchanges and clearing members;
· exposure to counterparties with whom we trade; and
· market risk exposure due to delayed or failed settlement, which, if not corrected, could become our responsibility as an agency clearing broker. In addition, we have market risk exposure on matched and unmatched principal transactions until offsetting trades are executed and settled.
Customers and counterparties that owe us money or securities may default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other reasons. Our reputation may be damaged if we are associated with a customer or counterparty that defaults, even if we do not have any direct losses from such an event. For further detail see the Risk Factor captioned “The securities settlement process exposes us to risks that may impact our liquidity and profitability. In addition, liability for unmatched principal trades could adversely affect our results of operations and statement of financial condition.”
We have adopted policies and procedures to identify, monitor and manage our credit risk, in both agency and principal transactions, through reporting and control procedures and by monitoring credit standards applicable to our clients. These policies and procedures, however, may not be fully effective. Some of our risk management methods depend upon the evaluation of information regarding markets, clients or other matters that are publicly available or otherwise accessible by us. That information may not, in all cases, be accurate, complete, up-to-date or properly evaluated. If our policies and procedures are not fully effective or we are not always successful in monitoring or evaluating the credit risks to which we are, or may, be exposed, our financial condition or results of operations could be adversely affected. In addition, our insurance policies are unlikely to provide coverage for these risks.
In addition, concerns about, or a default by, one institution could lead to significant liquidity problems, losses or defaults by other institutions, which in turn could adversely affect us. We may also be adversely affected if settlement, clearing or payment systems become unavailable, fail or are subject to systemic delays for any reason outside our control.
In certain instances, we may extend credit to our clearing customers for margin requirements, which subjects us to credit risks, and if we are unable to liquidate a customer’s position if the margin collateral becomes insufficient, we may suffer a loss.
In certain instances, we may provide credit for margin requirements to customers; therefore, we are subject to risks inherent in extending credit. Our credit risks include the risk that the value of the collateral we hold could fall below the amount of a customer’s indebtedness. This risk can be amplified in any situation where the market for the underlying instrument is rapidly declining. Agreements with customers that have margin accounts permit us to liquidate their positions in the event that the amount of margin collateral becomes insufficient. Despite those agreements and our risk management policies with respect to margin, we may be unable to liquidate the customers’ positions for various reasons, or at a price sufficient to cover any deficiency in a customer’s account. If we were unable to liquidate a position at a price sufficient to cover any deficiency or if a customer was unable to post additional margin, we could suffer a loss.
Certain of our clearing customers may choose to obtain a direct relationship with a clearing member, an exchange or a clearinghouse as their operations grow, in which case, we would lose the revenues generated by such customers.
We market our clearing services to our existing customers on the strength of our relationship with certain clearing members and exchanges and on our ability to perform related back-office functions at a lower cost than the customers could perform these functions themselves. As our customers’ operations grow, they may consider the option of obtaining a direct relationship with a clearing member, clearinghouse or exchange themselves in an effort to save costs. If our customers choose to obtain their clearing services directly from a clearing member or through other means, we would lose their revenue and our business could be adversely affected.
Risks Related to Our Operations.
We operate in a highly regulated industry and we may face restrictions with respect to the way we conduct certain of our operations.
Our business is subject to increasingly extensive governmental and other regulations and our relationships with our clients may subject us to increasing regulatory scrutiny. These regulations are designed to protect public interests generally rather than our stockholders. The SEC, FINRA, CFTC and other agencies extensively regulate the United States financial services industry, including much of our operations in the United States. Some of our international operations are subject to similar regulations in their respective jurisdictions, including regulations overseen by the FSA in the United Kingdom, the AMF in France, the SFC in Hong Kong, the MAS in Singapore, the Ministry of Finance and Economy in Korea and the SVS in Chile. These regulatory bodies are responsible for safeguarding the integrity of the securities and other financial markets and protecting the interests of investors in those markets. Most aspects of our business are subject to extensive regulation, including:
· the way we deal with clients;
· capital requirements;
· financial and reporting practices;
· required recordkeeping and record retention procedures;
· the licensing of employees;
· the conduct of directors, officers, employees and affiliates;
· systems and control requirements;
· restrictions on marketing, gifts and entertainment; and
· client identification and anti-money laundering requirements.
If we fail to comply with any of these laws, rules or regulations, we may be subject to censure, fines, cease-and-desist orders, suspension of business, suspensions of personnel or other sanctions, including revocation of our registrations with FINRA, withdrawal of our authorizations from the FSA or revocation of our registrations with other similar international agencies to whose regulation we are subject. For example, several of GFI Securities LLC’s equity and corporate bond brokerage desks have experienced issues relating to reporting trades to FINRA on a timely basis, which is required by FINRA rules. This subsidiary has also paid fines for trade reporting in recent years and is currently being reviewed by FINRA for similar issues relating to trade reporting. For more details on recent disciplinary proceedings, see “Item 3 - Legal Proceedings.”
Our authority to operate as a broker in a jurisdiction is dependent on continued registration or authorization in that jurisdiction or the maintenance of a proper exemption from such registration or authorization. Our ability to comply with all applicable laws and rules is largely dependent on our compliance, credit approval, audit and reporting systems and procedures, as well as our ability to attract and retain qualified compliance, credit approval, audit and risk management personnel. Our systems and procedures may not be sufficiently effective to prevent a violation of all applicable rules and regulations. In addition, the growth and expansion of our business may create additional strain on our compliance systems and procedures and has resulted, and we expect will continue to result, in increased costs to maintain and improve these systems.
In addition, because our industry is heavily regulated, regulatory approval may be required in order to continue or expand our business activities and we may not be able to obtain the necessary regulatory approvals. Even if approvals are obtained, they may impose restrictions on our business or we may not be able to continue to comply with the terms of the approvals or applicable regulations. The implementation of unfavorable regulations or unfavorable interpretations of existing regulations by courts or regulatory bodies could require us to incur significant compliance costs or cause the development or continuation of business activities in affected markets to become impractical. For a further description of the regulations which may limit our activities, see “Item 1 - Business-Regulation.”
Some of our subsidiaries are subject to regulations regarding changes in control of their ownership. These regulations generally provide that regulatory approval must be obtained in connection with any transaction resulting in a change in control of the subsidiary, which may include changes in control of GFI Group Inc. As a result of these regulations, our future efforts to sell shares or raise additional capital may be delayed or prohibited in circumstances in which such a transaction would give rise to a change in control as defined by the applicable regulatory body.
Broad changes in laws or regulations or in the application of such laws and regulations may have an adverse effect on our ability to conduct our business.
The financial services industry, in general, is heavily regulated. Proposals for legislation further regulating the financial services industry are continually being introduced in the United States Congress, in state legislatures and by foreign governments. The government agencies that regulate us continuously review legislative and regulatory initiatives and may adopt new or revised laws and regulations and have broad powers to investigate and enforce compliance and punish noncompliance with their rules, regulations and industry standards of practice. In light of recent conditions in the global financial markets and economy, regulators have increased their focus on the regulation of the financial services industry. We are unable to predict which of these proposals will be implemented or in what form, or whether any additional or similar changes to statutes or regulations, including the interpretation or implementation thereof, will occur in the future. Any such action could affect us in substantial and unpredictable ways and could have an adverse effect on our business, financial condition and results of operations.
We are also affected by the policies adopted by the Federal Reserve and international central banking authorities, which may directly impact our cost of funds for capital raising and investment activities and may impact the value of financial instruments we hold. In addition, such changes in monetary policy may affect the credit quality of our customers or increase the cost for our customers to trade the products for which we provide brokerage services. Changes in domestic and international monetary policy are beyond our control and are difficult to predict.
Additionally, governments and regulators in both the United States and Europe have called for increased regulation and transparency in the OTC markets. As a result, the Dodd-Frank Act was passed in the United States in July 2010 and regulators in Europe are working to enact similar legislation. For a detailed description of the Dodd-Frank Act, see the Risk Factor captioned “Failure to qualify as a SEF could significantly impact our business, financial condition and results of operations. Even if we qualify as a SEF, we will incur significant additional costs, our revenues may be lower than in the past and our financial condition and results of operations may be adversely affected.”
In September 2010, the European Commission released a draft proposal referred to as the European Market Infrastructure Regulation (“EMIR”) requiring that information on OTC derivative contracts should be reported to trade repositories and be accessible to supervisory authorities, that some transaction and price related information should be made available to all market participants and that standard OTC derivative contracts be cleared through central counterparties (“CCPs”). The proposed rules were issued in September of 2012 and, despite delays, are expected to be operational during 2013.
It is difficult to predict the effect these new laws and regulations will have on our business, but they may have an adverse effect on our operations or our ability to maintain our position as a provider of execution and brokerage services for many of the OTC products for which we have traditionally acted as an intermediary.
Failure to qualify as a SEF could significantly impact our business, financial condition and results of operations. Even if we qualify as a SEF, we will incur significant additional costs, our revenues may be lower than in the past and our financial condition and results of operations may be adversely affected.
The Dodd-Frank Act created a new type of regulated entity known as a SEF and mandated that certain cleared swaps (subject to an exemption from the clearing requirement) trade on either an exchange or SEF. The list of swaps that will be required to be cleared and therefore executed through a SEF is expected to encompass a vast number of swaps that have been traditionally executed OTC by wholesale brokers such as ourselves. Certain portions of the Dodd-Frank Act were effective immediately, while other portions will be effective only following rulemaking by the CFTC and SEC and an extended transition period. Subject to such rulemaking, we currently expect to establish and operate a SEF and a security-based SEF.
The CFTC and SEC have each issued proposed rules, some of which are now final, relating to the requirements for registering and operating as a SEF. We are in the process of preparing for compliance with these rules. However, certain of these rules are not yet final and are still subject to revision and therefore, the impact of the rules is not able to be predicted. The rules relating to SEFs would require, among other things, that an entity would have to comply with certain core principles to maintain registration as a SEF. These principles generally relate to trading and product requirements, compliance and audit-trail obligations, governance and disciplinary requirements, operational capabilities, surveillance obligations and financial information and resource requirements. In addition, SEFs will be required to maintain certain trading systems that meet the minimum functionality requirements set by the CFTC and SEC for trading in certain OTC derivatives that are required to be cleared.
While there continues to be uncertainty about the exact impact of these changes, we do know that the Company will be subject to a more complex regulatory framework, and that there will be significant costs to prepare for and to comply with these ongoing regulatory requirements. We will incur increased legal fees, personnel expenses and other costs as we work to analyze and implement the necessary legal structure for registration. There will also be significant costs related to the development, operation and enhancement of our technology relating to trade execution, trade reporting, surveillance, compliance and back-up and disaster recovery plans designed to meet the requirements of the regulators.
In addition, it is not clear at this point what the impact of these rules and regulations will be on the markets in which we currently provide our services. Following the implementation of the Dodd-Frank Act and related rules, the markets for cleared and non-cleared swaps may be less robust, there may be less volume and liquidity in these markets and there may be less demand for our services. There may also be a preference of market participants to trade certain swaps on an exchange, rather than a SEF, or to trade standardized derivatives, such as futures, in lieu of swaps. For example, during 2012, there was a general migration in the U.S. commodities markets towards the use of futures contracts instead of OTC swaps contracts.
Certain banks and other institutions will be limited in their conduct of proprietary trading and will be further limited or prohibited from trading in certain derivatives. The new rules, including the restrictions on the trading activities for certain
banks and large institutions, could materially impact transaction volumes and liquidity in these markets and our revenues, financial condition and business would be adversely impacted as a result.
If we fail to qualify as a SEF under any of these proposed rules, we will be unable to maintain our position as a provider of execution and brokerage services in the markets for many of the OTC products for which we have traditionally acted as an intermediary. This would have a broad impact on our business and could have a material adverse effect on our financial condition and results of operations.
Our regulated subsidiaries are subject to risks associated with net capital requirements, and we may not be able to engage in operations that require significant capital.
Many aspects of our business are subject to significant capital requirements. The SEC, FINRA, FSA and various other domestic and international regulatory agencies have stringent rules and regulations with respect to the maintenance of specific levels of net capital by broker-dealers. In addition, there will be capital requirements for SEFs, which will be regulated by the CFTC and the SEC.
Generally, a broker-dealer’s net capital is defined as its net worth plus qualified subordinated debt less deductions for certain types of assets. While we expect to continue to maintain levels of capital in excess of regulatory minimums, there can be no assurance that this will be the case in the future. If we fail to maintain the required capital levels, we will be required to suspend our broker-dealer operations during any period in which we are not in compliance with capital requirements, and may be subject to suspension or revocation of registration by the SEC and FINRA or withdrawal of authorization or other disciplinary action from domestic and international regulators, which would have a material adverse effect on our business. If these net capital rules are changed or expanded, or if there is an unusually large charge against net capital, operations that require the intensive use of capital would be limited. Also, our ability to withdraw capital from our regulated subsidiaries is subject to restrictions, which in turn could limit our ability to pay dividends, repay debt or purchase shares of our common stock. A large operating loss or charge against net capital could adversely affect our ability to expand or even maintain our present levels of business, which could have a material adverse effect on our business. In addition, we may become subject to net capital requirements in other foreign jurisdictions in which we currently operate or which we may enter.
In addition, we are required to maintain capital with our clearing firms, prime brokers and futures commission merchants and at clearing organizations of which we are a member. The amount of capital to be maintained is dependent on a number of factors, including the rules established by the clearing organization, the types of products to be cleared and the volume and size of positions to be cleared. If we fail to maintain the capital required by these clearing organizations and firms, our ability to clear through these clearing organizations and firms may be impaired, which may adversely affect our ability to process trades.
We cannot predict our future capital needs or our ability to obtain additional financing. For a further discussion of our net capital requirements, see “Item 1 - Business-Regulation” and Note 20 to the Consolidated Financial Statements.
Our risk management policies might not be effective, which could harm our business.
To manage the significant risks inherent in our business, we must maintain effective policies, procedures and systems that enable us to identify, monitor and control our exposure to financial, market, credit, legal, reputational and operational risks. For a description of our risk management approach, see “Item 7A. Quantitative and Qualitative Disclosure About Market Risk.” This risk management function requires, among other things, that we properly record and verify many thousands of transactions and events each day, and that we continuously monitor and evaluate the size and nature of our or our clients’ positions and the associated risks. In light of the high volume of transactions, it is impossible for us to review and assess every single transaction or to monitor at every moment in time our or our customers’ positions and the associated risks.
We must rely upon our analysis of information regarding markets, personnel, clients or other matters that is publicly available or otherwise accessible to us. That information may not in all cases be accurate, complete, up-to-date or properly analyzed. Furthermore, we rely on a combination of technical and human controls and supervision that are subject to error and potential failure, the challenges of which are exacerbated by the 24-hour-a-day, global nature of our business.
Our risk-management methods are based on internally developed controls, observed historical market behavior and what we believe to be industry practices. However, our methods may not adequately prevent future losses, particularly as they may relate to extreme market movements or events for which little or no historical precedent exists or our risk management efforts may be insufficient. Thus, our risk-management methods may prove to be ineffective because of their design, their implementation or the lack of adequate, accurate or timely information. Our risk management methods may also fail to identify a risk or understand a risk that might result in losses. If our risk-management policies and efforts are ineffective, we could suffer losses that could have a material adverse effect on our financial condition or operating results. Additionally, we could be subject to litigation, particularly from our clients, and sanctions or fines from regulators.
The securities settlement process exposes us to risks that may impact our liquidity and profitability. In addition, liability for unmatched principal trades could adversely affect our results of operations and statement of financial condition.
Through our subsidiaries, we provide brokerage services by executing transactions for our clients. A significant number of these transactions are “matched principal transactions” in which we act as a “middleman” by serving as a counterparty to both a buyer and a seller in matching reciprocal back-to-back trades. These transactions, which generally involve cash equities and bonds, are then settled through clearing institutions with which we have a contractual relationship.
In executing matched principal transactions, we are exposed to the risk that one of the counterparties to a transaction may fail to fulfill its obligations, either because it is not matched immediately or, even if matched, one party fails to deliver the cash or securities it is obligated to deliver. Our focus on less commoditized markets exacerbates this risk for us because transactions in these markets tend to be more likely not to settle on a timely basis. Adverse movements in the prices of securities that are the subject of these transactions can increase our risk. In addition, widespread technological or communication failures, as well as actual or perceived credit difficulties or the insolvency of one or more large or visible market participants, could cause market-wide credit difficulties or other market disruptions. These failures, difficulties or disruptions could result in a large number of market participants not settling transactions or otherwise not performing their obligations.
We are subject to financing risk in these circumstances because if a transaction does not settle on a timely basis, the resulting unmatched position may need to be financed, either directly by us or through one of our clearing organizations at our expense. These charges may be recoverable from the failing counterparty, but sometimes are not. Finally, in instances where the unmatched position or failure to deliver is prolonged or widespread due to rapid or widespread declines in liquidity for an instrument, there may also be regulatory capital charges required to be taken by us, which depending on their size and duration, could limit our business flexibility or even force the curtailment of those portions of our business requiring higher levels of capital.
In the process of executing matched principal transactions, miscommunications and other errors by our clients or us can arise whereby a transaction is not completed with one or more counterparties to the transaction, leaving us with either a long or short unmatched position. These unmatched positions are referred to as “out trades,” and they create a potential liability for our subsidiary involved in the trade. If an out trade is promptly discovered and there is a prompt disposition of the unmatched position, the risk to us is usually limited. If the discovery of an out trade is delayed, the risk is heightened by the increased possibility of intervening market movements prior to disposition. Although out trades usually become known at the time of, or later on the day of, the trade, it is possible that they may not be discovered until later in the settlement process. When out trades are discovered, our policy is generally to have the unmatched position disposed of promptly (usually on the same day and generally within three days), whether or not this disposition would result in a loss to us. The occurrence of out trades generally rises with increases in the volatility of the market and, depending on their number and amount, such out trades have the potential to have a material adverse effect on our financial condition and results of operations. In addition, the use of our electronic brokerage platforms for products that we broker on a matched principal basis, such as CreditMatch®, can present these risks because of the potential for erroneous entries by our clients or brokers coupled with the potential that such errors will not be discovered promptly.
We are exposed to market risk from principal transactions entered into by some of our desks.
We generally execute orders on a matched principal basis by entering into one side of a customer trade and entering into an offsetting trade with another party relatively quickly (often within minutes and generally on the same trading day). However, we may take unmatched positions for our own account primarily to facilitate the execution of existing customer orders or in anticipation that future customer orders will become available to fill the other side of the transaction. While we seek to minimize our exposure to market risk by entering into offsetting trades or a hedging transaction relatively quickly (often within minutes and generally on the same trading day), we may not always enter into an offsetting trade on the same trading day and any hedging transaction we may enter into may not fully offset our exposure. Therefore, although any unmatched positions are intended to be held short term, we may not entirely offset market risk and may be exposed to market risk for several days or more or to a partial extent or both. Our exposure varies based on the size of the overall positions, the terms and liquidity of the instruments brokered, and the amount of time the positions are held before we dispose of the position.
Although the significant majority of our principal trading is done on a “matched principal” basis, we have authorized a limited number of our desks to enter into principal investing transactions in which we commit our capital within predefined limits, either to facilitate customer trading activities or to engage in principal trading for our own account. These principal positions may ultimately be matched against a customer order or through a market intermediary, either in the short term (such as the same trading day) or we may hold these positions for several days or more. The number and size of these transactions may affect our results of operations in a given period and we may also incur losses from these trading activities due to market fluctuations and volatility from quarter to quarter. To the extent that we have long positions in any of those markets, a downturn in the value of those positions could result in losses from a decline in the value of those long positions. Conversely, to the extent that we have sold assets we do not own (i.e., have short positions) in any of those markets, an upturn in those markets could expose us to significant losses as we attempt to cover our short positions by acquiring assets in a rising market. In addition, in the event that one of our desks enters into principal transactions that exceed their authorized limit and we are unable to dispose of the position promptly, we could suffer losses that could have a material adverse effect on our financial condition or operating results.
Due to the factors described above, including the nature of the position and access to the market on which it trades, we may not be able to match a position or effectively hedge our exposure and often may hold a position overnight or longer that has not been hedged. To the extent these principal positions are not disposed of intra-day, we mark these positions to market. Adverse movements in the securities underlying these positions or a downturn or disruption in the markets for these positions could result in a substantial loss. In addition, any principal gains and losses resulting from these positions could on occasion have a disproportionate positive or negative effect, on our financial condition and results of operations for any particular reporting period.
We have equity investments or profit sharing interests in entities whose primary business is proprietary trading. These investments could expose us to losses that would adversely affect our net income and the value of our assets.
We have equity investments or profit sharing interests in entities whose primary business is proprietary trading. The accounting treatment applied for these investments varies depending on a number of factors, including, but not limited to, our percentage ownership or profit share and whether we have any influence or control over the relevant entity. Under certain accounting standards, any losses experienced by these entities on their investment activities would adversely impact our net income and the value of these assets. In addition, if these entities were to fail and cease operations, we could lose the entire value of our investment and the stream of any shared profits from trading.
Our investments in expanding our brokerage and clearing services, hybrid brokerage systems and market data and software businesses may not produce substantial revenue or profit.
We have made, and expect to continue to make, significant investments in our brokerage, clearing, market data and software services, including investments in personnel, technology and infrastructure, in order to pursue new growth opportunities. With respect to our brokerage services and hybrid brokerage systems, we may not receive significant revenue and profit from the development of a new brokerage desk or hybrid brokerage system or the revenue we do receive may not be sufficient to cover the start-up costs of the new desk or the substantial development expenses associated with creating a new hybrid brokerage system. Even when our personnel hires and systems are ultimately successful, there is typically a transition period before these hires or systems become profitable or increase productivity. In some instances, our clients may
determine that they do not need or prefer a hybrid brokerage system and the period before the system is successfully developed, introduced and adopted may extend over many months or years. The successful introduction of hybrid brokerage systems in one market or country does not ensure that the same system will be used or favored by clients in similar markets or other countries. Our continued expansion of brokerage personnel and systems to support new growth opportunities results in ongoing transition periods that could adversely affect the levels of our compensation and expense as a percentage of brokerage revenue.
With respect to our investment in clearing, settlement and back-office services, we may not produce significant revenues or profits. In addition, any revenues we do receive may not be sufficient to cover our invested capital or start-up costs. With respect to these services, we may incur significant costs developing and maintaining systems for back-office, risk management and exchange and clearing connections with relevant exchanges and clearing firms. In addition, this business may involve significant management effort to expand. If we are unable to generate sufficient revenue to cover the fixed costs associated with this business, our financial condition or results of operations could be adversely affected.
With respect to our market data and software businesses, which includes our Trayport and Fenics operations, we may incur substantial development, sales and marketing expenses and expend significant management effort to create a new product or service. Even after incurring these costs, we ultimately may not sell any or sell only small amounts of these products or services. Consequently, if revenue does not increase in a timely fashion as a result of these expansion and development initiatives, the up-front costs associated with them may exceed the related revenue and reduce our working capital and income.
If we are unable to manage the risks of international operations effectively, our business could be adversely affected.
We provide services and products to clients globally through offices in Europe, the Middle East, Africa, South America and Asia and we may seek to further expand our operations in the future. On a geographic basis, approximately 61% and 59% of our total revenues for the years ended December 31, 2012 and 2011, respectively, were generated by our operations in Europe, the Middle East and Africa (EMEA), 30% and 31%, respectively, were generated by our operations in the Americas, which include operations in South America, and 9% and 10%, respectively, were generated by our operations in the Asia-Pacific region. There are certain additional risks inherent in doing business in international markets, particularly in the regulated brokerage industry. These risks include:
· additional regulatory requirements;
· difficulties in recruiting and retaining personnel and managing the international operations;
· potentially adverse tax consequences, tariffs and other trade barriers;
· adverse labor laws; and
· reduced protection for intellectual property rights.
Our international operations also expose us to the risk of fluctuations in currency exchange rates. For example, a substantial portion of our revenue from our London office, our largest international office, is received in Euros and U.S. Dollars, whereas many of our expenses from our London operations are payable in British Pounds. Our risk management strategies relating to exchange rates may not prevent us from suffering losses that would adversely affect our financial condition or results of operations.
Our international operations are also subject to the political, legal and economic risks associated with politically unstable and less developed regions of the world, including the risk of war and other international conflicts and actions by governmental authorities, insurgent groups, terrorists and others. In addition, we are required to comply with the laws and regulations of foreign governmental and regulatory authorities of each country in which we conduct business. These may include laws, rules and regulations, including registration requirements. For example, in Europe, the European Commission published a formal proposal for the regulation of OTC derivatives, central clearing parties and trade repositories in September 2010, which is referred to as the European Market Infrastructure Regulation (“EMIR”). The proposed rules were issued in September of 2012 and are expected to be operational during 2013. Our compliance with these laws and regulations may be
difficult and time consuming and may require significant expenditures and personnel requirements, and our failure to be in compliance would subject us to legal and regulatory liabilities.
We may also experience difficulty in managing our international operations because of, among other things, competitive conditions overseas, established domestic markets, language and cultural differences and economic or political instability. For example, global markets and economic conditions have been negatively impacted by the ability of certain E.U. member states to service their sovereign debt obligations. The continued uncertainty over the outcome of the E.U. governments’ financial support programs and the possibility that other E.U. member states may experience similar financial troubles could further disrupt global markets. In particular, it has and could in the future disrupt equity markets and result in volatile bond yields on the sovereign debt of E.U. members. This has also had an impact on the creditworthiness of customers and counterparties and has and may continue to limit the number of customers we are willing to do business with in this region. Any of these factors could have a material adverse effect on the success of our international operations or limit our ability to grow our international operations and, consequently, on our business, financial condition and operating results.
We may be exposed to risk from our operations in emerging market countries, including counterparty risks exposure.
Our businesses and operations are increasingly expanding into new regions, including emerging markets, and we expect this trend to continue. We have entered into an increasing number of matched principal transactions with counterparties domiciled in countries in the Middle East, Latin America, Eastern Europe and Asia. Transactions with these counterparties are generally in instruments or contracts of sovereign or corporate issuers located in the same country or region as the counterparty. This exposes us to a higher degree of sovereign or convertibility risk than in more stable or developed countries. In addition, these risks may be correlated risks. A correlated risk arises when the counterparty’s inability to meet its obligations will also correspond to a decline in the value of the instrument traded. In the case of a sovereign convertibility event or outright default, the counterparty to the trade may be unable to pay or transfer payment of an instrument purchased out of the country when the value of the instrument has declined due to the default or convertibility event. Various emerging market countries have experienced severe economic and financial disruptions, including significant devaluations of their currencies, defaults or threatened defaults on sovereign debt, capital and currency exchange controls, and low or negative growth rates in their economies. These conditions could have an adverse impact on our businesses and increased volatility in financial markets generally. Through our risk management procedures, we monitor the creditworthiness of emerging countries and counterparties on an ongoing basis and when the risk of inconvertibility or sovereign default is deemed to be too great, correlated transactions or all transactions may be restricted or suspended. However, there can be no assurance that our procedures will be effective in controlling these risks, which, if not successfully controlled, could result in a loss that could have a material adverse effect on our financial condition and operating results.
We may have difficulty managing our expanding operations effectively.
We have significantly expanded our business activities and operations over the last several years, which have placed, and are expected to continue to place, a significant strain on our management and resources. Continued expansion into new markets and regions will require continued investment in management and other personnel, facilities, information technology infrastructure, financial and management systems and controls and regulatory compliance controls. The expansion of our international operations, particularly our Asia-Pacific and South American operations, involves additional challenges that we may not be able to meet, such as the difficulty in effectively managing and staffing these operations and complying with the increased regulatory requirements associated with operating in new jurisdictions.
We may not be successful in implementing all of the processes that are necessary to support these initiatives, which could result in our expenses increasing faster than our revenues, causing our operating margins and profitability to be adversely affected, or it could result in us having insufficient controls in our operations for a period of time. Accordingly, this expansion, if not properly managed, could result in a loss that could have a material adverse effect on our financial condition and operating results.
In the event of employee misconduct or error, our business may be harmed.
Employee misconduct or error could subject us to legal liability, financial losses and regulatory sanctions and could seriously harm our reputation and negatively affect our business. Misconduct by employees could include engaging in improper or unauthorized transactions or activities, failing to properly supervise other employees or improperly using confidential information. Employee errors, including mistakes in executing, recording or processing transactions for
customers, could cause us to enter into transactions that clients may disavow and refuse to settle, which could expose us to the risk of material losses even if the errors are detected and the transactions are unwound or reversed. If our clients are not able to settle their transactions on a timely basis, the time in which employee errors are detected may be increased and our risk of material loss could be increased. The risk of employee error or miscommunication may be greater for products that are new or have non-standardized terms. It is not always possible to deter employee misconduct or error, and the precautions we take to detect and prevent this activity may not be effective in all cases.
Brokerage services involve substantial risks of liability, and we therefore may become subject to risks of litigation.
Many aspects of our business, and the businesses of our clients, involve substantial risks of liability. Dissatisfied clients may make claims regarding quality of trade execution, improperly settled trades or mismanagement against us. We may become subject to these claims as the result of failures or malfunctions of our trading systems or other brokerage services provided by us, and third parties may seek recourse against us. We attempt to limit our liability to our customers through the use of written or “click-through” agreements, but we do not have such agreements with many of our clients. We could incur significant legal expenses defending claims, even those without merit. An adverse resolution of any lawsuit or claim against us could result in our obligation to pay substantial damages.
If we acquire other companies or businesses, or if we hire new brokerage personnel, we may have difficulty integrating their operations.
To achieve our strategic objectives, we have acquired or invested in, and in the future may seek to acquire or invest in, other companies and businesses. We also may seek to hire brokers for new or existing brokerage desks. These acquisitions or new hires may be necessary in order for us to enter into or develop new product areas or trading systems. Acquisitions and new hires entail numerous risks, including:
· difficulties in the assimilation of acquired personnel, operations, services or products;
· diversion of management’s attention from other business concerns;
· assumption of, or exposure to, known and unknown material liabilities of acquired companies or businesses, strategic alliances, collaborations or joint ventures;
· litigation and/or arbitration related to the hiring of brokerage personnel;
· the decrease in our cash reserves, the increased cost of borrowing funds or the dilution resulting from issuances of our equity securities, in each case as consideration to finance the purchase price of any significant acquisitions;
· to the extent that we pursue business opportunities outside the United States, exposure to political, economic, legal, regulatory, operational and other risks that are inherent in operating in a foreign country, including risks of possible nationalization, expropriation, price controls, capital controls, exchange controls and other restrictive governmental actions, as well as the outbreak of hostilities;
· the up-front costs associated with recruiting brokerage personnel, including when establishing a new brokerage desk, such as significant signing bonuses or contractual guarantees of a minimum level of compensation;
· failure to achieve financial or operating objectives; and
· potential loss of clients or key employees of acquired companies and businesses.
In addition, we expect to face competition for acquisition targets and/or joint venture partners, which may limit the number of acquisitions and growth opportunities and could lead to higher acquisition prices. We may not be able to successfully identify, acquire or manage profitably additional businesses or integrate businesses without substantial costs, delays or other operational or financial difficulties.
If we fail to manage these risks as we make acquisitions or make new hires, our profitability may be adversely affected, and we may never realize the anticipated benefits of the acquisitions or hires. In addition, entering into new businesses may require prior approval from regulators. Our ability to obtain timely approval from applicable regulators may hinder our ability to successfully enter new businesses.
Seasonal fluctuations in trading may cause our quarterly operating results to fluctuate.
In the past, our business has experienced seasonal fluctuations, reflecting reduced trading activity during summer months, particularly in August. We also generally experience reduced activity in December due to seasonal holidays. As a result, our quarterly operating results may not be indicative of the results we expect for the full year. Our operating results may also fluctuate quarter to quarter due to a variety of factors beyond our control, such as conditions in the global financial markets, terrorism, war and other economic and political events. Furthermore, we may experience reduced revenues in a quarter due to a decrease in the number of business days in that quarter compared to prior years.
Computer systems failures, capacity constraints, breaches of security and natural or other disasters could prevent us from operating parts of our business or otherwise damage our reputation or business.
We internally support and maintain many of our computer systems, brokerage platforms and networks. Our failure to monitor, maintain or, if necessary, replace these systems, brokerage platforms and networks in a timely and cost-effective manner could have a material adverse effect on our ability to conduct our operations.
We also rely and expect to continue to rely on third parties to supply and maintain various computer systems, trading platforms and communications systems, such as telephone companies, internet service providers, data processors, clearing organizations, software and hardware vendors and back-up services. Our systems, or those of our third party providers, may fail or operate slowly, causing one or more of the following:
· unanticipated disruptions in service to our clients;
· slower response times;
· delays in our clients’ trade execution;
· failed settlement of trades;
· decreased client satisfaction with our services or brokerage platforms;
· incomplete, untimely or inaccurate accounting, recording, reporting or processing of trades;
· financial losses;
· litigation or other client claims; and
· regulatory sanctions.
We may experience systems or office failures from power or telecommunications outages, acts of God, war, terrorism, human error, natural disasters, fire, sabotage, hardware or software malfunctions or defects, computer viruses, intentional acts of vandalism or similar events. Additionally, our business continuity or disaster recovery plans and related systems may not be effective to deal with such events and the failure of such plans or systems may have a material adverse effect on our business. Any system failure that causes an interruption in service or decreases the responsiveness of our service, including failures caused by client error or misuse of our systems, could damage our reputation, business and brand name. In addition, if security measures contained in our systems are breached as a result of third-party actions, employee error, malfeasance, or otherwise, our reputation may be damaged and our business could suffer.
If systems maintained by us or third parties malfunction, our clients or other third parties may seek recourse against us. We could incur significant legal expenses defending these claims, even those which we may believe to be without merit.
An adverse resolution of any lawsuits or claims against us could result in our obligation to pay substantial damages and could have a material adverse effect on our financial condition or results of operations.
If one or more of our offices were destroyed, damaged or unusable for a period of time we may suffer a loss of revenue, experience business interruption in that region or incur expenses to relocate or repair the affected office to the extent not covered by insurance. If any of these were to occur, it could have a material adverse effect on our financial condition or results of operations.
We may not be able to protect our intellectual property rights or may be prevented from using intellectual property necessary for our business.
Our business depends in part on whether we are able to maintain the proprietary aspects of our technology and to operate without infringing on the proprietary rights of others. We rely primarily on trade secret, contract, copyright, trademark and patent law to protect our proprietary technology. However, these protections may not be adequate to prevent third parties from copying or otherwise obtaining and using our proprietary technology without authorization or otherwise infringing on our rights.
We may also face claims of infringement that could interfere with our ability to use technology that is material to our business operations. We may face limitations or restrictions on the distribution of some of the market data generated by our brokerage desks, which may limit the comprehensiveness and quality of the data we are able to distribute or sell.
In addition, in the past several years, there has been proliferation of so-called “business method patents” applicable to the computer and financial services industries. There has also been a substantial increase in the number of such patent applications filed. Under current law, United States patent applications remain secret for 18 months and may, depending upon where else such applications are filed, remain secret until a patent is issued. In light of these factors, it is not economically practicable to determine in advance whether our products or services may infringe the present or future patent rights of others. In addition, although we take steps to protect our technology, we may not be able to protect our technology from disclosure or from other developing technologies that are similar or superior to our technology. Any failure to protect our intellectual property rights could materially and adversely affect our business and financial condition.
If we are unable to adequately protect our intellectual property rights or if we infringe on the rights of others, we could become involved in costly disputes and may be required to pay royalties or enter into license agreements with third parties.
In the future, we may have to rely on litigation to enforce our intellectual property rights, protect our trade secrets, determine the validity and scope of the proprietary rights of others or defend against claims of infringement or invalidity. This litigation could result from claims that we are violating the rights of others or may be necessary to enforce our own rights. Any such litigation would be time consuming and expensive to defend or resolve and would result in the diversion of the resources and attention of management, and the outcome of any such litigation cannot be accurately predicted. Any adverse determination in such litigation could subject us to significant liabilities or require us to pay royalties or enter into license agreements with third parties, which we may not be able to obtain on terms acceptable to us or at all.
We depend on third-party software licenses. The loss of any of our key licenses could adversely affect our ability to provide our brokerage services.
We license software from third parties, some of which is integral to our execution services, hybrid brokerage systems and our business. These licenses are generally terminable if we breach our obligations under the licenses or if the licensor gives us notice in advance of the termination. If any of these relationships were terminated, or if any of these third parties were to cease doing business, we may be forced to spend significant time and money to replace the licensed software. These replacements may not be available on reasonable terms, if at all. A termination of any of these relationships could have a material adverse effect on our financial condition and results of operations.
Risks Related to Our Liquidity and Financing Needs
Our liquidity and financial condition could be adversely affected by United States and international markets and economic conditions.
Liquidity is essential to our business and is of particular importance to our trading business. Any perceived liquidity issues may affect our clients’ and counterparties’ willingness to engage in brokerage transactions with us. In addition, our business is dependent upon the availability of adequate regulatory and clearing capital. Clearing capital is the amount of cash, guarantees or similar collateral that we must provide or deposit with our third party clearing organizations in support of our obligations under our contractual clearing arrangements with these organizations. Historically, these needs have been satisfied from internally generated funds, investments from our stockholders and lines of credit made available by commercial banking institutions.
Our liquidity could be impaired due to circumstances that we may be unable to control, such as a general market disruption or an operational problem that affects our clients, third parties or us. Further, our ability to sell assets to generate liquidity may be impaired if other market participants are seeking to sell similar assets at the same time.
Our ability to raise capital in the long-term or short-term debt capital markets or the equity capital markets has been and could continue to be adversely affected by conditions in the United States and international markets and economy. Global market and economic conditions have been, and continue to be, disrupted and volatile. In particular, our cost and availability of raising debt capital may be adversely affected by illiquid credit markets and wider credit spreads. As a result of concern about the stability of the markets, the strength of counterparties and other factors, including the impact of the Dodd-Frank Act and other pending legislation and regulatory proposals, many lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers in the financial industry. In addition, our credit rating may impact our ability to obtain to raise additional long or short term capital. See the Risk Factor captioned “Our business may be adversely affected by a reduction in our credit ratings” To the extent we need to raise additional capital, including for acquisitions or meeting increased capital requirements arising from growth in our brokerage business, we may not be able to obtain such additional financing on acceptable terms or on a timely basis, if at all. If we cannot raise additional capital on acceptable terms, we may not be able to develop or enhance our business, take advantage of future opportunities or acquisitions, respond to competitive pressure or meet contractual, regulatory or other unanticipated requirements and as a result, our ability to conduct our business may be materially adversely affected.
Our business may be adversely affected by a reduction in our credit ratings.
There are a number of factors that might contribute to the possibility of having our credit rating downgraded by one or more credit rating agencies, including our profitability and results of operations and the general condition of the economy and the global markets in which we provide our services. In the event of a downgrade of our credit rating by one or more credit rating agencies, our business may be adversely affected.
A reduction in our credit ratings would increase our borrowing costs under the 8.375% Senior Notes we issued in July 2011, which will mature in July 2018 (“8.375% Senior Notes”). In addition, any announcement by a rating agency that our credit rating is being downgraded could have a serious adverse impact on our business and, ultimately, on our operating results and financial condition. Moreover, concerns about our credit ratings may limit our ability to pursue acquisitions and, to the extent we pursue acquisitions that affect our credit ratings, our business may suffer. To avoid placing our credit rating at risk, we may need to limit the growth of our business, or we may even need to reduce our operations or other expenses to improve profitability. A credit-rating downgrade could also compel us to raise additional capital on unfavorable terms, which could result in substantial additional interest or other expenses and lower earnings. If we were forced to raise equity capital, that action could result in substantial dilution to our existing shareholders.
The financial maintenance covenants in our Credit Agreement could limit the manner in which we conduct our business, and we may be unable to engage in favorable business activities or finance future operations or capital needs as a result.
We are party to a credit agreement with Bank of America N.A. and certain other lenders (the “Credit Agreement”). Pursuant to an amendment to the credit agreement entered into in March 2013, $18.75 million of the lender commitments mature in December 2013 and the remaining $56.25 million of the lender commitments mature in December 2015. Under our Credit Agreement, we are required to satisfy and maintain specified financial ratios. Our ability to meet those financial
ratios can be affected by events beyond our control, and there can be no assurance that we will meet those ratios. An adverse development affecting our business could require us to seek waivers or amendments of covenants, alternative or additional sources of financing or reductions in expenditures. We cannot assure you that such waivers, amendments or alternative or additional financings could be obtained or, if obtained, would be on terms acceptable to us. A failure to comply with the covenants contained in our Credit Agreement could result in an event of default thereunder or under other agreements, which, if not cured or waived could have a material adverse effect on our business, financial condition and results of operations. In the event of any default under our Credit Agreement, the lenders may not be required to lend any additional amounts to us, or could elect to declare all indebtedness outstanding, together with any accrued and unpaid interest and fees, to be due and payable and terminate all commitments to extend further credit. Such actions by the lenders could cause cross defaults under our other indebtedness, including the indenture governing our 8.375% Senior Notes.
Risks Related to Owning Our Stock
Jersey Partners has significant voting power and may take actions that may not be in the best interest of our other stockholders.
Jersey Partners Inc. (“JPI”), in which our executive chairman and founder, Michael Gooch, is the controlling shareholder, owns approximately 41% of our outstanding common stock. Our chief executive officer, Colin Heffron, is also a minority shareholder of JPI. As a result, through JPI, Michael Gooch has the ability to exert substantial influence over all matters requiring approval by our stockholders, including the election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets and other corporate transactions. This concentration of control could be disadvantageous to other stockholders with interests different from those of Michael Gooch. This concentration of voting power may have the effect of delaying or impeding actions that could be beneficial to our other stockholders, including actions that may be supported by our Board of Directors. The trading price for our common stock could be adversely affected if investors perceive disadvantages to owning our stock as a result of this significant concentration of share ownership.
Provisions of our certificate of incorporation and bylaws, agreements to which we are a party, regulations to which we are subject and provisions of our equity incentive plans could delay or prevent a change in control of our company and entrench current management.
Our second amended and restated certificate of incorporation and bylaws may be deemed to have an anti-takeover effect and may delay, deter or prevent a change of control of us, such as a tender offer or takeover proposal that might result in a premium over the market price for our common stock. In addition, certain of these provisions make it more difficult to bring about a change in the composition of our board of directors, which could result in entrenchment of current management. For example, our second amended and restated certificate of incorporation and bylaws:
· provide for a classified board of directors;
· do not permit our stockholders to remove members of our board of directors other than for cause;
· do not permit stockholders to act by written consent or to call special meetings;
· require certain advance notice for director nominations and other actions to be taken at annual meetings of stockholders;
· require supermajority stockholder approval with respect to extraordinary transactions such as mergers and certain amendments to our certificate of incorporation and bylaws (including in respect of the provisions set forth above); and
· authorize the issuance of “blank check” preferred stock by our board of directors without stockholder approval, which could discourage a takeover attempt.
Under our Credit Agreement and our 8.375% Senior Notes, a change in control may lead the lenders to exercise remedies such as acceleration of the loan and, in the case of the Credit Agreement, termination of their obligations to fund additional advances.
Our brokerage businesses are heavily regulated and some of our regulators require that they approve transactions which could result in a change of control, as defined by the then-applicable rules of our regulators. The requirement that this approval be obtained may prevent or delay transactions that would result in a change of control.
In addition, our equity incentive plans contain provisions pursuant to which our Board may, in its discretion, determine to accelerate the vesting of outstanding options or restricted stock units in the event of a change of control. If the Board determines to accelerate the vesting of these unvested grants, it could have the effect of dissuading potential acquirers from pursuing merger discussions with us.
If we fail to maintain effective internal control over financial reporting as required by Section 404 of the Sarbanes-Oxley Act, it may have an adverse effect on our business.
We are subject to the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (“SOX”) and the applicable SEC rules and regulations that require our management to conduct an annual assessment and to report on the effectiveness of our internal controls over financial reporting. In addition, our independent registered public accounting firm must issue an attestation report addressing the operating effectiveness of the Company’s internal controls over financial reporting.
While our internal controls over financial reporting currently meet all of the standards required by SOX, failure to maintain an effective internal control environment could have a material adverse effect on our business, financial condition and results of operations. We cannot be certain as to our ability to continue to comply with the requirements of SOX. If we are not able to continue to comply with the requirements of SOX in a timely manner or with adequate compliance, we may be subject to sanctions or investigation by regulatory authorities, including the SEC. In addition, should we identify a material weakness, there can be no assurance that we would be able to remediate such material weakness in a timely manner in future periods. Moreover, if we are unable to assert that our internal control over financial reporting is effective in any future period (or if our auditors are unable to express an opinion on the effectiveness of our internal controls), we could lose investor confidence in the accuracy and completeness of our financial reports, and incur significant expenses to restructure our internal controls over financial reporting, which may have a material adverse effect on our Company.
We cannot provide assurance that we will continue to declare and pay dividends at all or in any particular amounts and we may elect not to pay dividends in the future.
Our Board of Directors has approved a policy of paying quarterly dividends, subject to available cash flow from operations, other considerations and the determination by our Board of Directors of the amount. However, there is no assurance that we will continue to declare and pay dividends at all or in any particular amounts and we may elect not to pay dividends in the future. Our dividend policy may be affected by, among other things, our earnings, financial condition, future capital requirements, level of indebtedness, contractual restrictions with respect to the payment of dividends, the issuance of special dividends from time to time, changes in tax rates and our determination to make certain investments or acquisitions. Our ability to declare a dividend is also subject to the limits imposed by Delaware corporate law and our Credit Agreement.
The market price of our common stock may fluctuate in the future, and future sales of our shares could adversely affect the market price of our common stock.
The market price of our common stock has fluctuated in the past and may fluctuate in the future depending upon many factors, including our actual results of operations and perceived prospects and the prospects of the financial marketplaces in general, differences between our actual financial and operating results and those expected by investors and analysts, changes in analysts’ recommendations or projections, seasonality, changes in general valuations for companies in our business segment, changes in general economic or market conditions and broad market fluctuations.
Future sales of our common stock also could adversely affect the market price of our common stock. If our existing stockholders sell a large number of shares, or if we issue a large number of shares of our common stock in connection with future acquisitions, strategic alliances, new or amended equity incentive plans or otherwise, the market price of our common stock could decline significantly. Moreover, the perception in the public market that our stockholders, including JPI, might sell shares of common stock could depress the market price of our common stock.
As of December 31, 2012, we had registered under the Securities Act of 1933, as amended (the “Securities Act”), an aggregate of 592,064 shares of our common stock which are reserved for issuance upon the exercise of outstanding options
under our 2000 and 2002 Stock Option Plans. In addition, as of December 31, 2012, we had registered under the Securities Act an aggregate of 37,400,000 shares of our common stock available for issuance under our 2008 Equity Incentive Plan in connection with existing and new grants of restricted stock units, stock options or similar types of equity compensation awards to our employees. Based on outstanding grants at December 31, 2012, there are 11,200,253 shares of our common stock available for future grants of awards under the 2008 Equity Incentive Plan. These shares can be sold in the public market upon issuance, subject to any vesting requirements and restrictions under the securities laws applicable to resale by affiliates. These sales might impact the liquidity of our common stock and might have a dilutive effect on existing stockholders making it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate.
We may be required to recognize impairments of our goodwill or other intangible assets, which could adversely affect our results of operations or financial condition.
Accounting standards require periodic testing for the impairment of goodwill and intangible assets. While we have not recognized any impairment of goodwill and intangible assets to date, any such non-cash charges in the future could have a material impact on our stockholders equity and our results of operations.
The determination of the value of goodwill and intangible assets requires management to make estimates and assumptions that affect our consolidated financial statements. We are required to test goodwill for impairment annually, or in interim periods if certain events occur indicating that the carrying value may be impaired. We assess potential impairments to intangible assets when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. Our judgments regarding the existence of impairment indicators and future cash flows related to goodwill and intangible assets are based on several factors which include: the operational performance of any acquired businesses, management’s current business plans which factor in current market conditions, market capitalization, the trading price of our common stock and trading volumes, as well as other factors. Management uses discounted cash flow analysis in their impairment assessments, which involves the subjective selection and interpretation of data inputs, and given market conditions at the testing date, can include a very limited amount of observable market inputs available in determining the model.
Changes to our business plan, increased macroeconomic weakness, declines in operating results and decreased market capitalization may result in our having to perform an interim goodwill impairment test or an intangible asset impairment test. These types of events and the resulting analysis could result in goodwill or intangible asset impairment charges in future periods.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
We have offices in the United States, Europe, Latin America, Asia, the Middle East and South Africa. Our executive headquarters are located at 55 Water Street, New York, New York 10041, where we occupy approximately 89,000 square feet of leased space, pursuant to a lease that expires in December 2027. Our largest office outside of the New York metropolitan area is our U.K. headquarters, which is located in London at 1 Snowden Street, EC2 2DQ, where we occupy approximately 44,000 square feet pursuant to a lease that expires in March 2025.
Our U.S. operations also lease office space in Los Angeles, Sugar Land (TX) and Iselin (NJ). Our foreign operations lease office space in London, Paris, Nyon, Madrid, Hong Kong, Seoul, Singapore, Manila, Sydney, Cape Town, Santiago, Bogota, Buenos Aires, Lima, Dubai, Dublin and Tel Aviv. We believe our facilities will be adequate for our operations for the next twelve months. The properties we occupy are used across all of our business segments, as well as for corporate purposes.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, we are and have been party to, or otherwise involved in, litigations, claims and arbitrations that involve claims for substantial amounts. These proceedings have generally involved either proceedings against our competitors in connection with employee hires, or claims from former employees in connection with the termination of their employment from us. There is also potential for client claims alleging the occurrence of errors in the execution of brokerage transactions. We are also currently and will, in the future, be involved, in examinations, investigations or proceedings by government agencies and self-regulatory organizations. These examinations or investigations could result in substantial fines or administrative proceedings that could result in censure, the issuance of cease and desist orders, the suspension or expulsion of a broker dealer and its affiliated persons, officers or employees or other similar consequences.
Several of our European subsidiaries are currently defending a claim that they improperly hired a number of employees of a competitor over the course of several months. The claim was filed almost a year after we hired the employees and notwithstanding that none of the employees breached their employment agreements with the competitor. Although the case is in its preliminary stages, the claimant is seeking a multi-million dollar award. We intend to vigorously defend against this action and believe that we have substantial defenses to the claims asserted against us.
Based on currently available information, the outcome of the Company’s outstanding matters are not expected to have a material adverse impact on the Company’s financial position. However, the outcome of any such matters may be material to the Company’s results of operations or cash flows in a given period. It is not presently possible to determine the Company’s ultimate exposure to these matters and there is no assurance that the resolution of the Company’s outstanding matters will not significantly exceed any reserves accrued by the Company.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Common Stock
On October 5, 2010 we transferred the listing of our common stock from the Nasdaq Global Select Market (“Nasdaq”) to the New York Stock Exchange Euronext (“NYSE Euronext”). Our common stock is traded under the symbol “GFIG,” the same symbol that was used on the Nasdaq since our initial public offering on January 26, 2005. The closing share price for our common stock on February 28, 2013, as reported by NYSE Euronext, was $3.51.
As of February 28, 2013, we had approximately 44 holders of record of our common stock.
Set forth below, for each of the last eight fiscal quarters, is the low and high sales prices per share of our common stock as reported on NYSE Euronext in the first quarter of 2011 through the fourth quarter of 2012.
Dividend Policy
Prior to 2008, we retained all earnings for investment in our business. In February 2008, our Board of Directors approved a policy of paying quarterly dividends, subject to available cash flow from operations, other considerations and the determination by our Board of Directors of the amount.
Any declaration and payment of dividends will be at the discretion of our Board of Directors and will depend upon, among other things, our earnings, financial condition, capital requirements, level of indebtedness, contractual restrictions with respect to the payment of dividends, and other considerations that our Board of Directors deems relevant. The Board’s ability to declare a dividend is also subject to limits imposed by Delaware corporate law. In addition, our subsidiaries are permitted to pay dividends to us subject to (i) certain regulatory restrictions related to the maintenance of minimum net capital in those of our subsidiaries that are subject to net capital requirements imposed by applicable law or regulation, and (ii) general restrictions imposed on dividend payments under the jurisdiction of incorporation or organization of each subsidiary. Finally, our Credit Agreement limits our ability to pay dividends in certain circumstances without the approval of our lenders and any instruments governing our future indebtedness may also contain various covenants that limit our ability to pay dividends.
Performance Graph
The following performance graph shows a comparison, from December 31, 2007 through December 31, 2012, of the cumulative total return for our common stock, the NYSE Composite Index, the Nasdaq Other Financial Index and our peer group. The peer group is comprised of ICAP Plc, Tullet Prebon Plc, Compagnie Financiere Tradition, MarketAxess Holdings Inc., BGC Partners Inc., Deutsche Boerse Group, ICE and the CME Group Inc.
The performance graph assumes that the value of the initial investment in the Company’s common stock, each index and the peer group was $100 on December 31, 2007 and that all dividends have been reinvested. Such returns are based on historical results and are not intended to suggest future performance. The returns of each company within the peer group have been weighted according to their respective stock market capitalization for purposes of arriving at a peer group average.
Purchase of Equity Securities
The table below sets forth the information with respect to purchases made by the Company of its common stock during the quarterly period ended December 31, 2012.
Issuer Purchases of Equity Securities
(a) In August 2007, the Board of Directors authorized the Company to implement a stock repurchase program to repurchase a limited number of shares of the Company’s common stock on the open market in such amounts as determined by the Company’s management. The authorization provides that such amounts are not to exceed, during any calendar year, the number of shares issued upon the exercise of stock options plus the number of shares underlying RSUs that are granted or which management reasonably anticipates will be granted in such calendar year. Any repurchases are also subject to compliance with certain covenants and limits under the Company’s Credit Agreement.
(b) Under our 2008 Equity Incentive Plan, we withhold shares of common stock to satisfy minimum statutory tax withholding obligations arising on the vesting and settlement of restricted stock units. When we withhold these shares, we are required to remit to the appropriate taxing authorities the market price of the shares withheld, which could be deemed a purchase of the shares of our common stock by us on the date of withholding.
(c) In December 2012, the Company and Jersey Partners, Inc. (“JPI”) entered into a stock purchase agreement pursuant to which the Company purchased 993,377 shares of common stock held by JPI at a price of $3.02 per share. JPI is the largest stockholder of GFI and Michael Gooch, GFI’s Executive Chairman is the majority shareholder of JPI. The review and approval of the stock purchase agreement was delegated by the Company’s Board of Directors to its Audit Committee, comprised of solely independent directors, which approved the stock purchase agreement.
(d) Amounts disclosed in this column include the number of RSUs granted by the Company and the number of shares issued upon the exercise of stock options less the number of shares repurchased by the Company on the open market for the current calendar year through December 31, 2012.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial data for the five years ended December 31, 2012. This selected consolidated financial data should be read in conjunction with “Item 7
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes thereof in Part II-Item 8 hereof. This discussion contains forward-looking statements. Actual results could differ materially from the results discussed in these forward-looking statements. Please see “Forward-Looking Statements” and “Risk Factors” for a discussion of some of the uncertainties, risks and assumptions associated with these statements.
Business Environment
As a leading provider of wholesale brokerage services, clearing services and electronic execution and trading support products for global financial markets, our results of operations are impacted by a number of external market factors, including market volatility and transactional volumes, the organic growth or contraction of the derivative and cash markets in which we provide our brokerage services, the particular mix of transactional activity in our various products, the competitive and regulatory environment in the various jurisdictions and markets in which we operate and the financial condition of the dealers, hedge funds, traders and other market participants to whom we provide our services. Outlined below are management’s observations of these external market factors during the most recent fiscal period. The factors outlined below are not the only factors that impacted our results of operations for the most recent fiscal period, and additional or other factors may impact, or have different degrees of impact, on our results of operations in future periods.
Market Volatility
As a general rule, our business typically benefits from volatility in the markets that we serve, as periods of increased volatility often coincide with more robust trading by our clients and a higher volume of transactions. However, periods of extreme volatility may result in significant market dislocations that can also lead clients to reduce their trading activity.
Market volatility is driven by a range of external factors, some of which are market specific and some of which are correlated to general macro-economic conditions. Volatility, as measured by The Chicago Board Options Exchange Volatility Index (“VIX”), on average, was lower for each quarter during the year ended December 31, 2012 as compared to the same periods in 2011. During 2012, many of the markets in which we operate continued to experience low trading volumes resulting from sluggish global economic conditions, regulatory, tax, political and market uncertainty and the continuing sovereign debt issues in the Eurozone.
Recent Activity in Underlying Markets
Our business has historically benefited from growth in the over-the-counter (“OTC”) derivatives markets due to either the expansion of existing markets, including increased notional amounts outstanding or increased transaction volumes, or the development of new products or classes of products. The level of growth in these markets is difficult to measure on a quarterly basis as there are only a few independent, objective measures of growth in outstanding notional amount of OTC derivatives, all of which are published retrospectively and do not measure transactional volumes. Therefore, to help gauge growth in any particular quarter, management also looks to the published results of large OTC derivatives dealers and certain futures and derivative exchanges as potential indicators of transactional activity in the related OTC derivative markets.
Futures and derivatives exchanges, in most cases, reported declines in average daily volume (“ADV”) for the year ended December 31, 2012 as compared to the year ended December 31, 2011. The CME Group, Inc. (“CME”) reported a 15.0% decrease in ADV of its futures and options products while IntercontinentalExchange, Inc. (“ICE”) reported a 9.7% increase in its ADV of its futures and option products. Revenues from ICE’s credit default swap trade execution, processing and clearing businesses declined 13.8% in 2012 compared to 2011. CME’s interest rate futures and options products ADV declined 19.8% in 2012 compared to 2011. NYSE Euronext reported ADV declines of 22.0% and 12.3% in its fixed income derivative and equity derivative products, respectively, for 2012 compared to 2011. Based on the published results of other wholesale market brokers, we believe that the broader OTC markets have also experienced significant declines in volumes year over year.
According to BIS, the size of the global OTC derivative markets, as measured by notional amounts outstanding, was $638.9 trillion as of June 30, 2012, the latest period reported, compared to $647.8 trillion and $706.9 trillion as of December
31, 2011 and June 30, 2011, respectively. The size of the global OTC derivatives markets as of June 30, 2012 decreased by $8.9 trillion, or 1.4%, and $68.0 trillion, or 9.6%, when compared to the notional amounts outstanding as of December 31, 2011 and June 30, 2011, respectively.
The International Swaps and Derivatives Association (“ISDA”) produced a market analysis report from 2007 through June 2012 based on the above BIS figures, reducing notional outstanding to include one side of two-sided cleared transactions and excluding foreign exchange contract volumes. Foreign exchange contracts typically reach maturity within a few months while other OTC derivatives mature over a longer period of time. The ISDA report also quantified the effect of compression, which involves the tearing up of matched trades or trades that do not contribute risk to a dealer’s portfolio, on the size of the OTC derivatives market. The adjusted notional amount outstanding of $416.9 trillion as of June 30, 2012 indicates increased clearing and compression of OTC derivatives resulting, in part, in the $23.2 trillion, or 5.3%, decline in the total notional amounts outstanding when compared to December 31, 2011 and the $73.7 trillion, or 15%, decline when compared to June 30, 2011. ISDA believes that the adjusted numbers provide better insight into underlying market activity and trends by showing the impact of clearing, netting, compression and collateral on notional amounts outstanding in the OTC derivatives market.
In the interest rate derivatives market, adjusted notional amounts outstanding decreased to $341.2 trillion as of June 30, 2012 as compared to $362.4 trillion and $405.1 trillion as of December 31, 2011 and June 30, 2011, respectively. This was a decrease of $21.2 trillion, or 5.9%, and $63.9 trillion, or 15.8%, when compared to December 31, 2011 and June 30, 2011, respectively. The decline in adjusted notional amounts outstanding was attributed to the effects of compression and lower interest rate derivative activity. ISDA estimates that 54.2% of adjusted interest rate swap volumes were centrally cleared as of June 30, 2012, up from 21.3% as of December 31, 2007. ISDA estimates that 43.2% of forward rate agreements were centrally cleared as of June 30, 2012, up from 0.0% at December 31, 2010.
In the credit default swaps market, adjusted notional amounts outstanding decreased by $1.6 trillion, or 6.2%, to $24.3 trillion from $25.9 trillion as of December 31, 2011, the lowest reported level since 2006 due to the substantial effects of compression and lower credit derivative activity. ISDA estimates that 10.7% of credit default swaps were centrally cleared as of June 30, 2012, up from 7.9% as of December 31, 2010.
Competitive and Regulatory Environment
Another major external market factor affecting our business and results of operations is competition, which may take the form of competitive pressure on the commissions we charge for our brokerage services or competition for brokerage and technology development personnel with extensive experience in the specialized markets we serve. We currently compete for the services of productive brokers with other wholesale market participants. While the demand for productive brokers has remained strong over the last few years, we believe such demand has begun to lessen as the wholesale brokerage industry has been impacted by lower trading volumes and sluggish trading conditions in certain markets we serve. However, the consolidation and personnel layoffs by dealers, hedge funds and other market participants over the last few years, as well as dealers exiting proprietary trading operations, has increased competition to provide brokerage services to a smaller number of market participants in the near term.
In addition, we believe that the ongoing global regulatory overhaul of many of the markets in which we provide our services has led to continued uncertainty in 2012 and resulted in lower trading volumes and fewer participants in these markets. Regulators and legislators in the U.S. and abroad have proposed and, in some instances, adopted a slate of regulatory changes that call for, among other things, central clearing of certain derivatives, greater transparency and reporting of derivatives transactions, mandatory trading of certain derivatives transactions on regulated exchanges or swap execution facilities (“SEF”) and increased use of electronic trading system technologies. We believe that these new and proposed regulations have not yet eliminated the uncertainty that has persisted in many OTC derivatives markets since the start of the financial crisis.
During the third quarter of 2012, ICE announced that all cleared swaps in energy products would be converted to regulated futures contracts on October 15, 2012 on the basis that trading those products as futures would present significant advantages to customers seeking to avoid the impact of the Dodd-Frank Act. CME also announced that certain contracts already listed as futures on CME ClearPort would be made available for trading on CME Globex on October 12, 2012, with more to be added in the future. Subject to the rules and regulations applicable to futures products, including with respect to
block trades, we expect to continue to broker all the products that we have customarily brokered as swaps prior to October 12, 2012 without regard to whether those products are now traded as futures.
We remain optimistic that pending regulatory reform, including requirements for enhanced regulatory transparency, central clearing and efficient execution, will benefit and eventually grow the global derivatives markets. We remain confident that our business will qualify in the U.S. as a SEF, and in Europe as an Organized Trading Facility. We are also actively preparing to meet all regulatory requirements necessary to support the brokerage of U.S. energy future contracts, as well as other futures contracts that migrate over from the swaps market. Over the past year, we have continued to expand our proprietary electronic trade execution capabilities as well as the number of users of our hybrid electronic trading platforms. We believe that this technological capability will position us well in the future as regulatory rules are finalized and implemented.
Financial Overview
Our results for the last three years continue to reflect the challenging economic and market conditions that have existed following the late-2000’s financial crisis, during which many market participants, including many of our key customers, had to deal with reduced liquidity, credit contraction, market consolidation and market participant bankruptcies. Our geographic and product diversity enabled us to take advantage of areas of market strength over this period, even as several OTC derivative markets in which we provide our services were impacted by economic and regulatory uncertainty. As more fully discussed below, our results of operations are significantly impacted by the amount of revenues we generate and the amount of compensation and benefits we provide to our employees. The following factors had a significant impact on our revenues we generate and employee costs during the three year period ended December 31, 2012:
Our total revenues decreased 9.0% to $924.6 million for the year ended December 31, 2012 from $1.02 billion for the year ended December 31, 2011. The main factors contributing to this decrease in our revenues were:
· Decreased trading activity in many of the derivative markets in which we provide our services due to (i) sluggish global economic conditions, (ii) fiscal, tax, political and market uncertainty, and (iii) sovereign debt issues in the Eurozone;
· Regulatory uncertainty as it relates to market structure and operations in OTC derivative markets, especially in North America and Europe, including the uncertainty resulting from the conversion of OTC swaps to exchange-traded futures contracts in many North American energy products;
· Lower market volatility in many derivative markets during the year compared to the prior year, including in many fixed income and equity derivatives;
· Lower trading volumes in many of the emerging markets globally in which we provide brokerage services;
· Lower trading activity in the U.S. in the fourth quarter of 2012 due to Hurricane Sandy and its effects on customer trading operations;
· The weakening of the Euro relative to the U.S. Dollar and its effect on the translation of brokerage revenues in EMEA; and
· The closure of certain unprofitable brokerage desks globally.
Offsetting the above factors were the following factors that affected our brokerage and other revenues, including:
· Contributions from investments in new brokerage businesses in certain financial products in France and Switzerland;
· The continued strong performance of our Trayport subsidiary, which led to an increase in our software, analytics and market data revenue;
· Increased clearing services revenues due to a variation in the mix of products and exchanges utilized by our new and existing clearing service customers at Kyte; and
· Increased use of our electronic matching sessions and hybrid electronic trading systems by our customers.
The main factors contributing to our increase in total revenues for the year ended December 31, 2011 from the year ended December 31, 2010 are set forth below under “Year Ended December 31, 2011 Compared to the Year Ended December 31, 2010.”
The most significant component of our cost structure is employee compensation and benefits, which includes salaries, sign-on and retention bonuses, incentive compensation and related employee benefits and taxes. Our employee compensation and benefits expense decreased 12.9% to $546.5 million for the year ended December 31, 2012 from $627.4 million for the year ended December 31, 2011.
Our compensation and employee benefits for all employees have both a fixed and a variable component. Base salaries and benefit costs are primarily fixed for all employees while performance bonuses constitute the variable portion of our compensation and employee benefits. Sign-on and retention bonuses, when granted, also increase the fixed component of our compensation and employee benefits for the remainder of the term over which such bonus is earned by the employee. Within overall compensation and employee benefits, the employment cost of our brokerage personnel is the key component. Bonuses for brokerage personnel are primarily based on individual performance and/or the operating results of their related brokerage desk. Additionally, a portion of our bonus expense is subject to contractual guarantees that may require us to make bonus payments to brokers regardless of their performance in any particular period. For many of our brokerage employees, bonuses constitute a significant component of their overall compensation. Broker performance bonuses decreased to $170.4 million for the year ended December 31, 2012 from $244.0 million for the year ended December 31, 2011.
Further, we may pay sign-on bonuses to certain newly-hired brokers and retention bonuses to certain of our existing brokers who agree to long-term employment agreements. These bonuses may be paid in the form of cash or restricted stock units (“RSUs”) and are typically expensed over the term of the related employment agreement for cash bonuses and the related service period for RSUs, which is generally two to four years. These employment agreements typically contain provisions requiring the repayment of all or a portion of the cash payment and forfeiture provisions for unvested RSUs should the employee voluntarily terminate his or her employment or if the employee’s employment is terminated for cause during the initial term of the agreement. Compensation expense resulting from the amortization of broker sign-on and retention bonuses was $34.6 million for the year ended December 31, 2012, as compared to $41.6 million for the year ended December 31, 2011.
Results of Consolidated Operations
The following table sets forth our consolidated results of operations for the periods indicated:
The following table sets forth our consolidated results of operations as a percentage of our revenues, net of interest and transaction-based expenses for the periods indicated:
Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011
Net (Loss) Income
GFI’s net loss for the year ended December 31, 2012 increased $6.8 million to $10.0 million from a net loss of $3.2 million for the year ended December 31, 2011. Total revenues decreased by $90.9 million, or 9.0%, to $924.6 million in the year ended December 31, 2012 from $1.02 billion in the prior year. The decrease in total revenues was primarily due to lower brokerage revenues, which decreased $101.1 million, or 12.7%, partially offset by a net increase in “Other Revenues,” as described in more detail below.
Total interest and transaction-based expenses increased $2.8 million to $137.5 million in 2012 from $134.7 million in 2011. The increase resulted from higher transaction fees on clearing services at our Kyte subsidiary primarily due to the mix of products and exchanges utilized by existing and new customers.
Total expenses, excluding interest and transaction-based expenses, decreased by $92.4 million, or 10.5%, to $788.3 million for the year ended December 31, 2012 from $880.7 million for the year ended December 31, 2011. The decrease in total other expenses was largely attributable to a decrease in compensation and employee benefits expense, which resulted primarily from (i) lower performance bonus expense as a result of lower brokerage revenues and (ii) initiatives implemented during the latter part of 2011 and throughout 2012 to reduce our aggregate compensation expense. The decrease was also due to lower travel and promotion expenses and professional fees.
Revenues
The following table sets forth the changes in revenues for the year ended December 31, 2012, as compared to the same period in 2011(dollars in thousands, except percentage data):
* Denotes % of revenues, net of interest and transaction-based expenses
** Denotes % change in 2012 as compared to 2011
Brokerage Revenues-We offer our brokerage services in four broad product categories: fixed income, equity, financial, and commodity. Below is a discussion of our brokerage revenues by product category for the year ended December 31, 2012.
· Broker productivity (defined as total brokerage revenues during the period divided by average monthly brokerage personnel headcount for the period) across all product categories decreased by approximately 13.1% for 2012, as compared to 2011.
· Fixed income product brokerage revenues decreased $46.2 million, or 19.7%, for the year ended December 31, 2012 compared to the same period for the prior year. Revenues from fixed income derivative and cash products decreased approximately 34.4% and 5.9%, respectively, as compared to the year ended December 31, 2011. This decrease was partially due to lower trading volumes attributable, in part, to pending reform in the swaps market, as well as poor global economic conditions, continued low interest rates, market uncertainty and the ongoing sovereign debt issues in the Eurozone. Our fixed income product brokerage personnel headcount decreased by 35 to 308 employees at December 31, 2012 from 343 employees at December 31, 2011.
· Equity product brokerage revenues decreased $39.0 million, or 22.3%, for the year ended December 31, 2012 compared to the same period for the prior year. The decrease was primarily attributable to reduced cash equity and equity derivative trading volumes in the U.S. and Europe. This decrease was consistent with the decline in equity volumes reported in the broader exchange-traded cash and derivatives markets. Our equity product brokerage personnel headcount decreased by 34 to 200 employees at December 31, 2012 from 234 employees at December 31, 2011.
· Financial product brokerage revenues decreased $6.6 million, or 3.5%, for the year ended December 31, 2012 compared to the same period in the prior year. The decrease was primarily due to slow trading conditions in emerging markets in Latin America and Asia, partially offset by revenues from our new brokerage desks in France and Switzerland, which commenced operations in October of 2011. Our financial product headcount increased by 2 to 380 employees at December 31, 2012 from 378 employees at December 31, 2011.
· Commodity product brokerage revenues decreased $9.2 million, or 4.7%, for the year ended December 31, 2012 compared to the same period in the prior year. We believe that this decrease was largely attributable to regulatory uncertainty as it relates to the U.S. energy markets and the conversion of OTC swaps to exchange-traded futures contracts in many North American energy products during the fourth quarter of 2012. Partially offsetting this decrease was an increase in commodity brokerage revenues due to growth in certain energy and metals businesses and the addition of new desks in the U.S. and Europe. Our commodity product brokerage personnel headcount decreased by 16 to 300 employees at December 31, 2012 from 316 employees at December 31, 2011.
Clearing Services Revenue
· Clearing services revenues increased by $5.3 million, or 4.7%, for the year ended December 31, 2012 to $118.0 million from $112.7 million in the same period in 2011 due to a variation in the mix of products and exchanges utilized by our new and existing clearing service customers partially offset by a decrease in the number of trades cleared by our Kyte subsidiary. Clearing services revenues are related solely to the operations of Kyte and consist of fees charged to our clearing service customers for clearing, settlement and other services. Kyte also incurs exchange fees on behalf of its customers, which Kyte then charges to its customers, and are therefore included in equal amounts in both revenues and expenses.
Other Revenues
· Other revenues were comprised of the following (dollars in thousands):
Other revenues increased by $4.9 million to $111.0 million for the year ended December 31, 2012 from $106.1 million for the year ended December 31, 2011. This increase was largely related to an increase in our software, analytics and market data revenues of $10.5 million, which was primarily attributable to an increase in software revenues at our Trayport subsidiary, due to growth in their customer base as well as new product offerings. Other revenues also increased due to a $2.4 million increase in net realized and unrealized gains related to foreign currency forward contracts used to hedge certain non-U.S. dollar assets and revenues. Partially offsetting these increases was a $3.4 million net decrease in Other revenues related to the remeasurement of foreign currency transactions and balances and a net decrease of $1.9 million in net earnings of unconsolidated businesses. The foreign currency remeasurement gains and losses result from the remeasurement of asset and liability balances that are denominated in currencies other than the functional currency of the business unit involved in such transactions.
Interest and Transaction-Based Expenses
· The increase in total interest and transaction-based expenses of $2.8 million for the year ended December 31, 2012 as compared to the same period in 2011 was due to an increase in transaction fees on clearing services of $5.4 million which are entirely related to the clearing operations of our Kyte subsidiary. This increase was primarily due to a variation in the mix of products and exchanges utilized by our new and existing clearing service customers partially offset by a decrease in the number of trades cleared. Kyte pays to use the services of third parties who act as general clearing members of clearing houses in order to clear cash and derivative products for its customers. Kyte also incurs exchange fees on behalf of its clients, which are mostly pass-through costs and are therefore included in equal amounts in both revenues and expenses. This increase was partially offset by a decrease in transaction fees on brokerage services of $1.7 million due to a decrease in brokerage revenues executed on a matched principal basis, for which we typically incur transaction-based expenses, such as clearing fees.
Expenses
The following table sets forth the changes in expenses for the year ended December 31, 2012 as compared to the same period in 2011 (dollars in thousands, except percentage data):
* Denotes % of revenues, net of interest and transaction-based expenses
** Denotes % change in 2012 as compared to 2011
Compensation and Employee Benefits
· The $80.9 million decrease in compensation and employee benefits expense for the year ended December 31, 2012 was primarily due to lower broker performance bonus expense resulting from lower brokerage revenues and initiatives implemented in the latter part of 2011 and throughout 2012 to reduce our aggregate compensation expense. Compensation expense was also higher in 2011 due to a $19.4 million charge taken in that year related to severance and other restructuring expenses.
· Total compensation and employee benefits as a percentage of revenues, net of interest and transaction-based expenses, decreased to 69.4% in 2012 from 71.2% in the prior year.
· Performance bonus expense represented 36.7% and 43.3% of total compensation and employee benefits expense for the year ended December 31, 2012 and 2011, respectively. A portion of our bonus expense is subject to contractual guarantees that may require us to make bonus payments to brokers regardless of their performance in any particular period. Additionally, sign-on and retention bonus expense, which includes the amortization of cash sign-on and retention bonuses initially paid in prior periods, represented 7.0% and 7.7% of total compensation and employee benefits expense for the years ended December 31, 2012 and 2011, respectively.
All Other Expenses
· The decrease in travel and promotion expense of $4.2 million was due, in large part, to the low volume trading environment that persisted throughout 2012 and a reduction in brokerage personnel headcount, as well as cost savings initiatives implemented in 2011 and 2012.
· The decrease in rent and occupancy expense of $1.0 million was primarily due to a gain of $3.2 million related to an adjustment of a loss accrual on a sublease of our former headquarters, partially offset by the renewal of our office lease in the U.K. in the fourth quarter of 2011 at a higher rent. See Note 2 to the Consolidated Financial Statements in Part II-Item 8 for further information related to a sublease loss accrual.
· The decrease in professional fees of $4.2 million for 2012 as compared to 2011 was partially due to a decrease in our global audit fee in the current year as well as lower consulting fees associated with regulatory compliance in the U.K.
· The increase in interest on borrowings of $1.1 million was due to the July 2011 issuance of $250.0 million of 8.375% Senior Notes (“8.375% Senior Notes”), which led to an increase in borrowings outstanding and a higher average effective interest rate on long-term debt borrowings during the year ended December 31, 2012. This increase was largely offset by $6.0 million in bond redemption costs recognized in the third quarter of 2011 associated with our July 2011 redemption of the entire $60.0 million principal amount of our then-outstanding 7.17% senior secured notes, which were due in January 2013 (“7.17% Senior Notes”).
· Our provision for income taxes increased to $8.4 million in 2012 compared to $2.6 million in 2011, primarily due to (i) additional U.S. tax expense related to certain international profits and (ii) the establishment of valuation allowances against deferred tax assets in jurisdictions where we have determined they are unlikely to be utilized. The increased tax rate was partially offset by (i) the impact of a decrease in the statutory corporate tax rate in the U.K, (ii) a release of an unrecognized tax benefit from 2008, 2009, and 2010 where the position has now been resolved with the relevant tax authority and (iii) a reconciliation of prior year estimates against tax return filings.
Year Ended December 31, 2011 Compared to the Year Ended December 31, 2010
Net (Loss) Income
GFI’s net loss for the year ended December 31, 2011 was $3.2 million as compared to net income of $25.6 million for the year ended December 31, 2010, a decrease of $28.8 million. Total revenues increased by $152.9 million, or 17.7%, to $1.02 billion for the year ended December 31, 2011 from $862.6 million for the same period in the prior year. The increase in total revenues for the year ended December 31, 2011 was due, in large part, to the inclusion of a full year of revenue for our
Kyte subsidiary, which we acquired on July 1, 2010. For the year ended December 31, 2011, as compared to the year ended December 31, 2010, Kyte’s operations contributed an increase of $70.8 million to our clearing services revenue, as well as increases to our brokerage revenues and to our equity in net earnings of unconsolidated businesses. The increase in total revenues was also due to (i) a $46.8 million increase in our brokerage revenues, as described below and (ii) an increase of $35.2 million in Other revenues, which is discussed in more detail below under the section “Other Revenues.”
Total interest and transaction-based expenses increased by $67.1 million, to $134.7 million for the year ended December 31, 2011 from $67.6 million for the year ended December 31, 2010. The increase was primarily due to the inclusion of a full year of revenue for our Kyte subsidiary. Kyte incurs exchange, clearing and execution costs in order to provide clearing services to its customers.
Total expenses other than interest and transaction-based expenses increased by $117.5 million, or 15.4%, to $880.7 million for the year ended December 31, 2011 from $763.2 million for the year ended December 31, 2010. The increase in total other expenses was largely attributable to (i) increased compensation and benefits expense, which resulted from a $19.4 million charge taken in 2011 related to severance and other restructuring expenses, (ii) increased salary expense related to an increased headcount in brokers, back office and Trayport employees, (iii) increased interest on borrowings due to the July 2011 issuance of $250.0 million of 8.375% Senior Notes and bond redemption costs associated with the July 2011 redemption of our 7.17% Senior Notes, (iv) $8.8 million of impairment charges taken related to certain equity method investments and (v) an increase in expenses related to the inclusion of a full year of operations for our Kyte subsidiary, including increased expenses relating to compensation and employee benefits, communications and market data, and depreciation and amortization.
Revenues
The following table sets forth the changes in revenues for the year ended December 31, 2011, as compared to the same period in 2010 (dollars in thousands, except percentage data):
* Denotes % of revenues, net of interest and transaction-based expenses
** Denotes % change in 2011 as compared to 2010
Brokerage Revenues-We offer our brokerage services in four broad product categories: fixed income, equity, financial, and commodity. Below is a discussion of our brokerage revenues by product category for the year ended December 31, 2011.
· Broker productivity (defined as total brokerage revenues during the period divided by average monthly brokerage personnel headcount for the period) across all product categories decreased by approximately 3.3% for 2011, as compared to 2010.
· The decrease in fixed income product brokerage revenues of $3.2 million, or 1.3%, in 2011 as compared with 2010 was primarily attributable to a decrease in revenues from fixed income derivative products of approximately 5.0%. This decrease in revenues from fixed income derivative products was due, in large part, to lower revenues in Europe partially offset by the inclusion of a full year of revenues at Kyte. Offsetting the decrease in fixed income derivatives revenues was a 2.3% increase in our cash fixed income businesses in 2011 as compared to 2010. Cash fixed income product revenues increased, in large part, to the acquisition of a cash fixed income brokerage firm in the fourth quarter of 2010. Our fixed income product brokerage personnel headcount increased by 18 to 343 employees at December 31, 2011 from 325 employees at December 31, 2010.
· The increase in equity product brokerage revenues of $1.3 million, or 0.8%, in 2011 as compared with 2010 was primarily attributable to higher revenues in Europe. The growth in revenues from equity products in Europe was due, in-part, to the heightened volatility caused by the ongoing sovereign debt and economic concerns, as well as incremental revenues from Kyte. This increase was partially offset by lower revenues from cash and derivative equity products in the U.S. Our equity product brokerage personnel headcount decreased by 13 to 234 employees at December 31, 2011 from 247 employees at December 31, 2010.
· The increase in financial product brokerage revenues of $35.7 million, or 22.9%, in 2011 as compared to 2010 was primarily attributable to improved market conditions and significant trading in emerging markets in Latin America, Eastern Europe and Asia, as well as increased usage of GFI’s ForexMatch® electronic trading platform. The opening of our offices in Colombia and Switzerland also contributed to increased financial product brokerage revenues in 2011. Our financial product brokerage personnel headcount increased by 83 to 378 employees at December 31, 2011 from 295 employees at December 31, 2010.
· The increase in commodity product brokerage revenues of $12.9 million, or 7.1%, in 2011 as compared to 2010 was primarily attributable to increased volatility and demand for certain commodity products, such as power, natural gas, emissions and metals, as well as the contribution from new desks in the Americas and Europe. Slightly offsetting this increase was a decrease in oil and freight revenues due to the closing of several desks in this product area. Our commodity product brokerage personnel headcount increased by 22 to 316 employees at December 31, 2011 from 294 employees at December 31, 2010.
Clearing Services Revenue
· Clearing services revenues increased by $70.8 million for the year ended December 31, 2011 to $112.7 million from $41.9 million in the same period in 2010. These revenues are entirely related to the operations of Kyte, which we acquired on July 1, 2010, and which are therefore only partially reflected in the year ended December 31, 2010. Kyte uses the services of third parties who act as general clearing members of clearing houses in order to clear cash and derivative products for its customers. Kyte charges a fee to its customers for clearing, settlement and other services against which customer negotiated rebates may be applied. Kyte also incurs exchange, clearing and execution costs on behalf of its clients, which are fully reimbursed and are therefore included in both revenues and expenses.
Other Revenues
· Other revenues were comprised of the following (dollars in thousands):
Other revenues increased by $35.2 million for the year ended December 31, 2011 to $106.1 million from $70.9 million for the year ended December 31, 2010. This increase was largely related to (i) an increase in our software, analytics and market data revenue of $13.0 million, which was largely attributable to an increase in software revenues at our Trayport subsidiary, (ii) a net increase of $11.5 million in Other, which was due, in part, to a $6.9 million gain related to the fair value mark-to-market on the future purchase commitment to acquire the residual 30% equity interest in Kyte compared to a gain of $0.2 million in 2010, (iii) an increase of $6.5 million in equity in net earnings of unconsolidated businesses, which was primarily related to equity method investments in certain Kyte backed traders and brokerage operations acquired on July 1, 2010 and (iv) a net increase of $6.6 million related to the remeasurement of foreign currency transactions and balances. Foreign currency remeasurement gains and losses result from the remeasurement of asset and liability balances that are denominated in currencies other than the functional currency of the business unit involved in such transactions. These increases in Other were slightly offset by a net decrease of $3.9 million in net realized and unrealized losses related to hedges of certain non-U.S. dollar assets, as well as hedges of current and anticipated revenues denominated in foreign currencies.
Interest and Transaction-Based Expenses
· Transaction fees on clearing services increased by $68.4 million to $108.3 million in the year ended December 31, 2011, from $39.9 million in 2010. These costs are entirely related to the clearing operations of Kyte, which we acquired on July 1, 2010 and which are therefore only partially reflected in the year ended December 31, 2010.
· Transactions fees on brokerage services decreased by $2.7 million to $24.5 million in the year ended December 31, 2011 from $27.2 million, or 9.9%, in 2011 as compared to 2010. Transaction fees on brokerage services as a percentage of our total revenues from principal transactions decreased to 10.4% for 2011, from 12.6% in 2010, as revenues from our cash equities businesses decreased relative to revenues from our cash fixed income businesses. Principal transactions are generally settled through third party clearing organizations that charge us a fee for their services. Transaction fees for cash fixed income principal transactions tend to be lower than for cash equity principal transactions. We also use the services of stock exchanges and floor brokers to assist in the execution of transactions. Fees paid to floor brokers and execution fees paid to exchanges in these circumstances are included in clearing fees. In addition, transaction fees also include fees incurred in certain equity transactions executed on an agency basis.
Expenses
The following table sets forth the changes in expenses for the year ended December 31, 2011 as compared to the same period in 2010 (dollars in thousands, except percentage data):
* Denotes % of revenues, net of interest and transaction-based expenses
** Denotes % change in 2011 as compared to 2010
Compensation and Employee Benefits
· The increase in compensation and employee benefits expenses of $69.1 million in the year ended December 31, 2011 was due, in large part, to (i) increased headcount in brokers, back office and Trayport employees, (ii) higher compensation expense related to Kyte, which we acquired on July 1, 2010 and which is therefore only partially reflected in the year ended December 31, 2010; and (iii) a $19.4 million charge taken in 2011 related to severance and other restructuring expenses and (iv) higher broker performance bonus compensation due to higher brokerage revenues.
· Total compensation and employee benefits as a percentage of revenues, net of interest and transaction-based expenses, increased to 71.2% in 2011 from 70.2% in the prior year. The higher compensation expense as a percentage of net revenues for 2011 was due to the charge for severance and other restructuring expenses in 2011.
· Performance bonus expense represented 43.3% and 46.0% of total compensation and employee benefits expense for the year ended December 31, 2011 and 2010, respectively. A portion of our bonus expense is subject to contractual guarantees that may require us to make bonus payments to brokers regardless of their performance in any particular period. Additionally, compensation expense resulting from the amortization of sign-on and retention bonuses paid in prior periods represented 7.7% and 6.7% of total compensation and employee benefits expense for the years ended December 31, 2011 and 2010, respectively.
All Other Expenses
· The increase in communications and market data of $11.1 million in 2011 was due, in large part, to a $7.3 million increase related to the inclusion of a full year of results for our Kyte subsidiary, which we acquired on July 1, 2010 and which is therefore only partially reflected in the year ended December 31, 2010. The remaining increase was primarily due to increased brokerage headcount and upgrades to existing systems.
· The increase in depreciation and amortization of $4.5 million was primarily due to the inclusion in 2011 of a full year of amortization of intangibles related to our acquisition of Kyte and other entities in the second half of 2010.
· The increase in interest on borrowings of $14.7 million was due, in large part, to the July 2011 issuance of $250.0 million of 8.375% Senior Notes, which led to greater borrowings outstanding and a higher average effective interest rate on term debt borrowings, during the year ended December 31, 2011 . The increase was also due, in part, to $6.0 million in bond redemption costs associated with the July 2011 redemption of the entire $60.0 million principal amount of our then-outstanding 7.17% Senior Notes.
· Other expenses increased $11.8 million in 2011 from 2010 primarily due to $8.8 million of impairment charges taken in 2011 related to certain equity method investments.
· Our provision for income taxes was $2.6 million in 2011 compared to $5.9 million in 2010. Our low level of profitability in 2011 caused non-deductible expenses to have a disproportionate effect on our tax provision in 2011.
Results of Segment Operations
Based on the nature of our operations, products and services in each geographic region, we determined that we have five operating segments: (i) Americas Brokerage, (ii) Europe, Middle East and Africa (“EMEA”) Brokerage, (iii) Asia Brokerage, (iv) Clearing and Backed Trading and (v) All Other. Our brokerage operations provide brokerage services in four broad product categories: fixed income, financial, equity and commodity. Our Clearing and Backed Trading segment encompasses our clearing, risk management, settlement and other back-office services, as well as the capital we provide to start-up trading groups, small hedge funds, market-makers and individual traders. Our All Other segment captures revenues and costs that are not directly assignable to one of the brokerage or clearing and backed trading operating business segments, primarily consisting of our corporate business activities and operations from software, analytics and market data.
The following tables summarize our Total revenues, Revenues, net of interest and transaction-based expenses, Other expenses and Income (loss) before income taxes by segment:
Segment Results for the Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011
Total Revenues
· Total revenues for Americas Brokerage decreased $37.1 million, or 11.8%, to $276.4 million for the year ended December 31, 2012 from $313.5 million for the year ended December 31, 2011. Total revenues for EMEA Brokerage decreased $47.5 million, or 12.3%, to $338.5 million for the year ended December 31, 2012 from $386.0 million for the year ended December 31, 2011. Total revenues for Asia Brokerage decreased $11.0 million, or 13.3%, to $71.9 million for the year ended December 31, 2012 from $82.9 million for the year ended December 31, 2011. Total revenues for our three brokerage segments decreased by $95.6 million, or 12.2%, to $686.8 million for the year ended December 31, 2012 from $782.4 million for the year ended December 31, 2011. The decrease in total revenues for our brokerage segments was primarily due to the factors described above under “Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011.”
· Total revenues for Clearing and Backed Trading decreased $5.0 million, or 3.0%, to $159.9 million for the year ended December 31, 2012 from $164.9 million for the year ended December 31, 2011. The decrease was due, in large part, to a decrease in equity earnings of unconsolidated businesses, a decrease in brokerage revenues at Kyte, lower clearing services revenues due to a variation in the mix of products and exchanges utilized by our new and existing clearing service customers and a decrease in the number of trades cleared by our Kyte subsidiary.
· Total revenues for our All Other segment primarily consisted of revenues generated from sales of software, analytics and market data. Total revenues from All Other increased by $9.7 million, or 14.2%, to $77.9 million for the year ended December 31, 2012 from $68.2 million for the year ended December 31, 2011. This increase was due, in large part, to an increase in software, analytics and market data revenues at our Trayport subsidiary due to growth in its customer base, as well as new product offerings.
Total interest and transaction-based expenses
· Total interest and transaction-based fees for our three brokerage segments decreased by $1.5 million, or 6.0%, to $23.7 million for the year ended December 31, 2012 from $25.2 million for the year ended December 31, 2011. This decrease was primarily due to a decrease in brokerage revenues executed on a matched principal basis, for which we incur transaction-based expenses.
· Total interest and transaction-based fees for our Clearing and Backed Trading segment increased by $4.5 million to $115.3 million for the year ended December 31, 2012 from $110.8 million the prior year primarily due to variations in the mix of products and exchanges utilized by existing and new clearing service customers partially offset by a market-wide decrease in trading volumes.
Other Expenses
· Other expenses for Americas Brokerage decreased $25.4 million, or 11.6%, to $192.9 million for the year ended December 31, 2012 from $218.3 million for the year ended December 31, 2011. Other expenses for EMEA Brokerage decreased $41.3 million, or 14.4%, to $245.4 million for the year ended December 31, 2012 from $286.7 million for the year ended December 31, 2011. Other expenses for Asia Brokerage decreased $10.6 million, or 15.8%, to $56.7 million for the year ended December 31, 2012 from $67.3 million for the year ended December 31, 2011. Total Other expenses for our three brokerage segments decreased by $77.3 million, or 13.5%, to $495.0 million for the year ended December 31, 2012 from $572.3 million for the year ended December 31, 2011. The decrease was primarily due to lower broker performance bonus expense resulting from lower brokerage revenues and initiatives implemented in the latter part of 2011 and throughout 2012 to reduce our aggregate compensation expense. The decrease was also due to a $19.4 million charge taken in 2011 related to severance and other restructuring expenses.
· For our brokerage segments, we record certain direct expenses, including compensation and employee benefits; however, we do not allocate certain expenses that are managed separately at the corporate level to these operating segments. The unallocated costs including rent and occupancy, depreciation and amortization, professional fees, interest and other expenses are included in the expenses for All Other described below. Management does not believe that allocating these costs to our brokerage segments is optimal for evaluating the performance of its brokerage segments.
· Other expenses for Clearing and Backed Trading decreased $7.0 million to $37.9 million for the year ended December 31, 2012 from $44.9 million for the year ended December 31, 2011. This decrease was due, in large part, to a decrease in compensation and employee benefits due to lower variable compensation expense.
· Other expenses for our All Other segment decreased by $8.1 million, or 3.1%, to $255.4 million for the year ended December 31, 2012 from $263.5 million for the year ended December 31, 2011. The decrease was due, in large part, to a decrease in compensation and employee benefits due to lower variable compensation expense for back office personnel and a decrease in professional fees for 2012 as compared to 2011, primarily due to a decrease in our global audit fee in the current year, as well as lower consulting fees associated with regulatory compliance in the U.K.
Segment Results for the Year Ended December 31, 2011 Compared to the Year Ended December 31, 2010
Total Revenues
· Total revenues for Americas Brokerage increased $18.6 million, or 6.3%, to $313.5 million for the year ended December 31, 2011 from $294.9 million for the year ended December 31, 2010. Total revenues for EMEA Brokerage increased $7.0 million, or 1.8%, to $386.0 million for the year ended December 31, 2011 from $379.0 million for the year ended December 31, 2010. Total revenues for Asia Brokerage increased $7.9 million, or 10.5%, to $82.9 million for the year ended December 31, 2011 from $75.0 million for the year ended December 31, 2010. Total revenues for our three brokerage segments increased by $33.5 million, or 4.5%, to $782.4 million for the year ended December 31, 2011 from $748.9 million for the year ended December 31, 2010. The increase in total revenues for our brokerage operations was primarily due to increases in brokerage revenues in financial and commodity products resulting from the factors described above under “Year Ended December 31, 2011 Compared to the Year Ended December 31, 2010.”
· Total revenues for Clearing and Backed Trading increased $111.8 to $164.9 million for the year ended December 31, 2011 from $53.1 million for the year ended December 31, 2010. These revenues are entirely related to our Kyte operations, which we acquired on July 1, 2010. Accordingly the year ended December 31, 2011 is not directly comparable to the year ended December 31, 2010. Total revenues for Clearing and backed trading for the year ended December 31, 2011 consist primarily of clearing services revenues of $112.7 million, brokerage revenues from principal transactions of $16.2 million, equity in earnings of unconsolidated subsidiaries of $14.7 million and other income of $19.0 million.
· Total revenues for our All Other segment primarily consisted of revenues generated from sales of software, analytics and market data. Total revenues from All Other increased by $7.6 million, or 12.5%, to $68.2 million for the year ended December 31, 2011 from $60.6 million for the year ended December 31, 2010. The increase was primarily related to a $12.9 million increase in software, analytics and market data, primarily attributable to an increase in software revenues at our Trayport subsidiary, partially offset by a $3.9 million decrease in equity in net losses of unconsolidated business.
Total interest and transaction-based expenses
· Total interest and transaction-based fees for our three brokerage segments decreased by $2.8 million, or 10.0%, from $28.0 million for the year ended December 31, 2010 to $25.2 million for the year ended December 31, 2011. The decrease was related to the decrease in transaction fees paid for brokerage services by our Americas and EMEA brokerage segments, which decreased by $2.5 million, or 15.1%, and $0.3 million, or 2.9%, respectively.
· Total interest and transaction-based fees for our Clearing and Backed Trading segment increased to $110.8 million for the year ended December 31, 2011 from $41.0 million the prior year. All of these expenses were incurred by Kyte following the acquisition on July 1, 2010 and are primarily due to transaction fees on clearing services of $108.3 million and $39.9 million in the years ended December 31, 2011 and 2010, respectively.
Other Expenses
· Other expenses for Americas Brokerage increased $6.1 million, or 2.9%, to $218.3 million for the year ended December 31, 2011 from $212.2 million for the year ended December 31, 2010. Other expenses for EMEA Brokerage increased $34.2 million, or 13.5%, to $286.7 million for the year ended December 31, 2011 from $252.5 million for the year ended December 31, 2010. Other expenses for Asia Brokerage increased $8.2 million, or 13.9%, to $67.3 million for the year ended December 31, 2011 from $59.1 million for the year ended December 31, 2010. Total Other expenses for our three brokerage segments increased by $48.5 million, or 9.3%, to $572.3 million for the year ended December 31, 2011 from $523.8 million for the year ended December 31, 2010. The increase was primarily due to a $41.5 million increase in compensation and employee benefits, as well as increases in communications and market data, travel and promotion, interest on borrowing
expenses and the other factors described above under “Year Ended December 31, 2011 Compared to the Year Ended December 31, 2010.”
· For our brokerage segments, we record certain direct expenses, including compensation and employee benefits; however, we do not allocate certain expenses that are managed separately at the corporate level to these operating segments. The unallocated costs including rent and occupancy, depreciation and amortization, professional fees, interest and other expenses are included in the expenses for All Other described below. Management does not believe that allocating these costs to our brokerage segments is optimal for evaluating their performance.
· Other expenses for Clearing and Backed Trading increased $29.7 million to $44.9 million for the year ended December 31, 2011 from $15.2 million for the year ended December 31, 2010. These expenses are entirely related to the operations of Kyte, which we acquired on July 1, 2010. Accordingly, the year ended December 31, 2011 is not directly comparable to the year ended December 31, 2010. Total expenses for Clearing and Backed trading for the year ended December 31, 2011 are comprised of, in large part, compensation and employee benefits expense of $18.4 million, communications and market data expense of $10.7 million and depreciation and amortization of $5.2 million.
· Other expenses for our All Other segment increased by $39.1 million, or 17.4%, to $263.5 million for the year ended December 31, 2011 from $224.4 million for the year ended December 31, 2010. The increase was largely due to a $14.4 million increase in compensation and employee benefits, an $11.5 million increase in interest on borrowings and a $10.1 million increase in other expenses. These factors are discussed above under “Year Ended December 31, 2011 Compared to the Year Ended December 31, 2010.”
Quarterly Results of Operations
The following table sets forth, by quarter, our unaudited Statement of Operations data for the period from January 1, 2011 to December 31, 2012. Results of any period are not necessarily indicative of results for a full year and may, in certain periods, be affected by seasonal fluctuations in our business.
The following table sets forth our quarterly results of operations as a percentage of our Revenues, net of interest and transaction-based expenses, for the indicated periods:
(1) Certain amounts related to equity in net earnings (losses) of unconsolidated businesses totaling $(1,448) for the three months ended March 31, 2011 was previously presented in the “Other expenses” line item in the Consolidated Statements of Operations. In order to enhance transparency in the presentation of the Consolidated Statements of Operations these amounts have been reclassified to the “Equity in net earnings (losses) of unconsolidated businesses” line item.
The tables below detail our brokerage revenues by product category in dollars and as a percentage of our total brokerage revenues for the indicated periods.
Liquidity and Capital Resources
Cash and cash equivalents consist of cash and highly liquid investments with maturities, when purchased, of three months or less. At December 31, 2012, we had $227.4 million of cash and cash equivalents compared to $245.9 million at December 31, 2011. Included in this amount are $165.1 million and $187.1 million of cash and cash equivalents held by subsidiaries outside of the United States at December 31, 2012 and December 31, 2011, respectively. We have historically asserted the intent to indefinitely reinvest, with very limited exceptions, the unremitted profits of our foreign subsidiaries. We continue to assert that our historic profits earned in foreign subsidiaries are indefinitely reinvested. However, management has concluded that profits earned in certain overseas subsidiaries commencing from January 1, 2013 will ultimately be repatriated to the United States and we will accrue additional income taxes, if any, on such international profits. We do not expect a material United States tax charge to arise on the repatriation of these profits.
In addition, included within Receivables from brokers, dealers and clearing organizations are cash balances which represent amounts clearing customers have on deposit with Kyte, our clearing affiliate, and which Kyte then deposits with third parties who act as general clearing members of clearing houses in order to clear cash and derivative products for Kyte’s customers. These amounts, while due to us from the general clearing members, ultimately represent cash payable to our clearing customers. Also included within Receivables from brokers, dealers and clearing organizations are cash, including deposits, held at clearing organizations and exchanges to facilitate settlement and clearance of matched principal transactions, and spreads on matched principal transactions that have not yet been remitted from clearing organizations and exchanges. We estimate that cash held at clearing organizations, net of amounts owed to our clearing customers and net of clearing customer cash included within Cash and cash equivalents, was $19.6 million and $41.6 million as of December 31, 2012 and 2011, respectively.
The following table summarizes our cash position as of December 31, 2012 and 2011, respectively.
We believe that, based on current levels of operations, our cash from operations, together with our current cash holdings and available borrowings under our credit agreement with Bank of America N.A. and certain other lenders (the “Credit Agreement”), will be sufficient to fund our operations for at least the next twelve months. Poor financial results, unanticipated expenses or unanticipated acquisitions or strategic investments could give rise to additional financing requirements sooner than we expect. There can be no assurance that equity or debt financing will be available when needed or, if available, that the financing will be on terms satisfactory to us and not dilutive to our then-current stockholders.
Sources and Uses of Cash
The following table sets forth our cash flows from operating activities, investing activities and financing activities for the indicated periods.
Net cash provided by operating activities was $48.7 million for the year ended December 31, 2012 compared with $4.6 million for the year ended December 31, 2011, a net increase of $44.1 million. The increase in cash provided by operating activities is due to a reduction in working capital employed in the business for the year ended December 31, 2012 relative to the same period in 2011. The decrease in working capital employed in the business was primarily due to (i) a $130.4 million decrease related to changes in net receivables from and payables to brokers, dealers and clearing organizations, (ii) a $12.9 million decrease related to the change in commissions receivable and (iii) a net decrease in the change in other assets and other liabilities of $9.1 million, largely attributable to a decrease in cash sign-on and retention bonuses paid of $16.4 million. These decreases in working capital requirements were partially offset by a $74.2 million increase in working capital used in the business related to the net changes in accrued compensation and accounts payable, a net increase of $15.0 million related to increases in each of cash and securities segregated under federal and other regulations and payables to clearing service customers. Offsetting this net reduction in working capital was a decrease of $7.1 million in net loss before attribution to non-controlling stockholders from $2.6 million for the year ended December 31, 2011 to $9.6 million for the year ended December 30, 2012.
Net cash provided by operating activities for the year ended December 31, 2011 was $4.6 million, as compared to $96.1 million for the year ended December 31, 2010, a decrease of $91.5 million. This decrease was due, in part, to a $28.5 million decrease in net income before attribution to non-controlling stockholders from $25.9 million for the year ended December 31, 2010 to a loss of $2.6 million for the year ended December 31, 2011.The decrease is also attributable to a $109.6 million increase in working capital employed in the business for the year ended December 31, 2011 relative to the same period in 2010. The increase in working capital employed in the business was primarily due to a $112.2 million increase related to changes in net receivables from brokers, dealers and clearing organizations, a net increase in the change in other assets and other liabilities of $26.5 million, largely attributable to an increase in sign-on and retention bonuses paid of $12.5 million in 2011 as compared to 2010. These increases in working capital requirements were offset by a $10.8 million decrease related to accrued compensation and accounts payable and a net decrease of $14.6 million related to decreases in each of segregated cash and payables to clearing services customers. Offsetting the decrease in net income and additional working capital employed in the business was a $46.6 million net change in items which reconcile net income to net cash used in operating activities, such as depreciation and amortization, share-based compensation expense, amortization of sign-on and retention bonuses and benefit from deferred taxes, as compared to the year ended December 31, 2010.
Changes in working capital are often related to the timing of settlement of matched principal trades. While our net exposure to these trades is minimal (since we simultaneously agree to buy instruments from one customer and sell them to another customer), there is sometimes a slight lag in the settlement of these offsetting trades that results in us maintaining a receivable or payable positions for a short period of time, typically overnight. Substantially all fail to deliver and fail to receive balances at December 31, 2012, 2011 and 2010, respectively, have subsequently settled at the contracted amounts.
Net cash used in investing activities for the year ended December 31, 2012 was $15.5 million compared to $46.3 million for 2011. The decrease in cash used for investing activities was related to (i) a decrease of $9.1 million in net payments due to the settlement of foreign exchange derivative hedge contracts, (ii) a decrease in purchases of cost and equity
method investments of $8.2 million, (iii) a decrease in purchases of property, equipment and leasehold improvements of $4.8 million, (iv) the issuance of note receivables of $5.0 million in the year ended December 31, 2011 and (v) the purchase of $3.3 million of intangible assets in the year ended December 31, 2011.
Net cash used in investing activities for the year ended December 31, 2011 was $46.3 million compared to $58.8 million for 2010. The decrease in cash used for investing activities was primarily attributable to a $25.4 million decrease in cash used in business acquisitions, net of cash acquired and purchases of intangible and other assets and a $13.3 million decrease in purchases of cost and equity method investments. These decreases were slightly offset by an increase of $12.2 million in net payments due to the settlement of foreign exchange derivative hedge contracts and an increase in purchases of property, equipment and leasehold improvements and payments for internally developed software of $10.1 million.
Net cash used in financing activities for the year ended December 31, 2012 was $55.1 million compared to $26.4 million in 2011. This increase was primarily due to the net proceeds of $250.0 million from the issuance of our 8.375% Senior Notes in July 2011, net of $8.8 million in debt issuance costs, and net of the repayments of all outstanding amounts under our Credit Agreement and all aggregate principal amounts of our then-outstanding 7.17% Senior Notes. This increase was also due to an increase of $5.4 million in cash dividends paid due to the accelerated dividend declared and paid in December 2012. These increases were offset by net decreases of $22.9 million in purchases of treasury stock. See Note 8 to our Consolidated Financial Statements in Part II-Item 8 for further discussion of our short-term borrowings and long-term obligations.
Net cash used in financing activities for the year ended December 31, 2011 was $26.4 million compared to $68.1 million in 2010. The decrease was due, in large part, to (i) proceeds of $250.0 million aggregate principal related to the issuance of our 8.375% Senior Notes, net of $9.1 million in debt issuance costs and (ii) decreases of $30.5 million in cash dividends paid. This decrease was offset by (i) the use of $195.0 million of the net proceeds from the offering to repay all outstanding amounts under our Credit Agreement and all aggregate principle amounts of our then-outstanding 7.17%Senior Notes, (ii) net increases of $13.3 million in purchases of treasury stock and (iii) $2.4 million in cash paid for taxes on the vesting of RSUs. See Note 8 to our Consolidated Financial Statements in Part II-Item 8 for further discussion of our short-term borrowings and long-term obligations.
Regulatory Requirements
Our liquidity and available cash resources are in part restricted by the regulatory requirements of certain of our material operating subsidiaries, including GFI Securities LLC, GFI Securities Limited, GFI Brokers LLC, Amerex Brokers LLC, GFI Brokers Limited, The Kyte Group Limited, Kyte Broking Limited, GFI (HK) Securities LLC, GFI (HK) Brokers Ltd, GFI Group PTE Ltd and GFI Korea Money Brokerage Limited. These operating subsidiaries are subject to minimum capital requirements and/or licensing and financial requirements imposed by their respective market regulators that are intended to ensure general financial soundness and liquidity based on certain minimum capital, licensing and financial requirements. U.S. and U.K. regulations prohibit a registered broker-dealer from repaying borrowings of its parent or affiliates, paying cash dividends, making loans to its parent or affiliates or otherwise entering into transactions that result in a significant reduction in its regulatory net capital position without prior notification or approval from its principal regulator. See Note 20 to the Consolidated Financial Statements in Part II-Item 8 for further details on our regulatory requirements.
Short and Long Term Debt
Our outstanding debt at December 31, 2012 and December 31, 2011 consists of our 8.375% Senior Notes. During the year ended December 31, 2011, we used $135.3 million and $67.8 million of the net proceeds from the issuance of the 8.375% Senior Notes to repay all outstanding amounts pursuant to the Credit Agreement and to repay all of the outstanding principal and interest to redeem the 7.17% Senior Notes, respectively, as well as to pay all premiums and transaction expenses associated therewith. Following the issuance of the 8.375% Senior Notes, the available borrowing capacity under the Credit Agreement decreased from $200 million to approximately $129.5 million. In March, 2013, we entered into an amendment to our Credit Agreement, which decreased the maximum borrowing capacity to $75 million until December 2013, at which time $18.75 million of the lender commitments mature. The remaining $56.25 million of the lender commitments mature in December 2015. See Note 8 to the Consolidated Financial Statements in Part II-Item 8 for further details on the Credit Agreement, our 8.375% Senior Notes and our 7.17% Senior Notes.
Credit Ratings
As of December 31, 2012, we maintained the following public long-term credit ratings and associated outlooks:
Credit ratings and outlooks can be revised at any time if such rating agency decides the circumstances warrant a revision. In addition, a reduction in our rating may affect the availability of future debt financing and the terms that are available to us. If our credit rating is further downgraded by any of the rating agencies, our applicable per annum interest rate on our outstanding 8.375% Senior Notes could increase up to a maximum of 200 basis points over the original interest rate.
On April 23, 2012, Standard & Poor’s (“S&P”) lowered its credit rating on our 8.375% Senior Notes one notch to BB+, which increased our applicable per annum interest, effective July 19, 2012, by 25 basis points, equating to $0.6 million in additional interest expense per annum. On July 6, 2012, Fitch Ratings Inc. (“Fitch”) lowered its credit rating on our 8.375% Senior Notes one notch to BBB-, which did not have any impact on the applicable interest rate related to the 8.375% Senior Notes as Fitch’s rating did not go below the base rating. On December 21, 2012, S&P further lowered its credit rating on our 8.375% Senior Notes two notches to BB-, which will increase our applicable per annum interest, effective January 19, 2013, by an additional 50 basis points, equating to $1.25 million in additional interest expense per annum. On January 18, 2013, Moody’s Investor Services lowered its credit rating on our 8.375% Senior Notes two notches to B1, which will increase our applicable per annum interest, effective January 19, 2013, by an additional 50 basis points, equating to $1.25 million in additional interest expense per annum.
The aggregate effect of these downgrades to our credit rating by the various rating agencies equate to $3.1 million in additional interest expense per annum.
Dividends Paid
Prior to 2008, we retained all earnings for investment in our business. In February 2008, our Board of Directors approved a policy of paying quarterly dividends, subject to available cash flow from operations, other considerations and the determination of the amount by our Board of Directors. In December 2010, in addition to the quarterly dividends declared by our Board of Directors, our Board also declared a special cash dividend of $0.25 per share. In December 2012, our Board of Directors declared a fourth quarter dividend that was declared and paid, on an accelerated basis, in December 2012. Cash dividends paid in 2012, 2011 and 2010 were approximately $29.6 million $24.2 million and $54.7, respectively.
Common Stock
It is our expectation that we may purchase additional shares of our common stock on the open market from time to time in accordance with a stock repurchase program authorized by our Board of Directors. See Note 10 to our Consolidated Financial Statements in Part II-Item 8 for further discussion of the stock repurchase program.
Contractual Obligations and Commitments
The following table summarizes certain of our contractual obligations as of December 31, 2012:
(1) The amounts listed under Operating leases include the future minimum rental commitments relating to a twenty-year lease that we entered into for our current primary U.S. office space in June 2007. At December 31, 2012, the total minimum rental commitments under this lease totaled $73.9 million, with $4.5 million due in less than one year, $8.9 million due within one to three years, $9.0 million due within three to five years and $51.5 million due in more than five years. See Note 13 to the Consolidated Financial Statements in Part II-Item 8 for further details.
(2) The amounts listed under Interest on Long-term obligations include increases to our applicable per annum interest on our 8.375% Senior Notes that were effective as a result of downgrades to our credit rating by the various credit agencies in 2012 and 2013. In the event that our credit ratings are subsequently changed, the applicable per annum interest could increase or decrease and the amounts disclosed in this table would also change. See Note 8 to the Consolidated Financial Statements in Part II-Item 8 for further details.
(3) The amounts listed under Purchase Obligations include agreements for quotes with various information service providers. Additionally, such amounts include purchase commitments for capital expenditures. See Note 13 to our Consolidated Financial Statements in Part II-Item 8 for further discussion.
As disclosed in Note 9 to the Consolidated Financial Statements in Part II-Item 8, we have unrecognized tax benefits of approximately $9.0 million, excluding interest of $1.0 million. Due to the uncertainty of the amounts to be ultimately paid as well as the timing of such payments, all liabilities for uncertain tax positions which have not been paid are excluded from the Contractual Obligations and Commitments table.
Off-Balance Sheet Arrangements
The Company did not have any off-balance sheet arrangements at December 31, 2012.
Critical Accounting Policies and Estimates
General
This Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements which have been prepared in accordance with U.S. generally accepted accounting principles, which require us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, net revenue and expenses, and the disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience and on various other factors that we believe are reasonable under the circumstances. We believe that the accounting estimates employed and the resulting balances are reasonable; however, actual results may differ materially from these estimates under different assumptions or conditions.
An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made; if different estimates reasonably could have been used; or if changes in the estimate that are reasonably likely to occur periodically could materially impact the financial
statements. We believe the following critical accounting policies reflect the significant estimates and assumptions used in the preparation of our Consolidated Financial Statements.
Fair Value of Financial Instruments
Certain of our assets and liabilities are carried at fair value or contracted amounts that approximate fair value. Assets and liabilities that are recorded at contracted amounts approximating fair value consist primarily of receivables from and payables to brokers, dealers and clearing organizations and payables to clearing services customers. These receivables and payables to brokers, dealers and clearing organizations are short-term in nature, and substantially all have settled at the contracted amounts following December 31, 2012. Our marketable equity securities, included in Other assets, are recorded at fair value based on their quoted market price. Our investments that are accounted for under the cost and equity methods are investments in companies that are not publicly traded and for which no established market for their securities exists. The fair value of these investments is not estimated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. Our debt obligations are carried at historical amounts.
Our financial assets and liabilities recorded at fair value have been categorized based upon a fair value hierarchy in accordance with ASC 820-10. In accordance with ASC 820-10, we have categorized our financial assets and liabilities, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy as set forth below.
Level 1-Financial assets and liabilities whose values are based on unadjusted quoted prices for identifiable assets or liabilities in an active market that the company has the ability to access at the measurement date (examples include active exchange-traded equity securities, listed derivatives, and most U.S. Government and agency securities).
Level 2-Financial assets and liabilities whose values are based on quoted prices in markets where trading occurs infrequently or whose values are based on quoted prices of instruments with similar attributes in active markets. Level 2 inputs include the following:
· Quoted prices for identifiable or similar assets or liabilities in non-active markets (examples include corporate and municipal bonds which trade infrequently);
· Inputs other than quoted prices that are observable for substantially the full term of the asset or liability (examples include interest rate and currency swaps), and
Level 3-Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability.
Valuation Techniques
A description of the valuation techniques applied to our major categories of assets and liabilities measured at fair value on a recurring basis are as follows:
U.S. Treasury Securities - U.S. Treasury securities are valued using quoted market prices. Valuation adjustments are not applied. Accordingly, U.S. Treasury securities are generally categorized in Level 1 of the fair value hierarchy.
Equity Securities - Equity securities include mostly exchange-traded corporate equity securities and are valued based on quoted market prices. Accordingly, exchange-traded equity securities are generally categorized in Level 1 of the fair value hierarchy. Non-exchange traded equity securities are measured primarily using broker quotations, pricing service data from external providers and prices observed for recently executed market transactions. Non-exchange traded equity securities are generally categorized within Level 2 of the fair value hierarchy.
Corporate Bonds - Corporate bonds are measured primarily using broker quotations, pricing service data from external providers and prices observed for recently executed market transactions. Corporate bonds are generally categorized in Level 2 of the fair value hierarchy.
Foreign government bonds - Foreign government bonds are mostly valued using quoted market prices. Accordingly, foreign government bonds are generally categorized in Level 1 of the fair value hierarchy.
Derivative Contracts - Derivative contracts include instruments such as foreign exchange, commodity, fixed income and equity derivative contracts.
Listed Derivative Contracts - Listed derivatives that are actively traded are valued based on quoted prices from the exchange and are categorized in Level 1 of the fair value hierarchy.
OTC Derivative Contracts - OTC derivative contracts include forwards, swaps, and options contracts related to foreign currencies. Depending on the product and the terms of the transaction, the fair value of OTC derivative products can be either observed or modeled using a series of techniques and model inputs from comparable benchmarks, including closed-form analytic formulas, such as the Black-Scholes option-pricing model, and simulation models or a combination thereof. Many pricing models do not entail material subjectivity because the methodologies employed do not necessitate significant judgment, and the pricing inputs are observed from actively quoted markets. In the case of more established derivative products, the pricing models used by us are widely accepted by the financial services industry. OTC derivative products valued by us using pricing models generally fall into this category and are categorized in Level 2 of the fair value hierarchy.
Equity warrants - Non-exchange traded equity warrants are classified within Level 3 of the fair value hierarchy and are measured using the Black-Scholes model with key inputs impacting the valuation including the underlying security price, implied volatility, dividend yield, interest rate curve, strike price and maturity date.
Convertible note receivable, available-for-sale - As discussed in Note 7 to the Consolidated Financial Statements in Part II-Item 8, the Company exchanged its membership interest in a third party brokerage firm for a convertible senior secured promissory note in that company. This security was previously measured using valuation techniques involving quoted prices of or market data for comparable companies, including credit ratings, peer company ratios and discounted cash flow analyses. As the inputs used in estimating the fair value of this convertible debt security were both unobservable and significant to the overall fair value measurement of this asset, the asset was categorized within Level 3 of the fair value hierarchy. During the three months ended September 30, 2012, the third party brokerage firm notified the Company that they had immediate liquidity concerns and that there was the prospect of insolvency in the near future. Based upon this information, the Company determined its estimated fair value of the convertible senior secured promissory note to be zero. See Note 7 for further details.
Future Purchase Commitment - In connection with the acquisition of 70% of the equity ownership interests in Kyte, we agreed to purchase the residual 30% equity interest in Kyte for an additional cash payment in an amount to be determined pursuant to a formula based on Kyte’s earnings, such payment to be made following June 30, 2013. In applying the income approach, we assumed a 15.5% and 16.0% discount rate as of December 31, 2012 and December 31, 2011, respectively, and used forecasted financial information for Kyte for the remaining period ended June 30, 2013. As the inputs used in estimating the fair value of this future purchase commitment are both unobservable and significant to the overall fair value measurement of this liability, the liability is categorized in Level 3 of the fair value hierarchy.
Contingent Consideration -The category consists primarily of contingent consideration related to the acquisition of a retail energy brokerage business, completed on November 1, 2009. This contingent liability is remeasured at fair value and is based on estimated future collections of accounts receivable of the business through October 31, 2013. As the inputs used in estimating the fair value of this contingent consideration are both unobservable and significant to the overall fair value measurement of this liability, the liability is categorized in Level 3 of the fair value hierarchy.
In the year ended December 31, 2012 and 2011, we did not have any material transfers amongst Level 1, Level 2, and Level 3.
Variable Interest Entities
We determine whether we hold any interests in entities deemed to be a variable interest entity (“VIE”). A VIE is an entity that lacks one or more of the following characteristics (i) the total equity investment at risk is sufficient to enable the entity to finance its activities independently and (ii) the equity holders have the power to direct the activities of the entity that most significantly impact its economic performance, the obligation to absorb the losses of the entity and the right to receive the residual returns of the entity. We have a controlling financial interest and will consolidate a VIE if we are the primary beneficiary.
The primary beneficiary is the party that has both (i) the power to direct the activities of the VIE that most significantly impact the economic performance of the entity and (ii) the obligation to absorb losses of the entity that could be potentially significant to the VIE or the right to receive benefits from the entity that could be potentially significant.
As of December 31, 2012, we hold interests in certain VIEs. One of these VIEs is consolidated because it was determined that we are the primary beneficiary of this VIE because: (1) we provided the majority of the start-up capital and (2) we have consent rights on activities that we believe would most significantly impact the economic performance of the entity. The remaining VIEs are not consolidated as it was determined that we are not the primary beneficiary, most commonly due the determination that we lacked significant equity ownership and voting power. We reassess our initial evaluation of whether an entity is a VIE when certain events occur, such as changes in economic ownership and voting power. We reassess our determination of whether we are the primary beneficiary of a VIE on an ongoing basis based on current facts and circumstances.
Software Development Capitalization-Internal-Use Software
We capitalize certain costs of software developed or obtained for internal use in accordance with ASC 350, Intangibles-Goodwill and Other. We capitalize software development costs when application development begins and it is probable that the project will be completed and the software will be used as intended. Costs associated with preliminary project stage activities, maintenance and all other post implementation stage activities are expensed as incurred. Our policy provides for the capitalization of certain payroll and payroll-related costs for employees who are directly associated with internal use computer software projects, as well as external direct costs of materials and services associated with developing or obtaining internal use software. Capitalized personnel costs are limited to time directly spent on such projects. Capitalized costs are ratably amortized, using the straight-line method, over the estimated useful lives, which are typically over three years. Our judgment as to which costs to capitalize, when to begin capitalizing such costs and what period to amortize the costs over, may materially affect our results of operations. If management determines that the fair value of the software is less than the carrying value, an impairment loss would be recognized in an amount equal to the difference between the fair value and the carrying value.
Goodwill and Intangible Assets
Under ASC 350, Intangibles-Goodwill and Other, management is required to perform a detailed review, at least annually, of the carrying value of our intangible assets, which includes goodwill. In this process, management is required to make estimates and assumptions in order to determine the fair value of our assets and liabilities and projected future earnings using various valuation techniques, including a discounted cash flow model. Management uses its best judgment and information available to it at the time to perform this review. Because management’s assumptions and estimates are used in projecting future earnings as part of the valuation, actual results may differ. If management determines that the fair value of the intangible asset with an indefinite life is less than its carrying value, an impairment loss would be recognized in an amount equal to the difference between the fair value and the carrying value.
In 2011, the Company early adopted Accounting Standards Update No. 2011-08”Intangibles - Goodwill and Other (Topic 350)” (“ASU 2011-08”). In accordance with the amended guidance prescribed by ASU 2011-08, we first assess qualitative factors to determine whether it is more likely than not (a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. The qualitative assessment is based on reviewing the totality of several factors, including macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, other entity specific events (for example, changes in management) or other events such as selling or disposing of a reporting unit. After assessing qualitative factors, if we determine that it is more likely than not that the fair value of the reporting unit is greater than its carrying amount, no further testing is necessary. If we determine that it is more likely than not that the fair value of the reporting unit is less than its carrying value or the Company elects to bypass the qualitative assessment for any reporting unit, then a two-step goodwill impairment test, prescribed by ASC 350, must be performed, whereby management
first compares the fair value of each reporting unit with recorded goodwill to that reporting unit’s book value. If management determines, as a result of this first step, that the fair value of the reporting unit is less than its carrying value, a second step in the impairment test process would require that the recorded goodwill at that reporting unit be written down to the value implied by the reporting unit’s recent valuation and the estimated fair value of the assets and liabilities.
For the reporting units where a two-step goodwill impairment test, is performed, the primary valuation methods used by us to estimate the fair value of its reporting units are the income and market approach. In applying the income approach, projected cash flows available for distribution and the terminal value are discounted to present value to derive an indication of fair value of the business enterprise. The market approach compares the reporting unit to selected reasonably similar publicly-traded companies. Trading and transaction comparables are used as general indicators to assess the general reasonableness of the estimated fair values.
Goodwill is required to be tested for impairment at least annually and more frequently when indicators of impairment exist. All of our goodwill is allocated to its reporting units and the goodwill impairment tests are performed at the reporting unit level. Based on the results of the annual impairment tests performed as of November 1, 2012 and 2011, respectively, no goodwill impairment was recognized during the years ended December 31, 2012 and 2011.
In 2011, we performed a qualitative assessment on the Trayport, Fenics, and Americas Brokerage reporting units and noted that it is more likely than not that the fair value of each reporting unit is greater than its carrying amount. However, for the EMEA Brokerage and Clearing and Backed Trading reporting units, we elected to bypass the qualitative assessment and perform a two-step goodwill impairment test. As a result of the two-step impairment test, the fair value of EMEA Brokerage and Clearing and Backed Trading were substantially in excess of their respective carrying values.
In 2012, we performed a qualitative assessment on the Trayport and Fenics reporting units and noted that it is more likely than not that the fair value of each reporting unit is greater than its carrying amount. However, for the Americas Brokerage, EMEA Brokerage, and Clearing and Backed Trading reporting units, we elected to bypass the qualitative assessment and perform a two-step goodwill impairment test. As a result of the two-step impairment test, the fair value of the Americas brokerage and EMEA brokerage reporting units were substantially in excess of their respective carrying values.
The Clearing and Backed Trading reporting unit’s fair value exceeded its carrying value by approximately 2.5%. We estimated the fair value of our Clearing and Backed Trading reporting unit using a weighted average of both the market and income approaches. Under the market approach, the fair value of the reporting unit was based on applying market multiples to its estimated projected revenues and earnings. Key assumptions included management’s budgeted statement of operations for the year ended December 31, 2013 and estimated growth rate assumptions for future periods, a range of forward market multiples of comparable companies and a reasonable control premium to apply to the derived market multiples. The applicable multiples were selected based on the similarities and differences between our Clearing and Backed Trading reporting unit and guideline companies in the same sector, including profitability, growth prospects, size, as well as overall risks. The estimated control premium was determined based upon general consideration of premiums paid in individual transactions over a period of time. Under the income approach, the fair value of the reporting unit was based on the present value of estimated future cash flows. Key assumptions used in estimating these cash flows included applying business growth rate assumptions to future cash flows over a period of time and an estimated terminal value thereafter. We discounted the resulting expected cash flows using an estimated weighted average cost of capital to arrive at a present value amount that approximates fair value. Changes in these estimates and assumptions could materially affect the determination of fair value and/or goodwill impairment evaluation for the Clearing and Backed trading reporting segment.
As a result of continued economic uncertainty and current market dynamics, determining whether an impairment of the goodwill asset exists is increasingly difficult and requires management to exercise significant judgment. In addition, to the extent that securities valuations or trading volumes are depressed for prolonged periods of time and market conditions stagnate or worsen as a result of local or global economic conditions, the revenues and profitability of our Clearing and Backed Trading reporting unit may be adversely affected. In addition, control premiums, industry earnings multiples and discount rates are impacted by economic conditions. As a result, subsequent impairment tests may be more frequent and be based upon more negative assumptions and future cash flow projections, which may result in an impairment of our Clearing and Backed Trading reporting unit at such time. Any impairment could reduce materially the recorded amount of goodwill with a corresponding charge to our earnings.
Contingencies
In the normal course of business, we have been named as defendants in various lawsuits and proceedings and have been involved in certain regulatory examinations. Additional actions, investigations or proceedings may be brought from time to time in the future. We are subject to the possibility of losses from these various contingencies. Considerable judgment is necessary to estimate the probability and amount of any loss from such contingencies. An accrual is made when it is probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. We accrue a liability for the estimated costs of adjudication or settlement of asserted and unasserted claims existing as of the balance sheet date. We have recorded reserves for certain contingencies to which we may have exposure, such as reserves for certain income tax and litigation contingencies and contingencies related to the employer portion of National Insurance Contributions in the U.K. We disclose asserted claims when it is at least reasonably possible that an asset had been impaired or a liability had been incurred as of the date of the financial statements and unasserted claims when it is considered probable that a claim will be asserted and there is a reasonable possibility that the outcome will be unfavorable.
Income Taxes
In accordance with ASC 740, Income Taxes, (“ASC 740”) we provide for income taxes using the asset and liability method under which deferred income taxes are recognized for the estimated future tax effects attributable to temporary differences and carryforwards that result from events that have been recognized either in the financial statements or the income tax returns, but not both. The measurement of current and deferred income tax liabilities and assets is based on provisions of enacted tax laws. Valuation allowances are recognized if, based on the weight of available evidence, it is more likely than not that some portion of the deferred tax assets will not be realized. Our interpretation of complex tax law may impact our measurement of current and deferred income taxes.
We are subject to regular examinations by the Internal Revenue Service, taxing authorities in foreign countries, and states in which we have significant business operations. We regularly assess the likelihood of additional assessments in each taxing jurisdiction resulting from on-going and subsequent years’ examinations. We record uncertain tax positions in accordance with ASC 740 on the basis of a two-step process whereby (1) we determine whether it is more likely than not that a tax position will be sustained based on the technical merits of the position, and (2) for those tax positions that are more likely than not to be sustained, we recognize the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant taxing authority.
Recent Accounting Pronouncements
In May 2011, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2011-04Fair Value Measurement (Topic 820) Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”). ASU 2011-04 amends current guidance to result in common fair value measurement and disclosures between accounting principles generally accepted in the United States and International Financial Reporting Standards. The amendments result in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between U.S. GAAP and IFRS. The amendments in ASU 2011-04 are effective for interim and annual periods beginning after December 15, 2011. The adoption of ASU 2011-04 did not have a material impact on our Consolidated Financial Statements and we have included the disclosures required by this guidance in Note 16 to the Consolidated Financial Statements.
In June 2011, the FASB issued ASU No. 2011-05 Comprehensive Income (Topic 220) Presentation of Comprehensive Income (“ASU 2011-05”). The main objective of ASU 2011-05 is to improve the comparability, consistency, and transparency of financial reporting and increase the prominence of items reported in other comprehensive income (“OCI”) by eliminating the option to present components of OCI as part of the statement of changes in stockholders’ equity. The amendments in this standard require entities to report the components of comprehensive income in either (1) a single continuous statement of comprehensive income or (2) in two separate but consecutive statements. The amendments in this standard do not change the items that must be reported in OCI. The amendments in ASU 2011-05 are effective for interim and annual periods beginning after December 15, 2011 and are to be applied retrospectively. The adoption of ASU 2011-05 did not have a material impact on our Consolidated Financial Statements.
In September 2011, the FASB issued ASU No. 2011-08 Intangibles - Goodwill and Other (Topic 350) (“ASU 2011-08”).ASU 2011-08 amends current guidance to allow entities to first assess qualitative factors to determine whether it is more likely than not (a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. After assessing qualitative factors, if an entity determines that it is not more likely than not that the fair value of the
reporting unit is less than its carrying amount, no further testing is necessary. If an entity determines that it is more likely than not that the fair value of the reporting unit is less than its carrying value, then the traditional two-step goodwill impairment test must be performed. The amendments in ASU 2011-08 are effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. We early adopted ASU 2011-08 effective the fourth quarter of 2011. The adoption of ASU 2011-08 did not have a material impact on our Consolidated Financial Statements as we were previously in compliance with the presentation requirements of this ASU.
In December 2011, the FASB issued ASU No. 2011-11 Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities (“ASU 2011-11”). ASU 2011-11 requires additional disclosure about financial instruments and derivatives instruments that are subject to netting arrangements to assist users of the financial statements in understanding the effect of those arrangements on its financial position. In January 2013, the FASB issued an amendment to ASU 2011-11, ASU No. 2013-01 Balance Sheet (Topic 210): Clarifying the Scope of Disclosure about Offsetting Assets and Liabilities (“ASU 2013-01”). ASU 2013-01 clarifies that the scope of ASU 2011-11 applies to derivatives accounted for in accordance with ASC 815- Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transaction that are either offset in accordance with Balance Sheet (Topic 210) guidance, Derivatives and Hedging (Topic 815) guidance, or subject to an enforceable master netting arrangement or similar agreement. The new disclosures are required for reporting periods beginning on or after January 1, 2013, including retrospectively for all comparative periods presented. We are evaluating the effect of this guidance and we do not expect the adoption of ASU 2013-01 to have a material impact on our Consolidated Financial Statements.
In July 2012, the FASB issued ASU No. 2012-02, Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment (“ASU 2012-02”).The amended guidance simplifies how entities test for impairment of indefinite-lived intangible assets. The amendments permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of the asset is less than its carrying amount as a basis for determining if performing a quantitative test is necessary. The amendments do not change the measurement of impairment losses. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012 with early adoption permitted. We do not expect the adoption of ASU 2012-02 to have a material impact on our Consolidated Financial Statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISLOSURES ABOUT MARKET RISK
Risk Management
In the normal course of business, we are exposed to various risks, including foreign currency exposure risk, interest rate risk, credit risk, market risk and operational risk. Top-level oversight of our risk management resides with the Risk Policy Committee of the Board of Directors. We also utilize several management committees made up of key executives with responsibility for identifying and managing risk. Specialized risk functions, such as our credit risk, compliance, internal audit and Sarbanes-Oxley compliance departments, perform regular monitoring and testing procedures to provide management with assurance regarding the design and operating effectiveness of risk control policies and procedures. Finally, business managers play an integral role in risk management by maintaining the processes and control activities designed to identify, mitigate, and report risk.
The various risks that may impact the Company, certain of our risk management procedures, and a sensitivity analysis estimating the effects of changes in fair values for exposures relating to foreign currency and interest rate exposures are outlined below.
Foreign Currency Exposure Risk
We are exposed to risks associated with changes in foreign exchange rates related to our international operations. As foreign currency exchange rates change, the U.S. Dollar equivalent of revenues and expenses denominated in foreign currencies change. Our U.K. operations generate a large majority of their revenues in U.S. Dollars and Euros but pay a significant amount of their expenses in British Pounds. We enter into foreign exchange forward contracts (“Foreign Exchange Derivative Contracts”) to mitigate our exposure to foreign currency exchange rate fluctuations. At December 31, 2012 and 2011, we had no Foreign Exchange Derivative Contracts that were designated as foreign currency cash flow hedges. We do not use derivative contracts for speculative purposes.
We are also exposed to counterparty credit risk for nonperformance of Foreign Exchange Derivative Contracts and in the event of nonperformance, to market risk for changes in currency rates. The counterparties with whom we execute foreign exchange derivative contracts are major international financial institutions. We monitor our positions with, and the credit quality of, these financial institutions and we do not anticipate nonperformance by the counterparties.
While our international results of operations, as measured in U.S. Dollars, are subject to foreign exchange rate fluctuations, we do not consider the related risk to be material to our results of operations. If the Euro strengthened against the U.S. Dollar by 10% and the British Pound Sterling weakened by 10% against the U.S. Dollar, the net impact to our net income would be a reduction of approximately $2.6 million as of December 31, 2012.
Interest Rate Risk
We are exposed to changes in market interest rates that impact our variable-rate short-term borrowings that may be outstanding under our Credit Agreement from time to time. As of December 31, 2012, we had no amounts outstanding under our Credit Agreement. As of December 31, 2012, the interest rate on our entire $250 million long-term debt was comprised of a fixed-rate. Fluctuations in market interest rates will have no impact on the amount of interest we must pay on these fixed-rate debt obligations.
Credit Risk
Credit risk arises from potential non-performance by counterparties of our matched principal business, as well as from nonpayment of commissions by customers of our agency brokerage business. We also have credit and counterparty risk in certain situations where we provide clearing and execution services. We provide agency clearing services though our relationships with general clearing member firms and/or exchanges. In these instances, our accounts at such institutions are used, in our name, to provide access to clearing services for our customers. Credit risk arises from the possibility that we may suffer losses due to the failure of our customers or other counterparties to satisfy their financial obligations to us or in a timely manner.
We have established policies and procedures to manage our exposure to credit risk. We maintain a thorough credit approval process to limit our exposure to counterparty risk and employ stringent monitoring to control the market and counterparty risk from our matched principal business. Our brokers may only execute transactions for clients that have been approved by our credit committee following review by our credit department. Our credit approval process includes verification of key financial information and operating data and anti-money laundering verification checks. Our credit review process may include consideration of independent credit agency reports and a visit to the entity’s premises, if necessary. We have developed and utilize a proprietary, electronic credit risk monitoring system.
Credit approval is granted by our credit committee, which is comprised of senior management and representatives from our compliance, finance and legal departments. Credit approval is granted subject to certain trading limits and may be subject to additional conditions, such as the receipt of collateral or other credit support. Our credit risk department assists the credit committee in the review of any proposed counterparty by conducting diligence on such party and by continuing to review such counterparties for continued credit approval on at least an annual basis. These results are reviewed by the credit committee. Maintenance procedures include reviewing current audited financial statements and publicly available information on the client, collecting data from credit rating agencies where available and reviewing any changes in ownership, title or capital of the client. For our agency business, our approval process includes the requisite anti-money laundering and know-your-customer verifications.
Market Risk
We are exposed to market risk associated with our principal transactions and, in certain instances, in the provision of clearing services. Through our subsidiaries, we conduct both matched principal and principal trading businesses, primarily involving fixed income and equity securities, but also for certain listed derivative products.
In matched principal transactions, we act as a “middleman” by serving as counterparty on one side of a customer trade and entering into an offsetting trade with another party relatively quickly (often within minutes and generally on the same trading day). These transactions are then settled through a third- party clearing organization. Settlement typically occurs within one to three business days after the trade date. Cash settlement of the transaction occurs upon receipt or delivery of the underlying instrument that was traded. In a limited number of circumstances, we may settle a principal transaction by physical delivery of the underlying instrument.
In executing matched principal transactions, we are exposed to the risk that one of the counterparties to a transaction may fail to fulfill its obligations, either because it is not matched immediately or, even if matched, one party fails to deliver the cash or securities it is obligated to deliver. Certain of the less liquid or OTC markets in which we provide our services exacerbate this risk for us because transactions in these markets are less likely to settle on a timely basis. Adverse movements in the prices of securities that are the subject of these transactions can increase our risk. In addition, widespread technological or communication failures, as well as actual or perceived credit difficulties or the insolvency of one or more large or visible market participants, could cause market-wide credit difficulties or other market disruptions. These failures, difficulties or disruptions could result in a large number of market participants not settling transactions or otherwise not performing their obligations.
We are subject to financing risk in these circumstances because if a transaction does not settle on a timely basis, the resulting unmatched position may need to be financed, either directly by us or through one of our clearing organizations at our expense. These charges may be recoverable from the failing counterparty, but sometimes are not. Finally, in instances where the unmatched position or failure to deliver is prolonged or pervasive due to rapid or widespread declines in liquidity for an instrument, there may also be regulatory capital charges required to be taken by us, which depending on their size and duration, could limit our business flexibility or even force the curtailment of those portions of our business requiring higher levels of capital. Credit or settlement losses of this nature could adversely affect our financial condition or results of operations.
In the process of executing matched principal transactions, miscommunications and other errors by us or our clients can arise whereby a transaction is not completed with one or more counterparties to the transaction, leaving us with either a long or short unmatched position. These unmatched positions are referred to as “out trades,” and they create a potential liability for us. If an out trade is promptly discovered and there is a prompt disposition of the unmatched position, the risk to us is usually limited. If the discovery of an out trade is delayed, the risk is heightened by the increased possibility of intervening market movements prior to disposition. Although out trades usually become known at the time of, or later on the day of, the trade, it is possible that they may not be discovered until later in the settlement process. When out trades are discovered, our policy is generally to have the unmatched position disposed of promptly (usually on the same day and generally within three days), whether or not this disposition would result in a loss to us. The occurrence of out trades generally rises with increases in the volatility of the market and, depending on their number and amount, such out trades have the potential to have a material adverse effect on our financial condition and results of operations.
Liability for unmatched trades could adversely affect our results of operations and balance sheet. Although the significant majority of our principal trading is done on a “matched principal” basis, we may take unmatched positions for our own account generally in response to customer demand, primarily to facilitate the execution of existing customer orders or in anticipation that future customer orders will become available to fill the other side of the transaction. While we seek to minimize our exposure to market risk by entering into offsetting trades or a hedging transaction relatively quickly (often within minutes and generally on the same trading day), we may not always enter into an offsetting trade on the same trading day and any hedging transaction we may enter into may not fully offset our exposure. Therefore, although any unmatched positions are intended to be held short term, we may not entirely offset market risk and may be exposed to market risk for several days or more or to a partial extent or both.
Additionally, we have authorized a limited number of our desks to enter into principal investing transactions in which we commit our capital within predefined limits, either to facilitate customer trading activities or to engage in principal
trading for our own account. These principal positions may ultimately be matched against a customer order or through a market intermediary, either in the short term (such as the same trading day) or we may hold these positions for several days or more. The number and size of these transactions may affect our results of operations in a given period and we may also incur losses from these trading activities due to market fluctuations and volatility from quarter to quarter. We are currently subject to covenants in our Credit Agreement, which generally limit the aggregate amount of securities which we may trade for our own account to 7.5% of our consolidated capital. To the extent that we own assets, i.e., have long positions, in any of those markets, a downturn in the value of those assets or in those markets could result in losses from a decline in the value of those long positions. Conversely, to the extent that we have sold assets we do not own, i.e., have short positions, in any of those markets, an upturn in those markets could expose us to significant losses as we attempt to cover our short positions by acquiring assets in a rising market. To the extent these securities positions are not disposed of intra-day, we mark these positions to market.
In certain instances, we may provide credit for margin requirements to customers, secured by collateral in a customer’s account. In such cases, we are exposed to the market risk that the value of the collateral we hold could fall below the amount of a customer’s indebtedness. This risk can be amplified in any situation where the market for the underlying security is rapidly declining. Agreements with customers that have margin accounts permit us to liquidate their securities in the event that the amount of margin collateral becomes insufficient. Despite those agreements and our risk management policies with respect to margin, we may be unable to liquidate a customer’s positions for various reasons, or at a price sufficient to cover any deficiency in a customer’s account. If we were unable to liquidate a position at a price sufficient to cover any deficiency or if a customer was unable to post additional margin, we may suffer a loss.
Adverse movements in the securities underlying these positions or a downturn or disruption in the markets for these positions could result in a substantial loss. In addition, principal gains and losses resulting from these positions could on occasion have a disproportionate effect, positive or negative, on our financial condition and results of operations for any particular reporting period.
In addition to entering into offsetting trades or a hedging transaction, we also monitor market risk exposure from our matched principal and principal trading business, including regularly monitoring concentration of market risk to financial instruments, countries or counterparties and regularly monitoring trades that have not settled within prescribed settlement periods or volume thresholds. Additionally, market risks are monitored and mitigated by the use of our proprietary, electronic risk monitoring system, which provides management with daily credit reports in each of our geographic regions that analyze credit concentration and facilitates the regular monitoring of transactions against key risk indicators.
Operational Risk
Operational risk refers to the risk of financial or other loss, or potential damage to our reputation, resulting from inadequate or failed internal processes, people, resources, systems or from external events. We may incur operational risk across the full scope of business activities and support functions. We have operational risk polices that are designed to reduce the likelihood and impact of operational incidents as well as to mitigate legal, regulatory and reputational risk. Primary responsibility for the management of operational risk resides with the business managers, risk and control functions, and various management committees through the use of processes and controls designed to identify, assess, manage, mitigate and report operational risk. For additional discussions of our operational risks, see “Item 1A - Risks Related to Our Operations.”
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reports of Independent Registered Public Accounting Firms
Consolidated Statements of Financial Condition
Consolidated Statements of Operations
Consolidated Statements of Comprehensive (Loss) Income
Consolidated Statements of Cash Flows
Consolidated Statements of Changes in Stockholders’ Equity
Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
GFI Group Inc.
In our opinion, the accompanying consolidated statement of financial condition and the related consolidated statements of operations, comprehensive (loss) income, cash flows and changes in stockholders’ equity present fairly, in all material respects, the financial position of GFI Group Inc. and its subsidiaries at December 31, 2012 and the results of their operations and their cash flows for the year in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, appearing under Item 9A, Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
New York, New York
March 12, 2013
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
GFI Group Inc.
New York, New York
We have audited the accompanying consolidated statement of financial condition of GFI Group Inc. and subsidiaries (the “Company”) as of December 31, 2011, and the related consolidated statements of operations, comprehensive (loss) income, cash flows and changes in stockholders’ equity for the years ended December 31, 2011 and 2010. Our audits also included the financial statement schedule listed in the Index at Item 15 for the periods ended December 31, 2011 and 2010. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of GFI Group Inc. and subsidiaries as of December 31, 2011, and the results of their operations and their cash flows for years ended December 31, 2011 and 2010, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
/s/ Deloitte & Touche LLP
New York, New York
March 15, 2012 (March 12, 2013 as to Note 2, Summary of Significant Accounting Policies - Recent Accounting Pronouncements - ASU No. 2011-05 Presentation of Comprehensive Income)
GFI GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands except share and per share amounts)
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(In thousands)
(1) Amounts are net of (provision for) benefit from income taxes of $(69), $547 and $(71) for the years ended December 31, 2012, 2011 and 2010, respectively.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(In thousands)
Non-Cash Investing and Financing Activities:
During 2012, the Company did not have any non-cash investing and financing activity. During 2011, the Company recorded a $1,084 debit to Additional paid in capital with respect to the cancellation of 276,625 shares of the Company’s common stock in connection with the exchange of the Company’s membership interest in an equity method investment for a convertible senior secured promissory note. During 2010, in connection with the business combinations described in Note 5, the Company recorded $20,604 within Other liabilities and recorded the following items within Stockholders’ Equity: $20,088 related to the issuance of 3,492,095 shares of the Company’s common stock and $15,558 related to 3,682,916 of contingently issuable shares of the Company’s common stock. Additionally, the Company recorded $1,627 with respect to the issuance of 414,938 shares of the Company’s common stock in connection with an equity method investment during 2010.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(In thousands)
(1) See footnote 6 in the notes to consolidated financial statements for discussion.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands except share and per share amounts)
1. ORGANIZATION AND BUSINESS
The Consolidated Financial Statements include the accounts of GFI Group Inc. and its subsidiaries (collectively, “GFI” or the “Company”). The Company, through its subsidiaries, provides wholesale brokerage and trade execution services, clearing services, and trading system software products to institutional clients in markets for a range of fixed income, financial, equity and commodity instruments. The Company complements its brokerage and trade execution capabilities with value-added services, such as market data and analytical software products for trader and back-office support, which it licenses primarily to companies in the financial services industry. As of December 31, 2012, Jersey Partners, Inc. (“JPI”) owned approximately 41% of the Company’s outstanding shares of common stock. The Company’s executive chairman, Michael Gooch, is the controlling shareholder of JPI.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation-The Company’s Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and the disclosure of contingencies in the Consolidated Financial Statements. Certain estimates and assumptions relate to the accounting for acquired goodwill and intangible assets, fair value measurements, compensation accruals, tax liabilities and the potential outcome of litigation matters. Management believes that the estimates utilized in the preparation of the Consolidated Financial Statements are reasonable and prudent. Actual results could differ materially from these estimates.
Certain amounts in the Consolidated Statement of Financial Position as of December 31, 2011 and Consolidated Statements of Cash Flows for the year ended December 30, 2011 and 2010 have been reclassified to conform to the current year presentation.
During the fourth quarter of 2012, the Company corrected an error related to an estimated loss accrual on a sublease of the Company’s former headquarters that originated in 2008. The Company has evaluated the effects of this error and concluded that it is immaterial to the Company’s previously issued quarterly and annual Consolidated Financial Statements. The Company also determined that the cumulative effect of this error is immaterial to the current year Consolidated Financial Statements. The adjustment was therefore corrected, on a cumulative basis, in the current year. The cumulative pre-tax adjustment recorded in 2012 was a reduction to both Accounts payable and accrued expenses and Rent and occupancy expense of $3,215, of which approximately $335, $160 and $160 related to 2012, 2011 and 2010, respectively. The remaining $2,560 related to years prior to 2010.
During the fourth quarter of 2012, the Company identified an error in its Consolidated Financial Statements for the years ended December 31, 2011 and 2010 related to the 2010 acquisition of Kyte. See Note 6 for further information.
Consolidation Policies
General- The Consolidated Financial Statements include the accounts of the Company, its wholly-owned subsidiaries and subsidiaries that are treated as such and other entities in which the Company has a controlling financial interest. For consolidated subsidiaries that are less than wholly-owned, equity interests that are not owned by the Company are referred to as non-controlling interests. The portion of net income attributable to non-controlling interests for such subsidiaries is presented as Net income attributable to non-controlling interests on the Consolidated Statements of Operations, and the portion of the stockholders’ equity of such subsidiaries is presented as Non-controlling interests in the Consolidated Statements of Financial Condition and Consolidated Statements of Changes in Stockholders’ Equity. All intercompany transactions and balances have been eliminated.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
Variable Interest Entities-The Company determines whether it holds any interests in entities deemed to be a variable interest entity (“VIE”). A VIE is an entity that lacks one or more of the following characteristics (i) the total equity investment at risk is sufficient to enable the entity to finance its activities independently and (ii) the equity holders have the power to direct the activities of the entity that most significantly impact its economic performance, the obligation to absorb the losses of the entity and the right to receive the residual returns of the entity. The Company has a controlling financial interest and will consolidate a VIE if it is the primary beneficiary.
The primary beneficiary is the party that has both (i) the power to direct the activities of the VIE that most significantly impact the economic performance of the entity and (ii) the obligation to absorb losses of the entity that could be potentially significant to the VIE or the right to receive benefits from the entity that could be potentially significant.
As of December 31, 2012, the company holds interests in certain VIEs. One of these VIEs is consolidated because it was determined that the Company is the primary beneficiary of this VIE because (1) the Company provided the majority of the VIE’s start-up capital and (2) the Company has consent rights regarding those activities that the Company believes would most significantly impact the economic performance of the entity. The remaining VIEs are not consolidated as it was determined that the Company is not the primary beneficiary due to the level of equity ownership and voting power. The Company reassesses its initial evaluation of whether an entity is a VIE when certain events occur, such as changes in economic ownership and voting power. The Company reassesses its determination of whether it is the primary beneficiary of a VIE on an ongoing basis based on current facts and circumstances. See Note 18 for disclosures on Variable Interest Entities.
Cash and Cash Equivalents-Cash and cash equivalents consist of cash and highly liquid investments with maturities, when purchased, of three months or less.
Cash and Securities Segregated Under Federal and Other Regulations-The Company holds cash and securities representing funds received in connection with customer trading activities. The Company’s subsidiaries are required to satisfy regulations mandated by their primary regulators to segregate or set aside cash or equivalent securities to satisfy regulations, promulgated to protect customer assets.
Commissions Receivable-Commissions receivable represents amounts due from brokers, dealers, banks and other financial and nonfinancial institutions for the execution of securities, commodities, foreign exchange and other derivative brokerage transactions. In estimating the allowance for doubtful accounts, management considers the length of time receivables are past due and historical experience. In addition, if the Company is aware of a client’s inability to meet its financial obligations, a specific provision for doubtful accounts is recorded in the amount of the estimated losses that will result from the inability of that client to meet its financial obligation. Commissions receivable are presented net of allowance for doubtful accounts of approximately $1,710 and $1,453 as of December 31, 2012 and 2011, respectively.
Receivables from and Payables to Brokers, Dealers and Clearing Organizations-Receivables from and payables to brokers, dealers and clearing organizations primarily represent: (i) principal transactions for which the stated settlement dates have not yet been reached, (ii) principal transactions which have not settled as of their stated settlement dates, (iii) cash, including deposits, held at clearing organizations and exchanges in support of the Company’s clearing business and to facilitate settlement and clearance of matched principal transactions and (iv) the spread on matched principal transactions that have not yet been remitted from/to clearing organizations and exchanges.
Property, Equipment and Leasehold Improvements-Property, equipment and leasehold improvements are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are calculated using the straight-line method, generally over three to seven years. Property and equipment are depreciated over their estimated useful lives. Leasehold improvements are amortized over the shorter of the remaining term of the respective lease to which they relate or the remaining useful life of the leasehold improvement. Internal and external costs incurred in developing or obtaining computer software for internal use are capitalized in accordance with Accounting Standards Codification (“ASC”) 350 Intangibles-Goodwill and Other (“ASC 350”), and are amortized on a straight-line basis over the estimated useful life of the software, generally three years. General and administrative costs related to developing or obtaining such software are expensed as incurred.
Goodwill and Intangible Assets-Goodwill represents the excess of the purchase price allocation over the fair value of tangible and identifiable intangible net assets acquired. The goodwill associated with each business combination is
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
allocated to the related reporting units, which are determined based on how the Company’s businesses are managed and how they are reviewed by the Company’s chief operating decision maker. Other intangible assets are recorded at their fair value upon completion of a business combination or certain other transactions.
In accordance with ASC 350, goodwill and other intangible assets with indefinite lives are not amortized, but instead are periodically tested for impairment. The Company reviews goodwill and other intangible assets with indefinite lives for impairment on an annual basis as of November 1 of each fiscal year or whenever an event occurs or circumstances change that could reduce the fair value of a reporting unit below its carrying amount.
In 2011, the Company early adopted Accounting Standards Update No. 2011-08”Intangibles - Goodwill and Other (Topic 350)” (“ASU 2011-08”). In accordance with the amended guidance prescribed by ASU 2011-08, the Company first assesses qualitative factors to determine whether it is more likely than not (a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. The qualitative assessment is based on reviewing the totality of several factors, including macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, other entity specific events (for example, changes in management) or other events such as selling or disposing of a reporting unit. After assessing qualitative factors, if the Company determines that it is more likely than not that the fair value of the reporting unit is greater than its carrying amount, no further testing is necessary. If the Company determines that it is more likely than not that the fair value of the reporting unit is less than its carrying value or the Company elects to bypass the qualitative assessment for any reporting unit, then a two-step goodwill impairment test, prescribed by ASC 350, must be performed, whereby management first compares the fair value of each reporting unit with recorded goodwill to that reporting unit’s book value. If management determines, as a result of this first step, that the fair value of the reporting unit is less than its carrying value, a second step in the impairment test process would require that the recorded goodwill at that reporting unit be written down to the value implied by the reporting unit’s recent valuation and the estimated fair value of the assets and liabilities.
For the reporting units where a two-step goodwill impairment test is performed, the primary valuation methods used by the Company to estimate the fair value of its reporting units are the income and market approach. In applying the income approach, projected cash flows available for distribution and the terminal value are discounted to present value to derive an indication of fair value of the business enterprise. The market approach compares the reporting unit to selected reasonably similar publicly-traded companies. Trading and transaction comparables are used as general indicators to assess the general reasonableness of the estimated fair values.
Intangible assets with definite lives are amortized on a straight-line basis over their estimated useful lives. See Note 6 for further information.
Prepaid Bonuses and Forgivable Employee Loans-Prepaid bonuses and forgivable loans to employees are stated at historical value net of amortization when the agreement between the Company and the employee provides for the return of proportionate amounts of the bonus or loan outstanding if employment is terminated in certain circumstances prior to the end of the term of the agreement. Amortization is calculated using the straight-line method over the term of the contract, which is generally two to four years, and is recorded in Compensation and employee benefits. The Company generally expects to recover the unamortized portion of prepaid bonuses and forgivable loans when employees voluntarily terminate their employment or if their employment is terminated for cause prior to the end of the term of the agreement. The prepaid bonuses and forgivable loans are included in Other assets in the Consolidated Statements of Financial Condition. At December 31, 2012 and 2011, the Company had prepaid bonuses of $31,847 and $36,797, respectively. At December 31, 2012 and 2011, the Company had forgivable employee loans and advances to employees of $31,655 and $23,909, respectively. Amortization of prepaid bonuses and forgivable employee loans for the years ended December 31, 2012, 2011 and 2010 was $26,549, $33,652 and $25,707, respectively, and is included within Compensation and employee benefits.
Investments-When the Company does not have a controlling financial interest in an entity but can exert significant influence over the entity’s operating and financial policies, the investment is accounted for under the equity method of accounting in accordance with ASC 323-10, Investments-Equity Method and Joint Ventures (“ASC 323-10”). Significant influence generally exists when the Company owns 20% to 50% of the entity’s common stock or in-substance common stock. The Company initially records the investment at cost and adjusts the carrying amount each period to recognize its share of the earnings and losses of the investee based on the percentage of ownership. See Note 19 for further information. Investments for which the Company does not have the ability to exert significant influence over operating and financial
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
policies are generally accounted for using the cost method of accounting in accordance with ASC 325-10, Investments-Other (“ASC 325-10”). At December 31, 2012 and 2011, the Company had cost method investments of $4,671 and $4,059, respectively, included within Other assets. The fair value of the Company’s cost method investments are not estimated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value. The Company monitors its equity and cost method investments for indicators of impairment each reporting period.
The Company accounts for its marketable equity securities and its debt securities in accordance with ASC 320-10, Investments-Debt and Equity Securities. Investments that are owned by the Company’s broker-dealer subsidiaries are recorded at fair value with realized and unrealized gains and losses reported in net income. Investments designated as available-for-sale that are owned by the Company’s non broker-dealer subsidiaries are recorded at fair value with unrealized gains or losses reported as a separate component of other comprehensive income, net of tax. The fair value of the Company’s available-for-sale securities was $3,355 and $8,263 as of December 31, 2012 and 2011, respectively, included within Other assets.
Fair Value of Financial Instruments-In accordance with ASC 820-10, Fair Value Measurements and Disclosures (“ASC 820-10”), the Company estimates fair values of financial instruments using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment in interpreting market data and, accordingly, changes in assumptions or in market conditions could adversely affect the estimates. The Company also discloses the fair value of its financial instruments in accordance with the fair value hierarchy as set forth by ASC 820-10. See Note 16 for further information.
Fair Value Option-In accordance with ASC 825-10-25, Financial Instruments - Recognition, the Company has elected the fair value option to account for its future commitment to purchase the remaining 30% equity interest in The Kyte Group Limited and Kyte Capital Management Limited (collectively “Kyte”). See Note 5 for further discussion regarding this future purchase commitment.
The fair value option election allows companies to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities. Any change in fair value for assets and liabilities for which the election is made is to be recognized in earnings as they occur. The fair value option election is permitted on an instrument by instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument.
The primary reason for electing the fair value option on the future commitment to purchase the remaining 30% equity interest in Kyte is to timely reflect economic events in earnings, as management’s assessment of the future purchase commitment value is driven by Kyte’s earnings subsequent to the initial acquisition date and net present value at a specific point in time.
Derivative Financial Instruments-The Company enters into derivative transactions for a variety of reasons, including managing its exposure to risk arising from changes in foreign currency, facilitating customer trading activities and, in certain instances, to engage in principal trading for the Company’s own account. Derivative assets and liabilities are carried on the Consolidated Statements of Financial Condition at fair value, with changes in the fair value recognized in the Consolidated Statements of Operations. Contracts entered into to manage risk arising from changes in foreign currency are recognized in Other income and contracts entered into to facilitate customer transactions and principal trading are recognized in Principal transactions. Derivatives are reported on a net-by-counterparty basis when management believes that a legal and enforceable right of offset exists under these agreements. See Note 17 for further information.
Payables to Clearing Services Customers-Payables to clearing services customers include amounts due on cash and margin transactions, including futures contracts transacted on behalf of customers.
Brokerage Transactions-The Company provides brokerage services to its clients in the form of either agency or principal transactions.
Agency Commissions-In agency transactions, the Company charges commissions for executing transactions between buyers and sellers. Agency commission revenues and related expenses are recognized on a trade date basis.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
Principal Transactions-Principal transactions revenue is primarily derived from matched principal and principal trading transactions. Principal transactions revenues and related expenses are recognized on a trade date basis. The Company earns revenue from principal transactions on the spread between the buy and sell price of the security that is brokered. In matched principal transactions, the Company simultaneously agrees to buy instruments from one customer and sell them to another customer.
In the normal course of its matched principal and principal trading businesses, the Company may hold security positions overnight. These positions are marked to market on a daily basis.
Clearing Services Revenues-The Company charges fees to customers for clearing services provided for cash and derivative transactions. Clearing services revenues are recorded on a trade date basis as customer transactions occur and are presented net of any customer negotiated rebates.
Software, Analytics and Market Data Revenue Recognition- Software revenue consists primarily of fees charged for Trayport electronic trading software, which are typically billed on a subscription basis and are recognized ratably over the term of the subscription period, which ranges from one to five years. Analytics revenue consists primarily of software license fees for Fenics pricing tools which are typically billed on a subscription basis, and is recognized ratably over the term of the subscription period, which is generally three years. Market data revenue primarily consists of subscription fees and fees from customized one-time sales. Market data subscription fees are recognized on a straight-line basis over the term of the subscription period, which ranges from one to two years. Market data revenue from customized one-time sales is recognized upon delivery of the data.
The Company markets its software, analytics and market data products through its direct sales force and, in some cases, indirectly through resellers. In general, the Company’s license agreements for such products do not provide for a right of return.
Other Income-Included within Other income on the Company’s Consolidated Statements of Operations are revaluations of foreign currency derivative contracts, realized and unrealized transaction gains and losses on certain foreign currency denominated items and gains and losses on certain investments and interest income earned on short-term investments.
Compensation and Employee Benefits-The Company’s compensation and employee benefits have both a fixed and variable component. Base salaries and benefit costs are primarily fixed for all employees while bonuses constitute the variable portion of compensation and employee benefits. The Company may pay certain performance bonuses in restricted stock units (“RSUs”). The Company also may grant sign-on and retention bonuses for certain newly-hired or existing employees who agree to long-term employment agreements.
In 2011, the Company recorded a charge of $19,443 to Compensation and employee benefits that primarily related to severance costs and the restructuring of certain employment agreements.
Share-Based Compensation-The Company’s share-based compensation mainly consists of RSUs. The Company accounts for share-based compensation in accordance with ASC 718 Compensation-Stock Compensation (“ASC 718”). This accounting guidance requires measurement of compensation expense for equity-based awards at fair value and recognition of compensation expense over the service period, net of estimated forfeitures. In all periods presented, the only share-based compensation expense recognized by the Company has been RSUs. The Company determines the fair value of RSUs based on the number of units granted and the grant date fair value of the Company’s common stock, measured as of the closing price on the date of grant. See Note 12 for further information.
Income Taxes-In accordance with ASC 740, Income Taxes, the Company provides for income taxes using the asset and liability method under which deferred income taxes are recognized for the estimated future tax effects attributable to temporary differences and carryforwards that result from events that have been recognized either in the financial statements or the income tax returns, but not both. The measurement of current and deferred income tax assets and liabilities is based on provisions of enacted tax laws. Valuation allowances are recognized if, based on the weight of available evidence, it is more likely than not that some portion of the deferred tax assets will not be realized. Management applies the more likely than not criteria prior to recognizing a financial statement benefit for a tax position taken (or expected to be taken) in a tax
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
return. The Company recognizes interest and/or penalties related to income tax matters in interest expense and other expense, respectively. See Note 9 for further information.
Treasury Stock-The Company accounts for Treasury stock using the cost method. Treasury stock held by the Company may be reissued with respect to vested RSUs in qualified jurisdictions. The Company’s policy is to account for these shares as a reduction of Treasury stock on a first-in, first-out basis.
Foreign Currency Translation Adjustments and Transactions- Assets and liabilities of foreign subsidiaries having non-U.S. dollar functional currencies are translated at the period end rates of exchange, and revenue and expenses are translated at the average rates of exchange for the period. Gains or losses resulting from translating foreign currency financial statements are reflected in foreign currency translation adjustments and are reported as a separate component of comprehensive (loss) income and included in accumulated other comprehensive income (loss) in stockholders’ equity. Net losses resulting from remeasurement of foreign currency transactions and balances for the years ended December 31, 2012, 2011 and 2010 were $(3,635), $(220) and $(6,770), respectively, and are included in Other income in the Consolidated Statement of Operations.
Recent Accounting Pronouncements-In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-04 Fair Value Measurement (Topic 820) Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”). ASU 2011-04 amends current guidance to result in common fair value measurement and disclosures between accounting principles generally accepted in the United States and International Financial Reporting Standards. The amendments result in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between U.S. GAAP and IFRS. The amendments in ASU 2011-04 are effective for interim and annual periods beginning after December 15, 2011. The adoption of ASU 2011-04 did not have a material impact on the Company’s Consolidated Financial Statements and the Company has included the disclosures required by this guidance in Note 16.
In June 2011, the FASB issued ASU No. 2011-05 Comprehensive Income (Topic 220) Presentation of Comprehensive Income (“ASU 2011-05”). The main objective of ASU 2011-05 is to improve the comparability, consistency, and transparency of financial reporting and increase the prominence of items reported in other comprehensive income (“OCI”) by eliminating the option to present components of OCI as part of the statement of changes in stockholders’ equity. The amendments in this standard require entities to report the components of comprehensive income in either (1) a single continuous statement of comprehensive income or (2) in two separate but consecutive statements. The amendments in this standard do not change the items that must be reported in OCI. The amendments in ASU 2011-05 are effective for interim and annual periods beginning after December 15, 2011 and are to be applied retrospectively. The adoption of ASU 2011-05 did not have a material impact on the Company’s Consolidated Financial Statements as the Company was previously in compliance with the presentation requirements of this ASU.
In September 2011, the FASB issued ASU No. 2011-08 Intangibles - Goodwill and Other (Topic 350)(“ASU 2011-08”) which amends current guidance to allow entities to first assess qualitative factors to determine whether it is more likely than not (a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. After assessing qualitative factors, if an entity determines that it is not more likely than not that the fair value of the reporting unit is less than its carrying amount, no further testing is necessary. If an entity determines that it is more likely than not that the fair value of the reporting unit is less than its carrying value, then the traditional two-step goodwill impairment test must be performed. The amendments in ASU 2011-08 are effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. The Company early adopted ASU 2011-08 effective the fourth quarter of 2011. The adoption of ASU 2011-08 did not have a material impact on the Company’s Consolidated Financial Statements.
In December 2011, the FASB issued ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities (“ASU 2011-11”). ASU 2011-11 requires additional disclosure about financial instruments and derivatives instruments that are subject to netting arrangements to assist users of the financial statements in understanding the effect of those arrangements on its financial position. In January 2013, the FASB issued an amendment to ASU 2011-11, ASU No. 2013-01 Balance Sheet (Topic 210): Clarifying the Scope of Disclosure about Offsetting Assets and Liabilities (“ASU 2013-01”). ASU 2013-01 clarifies that the scope of ASU 2011-11 applies to derivatives accounted for in accordance with ASC 815- Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
repurchase agreements, and securities borrowing and securities lending transaction that are either offset in accordance with Balance Sheet (Topic 210) guidance, Derivatives and Hedging (Topic 815) guidance, or subject to an enforceable master netting arrangement or similar agreement. The new disclosures are required for reporting periods beginning on or after January 1, 2013, including retrospectively for all comparative periods presented. The Company is evaluating the effect of this guidance and does not expect the adoption of ASU 2013-01 to have a material impact on the Company’s Consolidated Financial Statements.
In July 2012, the FASB issued ASU No. 2012-02, Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment (“ASU 2012-02”). The amended guidance simplifies how entities test for impairment of indefinite-lived intangible assets. The amendments permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of the asset is less than its carrying amount as a basis for determining if performing a quantitative test is necessary. The amendments do not change the measurement of impairment losses. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. The Company does not expect the adoption of ASU 2012-02 to have a material impact on its Consolidated Financial Statements.
3. RECEIVABLES FROM AND PAYABLES TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS
Amounts receivable from and payable to brokers, dealers and clearing organizations consisted of the following:
Substantially all fail to deliver and fail to receive balances at December 31, 2012 and 2011 have subsequently settled at the contracted amounts.
In addition to the balances above, the Company had Payables to clearing services customers of $139,627 and $120,909 at December 31, 2012 and 2011, respectively. These amounts represent cash payable to the Company’s clearing customers, that is held at the Company’s third party general clearing members and are included within Cash and cash equivalents, Cash and securities segregated under federal and other regulations, or Receivables from brokers, dealers and clearing organizations.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
4. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Property, equipment and leasehold improvements consist of the following:
Depreciation and amortization expense on property, equipment and leasehold improvements for the years ended December 31, 2012, 2011 and 2010 was $20,207, $21,476 and $21,235, respectively.
5. ACQUISITIONS
The Kyte Group Limited and Kyte Capital Management Limited
On July 1, 2010, the Company acquired a 70% equity ownership interest in each of The Kyte Group Limited and Kyte Capital Management Limited (collectively “Kyte”). The Company will acquire the residual 30% equity interest in Kyte for an additional cash payment to be made in or about the third quarter of 2013 in an amount to be determined pursuant to a formula based on Kyte’s post-acquisition earnings. Kyte has been included in the Consolidated Financial Statements as a wholly-owned subsidiary since the acquisition date, with a liability recorded for the future payment to be made in 2013. Included as part of the purchase price is £5,000 (or approximately $7,592) that was deposited into an escrow account with a third-party escrow agent and 1,339,158 contingently issuable shares of the Company’s common stock, all of which will be delivered to the selling shareholders of Kyte upon the satisfaction of certain conditions related to one of Kyte’s investments in a third party. As part of the purchase agreement, over the period from initial acquisition to when the Company will acquire the residual 30% equity interest in Kyte, the Company agreed to make up to £20,000 available to Kyte Capital Management Limited for investments in new trading entities subject to certain approvals.
The future purchase commitment requires the Company to pay an additional cash payment based on the performance of Kyte during the three year period ending June 30, 2013. The Company elected the fair value option for this purchase commitment as of the date of acquisition and determined the fair value using the income approach. Subsequent changes in the fair value of the future purchase commitment are recorded in Other income in the Consolidated Statements of Operations. The fair value of the future purchase commitment at the acquisition date was $19,264, which assumed a 17.7% discount rate and was recorded as a liability within Other liabilities. In applying the income approach, the Company used forecasted financial information for Kyte for the remaining period ending June 30, 2013.
The fair value of the future purchase commitment and the discount rate used in its estimated fair value as of December 31, 2012 and 2011 were as follows:
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
The amount of the future purchase commitment accrued in the Consolidated Statements of Financial Condition at December 31, 2012 decreased from December 31, 2011, primarily due to differences between previous forecasts and actual results for 2012, as well as changes to the forecasted performance for Kyte for the remaining period ending June 30, 2013, slightly offset by an increase in the net present value of the liability due to the passage of time.
6. GOODWILL AND INTANGIBLE ASSETS
Goodwill-Changes in the carrying amount of the Company’s goodwill for the years ended December 31, 2012 and 2011 were as follows:
During the second quarter of 2011, the Company recorded adjustments to its purchase price allocation, during the initial measurement period, for Kyte in the net amount of $1,546.
During the fourth quarter of 2012, the Company identified an error in its consolidated financial statements for the years ended December 31, 2011 and 2010 related to the 2010 acquisition of Kyte. The adjustment was based on information available to management during the initial measurement period, but was not corrected during that period. The error resulted in an overstatement of both goodwill and non-controlling interests. In accordance with authoritative guidance issued by the FASB, the Company corrected this error in the current period by adjusting both goodwill and non-controlling interests by $945. The Company believes this error was immaterial to all periods affected.
Goodwill is required to be tested for impairment at least annually and more frequently when indicators of impairment exist. All of the Company’s goodwill is allocated to its reporting units and the goodwill impairment tests are performed at the reporting unit level. The Company determined Americas Brokerage, EMEA Brokerage, Asia Brokerage, Clearing and Backed Trading, Trayport, and Fenics to be its reporting units. Based on the results of the annual impairment tests performed as of November 1, 2012 and 2011, respectively, no goodwill impairment was recognized during the years ended December 31, 2012 and 2011.
In 2011, the Company performed a qualitative assessment on the Trayport, Fenics, and Americas Brokerage reporting units and noted that it is more likely than not that the fair value of each reporting unit is greater than its carrying amount. However, for the EMEA Brokerage and Clearing and Backed Trading reporting units, the Company elected to bypass the qualitative assessment and perform a two-step goodwill impairment test. As a result of the two-step impairment test, the fair value of EMEA Brokerage and Clearing and Backed Trading were substantially in excess of their respective carrying values.
In 2012, the Company performed a qualitative assessment on the Trayport and Fenics reporting units and noted that it is more likely than not that the fair value of each reporting unit is greater than its carrying amount. However, for the
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
Americas Brokerage, EMEA Brokerage, and Clearing and Backed Trading reporting units, the Company elected to bypass the qualitative assessment and perform a two-step goodwill impairment test. As a result of the two-step impairment test, the fair value of the Americas brokerage and EMEA brokerage reporting units were substantially in excess of their respective carrying values.
The Clearing and Backed Trading reporting unit’s fair value exceeded its carrying value by approximately 2.5%. The Company estimated the fair value of the Clearing and Backed Trading reporting unit using a weighted average of both the market and income approaches. Under the market approach, the fair value of the reporting unit was based on applying market multiples to its estimated projected revenues and earnings. Key assumptions included management’s budgeted statement of operations for the year ended December 31, 2013 and estimated growth rate assumptions for future periods, a range of forward market multiples of comparable companies and a reasonable control premium to apply to the derived market multiples. The applicable multiples were selected based on the similarities and differences between the Company’s Clearing and Backed Trading reporting unit and guideline companies in the same sector, including profitability, growth prospects, size, as well as overall risks. The estimated control premium was determined based upon general consideration of premiums paid in individual transactions over a period of time. Under the income approach, the fair value of the reporting unit was based on the present value of estimated future cash flows. Key assumptions used in estimating these cash flows included applying business growth rate assumptions to future cash flows over a period of time and an estimated terminal value thereafter. The Company discounted the resulting expected cash flows using an estimated weighted average cost of capital to arrive at a present value amount that approximates fair value. Changes in these estimates and assumptions could materially affect the determination of fair value and/or goodwill impairment evaluation for the Clearing and Backed trading reporting segment.
As a result of continued economic uncertainty and current market dynamics, determining whether an impairment of the goodwill asset exists is increasingly difficult and requires management to exercise significant judgment. In addition, to the extent that securities valuations or trading volumes are depressed for prolonged periods of time and market conditions stagnate or worsen as a result of local or global economic conditions, the revenues and profitability of the Company’s Clearing and Backed Trading reporting unit may be adversely affected. In addition, control premiums, industry earnings multiples and discount rates are impacted by economic conditions. As a result, subsequent impairment tests may be more frequent and be based upon more negative assumptions and future cash flow projections, which may result in an impairment of the Company’s Clearing and Backed Trading reporting unit at such time. Any impairment could reduce materially the recorded amount of goodwill with corresponding a charge to the Company’s earnings.
Intangible Assets-Intangible assets consisted of the following:
In July 2011, the Company completed an asset purchase of certain patents from a third party for consideration in the amount of $3,100. The patents have a weighted-average useful life of approximately 6 years.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
Amortization expense for the years ending December 31, 2012, 2011 and 2010 was $11,293, $12,190 and $7,815, respectively.
At December 31, 2012, expected amortization expense for the definite lived intangible assets is as follows:
7. OTHER ASSETS AND OTHER LIABILITIES
Other assets consisted of the following:
(1) Balances as of December 31, 2011 have been reclassified for comparative presentation.
During the third quarter of 2011, the Company determined that its equity method investment in a third party brokerage firm with a proprietary trading platform was other-than-temporarily impaired and, in accordance with ASC 323-10, the investment was written down to its estimated fair value. The impairment recognized in the third quarter of 2011 was $2,255. During the fourth quarter of 2011, the Company exchanged its membership interests in this investment for a convertible senior secured promissory note (the “Note”) due in 2016 with a face value of $14,059. Upon the exchange of its membership interests, the Company recognized a loss of $4,094 for the difference between the book value of the membership interests and the fair value of the Note.
During the second quarter of 2012, the Company modified the Note by reducing its face value from $14,059 to $5,000 and increasing the percentage of membership interests into which the Note is convertible to 55%. The Company accounted for the Note as an available-for-sale security. Due to these modifications, the Company recorded a $2,700 impairment charge in the first quarter of 2012 in accordance with ASC 310-40 Troubled Debt Restructurings by Creditors. During the third quarter of 2012, the third party brokerage firm notified the Company that they had immediate liquidity concerns and that there was the prospect of insolvency in the near future. In accordance with ASC 320-10 Investments-Debt and Equity Securities, the Company determined that the Note had further been impaired and, therefore, the Note was written down to its estimated fair value, which was concluded to be zero. The impairment recognized in the third quarter of 2012 was $2,662.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
The Company recorded the following impairment charges related to its investment in this third party brokerage firm:
Other liabilities consisted of the following:
8. SHORT-TERM BORROWINGS AND LONG-TERM OBLIGATIONS
The Company had outstanding Long-term obligations as of December 31, 2012 and 2011 as follows:
8.375% Senior Notes
In July 2011, the Company issued $250,000 in aggregate principal amount of 8.375% Senior Notes (the “8.375% Senior Notes”) due 2018 in a private offering (the “Offering”) to qualified institutional buyers pursuant to Rule 144A and to certain persons in offshore transactions pursuant to Regulation S, each under the Securities Act of 1933, as amended (the “Securities Act”). The notes were priced to investors at 100% of their principal amount, and mature in July 2018. Interest on these notes is payable, semi-annually in arrears on the 19th of January and July. Transaction costs of approximately $9,100 related to the 8.375% Senior Notes was deferred and is being amortized over the term of the notes. On December 21, 2011, the Company completed an exchange offer for the 8.375% Senior Notes whereby it exchanged $250,000 in aggregate principal amount of the 8.375% Senior Notes for 8.375% Senior Notes that are registered under the Securities Act. On April 23, 2012, Standard & Poor’s (“S&P”) lowered its credit rating on the Company’s 8.375% Senior Notes one notch to BB+, which, pursuant to the terms of the 8.375% Senior Notes, increased the applicable per annum interest rate, effective July 19, 2012, by 25 basis points, equating to an additional $625 of interest per annum. On December 21, 2012, S&P further lowered its credit rating on the Company’s 8.375% Senior Notes two notches to BB-, which, pursuant to the terms of the 8.375% Senior Notes, increased the applicable per annum interest rate, effective January 19, 2013, by an additional 50 basis points, equating to an additional $1,250 of interest per annum. On January 18, 2013, Moody’s Investor Services lowered its credit rating on the Company’s 8.375% Senior Notes two notches to B1, which, pursuant to the terms of the 8.375% Senior Notes, increased the applicable per annum interest rate, effective January 19, 2013, by an additional 50 basis points, equating to an additional $1,250 of interest per annum. The aggregate effect of these downgrades to the Company’s credit rating by the various rating agencies equate to $3,125 in additional interest expense per annum.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
At December 31, 2012 and December 31, 2011, unamortized deferred financing fees related to the 8.375% Senior Notes of $7,205 and $8,552, respectively, were recorded within Other assets and the Company was in compliance with all applicable covenants.
Credit Agreement
In March 2013, the Company entered into an amendment to its second amended and restated credit agreement (as amended, the “Credit Agreement”) with Bank of America, N.A. and certain other lenders. The Credit Agreement provides for maximum revolving loans of up to $75,000 until December 2013, at which time $18,750 of the lender commitments mature. The remaining $56,250 of lender commitments mature in December 2015. The Credit Agreement provides for up to $50,000 for letters of credit. Revolving loans may be either base rate loans or Eurocurrency rate loans. Eurocurrency rate loans bear interest at the annualized rate of one-month LIBOR plus the application margin and base rate loans bear interest at a rate per annum equal to a prime rate plus the applicable margin. Letter of credit fees per annum are equal to the applicable margin times the outstanding amount drawn under such letter of credit. As long as no default has occurred under the Credit Agreement, the applicable margin for base rate and Eurocurrency rate loans and letters of credit is based on a matrix that varies with a ratio of outstanding debt to EBITDA, as defined in the Credit Agreement.
In July 2011, the Company used $135,319 of the net proceeds from the Offering of the 8.375% Senior Notes to repay all then outstanding amounts under the Credit Agreement, including accrued and unpaid interest.
As a result of the Offering, the available borrowing capacity under the Credit Agreement decreased from $200,000 to approximately $129,500. In March 2013, the borrowing capacity was lowered to $75,000 as discussed above.
The Company had outstanding borrowings under its Credit Agreement as of December 31, 2012 and 2011 as follows:
(1) Amounts available include up to $50,000 for letters of credit as of December 31, 2012 and December 31, 2011.
At December 31, 2012 and December 31, 2011, unamortized deferred financing fees related to the Credit Agreement of $869 and $1,738, respectively, were recorded within Other assets.
The Credit Agreement contains certain financial and other covenants. The Company was in compliance with all applicable covenants at December 31, 2012 and 2011.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
9. INCOME TAXES
The provision for income taxes consists of the following:
The Company had pre-tax income from foreign operations of $31,571, $37,589 and $81,768 for the years ended December 31, 2012, 2011 and 2010, respectively. Pre-tax (loss) from domestic operations was $(32,828), $(37,507) and $(49,965) for the years ended December 31, 2012, 2011 and 2010, respectively.
Deferred income taxes reflect the net tax effects of temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when such differences are expected to reverse. Significant components of the Company’s gross deferred tax assets and liabilities are set forth below:
(1) Balances as of December 31, 2011 have been reclassified for comparative presentation.
As a result of certain realization requirements of ASC 718, the table of deferred tax assets and liabilities shown above does not include certain deferred tax assets as of December 31, 2012 and 2011 that arose directly from tax deductions related to equity compensation in excess of compensation expense recognized for financial reporting purposes. Stockholders’ Equity will be increased by $2,213 when such deferred tax assets are ultimately realized. The Company uses tax law ordering when determining when excess tax benefits have been realized.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
Cumulative undistributed earnings of foreign subsidiaries were approximately $330,108 at December 31, 2012. U.S. income and foreign withholding taxes have not been recognized on the excess of the amount for financial reporting over the tax basis of investments in foreign subsidiaries that are essentially permanent in duration. This amount becomes taxable upon a repatriation of assets from the subsidiary or a sale or liquidation of the subsidiary. To the extent these earnings are repatriated, the Company does not expect a material U.S. tax charge to arise. The Company considers the historic undistributed earnings of our foreign subsidiaries to be indefinitely reinvested and, accordingly, no U.S. income taxes have been provided thereon. Management has concluded that certain earnings commencing from January 1, 2013 will ultimately be repatriated and will provide U.S. tax on those amounts.
The deferred tax assets relating to foreign deferred items listed above consist primarily of depreciation and amortization, and deferred compensation. The valuation allowance relates primarily to the inability to utilize net operating losses and foreign tax credits in various tax jurisdictions. At December 31, 2012, the Company established a valuation allowance for the current year’s state and local net operating loss, to the extent that it is more likely than not unrealizable. The Company had U.S. federal net operating loss carryforwards of $57,341, U.S. state and local net operating loss carryforwards of $95,587 and foreign net operating loss carryforwards of $52,314. The U.S. amounts are subject to annual limitations on utilization and will begin to expire in 2018. The foreign amounts are subject to annual limitations on utilization and will generally begin to expire in 2013. Further, the Company has $10,944 of foreign tax credit carryforwards at December 31, 2012 that will begin to expire in 2013. The Company continues to monitor the realizability of these losses and believes it is more likely than not that the tax benefits associated with these losses will be realized to the extent a valuation allowance has not been established. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized and, when necessary, a valuation allowance is established. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences become deductible. Management considers the following possible sources of taxable income when assessing the realization of deferred tax assets:
· future reversals of existing taxable temporary differences;
· future taxable income exclusive of reversing temporary differences and carryforwards;
· taxable income in prior carryback years; and
· tax planning strategies.
The assessment regarding whether a valuation allowance is required or should be adjusted also considers all available positive and negative evidence, including, but not limited to, the following:
· the nature, frequency, and severity of any recent losses;
· the duration of statutory carryforward periods;
· historical experience with tax attributes expiring unused; and
· the Company’s estimated near- and medium-term financial outlook.
In making the determination of the realizability of these deferred tax assets the Company has identified certain prudent and feasible tax planning strategies that the Company will implement unless the need to do so is eliminated in the future. However, this determination is a judgment and could be impacted by further market fluctuations.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
The corporate statutory U.S. federal tax rate was 35.0% for the three years presented. A reconciliation of the Company’s provision for income tax and the statutory tax rate is as follows:
(1) Valuation allowance provided for deferred taxes related to state and local taxes, capital loss and charitable contribution carryforwards.
(2) Foreign rate differential adjusted for non-deductible expenses and valuation allowance.
(3) U.S. taxes associated with actual and deemed repatriations of earnings from our non-U.S. subsidiaries.
Income tax expense of approximately $2,213, $1,764 and $2,042 from the exercise of stock options and the vesting of RSUs was recorded directly to additional paid-in capital in 2012, 2011 and 2010, respectively.
Total unrecognized tax benefits (net of the federal benefit on state tax positions) as of December 31, 2012 were approximately $10,007, including interest of $1,050, all of which could affect the effective income tax rate in future periods. A reconciliation of the beginning and ending amount of unrecognized tax benefits, showing only items of movement, is as follows:
The Company is under continuous examination by the Internal Revenue Service (the “IRS”) and other tax authorities in certain countries, such as the U.K., and states in which the Company has significant business operations, such as New York. The Company is currently under examination by the IRS covering tax years 2004 - 2009. Also, the Company is currently at various levels of field examination with respect to audits with New York State and New York City for tax years 2006 - 2008. The Company has substantially concluded all U.S. federal, state and local income tax matters for years prior to 2004.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
In the U.K., the Company is in discussion with tax authorities regarding whether certain compensation expenses were deductible by the Company in prior years. A portion of the compensation payment is held by a trustee and the Company may request, but not compel, the trustee to use the money to offset the cost to the Company of the potential tax liability, if any, arising from the disallowance of the deduction.
The Company believes that the resolution of tax matters will not have a material effect on the consolidated statements of financial condition of the Company, although a resolution could have a material impact on the Company’s consolidated statements of income for a particular future period and on the Company’s effective income tax rate for any period in which such resolution occurs. The Company has established a liability for unrecognized tax benefits that the Company believes is adequate in relation to the potential for additional assessments. Once established, the Company adjusts unrecognized tax benefits only when more information is available or when an event occurs necessitating a change.
The Company recognizes interest and penalties related to income tax matters in interest expense and other expense, respectively. As of December 31, 2012 and 2011, the Company had approximately $1,050 and $834, respectively, of accrued interest related to uncertain tax positions.
10. STOCKHOLDERS’ EQUITY
Share Issuance
During 2012 and 2011, the Company issued 3,952,172 and 3,142,758 shares of common stock, respectively, in connection with the exercise of stock options and vesting of RSUs. The Company received total cash proceeds of $30 and $75 in 2012 and 2011, respectively, in connection with the exercise of stock options. In 2011, in connection with an investment, the Company issued 138,313 shares of common stock as part of the purchase price.
Common Stock
Each holder of the Company’s common stock is entitled to one vote per share on all matters submitted to a vote of stockholders. Subject to the rights of holders of the Company’s preferred stock, if any, the holders of shares of the Company’s common stock are entitled to receive dividends when, as and if declared by the Company’s Board of Directors.
On each of March 30, May 31, August 31, November 30 and December 27, 2012, the Company paid a cash dividend of $0.05 per share, which, based upon the number of shares outstanding on the record date for such dividends, totaled $5,897, $5,991, $5,873, $5,901 and $5,904, respectively. On each of March 31, May 31, August 31 and November 30, 2011, the Company paid a cash dividend of $0.05 per share, which, based upon the number of shares outstanding on the record date for such dividends, totaled $6,100, $6,205, $5,955 and $5,920, respectively.
Preferred Stock
As of December 31, 2012 and 2011, the Company had one class of preferred stock with 5,000,000 shares authorized and none issued.
Treasury Stock
In August 2007, the Company’s Board of Directors authorized the Company to implement a stock repurchase program to repurchase a limited number of shares of the Company’s common stock. Under the repurchase plan, the Board of Directors authorized the Company to repurchase shares of the Company’s common stock on the open market in such amounts
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
as determined by the Company’s management, provided, however, such amounts are not to exceed, during any calendar year, the number of shares issued upon the exercise of stock options plus the number of shares underlying grants of RSUs that are granted or which management reasonably anticipates will be granted in such calendar year. During the year ended December 31, 2012, the Company repurchased 3,107,469 shares of its common stock on the open market at an average price of $3.17 per share and for a total cost of $9,939, including sales commissions. During the year ended December 31, 2011, the Company repurchased 5,650,000 shares of its common stock on the open market at an average price of $4.55 per share and for a total cost of $25,868, including sales commissions. These repurchased shares were recorded at cost as treasury stock in the Consolidated Statements of Financial Condition.
On December 28, 2012, the Company and JPI entered into a stock purchase agreement pursuant to which the Company purchased 993,377 shares of common stock held by JPI at a price of $3.02 per share for a purchase price of $3,000. On November 15, 2011, the Company entered into a stock purchase agreement with Michael Gooch and JPI pursuant to which the Company purchased 1,053,746 and 1,163,548 shares of the Company’s common stock held by Michael Gooch and JPI, respectively, at a price of $4.51 per share for an aggregate purchase price of $10,000. The review and approval of these stock purchase agreements was delegated by the Company’s Board of Directors to its Audit Committee, comprised of solely independent directors, which approved such stock purchase agreements. These repurchased shares were recorded at cost as treasury stock in the Consolidated Statements of Financial Condition.
During the years ended December 31, 2012 and 2011, the Company reissued 932,198 and 300,089 shares of its Treasury stock, respectively, in relation to the settlement of vested RSUs. The reissuance of these shares is accounted for as a reduction of Treasury stock on a first-in, first-out basis. The total amounts reduced from Treasury stock relating to the settlement of RSUs during the years ended December 31, 2012 and 2011 were $11,839 and $5,382, respectively.
11. (LOSS) EARNINGS PER SHARE
Basic (loss) earnings per share for common stock is calculated by dividing net (loss) income available to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted (loss) earnings per share is calculated by dividing net (loss) income by the sum of: (i) the weighted average number of shares outstanding, (ii) outstanding stock options and RSUs (using the “treasury stock” method when the impact of such options and RSUs would be dilutive), and (iii) any contingently issuable shares when dilutive.
Basic and diluted (loss) earnings per share for the years ended December 31, 2012, 2011 and 2010 were as follows:
Excluded from the computation of diluted (loss) earnings per share because their effect would be anti-dilutive were the following: (i) 7,195,315 RSUs and 206,826 stock options for the year ended December 31, 2012; (ii) 2,437,984 RSUs and 96,752 stock options for the year ended December 31, 2011; and (iii) 1,643,217 RSUs and 56,033 stock options for the year ended December 31, 2010.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
Included in the computation of diluted (loss) earnings per share, but not in the computation of basic (loss) earnings per share, as the conditions for issuance were not satisfied as of the respective reporting period were 1,414,644 contingently issuable shares for the year ended December 31, 2010.
As a result of the net loss for the year ended December 31, 2012, the following were excluded from the computation of diluted loss per share for that period: common shares underlying options to purchase 48,431 shares of common stock, 3,709,611 RSUs, and 3,682,916 shares that were contingently issuable.
As a result of the net loss for the year ended December 31, 2011, the following were excluded from the computation of diluted loss per share for that period: common shares underlying options to purchase 146,257 shares of common stock, 4,191,049 RSUs, and 3,936,047 shares that were contingently issuable.
12. SHARE-BASED COMPENSATION
The Company issues RSUs to its employees under the GFI Group Inc. 2008 Equity Incentive Plan, which was approved by the Company’s stockholders on June 11, 2008 (as amended, the “2008 Equity Incentive Plan”). The 2008 Equity Incentive Plan was subsequently amended at each of the Company’s annual stockholders meetings since the Plan was initially approved in order to increase the number of shares of common stock available for grant under the Plan. Prior to June 11, 2008, the Company issued RSUs under the GFI Group Inc. 2004 Equity Incentive Plan (the “2004 Equity Incentive Plan”).
The 2008 Equity Incentive Plan permits the grant of non-qualified stock options, incentive stock options, stock appreciation rights, shares of restricted stock, restricted stock units and performance units to employees, non-employee directors or consultants. The Company issues shares from authorized but unissued shares and authorized and issued shares reacquired and held as treasury shares, which are reserved for issuance upon the vesting of RSUs granted pursuant to the 2008 Equity Incentive Plan. As of December 31, 2012, there were 11,200,253 shares of common stock available for future grants of awards under this plan. The fair value of RSUs is based on the closing price of the Company’s common stock on the date of grant and is recorded as compensation expense over the service period, net of estimated forfeitures.
The following is a summary of RSU transactions under both the 2008 Equity Incentive Plan and the 2004 Equity Incentive Plan:
The weighted average grant-date fair value of RSUs granted during 2012 was $3.55 per unit, compared with $4.74 per unit for the same period in the prior year. Total compensation expense and related income tax benefits recognized in relation to RSUs is as follows:
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
The Company has modified the vesting terms of RSU grants for certain employees in connection with the termination of their employment. As a result of these modifications, the Company recorded incremental compensation expense totaling $255, $2,210 and $66 during 2012, 2011, and 2010, respectively.
At December 31, 2012, total unrecognized compensation cost related to the RSUs prior to the consideration of expected forfeitures was approximately $56,873 and is expected to be recognized over a weighted-average period of 1.74 years. The total fair value of RSUs that vested during the years ended December 31, 2012, 2011 and 2010 was $31,514, $27,407 and $22,950, respectively.
As of December 31, 2012, the Company had stock options outstanding under two plans: the GFI Group 2002 Stock Option Plan (the “GFI Group 2002 Plan”) and the GFInet Inc. 2000 Stock Option Plan (the “GFInet 2000 Plan”). No additional grants will be made under these plans. Under each plan: options were granted to employees, non-employee directors or consultants to the Company; both incentive and non-qualified stock options were available for grant; options were issued with terms up to ten years from date of grant; and options were generally issued with an exercise price equal to or greater than the fair market value at the time the option was granted. In addition to these terms, both the GFI Group 2002 Plan and the GFInet 2000 Plan contained events that had to occur prior to any options becoming exercisable. Under both plans, the options became exercisable upon the completion of the Company’s initial public offering, which occurred in January 2005. Options outstanding under both plans are exercisable for shares of the Company’s common stock. The Company issues shares from the authorized but unissued shares reserved for issuance under the GFI Group 2002 Plan or the GFInet 2000 Plan, respectively, upon the exercise of option grants under such plans.
The following is a summary of stock options outstanding under both the GFI Group 2002 Plan and the GFInet 2000 Plan:
As of December 31, 2012, 2011, and 2010, there was no unrecognized compensation cost related to stock options.
The total intrinsic value of options exercised for the years ended December 31, 2012, 2011 and 2010 was $2, $52 and $661, respectively. Additionally, the total intrinsic value of options outstanding and exercisable at December 31, 2012 was $139.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
13. COMMITMENTS AND CONTINGENCIES
Operating Leases-The Company has non-cancelable operating leases, principally for office space, that expire on various dates through 2027. At December 31, 2012, the future minimum rental commitments under such leases are as follows:
Many of the leases for office space contain escalation clauses that require payment of additional rent to the extent of increases in certain operating and other costs. In addition, certain of the Company’s leases grant a free rent period, which is amortized over the lease term. The accompanying Consolidated Statements of Operations reflect all rent expense on a straight-line basis over the term of the leases. Rent expense under the leases for the years ended December 31, 2012, 2011 and 2010 was $13,465, $15,252 and $13,797, respectively.
In connection with moving the Company’s headquarters in 2008, the Company terminated a portion of the former facility lease with respect to approximately 51,000 square feet, effective June 30, 2008. The Company remains liable for all of the obligations under the lease for the remaining approximately 37,000 square feet. In January 2009, the Company entered into a sublease for approximately 23,000 square feet of the remaining leased space. The Company will receive monthly payments of $55 until the sublease expires in September 2013. See Note 2 for discussion regarding the correction of an error in 2012 related to the Company’s estimated loss accrual for this sublease.
Purchase Obligations-The Company has various unconditional purchase obligations. These obligations are for the purchase of market data from a number of information service providers during the normal course of business. As of December 31, 2012, the Company had total purchase commitments for market data of approximately $22,879, with $19,589 due within the next twelve months and $3,290 due between one to three years. Additionally, the Company had other purchase commitments of $6,135, primarily related to network implementations in the U.S. and U.K., and $490, primarily related to hosting and software license agreements. Of these other purchase commitments, approximately $3,161 are due within the next twelve months.
In connection with the acquisition of 70% of the equity ownership interests in Kyte, the Company agreed to purchase the residual 30% equity interest in Kyte for an additional cash payment in an amount to be determined pursuant to a formula based on Kyte’s earnings, such payment to be made following June 30, 2013. See Note 5 to the Consolidated Financial Statements for further information.
Contingencies-In the normal course of business, the Company and certain subsidiaries included in the consolidated financial statements are, and have been in the past, involved in various lawsuits and proceedings and are, and have been in the past, involved in certain regulatory examinations. These legal proceedings are at varying stages of adjudication, arbitration or investigation and involve a wide variety of claims. In view of the inherent difficulty of predicting the outcome of such litigation and regulatory matters, particularly where the claimants seek very large or indeterminate damages or where the matters present novel legal theories, the Company generally cannot predict what the eventual outcome of the pending matters will be, what the timing of the ultimate resolution of these matters will be, or what the eventual loss, fines or penalties, if any, relating to each matter may be.
The Company is subject to the possibility of losses from these various contingencies. Considerable judgment is necessary to estimate the probability and amount of any loss from such contingencies. In accordance with applicable accounting guidelines, an accrual is made when it is probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. Where a loss contingency is not both probable and estimable, the Company does not establish an accrued liability. Several of the Company’s European subsidiaries are currently defending a claim that they improperly hired a number of employees of a competitor over the course of several months. The claim was
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
filed almost a year after the Company hired the employees and notwithstanding that none of the employees breached their employment agreements with the competitor. Although the case is in its preliminary stages, the claimant is seeking a multi-million dollar award. The Company intends to vigorously defend against this action and believes that it has substantial defenses to the claims asserted against it.
The Company is subject to regular examinations by various tax authorities in jurisdictions in which the Company has significant business operations. The Company regularly assesses the likelihood of additional tax assessments that may result from these examinations in each of the tax jurisdictions. A tax accrual has been established, which the Company believes to be adequate in relation to the potential for additional tax assessments. Once established, the accrual may be adjusted based on new information or events. The imposition of additional tax assessments, penalties or fines by a tax authority could have a material impact on the Company’s effective tax rate.
Additionally, the Company has recorded reserves for certain contingencies to which it may have exposure, such as contingencies related to the employer portion of National Insurance Contributions in the U.K.
Based on currently available information, the outcome of the Company’s outstanding legal proceedings are not expected to have a material adverse impact on the Company’s financial statements. However, the outcome of any such matters may be material to the Company’s results of operations or cash flows in a given period. It is not presently possible to determine the Company’s ultimate exposure to these matters and there is no assurance that the resolution of the Company’s outstanding matters will not significantly exceed any reserves accrued by the Company.
Risks and Uncertainties-The Company primarily generates its revenues by executing and facilitating transactions for counterparties. Revenues for these services are transaction based. As a result, the Company’s revenues will likely vary based upon the trading volumes of the various securities, commodities, foreign exchange and other cash and derivative markets in which the Company provides its services.
Guarantees-The Company, through its subsidiaries, is a member of certain exchanges and clearing houses. Under the membership agreements, members are generally required to guarantee certain obligations. To mitigate the performance risks of its members, the exchanges and clearing houses may, from time to time, require members to post collateral, as well as meet certain minimum financial standards. The Company’s maximum potential liability under these arrangements cannot be quantified. However, management believes that the potential for the Company to be required to make payments under these arrangements is unlikely. Accordingly, no contingent liability is recorded in the Consolidated Statements of Financial Condition for these arrangements.
14. RETIREMENT PLANS
In the United States, the Company has established the GFI Group 401(k) plan, pursuant to the applicable provisions of the Internal Revenue Code. It is available to all eligible U.S. employees and is subject to the provisions of the Employee Retirement Income Security Act of 1974. Employees may voluntarily contribute a portion of their compensation, not to exceed the statutory limits. The Company did not make any contributions to the plan for the years ended December 31, 2012, 2011 or 2010.
In the U.K. the Company has established three defined contribution plans pursuant to the applicable laws in the U.K. Employees of certain U.K. subsidiaries may voluntarily designate a portion of their monthly compensation to be contributed, which the Company matches up to a certain percentage. The Company has made aggregate contributions of $1,859, $1,461 and $1,316 in 2012, 2011 and 2010, respectively, for these defined contribution plans, recorded in compensation and employee benefits.
15. MARKET AND CREDIT RISKS
Market Risk
The Company, through its subsidiaries, operates as a wholesale broker. The Company provides brokerage services to its customers through agency or principal transactions. Agency brokerage transactions facilitated by the Company are settled between the counterparties on a give-up basis. In matched principal transactions, the Company is interposed between buyers and sellers and the transactions are cleared through various clearing organizations. In the event of counterparty nonperformance, the Company may be required to purchase or sell financial instruments at unfavorable market prices, which may result in a loss to the Company. The Company does not anticipate nonperformance by counterparties. The Company
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
monitors its credit risk daily and has a policy of regularly reviewing the credit standing of counterparties with which it conducts business. The Company may also enter into principal investing transactions in which the Company commits its capital within predefined limits, either to facilitate customer trading activities or to engage in principal trading for the Company’s own account. To the extent that the Company owns assets (i.e. has long positions) in fluctuating markets, a downturn in the value of those assets or in those markets could result in losses from a decline in the value of those long positions. Conversely, to the extent that the Company has sold assets that the Company does not own (i.e. has short positions) in any of those markets, an upturn in those markets could expose the Company to significant losses as the Company attempts to cover short positions in a rising market.
Unsettled transactions (i.e., securities failed-to-receive and securities failed-to-deliver) are attributable to matched principal transactions executed by subsidiaries and are recorded at contract value. Cash settlement is achieved upon receipt or delivery of the security. In the event of nonperformance, the Company may purchase or sell the security in the market and seek reimbursement for losses from the contracted counterparty.
In certain instances, the Company may provide credit for margin requirements to customers, secured by collateral in a customer’s account. In such cases, the Company is exposed to the market risk that the value of the collateral the Company holds could fall below the amount of a customer’s indebtedness. This risk can be amplified in any situation where the market for the underlying instrument is rapidly declining. Agreements with customers that have margin accounts permit the Company to liquidate their positions in the event that the amount of margin collateral becomes insufficient. Despite those agreements and the Company’s risk management policies with respect to margin, the Company may be unable to liquidate a customer’s positions for various reasons, or at a price sufficient to cover any deficiency in a customer’s account. If the Company were unable to liquidate a position at a price sufficient to cover any deficiency or if a customer was unable to post additional margin, the Company may suffer a loss.
Credit Risk
Credit risk arises from potential non-performance by counterparties of our matched principal business, as well as from nonpayment of commissions by customers of our agency brokerage business. The Company also has credit and counterparty risk in certain situations where it provides clearing and execution services. The Company provides agency clearing services through its relationships with general clearing member firms and/or exchanges. In these instances, the Company’s accounts at such institutions are used, in its name, to provide access to clearing services for its customers. Credit risk arises from the possibility that the Company may suffer losses due to the failure of its customers or other counterparties to satisfy their financial obligations to the Company or in a timely manner.
The Company has established policies and procedures to manage its exposure to credit risk. The Company maintains a thorough credit approval process to limit its exposure to counterparty risk and employs stringent monitoring to control the market and counterparty risk from its matched principal business. The Company’s brokers may only execute transactions for clients that have been approved by the Company’s credit committee following review by the Company’s credit department. The Company’s credit approval process includes verification of key financial information and operating data and anti-money laundering verification checks. The Company’s credit review process may include consideration of independent credit agency reports and a visit to the entity’s premises, if necessary. The Company has developed and utilizes a proprietary, electronic credit risk monitoring system.
Credit approval is granted by the Company’s credit committee, which is comprised of senior management and representatives from its compliance, finance and legal departments. Credit approval is granted subject to certain trading limits and may be subject to additional conditions, such as the receipt of collateral or other credit support. The Company’s credit risk department assists the credit committee in the review of any proposed counterparty by conducting diligence on such party and by continuing to review such counterparties for continued credit approval on at least an annual basis. These results are reviewed by the credit committee. Maintenance procedures include reviewing current audited financial statements and publicly available information on the client, collecting data from credit rating agencies where available and reviewing any changes in ownership, title or capital of the client. For the Company’s agency business, the approval process includes the requisite anti-money laundering and know-your-customer verifications.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
16. FAIR VALUE OF FINANCIAL INSTRUMENTS
Certain of the Company’s assets and liabilities are carried at fair value or contracted amounts that approximate fair value. Assets and liabilities that are recorded at contracted amounts approximating fair value consist primarily of receivables from and payables to brokers, dealers and clearing organizations and payables to clearing services customers. These receivables and payables to brokers, dealers and clearing organizations are short-term in nature, and following December 31, 2012, substantially all have settled at the contracted amounts. The Company’s marketable equity securities, included in Other assets, are recorded at fair value based on their quoted market price. The Company’s investments that are accounted for under the cost and equity methods are investments in companies that are not publicly traded and for which no established market for their securities exists. The fair value of these investments is only estimated if there are identified events or changes in circumstances that may have a significant adverse effect on the carrying value of the investment.
The Company’s financial assets and liabilities recorded at fair value have been categorized based upon a fair value hierarchy in accordance with ASC 820-10. In accordance with ASC 820-10, the Company has categorized its financial assets and liabilities, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy as set forth below.
Level 1-Financial assets and liabilities whose values are based on unadjusted quoted prices for identifiable assets or liabilities in an active market that the company has the ability to access at the measurement date (examples include active exchange-traded equity securities, listed derivatives, and most U.S. Government and agency securities).
Level 2-Financial assets and liabilities whose values are based on quoted prices in markets where trading occurs infrequently or whose values are based on quoted prices of instruments with similar attributes in active markets. Level 2 inputs include the following:
· Quoted prices for identifiable or similar assets or liabilities in non-active markets (examples include corporate and municipal bonds which trade infrequently);
· Inputs other than quoted prices that are observable for substantially the full term of the asset or liability (examples include interest rate and currency swaps), and
Level 3-Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability.
The Company’s debt obligations are carried at historical amounts. The fair value of the Company’s Long-term obligations, categorized within Level 2 of the fair value hierarchy and measured primarily using pricing service data from external providers as of December 31, 2012 and December 31, 2011, was as follows:
Valuation Techniques
A description of the valuation techniques applied to the Company’s major categories of assets and liabilities measured at fair value on a recurring basis are as follows:
U.S. Treasury Securities - U.S. Treasury securities are valued using quoted market prices. Valuation adjustments are not applied. Accordingly, U.S. Treasury securities are generally categorized in Level 1 of the fair value hierarchy.
Equity Securities - Equity securities include mostly exchange-traded securities and are valued based on quoted market prices. Accordingly, exchange-traded equity securities are generally categorized in Level 1 of the fair value
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
hierarchy. Non-exchange traded equity securities are measured primarily using broker quotations, pricing service data from external providers and prices observed for recently executed market transactions. Non-exchange traded equity securities are generally categorized within Level 2 of the fair value hierarchy.
Corporate Bonds - Corporate bonds are measured primarily using broker quotations, pricing service data from external providers and prices observed for recently executed market transactions. Corporate bonds are generally categorized in Level 2 of the fair value hierarchy.
Foreign government bonds - Foreign government bonds are mostly valued using quoted market prices. Accordingly, foreign government bonds are generally categorized in Level 1 of the fair value hierarchy.
Derivative Contracts - Derivative contracts include instruments such as foreign exchange, commodity, fixed income and equity derivative contracts.
Listed Derivative Contracts - Listed derivatives that are actively traded are valued based on quoted prices from the exchange and are categorized in Level 1 of the fair value hierarchy.
OTC Derivative Contracts - OTC derivative contracts include forwards, swaps, and options contracts related to foreign currencies. Depending on the product and the terms of the transaction, the fair value of OTC derivative products can be either observed or modeled using a series of techniques and model inputs from comparable benchmarks, including closed-form analytic formulas, such as the Black-Scholes option-pricing model, and simulation models or a combination thereof. Many pricing models do not entail material subjectivity because the methodologies employed do not necessitate significant judgment, and the pricing inputs are observed from actively quoted markets. In the case of more established derivative products, the pricing models used by the Company are widely accepted by the financial services industry. OTC derivative products valued by the Company using pricing models generally fall into this category and are categorized in Level 2 of the fair value hierarchy.
Equity warrants - Non-exchange traded equity warrants are classified within Level 3 of the fair value hierarchy and are measured using the Black-Scholes model with key inputs impacting the valuation including the underlying security price, implied volatility, dividend yield, interest rate curve, strike price and maturity date.
Convertible note receivable, available-for-sale - As discussed in Note 7, during the fourth quarter of 2011, the Company exchanged its membership interest in a third party brokerage firm for a convertible senior secured promissory note in that company. This security was previously measured using valuation techniques involving quoted prices of or market data for comparable companies, including credit ratings, peer company ratios and discounted cash flow analyses. As the inputs used in estimating the fair value of this convertible debt security were both unobservable and significant to the overall fair value measurement of this asset, the asset was categorized within Level 3 of the fair value hierarchy. During the three months ended September 30, 2012, the third party brokerage firm notified the Company that they had immediate liquidity concerns and that there was the prospect of insolvency in the near future. Based upon this information, the Company determined its estimated fair value of the convertible senior secured promissory note to be zero. See Note 7 for further details.
Future Purchase Commitment - In connection with the acquisition of 70% of the equity ownership interests in Kyte, the Company agreed to purchase the residual 30% equity interest in Kyte for an additional cash payment in an amount to be determined pursuant to a formula based on Kyte’s earnings, such payment to be made following June 30, 2013. In applying the income approach, the Company assumed a 15.5% and 16.0% discount rate as of December 31, 2012 and December 31, 2011, respectively, and used forecasted financial information for Kyte for the remaining period ended June 30, 2013. As the inputs used in estimating the fair value of this future purchase commitment are both unobservable and significant to the overall fair value measurement of this liability, the liability is categorized in Level 3 of the fair value hierarchy.
Contingent Consideration -The category consists primarily of contingent consideration related to the acquisition of a retail energy brokerage business, completed on November 1, 2009. This contingent liability is remeasured at fair value and is based on estimated future collections of accounts receivable of the business through October 31, 2013.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
As the inputs used in estimating the fair value of this contingent consideration are both unobservable and significant to the overall fair value measurement of this liability, the liability is categorized in Level 3 of the fair value hierarchy.
In the year ended December 30, 2012 and 2011, the Company did not have any material transfers amongst Level 1, Level 2, and Level 3.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
Financial Assets and Liabilities measured at fair value on a recurring basis as of December 31, 2012 are as follows:
(1) Represents the impact of netting on a net-by-counterparty basis.
Excluded from the table above is variation margin on net long derivative contracts related to exchange traded futures in the amount of $49 and net short derivative contracts related to exchange traded futures in the amount of $14,986. These amounts were included within Receivables from brokers, dealers and clearing organizations.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
Financial Assets and Liabilities measured at fair value on a recurring basis as of December 31, 2011 are as follows:
(1) Represents the impact of netting on a net-by-counterparty basis.
Excluded from the table above is variation margin on long and short derivative contracts related to exchange traded futures in the amount of $1,125 which are included within Receivables from brokers, dealers and clearing organizations.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
Changes in Level 3 Financial Assets and Liabilities measured at fair value on a recurring basis for the year ended December 31, 2012 are as follows:
(1) Realized and unrealized gains (losses) are reported in Other income in the Consolidated Statements of Operations.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
Changes in Level 3 Financial Assets and Liabilities measured at fair value on a recurring basis for the year ended December, 2011 are as follows:
(1) Realized and unrealized gains (losses) are reported in Other income in the Consolidated Statements of Operations.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
Quantitative Information about Level 3 Fair Value Measurements
The following table presents quantitative information about the significant unobservable inputs utilized by the Company in the fair value measurement of Level 3 Assets and Liabilities measured at fair value on a recurring basis.
(a) As of December 31, 2012, each asset and liability type consists of one security.
(b) To determine the estimated price per convertible unit, the Company estimated the fair value of a non-controlling interest in the entity utilizing a discounted cash flow, appropriate discount rate and combined discount for lack of control and marketability.
(c) The Company’s future purchase commitment is based on Kyte’s projected earnings through June 30, 2013. In estimating the fair value, the Company utilized post-tax projected earnings for the remaining period through June 30, 2013.
Valuation Processes-Level 3 Measurements-Depending on the instrument, the Company utilizes a valuation technique, including discounted cash flow methods, option pricing methods and present value methods, as indicated above. Valuations are generally conducted by the Company, with consultation of a third-party valuation expert to develop the valuation model when the asset or liability is initially recorded. Each reporting period, the Company updates unobservable inputs utilizing relevant published information, where applicable. The Company has a formal process to review changes in fair value for satisfactory explanation.
Sensitivity Analysis-Level 3 Measurements
Equity derivative contracts - The significant unobservable inputs used in the fair value of the Company’s equity derivative contracts are the expected volatility and an estimated share price. Significant increases (decreases) in expected volatility or estimated share price would result in a higher (lower) fair value measurement.
Convertible note receivable, available-for-sale - The significant unobservable inputs used in the fair value of the Company’s convertible note receivable, available-for-sale, are an estimated credit spread, expected volatility and the estimated price per convertible unit. Significant increases (decreases) in expected volatility or estimated price per convertible unit would result in a higher (lower) fair value measurement. Significant increases (decreases) in the estimated credit spread would result in a lower (higher) fair value measurement.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
Future purchase commitment - The significant unobservable inputs used in the fair value of the Company’s future purchase commitment for the residual 30% equity interest in Kyte are the discount rate and forecasted financial information. Significant increases (decreases) in the discount rate would result in a lower (higher) fair value measurement. Significant increases (decreases) in the forecasted financial information would result in a higher (lower) fair value measurement.
For all significant unobservable inputs used in the fair value measurement of all Level 3 assets and liabilities, a change in one of the inputs would not necessarily result in a directionally similar change in the other.
Assets and Liabilities Measured at Fair Value on a Non-recurring Basis
The Company has cost and equity method investments which are monitored for indicators of impairment each reporting period. If the Company determines that an other-than-temporary impairment has occurred, the investment will be written down to its estimated fair value. There were no assets or liabilities measured at fair value on a non-recurring basis at December 31, 2012.
For the year ended December 31, 2011, in accordance with the provisions of ASC 323-10, the Company determined that certain equity method investments were other-than-temporarily impaired and were written down to their estimated fair value. The Company primarily utilized the income approach by assuming an estimated discount rate and forecasted financial information to determine its estimated fair value. The Company measured this equity method investment at fair value on a non-recurring basis and it is not included in the tables above.
The following table presents the balance of the equity method investments at December 31, 2011 that have been measured at fair value on a non-recurring basis, using the process described above, and the impairment charges recorded during the year ended December 31, 2011:
(1) Impairment losses are recorded within Other expenses in the Consolidated Statements of Operations for the year ended December 31, 2011.
There were no liabilities measured at fair value on a non-recurring basis at December 31, 2011.
17. DERIVATIVE FINANCIAL INSTRUMENTS
The Company uses foreign exchange derivative contracts, including forward contracts and foreign currency swaps, to reduce the effects of fluctuations in certain assets and liabilities denominated in foreign currencies. The Company also hedges a portion of its foreign currency exposures on anticipated foreign currency denominated revenues and expenses by entering into forward foreign exchange contracts. As of December 31, 2012 and December 31, 2011, none of these contracts were designated as foreign currency cash flow hedges under ASC 815-10, Derivatives and Hedging (“ASC 815-10”).
The Company provides brokerage services to its customers for exchange-traded and over-the-counter derivative products, which include futures, forwards and options contracts. The Company may enter into principal transactions for exchange-traded and over-the-counter derivative products to facilitate customer trading activities or to engage in principal trading for the Company’s own account.
The Company monitors market risk exposure from its matched principal business and principal trading business by regularly monitoring its concentration of market risk to financial instruments, countries or counterparties and regularly monitoring trades that have not settled within prescribed settlement periods or volume thresholds. Additionally, market risks
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
are monitored and mitigated by the use of the Company’s proprietary, electronic risk monitoring system, which provides daily credit reports in each of the Company’s geographic regions that analyze credit concentration and facilitates the regular monitoring of transactions against key risk indicators.
For certain derivative contracts, the Company has entered into agreements with counterparties that allow for the netting of positions. The Company reports these derivative contracts on a net-by-counterparty basis when management believes that a legal and enforceable right of offset exists under these agreements.
Fair values of derivative contracts on a gross and net basis as of December 31, 2012 and December 31, 2011 are as follows:
(1) Reflects futures and options on futures contracts within Receivables from brokers, dealers and clearing organizations and options and forwards contracts within Other assets.
(2) Reflects futures and options on futures contracts within Payables to brokers, dealers and clearing organizations and options and forwards contracts within Other liabilities.
In addition, as of December 31, 2012 and December 31, 2011, the Company had outstanding forward foreign exchange contracts with a combined notional value of $96,234 and $128,197, respectively. Approximately $26,390 and $32,743 of these forward foreign exchange contracts represents a hedge of euro-denominated balance sheet positions at December 31, 2012 and December 31, 2011, respectively. The remaining contracts are hedges of anticipated future cash flows.
In addition to the Company’s outstanding forward foreign exchange contracts, the following table includes the outstanding long and short notional amounts on a gross basis of derivative financial instruments as of December 30, 2012 and December 31, 2011:
The following is a summary of the effect of derivative contracts on the Consolidated Statements of Operations for the year ended December 31, 2012 and 2011:
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
(1) For the year ended December 31, 2012, approximately $2,011 of gains on foreign exchange derivative contracts were included within Other income and approximately $4,333 of gains on foreign currency options were included within Total brokerage revenues. For the year ended December 31, 2011, approximately $415 of losses on foreign exchange derivative contracts were included within Other income and approximately $4,505 of gains on foreign currency options were included within Principal transactions.
(2) For the year ended December 31, 2012, approximately $2,475 of losses on equity derivative contracts were included within Other income and approximately $1,320 of gains on equity derivative contracts were included within Principal transactions. For the year ended December 31, 2011, approximately $4,885 of gains on equity derivative contracts were included within Principal transactions.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
18. VARIABLE INTEREST ENTITIES
Non-consolidated VIEs
The Company holds interests in certain VIEs that it does not consolidate. The Company has determined that it is not the primary beneficiary, mostly due to a lack of significant economic interest, voting power and/or power to direct the activities that would most significantly impact the economic performance of the VIE .
As of December 31, 2012 and December 31, 2011, the Company had certain variable interests in non-consolidated VIEs in the form of direct equity interests and a convertible note. The carrying amount of these VIEs was $4,438 and $10,640, respectively, and was recorded within Other assets. These VIEs include an independent brokerage firm with a proprietary trading platform, trading entities in which the Company has provided initial capital to fund trading activities, a commodity pool operator and an investment fund manager. The Company also provides clearing and other administrative services to certain of these non-consolidated VIEs. The maximum exposure to loss on these VIEs was $4,438 and $10,640, as of December 31, 2012 and December 31, 2011, respectively.
As of December 31, 2012, the Company had certain variable interests in non-consolidated VIEs in the form of trading margin accounts in which the Company has an economic interest in profits and losses and has provided initial capital to fund trading activities. The Company also provides clearing and other administrative services to these non-consolidated VIEs. The carrying amount of these VIEs was $9,784 and was recorded within Receivables from brokers, dealers and clearing organizations. The maximum exposure to loss of these VIEs was $10,703 as of December 31, 2012.
The Company has not recorded any liabilities with respect to non-consolidated VIEs.
Consolidated VIEs
In December 2010, Kyte invested in a limited company that is focused on developing a proprietary trading business. The limited company is a VIE and it was determined that the Company is the primary beneficiary of this VIE because the Company, through Kyte, was the provider of the majority of this VIE’s start-up capital and has the power to direct the activities of this VIE that most significantly impact its economic performance, primarily through its voting percentage and consent rights on the activities that would most significantly influence the entity. The consolidated VIE had total assets of $6,428 and $5,618 at December 31, 2012, and December 31, 2011, respectively, which primarily consisted of clearing margin. There were no material restrictions on the consolidated VIE’s assets. The consolidated VIE had total liabilities of $1,558 and $1,154 at December 31, 2012 and December 31, 2011, respectively.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands except share and per share amounts)
19. EQUITY METHOD INVESTMENTS
The Company has investments accounted for under the equity method (see Note 2) with an aggregate carrying value of $26,743 and $28,997, at December 31, 2012 and 2011, respectively, and which are included in Other assets. Included within Equity in net earnings of unconsolidated businesses was $8,569, $10,466 and $3,974 in 2012, 2011 and 2010, respectively, related to these investments. The Company also provides clearing and other administrative services to certain of these equity method investments.
Investments accounted for under the equity method included the following:
· Investments in a number of unconsolidated U.K. brokerage and trading operations acquired in the July 1, 2010 acquisition of Kyte and investments made by Kyte subsequent to the Company’s acquisition; and
· Investments in a number of U.S. based brokerage, trading and investment firms.
For material investments accounted for under the equity method, which include certain brokerage businesses located in the U.K., total revenues, gross profit, net income and the Company’s contractual share of affiliates’ operating results, on an aggregate basis, for the year ended December 31, 2012 were $70,277, $48,558, $38,742, and $6,798, respectively. The aforementioned investees report on a different fiscal year end than the Company. Therefore, the Company has made certain estimates with the summarized financial information provided by management of these equity method investments to align the fiscal year-ends. Total assets and total liabilities, on an aggregate basis, for these material investments were $14,558 and $7,299 at December 31, 2012, respectively. The summarized financial information was prepared in accordance with U.K. GAAP, which the Company has determined is not materially different than if these amounts were prepared in accordance with U.S. GAAP.
As of December 31, 2012, the Company also had 13 investments accounted for under the equity method, which were not included in the paragraph above, as management had determined these investments to be immaterial individually and in the aggregate.
During the year ended December 31, 2011, the Company recorded a $1,863 loss related to the accounting impact of an increased ownership stake in an equity method investment previously accounted for under the cost method. During the year ended December 31, 2011, the Company recorded $521 of pre-tax income representing the Company’s share of equity in prior period earnings of an equity-method investee.
The Company reviews investments accounted for under the equity method for decline in value that may be other than temporary. During the year ended December 31, 2012, the Company did not record any write-downs related to equity method investments. During the year ended December 31, 2011, the Company recorded write-downs of $4,717 related to equity method investments that were determined to be impaired on an other-than-temporary basis. The value of the Company’s ownership interest in these entities was evaluated in light of recent and projected operating losses of these investees. A decline in current and projected cash flows resulted in the value of the Company’s ownership interests being less than the carrying amount of these investments. These write-downs are included in Other expenses in the Consolidated Statements of Operations.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share amounts)
20. REGULATORY REQUIREMENTS
The following material operating subsidiaries of the Company are required to maintain minimum levels of regulatory capital pursuant to applicable regulations:
GFI Securities LLC is a registered broker-dealer with the SEC and FINRA. GFI Securities LLC is also a registered introducing broker with the National Futures Association (“NFA”) and the Commodity Futures Trading Commission (“CFTC”). Accordingly, GFI Securities LLC is subject to the net capital rules under the Exchange Act and the Commodity Exchange Act. Under these rules, GFI Securities LLC is required to maintain minimum Net Capital, as defined by applicable regulations, of not less than the greater of $250 or 2% of aggregate debits, as defined by applicable regulations.
In January 2013, GFI Brokers LLC and Amerex Brokers LLC were registered as introducing brokers with the NFA and CFTC. As introducing brokers, GFI Brokers LLC and Amerex Brokers LLC are also subject to the applicable CFTC minimum capital requirement, which is to maintain Adjusted Net Capital equal to the greater of (i) $45, (ii) for introducing brokers with less than $1,000 in Adjusted Net Capital, $6 per office or $3 per Associated Person, whichever is greater, or (iii) if the introducing broker is also a broker-dealer, the SEC requirement applicable to broker-dealers.
GFI Brokers Limited, GFI Securities Limited, The Kyte Group Limited and Kyte Broking Limited are subject to the capital requirements of the Financial Services Authority in the United Kingdom (“FSA”). In addition, GFI Securities Limited and The Kyte Group Limited are subject to the FSA consolidated capital requirements.
GFI (HK) Securities LLC is subject to the capital requirements of the Securities and Futures Commission in Hong Kong (the “SFC”).
The following table sets forth information about the minimum regulatory capital that certain of the Company’s subsidiaries were required to maintain as of December 31, 2012:
Certain of the Company’s material operating subsidiaries are subject to other financial requirements as set forth below:
GFI (HK) Brokers Ltd. is registered with and regulated by the Hong Kong Monetary Authority. As part of this registration, GFI (HK) Brokers Ltd. is required to maintain stockholders’ equity of 5,000 Hong Kong dollars (or approximately $645). At December 31, 2012, GFI (HK) Brokers Ltd. had stockholders’ equity of 37,291 Hong Kong dollars (or approximately $4,811), which exceeded the minimum requirement by 32,291 Hong Kong dollars (or approximately $4,166).
GFI Group Pte. Ltd. is subject to the compliance requirements of the Monetary Authority of Singapore, which requires that GFI Group Pte. Ltd., among other things, maintain stockholders’ equity of 3,000 Singapore dollars (or approximately $2,464). At December 31, 2012, GFI Group Pte. Ltd. exceeded the minimum requirement by approximately 18,277 Singapore dollars (or approximately $15,012).
GFI Korea Money Brokerage Limited is licensed and regulated by the Ministry of Finance and Economy to engage in foreign exchange brokerage business, and is subject to certain regulatory requirements under the Foreign Exchange Transaction Act. As a licensed foreign exchange brokerage company, GFI Korea Money Brokerage Limited is required to maintain minimum paid-in capital of 5,000,000 Korean Won (or approximately $4,700). At December 31, 2012, GFI Korea Money Brokerage Limited exceeded the minimum requirement for paid-in-capital by approximately 5,606,378 Korean Won (or approximately $5,270).
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share amounts)
These regulatory rules may restrict the Company’s ability to withdraw capital from its regulated subsidiaries. In addition to the requirements set forth above, certain of the Company’s other subsidiaries are subject to minimum net capital, minimum stockholders’ equity or similar requirements of the jurisdictions in which they operate. The Company believes it was in compliance with all of these requirements at December 31, 2012 and 2011.
21. SEGMENT AND GEOGRAPHIC INFORMATION
In accordance with ASC 280-10, Segment Reporting (“ASC 280-10”) and based on the nature of the Company’s operations, products and services in each geographic region, the Company determined that it has five operating segments: (i) Americas Brokerage, (ii) Europe, Middle East and Africa (“EMEA”) Brokerage, (iii) Asia Brokerage, (iv) Clearing and Backed Trading and (v) All Other. The Company’s brokerage operations provide brokerage services in four broad product categories: fixed income, financial, equity and commodity. The Clearing and Backed Trading segment encompasses the Company’s clearing, risk management, settlement and other back-office services, as well as the capital we provide to start-up trading groups, small hedge funds, market-makers and individual traders. The All Other segment captures revenues and costs that are not directly assignable to one of the brokerage or clearing and backed trading operating segments, primarily consisting of the Company’s corporate business activities and operations from software, analytics and market data.
The accounting policies of the segments are the same as those described above in Note 2-Summary of Significant Accounting Policies. The Company evaluates performance of the operating segments based on income (loss) before income taxes, which it defines as revenues less direct expenses. Revenues within each brokerage segment include revenues that are directly related to providing brokerage services along with interest and other income (loss) directly attributable to the operating segment. Revenues within the Clearing and Backed Trading segment primarily include revenues that are directly related to providing clearing services along with the Company’s share of profit (loss) on trading activity from capital investments. The Company’s Clearing and Backed Trading segment incurs exchanges fees on behalf of its clients, which are reflected within Interest and transaction-based expenses. The reimbursement of these fees from the Company’s clients is reflected within Total Revenues. Therefore, the Company evaluates the top-line performance of its Clearing and Backed Trading segment using Revenues, net of interest and transaction-based expenses. Direct expenses of the operating segments are those expenses that are directly related to providing the brokerage or clearing services and trading activities of the operating segments and include compensation expense related to the segment management and staff, communication and market data, travel and promotion, and certain professional fees and other expenses that are directly incurred by the operating segments. However, the Company does not allocate to its brokerage operating segments certain expenses which it manages separately at the corporate level. The unallocated costs include rent and occupancy, depreciation and amortization, professional fees, interest on borrowings and other expenses and are included in the All Other operating segment. Management generally does not consider the unallocated costs in its performance measurement of (i) Americas Brokerage, (ii) Europe, Middle East and Africa (“EMEA”) Brokerage, (iii) Asia Brokerage, and (iv) Clearing and Backed Trading.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share amounts)
Selected financial information for the Company’s reportable segments is presented below for periods indicated:
In addition, with the exception for goodwill, the Company does not identify or allocate assets by operating segment, nor does its chief operating decision maker evaluate operating segments using discrete asset information. See Note 6 for goodwill by reportable segment.
For the years ended December 31, 2012, 2011, and 2010, the U.K. is the only individual foreign country that accounts for 10% or more of the total sales and total long-lived assets. Information regarding revenue for the years ended December 31, 2012, 2011, and 2010, and information regarding long-lived assets (defined as property, equipment, leasehold improvements and software inventory) in geographic areas as of December 31, 2012 and 2011 are as follows:
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share amounts)
Revenues are attributed to geographic areas based on the location of the particular subsidiary of the Company which generated the revenues.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share amounts)
22. PARENT COMPANY INFORMATION
The following presents the Parent company only’s Condensed Statements of Financial condition, Operations and comprehensive (loss) income and Cash flows:
Parent Company Only
Condensed Statements of Financial Condition
(In thousands, except share and per share data)
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share amounts)
Parent Company Only
Condensed Statements of Operations and Comprehensive (Loss) Income
(In thousands)
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share amounts)
Parent Company Only
Condensed Statements of Cash Flows
(In thousands)
Guarantees
From time to time, the Company provides guarantees, on behalf of its subsidiaries, to clients for the purpose of providing credit enhancement for such clients. Such guarantees generally provide that the Company will guarantee the performance of all liabilities, obligations and undertakings owed by such subsidiary with respect to matched principal transactions entered into by such subsidiary with the relevant client. These guarantees are generally terminable on less than 30 days’ notice. The Company has not recorded any contingent liability in the condensed financial statements for these guarantees and believes that the occurrence of any events that would trigger payments under these guarantees is remote.
Advances to Subsidiaries
As of December 31, 2012, 2011 and 2010, the Parent company had receivables from subsidiaries of $189,189, $258,951 and $302,079, respectively, related primarily to the allocation of funds received, from notes payable and the issuance of equity securities to subsidiaries to fund working capital.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except share and per share amounts)
23. SUBSEQUENT EVENTS
On January 18, 2013, Moody’s Investor Services lowered its credit rating on the Company’s 8.375% Senior Notes two notches to B1. See Note 8 for a further discussion of this downgrade and the impact on the Company’s per annum interest expense.
In March 2013, the Company entered into an amendment to its Credit Agreement, which decreased the maximum borrowing capacity to $75,000 until December 2013, at which time $18,750 of the lender commitments mature. The remaining $56,250 of lender commitments mature in December 2015. See Note 8 for further details on the Credit Agreement.
In March 2013, the Company repurchased $10,000 principal amount of its 8.375% Senior Notes on the open market for an aggregate purchase price of $9,602, including accrued interest and sales commissions. The Company funded the repurchase of these notes with borrowings under its Credit Agreement.
Subsequent events have been evaluated for disclosure in the notes to the Consolidated Financial Statements through the filing date of this Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls
As of the end of the period covered by this report, the Company’s management carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act). Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Form 10-K.
Management’s Report on Internal Control Over Financial Reporting
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Internal control over financial reporting is a process designed under the supervision of the Company’s principal executive and principal financial officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with generally accepted accounting principles.
The Company’s internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on its assessment and the COSO criteria, management believes that, as of December 31, 2012, the Company maintained effective internal control over financial reporting.
The Company’s independent registered public accounting firm has audited and issued their auditor’s report on management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012. That report appears on Page 88 of this Form 10-K.
Change in Internal Controls
In addition, the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the Company’s internal controls over financial reporting (as defined in Rule 13A-15(f) of the Exchange Act) and determined that there have been no changes in our internal controls over financial reporting during the fourth quarter of 2012 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required to be furnished pursuant to this item will be set forth under the captions “Election of Directors” and “Executive Officers” in the registrant’s proxy statement (the “Proxy Statement”) to be furnished to stockholders in connection with the 2013 Annual Meeting of Stockholders which we expect will be held on June 6, 2013, and is incorporated herein by reference.
The information required to be furnished pursuant to this item with respect to compliance with Section 16(a) of the Exchange Act will be set forth under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement, and is incorporated herein by reference.
We have adopted a Code of Business Conduct and Ethics that applies to all directors, officers and employees. We have also adopted a Code of Business Conduct and Ethics that is applicable to the Company’s senior financial and accounting officers (including the chief executive officer, chief financial officer and corporate controller). A copy of these codes are posted on the Company’s website, www.gfigroup.com, under the section “Investor Relations-Corporate Governance.” In the event the Company substantively amends or waives a provision of its Codes of Business Conduct and Ethics, the Company intends to disclose the amendment or waiver on the Company’s website as well.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required to be furnished pursuant to this item will be set forth under the caption “Executive Compensation” in the Proxy Statement, and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required to be furnished pursuant to this item will be set forth under the captions “Security Ownership of Certain Beneficial Owners,” “Security Ownership of Directors and Executive Officers” and “Equity Compensation Plan Information” in the Proxy Statement, and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required to be furnished pursuant to this item will be set forth under the caption “Certain Relationships and Related Party Transactions and Director Independence” in the Proxy Statement, and is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required to be furnished pursuant to this item will be set forth under the caption “Fees Paid to Independent Auditors” in the Proxy Statement, and is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements. See Index to Financial Statements on page 87.
(a)(2) Financial Statement Schedules. We have included Schedule II-Valuation and Qualifying Accounts on page 147. All other schedules are omitted as they are not applicable, or the information required is included in the Financial Statements or notes thereto.
(a)(3) Exhibits. The following Exhibits are filed as part of this Report as required by Regulation S-K. Exhibits 10.2 through 10.22 are management contracts or compensatory plans or arrangements.
Number
Description
3.1*
Second Amended and Restated Certificate of Incorporation of the Registrant (Filed as Exhibit 3.1 to the Company’s Annual Report on Form 10-K filed on March 31, 2005, File No. 000-51103)
3.1.1*
Certificate of Amendment to Certificate of Incorporation (Filed as Exhibit 3.1.1 to the Company’s Annual Report on Form 10-K filed on February 29, 2008, File No. 000-51103)
3.2*
Third Amended and Restated Bylaws of the Registrant (Filed as Exhibit 3.2 to the Company’s Current Report on Form 8-K filed on February 13, 2013)
4.1*
See Exhibits 3.1, 3.1.1 and 3.2 for provisions of the Second Amended and Restated Certificate of Incorporation and Third Amended and Restated Bylaws of the Registrant defining the rights of holders of Common Stock of the Registrant.
4.2*
Specimen Stock Certificate (Filed as Exhibit 4.2 to Amendment No. 5 to the Company’s Registration Statement on Form S-1 filed on January 24, 2005, File No. 333-116517)
4.3*
Indenture, dated as of July 19, 2011, by and between GFI Group Inc., as Issuer, and The Bank of New York Mellon Trust Company, N. A., as Trustee, relating to the 8.375% Senior Notes due 2018 of GFI Group, Inc. (Filed as Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on July 22, 2011, File No.001-34897)
4.4*
Registration Rights Agreement, dated as of July 19, 2011, by and between GFI Group Inc. and Jefferies & Company, Inc., relating to the GFI Group Inc.’s 8.375% Senior Notes due 2018 (Filed as Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on July 22, 2011)
4.5*
Form of Exchange 8.375% Senior Note due 2018 (Filed as Exhibit 4.4 to Amendment No. 1 to the Company’s Registration Statement on Form S-4 filed on November 14, 2011, File No. 333-177459)
10.1*
Second Amended and Restated Credit Agreement, dated December 20, 2010, among the Registrant and GFI Holdings Limited, as borrowers, subsidiaries of the Registrant named therein, as guarantors, Bank of America, N.A., as administrative agent, Barclays Bank Plc and The Royal Bank of Scotland PLC, as co-syndication agents, the other lenders party thereto and Merrill Lynch, Pierce, Fenner & Smith Incorporated and Barclays Bank PLC, as joint lead arrangers and joint book running managers (Filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on December 22, 2010, File No. 000-51103)
10.2*
Disability Agreement, dated as of December 30, 2004, between the Registrant and Michael A. Gooch (Filed as Exhibit 10.4 to Amendment No. 5 to the Company’s Registration Statement on Form S-1 filed on January 24, 2005, File No. 333-116517)
10.3*
Employment Agreement, dated as of November 18, 2002, between the Registrant and James A. Peers (Filed as Exhibit 10.6 to Amendment No. 2 to the Company’s Registration Statement on Form S-1 filed on September 17, 2004, File No. 333-116517)
Number
Description
10.4*
Guardian Trust of GFI Brokers Limited (Filed as Exhibit 10.10 to Amendment No. 2 to the Company’s Registration Statement on Form S-1 file don September 17, 2004, File No. 333-116517)
10.5*
Employment Agreement, dated as of August 20, 2008, between GFI Group Inc. and Ronald Daniel Levi (Filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on August 22, 2008, File No. 000-51103)
10.6*
Employment Agreement, dated March 26, 2007, between GFI Group Inc. and Scott Pintoff (Filed as Exhibit 10.16 to the Company’s Quarterly Report on Form 10-Q filed on May 10, 2007, File No. 000-51103)
10.7*
Employment Agreement, dated March 26, 2007, between GFI Group Inc. and J. Christopher Giancarlo (Filed as Exhibit 10.16 to the Company’s Quarterly Report on Form 10-Q filed on May 10, 2007, File No. 000-51103)
10.8*
Employment Agreement, dated April 30, 2007, between GFI Group Inc. and Colin Heffron (Filed as Exhibit 10.1 to the Company’s current report on Form 8-K filed on May 2, 2007, File No. 000-51103)
10.9*
GFI Group Inc. 2008 Equity Incentive Plan (Filed as Exhibit 10.22 to the Company’s Quarterly Report on Form 10-Q filed on August 8, 2008, File No. 000-51103)
10.10*
GFI Group Inc. 2008 Senior Annual Bonus Plan (Filed as Exhibit 10.23 to the Company’s Quarterly Report on Form 10-Q filed on August 8, 2008, File No. 000-51103)
10.11*
Amendment No. 1 to Disability Agreement, dated December 31, 2008, between GFI Group Inc. and Michael Gooch (Filed as Exhibit 10.25 to the Company’s Annual Report on Form 10-K filed on March 2, 2009, File No. 000-51103)
10.12*
Amendment No. 1 to Employment Agreement, dated December 24, 2008, between GFI Group Inc. and James Peers (Filed as Exhibit 10.26 to the Company’s Annual Report on Form 10-K filed on March 2, 2009, File No. 000-51103)
10.13*
Amendment No. 1 to Employment Agreement, dated December 31, 2008, between GFI Group Inc. and Colin Heffron (Filed as Exhibit 10.27 to the Company’s Annual Report on Form 10-K filed on March 2, 2009, File No. 000-51103)
10.14*
Amendment No. 1 to Employment Agreement, dated December 31, 2008, between GFI Group Inc. and Ronald Levi (Filed as Exhibit 10.28 to the Company’s Annual Report on Form 10-K filed on March 2, 2009, File No. 000-51103)
10.15*
Amendment No. 1 to Employment Agreement, dated December 31, 2008, between GFI Group Inc. and Scott Pintoff (Filed as Exhibit 10.29 to the Company’s Annual Report on Form 10-K filed on March 2, 2009, File No. 000-51103)
10.16*
Amendment No. 1 to Employment Agreement, dated December 5, 2008, between GFI Group Inc. and J. Christopher Giancarlo (Filed as Exhibit 10.30 to the Company’s Annual Report on Form 10-K filed on March 2, 2009, File No. 000-51103)
10.17*
Amendment No. 2 to Employment Agreement, dated March 30, 2009, between GFI Group Inc. and Ronald Levi (Filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed May 11, 2009, File No. 000-51103)
10.18*
First Amendment to the GFI Group Inc. 2008 Equity Incentive Plan (Filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on August 10, 2009, File No. 000-51103)
10.19*
Second Amendment to the GFI Group Inc. 2008 Equity Incentive Plan (filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on August 9, 2010, File No. 000-51103)
Number
Description
10.20*
Third Amendment to the GFI Group Inc. 2008 Equity Incentive Plan (Filed on Exhibit 10.20 to the Company’s Annual Report on Form 10-K filed on March 15, 2012, File No. 000-51103)
10.21*
Fourth Amendment to the GFI Group Inc. 2008 Equity Incentive Plan (Filed on Exhibit 10 to the Company’s Quarterly Report on Form 10-Q filed on August 9, 2012, File No. 000-51103)
10.22*
GFI Group Inc. Deferred Cash Award Program (Filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed on February 14, 2013, File No. 001-34897)
10.23*
First Amendment to Credit Agreement and Consent, dated as of March 6, 2013, among GFI Group Inc. and GFI Holdings Limited, as Borrowers, certain subsidiaries of the Company as Guarantors, various Lenders and, Bank of America, N.A., as Administrative Agent (Filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed on March 7, 2013)
Computation of Ratio of Earnings to Fixed Charges
21.1
List of subsidiaries of the Registrant
23.1
Consent of Independent Registered Public Accounting Firm- PricewaterhouseCoopers LLP
23.2
Consent of Independent Registered Public Accounting Firm- Deloitte & Touche LLP
31.1
Certification of Principal Executive Officer.
31.2
Certification of Principal Financial Officer.
32.1
Written Statement of Chief Executive Officer Pursuant to Section 9.06 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
32.2
Written Statement of Chief Financial Officer Pursuant to Section 9.06 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
101.INS**
XBRL Instance Document
101.SCH**
XBRL Taxonomy Extension Schema Document
101.CAL**
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF**
XBRL Taxonomy Extension Definition Linkbase
101.LAB**
XBRL Taxonomy Extension Label Linkbase Document
101.PRE**
XBRL Taxonomy Extension Presentation Linkbase Document
(*) Previously filed.
(**) Furnished with this Annual Report on Form 10-K and included in Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Statements of Financial Condition as of December 31, 2012 and December 31, 2011, (ii) the Consolidated Statements of Operations for the years ended December 31, 2012, 2011, and 2010 (iii) the Consolidated Statements of Comprehensive Income for the years ended December 31, 2012, 2011, and 2010, (iv) the Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 2010, (v) the Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2012, 2011, and 2010 and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text. As provided in Rule 406T of Regulation S-T, this information is “furnished” and not “filed” for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934. Such exhibit will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934 unless GFI Group, Inc. specifically incorporates it by reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report on Form 10-K for the fiscal year ended December 31, 2012 to be signed on its behalf by the undersigned, thereunto duly authorized, on the 13th day of March, 2013.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report on Form 10-K has been signed by the following persons in the capacities and on the dates indicated.
Signature
Title
Date
/s/ MICHAEL GOOCH
Executive Chairman of the Board
March 13, 2013
Michael Gooch
/s/ COLIN HEFFRON
Chief Executive Officer (principal executive
March 13, 2013
Colin Heffron
officer) and Director
/s/ JAMES A. PEERS
Chief Financial Officer (principal financial
March 13, 2013
James A. Peers
and accounting officer)
/s/ JOHN W. WARD
Director
March 13, 2013
John W. Ward
/s/ MARISA CASSONI
Director
March 13, 2013
Marisa Cassoni
/s/ FRANK FANZILLI, JR.
Director
March 13, 2013
Frank Fanzilli, Jr.
/s/ RICHARD W. P. MAGEE
Director
March 13, 2013
Richard W. P. Magee
Schedule II
GFI GROUP INC. AND SUBSIDIARIES
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
(a) For all periods it includes the effects for exchange rate changes.
(b) Net adjustments to the reserve accounts for write-offs and credits issued during the years.