ITEM 1. BUSINESS.
(a) GENERAL DEVELOPMENT OF BUSINESS
McDonald & Company Investments, Inc. is a holding company which was incorporated under the laws of the State of Delaware on May 20, 1983. As used in this Report, the "Company" refers, unless the context requires otherwise, to McDonald & Company Investments, Inc. and its subsidiaries. McDonald & Company Investments, Inc. conducts substantially all of its business through its principal subsidiary, McDonald & Company Securities, Inc. ("McDonald Securities"), which operates a regional investment banking, investment advisory and brokerage business. The Company also provides personal trust services through its wholly-owned subsidiary, McDonald Trust Company.
Effective October 4, 1991, the Company entered into an agreement of Merger with Gradison & Company Incorporated, ("Gradison"). Gradison operated as a full-service regional brokerage and investment advisory firm headquartered in Cincinnati, Ohio with a primary market of southwestern Ohio and northern Kentucky. Subsequent to the merger, Gradison operates as a division of McDonald Securities. The merger allowed the Company to increase the size of its retail sales force and its customer base and gave the Company a strong presence in southwestern Ohio. Gradison also added significant asset management capabilities to the Company.
The Company's executive offices are located at McDonald Investment Center, 800 Superior Avenue, Cleveland, Ohio 44ll4-2603 and its telephone number is (216) 443-2300. The Company has 22 other offices in Ohio (including the Gradison Division in Cincinnati, Ohio and the S. J. Wolfe Division in Dayton, Ohio) and 19 additional offices in 10 other states.
(b) INDUSTRY SEGMENT DATA
The Company is engaged in one line of business, that of a securities broker-dealer, which is comprised of several classes of products or services including underwriting and investment banking, principal and agency transactions, and investment advisory services.
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ITEM 1. BUSINESS--Continued
(c) NARRATIVE DESCRIPTION OF BUSINESS
GENERAL - -------
The Company, through its principal subsidiary, McDonald Securities, operates a regional investment banking and brokerage business. The Company's activities include the origination, underwriting, distribution, trading and brokerage of fixed income and equity securities, investment advisory services, and investment research and other related services. On July 20, 1983, the Company succeeded to the business of McDonald & Company, a partnership, which was established in 1927. The Company has expanded to its present size primarily through internal growth rather than by acquisition, except for the merger with Gradison.
The Company serves institutional customers which are located throughout the United States and in Canada, Europe, and the Far East. The Company's retail (individual) customers are primarily located in the tri-state region of Ohio, Michigan and Indiana. For the fiscal year ended March 28, 1997, approximately 53% of total revenues were derived from retail customers, 21% from institutional customers, 18% from non-customer related principal transactions, investment banking fees and other activities and 8% from interest and dividend income.
The Company has formulated a comprehensive strategic plan, which is periodically reviewed and revised as business conditions dictate. The plan emphasizes the Company's historical roots as a regional brokerage and investment banking firm. The Company has focused on the Ohio, Michigan and Indiana area by increasing the number of investment brokers covering individual investors, as well as increasing investment banking activities in the region. The merger with Gradison has enabled the Company to expand its retail sales force and its customer base in southwestern Ohio and northern Kentucky, and has added significantly to the Company's asset management capabilities.
McDonald Securities is a member of the New York Stock Exchange, Inc. (the "NYSE"), the American Stock Exchange, Inc. (Associate), the Midwest Stock Exchange, Inc., the Philadelphia Stock Exchange, Inc. and the National Association of Securities Dealers, Inc. (the "NASD"). The Company is also a member of the Securities Investor Protection Corporation ("SIPC").
The Company has a total of 42 offices in 11 states, all of which offices are leased. The Company has approximately 1,300 employees, of whom 322 are full-time retail investment consultants and 81 are full time institutional investment consultants.
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ITEM 1. BUSINESS--Continued
REVENUES BY SOURCE - ------------------
The following table sets forth the revenues of the Company on a comparative basis for the three most recent fiscal years.
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ITEM 1. BUSINESS--Continued
UNDERWRITING AND INVESTMENT BANKING - -----------------------------------
McDonald Securities participates in corporate and municipal securities distributions as a manager or co-manager of an underwriting syndicate or as a member thereof, or as a member of a selling group. Municipal securities are obligations issued by state and local governments, hospitals, public utility systems and industrial development authorities.
Revenues from underwriting and investment banking activities are highly dependent on general market conditions for such business activities. Market conditions for underwriting and investment banking services can be affected by political and economic events both in the United States and abroad. To the extent future events are unpredictable, uncertainty will be a factor in the level of McDonald's business activity. Also, competitive pressure from other investment bankers has an effect on the success of McDonald Securities in obtaining such business and on the prices which can be charged for investment banking and underwriting services. The management of McDonald Securities believes it can compete effectively in this segment of its business activities.
Participation in an underwriting syndicate or selling group involves both economic and regulatory risks. An underwriter or selling group member may incur losses if it is forced to resell the securities it is committed to purchase at less than the agreed purchase price. In addition, under the federal securities laws, other statutes and court decisions with respect to underwriters' liabilities and limitations on indemnification of underwriters by issuers, an underwriter is subject to substantial potential liability for material misstatements or omissions in prospectuses and other communications with respect to underwritten offerings. Further, underwriting or selling commitments constitute a charge against net capital, and the Company's underwriting or selling commitments may be limited by the requirement that it must at all times be in compliance with the net capital rule. See "Net Capital Requirements."
In addition to its underwriting and selling group activities, McDonald Securities engages in structuring, managing and marketing private offerings of corporate and municipal securities, and assists in arranging mergers, acquisitions, divestitures, lease financing and venture capital financing. The Company provides valuation and financial consulting services for gift and estate tax purposes, employee stock ownership trusts, mergers, acquisitions, stock purchase agreements, and other corporate purposes, as well as valuations for public companies in the process of going private.
McDonald Securities also markets investments in real estate, primarily qualified low-income housing tax credit funds, and similar ventures. These investments generally are in the form of limited partnership interests, which are primarily marketed to institutional investors. In most cases McDonald Securities originates such programs, and other subsidiaries of the Company may act as a general partner.
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ITEM 1. BUSINESS--Continued
PRINCIPAL TRANSACTIONS - ----------------------
McDonald Securities actively engages in trading as principal in various phases of the over-the-counter securities business. To facilitate trading by its customers, McDonald Securities buys, sells and maintains inventories of municipal bonds, corporate bonds, government bonds, mortgage-backed securities, common stocks and preferred stocks in order to "make markets" in those securities. Revenues from principal transactions depend upon the general trend of prices and level of activity in the securities market, the skill of employees in market-making areas and the size of the inventories. Activities in trading as a principal require the commitment of capital and create an opportunity for profit and risk of loss due to market fluctuations. As of March 28, 1997, McDonald Securities made markets in the common stock or other equity securities of approximately 300 NASDAQ-quoted corporations, as well as other corporations with less actively traded securities. McDonald Securities has acted as a managing underwriter for and provides research coverage of certain of these corporations.
In executing customers' orders to buy or sell in the over-the-counter market in a security in which it makes a market, McDonald Securities sells to or purchases from its customers at a price which is approximately equal to the current inter-dealer market price, plus or minus a markup or markdown. Alternatively, McDonald Securities may act as agent and execute a customer's purchase or sale order with another broker-dealer which acts as a market-maker at the best inter-dealer market price available and charge a commission.
The Securities and Exchange Commission has recently adopted significant market structure rules under the Securities and Exchange Act of 1934 involving the handling and execution of customer limit orders. A market maker in over-the-counter securities is now required to display in their quote the price and full size of customer limit orders. In addition, market makers are also required to display in their quote any better priced orders that the market maker places into an electronic network such as Selectnet or Instinet, unless an alternative provided by the rule is available. The effect of these rules will be to narrow spreads on NASDAQ trades and to reduce the potential for trading profit on dealer to dealer trades. Approximately 20% of the NASDAQ-quoted companies in which McDonald Securities makes a market are currently subject to these rules. Eventually, 100% of these companies will be subject to these rules. As more companies become subject to these rules, McDonald Securities' profitability from trading NASDAQ-quoted companies will be reduced.
McDonald Securities is a dealer in corporate, mortgage-backed, and government fixed income securities which are carried in inventory primarily for distribution to individual and institutional customers. McDonald Securities buys, sells and positions mortgage-derivative securities and structured notes. Holdings of high-yield securities are not material. McDonald Securities may enter into short positions in United States Treasury securities in order to hedge its interest rate risk related to fixed income securities.
The Company's securities positions are subject to fluctuations in market value and liquidity. The Company seeks to minimize the risks associated with owning securities by monitoring its security positions on an ongoing basis. The Company marks its securities to market daily. In addition, each trading department adheres to a risk limit and a capital commitment limit determined by senior management. Senior management regularly reviews the Company's securities positions to ensure that these limits are not exceeded.
COMMISSIONS - -----------
In executing customers' orders to buy or sell listed securities and unlisted stocks and bonds in which it does not make a market, McDonald Securities generally acts as an agent and charges a commission which is competitive within the industry.
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ITEM 1. BUSINESS--Continued
INVESTMENT MANAGEMENT FEES - --------------------------
Revenues from investment management fees include advisory fees from the Company's mutual funds and money market funds and investment advisory fees earned related to individual managed accounts.
Under asset management programs, the Company provides investment advisory services to individual, corporate and employee benefit plan clients. Investment advisory fees for the fiscal year ended March 28, 1997 from individual managed accounts represented approximately 58% of total revenues from investment management fees.
As of March 28, 1997, McDonald Securities is the investment advisor to and the distributor of the following mutual funds: Gradison-McDonald Cash Reserve Trust, which is comprised of one portfolio, Gradison U.S. Government Reserves ("GMU", a money market fund investing in U.S. Government Securities), Gradison Custodian Trust, which is comprised of one portfolio, Gradison Government Income Fund ("GIF", a U.S. Government Securities income fund), Gradison-McDonald Municipal Custodian Trust, which is comprised of one portfolio, Gradison Ohio Tax-Free Income Fund ("GMO", a double tax-free income fund for Ohio investors), Gradison Growth Trust, which is comprised of four portfolios, Gradison Established Value Fund ("EST", a common stock fund investing in large, established companies), Gradison Opportunity Value Fund ("OPP", a common stock fund investing in small companies), Gradison Growth & Income Fund ("GRI", a common stock fund seeking long-term growth of capital, current income and growth of income) and Gradison International Fund ("INT", a common stock fund investing in non-United States companies). INT was established during the fiscal year ended March 29, 1996. All of these funds are diversified, open-end management investment companies.
As of March 29, 1996, McDonald Securities was also the investment advisor to and sole distributor of Gradison-McDonald Intermediate Municipal Income Fund ("IMI," an intermediate term municipal income fund), a portfolio in the Gradison-McDonald Municipal Custodian Trust. IMI, a diversified, open-ended management investment company, was liquidated on August 16, 1996.
The following summarizes the number of accounts and the size of each of the Funds as of March 28, 1997 and March 29, 1996:
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ITEM 1. BUSINESS--Continued
INVESTMENT MANAGEMENT FEES (cont.) - ----------------------------------
The investment advisory fees received from these funds are directly related to the amounts invested in the funds. Accordingly, McDonald Securities' investment advisory fees from the investment companies would be reduced in the future if the amounts invested in the funds decrease.
McDonald Securities also receives reimbursements from the Gradison Funds for providing such funds with data processing, shareholder services and other miscellaneous services.
INTEREST AND DIVIDENDS - ----------------------
A significant portion of the Company's pretax income is derived from interest income net of interest expense. The amount of interest and dividend income is directly impacted by the level of securities owned and customer margin account balances, and by general fluctuations in interest rates. Approximately 57% of interest and dividend income represents interest charged to customers on the amount borrowed to finance margin transactions. The rate of interest charged to customers is based on the broker's call money rate (the interest rate on bank loans to brokers secured by firm and customers' margin account securities) to which an additional amount, up to 2.5%, is added depending on the size of the debit balance. Approximately 33% of the Company's interest and dividend income is generated from securities owned. Of the remaining 10% of the Company's interest and dividend income, approximately 8%, is generated from securities borrowed and approximately 2% represents dividend income.
OTHER - -----
During the fiscal year ended March 28, 1997, approximately 29% of other income represents service fees, IRA administration fees, and other retail-related revenues compared to 27% and 37%, respectively, for the fiscal years ended in March 1996 and 1995. Approximately 44% of other income represents transfer agent fees and other fees derived from the Company's money market and mutual funds compared to 36% and 49%, respectively, for the fiscal 1996 and 1995 years. For the fiscal year ended March 28, 1997, 17% of other income represented revenues related to certain venture capital investments, compared to 24% in fiscal 1996 and 6% in fiscal 1995. The Company periodically invests in venture capital and other investments in the form of limited partnerships, general partnerships and equity positions. Miscellaneous income represented 10%, 13% and 8% of other income, respectively, in the fiscal years ended March 1997, 1996 and 1995.
RETAIL BUSINESS - ---------------
During the fiscal year ended March 28, 1997, approximately 72% of the Company's total revenues from customers were from individuals. During the fiscal year ended March 28, 1997, approximately 28% of the revenues from individual accounts were derived from agency transactions in listed and unlisted securities. Individual commission rates on agency transactions are based upon a schedule which is competitive within the securities industry. Discounts from the schedule may be granted to retail customers on large trades.
Approximately 29% of revenues from individual customers were derived from propriety and nonpropriety mutual funds. These revenues include sales charges, fees received from the funds under Section 12(b)(1), and advisory fees and other fee income related to the propriety mutual funds. Approximately 20% of retail-related revenues are derived from principal transactions in equity and debt securities. The remaining 23% of retail-related revenues include revenues from the sale of investment banking products and revenues from the sale of annuities, life insurance and other products.
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ITEM 1. BUSINESS--Continued
INSTITUTIONAL BUSINESS - ----------------------
During the fiscal year ended March 28, 1997, approximately 28% of the Company's total revenues from customers were from institutions. Institutional customers include banks, insurance companies, thrift institutions, pension funds, mutual funds and money managers. During the fiscal year ended March 28, 1997, approximately 50% of the revenues from institutional accounts were derived from principal transactions, 31% from investment banking and 19% from agency transactions. Commissions charged on agency transactions on behalf of institutional customers are on a negotiated basis and represent a significant discount from the Company's retail commission schedule.
MARGIN ACCOUNTS - ---------------
Customers' transactions in securities are effected on either a cash or margin basis. Purchases and sales on a cash basis require full payment or delivery of securities by the designated settlement date, generally the third business day following the transaction date. McDonald Securities is at risk in the event a customer fails to settle a trade and the value of the securities declines, for a customer purchase or increases, for a customer sale, subsequent to the transaction date. In a margin account, the customer pays a portion of the cost of securities purchased and the broker-dealer makes a loan for the balance, secured by the securities purchased or other securities owned by the investor. The amount of the loan is subject to the margin regulations (Regulation T) of the Board of Governors of the Federal Reserve System, NYSE margin requirements and McDonald Securities' internal policies, which in some instances are more stringent than Regulation T or NYSE margin requirements. Currently, in most transactions Regulation T limits the amount loaned to a customer for the purchase of a particular security to 50% of the purchase price. In the event of a decline in the market value of the securities in a customer's margin account, a member firm, under NYSE rules, is required to have the customer deposit cash or additional securities so that the loan to the customer is no greater than 75% of the value of collateral securities in the account. In permitting customers to purchase securities on margin, McDonald Securities is subject to the risk of a market decline which could reduce the value of its collateral below the customers' indebtedness.
SECURITY REPURCHASE ACTIVITIES - ------------------------------
McDonald Securities acts as principal in the purchase and sale to its customers of securities of the United States Government and its agencies, including repurchase agreements in such securities. McDonald Securities may match purchases and sales of these securities and is at risk to the extent that it does not properly match the contracts or their customers are unable to meet their obligations, especially during periods of rapidly changing interest rates and fluctuations in market conditions. All positions are collateralized. McDonald Securities generally takes physical possession of securities purchased under agreements to resell. Such agreements provide McDonald Securities with the right to maintain the relationship between the market value of the collateral and the receivable. Typically, these contracts are entered into only with clients of substantial size and credit-worthiness. McDonald Securities also utilizes securities sold under repurchase agreements as a means of financing portions of its trading inventories and facilitating hedging transactions.
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ITEM 1. BUSINESS--Continued
SECURITIES BORROWING AND LENDING ACTIVITIES - -------------------------------------------
McDonald Securities borrows securities from other brokers and dealers to facilitate short sales and clearance and delivery of securities that have been sold by their customers when such customers fail to deliver securities prior to settlement date. McDonald Securities also borrows securities to cover short positions in NASDAQ securities in the ordinary course of business in its over-the-counter trading operations. McDonald Securities pays to the lending broker a cash deposit generally equal to 102 percent of the market value of the securities borrowed and receives interest on the cash deposit. McDonald Securities is at risk to the extent that the securities it borrows decline in value and the loaning broker fails to return McDonald Securities' cash deposit.
When engaging in securities lending activities, McDonald Securities lends excess customer margin securities to the borrowing broker and collects cash deposits that collateralize the securities loaned. In securities lending transactions, McDonald Securities is at risk to the extent that it does not maintain the relationship between the market value of securities loaned and the value of the cash deposit held.
RESEARCH SERVICES - -----------------
McDonald Securities maintains both an equity and fixed income research staff which concentrates its efforts on regional research services for both retail and institutional customers. McDonald Securities employs 26 equity analysts who cover approximately 250 companies, a majority of which maintain their headquarters in the Midwest. 9 of the 26 analysts are Chartered Financial Analysts.
Research services are made available generally without charge to customers. Research services include the review and analysis of the economy, general market conditions, industries and specific companies; recommendation of specific action with regard to industries and specific companies; review of customer portfolios; the furnishing of information to retail and institutional customers; and responses to inquiries from customers and investment brokers. In addition, McDonald Securities purchases several outside research services which provide its customers with research more national in scope.
Management believes that a significant portion of its institutional equity business is attributable to research services. McDonald Securities provides services to a nationwide institutional base as well as to institutional clients in Canada, England, Scotland, Germany, Switzerland and the Far East.
COMPETITIVE FACTORS - -------------------
Considerable consolidation has occurred in the securities industry as numerous securities firms have either ceased operation or been acquired by other securities firms, in many cases resulting in firms with greater financial resources than firms such as McDonald Securities. In addition, a number of substantial companies (mostly commercial banks) not previously engaged in the securities business have made investments in and acquired securities firms. These developments have resulted in significant additional competition for McDonald Securities. Increasing competitive pressures in the securities industry are requiring regional firms such as McDonald Securities to offer to their customers many of the financial services which are provided by much larger securities firms that have substantially greater resources and may have greater operating efficiencies than McDonald Securities.
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ITEM 1. BUSINESS--Continued
COMPETITIVE FACTORS (cont.) - ---------------------------
McDonald Securities competes with other securities firms and with banks, insurance companies, and other financial institutions principally on the basis of service, product selection, price, location and reputation in local markets. McDonald Securities operates at a price disadvantage to discount brokerage firms that do not offer equivalent services. These firms generally effect transactions at lower commission rates on an "execution only" basis, without offering other services such as investment advice and research which are provided by "full-service" brokerage firms such as McDonald Securities. In addition, some discount brokerage firms have increased the range of services which they offer. The existence of and anticipated continued increase in the number of discount brokerage firms and services provided by such firms may adversely affect the Company.
Certain institutions, notably commercial banks and thrift institutions, have become a competitive factor by offering certain investment banking and corporate and individual financial services traditionally provided only by securities firms. With the prior approval of the Federal Reserve, securities subsidiaries of bank holding companies may now underwrite and deal in corporate debt and equity securities, provided that they comply with certain firewalls and that the revenues from such activities do not exceed 25 percent of the securities subsidiary's total revenues. Legislative proposals currently under consideration would eliminate this limit on such activities and would permit banks, bank holding companies and their subsidiaries and affiliates to offer additional services which have traditionally been provided only by securities and money management firms. While it is presently not possible to predict the type and extent of competitive services which banks and other institutions ultimately may offer or the extent to which administrative or legislative barriers will be repealed or modified, to the extent that such services are offered on a large scale, securities firms such as McDonald Securities may be adversely affected.
EMPLOYEES - ---------
The Company has 1,291 employees, of whom 18 have senior managerial responsibilities, 403 are full-time investment brokers, 250 are engaged in other production areas, including trading, research, investment banking, and investment advisory, and 620 are employed in processing securities transactions, accounting, management information systems, mutual fund services, personnel and other administrative services.
Competition among securities firms and other competitors for successful investment brokers, securities traders, investment bankers and research analysts is intense. The Company recognizes the importance of hiring, training and retaining investment brokers. The Company trains new investment brokers who are required to take examinations given by the NYSE, the NASD and various states in order to be registered and qualified. The Company also provides ongoing training programs for investment brokers. The Company has experienced a relatively low rate of turnover of investment brokers. From time to time, however, the Company experiences the loss of valuable personnel.
The Company considers its employee relations to be good and believes that its compensation and employee benefits, which include medical, life and disability insurance, and a 401(k) defined contribution and profit-sharing plan, are competitive with those offered by other securities firms. None of the Company's employees is covered by a collective bargaining agreement.
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ITEM 1. BUSINESS--Continued
REGULATION - ----------
The securities industry in the United States is subject to extensive regulation under federal and state laws. The Securities and Exchange Commission (the "Commission") is the federal agency charged with administration of the federal securities laws. Much of the regulation of broker-dealers, however, has been delegated to self-regulatory organizations, principally the NASD and the national securities exchanges. These self-regulatory organizations adopt rules (which are subject to approval by the Commission) which govern the industry and conduct periodic examinations of member broker-dealers. Securities firms are also subject to examination by state securities commissions in the states in which they are registered. McDonald Securities is currently registered as a broker-dealer in all states. In addition, McDonald Securities is registered as a broker-dealer with the Commission.
The regulations to which broker-dealers are subject cover all aspects of the securities business, including sales methods, trade practices among broker-dealers, capital structure of securities firms, record-keeping and the conduct of directors, officers and employees. Additional legislation, changes in rules promulgated by the Commission and by self-regulatory organizations, or changes in the interpretation or enforcement of existing laws and rules often directly affect the method of operation and profitability of broker-dealers. The Commission and the self-regulatory organizations may conduct administrative proceedings which can result in censure, fine, suspension or expulsion of a broker-dealer, its officers or employees. The principal purpose of regulation and discipline of broker-dealers is the protection of customers and the securities market rather than protection of creditors and stockholders of broker-dealers.
The Company anticipates regulation of the securities industry to increase and for compliance with regulations to become more difficult. At present the Company is unable to predict the extent of changes that may be enacted, or the effect on the Company's business.
McDonald Securities' Compliance Committee has the responsibility of performing reviews to provide reasonable assurance that the officers, directors, and employees comply with the regulatory requirements of the Commission, self-regulatory agencies, and McDonald Securities' internal requirements.
McDonald Securities is required by federal law to belong to the SIPC. When the SIPC fund falls below a certain minimum amount, members are required to pay annual assessments to restore the fund. The SIPC fund provides protection for securities held in customer accounts up to $500,000 per customer, with a limitation of $100,000 on claims for cash balances.
NET CAPITAL REQUIREMENTS - ------------------------
As a broker-dealer and member of the NYSE, McDonald Securities is subject to the Uniform Net Capital Rule promulgated by the Commission (Rule 15c3-1) which provides that a broker-dealer doing business with the public shall not permit its aggregate indebtedness (as defined) to exceed 15 times its net capital (as defined) or, alternatively, that its net capital shall not be less than 2% of aggregate debit balances (primarily receivables from customers) computed in accordance with Rule 15c3-3. The Rule is designed to measure the general financial integrity and liquidity of a broker-dealer and the minimum net capital deemed necessary to meet the broker-dealer's continuing commitments to its customers. Management believes that the alternative method is more directly related to the level of customer business, therefore McDonald Securities computes its net capital under the alternative method.
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ITEM 1. BUSINESS--Continued
NET CAPITAL REQUIREMENTS (cont.) - --------------------------------
A broker-dealer may be required to reduce its business if its net capital is less than 4% of aggregate debit balances and may be prohibited from expanding its business or declaring cash dividends if its net capital is less than 5% of aggregate debit balances. In addition, a broker-dealer may be subject to disciplinary action by the Commission and self-regulatory agencies, such as the NYSE, including fines, censure, suspension or expulsion.
Under Rule 15c3-1 a broker-dealer is required to provide advance written notice to the Commission of any loan, unsecured advance, or withdrawal of equity capital which exceeds, in any 30 day period, 30% of excess net capital. Additionally, written notice must be given to the Commission of any loan, unsecured advance, or withdrawal of equity capital which exceeds, in any 30 day period, 20% of excess net capital, within two business days subsequent to the transaction.
In computing net capital, various adjustments are made to net worth with a view to excluding assets which are not readily convertible into cash and to a conservative statement of the other assets such as a firm's position in securities. Compliance with the Uniform Net Capital Rule may limit those operations of a firm which require the use of its capital for purposes of maintaining the inventory required for trading in securities, underwriting securities and financing customer margin account balances. A significant operating loss or an extraordinary charge against net capital could adversely affect the ability of a broker-dealer to expand or even maintain its present level of business. Net capital and aggregate debit balances change from day to day. At March 28, 1997, McDonald Securities' net capital was $78,724,000 which was 39% of its aggregate debit balances and $74,686,000 in excess of the minimum required net capital.
McDonald Securities has outstanding $25,000,000 in aggregate principal amount of 8.24% Subordinated Notes due January 15, 2002. McDonald Securities is required to prepay principal amounts of $5,000,000 on January 15 in each year beginning in 1998. The notes are subordinated in right of payment to all senior indebtedness and general creditors of McDonald Securities. The principal amount of the notes has been approved by the New York Stock Exchange Inc. for inclusion in the regulatory capital of McDonald Securities.
(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES
Not Applicable.
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ITEM 2.
ITEM 2. PROPERTIES.
The Company has a total of 42 offices in 11 states, all of which are leased under lease agreements expiring from 1997 to 2009. Certain of these leases have renewal options. The table below sets forth the location of each of the Company's offices and the number of full-time investment brokers in each office:
The Company's executive office and largest sales office is located in Cleveland, Ohio. The Company's order entry, trading, investment banking, research, operations and accounting activities are primarily centralized in the Cleveland office. The office, which occupies approximately 158,500 square feet of space, is operated under a lease expiring in 2009. The Gradison Division of McDonald Securities is located in Cincinnati, Ohio. The Gradison Division office, which occupies approximately 48,000 square feet of space, is operating under a lease expiring in 2008. Personnel at the Gradison Division are primarily involved in the mutual fund and investment advisory operations, retail sales, management, and also certain accounting and administrative functions. The S. J. Wolfe Division was opened in December, 1990 when the Company acquired certain assets and the business of S. J. Wolfe & Co., a stock brokerage firm. The S. J. Wolfe Division has an over-the-counter trading operation.
The Company believes that at the present time its administrative and sales office space is adequate and is suitably utilized.
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ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
As is the case with many firms in the securities industry, McDonald Securities is a defendant or co-defendant in a number of lawsuits alleging damages, which are ordinary and routine litigation, incidental to the securities and investment banking business. The Company is contesting the allegations of the complaints in these cases and believes that there are meritorious defenses in each of these lawsuits. Some of the proceedings relate to public underwritings of securities in which McDonald Securities participated as a member of the underwriting syndicate. The Company is also aware of litigation against certain underwriters of offerings in which McDonald Securities was a participant, but where McDonald Securities is not now a defendant. In these latter cases, it is possible that McDonald Securities may be called upon to contribute to settlements or judgments.
McDonald Securities is a defendant in STEPHANIE TUBBS JONES ET. AL. V. MCDONALD & CO. SECURITIES, INC., ET. AL. (the "Jones Litigation"), a lawsuit currently pending in Cuyahoga County, Ohio, Court of Common Pleas. The action arose out of losses allegedly incurred by Cuyahoga County's Secured Assets Fund Earnings Program ("SAFE"). McDonald Securities and six other defendants have been named in the lawsuit. The complaint alleges that, in breach of various legal duties allegedly owed to the plaintiff, McDonald Securities and/or the other defendants enabled, facilitated and/or assisted the County's investment staff to engage in unsuitable and inappropriate investment and trading activities and practices. The plaintiff seeks to hold each of the defendants liable for compensatory and consequential damages. In addition, the complaint contains allegations of fraud and negligent misrepresentation against McDonald Securities and another defendant arising out of their respective roles as underwriters of two issuances of tax and current revenue anticipation notes ("TANS/CRANS") during 1993 and 1994. The plaintiff seeks to hold McDonald Securities liable for compensatory, consequential and punitive damages as a result of its role as an underwriter of the TANS/CRANS offerings. In June 1996, the court denied motions to dismiss the plaintiff's claims filed by McDonald Securities and various other defendants. In February 1997, the court granted defendants' motion to disqualify the Cuyahoga County Prosecutor's Office from the case. That ruling is currently being appealed by the plaintiff. In April 1997, pursuant to a stipulation entered into between the plaintiff and McDonald Securities' co-defendant in the allegations related to the TANS/CRANS offerings, the plaintiff dismissed its TANS/CRANS claims against the co-defendant, without prejudice.
On December 23, 1996, McDonald Securities filed an answer denying the allegations of liability made by the plaintiff and raising a number of affirmative defenses to the plaintiff's allegations. McDonald Securities also filed counterclaims against the Cuyahoga County Board of Commissioners (the "Board"). McDonald Securities' counterclaims consist of a breach of contract claim arising out of representations and warranties made by the Board concerning the absence of material misstatements or omissions in the Official Statements for the TANS/CRANS offerings, and an estoppel claim arising out of McDonald Securities' justifiable reliance on assurance provided by the Board concerning, among other things, the investment experience of the Board's agents, the authorizations of the transactions in question by the Board's Investment Committee and the conformity of such transactions with the County's investment policies and procedures. The case is currently in the discovery stage and no trial date has been set. Based on the facts known to date, the Company believes that the plaintiff's claims against McDonald Securities are without merit, and intends to contest vigorously the allegations in the complaint.
On February 29, 1996, the Company filed an application (the "Application") with the Securities and Exchange Commission pursuant to Section 9(c) of the Investment Company Act of 1940 (the "Investment Company Act") for a Temporary Order and a Permanent Order exempting it from the provisions of Section 9(a)(1) of the Investment Company Act. That section prohibits, among other things, any person convicted of a misdemeanor arising out of such person's conduct as a broker-dealer from serving as an investment advisor to, or principal underwriter for, any registered investment company. The Application was prompted by the decision of the Franklin County Court of Common Pleas that the Company violated Section 101.41(C) of the Ohio Revised Code by failing to accurately report certain lawful expenditures (i.e., payments of honoraria to speakers at Company-sponsored meetings) during 1993. The Company has been granted temporary exemptions by the SEC, and its application for a Permanent Order exempting it from Section 9(a)(1) is currently pending. Based upon its discussions with the staff of the SEC and the treatment of similarly situated persons in prior proceedings, the Company has no reason to believe that its application for a permanent exemption will not be granted.
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ITEM 3. LEGAL PROCEEDINGS - Continued
In view of the number and diversity of claims against the Company and the inherent difficulty of predicting the outcome of litigation and other claims, the Company cannot state with certainty what the eventual outcome of pending litigation or other claims will be. The Company provides for costs relating to these matters when a loss is probable and the amount can be reasonably estimated. The effect of the outcome of these matters on the Company's future results of operations cannot be predicted because any such effect depends on future results of operations and the amount and timing of the resolution of such matters. While it is not possible to predict with certainty, management believes that the ultimate resolution of such matters will not have a material adverse effect on the consolidated financial position, liquidity, or results of operations of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
- 17 - EXECUTIVE OFFICERS OF THE REGISTRANT.
(Included pursuant to Instruction 3 to Item 401(b) of Regulation S-K)
The following table sets forth the executive officers of the Company and certain other information with respect to each individual, including the years certain individuals were partners in the Partnership, the predecessor to the Company's business. Except for Mr. Weston, each of the executive officers listed below is a Director of McDonald Securities.
NAME AGE PRINCIPAL OCCUPATION ---- --- --------------------
Thomas M. O'Donnell 61 Chairman of the Company since April 1, 1989; Director of the Company since June 7, 1983; Chairman of McDonald Securities from April 1, 1989 to August 1, 1995; Chief Executive Officer of the Company from April 1, 1989 to January 1, 1994; President of the Company and McDonald Securities from July 23, 1984 to April 1, 1989; Secretary of the Company from June 7, 1983 to July 23, 1984; Managing Director (Corporate Finance and Special Products) and Secretary of McDonald Securities from June 7, 1983 to July 23, 1984; Partner from 1968 to 1990 and Managing Partner from 1989 to 1990.
William B. Summers, Jr. 47 Director of the Company since June 7, 1983; Chief Executive Officer of the Company and McDonald Securities since January 1, 1994; President of the Company since April 1, 1989; Chairman of McDonald Securities since August 2, 1995; President of McDonald Securities from April 1, 1989 to August 1, 1995; Executive Vice President of the Company and McDonald Securities from November 1, 1988 to April 1, 1989; Managing Director (Fixed Income Institutional Sales) of McDonald Securities from June 7, 1983 to November 1, 1988; Partner from 1975 to 1990.
Robert T. Clutterbuck 46 Director of the Company since August 7, 1996; President and Chief Operating Officer of McDonald Securities since August 2, 1995; Treasurer of the Company since January 1, 1994; Chief Financial Officer of McDonald Securities from January 1, 1994 to June 14, 1996; Executive Managing Director of McDonald Securities from January 1, 1994 to August 1, 1995; Senior Managing Director (Municipal Bond Trading and Underwriting) of McDonald Securities from June 1, 1992 to December 31, 1993; Managing Director from May 1, 1987 to May 31, 1992; Senior Vice President from May 1, 1984 to April 30, 1987; First Vice President from June 7, 1983 to April 30, 1984; Partner from 1978 to 1990.
Daniel F. Austin 45 Vice Chairman of McDonald Securities since August 2, 1995; Senior Managing Director (Corporate and Public Finance) of McDonald Securities from June 1, 1992 to August 1, 1995; Managing Director from January 4, 1991 to May 31, 1992; Senior Vice President from May 1, 1986 to January 3, 1991; First Vice President from May 1, 1985 to April 30, 1986.
Jack N. Aydin 56 Managing Director (Resident Manager - Jersey City, New Jersey) of McDonald Securities since May 1, 1988; Senior Vice President from May 1, 1986 to April 30, 1988; First Vice President from June 7, 1983 to April 30, 1986; Partner from 1977 to 1990.
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EXECUTIVE OFFICERS OF THE REGISTRANT (cont.)
NAME AGE PRINCIPAL OCCUPATION ---- --- --------------------
Eugene H. Bosart III 54 Senior Managing Director (Regional Sales Manager - Michigan) of McDonald Securities since June 15, 1996; Managing Director from May 1, 1987 to June 14, 1996; Senior Vice President from June 7, 1983 to April 30, 1987; Partner from 1972 to 1990.
Thomas G. Clevidence 47 Senior Managing Director (Human Resources and Community Affairs) of McDonald Securities since June 15, 1996; Managing Director (Human Resources and Community Affairs) from January 2, 1996 to June 14, 1996; Managing Director (Human Resources) from July 1, 1992 to June 14, 1996; Vice President - Corporate Employment, Society Corporation/Ameritrust Corporation, from October 1989 to June 30, 1992; Senior Manager, Ernst & Young, from 1982 to October 1989.
Ralph Della Ratta 43 Senior Managing Director (Corporate Finance) of McDonald Securities since June 1, 1996; Managing Director from June 1, 1992 to May 31, 1996; Senior Vice President from June 1, 1991 to May 31, 1992; First Vice President from June 1, 1990 to May 31, 1991; Vice President from October 12, 1987 to May 31, 1990.
Dennis J. Donnelly 47 Senior Managing Director (Operations) of McDonald Securities since June 1, 1992; Managing Director from May 1, 1987 to May 31, 1992; Senior Vice President from May 1, 1984 to April 30, 1987; First Vice President from June 7, 1983 to April 30, 1984; Partner from 1980 to 1990.
David W. Ellis, III 41 Managing Director (Gradison-McDonald Asset Management) Gradison Division of McDonald Securities, since June 15, 1996; Senior Vice President, Gradison Division of McDonald Securities, from October 4, 1991 to June 14, 1996; Director of Gradison & Company Incorporated from January 1, 1987 to October 3, 1991; Senior Vice President, Gradison & Company Incorporated from September 1, 1988 to October 3, 1991; Vice President from September 1, 1980 to August 31, 1988.
Patricia J. Jamieson 42 Senior Managing Director (Chief Financial Officer) of McDonald Securities since June 1, 1997; Managing Director and Chief Financial Officer from June 15, 1996 to May 31, 1997; Chief Accounting Officer of McDonald Securities from August 2, 1995 to June 14, 1996; Senior Vice President since June 1, 1991; First Vice President from May 1, 1985 to May 31, 1991; Vice President from August 15, 1984 to April 30, 1985; Associate Vice President from October 3, 1983 to August 14, 1984.
David W. Knall 52 Senior Managing Director (Resident Manager - Indianapolis, Indiana) of McDonald Securities since June 15, 1996; Managing Director from June 7, 1983 to June 14, 1996; Partner from 1973 to 1990.
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EXECUTIVE OFFICERS OF THE REGISTRANT (cont.)
NAME AGE PRINCIPAL OCCUPATION ---- --- --------------------
Thomas M. McDonald 50 Senior Managing Director (Private Client Group) of McDonald Securities since June 1, 1997; Managing Director from June 1, 1993 to May 31, 1997; Senior Vice President from September 27, 1991 to May 31, 1993; Senior Vice President of Prescott Ball & Turben, a division of Kemper Securities Group, Inc. from February 1988 to September 26, 1991.
Lawrence T. Oakar 62 Managing Director (Private Client Group) of McDonald Securities since June 15, 1996; Senior Vice President from May 1, 1986 to June 14, 1996; First Vice President from July 20, 1983 to April 30, 1986; Partner from 1979 to 1990.
John F. O'Brien 60 Senior Managing Director (Private Client Group) of McDonald Securities since June 1, 1992; Managing Director from June 17, 1983 to May 31, 1992; Partner from 1971 to 1990.
James C. Redinger 60 Senior Managing Director (Equity Institutional Sales and Trading) of McDonald Securities since June 1, 1992; Managing Director from May 1, 1987 to May 31, 1992; Senior Vice President from May 1, 1984 to April 30, 1987; First Vice President from June 7, 1983 to April 30, 1984; Partner from 1980 to 1990.
David D. Sutcliffe 36 Managing Director (Fixed Income Sales) of McDonald Securities since June 15, 1996; Senior Vice President from May 1, 1989 to June 14, 1996; First Vice President from May 1, 1987 to April 30, 1989; Vice President from 1984 to April 30, 1987.
Bradley E. Turner 38 Senior Managing Director (Gradison-McDonald Asset Management) of McDonald Securities since June 15, 1996; Managing Director (Gradison-McDonald Asset Management) of McDonald Securities from June 1, 1995 to June 14, 1996; Senior Vice President (Portfolio Strategies Group) from June 1, 1992 to May 31, 1995; First Vice President (Portfolio Strategies Group) from June 1, 1990 to May 31, 1992; Vice President from May 1, 1988 to May 31, 1990; Associate Vice President from May 1, 1986 to April 30, 1988.
Donald E. Weston 61 Director of the Company since October 4, 1991; Chairman and Chief Executive Officer of the Gradison Division of McDonald Securities since October 4, 1991; Chairman of the Board and Chief Executive Officer of Gradison & Company Incorporated from January, 1982 to October 4, 1991; Trustee and Chairman of the Board of the Gradison-McDonald Cash Reserves Trust since August, 1982; of the Gradison Growth Trust since August, 1983; of the Gradison Custodian Trust since September, 1987 and of the Gradison-McDonald Municipal Custodian Trust since September, 1992.
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PART II -------
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.
The information required by this item is included herein at Exhibit 99(a) to this Form 10-K Annual Report set forth under the caption "Supplementary Financial Data - Quarterly Data (Unaudited)".
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The information required by this item is included herein at Exhibit 99(b) to this Form 10-K Annual Report.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The information required by this item is included herein at Exhibit 99(c) to this Form 10-K Annual Report.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this item is included herein at Exhibit 99(d) to this Form 10-K Annual Report.
ITEM 9.
ITEM 9. DISAGREEMENTS WITH ACCOUNTANTS ON FINANCIAL DISCLOSURE.
None.
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PART III --------
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information regarding Directors appearing under the caption of "Election of Directors" in the registrant's definitive Proxy Statement to be used in connection with Annual Meeting of Stockholders to be held on July 30, 1997 (the "1997 Proxy Statement") is incorporated herein by reference. Information regarding executive officers of the Registrant is set forth in Part I of this Form 10-K Annual Report.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is incorporated herein by reference to "Executive Compensation" in the 1997 Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item is incorporated by reference to "Stock Ownership of Principal Holders and Management" in the 1997 Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated herein by reference to "Certain Transactions" in the 1997 Proxy Statement.
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PART IV -------
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) DOCUMENT LIST
1. Financial Statements
The following financial statements and other information are filed as part of this Form 10-K Annual Report herein at Exhibit 99(d).
McDonald & Company Investments, Inc. and Subsidiaries: - ------------------------------------------------------
(i) Consolidated Statements of Income--fiscal years ended March 28, 1997, March 29, 1996 and March 31, 1995
(ii) Consolidated Statements of Financial Condition--March 28, 1997 and March 29, 1996
(iii) Consolidated Statements of Changes in Stockholders' Equity--fiscal years ended March 28, 1997, March 29, 1996 and March 31, 1995
(iv) Consolidated Statements of Cash Flows--fiscal years ended March 28, 1997, March 29, 1996 and March 31, 1995
(v) Notes to Consolidated Financial Statements--March 28, 1997
(vi) Report of Independent Auditors
2. Supplementary Data and Financial Statement Schedules
(i) Supplementary data entitled "Supplementary Financial Data- Quarterly Data (Unaudited)" is filed as part of this Form 10-K Annual Report herein at Exhibit 99(a).
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.
- 23 -
ITEM 14(a) DOCUMENT LIST -- Continued
3. Exhibits Required by Securities and Exchange Commission Regulation S-K
(a) The following exhibits are filed as part of this Report:
- 24 -
ITEM 14(a) DOCUMENT LIST -- Continued
10(a): Stock Option Plan (incorporated by reference to Exhibit 4(b) to the Company's Form S-8 Registration Statement (Reg. No. 33-ll335), which became effective on February 2, 1987)*
10(b): 1990 Stock Option Plan for Outside Directors (incorporated by reference to Exhibit 4.4 to the Company's Form S-8 Registration Statement (Reg. No. 33-37603), which became effective on November 5, 1990)*
10(c): Documents reflecting lines of credit with First National Bank of Chicago ($25,000,000), and the Bank of Tokyo ($45,000,000) (incorporated by reference to Exhibit 10(p) to the Company's Form 10-K for the fiscal year ended March 27, 1992)
10(d): Documents reflecting line of credit with The Northern Trust Company ($10,000,000) (incorporated by reference to Exhibit 10(p) to the Company's Form 10-K for the fiscal year ended March 29, 1991)
10(e): Documents reflecting lines of credit with Bankers Trust Company ($50,000,000), and Huntington National Bank ($25,000,000) (incorporated by reference to Exhibit 10(p) to the Company's Form 10-K for the fiscal year ended March 26, 1993)
10(f): Documents reflecting lines of credit with National City Bank ($25,000,000) and Star Bank ($20,000,000) (incorporated by reference to Exhibit 10(m) to the Company's Form 10-Q for the fiscal quarter ended September 24, 1993)
10(g): 1993 Restricted Stock Bonus Plan (incorporated herein by reference to the Company's Definitive Proxy Statement for its Annual Meeting held on July 27, 1993)*
10(h): Form of Note Purchase Agreement between McDonald & Company Securities, Inc. and the Purchasers listed therein, dated as of January 15, 1993, relating to $25,000,000 principal amount of 8.24% Subordinated Notes (incorporated by reference to Exhibit 10 of the Company's Form 8-K filed with the Securities and Exchange Commission on February 5, 1993)
10(i): McDonald & Company Securities, Inc. Retirement Savings Trust and Plan (incorporated by reference to Exhibit 10(n) to the Company's Form 10-Q for the fiscal quarter ended September 24, 1993)*
10(j): Documents reflecting lines of credit with Bank of New York ($90,000,000) (incorporated by reference to Exhibit 10(m) to the Company's Form 10-K for the fiscal year ended March 25, 1994)
10(k): Lease Agreement dated July 21, 1994 for the Company's executive offices, which became effective April 1, 1994 (incorporated by reference to Exhibit 10(k) to the Company's Form 10-K for the fiscal year ended March 31, 1995)
10(l): 1995 Stock Bonus Plan (incorporated by reference to the Company's Definitive Proxy Statement for its Annual Meeting held on August 2, 1995)*
10(m): 1995 Key Employees Stock Option Plan (incorporated by reference to the Company's Definitive Proxy Statement for its Annual Meeting held on August 2, 1995)*
10(n): 1995 Stock Option Plan for Non-Officer Directors (incorporated by reference to the Company's Definitive Proxy Statement for its Annual Meeting held on August 7, 1996)*
* Management contract or compensatory plan or arrangement identified pursuant to Item 14(c) of this Form 10-K.
- 25 -
ITEM 14(a) DOCUMENT LIST--Continued
10(o): Lease Agreement dated May 21, 1996 for the Company's Gradison Division, which became effective July 1, 1996 (incorporated by reference to Exhibit 10(p) to the Company's Form 10-Q for the fiscal quarter ended September 27, 1996)
10(p): Documents reflecting line of credit with Star Bank ($20,000,000) (incorporated by reference to Exhibit 10(q) to the Company's Form 10-Q for the fiscal quarter ended December 31, 1996)
10(q): First Amendment to the Stock Bonus Plan, which became effective March 30, 1996 (incorporated by reference to the Company's Definitive Proxy Statement for its Annual Meeting to be held on July 30, 1997)*
ITEM 14(b) REPORTS ON FORM 8-K.
The Company did not file a current Report on Form 8-K during the fiscal quarter ended March 28, 1997.
OTHER - -----
On February 9, 1995, the Company announced the continuation of an open market repurchase program originally instituted in July 1987. The current program allows the Company to purchase up to 1,000,000 shares of its Common Stock at an aggregate price not to exceed $25,000,000. Treasury shares may be used to satisfy options exercised under the Company's stock option plans and shares awarded under the Company's 1995 Stock Bonus Plan.
During the fiscal year ended March 28, 1997 the Company purchased 176,803 shares of the Company's Common Stock at an average price of $18.716 per share. During the fiscal year ended March 28, 1997, the Company utilized 83,362 shares of the Company's Common Stock held in treasury to satisfy options exercised under the Company's stock option plans.
* Management contract or compensatory plan on arrangement identified pursuant to Item 14(c) of this Form 10-K.
- 26 -
SIGNATURES ----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized at Cleveland, Ohio on this 20th day of June, 1997.
McDONALD AND COMPANY INVESTMENTS, INC.
By: /s/ William B. Summers, Jr. --------------------------------------- William B. Summers, Jr., President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on .
- 27 -
McDonald & Company Investments, Inc.
Report on FORM 10-K for the Fiscal Year ended March 28, 1997
EXHIBIT INDEX -------------
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