Cohen & Co Inc. - Annual Report: 2013 (Form 10-K)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2013 

OR

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                      

Commission file number: 001-32026

INSTITUTIONAL FINANCIAL MARKETS, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (215) 701-9555

Securities registered pursuant to Section 12(b) of the Act:

 

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨ 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files,    Yes  x    No  ¨ 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x 

As of June 30, 2013, the aggregate market value of the Common Stock held by non-affiliates of the Registrant was approximately $22.4 million.

As of February 28, 2014, there were 15,123,059 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the Registrant’s 2014 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K. 

 

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INSTITUTIONAL FINANCIAL MARKETS, INC. 

 

TABLE OF CONTENTS

 

 

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Forward Looking Statements

This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Forward-looking statements discuss matters that are not historical facts. Because they discuss future events or conditions, forward-looking statements may include words such as “anticipate,” “believe,” “estimate,” “intend,” “could,” “should,” “would,” “may,” “seek,” “plan,” “might,” “will,” “expect,” “anticipate,” “predict,” “project,” “forecast,” “potential,” “continue,” negatives thereof or similar expressions. Forward-looking statements speak only as of the date they are made, are based on various underlying assumptions and current expectations about the future, and are not guarantees. Such statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, level of activity, performance or achievement to be materially different from the results of operations or plans expressed or implied by such forward-looking statements.

These forward-looking statements are found at various places throughout this Annual Report on Form 10-K and include information concerning possible or assumed future results of our operations, including statements about the following subjects:

•benefits, results, costs reductions and synergies resulting from the Company’s business combinations;

•integration of operations;

•business strategies;

•growth opportunities;

•competitive position;

•market outlook;

•expected financial position;

•expected results of operations;

•future cash flows;

•financing plans;

•plans and objectives of management;

•tax treatment of the business combinations;

•fair value of assets; and

•any other statements regarding future growth, future cash needs, future operations, business plans and future financial results, and any other statements that are not historical facts.

These forward-looking statements represent our intentions, plans, expectations, assumptions and beliefs about future events and are subject to risks, uncertainties and other factors. Many of those factors are outside of our control and could cause actual results to differ materially from the results expressed or implied by those forward-looking statements. In light of these risks, uncertainties and assumptions, the events described in the forward-looking statements might not occur or might occur to a different extent or at a different time than we have described. You should consider the areas of risk and uncertainty described above and discussed under “Item 1A — Risk Factors.” Actual results may differ materially as a result of various factors, some of which are outside our control, including the following:

•a decline in general economic conditions or the global financial markets;

•losses caused by financial or other problems experienced by third parties;

•losses due to unidentified or unanticipated risks;

•a lack of liquidity, i.e., ready access to funds for use in our businesses;

•the ability to attract and retain personnel;

•the ability to meet regulatory capital requirements administered by federal agencies;

•an inability to generate incremental income from acquired businesses;

•unanticipated market closures due to inclement weather or other disasters;

•the volume of trading in securities;

•the liquidity in capital markets;

•the credit-worthiness of our correspondents, trading counterparties and our banking and margin customers;

•the demand for investment banking services;

•competitive conditions in each of our business segments;

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•the ability to attract and retain key personnel;

•the availability of borrowings under credit lines, credit agreements and credit facilities;

•the potential misconduct or errors by our employees or by entities with whom we conduct business; and

•the potential for litigation and other regulatory liability.

 

You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K. All subsequent written and oral forward-looking statements concerning other matters addressed in this Annual Report on Form 10-K and attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this Annual Report on Form 10-K. Except to the extent required by law, we undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, a change in events, conditions, circumstances or assumptions underlying such statements, or otherwise. Certain Terms Used in this Annual Report on Form 10-K

In this Annual Report on Form 10-K, unless otherwise noted or as the context otherwise requires: “IFMI” refers to Institutional Financial Markets, Inc., a Maryland corporation. The “Company,” “we,” “us,” and “our” refer to IFMI and its subsidiaries on a consolidated basis; “IFMI, LLC” (formerly Cohen Brothers, LLC) or the “Operating LLC” refer to IFMI, LLC, the main operating subsidiary of the Company; “Cohen Brothers” refers to the pre-merger Cohen Brothers, LLC and its subsidiaries; “AFN” refers to the pre-merger Alesco Financial Inc. and its subsidiaries; “Merger Agreement” refers to the Agreement and Plan of Merger among AFN Alesco Financial Holdings, LLC, a wholly owned subsidiary of AFN, which we refer to as the “Merger Sub,” and Cohen Brothers, dated as of February 20, 2009 and amended on June 1, 2009, August 20, 2009, and September 30, 2009; “Merger” refers to the December 16, 2009 closing of the merger of Merger Sub with and into Cohen Brothers pursuant to the terms of the Merger Agreement, which resulted in Cohen Brothers becoming a majority owned subsidiary of the Company. When the term, “IFMI” is used, it is referring to the parent company itself, Institutional Financial Markets, Inc. “JVB Holdings” refers to JVB Financial Holdings, L.L.C.; “JVB” refers to JVB Financial Group, LLC, a broker dealer subsidiary; “CCFL” refers to Cohen & Company Financial Limited (formerly known as EuroDekania Management LTD), a subsidiary regulated by the Financial Conduct Authority (formerly known as the Financial Services Authority) in the United Kingdom; “CCPRH” refers to C&Co/PrinceRidge Holdings LP (formerly known as PrinceRidge Holdings LP) and its subsidiaries; “PrinceRidge GP” refers to C&Co/PrinceRidge Partners LLC (formerly known as PrinceRidge Partners LLC); “PrinceRidge” refers to CCPRH together with PrinceRidge GP; and “CCPR” refers to C&Co/PrinceRidge LLC (formerly known as The PrinceRidge Group LLC), a broker dealer subsidiary

On January 31, 2014, JVB merged into CCPR.  In connection with this merger CCPRH changed its name from C&Co/PrinceRidge Holdings LP to J.V.B. Financial Group Holdings and CCPR changed its name from C&Co/PrinceRidge LLC to J.V.B. Financial Group, LLC.  Also, beginning on January 31, 2014, CCPR began to do business under the JVB brand.  Therefore, when we are discussing the operations of CCPR on or subsequent to January 31, 2014, we refer to it as JVB. 

“Securities Act” refers to the Securities Act of 1933, as amended; and “Exchange Act” refers to the Securities Exchange Act of 1934, as amended. In accordance with accounting principles generally accepted in the United States of America, or “U.S. GAAP,” the Merger was accounted for as a reverse acquisition, Cohen Brothers was deemed to be the accounting acquirer and all of AFN’s assets and liabilities were required to be revalued at fair value as of the acquisition date. Therefore, any financial information reported herein prior to the Merger is the historical financial information of Cohen Brothers. As used throughout this filing, the terms, the “Company,” “we,” “us,” and “our” refer to the operations of Cohen Brothers and its consolidated subsidiaries prior to December 17, 2009 and the combined operations of the merged company and its consolidated subsidiaries from December 17, 2009 forward. AFN refers to the historical operations of Alesco Financial Inc. through to December 16, 2009, the date of the Merger, or the “Merger Date.” 

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PART I

ITEM  1.BUSINESS.

INFORMATION REGARDING INSTITUTIONAL FINANCIAL MARKETS, INC.

Overview

 

We are a financial services company specializing in credit-related fixed income investments. We were founded in 1999 as an investment firm focused on small-cap banking institutions, but have grown to provide an expanding range of capital markets, investment banking, and asset management solutions to institutional investors, corporations, and other small broker-dealers. Our business segments are Capital Markets, Asset Management, and Principal Investing. Our Capital Markets business segment consists of credit-related fixed income sales, trading, and financing as well as new issue placements in corporate and securitized products and advisory services, operating primarily through our subsidiaries, JVB in the United States and CCFL in Europe. In October 2013, we began the process of consolidating our two domestic broker-dealer subsidiaries, CCPR and JVB, into a single broker-dealer subsidiary. Following FINRA approval, the consolidation was completed in January 2014 resulting in one broker-dealer subsidiary in the United States operating as JVB. In connection with the consolidation, we significantly downsized our workforce and eliminated certain non-core business lines, including the majority of our domestic investment banking operation with the exception of the financing of special purpose acquisition companies (“SPACs”) and the origination and selling of structured products, primarily collateralized loan obligations (“CLOs”). Our Asset Management business segment manages assets through investment vehicles, such as collateralized debt obligations (“CDOs”), permanent capital vehicles, and managed accounts. As of December 31, 2013, we had approximately $5.7 billion of assets under management (“AUM”) in credit-related fixed income assets in a variety of asset classes including U.S. trust preferred securities, European hybrid capital securities, Asian commercial real estate debt, and mortgage- and asset-backed securities. Most of our AUM, $5.4 billion, or 94.4%, was in CDOs we manage. Our Principal Investing business segment is comprised primarily of our investments in the investment vehicles we manage.

 

In February 2014, we announced the sale of all of our interests in the Star Asia Group (as defined below) for $20.0 million and a 15% revenue share of certain Star Asia Group management companies, which will last for a period of at least four years. The Star Asia Group includes: our 28% interest in Star Asia Finance, Limited (“Star Asia”); our 100% interest in Star Asia Management Ltd. (“Star Asia Manager”), the manager of Star Asia; our 2.2% interest in Star Asia Japan Special Situations LP (the “Star Asia Special Situations Fund”); our 33.3% interest in Star Asia Advisors, Ltd. (“SAA Manager”), the manager of the Star Asia Special Situations Fund; our 33.3% interest in Star Asia Partners Ltd. (“SAP GP”), the general partner of the Star Asia Special Situations Fund; and our 33.3% interest in Star Asia Capital Management, LLC (“Star Asia Capital Management”), the manager of the entity that owns a portfolio of multifamily residential properties located in Japan. As of December 31, 2013, our interests in the Star Asia Group accounted for 5% of our AUM and over 75% of our Principal Investing portfolio. Going forward, our Principal Investing segment may invest the proceeds of this sale and additional available capital outside of the investment vehicles that we manage.

Financial information concerning our business segments is set forth in “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” beginning on page 46 and note 27 to our consolidated financial statements included in this Annual Report on Form 10-K. For more information regarding our geographic locations, see Item. 2 Properties, below, and note 27 to our consolidated financial statements included in this Annual Report on Form 10-K.

Capital Markets

Our Capital Markets business segment consists primarily of credit-related fixed income sales, trading, and financing as well as new issue placements in corporate and securitized products and advisory services operated through our subsidiaries, JVB in the United States and CCFL in Europe. At the beginning of 2011, we closed our acquisition of JVB Holdings, the parent company of JVB, a Boca Raton, Florida based fixed income broker-dealer that specializes in small size transactions in certificates of deposit (“CDs”), corporate bonds, mortgage-backed securities (“MBS”), structured products, municipal securities, and U.S. government agency securities primarily within the dealer market. In May 2011, we contributed a substantial part of our non-JVB Capital Markets business segment to PrinceRidge, CCPR’s parent company, in exchange for an approximate 70% ownership interest in PrinceRidge, a New York-based financial services firm comprised of an investment banking group and a sales and trading group. During 2012 and 2013, our ownership interest in PrinceRidge increased to 100% with the repurchase of all of PrinceRidge’s minority partner ownership interests therein. PrinceRidge’s investment banking group had specialized in chemicals, consumer and retail, energy, financial institutions, and industrial.  Following the downsizing in the later part of 2013, it began to specialize in the financing of SPACs and the origination and selling of structured products. Through the acquisitions of JVB and PrinceRidge, we acquired highly complementary businesses with little overlap. In the later part of 2013, we made the decision to combine CCPR and JVB into one broker-dealer. The combination was completed in January 2014. As a result, our combined broker-dealer subsidiary in the United States now operates under the JVB brand.  JVB focuses on mortgages, rates, corporate, and structured products in the wholesale and institutional marketplaces, as well as providing financing and advisory services.

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Historically, our Capital Markets business segment has included the following U.S. broker-dealers: Cohen & Company Securities, LLC (“CCS”), Cohen & Company Capital Markets, LLC (“CCCM”), CCPR, and JVB. We acquired CCCM in 2010 (formerly known as Fairfax, LLC) primarily to avail ourselves of an existing clearing relationship. In May 2011, CCCM became a wholly-owned subsidiary of PrinceRidge and in February 2012, PrinceRidge merged CCCM into CCPR. CCPR operated under our PrinceRidge subsidiary until the merger with JVB became effective in January 2014. JVB operates under our JVB Holdings subsidiary. CCS was our legacy broker-dealer that was registered under the Exchange Act and was a member of the Financial Industry Regulatory Authority (“FINRA”) and the Securities Industry Protection Corporation (“SIPC”) until it filed a Form BDW in September 2012 seeking to withdraw all of its registrations with the Securities and Exchange Commission and from each jurisdiction in which it was licensed or registered as a securities broker-dealer, as well as its membership in FINRA, the NASDAQ Stock Market, and the International Securities Exchange. CCS’ withdrawal from all such regulatory authorities became effective in November 2012. CCS has conducted no securities-related business activities since May 2011. Currently, JVB is our sole operating U.S. broker-dealer subsidiary. In addition, our European subsidiary, CCFL, is regulated by the Financial Conduct Authority (“FCA”) in the United Kingdom.

Our fixed income sales and trading group provides trade execution to corporate investors, institutional investors, and other smaller broker-dealers. We specialize in a variety of products, including but not limited to: corporate bonds and loans, asset-backed securities (“ABS”), MBS, residential mortgage-backed securities (“RMBS”), CDOs, CLOs, collateralized bond obligations (“CBOs”), collateralized mortgage obligations (“CMOs”), municipal securities, Small Business Administration loans (“SBA loans”), U.S. government bonds, U.S. government agency securities, brokered deposits and CDs for small banks and, hybrid capital of financial institutions including trust preferred securities (“TruPS”), whole loans, and other structured financial instruments. We had offered execution and brokerage services for equity derivative products until December 31, 2012, when we sold our equity derivatives brokerage business to a new entity owned by two of our former employees. See note 5 to our consolidated financial statements included in this Annual Report on Form 10-K.

In addition, JVB, formerly CCPR, has a funding desk that acts as an intermediary between borrowers and lenders of short-term funds and provides funding for various inventory positions through the use of repurchase agreements. In 2012, a trading desk for “to-be-announced” securities (“TBAs”) was established. TBAs are forward mortgage-backed securities whose collateral remain unknown until just prior to the trade settlement. The forward collateral types are exclusively issued by United States government agencies, such as the Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac”), and the Government National Mortgage Association (“Ginnie Mae”). The objective of the TBA business is to provide liquidity to institutional mortgage originators who hedge their mortgage pipelines. In addition to providing credit for MBS trading lines, JVB offers hedging strategies, trading of specified pools, and financing for qualified originators. The TBA desk offers a wide range of solutions for institutional clients seeking to enhance mortgage pipeline execution and overall portfolio profitability.

Our Capital Markets business segment generates revenue through the following activities: (1) trading activities, which include execution and brokerage services, securities lending activities, riskless trading activities as well as gains and losses (unrealized and realized), and income and expense earned on securities classified as trading, (2) new issue and advisory revenue comprised of (a) origination fees for corporate debt issues originated by us, (b) revenue from advisory services, and (c) new issue revenue associated with arranging and placing the issuance of newly created debt, equity, and hybrid financial instruments. Our Capital Markets business segment has offices in Boca Raton, Charlotte, Chicago, Houston, Hunt Valley (Maryland), Locust Valley (New York), London, New York, Paris, Philadelphia, and Red Bank (New Jersey).

We have been in the Capital Markets business since our inception. Our Capital Markets business segment has transformed over time in response to market opportunities and the needs of our clients. The initial focus was on sales and trading of listed equities of small financial companies with a particular emphasis on bank stocks. Early on, a market opportunity arose for participation in a particular segment of the debt market, the securitization of TruPS. We began assisting small banks in the issuance of TruPS through securitized pools. These investment vehicles were structured and underwritten by large investment banks while our broker-dealer typically participated as a co-placement agent or selling group member. We also participated in the secondary market trading of these securities between institutional clients.

For the better part of a decade, we have actively engaged in the brokering of TruPS and pooled TruPS in the secondary market. However, there has been essentially no new issuance of pooled TruPS since 2007 because the credit market disruption resulted in market yields that are much higher than banks are willing to pay to issue securities into an investment vehicle. However, while new issuance activity closed down, secondary trading volumes initially increased dramatically. A large number of entities were motivated or forced to sell their holdings. Reasons for selling included margin calls on financed assets, hedge fund redemptions, ratings downgrades, warehouse liquidations, and investment vehicles breaching covenants and liquidating. At the same time, investors who had historically invested in the initial issuance of these securities were not as active in the market. We recognized that the conditions that caused increased secondary trading opportunities in the TruPS market also existed in other credit-based fixed income markets including corporate bonds, RMBS, European credit securities, and leveraged finance securities (high yield bonds and leveraged loans).

In early 2008, our management team made the strategic decision to restructure our Capital Markets business model from exclusively focusing on TruPS and structured credit products to a more traditional fixed income broker-dealer platform with more

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diversified revenue streams primarily from trading activity. Over the past several years, we have hired many sales and trading professionals with expertise in areas that complement our core competency in structured credit. In 2011, our acquisitions of JVB and PrinceRidge further expanded our Capital Markets platform. As a result of these acquisitions, offset by subsequent downsizings, our Capital Markets staffing increased from six sales and trading professionals at the beginning of 2008, to over 230 professionals in mid-2011, and decreased to approximately 90 professionals as of December 31, 2013. We continue to explore opportunities to add complementary distribution channels, hire experienced talent, expand our presence across asset classes, and bolster the service capabilities of our Capital Markets business segment.

Trades in our Capital Markets business segment can be either “riskless” or risk-based. “Riskless trades” are transacted with a customer order in hand, resulting in limited risk to us. “Risk-based trades” involve us owning the securities and thus placing our capital at risk. Such risk-based trading activity may include the use of leverage. In recent years, we began to utilize more leverage in our Capital Markets business segment. We believe that the prudent use of capital to facilitate client orders increases trading volume and profitability. Any gains or losses on securities that we have purchased in the secondary market are recorded in our Capital Markets business segment, whereas any gains or losses on securities that we retained in our sponsored investment vehicles or other principal investments are recorded in our Principal Investing business segment.

Asset Management

Our Asset Management business segment manages assets within a variety of investment vehicles, including CDOs, permanent capital vehicles, managed accounts, and investment funds. We earn management fees for our ongoing asset management services provided to these investment vehicles, which may include fees both senior and subordinate to the securities issued by the investment vehicles. Management fees are based on the value of the AUM or the investment performance of the vehicle, or both. As of December 31, 2013, we had $5.7 billion in AUM, of which 94.4%, or $5.4 billion, was in CDOs we manage.

Our AUM increased from $965.8 million at December 31, 2003, to $5.7 billion at December 31, 2013, but has declined year-to-year since 2007. AUM refers to assets under management, and equals the sum of: (1) the gross assets included in the CDOs that we have sponsored and/or manage; plus (2) the net asset value (“NAV”) of the permanent capital vehicles and investment funds we manage; plus (3) the NAV of other managed accounts. Our calculation of AUM may differ from the calculations of other asset managers and, as a result, this measure may not be comparable to similar measures presented by other asset managers. This definition of AUM is not necessarily identical to any definition of AUM that may be used in our management agreements.

 

As of December 31, 2013, we had four subsidiaries that act as collateral managers and investment advisors to the CDOs that we manage. With the exception of CCFL, these entities are registered investment advisors under the Investment Advisers Act of 1940 (the “Investment Advisers Act”). CCFL is regulated by the FCA.

 

 

The value to us of a CDO structure was derived from the arbitrage between the cost of borrowing and the return profile of the underlying collateral. With our asset classes, we sought to maximize the spread differential between the yield on the underlying collateral and our cost of financing. Each portfolio was structured to maximize relative value based on our credit views and maximize diversification in order to minimize the effect of isolated credit events on the overall portfolio. Our management of the portfolio utilizes our infrastructure to minimize defaults of underlying assets and to maximize recoveries in the case of defaults. We sought to achieve diversification of overall asset exposure. Thus, CDOs were structured across a range of sectors to maximize portfolio diversification and to minimize correlation among the expected performance of our various asset classes.

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The chart below shows changes in our AUM by product line for the last five years.

 

 

(1)On July 29, 2010, we completed the sale of our Alesco X-XVII contracts to an unrelated third party. For more information see “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” beginning on page 46.  

(2)Dekania Europe and Munda portfolios are denominated in Euros. For purposes of the table above they have been converted to U.S. dollars at the prevailing exchange rates at the points in time presented.

(3)During the third quarter of 2012, we resigned as asset manager of the Xenon deal and agreed to forego certain collateral manager rights that were unique to this CDO, related to the auction provisions.

(4)On March 29, 2011, we completed the sale of our investment advisory agreements relating to a series of closed-end distressed debt funds, known as the Deep Value funds, and certain separately managed accounts to a new entity owned by two of our former employees, known as Strategos Capital Management, LLC. At the same time, we changed the name of our wholly owned subsidiary that previously served as the investment advisor from Strategos Capital Management, LLC to Cira SCM, LLC. This entity still serves as the collateral manager for three Kleros deals and one Libertas deal. In connection with the transaction, we entered into a sub-advisory agreement to employ Strategos Capital Management, LLC to render advice and assistance with respect to collateral management services to the Kleros and Libertas portfolios.

(5)During the second half of 2013, we resigned as collateral manager of one of the Kleros deals and two of the Libertas deals. For the Kleros deal, our resignation was effective in August 2013. For the Libertas deals, our resignation from one deal was effective in February 2014 and our resignation from the other deal is pending and expected to become effective during the first half of 2014.

(6)Prior to August 2012, we served only as the junior manager of the Munda CLO and we shared the management fees equally with the lead manager. In August 2012, we became lead manager (and remained as junior manager). Subsequent to becoming the lead manager, we earn all of the management fees related to the Munda CLO.

(7)In February 2014, we announced the completion of the sale of our ownership interests in the Star Asia Group, which accounted for $282 million of our AUM as of December 31, 2013. See note 31 to our consolidated financial statements included in this Annual Report on Form 10-K.

CDO Asset Class:

A CDO is a form of secured borrowing. The borrowing is secured by different types of fixed income assets such as corporate or mortgage loans or bonds. The borrowing is in the form of a securitization, which means that the lenders are actually investing in notes secured by the assets. In the event of a default, the lender will have recourse only to the assets securing the loan. We have originated assets for, served as co-placement agent for, and continue to manage this type of investment vehicle, which is generally structured as a trust or other special purpose vehicle. In addition, we invested in some of the debt and equity securities initially issued by certain CDOs, gains and losses of which are part of our Principal Investing business segment.

The credit crisis caused available liquidity, particularly through CDOs and other types of securitizations, to decline precipitously. Our ability to accumulate assets for securitization effectively ended with the market disruption. We securitized $14.8 billion of assets in 16 trusts during 2006; $17.8 billion of assets in 16 trusts during 2007; $400 million of assets in one trust during 2008; and zero assets in zero trusts during 2009 through 2013.

These structures can hold different types of securities. Historically, we have focused on the following asset classes: (1) United States and European bank and insurance TruPS and subordinated debt; (2) United States ABS, such as MBS and commercial real estate loans; (3) United States corporate loans; and (4) United States obligations of non-profit entities.

We generate asset management revenue for our services as asset manager. Many of our sponsored CDOs, particularly those where the assets are bank TruPS and ABS, have experienced asset deferrals, defaults, and rating agency downgrades that reduce our management fees. In 16 out of 19 of our ABS deals, the extent of the deferrals, defaults, and downgrades caused credit-related coverage tests to trigger an event of default. Under an event of default, the senior debt holders in the structure can generally force a

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liquidation of the entity. To date, 13 of our ABS structures have been liquidated following an event of default. In addition, all of the bank TruPS structures we manage and all of the ABS structures we manage have experienced high enough levels of deferrals, defaults, and downgrades to reduce our subordinated management fees to zero. In a typical structure, any failure of a covenant coverage test redirects cash flow to pay down the senior debt until compliance is restored. If compliance is eventually restored, the entity will resume paying subordinated management fees to us, including those that accrued but remained unpaid during the period of non-compliance.

 

A description of each of our CDO product lines is set forth below.

Alesco, Dekania, and Xenon. Cohen & Company Financial Management, LLC manages our Alesco platform. Dekania Capital Management, LLC manages the first four Dekania deals that were issued, which include both Dekania U.S. (denominated in U.S. dollars) and Dekania Europe (denominated in Euros) structures. CCFL manages the last Dekania Europe and managed the only Xenon product line that was issued until August 2012 when CCFL resigned as manager of the Xenon product line and agreed to forego certain collateral manager rights; both of these deals are/were Euro-denominated. From September 2003 through December 31, 2013, we originated or placed approximately $11.9 billion in subordinated financing in the form of TruPS and surplus notes issued by banks, bank holding companies, thrift holding companies, and insurance companies in the United States and Europe. As of December 31, 2013, we managed nine Alesco deals, two Dekania U.S. deals, and three Dekania Europe deals. We have five professionals who are primarily focused on these programs.

In general, our Alesco and Dekania deals have the following terms. We receive senior and subordinate management fees, and there is a potential for incentive fees on certain deals if equity internal rates of return are greater than 15%. We can be removed as manager without cause if 66.7% of the rated note holders voting separately by class and 66.7% of the equity holders vote to remove us, or if 75% of the most senior note holders vote to remove us when certain over-collateralization ratios fall below 100%. We can be removed as manager for cause if a majority of the controlling class of note holders or a majority of equity holders vote to remove us. “Cause” includes unremedied violations of the collateral management agreement or indenture, defaults attributable to certain actions of the manager, misrepresentations or fraud, criminal activity, bankruptcy, insolvency or dissolution. There is a non-call period for the equity holders, which ranges from three to six years. Once this non-call period expires, a majority of the equity holders can trigger an optional redemption as long as the liquidation of the collateral generates sufficient proceeds to pay all principal and accrued interest on the rated notes and all expenses. In ten years from closing, an auction call will be triggered if the rated notes have not been redeemed in full. In an auction call redemption, an appointee will conduct an auction of the collateral, which will only be executed if the highest bid results in sufficient proceeds to pay all principal and accrued interest on the rated notes and all expenses. If the auction is not successfully completed, all residual interest that would normally be distributed to equity holders will be sequentially applied to reduce the principal of the rated notes. Any failure of an over-collateralization coverage test redirects interest to paying down notes until compliance is restored. The securities mature 30 years from closing. An event of default will occur if certain over-collateralization ratios drop below 100%. While an event of default exists, a majority of the senior note holders can declare the principal and accrued and unpaid interest immediately due and payable.

Our aggregate Alesco, Dekania, and Xenon AUM have increased from approximately $965.8 million as of December 31, 2003, to approximately $4.2 billion as of December 31, 2013, but has declined year-to-year since 2007.

Kleros/Libertas/Scorpius. Cira SCM, LLC manages our MBS and ABS program. We have completed 13 deals under the Kleros and Kleros Real Estate brand names, collateralized by high grade RMBS (generally backed by securities initially rated single A or higher). We have also completed five deals under the Libertas brand name, collateralized by mezzanine grade ABS (generally backed by securities initially rated BBB on average), and one deal under the Scorpius brand name, collateralized by synthetic mezzanine grade ABS (generally backed by synthetic or credit default swap securities). During 2008, as a result of turmoil in the credit markets and the real estate sector in particular, one of the Kleros Real Estate and two of the Libertas deals were liquidated. In 2009, the one Scorpius deal and one of the Kleros deals were liquidated. In 2011, two of the Kleros Real Estate deals, one of the Kleros deals, and one of the Libertas deals were liquidated. In 2012, one of the Kleros Real Estate deals and three of the Kleros deals were liquidated. In 2013, we resigned as collateral manager of one of the Kleros deals and transferred the management agreement to an unrelated third party. In 2013, we resigned as collateral manager of two of the Libertas deals and transferred one management agreement to an unrelated third party in early 2014 and expect to transfer the other management agreement to an unrelated third party during the first half of 2014. In early 2014, we still manage three Kleros deals and one Libertas deal.

On March 29, 2011, we completed the sale of our investment advisory agreements relating to a series of closed-end distressed debt funds, known as the Deep Value funds, and certain separately managed accounts to a new entity owned by two of our former employees, known as Strategos Capital Management, LLC. At the same time, we changed the name of our wholly owned subsidiary that previously served as the investment advisor from Strategos Capital Management, LLC to Cira SCM, LLC. This entity still serves as the collateral manager for the Kleros and Libertas portfolios. In connection with the transaction, we entered into a sub-advisory agreement to employ Strategos Capital Management, LLC to render advice and assistance with respect to collateral management services for the Kleros and Libertas portfolios.

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In general, our Kleros and Libertas deals have the following terms. We receive senior management fees. All of the subordinate management fees have been deferred with no potential for collection, and there is no potential for incentive fees. Typically, we cannot be removed as manager without cause. We can be removed as manager for cause if 66.7% of the controlling class of note holders or a majority of equity holders vote to remove us. In general, cause includes unremedied violations of the collateral management agreement or indenture, defaults attributable to certain actions of the manager, misrepresentations or fraud, criminal activity, bankruptcy, insolvency or dissolution, as well as an event of default. Certain of the deals have a reinvestment period after closing, which ranges from three to five years, during which the manager may sell and purchase collateral for the portfolio; such reinvestment period is terminated upon the occurrence of an event of default. Typically, there is a three or four year non-call period for the equity holders. Once this non-call period expires, a majority of the equity holders can trigger an optional redemption as long as the liquidation of the collateral generates sufficient proceeds to cover all principal and accrued interest on the rated notes and all expenses. In seven or eight years from closing, an auction call will be triggered if the rated notes have not been redeemed in full. In an auction call redemption, an appointee will conduct an auction for the collateral, which will only be executed if the highest bid results in sufficient proceeds to pay all principal and accrued interest on the notes and all expenses. There is no protection for equity holders in an auction call. If the auction is not successfully completed, all residual interest that would normally be distributed to equity holders will be sequentially applied to reduce the principal of the rated notes. The securities mature 40 to 45 years from closing. An event of default will occur if certain credit covenant ratios drop below specific levels. While an event of default exists, a majority of the senior note holders can declare the principal and accrued and unpaid interest immediately due and payable. As of December 31, 2013, only two of our Kleros deals and one of our Libertas deals have not yet triggered an event of default. AUM in our Kleros, Libertas, and Scorpius product lines increased from $996.0 million as of December 31, 2005, to $24.3 billion as of December 31, 2007, reflecting a compound annual growth rate of 394%. This period of rapid growth was driven by high levels of home price appreciation as well as the loosening of mortgage underwriting standards which generated record mortgage origination volume. In 2007, many regions of the country started reporting declining home prices. The aggressive underwriting standards and declining home prices led to higher than anticipated delinquencies, defaults, and losses. AUM declined to $363 million as of December 31, 2013.

Munda. CCFL acts as lead and junior investment manager to Munda CLO I B.V. (f/k/a Neptuno CLO III B.V.) (“Munda I”), a limited liability company incorporated under the laws of the Netherlands. In September 2012, CCFL assumed the lead investment management role from a large European bank. In conjunction with assuming the lead investment management role, CCFL hired a team of ten asset management professionals who are located in Madrid, Spain. Munda I is comprised of European broadly syndicated corporate loans. Munda I was initially securitized in December 2007.

In general, Munda I has the following terms. We receive senior and subordinate management fees, and there is no potential to earn incentive fees. We cannot be removed as investment manager without cause. We can be removed as investment manager for cause if 66.7% of the senior note holders and 66.7% of the equity holders vote to remove us. Cause includes unremedied violations of the collateral management agreement or trust deed, breach of the collateral management agreement that is not cured within 30-60 days, misrepresentations or fraud, criminal activity, bankruptcy, insolvency or dissolution, and certain key man provisions. There is a six year reinvestment period after closing during which the manager may sell and purchase collateral for the deal. After the last day of the reinvestment period, collateral principal collections will be applied to pay down the notes sequentially. There is a three year non-call period for the equity holders. Once this non-call period is over, a majority of the equity holders can trigger an optional redemption as long as the liquidation of collateral generates sufficient proceeds to cover all principal and accrued interest on the rated notes and all expenses. Any failure of over-collateralization coverage tests redirects interest to pay down notes until compliance is restored. Any failure of interest diversion tests during the reinvestment period redirects interest to purchasing collateral until compliance is restored. The maturity of the securities is 17 years from closing. An event of default will occur if certain over-collateralization ratios drop below 100%. While an event of default exists, a majority of the senior note holders can declare the principal and accrued and unpaid interest immediately due and payable.

Permanent Capital Vehicles:

The objective of permanent capital vehicles is to provide stockholders with attractive risk-adjusted returns and predictable cash distributions by investing in selected credit asset classes. Events in the financial markets over the last few years have challenged the investment strategy of our permanent capital vehicles. In general, poor credit performance reduces investor demand for the asset classes in which we specialize, thereby making it more difficult for us to raise additional capital into existing permanent capital vehicles.

EuroDekania

 

EuroDekania (Cayman) Ltd. (“EuroDekania”) is a Cayman Islands exempted company that is externally managed by CCFL. In December 2013, as a cost savings measure, EuroDekania was restructured from a Guernsey closed end fund to a Cayman Islands exempted company. CCFL is entitled to receive an annual management fee of 0.50% of the gross equity of EuroDekania. This management fee is reduced, but not below zero, by EuroDekania’s proportionate share of the amount of any CDO collateral management fees that are paid to CCFL and its affiliates in connection with EuroDekania’s investment in CDOs managed by CCFL based on the percentage of equity EuroDekania holds in such CDOs. CCFL has not received any management fee since 2008, when EuroDekania invested in Munda I. EuroDekania invests in hybrid capital securities of European banks and insurance companies,

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commercial mortgage backed securities (“CMBS”), RMBS, and widely syndicated leverage loans. EuroDekania’s investments are denominated in Euros or British Pounds. EuroDekania began operations in March 2007 when it raised approximately €218 million in net proceeds from a private offering of securities, of which we invested €5.3 million. In addition, we made follow-on investments in EuroDekania through secondary trades of $0.3 million in August 2010, $0.4 million in May 2011, $0.1 million in June 2011, $15 thousand in November 2012, and $1.0 million in December 2013.

Our Vice Chairman (formerly our Chairman and Chief Executive Officer), Daniel G. Cohen, served as one of five members of the board of directors of EuroDekania until December 18, 2013 when EuroDekania and its board of directors were restructured. Currently, there is only one director of EuroDekania.  As of December 31, 2013, we owned approximately 17% of EuroDekania’s outstanding shares, which were valued at $4.2 million. At December 31, 2013, EuroDekania had an estimated NAV of $24.8 million.

MFCA / Tiptree

Muni Funding Company of America, LLC (“MFCA”) was a Delaware limited liability company that we managed until March 18, 2009. Under the MFCA management agreement, we received an annual management fee of 0.50% of MFCA’s equity.  MFCA primarily invested in securities exempt from United States federal income taxes directly or through structured tax-exempt pass-through vehicles which are similar in nature to CDOs, as well as other structured credit entities. MFCA began operations in June 2007 when it raised approximately $159 million of net proceeds from a private offering of securities, of which we invested $5.0 million. In June 2009, MFCA completed a rights offering in which we invested $0.6 million.

In February 2009, a new shareholder obtained a controlling interest in MFCA and requested that our management agreement with MFCA be assigned to a new management company controlled by the new majority shareholder. On March 18, 2009, we assigned the MFCA management agreement to that new management company.

In June 2011, MFCA was merged into Tiptree Financial Partners, L.P. (“Tiptree”). In mid-2013, Tiptree completed a transaction with its publicly-traded, majority-owned subsidiary, Care Investment Trust Inc., which combined their businesses into a single operating company. In connection with the closing of this transaction, the company, formerly known as Care Investment Trust Inc., changed its name to “Tiptree Financial Inc.”  Tiptree Financial Inc. (“Tiptree Inc.”) (NASDAQ: TIPT), a Maryland corporation, is a diversified financial services holding company that was organized in 2007 and primarily focuses on the acquisition of majority control equity interests in financial services businesses.

Our Vice Chairman (formerly our Chairman and Chief Executive Officer), Daniel G. Cohen, served as a member of the board of directors of MFCA until June 23, 2011, and our former President and current member of our Board of Directors, Christopher Ricciardi, served as a member of the board of directors of MFCA until March 18, 2009. As of December 31, 2013, we owned approximately 1% of Tiptree’s outstanding shares, which were valued at $2.3 million.

 

Star Asia

Star Asia Finance, Limited (“Star Asia”) is a Guernsey closed end fund that is externally managed by Star Asia Manager, which was a 50/50 joint venture between us and Star Asia Mercury LLC (formerly, Mercury Partners, LLC), a third party real estate investment management company, until March 1, 2013 when it became wholly-owned by our subsidiary Cohen Asia Investments, Ltd. Prior to March 1, 2013, Star Asia Manager was one of our equity method affiliates, and thereafter it was one of our consolidated subsidiaries.

Star Asia Manager charges Star Asia an annual management fee of 1.75% of realized NAV. Star Asia seeks to invest in Asian commercial real estate structured finance products, including CMBS, corporate debt of real estate investment trusts (“REITs”) and real estate operating companies, whole loans, mezzanine loans, and other commercial real estate fixed income investments and in real property in Japan. Star Asia began operations in March 2007 when it raised approximately $255 million in net proceeds from a private offering of securities, of which we invested $10.0 million. Star Asia completed rights offerings in April 2008, raising approximately $49 million in net proceeds, of which we invested $7.0 million, and in March 2010, raising $5.7 million in net proceeds, of which we invested $1.3 million. In 2008, 2009, 2010, 2011, and 2012 we made follow-on investments of $0.4 million, $0.1 million, $4.5 million, $0.4 million, and $0.1 million, respectively, in Star Asia through secondary trades.

Our Vice Chairman (formerly our Chairman and Chief Executive Officer), Daniel G. Cohen, was one of three members of the board of directors of Star Asia until February 20, 2014. As of December 31, 2013, we owned approximately 28% of Star Asia’s outstanding shares, which were valued at $17.1 million. At December 31, 2013, Star Asia had a NAV of $110.0 million.

In February 2014, we announced the completion of the sale all of our ownership interests in the Star Asia Group, which included our interests in Star Asia and Star Asia Manager.

Managed Accounts:

We provide investment management services to a number of separately managed accounts. Part of our European CDO team has transitioned to providing investment management services primarily to European family offices, high net worth individuals, and asset

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managers. The investment focus is on CDO notes and debt instruments where the investment managers have relevant expertise. For these services, we are paid gross annual base management fees of approximately 1.5% plus a gross annual performance fee of 20% of cash-on-cash returns in excess of an 8% hurdle. There is also an early redemption fee if any of the clients were to terminate their arrangement within the first five years of the relationship. AUM of these European managed accounts was $35.8 million at December 31, 2013.

In addition, our Kleros and Libertas CDO team provided investment management services to a state’s retirement system and a third party asset manager for portfolios of mortgage securities until March 29, 2011 when we completed the sale of the investment advisory agreements. For these services, we were paid annual management fees of 0.5% to 1.5% of the net asset value of the aggregate AUM.

Investment Funds:

Star Asia SPV

In March 2010, Star Asia raised approximately $19.6 million in net proceeds in a rights offering through the Star Asia Special Purpose Vehicle (“Star Asia SPV”), of which we invested $4.1 million. Star Asia SPV was formed to create a pool of assets that would provide collateral to investors who participated in Star Asia’s March 2010 rights offering. Investors in Star Asia’s March 2010 rights offering also received equity interests in Star Asia SPV. Star Asia SPV purchased certain assets from Star Asia and the equity interest holders of Star Asia SPV were entitled to receive investment returns on the assets held in Star Asia SPV up to an agreed upon maximum. During the second quarter of 2013, we received our maximum investment return from Star Asia SPV and we no longer have an ownership interest in the entity. Any returns above the agreed upon maximum will be remitted back to Star Asia. Star Asia SPV is externally managed by Star Asia Manager and is in the process of liquidating.

Star Asia Opportunity

In August 2011, approximately $14.7 million in proceeds were raised in an equity offering through Star Asia Opportunity, LLC (“Star Asia Opportunity”), of which we invested $4.1 million. Star Asia Opportunity was formed to partially finance the acquisition of seven real estate properties in Tokyo, Japan. As of December 31, 2013, all seven of such real estate properties had been sold. Star Asia Capital Management serves as external manager to Star Asia Opportunity and charges Star Asia Opportunity an annual management fee of 1.25% of equity. As of December 31, 2013, we owned approximately 28% of Star Asia Opportunity’s outstanding equity interests, which were carried at $17 thousand. It is anticipated that Star Asia Opportunity will be fully liquidated during 2014 upon settlement of residual expenses and that any excess cash will be returned to the equity holders.

Star Asia Opportunity II

In August 2012, approximately $23.1 million in proceeds were raised in an equity offering through Star Asia Opportunity II, LLC (“Star Asia Opportunity II”), of which we invested $4.7 million. Star Asia Opportunity II was formed to finance the acquisition of one real estate property in Japan. Prior to December 20, 2012, we owned 20% of Star Asia Opportunity II. On December 20, 2012, Star Asia Opportunity II was reorganized. During the reorganization, we monetized a portion of our investment in Star Asia Opportunity II and a portion of Star Asia Opportunity II’s underlying assets were contributed into a new Japanese investment fund. Pursuant to the reorganization, we received $2.5 million in cash and a 6% interest in the Star Asia Special Situations Fund. Star Asia Capital Management served as external manager to Star Asia Opportunity II and charged Star Asia Opportunity II an annual management fee of 1.25% of equity. As of December 31, 2013, we no longer had an investment in Star Asia Opportunity II. Star Asia Opportunity II still exists and is owned by two unrelated third parties, and its only asset is an investment in a sub fund, Star Asia Japan Special Situations Sub LP, an entity jointly owned by Star Asia Opportunity II and the Star Asia Special Situations Fund. In February 2014, we announced the completion of the sale of our ownership interests in the Star Asia Group, which included the Star Asia Special Situations Fund.

The Star Asia Special Situations Fund

In December 2012, we, along with two other parties, sponsored the creation of a new investment fund, the Star Asia Special Situations Fund. The Star Asia Special Situations Fund is an investment fund that primarily invests in real estate and securities backed by real estate in Japan. In particular, the focus is on stressed or defaulted Japanese commercial real estate securitized debt and equity with one or more of the following characteristics: (i) commercial mortgage-backed securities, A-notes, B-notes, mezzanine loans, whole loans, convertible debt, unsecured debt, preferred equity, direct equity or partnership units, (ii) defaulted or a high likelihood of defaulting within two years, (iii) motivated sellers (resulting from regulatory, liquidity, or fund maturity issues), (iv) clearly defined control rights, (v) a controlling class, and/or (vi) fully disclosed transaction documents. The Star Asia Special Situations Fund is a closed end fund that does not offer investor redemptions. It has an initial life of three years, which can be extended under certain circumstances. SAP GP serves as the general partner for the Star Asia Special Situations Fund and SAA Manager serves as the external manager of the Star Asia Special Situations Fund. As of December 31, 2013, we owned approximately 2.2% of the Star Asia Special Situations Fund, 33.3% of SAP GP, and 33.3% of SAA Manager. As of December 31, 2013, the estimated NAV of the Star Asia Special Situations Fund was $157.2 million and our investment was valued at $2.7 million. In February 2014, we announced the

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completion of the sale of our ownership interests in the Star Asia Group, which included the Star Asia Special Situations Fund, SAP GP, and SAA Manager.  

 

The general terms of investments in the Star Asia Special Situations Fund include a minimum capital contribution of 500 million Japanese Yen, no redemptions, interim closings may occur until the nine-month anniversary of the initial closing, two-year investment period with optional one-year extension, committed capital must be drawn within the investment period, 10% maximum concentration in non-income producing land, orderly liquidation upon certain events, and a 1.25% annual management fee paid quarterly.

At the option of SAP GP or after the expiration of the investment period, the Star Asia Special Situations Fund will begin to distribute at least annually all net cash available for distribution as follows:

1. Return of Capital: 100% to the limited partner investors in proportion to their capital contributions until the aggregate cumulative distributions equal their aggregate capital contributions;

2. Preferred Return: Then, 100% to the limited partner investors until each has received a return of 8% compounded annually on their total capital contributions for the period during which they were outstanding; and

3. Carried Interest: Then, 80% to the limited partner investors and 20% to the general partners.

We earned management fees through our ownership interest in SAA Manager, which were based on the realized NAV of the Star Asia Special Situations Fund. As described above, we could have earned carried interest based on the performance of the Star Asia Special Situations Fund. The Star Asia Special Situations Fund has an expected term of three years from the initial closing, but can be extended for one year by SAP GP. In addition, in 2013 we earned $0.2 million of investment returns on our investment in the Star Asia Special Situations Fund through our Principal Investing business segment.

Our investments in the Star Asia Special Situations Fund, SAP GP, and SAA Manager were included in the sale of our ownership interests in the Star Asia Group that was completed in February 2014 as discussed above. As part of the sale of the Star Asia Group, we will receive a 15% revenue share of revenues generated by SAA Manager, Star Asia Capital Management, and SAP GP, as well as management fees or incentive fees generated by certain affiliated entities. This revenue share will last for a period of at least four years.

Deep Value

We had an investment in and served as external manager of a series of closed-end, distressed debt funds and other related entities that we refer to collectively as Deep Value. Deep Value earned investment returns by investing in a diversified portfolio of ABS consisting primarily of RMBS and other real estate related securities, as well as other United States real estate related assets and related securities. Deep Value’s management team consisted primarily of investment professionals from our Kleros and Libertas CDO team. On March 29, 2011, we completed the sale of our investment advisory agreements relating to Deep Value and certain separately managed accounts to a new entity owned by two of our former employees. We retained our ownership in the general partners of the existing Deep Value funds and our rights to receive incentive fees from the Deep Value funds that had not yet been liquidated. While Deep Value was owned by us, we launched three master funds. We formed the initial fund in October 2007, which consummated its first closing in April 2008 and successfully completed its liquidation in December 2010; the second fund consummated its first closing in February 2009 and successfully completed its liquidation in June 2011; and the third fund closed in December 2009 and successfully completed its liquidation in December 2012. The first master fund had two feeder funds. One feeder fund was referred to as the “onshore fund” and was designed for investors that are non-tax-exempt United States taxpayers. Foreign and United States tax-exempt investors invested through a second feeder fund referred to as the “offshore fund”. The second master fund did not have feeder funds. The third master fund had an offshore feeder fund only. Investors held limited partnership interests in the feeder funds (in the case of the first and third master fund) or in the master fund itself (in the case of the second master fund). The Strategos Deep Value Credit GP, LLC (the “Deep Value GP”) served as the general partner for the feeder funds (in the case of the first master fund) and as the general partner of the master fund itself (in the case of the second master fund). The Strategos Deep Value Credit II GP, LLC (the “Deep Value GP II”), served as the general partner for the offshore feeder fund (in the case of the third master fund). Deep Value GP and Deep Value GP II are collectively referred to as the “Deep Value GPs”.

 

Until March 29, 2011, we served as external manager of Deep Value. We owned 50% of the general partner of the first and second master funds and owned 40% of the general partner of the third master fund. In addition, we made limited partnership investments in certain of the feeder funds.

The general terms of the investments in Deep Value included a minimum capital contribution of $10 million (in the case of the first two master funds) and $1 million (in the case of the third master fund), no redemptions, no short sales, no leverage (in the case of the first two master funds) or leverage only if it is non-recourse and non-callable for the term or if leverage becomes available directly or indirectly through a government program (in the case of the third master fund), no trading with any IFMI-related entity except as part of an exit strategy, 10% maximum concentration of non-real estate related assets, 5% maximum concentration in any single issuer of securities, investment in assets located primarily in the United States, limited investments in securities paying dividends or interest

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income subject to United States withholding taxes, committed capital must be drawn within one year of the final closing, orderly liquidation upon certain events, and a 1.5% annual management fee paid quarterly.

One year from the final closings of each of the master funds, Deep Value began to distribute at least quarterly all net cash available for distribution as follows:

1. Return of Capital: 100% to the limited partner investors in proportion to their capital contributions until the aggregate cumulative distributions equal their aggregate capital contributions;

2. Preferred Return: Then, 100% to the limited partner investors until each received a return of 10% (in the case of the first two master funds) and 8.0% (in the case of the third master fund) compounded annually on each investor’s total capital contributions for the period during which they were outstanding;

3. First Tier Incentive Fee: Then, 80% to the Deep Value GPs and 20% to the limited partner investors until the aggregate distributions made to the general partner equal 20% of the cumulative distributions made to all limited partner investors pursuant to the Preferred Return and this First Tier Incentive Fee; and

4. Second Tier Incentive Fee: Then, 80% to the limited partner investors and 20% to the Deep Value GPs.

We earned management fees based on the drawn committed capital of Deep Value during the first year after the final closing and, thereafter, based on NAV of Deep Value; however, we did not earn management fees on our own investment in Deep Value. As described above, we could also earn incentive fees based on the performance of Deep Value upon liquidation. We earned a $6.2 million incentive fee upon the successful liquidation of the first Deep Value fund during the second half of 2010, a $4.4 million incentive fee upon the successful liquidation of the second Deep Value fund during mid-2011, and a $1.7 million incentive fee upon the successful liquidation of the third Deep Value fund at the end of 2012. The Deep Value funds had an expected term of three years from the final closing, but could be extended for one year by the Deep Value GP and could be extended for an additional year with the approval of Deep Value’s advisory board. The advisory board was comprised of representatives from select limited partners not affiliated with the Deep Value GP or us. In addition, we earned investment returns on our investment in Deep Value through our Principal Investing business segment.

We seeded Deep Value with an initial capital commitment of $15 million at inception. During April to October 2008, $110 million of outside capital was committed to the first master fund. In February, July, September, and December 2009, an additional $25 million, $7 million, $8 million, and $42.5 million, respectively, of outside capital was committed to Deep Value. Investors in Deep Value, which are closed end funds, do not have redemption rights. During the period from December 2009 through December 2010, we received capital distributions of $24.2 million from our investment in Deep Value.

 

Brigadier

We had an investment in and served as external manager of a series of investment funds and related entities that we refer to collectively as “Brigadier.” Brigadier, formed by us in 2006 and liquidated in 2010, was a series of investment funds that primarily earned investment returns by investing in various fixed income and credit-related investments and related securities through a master fund. Brigadier had a single master fund and two feeder funds. One feeder fund was referred to as the “onshore feeder fund” and was designed for investors that are non-tax-exempt U.S. tax payers. Foreign and U.S. tax-exempt investors invested through a second feeder fund referred to as the “offshore feeder fund.” We were the general partner and made an initial investment in the offshore feeder fund. In addition to being general partner of the onshore feeder fund, we made an investment as a limited partner as well.

The primary investment activities of Brigadier focused on relative value strategies in the credit markets. Target assets included long and short exposure to corporate investment grade and high yield securities, MBS, structured credit and other related securities, derivatives, and indices.

The general terms of investments in Brigadier included a minimum initial capital contribution of $500,000, a one-year lock-up period, quarterly redemptions after the lock-up period upon 90 days’ notice, capital contributions accepted on the first business day of each quarter, no restrictions on the amount of leverage utilized, a 2.0% annual management fee paid quarterly, a 20% annual incentive fee on the excess net capital appreciation after deducting management fees payable only if the net capital is above its high water mark, and quarterly reporting requirements.

We earned management and incentive fees based on the performance of Brigadier. We did not earn management or incentive fees on our own investment in Brigadier; however, we did earn investment returns on our investment in Brigadier through our Principal Investing business segment.

For most of 2010 Brigadier was in the process of liquidating. Brigadier experienced significant redemptions in 2009 and, effective in the second quarter of 2010, Brigadier ceased permitting redemptions until its final liquidation which was completed during the fourth quarter of 2010.

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We seeded Brigadier with an initial investment of $30 million at its inception in May 2006. In September 2008, Brigadier won an award for best “Long/Short Credit Hedge Fund — Relative Value” presented by CreditFlux magazine, a publication that covers the credit markets. The award was based on quantifiable return and volatility measures.

During the period from May 2008 through November 2010, we redeemed $56.8 million of our investment in Brigadier. As of December 31, 2010, Brigadier had completed its final liquidation.

Principal Investing

Our Principal Investing business segment has historically been comprised of investments in the investment vehicles we manage, as well as investments in certain other structured products, and the related gains and losses that they generate. After the sale of our interests in the Star Asia Group as discussed above, our Principal Investing portfolio is primarily comprised of our investments in EuroDekania and MFCA/Tiptree. In the future, we may focus our investing activity on products that we do not manage.

Investments in Permanent Capital Vehicles:

EuroDekania. We made an initial investment of €5.3 million in EuroDekania in its initial private offering of securities in March 2007. In August 2010, May 2011, June 2011, November 2012, and December 2013, we purchased an additional $0.3 million, $0.4 million, $0.1 million, $15 thousand, and $1.0 million, respectively, in secondary trades. In addition to changes in the NAV of the entity, the value of our investment is impacted by changes in the U.S. dollar-Euro currency exchange rate due to the fact that our investment in EuroDekania is denominated in Euros. During 2013, we recorded $1.2 million of investment gains on our investment in EuroDekania. As of December 31, 2013, we owned approximately 17% of EuroDekania, and our 2.4 million shares of EuroDekania were valued at $4.2 million.

 

MFCA/Tiptree. We made an initial investment of $5.0 million in MFCA in its initial private offering of securities in June 2007 and a follow-on investment of $0.6 million in its rights offering in June 2009. In June 2011, MFCA was merged into Tiptree Financial Partners, LP. In mid-2013, Tiptree Financial Partners, LP completed a transaction with its publicly-traded, majority-owned subsidiary, Care Investment Trust Inc., which combined their businesses into a single operating company. In connection with the closing of this transaction, the company, formerly known as Care Investment Trust Inc., changed its name to Tiptree, Inc. (NASDAQ: TIPT), a Maryland corporation, is a diversified financial services holding company that was organized in 2007, and primarily focuses on the acquisition of majority control equity interests in financial services businesses. During 2013, we recorded $0.6 million of investment losses on our investment in MFCA/Tiptree. As of December 31, 2013, we owned approximately 1% of Tiptree, and our 310,950 shares of Tiptree were valued at $2.3 million.

Star Asia. We made an initial investment of $10.0 million in Star Asia in its initial private offering of securities in March 2007. We also made follow-on investments in its rights offerings in April 2008 and March 2010, in the amounts of $7.0 million and $1.3 million, respectively. In addition, we made follow-on investments through secondary trades of $0.4 million in 2008, $0.1 million in 2009, $4.5 million in 2010, $0.4 in 2011, and $0.1 million in 2012. During 2013, we recorded $13.1 million of investment losses on our investment in Star Asia, of which $7.6 million was attributable to foreign exchange losses due to the weakening of the Japanese Yen. As of December 31, 2013, we owned approximately 28% of Star Asia and our 4.6 million shares of Star Asia were valued at $17.1 million, or $3.74 per share. During 2010, 2012, and 2013 we put in place Japanese Yen-based forward contracts to partially hedge fluctuations in the investment value of Star Asia. The 2010 forward contracts were terminated in October 2011, the 2012 forward contracts were terminated in November 2012, and the 2013 forward contracts we terminated in early 2014. We recorded $0.3 million of investment gains related to our investment in these forward contracts during 2013. Our investment in Star Asia was included in the sale of our ownership interests in the Star Asia Group that was completed in February 2014, as discussed above. Currently, we have no exposure to Japanese Yen-based currency fluctuation.

Investment in Investment Funds:

Star Asia Special Situations Fund. The Star Asia Special Situations Fund was created in December 2012 through the reorganization of Star Asia Opportunity II. As part of the reorganization of Star Asia Opportunity II, we received an interest in the Star Asia Special Situations Fund, the value of which was impacted by the fund’s returns and distributions. As it is a closed-end fund, investors in the Star Asia Special Situations Fund do not have redemption rights. At December 31, 2013 the Star Asia Special Situations Fund had an estimated NAV of $157.2 million. As of December 31, 2013, our 2.2% interest in the Star Asia Special Situations Fund had a carrying value of approximately $2.7 million. During 2013, we recorded $0.2 million of investment gains on our investment in the Star Asia Special Situations Fund. Our investment in the Star Asia Special Situations Fund was included in the sale of our ownership interests in the Star Asia Group that was completed in February 2014, as discussed above.

Other Investments:

Investments in Equity Method Affiliates. Our investments that are classified as equity method affiliates include: Star Asia Manager, Star Asia SPV, Star Asia Opportunity, Star Asia Capital Management, Star Asia Opportunity II, SAA Manager, SAP GP,

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Deep Value GP, and Deep Value GP II. For a discussion of equity method affiliates accounting see “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” beginning on page 46.  

•Star Asia Manager. On March 1, 2013, we obtained 100% voting control of Star Asia Manager, which serves as external manager to Star Asia, and began consolidating the entity. As of the date of consolidation and as of December 31, 2013, Star Asia Manager was no longer classified as an equity method affiliate. Prior to March 1, 2013, we and our joint venture partner, Star Asia Mercury LLC (formerly Mercury Partners LLC), each owned 50% of Star Asia Manager. Therefore, the value of our investment in Star Asia Manager changed by 50% of Star Asia Manager’s net income or loss. In addition, our investment in Star Asia Manager was included in the sale of our ownership interests in the Star Asia Group that was completed in February 2014.

•Star Asia SPV. Our investment in the Star Asia rights offering in March 2010 was made through a special purpose entity, Star Asia SPV. The equity interest holders of Star Asia SPV were entitled to receive investment returns on the assets held in Star Asia SPV up to an agreed upon maximum. During the second quarter of 2013, we received our maximum investment return from Star Asia SPV and we no longer have an ownership interest in the entity. Star Asia SPV is externally managed by Star Asia Manager and is in the process of liquidating.

 

•Star Asia Opportunity. In August 2011, Star Asia Opportunity was capitalized through a $14.7 million equity offering. Currently, Star Asia Opportunity is in the process of winding down and its only asset is cash. As of December 31, 2013, Star Asia Opportunity had an estimated net asset value (“NAV”) of approximately $60 thousand. We own approximately 28% of Star Asia Opportunity. As of December 31, 2013, our investment in Star Asia Opportunity had a carrying value of $17 thousand.

•Star Asia Capital Management. We had an investment in Star Asia Capital Management, which serves as external manager to Star Asia Opportunity and served as the external manager to Star Asia Opportunity II, until the sale of our ownership interests in the Star Asia Group was completed in February 2014. We owned 33.3% of Star Asia Capital Management. Therefore, the value of our investment in Star Asia Capital Management changed by 33.3% of Star Asia Capital Management’s net income or loss. As of December 31, 2013, our investment in Star Asia Capital Management had a carrying value of $(81) thousand.

•Star Asia Opportunity II. In August 2012, Star Asia Opportunity II was capitalized through a $23.1 million equity offering. Prior to December 20, 2012, we owned 20% of Star Asia Opportunity II. On December 20, 2012, Star Asia Opportunity II was reorganized. During the reorganization, we monetized a portion of our investment in Star Asia Opportunity II and a portion of Star Asia Opportunity II’s underlying assets were contributed into the new Star Asia Special Situations Fund. In connection with the reorganization, we received $2.5 million in cash and an interest in the Star Asia Special Situations Fund. As of December 31, 2013, we no longer had an investment in Star Asia Opportunity II. Star Asia Opportunity II still exists and is owned by two unrelated third parties, and its only asset is an investment in a sub fund, Star Asia Japan Special Situations Sub LP, an entity jointly owned by Star Asia Opportunity II and the Star Asia Special Situations Fund.

•SAA Manager. We owned 33.3% of SAA Manager.  SAA Manager serves as external manager to the Star Asia Special Situations Fund. Therefore, the value of our investment in SAA Manager changed by 33.3% of SAA Manager’s net income or loss. As of December 31, 2013, our investment in SAA Manager had a carrying value of $12 thousand. Our investment in SAA Manager was included in the sale of our ownership interests in the Star Asia Group that was completed in February 2014.

•SAP GP. We owned 33.3% of SAP GP.  SAP GP is the general partner of the Star Asia Special Situations Fund. Therefore, the value of our investment in SAP GP changed by 33.3% of SAP GP’s net income or loss. As of December 31, 2013, we had not recognized any income or loss related to SAP GP. Our investment in SAP GP was included in the sale of our ownership interests in the Star Asia Group that was completed in February 2014.

•Deep Value GP. We served as external manager of the first two Deep Value funds and we owned 50% of the general partner of the onshore and offshore feeder funds of the first two Deep Value funds (the “Deep Value GP”). Therefore, the value of our investment in Deep Value GP changed by 50% of Deep Value GP’s net income or loss. We made an initial investment in Deep Value GP of $0.1 million in May 2008. The first two Deep Value funds were fully liquidated and the Deep Value GP made its final liquidation payment in 2013 after all expenses had been paid. As of December 31, 2013, we no longer had an investment in Deep Value GP.

•Deep Value GP II. We served as external manager of the third Deep Value fund and we owned 40% of the general partner of the offshore feeder fund of the third Deep Value fund (the “Deep Value GP II”). Therefore, the value of our investment in Deep Value GP II changed by 40% of Deep Value GP II’s net income or loss. The third Deep Value fund was fully liquidated and the Deep Value GP II made its final liquidation payment in 2013 after all expenses were paid. As of December 31, 2013, we no longer had an investment in Deep Value GP II.

Investments in CDO and Other Securities. We have invested in various original issuance securities of the deals we have sponsored and certain other deals that we have not sponsored. We have also received options or warrants in publicly traded securities

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as payment for certain investment banking services that we have provided. In addition, upon the closing of the Merger, we assumed ownership of the investments that AFN had made prior to the closing of the Merger. As of December 31, 2013, we had approximately $0.4 million in fair value of these CDO and other securities.

 

Previous Investments:

Deep Value. We seeded Deep Value with an initial capital commitment of $15 million at its inception in April 2008. The initial capital commitment was drawn during the following six months. This initial investment was subsequently impacted by the fund’s returns and distributions. As they were closed-end funds, investors in Deep Value did not have redemption rights. In December 2009, Deep Value started distributing net cash available for distribution. From December 2009 through December 2010, we received $24.2 million of these distributions. Our net investment in Deep Value was fully distributed in 2011 with a final immaterial distribution.

Duart Fund. We seeded the Duart Global Deep Value Securities Fund LP (“Duart Fund”) with a $4.5 million investment in September 2010. The Duart Fund was a specialized deep value and special situations opportunity fund. The Duart Fund’s investment objective was to provide superior absolute returns by investing primarily in a portfolio of long and short positions in public and private real estate equity securities, equity-linked securities, or debt securities (including, but not limited to, convertible debt, debt with warrants, warrants, and credit default swaps related to real estate securities) and partnership or fund interests in the real estate industry globally. We did not manage the Duart Fund but we own 20% of the investment manager. Effective December 31, 2010, we submitted a redemption notice to the Duart Fund to redeem 100% of our capital. We received our redemption in April 2011 in the amount of $3.8 million. During 2010 and 2011, we recorded investment losses of $0.2 million and $0.5 million, respectively, on our investment in the Duart Fund. In addition, we funded $2.0 million into the manager of the Duart Fund, which resulted in losses of $1.3 million in 2010 and $0.7 million in 2011. We have no further funding obligation related to the Duart Fund or its manager.

Brigadier. We seeded Brigadier with an initial investment of $30 million at its inception in May 2006. The initial investment was subsequently impacted by the fund’s returns as well as our redemptions. The change in value that is a result of the fund’s returns is what flowed through our Principal Investing business segment statement of operations. Prior to its liquidation in 2010, we redeemed $56.8 million including our initial investment. During 2010, Brigadier was liquidated and our investment was fully redeemed in 2010.

Investments in Publicly Traded Equity Securities. In March 2005, we sponsored the formation of Taberna. Taberna was a separate company through which we spun off our business of originating TruPS primarily issued by REITs and sponsoring and managing investment vehicles collateralized by those assets. We did not manage Taberna. In December 2006, Taberna was acquired by RAIT Financial Trust, a publicly-traded REIT (NYSE: RAS). Our Vice Chairman (formerly our Chairman and Chief Executive Officer), Daniel G. Cohen, is the former Chief Executive Officer and was a trustee of RAIT until he resigned from these positions on February 26, 2010. We sold our 510,434 common shares of RAIT in March 2010.

Employees

As of December 31, 2013, we employed a total of 148 full time professionals and support staff. This number includes 37 employees of our PrinceRidge (now JVB) subsidiary, 52 employees of our JVB subsidiary, 19 employees of our European Capital Markets business segment, 23 employees of our Asset Management business segment, 2 employees of our Principal Investing business segment, and 15 employees of our support services group. Upon the completion of the sale of our ownership interests in the Star Asia Group in February 2014, our total number of employees decreased by eight employees. JVB and PrinceRidge were merged effective January 31, 2014.  Incorporated in the total number of IFMI employees as of December 31, 2013 is the previously announced 20% workforce reduction related to the merger of JVB and PrinceRidge.  These reductions occurred in October 2013. We consider our employee relations to be good and believe that our compensation and employee benefits are competitive with those offered by other securities firms. None of our employees is subject to any collective bargaining agreements. Our core asset is our professionals, their intellectual capital, and their dedication to providing the highest quality services to our clients. Prior to joining us, members of our management team held positions with other leading financial services firms, accounting firms, law firms or investment firms. Lester R. Brafman and Joseph W. Pooler, Jr. are our executive operating officers, and biographical information relating to each of these officers is incorporated by reference in “Part III — Item 10 — Directors, Executive Officers and Corporate Governance” to the Company’s Proxy Statement, to be filed in connection with the Company’s 2014 Annual Meeting of Stockholders.

 

Competition

All areas of our business are intensely competitive and we expect them to remain so. We believe that the principal factors affecting competition in our business include economic environment, quality and price of our products and services, client relationships, reputation, market focus and the ability of our professionals.

Our competitors are other public and private asset managers, investment banks, brokerage firms, merchant banks, and financial advisory firms. We compete globally and on a regional, product or niche basis. Many of our competitors have substantially greater capital and resources than we do and offer a broader range of financial products and services. Certain of these competitors continue to raise additional amounts of capital to pursue business strategies which may be similar to ours. Some of these competitors may also have access to liquidity sources that are not available to us, which may pose challenges for us with respect to investment opportunities.

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In addition, some of these competitors may have higher risk tolerances or make different risk assessments than we do, allowing them to consider a wider variety of investments and establish broader business relationships.

In recent years, there has been substantial consolidation and convergence among companies in the financial services industry, including among many of our former competitors. In particular, a number of large commercial banks have established or acquired broker-dealers or have merged with other financial institutions. Many of these firms have the ability to offer a wider range of products than we offer, including loans, deposit taking, and insurance. Many of these firms also have more extensive investment banking services, which may enhance their competitive position. They also have the ability to support investment banking and securities products with commercial banking and other financial services revenue in an effort to gain market share, which could result in pricing pressure in our business. This trend toward consolidation and convergence has significantly increased the capital base and geographic reach of our competitors.

Competition is intense for the recruitment and retention of experienced and qualified professionals. The success of our business and our ability to continue to compete effectively will depend significantly upon our continued ability to retain and motivate our existing professionals and attract new professionals. See “Item 1A — Risk Factors” beginning on page 21.  

Regulation

Certain of our subsidiaries, in the ordinary course of their business, are subject to extensive regulation by government and self-regulatory organizations both in the United States and abroad. As a matter of public policy, these regulatory bodies are responsible for safeguarding the integrity of the securities and other financial markets. The regulations promulgated by these regulatory bodies are designed primarily to protect the interests of the investing public generally and thus cannot be expected to protect or further the interests of our company or our stockholders and may have the effect of limiting or curtailing our activities, including activities that might be profitable.

As of December, 31, 2013, our regulated subsidiaries include: CCPR and JVB, each of which is a registered broker-dealer regulated by FINRA and subject to oversight by the Securities and Exchange Commission (“SEC”); CCFL (previously known as EuroDekania Management Limited), a U.K. company regulated by the FCA; and Cohen & Company Financial Management, LLC, Dekania Capital Management, LLC, and Cira SCM, LLC, each of which is a registered investment advisor regulated by the SEC under the Investment Advisers Act. Since our inception, our businesses have been operated within a legal and regulatory framework that is constantly developing and changing, requiring us to be able to monitor and comply with a broad range of legal and regulatory developments that affect our activities.

Certain of our businesses are also subject to compliance with laws and regulations of United States federal and state governments, foreign governments, their respective agencies and/or various self-regulatory organizations or exchanges relating to, among other things, the privacy of client information and any failure to comply with these regulations could expose us to liability and/or reputational damage. Additional legislation, changes in rules promulgated by financial authorities and self-regulatory organizations or changes in the interpretation or enforcement of existing laws and rules, either in the United States or abroad, may directly affect our mode of operation and profitability.

The United States and foreign government agencies and self-regulatory organizations, as well as state securities commissions in the United States, are empowered to conduct periodic examinations and initiate administrative proceedings that can result in censure, fine, the issuance of cease-and-desist orders and/or the suspension or expulsion of a broker-dealer or its directors, officers or employees. See “Item 1A — Risk Factors” beginning on page 21.  

United States Regulation. As of December 31, 2013, JVB and CCPR were registered as broker-dealers with the SEC, were licensed to conduct business, and are members of and regulated by FINRA. Subsequent to the merger of JVB and CCPR, JVB is the only broker-dealer that is subject to the regulations of FINRA and industry standards of practice that cover many aspects of its business, including initial licensing requirements, sales and trading practices, relationships with customers (including the handling of cash and margin accounts), capital structure, capital requirements, record-keeping and reporting procedures, experience and training requirements for certain employees, and supervision of the conduct of affiliated persons, including directors, officers and employees. FINRA has the power to expel, fine and otherwise discipline member firms and their employees for violations of these rules and regulations. JVB is also registered as broker-dealers in certain states, requiring us to comply with the laws, rules and regulations of each state in which a broker-dealer subsidiary is registered. Each state may revoke the registration to conduct a securities business in that state and may fine or otherwise discipline broker-dealers and their employees for failure to comply with such state’s laws, rules, and regulations.

The SEC, FINRA, and various other regulatory agencies within and outside of the United States have stringent rules and regulations with respect to the maintenance of specific levels of net capital by regulated entities. Generally, a broker-dealer’s net capital is net worth plus qualified subordinated debt less deductions for certain types of assets. The net capital rule under the Exchange Act requires that at least a minimum part of a broker-dealer’s assets be maintained in a relatively liquid form. The SEC and FINRA impose rules that require notification when net capital falls below certain predefined criteria. These rules also dictate the ratio of debt to equity in the regulatory capital composition of a broker-dealer and constrain the ability of a broker-dealer to expand its business

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under certain circumstances. If a firm fails to maintain the required net capital, it may be subject to suspension or revocation of registration by the applicable regulatory agency, and suspension or expulsion by these regulators could ultimately lead to the firm’s liquidation. Additionally, the net capital rule under the Exchange Act and certain FINRA rules impose requirements that may have the effect of prohibiting a broker-dealer from distributing or withdrawing capital and requiring prior notice to the SEC and FINRA for certain capital withdrawals.

If these net capital rules are changed or expanded, or if there is an unusually large charge against our net capital, our operations that require the intensive use of capital would be limited. A large operating loss or charge against our net capital could adversely affect our ability to expand or even maintain current levels of business, which could have a material adverse effect on our business and financial condition.

Our investment advisor subsidiaries are registered with the SEC as investment advisers and are subject to the rules and regulations of the Investment Advisers Act. The Investment Advisers Act imposes numerous obligations on registered investment advisers including record-keeping, operational and marketing requirements, disclosure obligations, limitations on principal transactions between an adviser and its affiliates and advisory clients and prohibitions on fraudulent activities. The SEC is authorized to institute proceedings and impose sanctions for violations of the Investment Advisers Act, ranging from fines and censure to termination of an investment adviser’s registration. Investment advisers are also subject to certain state securities laws and regulations.

 

We are also subject to the USA PATRIOT Act of 2001 (the “Patriot Act”), which imposes obligations regarding the prevention and detection of money-laundering activities, including the establishment of customer due diligence, customer verification, and other compliance policies and procedures. These regulations require certain disclosures by, and restrict the activities of, research analysts and broker-dealers, among others. Failure to comply with these new requirements may result in monetary, regulatory and, in the case of the Patriot Act, criminal penalties.

In July 2010, the federal government passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act significantly restructures and intensifies regulation in the financial services industry, with provisions that include, among other things, the creation of a new systemic risk oversight body  (i.e., the Financial Stability Oversight Council), expansion of the authority of existing regulators, increased regulation of and restrictions on OTC derivatives markets and transactions, broadening of the reporting and regulation of executive compensation, expansion of the standards for market participants in dealing with clients and customers, and regulation of fiduciary duties owed by municipal advisors or conduit borrowers of municipal securities. In addition, Section 619 of the Dodd-Frank Act (known as the “Volker Rule”) and section 716 of the Dodd-Frank Act (known as the “swaps push-out rule”) limit proprietary trading of certain securities and swaps by certain banking entities. Although we are not a banking entity and are not otherwise subject to these rules, some of our clients and many of our counterparties are banks or entities affiliated with banks and will be subject to these restrictions.  These sections of the Dodd-Frank Act and the regulations that are adopted to implement them could negatively affect the swaps and securities markets by reducing their depth and liquidity and thereby affect pricing in these markets.  Further, the Dodd-Frank Act as a whole and the intensified regulatory environment will likely alter certain business practices and change the competitive landscape of the financial services industry, which may have an adverse effect on our business, financial condition and results of operations.  We will continue to monitor all applicable developments in the implementation of Dodd-Frank and expect to adapt successfully to any new applicable legislative and regulatory requirements.

Foreign Regulation. Our U.K. subsidiary, CCFL, is authorized and regulated by the FCA. CCFL has FCA permission to carry on the following activities: (1) advising on investments; (2) agreeing to carry on a regulated activity; (3) arranging (bringing about) deals in investments; (4) arranging safeguarding and administration of assets; (5) dealing in investments as agent; (6) dealing in investments as principal; (7) making arrangements with a view to transactions in investments; and (8) managing investments. An overview of key aspects of the U.K.’s regulatory regime, which apply to CCFL, is set out below.

Ongoing regulatory obligations. As an FCA regulated entity, CCFL is subject to the FCA’s ongoing regulatory obligations, which cover the following wide-ranging aspects of its business:

Threshold conditions: The FCA’s Threshold Conditions Sourcebook sets out five conditions which all U.K. authorized firms, including CCFL, must satisfy in order to become and remain authorized by the FCA. These relate to having adequate legal status, an appropriate location for the firm’s registered or head office, fit and proper links, adequate financial and non-financial resources, and the suitability to be and to remain authorized.

Principles for Businesses: CCFL is expected to comply with the FCA’s high-level principles, set out in the Principles for Businesses Sourcebook (the “Principles”). The Principles govern the way in which a regulated firm conducts business and include obligations to conduct business with integrity, due skill, care and diligence, to have appropriate regard for customers’ interests, to ensure adequate and appropriate communication with clients, and to ensure appropriate dialogue with regulators (both in the U.K. and overseas).

Systems and controls: One of the FCA’s Principles requires a regulated firm to take reasonable care to organize and control its affairs responsibly and effectively, with adequate risk management systems. Consequently, the FCA imposes overarching

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responsibilities on the directors and senior management of a regulated firm. The FCA ultimately expects the senior management of a regulated firm to take responsibility for determining what processes and internal organization are appropriate to its business. Key requirements in this context include the need to have adequate systems and controls in relation to: (1) senior management arrangements and general organizational requirements; (2) compliance, internal audit and financial crime prevention; (3) outsourcing; (4) record keeping; and (5) managing conflicts of interest.

Conduct of business obligation. The FCA imposes conduct of business rules which set out the obligations to which regulated firms are subject in their dealings with clients and potential clients. CCFL has FCA permission to deal only with eligible counterparties and professional clients in relation to the regulated activities it conducts. The detailed level of the conduct of business rules with which CCFL must comply is dependent on the categorization of its clients, which should be considered in the context of the regulated activity being performed. These rules include requirements relating to the type and level of information which must be provided to clients before business is conducted with or for them, the regulation of financial promotions, procedures for entering into client agreements, obligations relating to the suitability and appropriateness of investments and rules about managing investments and reporting to clients.

 

Reporting. All authorized firms in the U.K. are required to report to the FCA on a periodic basis. CCFL’s reporting requirements are based on its scope of permissions. The FCA will use the information submitted by CCFL to monitor it on an ongoing basis. There are also high level reporting obligations under the Principles, whereby CCFL is required to deal with the FCA and other regulators in an open and co-operative way and to disclose to regulators appropriately anything relating to it of which the regulators would reasonably expect notice.

FCA’s enforcement powers. The FCA has a wide range of disciplinary and enforcement tools which it can use should a regulated firm fail to comply with its regulatory obligations. The FCA is not only able to investigate and take enforcement action in respect of breaches of FCA rules, but also in respect of insider dealing and market abuse offenses and breaches of anti-money laundering legislation. Formal sanctions vary from public censure to financial penalties to cancellation of an authorized firm’s permissions or withdrawal of an approved person’s approval.

Financial resources. One of the FCA’s Principles requires a regulated firm to maintain adequate financial resources. Under the FCA rules, the required level of capital depends on CCFL’s prudential categorization, calculated in accordance with the relevant FCA rules. A firm’s prudential categorization is loosely based on the type of regulated activities which it conducts, as this in turn determines the level of risk to which a firm is considered exposed. CCFL is classified as a full scope BIPRU 730K Investment firm. In broad terms, this means that it would be subject to a base capital requirement of the higher of (1) €730,000; or (2) its credit risk plus its market risk plus its operational risk. There are also detailed ongoing regulatory capital requirements applicable to a regulated firm, including those relating to limits on large exposures, and settlement and counterparty risk, client monies and client relationships.

Anti-money laundering requirements. A U.K. financial institution is subject to additional client acceptance requirements, which stem from anti-money laundering legislation which requires a firm to identify its clients before conducting business with or for them and to retain appropriate documentary evidence of this process.

The key U.K. anti-money laundering rules and regulation are: (1) the Proceeds of Crime Act 2002 (as amended); (2) the Terrorism Act 2000 (as amended); (3) the Money Laundering Regulations 2007 (as amended); (4) the Anti-Terrorism, Crime and Security Act 2001; and (5) the Counter-Terrorism Act 2008. For an FCA regulated firm such as CCFL, there are additional obligations contained in the FCA’s rules. Guidance is also set out in the U.K. Joint Money Laundering Steering Group Guidance Notes, which the FCA may consider when determining compliance by a regulated firm with U.K. money laundering requirements.

As an FCA regulated entity, CCFL is required to ensure that it has adequate systems and controls to enable it to identify, assess, monitor and manage financial crime risk. CCFL must also ensure that these systems and controls are comprehensive and proportionate to the nature, scale and complexity of its activities.

In addition to potential regulatory sanctions from the FCA, failure to comply with the U.K.’s anti-money laundering requirements is a criminal offense; depending on the exact nature of the offense, such a failure is punishable by an unlimited fine, imprisonment or both.

Approved persons regime. Individuals performing certain functions within a regulated entity (known as “controlled functions”) are required to be approved by the FCA. Once approved, the “approved person” becomes subject to the FCA’s Statements of Principle for Approved Persons, which include the obligation to act with integrity, and with due skill, care and diligence. The FCA can take action against an approved person if it appears to it that such person is guilty of misconduct and the FCA is satisfied that it is appropriate in all the circumstances to take action against such person.

Consequently, CCFL is required to have approved persons performing certain key functions, known as required functions. In addition, CCFL must have its senior management personnel approved to perform the appropriate “governing functions.” CCFL is required to ensure that it assesses and monitors the ongoing competence of its approved persons and their fitness and propriety.

 

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Changes in Existing Laws and Rules. Additional legislation and regulations, changes in rules promulgated by the government regulatory bodies or changes in the interpretation or enforcement of laws and regulations may directly affect the manner of our operation, our net capital requirements or our profitability. In addition, any expansion of our activities into new areas may subject us to additional regulatory requirements that could adversely affect our business, reputation and results of operations.

Available Information

Our internet website address is www.ifmi.com. We make available through our website, free of charge, our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K, and any amendments to those reports which we file or furnish pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such information with, or furnish such information to, the SEC.

Our SEC filings are available to be read or copied at the SEC’s Public Reference Room, located at 100 F Street, N.E., Washington D.C. 20549. Information regarding the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. Our filings can also be obtained for free on the SEC’s Internet site at http://www.sec.gov. The reference to our website address does not constitute incorporation by reference of the information contained on our website in this filing or in other filings with the SEC, and the information contained on our website is not part of this filing.

 

 

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ITEM 1A. RISK FACTORS.

 

You should carefully consider the risks and uncertainties described below and elsewhere in this Annual Report on Form 10-K. If any of these risks actually occur, our business, financial condition, liquidity and results of operations could be adversely affected. The risks and uncertainties described below constitute all of the material risks of the Company of which we are currently aware; however, the risks and uncertainties described below may not be the only risks the Company will face. Additional risks and uncertainties of which we are presently unaware, or that we do not currently deem to be material, may become important factors that affect us and could materially and adversely affect our business, financial condition, results of operations and the trading price of our securities. Investing in the Company’s securities involves risk and the following risk factors, together with the other information contained in this report and the other reports and documents filed by us with the SEC, should be considered carefully.

Risks Related to Our Business

Difficult market conditions have adversely affected our business in many ways and may continue to adversely affect our business in a manner which could materially reduce our revenues.

Our business has been and will continue to be materially affected by conditions in the global financial markets and economic conditions throughout the world. The past several years have been extremely volatile and have presented many challenges including declines in the housing and credit markets in the U.S. and Europe and heightened concerns over the creditworthiness of various financial institutions. Global credit markets have continued to experience illiquidity and wider credit spreads. These factors have resulted in significant declines in the performance of financial assets in general with even more severe pressure on securitized financial assets.

Our Capital Markets segment has been and continues to be materially and directly affected by conditions in the global financial markets. As a result of various acquisitions and bankruptcies stemming from the credit crisis, consolidation in certain sectors of the financial services industry has created pricing pressures in our Capital Markets segment as some of our competitors seek to increase market share by reducing prices and institutional investors have reduced the amounts they are willing to pay for our services.

Our asset management revenues and investments in collateralized debt obligations have been and continue to be materially and directly affected by conditions in the global securitization markets. Further, since a significant portion of our asset management contracts and collateralized debt obligation investments relate to entities that are collateralized by securities issued by banks and insurance companies, and real estate-related securities, we have been and continue to be directly and materially affected by adverse changes in those sectors. During the past few years of unfavorable market and economic conditions, including loss of confidence of ratings agencies, the credit quality of certain assets underlying collateralized debt obligations has been adversely affected and investors have been and continue to be unwilling to invest in collateralized debt obligations. As a result, our profitability has been adversely affected, and these same factors may continue to adversely affect our business. The future market and economic climate may further deteriorate due to factors beyond our control, including rising interest rates or inflation, increasing unemployment, continued turmoil in the global credit markets, terrorism or political uncertainty.

In addition, since the collapse of the new issue securitization market, our new issue revenues have been a much smaller component of our overall revenues. If we are unable to increase these revenues, or replace them with new or other sources of revenue, our results of operations could continue to be adversely affected.

A prolonged economic slowdown, volatility in the markets, a recession, declining real estate values and increasing interest rates could impair our investments and harm our operating results.

Our investments are, and will continue to be, susceptible to economic slowdowns, recessions and rising interest rates, which may lead to financial losses in our investments and a decrease in revenues, net income and asset values. These events may reduce the value of our investments, reduce the number of attractive investment opportunities available to us and harm our operating results, which, in turn, may adversely affect our cash flow from operations.

 

Our ability to raise capital in the long-term or short-term debt capital markets or the equity markets, or to access secured lending markets, has been and could continue to be adversely affected by conditions in the U.S. and international markets and the economy. Global market and economic conditions have been, and continue to be, disrupted and volatile. In particular, the cost and availability of funding have been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. As a result of concern about the stability of the markets generally and the strength of counterparties specifically, many lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers. Continued turbulence in the U.S. and international markets and economy may adversely affect our liquidity and financial condition and the willingness of certain counterparties to do business with us.

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We may experience further write downs of financial instruments and other losses related to the volatile and illiquid market conditions.

The credit markets in the U.S. began suffering significant disruption in the summer of 2007. Available liquidity, particularly through ABS, collateralized debt obligations and other securitizations, declined precipitously during 2007, continued to decline in 2008 and remains significantly depressed. Concerns about the capital adequacy of financial services companies, disruptions in global credit markets, volatility in commodities prices and price declines in the U.S. housing market have led to further disruptions in the financial markets, adversely affecting regional banks, and have exacerbated the longevity and severity of the credit crisis. The disruption in these markets generally, and in the U.S. and European real estate markets in particular, has directly impacted and may continue to directly impact our business because our investment portfolio includes investments in MBS, residential mortgages, leveraged loans and bank and insurance company debt. Furthermore, the asset management revenues we derive from collateralized debt obligations that hold these types of investments are based on the outstanding performing principal balance of those investments. Therefore, as adverse market conditions result in defaults within these collateralized debt obligations, our management fees have declined and may continue to decline. We have exposure to these markets and products, and if market conditions continue to worsen, the fair value of our investments and our management fees could further deteriorate. In addition, market volatility, illiquid market conditions and disruptions in the global credit markets have made it extremely difficult to value certain of our securities. Subsequent valuations, in light of factors then prevailing, may result in significant changes in the values of these securities, and when such securities are sold, it may be at a price materially lower than the current fair value. Any of these factors could require us to take further write downs in the fair value of our investment portfolio or cause our management fees to decline, which may have an adverse effect on our results of operations in future periods.

We have incurred losses for the period covered by this report and in the recent past, and may incur losses in the future.

The Company recorded net losses of $19.9 million for the year ended December 31, 2013 and of $2.0 million for the year ended December 31, 2012. We may incur additional losses in future periods. If we are unable to finance future losses, those losses may have a significant effect on our liquidity as well as our ability to operate our business.

In addition, the Company may incur significant expenses in connection with initiating new business activities or in connection with any expansion or reorganization of our businesses. We may also engage in strategic acquisitions and investments for which we may incur significant expenses. Accordingly, we may need to increase our revenue at a rate greater than our expenses in order to achieve and maintain our profitability. If our revenue does not increase sufficiently, or even if our revenue does increase but we are unable to manage our expenses, we will not achieve and maintain profitability in future periods.

 

We have experienced difficulties in our Capital Markets segment over the past several years due to intense competition in our industry, which has resulted in significant strain on our administrative, operational and financial resources. These difficulties may continue in the future.

The financial services industry and all of our businesses are intensely competitive, and we expect them to remain so. We compete with commercial banks, brokerage firms, insurance companies, sponsors of mutual funds, hedge funds and other companies offering financial services in the United States, globally, and through the internet. We compete on the basis of several factors, including transaction execution, capital or access to capital, products and services, innovation, reputation, risk appetite and price. Over time, certain sectors of the financial services industry have become more concentrated as institutions involved in a broad range of financial services have been acquired by or merged into other firms or have declared bankruptcy. These developments could result in our competitors gaining greater capital and other resources such as a broader range of products and services and geographic diversity. We have experienced and may continue to experience pricing pressures in our Capital Markets segment as a result of these factors and as some of our competitors seek to increase market share by reducing prices.

During 2011,  2012 and 2013, both margins and volumes in certain products and markets within the corporate bond brokerage business have decreased materially as competition has increased and general market activity has declined. Further, we expect that competition will increase over time, resulting in continued margin pressure. These challenges have materially adversely affected our Capital Markets segment’s results of operations and may continue to do so.

We intend to focus on improving the performance of our Capital Markets segment, which could place additional demands on our resources and increase our expenses. Improving the performance of our Capital Markets segment will depend on, among other things, our ability to successfully identify groups and individuals to join our firm. It may take more than a year for us to determine whether we have successfully integrated new individuals and capabilities into our operations. During that time, we may incur significant expenses and expend significant time and resources toward training, integration and business development. In addition, our membership agreement with FINRA limits the number of representatives who have direct contact with our public customers without FINRA review and approval. The need to obtain such approval could slow or prevent our growth. If we are unable to hire and retain senior management or other qualified personnel, such as sales people and traders, we will not be able to grow our business and our financial results may be materially and adversely affected.

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There can be no assurance that we will be able to successfully improve the operations of our Capital Markets segment, and any failure to do so could have a material adverse effect on our ability to generate revenue and control expenses.

The failure of the Company to successfully integrate the operations of CCPR and JVB may not result in improved profitability and could have a material adverse effect on the Company’s business, financial condition and operating results.

On January 31, 2014, the Company completed the merger of its two registered broker-dealer subsidiaries, CCPR and JVB, into a single broker-dealer subsidiary which now operates under the JVB brand.  In connection with the merger, the Company reduced the size of its workforce by approximately 20%, which has placed and will continue to place a burden on our management, systems and resources, and will generally increase our dependence on key persons and reduce functional back-ups.  Many of the employees who were terminated possessed specific knowledge or expertise, and we may be unable to transfer that knowledge or expertise to our remaining employees.  In that case, the absence of such employees may create significant operational difficulties.  As a result, our ability to respond to unexpected challenges may be impaired, and we may be unable to take advantage of new opportunities.  Further, the measures which we have adopted may not result in the improved profitability which we are seeking to achieve.

In addition, we will continue to need to overcome significant challenges to realize the expected benefits and synergies of the merger of CCPR and JVB. These challenges include:

•integrating the management teams, strategies, cultures, technologies and operations of the two broker-dealers;

•retaining and assimilating the key personnel of the two broker-dealers;

•retaining clients of the two broker-dealers;

•implementing uniform standards, controls, procedures, policies and information systems; and

 

•achieving revenue growth.

There is no assurance that the two broker-dealers will be successfully integrated. It is possible that the integration process could result in the disruption of the ongoing businesses or inconsistencies in standards, procedures and policies due to possible cultural conflicts or differences of opinions on technical decisions and product road maps that adversely affect the Company’s ability to maintain relationships with clients, suppliers and employees or to achieve the anticipated benefits of such acquisitions.

If we fail to manage our cost reductions effectively, our business could be disrupted and our financial results could be adversely affected.

In response to the financial market disruption, the Company implemented restructuring objectives to reduce infrastructure costs and reposition itself in the financial services industry. Beginning in 2010 and continuing into 2013, the Company executed initiatives that created efficiencies within its business and decreased operating expenses through a reduction in workforce, realignment of operating facilities, a merger of its two registered U.S. broker-dealer subsidiaries, and restructuring of operating systems and system support. In 2011, 2012 and 2013, we curtailed our investment in brokerage and market data and analytics services, including investments in personnel, technology and infrastructure. If these objectives do not have the desired effects or result in the projected increased efficiencies, the Company may incur additional or unexpected expenses, reputation damage, or loss of customers which would adversely affect the Company’s operations and revenues.

In addition, during 2013, we further reduced our headcount. Our cost reduction initiatives have placed and will continue to place a burden on our management, systems and resources, and will generally increase our dependence on key persons and reduce functional back-ups. Many of the employees who were terminated possessed specific knowledge or expertise, and we may be unable to transfer that knowledge or expertise to our remaining employees. In that case, the absence of such employees may create significant operational difficulties. Further, the reduction in workforce may reduce employee morale and create concern among potential and existing employees about job security, which may lead to difficulty in hiring and increased turnover in our current workforce, and place undue strain upon our operational resources. In addition, we may experience further reductions in our workforce, which would compound the risks we face. As a result, our ability to respond to unexpected challenges may be impaired, and we may be unable to take advantage of new opportunities.

We must retain, train, supervise and manage our remaining employees effectively during this period of change in our business, and our ability to retain our employees may become more difficult as we face an increasingly competitive landscape.

In response to changes in industry and market conditions, the Company may be required to further strategically realign its resources and consider restructuring, disposing of, or otherwise exiting businesses. We cannot assure you that we will be able to:

•Expand our capabilities or systems effectively;

•Successfully develop new products or services;

•Allocate our human resources optimally;

 

•Identify, hire or retain qualified employees or vendors;

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•Incorporate effectively the components of any business that we may acquire in our effort to achieve growth;

•Sell businesses or assets at their fair market value; or

•Effectively manage the costs associated with exiting a business.

Our Capital Markets segment depends significantly on a limited group of customers.

From time to time, based on market conditions, a small number of our customers may account for a significant portion of our revenues earned in our Capital Markets segment. None of our customers is obligated contractually to use our services. Accordingly, these customers may direct their activities to other firms at any time. The loss of or a significant reduction in demand for our services from any of these customers could have a material adverse effect on our business, financial condition and operating results.

If we do not retain our senior management and continue to attract and retain qualified personnel, we may not be able to execute our business strategy.

The members of our senior management team have extensive experience in the financial services industry. Their reputations and relationships with investors, financing sources and members of the business community in our industry, among others, are critical elements in operating and expanding our business. As a result, the loss of the services of one or more members of our senior management team could impair our ability to execute our business strategies, which could hinder our ability to achieve and sustain profitability.

The Operating LLC has entered into an employment agreement (including non-competition provisions) with each of Mr. Daniel G. Cohen, our Vice Chairman, Mr. Lester R. Brafman, our Chief Executive Officer, and Mr. Joseph W. Pooler, Jr., our Executive Vice President and Chief Financial Officer, and the term of each such employment agreement ends on December 31, 2014. The employment agreements with Mr. Cohen and Mr. Pooler provide that the term will be renewed automatically for additional one-year periods, unless terminated by either of the parties in accordance with the terms of each of the employment agreements. There can be no assurance that the terms of the employment agreements will provide sufficient incentives for each of the executive officers to continue employment with us.

We depend on the diligence, experience, skill and network of business contacts of our executive officers and employees in connection with (1) our Capital Markets segment, (2) our asset management operations, (3) our investment activities, and (4) the evaluation, negotiation, structuring and management of our investment funds, permanent capital vehicles, and structured products. Our business depends on the expertise of our personnel and their ability to work together as an effective team and our success depends substantially on our ability to attract and retain qualified personnel. Competition for employees with the necessary qualifications is intense, and we may not be successful in our efforts to recruit and retain the required personnel. The inability to retain and recruit qualified personnel could affect our ability to provide an acceptable level of service to our clients and funds, attract new clients, and develop new lines of business, each of which could have a material adverse effect on our business.

Payment of severance could strain our cash flow.

Certain members of our senior management have agreements that provide for substantial severance payments. Should several of these senior managers leave our employ under circumstances entitling them to severance, or become disabled or die, the need to pay these severance benefits could put a strain on our cash flow.

 

Our business will require a significant amount of cash, and if it is not available, our business and financial performance will be significantly harmed.

We require a substantial amount of cash to fund our investments, pay our expenses and hold our assets. More specifically, we require cash to:

•meet our working capital requirements and debt service obligations;

•make seed investments in investment vehicles;

•make incremental investments in our Capital Markets segment;

•hire new employees; and

•meet other needs.

Our primary sources of working capital and cash are expected to consist of:

•revenue from operations, including net trading revenue, asset management revenue, new issue and advisory revenue, interest income and dividends from our investment portfolio and potential monetization of principal investments;

•interest income from temporary investments and cash equivalents;

•sales of assets; and

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•proceeds from future borrowings or any offerings of our equity or debt securities.

We may not be able to generate a sufficient amount of cash from operations and investing and financing activities in order to successfully execute our business strategy.

Failure to obtain or maintain adequate capital and funding would adversely affect the growth and results of our operations and may, in turn, negatively affect the market price of our common stock par value $0.001 per share (“Common Stock”).

Liquidity is essential to our businesses. We depend upon the availability of adequate funding and capital for our operations. In particular, we may need to raise additional capital in order to significantly grow our business. Our liquidity could be substantially adversely affected by our inability to raise funding in the long-term or short-term debt capital markets or the equity capital markets or our inability to access the secured lending markets. Factors that we cannot control, such as continued or additional disruption of the financial markets, or negative views about the financial services industry generally, have limited and may continue to limit our ability to raise capital. In addition, our ability to raise capital could be impaired if lenders develop a negative perception of our long-term or short-term financial prospects. Such negative perceptions could be developed if we incur large trading losses, we suffer a decline in the level of our business activity, we suffer material litigation losses, regulatory authorities take significant action against us, or we discover significant employee misconduct or illegal activity, among other reasons. Sufficient funding or capital may not be available to us in the future on terms that are acceptable, or at all. If we are unable to raise funding using the methods described above, we would likely need to finance or liquidate unencumbered assets, such as our investment and trading portfolios, in order to meet our maturing liabilities. We may be unable to sell some of our assets, or we may have to sell assets at a discount from market value, either of which could adversely affect our results of operations and cash flows. In addition, in May 2014, some or all of the holders of our 10.50% contingent convertible senior notes due 2027 may exercise their right to require us to repurchase up to $3.1 million aggregate principal amount of their notes. Our liquidity could be constrained if we are unable to obtain financing to pay for such repurchases on acceptable terms, or at all. If we are unable to meet our funding needs on a timely basis, our business would be adversely affected and there may be a negative impact on the market price of our Common Stock.

 

The lack of liquidity in certain investments may adversely affect our business, financial condition and results of operations.

We hold investments in securities of private companies, investment funds, collateralized debt obligations and collateralized loan obligations. A portion of these securities may be subject to legal and other restrictions on resale or may otherwise be less liquid than publicly traded securities. The illiquidity of our investments may make it difficult for us to sell such investments if the need arises.

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 in Europe, through offices in London, Paris and Madrid and may seek to further expand our international operations in the future. There are certain additional risks inherent in doing business in international markets, particularly in the regulated brokerage and asset management industries. 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.

If we are unable to manage any of these risks effectively, our business could be adversely affected.

In addition, our international operations expose us to the risk of fluctuations in currency exchange rates generally and fluctuations in the exchange rates for the Euro and the British Pound Sterling in particular. Although we may hedge our foreign currency risk, we may not be able to do so successfully and may incur losses that could adversely affect our financial condition or results of operations.

The securities settlement process exposes us to risks that may adversely affect our business, financial condition and results of operations.

We provide brokerage services to our clients in the form of “matched principal transactions” or by providing liquidity by purchasing securities from them on a principal basis.  In “matched principal transactions” 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 bonds, are then settled through clearing institutions with which we have a contractual relationship. There is no guarantee that we will be able to maintain existing contractual relationships with clearing institutions on favorable terms or that we will be able to establish relationships with new clearing institutions on favorable terms, or at all.

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

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it is obligated to deliver upon settlement. In addition, some of the products we trade or may trade in the future are in less commoditized markets which may exacerbate this risk because transactions in such markets may 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 not be recoverable from the failing counterparty. 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. 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 our clients or by 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. If the unmatched position 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 will generally be to have the unmatched position disposed of promptly, whether or not this disposition would result in a loss to us. The occurrence of unmatched positions 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.

From time to time we may also provide brokerage services in the form of agency transaction. 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 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 agency brokerage services.

Participation in matched principal, principal, or agency transactions subjects us to disputes, counterparty credit risk, lack of liquidity, operational failure or other market wide or counterparty specific risks. Any losses arising from such risks could adversely affect our financial condition or results of operations. In addition, 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 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.

We have policies and procedures to identify, monitor and manage these risks, 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 will 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 risks to which we may be exposed, our financial condition or results of operations could be adversely affected. In addition, we may not be able to obtain insurance to cover all of the types of risks we face and any insurance policies we do obtain may not provide adequate coverage for covered risks.

We are exposed to the risk that third parties that are indebted to us will not perform their obligations.

Credit risk refers to the risk of loss arising from borrower or counterparty default when a borrower, counterparty or obligor does not meet its obligations. We incur significant credit risk exposure through our Capital Markets segment. This risk may arise from a variety of business activities, including but not limited to extending credit to clients through various lending commitments; providing short or long-term funding that is secured by physical or financial collateral whose value may at times be insufficient to fully cover the loan repayment amount; entering into swap or other derivative contracts under which counterparties have obligations to make payments to us; and posting margin and/or collateral to clearing houses, clearing agencies, exchanges, banks, securities firms and other financial counterparties. We incur credit risk in traded securities and loan pools whereby the value of these assets may fluctuate based on realized or expected defaults on the underlying obligations or loans.

There is a possibility that continued difficult economic conditions may further negatively impact our clients and our current credit exposures. Although we regularly review our credit exposures, default risk may arise from events or circumstances that are difficult to detect or foresee.

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We are exposed to various risks related to margin requirements under repurchase agreements and securities financing arrangements and are highly dependent on our clearing relationships. 

We maintain repurchase agreements with various third party financial institutions and other counterparties.  Under those repurchase agreements we act as both a buyer and a seller of the subject securities. Our business related to these repurchase agreements is predominantly matched, meaning that we do not purchase or sell securities unless there is another institution prepared to simultaneously purchase or sell securities to or from us, as applicable. There are limits to the amount of securities that may be transferred pursuant to these agreements, and available lines both for us and our counterparties for whom we purchase securities are approved on a case-by-case basis after each counterparty has gone through a credit review process. The repurchase agreements we execute with our counterparties include substantive provisions other than those covenants and other customary provisions contained in standard master repurchase agreements. However, while these additional provisions may work to mitigate some of the risks related to repurchase agreement transactions, these additional substantive provisions do not guarantee the performance of a counterparty or alleviate all of the potential risks we could face from entering into repurchase agreement transactions. 

The repurchase agreements generally require the seller under such repurchase agreement to transfer additional securities to the counterparty who is acting as the buyer under the repurchase agreement in the event that the value of the securities then held by the buyer falls below specified levels. The repurchase agreements contain events of default in cases where a counterparty breaches its obligations under the agreements. When we are acting in the capacity of a seller under these agreements we receive margin calls from time to time in the ordinary course of business, and no assurance can be given that we will be able to satisfy requests from our counterparties to post additional collateral in the future. Similarly, when we are acting in the capacity of a buyer under these agreements we make margin calls from time to time to our seller counterparties in the ordinary course of business and no assurance can be given that our counterparties will have adequate funds or collateral to satisfy such margin call requirements. Generally, if there were an event of default under the repurchase agreements, such event of default would provide the non-defaulting counterparty with the option to terminate all outstanding repurchase transactions with us and make all amounts due from the defaulting counterparty immediately payable. However, there can be no assurance that any such defaulting counterparty will have the funds or collateral needed to fully satisfy any such margin call or other amount due.  Generally, repurchase obligations are full recourse obligations and  if we were to default under a repurchase obligation, the counterparty would have recourse to our other assets if the collateral was not sufficient to satisfy the obligation in full.

In addition, our clearing brokers provide securities financing arrangements including margin arrangements and securities borrowing and lending arrangements. These arrangements generally require us to transfer additional securities or cash to the clearing broker in the event that the value of the securities then held by the clearing broker in the margin account falls below specified levels, and contain events of default in cases where we breach our obligations under such agreements. An event of default under a clearing agreement would give the clearing broker the option to terminate the clearing arrangement and any amounts owed to the clearing broker would be immediately due and payable. These obligations are recourse to us.

Furthermore, we are highly dependent on our relationships with our clearing brokers. Any termination of our clearing arrangements whether due to a breach of the agreement or any default, bankruptcy or reorganization of our clearing brokers would result in a significant disruption to our business as we clear all trades through these entities. Any such termination would have a significant negative impact on our dealings and relationship with our customers.

We have market risk exposure from unmatched principal transactions entered into by our brokerage desks, which could result in substantial losses to us and adversely affect our financial condition and results of operations.  

We allow certain of our brokerage desks access to limited capital to enter into unmatched principal transactions in the ordinary course of business for the purpose of facilitating clients’ execution needs for transactions initiated by such clients or to add liquidity to certain illiquid markets. As a result, we have market risk exposure on these unmatched principal transactions. Our exposure will vary based on the size of the overall positions, the terms and liquidity of the instruments brokered, and the amount of time the positions will be held before we dispose of the position.

 

We do not expect to track our exposure to unmatched positions on an intra-day basis. These unmatched positions are intended to be held short-term. Due to a number of factors, including the nature of the position and access to the market on which we trade, we may not be able to match the position or effectively hedge our exposure and often may be forced to hold a position overnight that has not been hedged. To the extent these unmatched 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 our sustaining a substantial loss. In addition, any 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.

Pricing and other competitive pressures may impair the revenues and profitability of our brokerage business. 

In recent years, we have experienced significant pricing pressures on trading margins and commissions, primarily in debt trading. In the fixed income market, regulatory requirements have resulted in greater price transparency, leading to increased price competition and decreased trading margins. The trend toward using alternative trading systems is continuing to grow, which may result in decreased commission and trading revenue, reduce our participation in the trading markets and our ability to access market

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information, and lead to the creation of new and stronger competitors. Additional pressure on sales and trading revenue may impair the profitability of our brokerage business. We believe that price competition and pricing pressures in these and other areas will continue as institutional investors continue to reduce the amounts they are willing to pay, including reducing the number of brokerage firms they use, and some of our competitors seek to obtain market share by reducing fees, commissions or margins.

Increase in capital commitments in our trading business increases the potential for significant losses. 

We may enter into transactions in which we commit our own capital as part of our trading business. The number and size of these transactions may materially affect our results of operations in a given period. We may also incur significant losses from our trading activities due to market fluctuations and volatility from quarter to quarter. We maintain trading positions in the fixed income market to facilitate client-trading activities. To the extent that we own security positions, in any of those markets, a downturn in the value of those securities or in those markets could result in losses from a decline in value. Conversely, to the extent that we have sold securities we do not own in any of those markets, an upturn in those markets could expose us to potentially unlimited losses as we attempt to acquire the securities in a rising market. Moreover, taking such positions in times of significant volatility can lead to significant unrealized losses, which further impact our ability to borrow to finance such activities.

Our principal trading and investments expose us to risk of loss. 

A significant portion of our revenues is derived from trading in which we act as principal. The Company may incur trading losses relating to the purchase, sale or short sale of corporate and asset-backed fixed income securities and other securities for our own account and from other principal trading. In any period, we may experience losses as a result of price declines, lack of trading volume, general market conditions, employee inexperience, errors or misconduct, and illiquidity. From time to time, we may engage in a large block trade in a single security or maintain large position concentrations in a single security, securities of a single issuer, or securities of issuers engaged in a specific industry. In general, any downward price movement in these securities could result in a reduction of our revenues and profits.

 

In addition, we may engage in hedging transactions and strategies that may not properly mitigate losses in our principal positions. If the transactions and strategies are not successful, we could suffer significant losses.

Our principal investments are concentrated in a few investments and may represent a significant portion of our invested capital

As of December 31, 2013, we have $26.9 million of other investments, at fair value representing our principal investment portfolio. Of this amount, $19.9 million, or 74%, was comprised of our investments in Star Asia and Star Asia Special Situations Fund which were sold in February 2014.  Further, $6.5 million, or 24%, was comprised of our investments in two separate investment funds and permanent capital vehicles: EuroDekania and Tiptree.  Although the amount of our invested capital related to principal investments will decline substantially with the sale of Star Asia and Star Asia Special Situations Fund, we may use the proceeds to make additional principal investments.  Our results of operations and financial condition may be significantly impacted by the financial results of these investments.

We may not realize gains or income from our investments.

Certain of our investments have declined in value and may continue to decline in value, and the financings that we originated and the securities in which they invest have defaulted, or may default in the future, on interest and/or principal payments. Accordingly, we may not be able to realize gains or income from our investments. Any gains that we do realize may not be sufficient to offset any other losses we experience. Any income that we realize may not be sufficient to offset our expenses.

As of the date of this filing, our investment portfolios have been directly impacted by the disruption in various markets including in the U.S. and Europe due to investments in, among other things, MBS, residential mortgages, leveraged loans and bank and insurance company debt. We continue to have significant exposure to these markets and products, and as market conditions continue to evolve, the fair value of these investments could further deteriorate. Any of these factors could require us to take additional write downs in the fair value of our investment portfolios, which may have an adverse effect on our results of operations in future periods.

If the investments we make on behalf of our investment funds, permanent capital vehicles and collateralized debt obligations perform poorly, we will suffer a decline in our asset management revenue and earnings because some of our fees are subject to the credit performance of the portfolios of assets. In addition, the investors in our investment funds and collateralized debt obligations and, to a lesser extent, our permanent capital vehicles may seek to terminate our management agreements based on poor performance. Any of these results could adversely affect our results of operations and our ability to raise capital for future investment funds, permanent capital vehicles and collateralized debt obligations.

Our revenue from our asset management business is derived from fees earned for managing our collateralized debt obligations and management fees paid by the permanent capital vehicles and investment funds we manage. Our collateralized debt obligations will generate three types of fees: (1) senior fees that are generally paid to us before interest is paid on any of the securities in the capital structure; (2) subordinated fees that are generally paid to us after interest is paid on securities in the capital structure; and

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(3) incentive fees that are generally paid to us after a period of years in the life of the collateralized debt obligation and after the holders of the most junior collateralized debt obligation securities have been paid a specified return.

In the case of the permanent capital vehicles and investment funds, our management fees are based on the equity of and net income earned by the vehicles, which is substantially based on the performance of our collateralized debt obligations or other securities in which they invest.

 

Furthermore, in the event that our collateralized debt obligations, investment funds or permanent capital vehicles perform poorly, our asset management revenues and earnings will suffer a decline and it will be more difficult for us to structure new collateralized debt obligations and raise funds for the existing or future permanent capital vehicles or investment funds. Our management contracts may be terminated for various reasons.

We could lose management fee income from the collateralized debt obligations we manage or client assets under management as a result of the triggering of certain structural protections built into such collateralized debt obligations.

The collateralized debt obligations we manage generally contain structural provisions including, but not limited to, over-collateralization requirements and/or market value triggers that are meant to protect investors from deterioration in the credit quality of the underlying collateral pool. In certain cases, breaches of these structural provisions can lead to events of default under the indentures governing the collateralized debt obligations and, ultimately, acceleration of the notes issued by the collateralized debt obligation and liquidation of the underlying collateral. In the event of a liquidation of the collateral underlying a collateralized debt obligation, we will lose client assets under management and therefore management fees, which could have a material adverse effect on our earnings.

We may need to offer new investment strategies and products in order to continue to generate revenue.

The asset management industry is subject to rapid change. Strategies and products that had historically been attractive may lose their appeal for various reasons. Thus, strategies and products that have generated fee revenue for us in the past may fail to do so in the future, in which case we would have to develop new strategies and products. It could be both expensive and difficult for us to develop new strategies and products, and we may not be successful in this regard. Recently, we have been unable to expand our offerings which has inhibited our growth and harmed our competitive position in the asset management industry, and this may continue in the future.

If our risk management systems for our businesses are ineffective, we may be exposed to material unanticipated losses.

We seek to manage, monitor, and control our operational, legal and regulatory risk through operational and compliance reporting systems, internal controls, management review processes and other mechanisms, and may not fully mitigate the risk exposure of our businesses in all economic or market environments or protect against all types of risk. Further, our risk management methods may not effectively predict future risk exposures, which could be significantly greater than the historical measures indicate. In addition, some of our risk management methods are based on an evaluation of information regarding markets, clients, and other matters that are based on assumptions that may no longer be accurate. A failure to adequately manage our growth, or to effectively manage our risk, could materially and adversely affect our business and financial condition. Our risk management processes include addressing potential conflicts of interest that arise in our business. We have procedures and controls in place to address conflicts of interest. Management of potential conflicts of interest has become increasingly complex as we expand our business activities through more numerous transactions, obligations and interests with and among our clients. The failure to adequately address, or the perceived failure to adequately address, conflicts of interest could affect our reputation, the willingness of clients to transact business with us, or give rise to litigation or regulatory actions. Therefore, there can be no assurance that conflicts of interest will not arise in the future, and such conflicts could cause material harm to us.

Our failure to deal appropriately with conflicts of interest could damage our reputation and adversely affect our business.

As we expanded our business, we increasingly confronted potential conflicts of interest relating to the investment activities of the entities we manage. As a result, certain of our permanent capital vehicles and our investment funds may have overlapping investment objectives, which may create conflicts of interest issues for us. These entities will have different fee structures and potential conflicts may arise with respect to our decisions regarding how to allocate investment opportunities among those entities.

It is possible that potential or perceived conflicts could give rise to investor dissatisfaction or litigation or regulatory enforcement actions. Appropriately dealing with conflicts of interest is complex and difficult and our reputation could be damaged if we fail, or appear to fail, to deal appropriately with one or more potential or actual conflicts of interest. Regulatory scrutiny of, or litigation in connection with, conflicts of interest would have a material adverse effect on our reputation, which could materially and adversely affect our business in a number of ways, including as a result of sales of stock by investors in our permanent capital vehicles, an inability to raise additional funds, a reluctance of counterparties to do business with us and the costs of defending litigation.

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We are highly dependent on information and communications systems. Systems failures could significantly disrupt our business, which may, in turn, negatively affect our operating results.

Our business will depend, to a substantial degree, on the proper functioning of our information and communications systems and our ability to retain the employees and consultants who operate and maintain these systems. Any failure or interruption of our systems, due to systems failures, staff departures or otherwise, could result in delays, increased costs or other problems which could have a material adverse effect on our operating results. A disaster, such as water damage to an office, an explosion or a prolonged loss of electrical power, could materially interrupt our business operations and cause material financial loss, regulatory actions, reputational harm or legal liability. In addition, if security measures contained in our systems are breached as a result of third party action, employee error, malfeasance or otherwise, our reputation may be damaged and our business could suffer. We have developed a business continuity plan, however, there are no assurances that such plan will be successful in preventing, timely and adequately addressing, or mitigating the negative effects of any failure or interruption.

There can be no assurance that our information systems and other technology will continue to be able to accommodate our operations, or that the cost of maintaining the systems and technology will not materially increase from the current level. A failure to accommodate our operations, or a material increase in costs related to information systems and technology, could have a material adverse effect on our business.

We may not be able to keep pace with continuing changes in technology.

Our market is characterized by rapidly changing technology. To be successful, we must adapt to this rapidly changing environment by continually improving the performance, features, and reliability of our services. We could incur substantial costs if we need to modify our services or infrastructure or adapt our technology to respond to these changes. A delay or failure to address technological advances and developments or an increase in costs resulting from these changes could have a material and adverse effect on our business, financial condition and results of operations.

Failure to protect client data or prevent breaches of our information systems could expose us to liability or reputational damage.

The secure transmission of confidential information over public networks is a critical element of our operations.  We are dependent on information technology networks and systems to securely process, transmit and store electronic information and to communicate among our locations and with our clients and vendors.  As the breadth and complexity of this infrastructure continue to grow, the potential risk of security breaches and cyber-attacks increases.  As a financial services company, we may be subject to cyber-attacks by third parties.  In addition, vulnerabilities of our external service providers and other third parties could pose security risks to client information.  Such breaches could lead to shutdowns or disruptions of our systems and potential unauthorized disclosure of confidential information.

In providing services to clients, we manage, utilize and store sensitive and confidential client data, including personal data.  As a result, we are subject to numerous laws and regulations designed to protect this information, such as U.S. federal and state laws and foreign regulations governing the protection of personally identifiable information.  These laws and regulations are increasing in complexity and number, change frequently and sometimes conflict.  If any person, including any of our employees, negligently disregards or intentionally breaches our established controls with respect to client date, or otherwise mismanages or misappropriates that data, we could be subject to significant monetary damages, regulatory enforcement actions, fines and/or criminal prosecution in one or more jurisdictions.  Unauthorized disclosure of sensitive or confidential client data, whether through systems failure, employee negligence, fraud or misappropriation, could damage our reputation and cause us to lose clients.  Similarly, unauthorized access to or through our information systems, whether by our employees or third parties, including a cyber-attack by computer programmers and hackers who may deploy viruses, worms or other malicious software programs, could result in negative publicity, significant remediation costs, legal liability, financial responsibility under our security guarantee to reimburse clients for losses resulting from unauthorized activity in their accounts and damage to our reputation and could have a material adverse effect on our results of operations.  In addition, our liability insurance might not be sufficient in type or amount to cover us against claims related to security breaches, cyber-attacks and other related breaches.

 

We depend on third-party software licenses and 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 electronic brokerage systems and our business. Such 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, or at all. A termination of any of these relationships could have a material adverse effect on our financial condition and results of operations.

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Our substantial level of indebtedness could adversely affect our financial health and ability to compete. In addition, our failure to satisfy the financial covenants in our debt agreements could result in a default and acceleration of repayment of the indebtedness thereunder.

Our balance sheet includes approximately $59.5 million par value of recourse indebtedness. Our indebtedness could have important consequences to our stockholders. For example, our indebtedness could:

•make it more difficult for us to pay our debts as they become due during general adverse economic and market industry conditions because any related decrease in revenues could cause our cash flows from operations to decrease and make it difficult for us to make our scheduled debt payments;

•limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate and consequently, place us at a competitive disadvantage to our competitors with less debt;

•require a substantial portion of our cash flow from operations to be used for debt service payments, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, acquisitions and other general corporate purposes;

•limit our ability to borrow additional funds to expand our business or alleviate liquidity constraints, as a result of financial and other restrictive covenants in our indebtedness; and

•result in higher interest expense in the event of increases in interest rates since some of our borrowings are and will continue to be, at variable rates of interest.

Under the junior subordinated notes related to the Alesco Capital Trust, we are required to maintain a total debt to capitalization ratio of less than 0.95 to 1.0. Also, because the aggregate amount of our outstanding subordinated debt exceeds 25% of our net worth, we are unable to issue any further subordinated debt.

In addition, our indebtedness imposes restrictions that limit our discretion with regard to certain business matters, including our ability to engage in consolidations and mergers and our ability to transfer and lease certain of our properties. Such restrictions could make it more difficult for us to expand, finance our operations and engage in other business activities that may be in our interest.

Our ability to comply with these and any other provisions of such agreements will be affected by changes in our operating and financial performance, changes in business conditions or results of operations, adverse regulatory developments or other events beyond our control. The breach of any of these covenants could result in a default, which could cause our indebtedness to become due and payable. If the maturity of our indebtedness were accelerated, we may not have sufficient funds to pay such indebtedness. Any additional indebtedness we may incur in the future may subject us to similar or even more restrictive conditions.

In addition, in May 2014, some or all of the holders of our 10.50% contingent convertible senior notes due 2027 may exercise their right to require us to repurchase up to $3.1 million aggregate principal amount of their notes. Our liquidity could be constrained if we are unable to obtain financing to pay for such repurchases on acceptable terms, or at all. If we are unable to meet our funding needs on a timely basis, our business would be adversely affected and there may be a negative impact on the market price of our Common Stock.

 

If we fail to maintain effective internal control over financial reporting and disclosure controls and procedures in the future, we may not be able to accurately report our financial results, which could have an adverse effect on our business.

If our internal controls over financial reporting and disclosure controls and procedures are not effective, we may not be able to provide reliable financial information. Because we are a non-accelerated filer, we are not required to obtain, nor have we voluntarily obtained, an auditor attestation regarding the effectiveness of our controls as of December 31, 2013. Therefore, as of December 31, 2013, we have only performed management’s assessment of the effectiveness of our internal controls and management has determined that our internal controls are effective as of December 31, 2013. Any failure to maintain effective controls in the future could adversely affect our business or cause us to fail to meet our reporting obligations. Such non-compliance could also result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financial statements. In addition, perceptions of our business among customers, suppliers, rating agencies, lenders, investors, securities analysts and others could be adversely affected.

Accounting rules for certain of our transactions are highly complex and involve significant judgment and assumptions. Changes in accounting interpretations or assumptions could adversely impact our financial statements.

Accounting rules for transfers of financial assets, income taxes, compensation arrangements including share based compensation, securitization transactions, consolidation of variable interest entities, determining the fair value of financial instruments and other aspects of our operations are highly complex and involve significant judgment and assumptions. These complexities could lead to delay in preparation of our financial information. Changes in accounting interpretations or assumptions could materially impact our financial statements.

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We may change our investment strategy, hedging strategy, asset allocation and operational policies without our stockholders’ consent, which may result in riskier investments and adversely affect the market value of our Common Stock.

We may change our investment strategy, hedging strategy, asset allocation and/or operational policies at any time without the consent of our stockholders. A change in our investment or hedging strategy may increase our exposure to interest rate, exchange rate, and real estate market fluctuations. Furthermore, our board of directors will determine our operational policies and may amend or revise our policies, including polices with respect to our acquisitions, growth, operations, indebtedness, capitalization and distributions, or our board may approve transactions that deviate from these policies without a vote of, or notice to, our stockholders. Operational policy changes could adversely affect the market value of our Common Stock.

Maintenance of our Investment Company Act exemption imposes limits on our operations, and loss of our Investment Company Act exemption would adversely affect our operations.

We seek to conduct our operations so that we are not required to register as an investment company under the Investment Company Act. Section 3(a)(l)(C) of the Investment Company Act of 1940, as amended (the “Investment Company Act”), defines an “investment company” as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis. Excluded from the term “investment securities,” among other things, are securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company set forth in Section 3(c)(l) or Section 3(c)(7) of the Investment Company Act.

We are a holding company that conducts our business primarily through the Operating LLC as a majority owned subsidiary. Whether or not we qualify under the 40% test is primarily based on whether the securities we hold in the Operating LLC are investment securities. If we were required to register as an investment company under the Investment Company Act, we would become subject to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the Investment Company Act) and other matters. Such limitations could have a material adverse effect on our business and operations. As of December 31, 2013, we are in compliance with and meet the Section 3(a)(1)(C) exclusion.

Insurance may be inadequate to cover risks facing the Company.

Our operations and financial results are subject to risks and uncertainties related to our use of a combination of insurance, self-insured retention and self-insurance for a number of risks, including most significantly: property and casualty, workers’ compensation, errors and omissions liability, general liability and the portion of employee-related health care benefits plans we fund, among others.

While we endeavor to purchase insurance coverage that is appropriate to our assessment of risk, we are unable to predict with certainty the frequency, nature or magnitude of claims for direct or consequential damages. Our business may be negatively affected if in the future our insurance proves to be inadequate or unavailable. In addition, insurance claims may harm our reputation or divert management resources away from operating our business.

Risks Related to Our Industry

The soundness of other financial institutions and intermediaries affects us. 

We face the risk of operational failure, termination or capacity constraints of any of the clearing agents, exchanges, clearing houses or other financial intermediaries that we use to facilitate our securities transactions. As a result of the consolidation over the years among clearing agents, exchanges and clearing houses, our exposure to certain financial intermediaries has increased and could affect our ability to find adequate and cost-effective alternatives should the need arise. Any failure, termination or constraint of these intermediaries could adversely affect our ability to execute transactions, service our clients and manage our exposure to risk.

Our ability to engage in routine trading and funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, funding, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mortgage originators and other institutional clients. Furthermore, although we do not hold any EU sovereign debt, we may do business with and be exposed to financial institutions that have been affected by the recent EU sovereign debt crisis. As a result, defaults by, or even rumors or questions about the financial condition of, one or more financial services institutions, or the financial services industry generally, have historically led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due us. Although we have not suffered any material or significant losses as a result of the failure of any financial counterparty, any such losses in the future may materially adversely affect our results of operations.

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We operate in a highly regulated industry and may face restrictions on, and examination of, the way we conduct certain of our operations.

Our business is subject to extensive government and other regulation, and our relationship with our broker-dealer clients may subject us to increased regulatory scrutiny. These regulations are designed to protect the interests of the investing public generally rather than our stockholders and may result in limitations on our activities. Governmental and self-regulatory organizations, including the SEC, FINRA, the Commodity Futures Trading Commission and other agencies and securities exchanges such as the NYSE and NYSE MKT regulate the U.S. financial services industry, and regulate certain of our operations in the U.S. Some of our international operations are subject to similar regulations in their respective jurisdictions, including rules promulgated by the FCA, which apply to entities which are authorized and regulated by the FCA. 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. In addition, all records of registered investment advisors and broker-dealers are subject at any time, and from time to time, to examination by the SEC. Some aspects of the business that are subject to extensive regulation and/or examination by regulatory agencies, include:

•sales methods, trading procedures and valuation practices;

•investment decision making processes and compensation practices;

•use and safekeeping of client funds and securities;

•the manner in which we deal with clients;

•capital requirements;

•financial and reporting practices;

•required record keeping and record retention procedures;

•the licensing of employees;

•the conduct of directors, officers, employees and affiliates;

•systems and control requirements;

•conflicts of interest;

•restrictions on marketing, gifts and entertainment; and

•client identification and anti-money laundering requirements.

The SEC, FINRA, the FCA and various other domestic and international regulatory agencies also have stringent rules and regulations with respect to the maintenance of specific levels of net capital by broker-dealers. Generally, in the U.S., a broker-dealer’s net capital is defined as its net worth, plus qualified subordinated debt, less deductions for certain types of assets. If these net capital rules are changed or expanded, or if there is an unusually large charge against net capital, our 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 or that of our subsidiaries to pay dividends, repay debt, make distributions and redeem or purchase shares of our Common Stock or other equity interests in our subsidiaries. A large operating loss or charge against net capital could adversely affect our ability to expand or even maintain our expected 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 operate. While we expect to maintain levels of capital in excess of regulatory minimums, we cannot predict our future capital needs or our ability to obtain additional financing.

If we or any of our subsidiaries fail to comply with any of these laws, rules or regulations, we or such subsidiary may be subject to censure, significant fines, cease-and-desist orders, suspension of business, suspensions of personnel or other sanctions, including revocation of registrations with FINRA, withdrawal of authorizations from the FCA or revocation of registrations with other similar international agencies to whose regulation we are subject, which would have a material adverse effect on our business. The adverse publicity arising from the imposition of sanctions against us by regulators, even if the amount of such sanctions is small, could harm our reputation and cause us to lose existing clients or fail to gain new clients.

The authority to operate as a broker-dealer in a jurisdiction is dependent on the 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 personnel. Any growth or expansion of our business may create additional strain on our compliance, credit approval, audit and reporting systems and procedures and could result in increased costs to maintain and improve such systems and procedures.

In addition, new laws or regulations or changes in the enforcement of existing laws or regulations applicable to us and our clients may adversely affect our business, and our ability to function in this environment will depend on our ability to constantly monitor and react to these changes. Such changes may cause us to change the way we conduct our business, both in the U.S. and internationally. The government agencies that regulate us have broad powers to investigate and enforce compliance and punish

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noncompliance with their rules, regulations and industry standards of practice. If we and our directors, officers and employees fail to comply with the rules and regulations of these government agencies, we and they may be subject to claims or actions by such agencies.

Legislation passed during the last few years may result in changes to rules and regulations applicable to our business, which may negatively impact our business and financial results.

In July 2010, the Dodd-Frank Act was signed into law by President Obama. The Dodd-Frank Act contains a comprehensive set of provisions designed to govern the practices and oversight of financial institutions and other participants in the financial markets.  Section 619 of the Dodd-Frank Act (Volker Rule) and section 716 of the Dodd-Frank Act (swaps push-out rule) limit proprietary trading of certain securities and swaps by banking entities such as banks, bank holding companies and similar institutions.  Although we are not a banking entity and are not otherwise subject to these rules, some of our clients and many of our counterparties are banks or entities affiliated with banks and will be subject to these restrictions.  These sections of the Dodd-Frank Act and the regulations that are adopted to implement them could negatively affect the swaps and securities markets by reducing their depth and liquidity and thereby affect pricing in these markets.  Other negative effects could result from an expansive extraterritorial application of the Dodd-Frank Act in general or the Volker Rule in particular and/or insufficient international coordination with respect to adoption of rules for derivatives and other financial reforms in other jurisdictions.  We will not know the exact impact that these changes in the markets will have on our business until after the final rules are implemented.

The Dodd-Frank Act, in addressing systemic risks to the financial system, charges the Federal Reserve with drafting enhanced regulatory requirements for the systemically important bank holding companies and certain other nonbank financial companies designated as systemically important by the Financial Stability Oversight Council.  The enhanced requirements proposed by the Federal Reserve include capital requirements, liquidity requirements, limits on credit exposure concentrations and risk management requirements.  We do not believe that we will be deemed to be a systemically important nonbank financial company under the new legislation and therefore will not be directly impacted.  However, there will be an indirect impact to us to the extent that the new regulations apply to our competitors, counterparts and certain of our clients.

Substantial legal liability or significant regulatory action could have material adverse financial effects or cause significant reputational harm, either of which could seriously harm our business.

We face substantial regulatory and litigation risks and conflicts of interests, and may face legal liability and reduced revenues and profitability if our business is not regarded as compliant or for other reasons. We are subject to extensive regulation, and many aspects of our business will subject us to substantial risks of liability. We engage in activities in connection with (1) the evaluation, negotiation, structuring, sales and management of our investment funds, permanent capital vehicles and structured products, including collateralized debt obligations, (2) our Capital Markets segment, (3) our asset management operations, and (4) our investment activities. Our activities may subject us to the risk of significant legal liabilities under securities or other laws for material omissions or material false or misleading statements made in connection with securities offerings and other transactions. In addition, to the extent our clients, or investors in our investment funds, permanent capital vehicles and structured products, suffer losses, they may claim those losses resulting from our or our officers’, directors’, employees’, or agents’ or affiliates’ breach of contract, fraud, negligence, willful misconduct or other similar misconduct, and may bring actions against us under federal or state securities or other applicable laws. Dissatisfied clients may also 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 electronic trading platforms or other brokerage services, including failures or malfunctions of third party providers’ systems which are beyond our control, and third parties may seek recourse against us for any losses. In addition, investors may claim breaches of collateral management agreements, which could lead to our termination as collateral manager under such agreements.

In recent years, the volume of claims and amount of damages claimed in litigation and regulatory proceedings against financial advisors and asset managers has been increasing. With respect to the asset management business, we make investment decisions on behalf of our clients that could result in, and in some instances in the past have resulted in, substantial losses. In addition, all of the permanent capital vehicles that we manage rely on exemptions from regulation under the Investment Company Act and some of them are structured to comply with certain provisions of the Internal Revenue Code. As the manager of these vehicles, we are responsible for their compliance with regulatory requirements. Investment decisions we make on behalf of the vehicles could cause the vehicles to fail to comply with regulatory requirements and could result in substantial losses to such vehicles. Although the management agreements relating to such vehicles generally include broad indemnities and provisions designed to limit our exposure to legal claims relating to our services, these provisions may not protect us or may not be enforced in all cases.

In addition, we are exposed to risks of litigation or investigation relating to transactions which present conflicts of interest that are not properly addressed. In such actions, we could be obligated to bear legal, settlement and other costs (which may be in excess of available insurance coverage). Also, with a workforce consisting of many very highly paid professionals, we may face the risk of lawsuits relating to claims for compensation, which may individually or in the aggregate be significant in amount. Similarly, certain corporate events, such as a reduction in our workforce or employee separations, could also result in additional litigation or arbitration. In addition, as a public company, we are subject to the risk of investigation or litigation by regulators or our public stockholders

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arising from an array of possible claims, including investor dissatisfaction with the performance of our business or our share price, allegations of misconduct by our officers and directors or claims that we inappropriately dealt with conflicts of interest or investment allocations. In addition, we may incur significant expenses in defending claims, even those without merit. If any claims brought against us result in a finding of substantial legal liability and/or require us to incur all or a portion of the costs arising out of litigation or investigation, our business, financial condition, liquidity and results of operations could be materially and adversely affected. Such litigation or investigation, whether resolved in our favor or not, could cause significant reputational harm, which could seriously harm our business.

The competitive pressures we face as a result of operating in a highly competitive market could have a material adverse effect on our business, financial condition, liquidity and results of operations.

A number of entities conduct asset management, origination, investment and broker-dealer activities. We compete with public and private funds, REITS, commercial and investment banks, savings and loan institutions, mortgage bankers, insurance companies, institutional bankers, governmental bodies, commercial finance companies, traditional asset managers, brokerage firms and other entities.

Many firms offer similar and/or additional products and services to the same types of clients that we target or may target in the future. Many of our competitors are substantially larger and have more relevant experience, have considerably greater financial, technical and marketing resources, and have more personnel than we have. There are few barriers to entry, including a relatively low cost of entering these lines of business, and the successful efforts of new entrants into our expected lines of business, including major banks and other financial institutions, may result in increased competition. Other industry participants may, from time to time, seek to recruit our investment professionals and other employees away from us.

With respect to our asset management activities, our competitors may have more extensive distribution capabilities, more effective marketing strategies, more attractive investment vehicle structures and broader name recognition than we do. Further, other investment managers may offer services at more competitive prices than we do, which could put downward pressure on our fee structure. With respect to our origination and investment activities, some competitors may have a lower cost of funds, enhanced operating efficiencies, and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than we can. The competitive pressures we face, if not effectively managed, may have a material adverse effect on our business, financial condition, liquidity and results of operations.

Also, as a result of this competition, we may not be able to take advantage of attractive asset management, origination and investment opportunities and, therefore, may not be able to identify and pursue opportunities that are consistent with our business objectives. Competition may limit the number of suitable investment opportunities offered to us. It may also result in higher prices, lower yields and a narrower spread of yields over our borrowing costs, making it more difficult for us to acquire new investments on attractive terms. In addition, competition for desirable investments could delay the investment in desirable assets, which may in turn reduce our earnings per share.

With respect to our broker-dealer activities, our revenues could be adversely affected if large institutional clients that we have increase the amount of trading they do directly with each other rather than through our broker-dealers, decrease the amount of trading they do with our broker-dealers because they decide to trade more with our competitors, decrease their trading of certain over-the-counter (“OTC”) products in favor of exchange-traded products, or hire in-house professionals to handle trading that our broker-dealers would otherwise be engaged to do.

We have experienced intense price competition in our brokerage business in recent years. Some competitors may offer brokerage services to clients at lower prices than we offer, which may force us to reduce our prices or to lose market share and revenue. In addition, we intend to 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. 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. Further, the recent consolidation among exchange firms, 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.

Financial problems experienced by third parties could affect the markets in which we provide brokerage services. In addition, a disruption in the credit derivatives market could affect our net trading revenues.

Problems experienced by third parties could affect the markets in which we provide brokerage services. For example, in recent years, hedge funds have increasingly begun to make use of credit and other derivatives as part of their trading strategies. As a result, an increasing percentage of our business, directly or indirectly, resulted from trading activity by institutional investors. For example, hedge funds typically employ a significant amount of leverage to achieve their results and, in the past, certain hedge funds have had

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difficulty managing this leverage, which has resulted in market-wide disruptions. If one or more hedge funds that is a significant participant in a credit derivatives market experiences similar problems in the future, including as a result of the volatility in such market, that credit derivatives market could be adversely affected and, accordingly, our trading revenues in that credit derivatives market could decrease.

In addition, in recent years, reports in the U.S. and United Kingdom have suggested weaknesses in the way credit derivatives are assigned by participants in the credit derivatives markets. Such reports expressed concern that, due to the size of the credit derivatives market, the volume of assignments and the suggested weaknesses in the assignment process, one or more significant defaults by corporate issuers of debt may lead to further market-wide disruption or result in the bankruptcy or operational failure of hedge funds or other market participants which could adversely affect our business and revenues.

Employee misconduct or error, which can be difficult to detect and deter, could harm us by impairing our ability to attract and retain clients and by subjecting us to significant legal liability and reputational harm.

There have been a number of highly-publicized cases involving fraud, trading on material non-public information, or other misconduct by employees and others in the financial services industry, and there is a risk that our employees could engage in misconduct that adversely affects our business. For example, we may be subject to the risk of significant legal liabilities under securities or other laws for our employees’ material omissions or materially false or misleading statements in connection with securities and other transactions. In addition, our advisory business requires that we deal with confidential matters of great significance to our clients. If our employees were to improperly use or disclose confidential information provided by our clients, we could be subject to regulatory sanctions and could suffer serious harm to our reputation, financial position, current client relationships and ability to attract future clients. We are also subject to extensive regulation under securities laws and other laws in connection with our asset management business. Failure to comply with these legislative and regulatory requirements by any of our employees could adversely affect us and our clients. It is not always possible to deter employee misconduct, and any precautions taken by us to detect and prevent this activity may not be effective in all cases.

Furthermore, employee errors, including mistakes in executing, recording or reporting transactions for clients (such as entering into transactions that clients may disavow and refuse to settle) could expose us to financial losses and could seriously harm our reputation and negatively affect our business. The risk of employee error or miscommunication may be greater for products that are new or have non-standardized terms.

 

Risks Related to Our Organizational Structure and Ownership of Our Common Stock

We are a holding company whose primary asset is membership units in the Operating LLC, and we are dependent on distributions from the Operating LLC to pay taxes and other obligations.

We are a holding company whose primary asset is membership units in the Operating LLC. Since the Operating LLC is a limited liability company taxed as a partnership, we, as a member of the Operating LLC, could incur tax obligations as a result of our allocable share of the income from the operations of the Operating LLC. In addition, we have convertible senior debt and junior subordinated notes outstanding. The Operating LLC will pay distributions to us in amounts necessary to satisfy our tax obligations and regularly scheduled payments of interest in connection with our convertible senior debt and our junior subordinated notes, and we are dependent on these distributions from the Operating LLC in order to generate the funds necessary to meet these obligations and liabilities. Industry conditions and financial, business and other factors will affect our ability to generate the cash flows we need to make these distributions. There may be circumstances under which the Operating LLC may be restricted from paying dividends to us under applicable law or regulation (for example due to Delaware limited liability company act limitations on the Operating LLC’s ability to make distributions if liabilities of the Operating LLC after the distribution would exceed the value of the Operating LLC’s assets).

As a holding company that does not conduct business operations in its own right, substantially all of the assets of the Company are comprised of our majority ownership interest in the Operating LLC. The Company’s ability to pay dividends to our stockholders will be dependent on distributions we receive from the Operating LLC and subject to the Operating LLC’s operating agreement (the “Operating LLC Agreement”). The amount and timing of distributions by the Operating LLC will be at the discretion of the Operating LLC’s board of managers, which is comprised of the same individuals that serve on our Board of Directors.

Certain subsidiaries of the Operating LLC have restrictions on the withdrawal of capital and otherwise in making distributions and loans. JVB is subject to net capital restrictions imposed by the SEC and FINRA, which require certain minimum levels of net capital to remain in JVB. In addition, these restrictions could potentially impose notice requirements or limit the Company’s ability to withdraw capital above the required minimum amounts (excess capital) whether through distribution or loan. CCFL is regulated by the FCA in the United Kingdom and must maintain certain minimum levels of capital but will allow withdrawal of excess capital without restriction.

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Daniel G. Cohen, our Vice Chairman, may have ownership interests in the Operating LLC and competing duties to other entities that could create potential conflicts of interest and may result in decisions that are not in the best interests of other IFMI stockholders.

The Operating LLC Agreement prevents the Operating LLC from undertaking certain actions without the affirmative approval of IFMI and a majority of voting power of the Operating LLC members, other than IFMI, having a percentage interest of at least 10% of the Operating LLC membership units. Daniel G. Cohen, our Vice Chairman, through an entity he wholly owns, Cohen Bros. Financial, LLC (“CBF”) has a majority of the voting power of the Operating LLC members other than IFMI having a percentage interest of at least 10% of the Operating LLC membership units and these actions are subject to his approval. As a result, it is possible that Mr. Cohen, in his capacity as a the Operating LLC member with approval rights over the actions identified above, could disapprove actions that would be in the best interests of IFMI even though, Mr. Cohen as Vice Chairman of IFMI, will have fiduciary duties to IFMI.

 

Daniel G. Cohen, Jack J. DiMaio, Jr., Christopher Ricciardi and other executive officers and directors may exercise significant influence over matters requiring stockholder approval.

In addition to the 9.9% of our Common Stock outstanding beneficially owned by Daniel G. Cohen, our Vice Chairman, Mr. Cohen beneficially owns 4,983,557 shares of our Series E preferred stock, which have no economic rights, but entitle him to vote together with our stockholders on all matters presented to the stockholders.  So, when factoring in the Series E preferred stock, Mr. Cohen can exercise approximately 32.6% of total shares outstanding that are entitled to vote.  Further, Mr. Jack J. DiMaio, Jr., our Chairman, and Mr. Christopher Ricciardi, a member of our Board of Directors, are the beneficial owners of 974,585 and 1,959,466 shares of our Common Stock, respectively, representing 4.9% and 9.9% of our total shares outstanding that are entitled to vote, respectively.  Except with respect to certain agreements relating to the election of Messrs. Cohen, DiMaio and Ricciardi to our Board of Directors, there are no voting agreements or other arrangements or understandings among Messrs. Cohen, DiMaio, Ricciardi and our other directors and executive officers with respect to our equity securities; however, to the extent that Messrs. Cohen, DiMaio, Ricciardi and our other directors and executive officers vote their shares in the same manner, their combined stock ownership and voting rights will have a significant or even decisive effect on the election of all of the directors and the approval of matters that are presented to our stockholders. Their ownership may discourage someone from making a significant equity investment in us, even if we needed the investment to operate our business. The size of their combined stock holdings could be a significant factor in delaying or preventing a change of control transaction that other of our stockholders may deem to be in their best interests, such as a transaction in which the other stockholders would receive a premium for their shares over their then current market prices. 

On several occasions, our Board of Directors has declared cash dividends. Any future distributions to our stockholders will depend upon certain factors affecting our operating results, some of which are beyond our control.

Our ability to make and sustain cash distributions is based on many factors, including the return on our investments, operating expense levels and certain restrictions imposed by Maryland law. Some of these factors are beyond our control and a change in any such factor could affect our ability to make distributions in the future. We may not be able to make distributions. Our stockholders should rely on increases, if any, in the price of our Common Stock for any return on their investment. Furthermore, we are dependent on distributions from the Operating LLC to be able to make distributions. See the risk factor above titled “We are a holding company whose primary asset is membership units in the Operating LLC and we are dependent on distributions from the Operating LLC to pay taxes and other obligations.”

Future sales of our Common Stock in the public market could lower the price of our Common Stock and impair our ability to raise funds in future securities offerings.

Future sales of a substantial number of shares of our Common Stock in the public market, or the perception that such sales may occur, could adversely affect the then prevailing market price of our Common Stock and could make it more difficult for us to raise funds in the future through a public offering of our securities.

Your percentage ownership in the Company may be diluted in the future.

Your percentage ownership in the Company may be diluted in the future because of equity awards that have been, or may be, granted to our directors, officers and employees. We have adopted equity compensation plans that provide for the grant of equity based awards, including restricted stock, stock options and other equity-based awards to our directors, officers and other employees, advisors and consultants. At December 31, 2013, we had 181,275 shares of restricted stock, 632,450 of restricted units, and 3,000,000 stock options (including 2,500,000 subject to stockholder approval) outstanding to employees and directors of the Company and there were 1,549,145 (presuming stockholder approval of 2,500,000 aforementioned options) shares available for future awards under our equity compensation plans. Vesting of restricted stock and stock option grants is generally contingent upon performance conditions and/or service conditions. Vesting of those shares of restricted units and stock would dilute the ownership interest of existing stockholders. Equity awards will continue to be a source of compensation for employees and directors.

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If we raise additional capital, we expect it will be necessary for us to issue additional equity or convertible debt securities. If we issue equity or convertible debt securities, the price at which we offer such securities may not bear any relationship to our value, the net tangible book value per share may decrease, the percentage ownership of our current stockholders would be diluted, and any equity securities we may issue in such offering or upon conversion of convertible debt securities issued in such offering, may have rights, preferences or privileges with respect to liquidation, dividends, redemption, voting and other matters that are senior to or more advantageous than our Common Stock. If we finance acquisitions by issuing equity securities or securities convertible into equity securities, our existing stockholders will also be diluted.

The issuance of the shares of the Company’s Common Stock upon the conversion, if any, of the notes purchased by Mead Park Capital and EBC, as assignee of CBF, may cause substantial dilution to our existing stockholders and may cause the price of our Common Stock to decline.

In connection with the investments by Mead Park Capital Partners, LLC (“Mead Park Capital”) and EBC 2013 Family Trust (“EBC”), as assignee of CBF, in September 2013 pursuant to the definitive agreements, the Company issued $8,247,501 in aggregate principal amount of the 8% convertible senior promissory notes (the “8.0% Convertible Notes”).  The 8.0% Convertible Notes are convertible into a maximum aggregate amount of 4,086,308 shares of the Company’s Common Stock assuming none of the interest under the 8.0% Convertible Notes is paid to the holders thereof in cash.  If the holders of the 8.0% Convertible Notes elect to convert such notes into shares of our Common Stock, our existing stockholders may be substantially diluted and the price of our Common Stock may decline.

The resale of the shares of our Common Stock by Mead Park Capital and/or EBC could make it more difficult for us to sell equity or equity-related securities in the future at a time and at a price that we might otherwise wish to effect sales.

In connection the registration rights agreement, dated May 9, 2013, which the Company entered into with Mead Park Capital and CBF, the Company filed a registration statement on Form S-3 with the Securities and Exchange Commission  registering the resale of all of the shares of our Common Stock issued or issuable to Mead Park Capital and EBC, as assignee of CBF, under the definitive agreements and the 8.0% Convertible Notes, respectively.  The resale of such shares of our Common Stock by Mead Park Capital and/or EBC could make it more difficult for us to sell equity or equity-related securities in the future at a time and at a price that we might otherwise wish to effect sales.

The Maryland General Corporation Law (the “MGCL”), provisions in our charter and bylaws, and our stockholder rights plan may prevent takeover attempts that could be beneficial to its stockholders.

Provisions of the MGCL and our charter and bylaws could discourage a takeover of us even if a change of control would be beneficial to the interests of its stockholders. These statutory, charter and bylaw provisions include the following:

•the MGCL generally requires the affirmative vote of two-thirds of all votes entitled to be cast on the matter to approve a merger, consolidation, or share exchange involving us or the transfer of all or substantially all of its assets;

•our board has the power to classify and reclassify authorized and unissued shares of our Common Stock or preferred stock and, subject to certain restrictions in the Operating LLC Agreement, authorize the issuance of a class or series of Common Stock or preferred stock without stockholder approval;

•Our charter may be amended only if the amendment is declared advisable by its Board of Directors and approved by the affirmative vote of the holders of our Common Stock entitled to cast at least two-thirds of all of the votes entitled to be cast on the matter;

•a director may be removed from office at any time with or without cause by the affirmative vote of the holders of our Common Stock entitled to cast at least two-thirds of the votes of the stock entitled to be cast in the election of directors;

•an advance notice procedure for stockholder proposals to be brought before an annual meeting of our stockholders and nominations of persons for election to our Board of Directors at an annual or special meeting of its stockholders;

•no stockholder is entitled to cumulate votes at any election of directors; and

•our stockholders may take action in lieu of a meeting with respect to any actions that are required or permitted to be taken by its stockholders at any annual or special meeting of stockholders only by unanimous consent.

The Operating LLC Agreement prevents the Operating LLC from undertaking certain actions that may be in the best interest of the Operating LLC and IFMI without the affirmative approval of IFMI and the affirmative approval of a majority of the Operating LLC members, other than IFMI, having a percentage interest of at least 10% of the Operating LLC membership units.

The Operating LLC Agreement prevents the Operating LLC from undertaking the following actions without the affirmative approval of IFMI and a majority of voting power of the Operating LLC members, other than IFMI, having a percentage interest of at least 10% of the Operating LLC membership units (the “Designated Non-Parent Members”): 

•enter into or suffer a transaction constituting a change of control of the Operating LLC;

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•amend the Operating LLC’s certificate of formation, if such amendment adversely affects the Designated Non-Parent Members; or

•adopt any plan of liquidation or dissolution, or file a certificate of dissolution.

Daniel G. Cohen, our Vice Chairman, through an entity which he wholly-owns, CBF, has a majority of the voting power of the Designated Non-Parent Members and each of the actions set forth above is subject to his approval. As a result, it is possible that Mr. Cohen, in his capacity as a member of the Operating LLC with approval rights over the matters identified above, could disapprove actions that would be in the best interests of IFMI even though, as Vice Chairman of IFMI, he will owe IFMI a fiduciary duty.

The market price of our Common Stock may be volatile and may be affected by market conditions beyond our control.

The market price of our Common Stock is subject to significant fluctuations in response to, among other factors:

•variations in our operating results and market conditions specific to our business;

•changes in financial estimates or recommendations by securities analysts;

•the emergence of new competitors or new technologies;

•operating and market price performance of other companies that investors deem comparable;

•changes in our board or management;

•sales or purchases of our Common Stock by insiders;

•commencement of, or involvement in, litigation;

•changes in governmental regulations; and

•general economic conditions and slow or negative growth of related markets.

In addition, if the market for stocks in our industry, or the stock market in general, experience a loss of investor confidence, the market price of our Common Stock could decline for reasons unrelated to our business, financial condition or results of operations. If any of the foregoing occurs, it could cause the price of our Common Stock to fall and may expose us to lawsuits that, even if unsuccessful, could be costly to defend and a distraction to the Board of Directors and management.

Our Common Stock may be delisted, which may have a material adverse effect on the liquidity and value of our Common Stock.

To maintain our listing on the NYSE MKT, we must meet certain financial and liquidity criteria. In addition, we may be subject to delisting by the NYSE MKT if our Common Stock sells for a substantial period of time at a low price per share, and we fail to effect a reverse split within a reasonable time after being notified that the NYSE MKT deems such action to be appropriate. The market price of our Common Stock has been and may continue to be subject to significant fluctuation as a result of periodic variations in our revenues and results of operations. If we violate the NYSE MKT listing requirements, we may be delisted. If we fail to meet any of the NYSE MKT’s listing standards, we may be delisted. In addition, our board may determine that the cost of maintaining our listing on a national securities exchange outweighs the benefits of such listing. Delisting of our Common Stock could have a material adverse effect on the liquidity and value of our Common Stock.

In addition, the holders of our outstanding $3.1 million aggregate principal amount of convertible senior debt will have the right to require us to repurchase their notes at 100% of their principal amount together with accrued but unpaid interest thereon if, among other things, our Common Stock ceases to be listed on the NYSE MKT, another established national securities exchange or an automated OTC trading market in the U.S. If our Common Stock is delisted due to a failure to meet any of the NYSE MKT’s listing standards and we are unable to list our Common Stock on another established national securities exchange or an automated OTC trading market, some or all of the holders of our convertible notes may exercise their right to require us to repurchase up to $3.1 million aggregate principal amount of their notes.

Because our Common Stock is deemed a low-priced “penny” stock, an investment in our Common Stock should be considered high risk and subject to marketability restrictions.

Since our Common Stock is a penny stock, as defined in Rule 3a51-1 under the Securities Exchange Act, it will be more difficult for investors to liquidate their investment in our Common Stock. Until the trading price of our Common Stock rises above $5.00 per share, if ever, trading in our Common Stock is subject to the penny stock rules of the Securities Exchange Act specified in Rules 15g-1 through 15g-10. Those rules require broker-dealers, before effecting transactions in any penny stock, to:

•Deliver to the customer, and obtain a written receipt for, a disclosure document;

•Disclose certain price information about the stock;

•Disclose the amount of compensation received by the broker-dealer or any associated person of the broker-dealer;

•Send monthly statements to customers with market and price information about the penny stock; and

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•In some circumstances, approve the purchaser’s account under certain standards and deliver written statements to the customer with information specified in the rules.

Consequently, the penny stock rules may restrict the ability or willingness of broker-dealers to sell our Common Stock and may affect the ability of holders to sell their Common Stock in the secondary market and the price at which such holders can sell any such securities. These additional procedures could also limit our ability to raise additional capital in the future.

  

 

ITEM 1B. UNRESOLVED STAFF COMMENTS.

None.

ITEM 2.           PROPERTIES.

In addition to our U.S. broker-dealers’ properties described below, we have offices located in Philadelphia, New York, Boca Raton, Madrid, London, and Paris. Our principal offices are our Philadelphia executive offices located at Cira Centre, 2929 Arch Street, 17th Floor, Philadelphia, Pennsylvania, and our New York office (as more fully described below). As of December 31, 2013, we lease an aggregate of 10,396 square feet of office space in Philadelphia under a lease, which will expire in April 2016. We lease 12,800 square feet of office space on each of the 21st and 22nd floors at 135 East 57th Street, New York, New York, with our leases with respect to such space expiring November 2016 and December 2016, respectively. We sublease the 21st and 22nd floor to third parties. We lease approximately 220 square meters of office space at 3 rue Du Faubourg Saint Honoré, Paris, France, with such lease having an option to be terminated by us in December 2016. Our London office is located at 23 College Hill, 6th Floor London, U.K., with such lease covering approximately 3,043 square feet of office space expiring in June 2015. Our Madrid office is located at Calle General Castanos, 28004 Madrid, Spain, with such lease covering approximately 300 square meters of office space expiring in July 2014.

Effective January 1, 2011, we acquired JVB. JVB is part of our Capital Markets business segment. JVB has its principal office in Boca Raton, Florida, with additional offices in Hunt Valley, Maryland; Charlotte, North Carolina; and Ridgefield, Connecticut that it maintains and leases pursuant to operating leases. JVB’s corporate headquarters is located at 1825 NW Corporate Blvd, Suite 100, Boca Raton, Florida. As of December 31, 2013, JVB leased an aggregate of 9,752 square feet of office space in Boca Raton under a lease which will expire in December 2020.  Effective January 31, 2014, JVB merged with and into CCPR. 

Effective May 31, 2011, we acquired an approximate 70% interest in PrinceRidge. As of December 31, 2013, we owned 100% of PrinceRidge. PrinceRidge is part of our Capital Markets business segment. PrinceRidge has its principal office in New York, New York, with additional offices in Chicago, Illinois; Boca Raton, Florida; Red Bank, New Jersey; Locust Valley, New York; and Houston, Texas that it maintains and leases pursuant to operating leases. PrinceRidge’s corporate headquarters is located at 1633 Broadway, 28th Floor, New York, New York. As of December 31, 2013, PrinceRidge leases an aggregate of 28,122 square feet in its headquarters in New York and the lease expires in July 2015.

The properties that we occupy are used either by the Company’s Capital Markets business segment or Asset Management business segment or both business segments.

We believe that the facilities we occupy are suitable and adequate for our current operations.

ITEM  3.LEGAL PROCEEDINGS.

The Company was named in litigation commenced in the United States District Court for the Southern District of New York on June 29, 2012, under the caption U.S. Bank National Association v. Institutional Financial Markets, Inc. The plaintiff, U.S. Bank, alleges breach of contract respecting certain fees allegedly owing to U.S. Bank, as Trustee, in connection with the issuance of trust preferred securities, seeking damages and a declaration that the Company must make certain future fee payments. The Company filed a motion to dismiss the complaint in lieu of an answer on October 26, 2012, and U.S. Bank filed its response to the motion on November 26, 2012. On July 19, 2013, the court entered a Memorandum and Order denying the Company’s motion to dismiss.  The Company filed its answer to the Complaint on August 19, 2013.  On January 30, 2014, the parties entered into an agreement to settle the litigation.  On February 11, 2014, the parties filed a Joint Stipulation of Dismissal with Prejudice with the Court, ending the litigation.  As of December 31, 2013, the Company had accrued a loss sufficient to cover the confidential settlement.

The Company’s former U.S. broker-dealer subsidiary, Cohen & Company Securities, LLC (“CCS”), and one of its registered investment adviser subsidiaries, CIRA SCM, LLC (“CIRA”), are parties to litigation commenced on June 7, 2013, in the Supreme Court of the State of New York under the caption Northern Rock (Asset Management) PLC v. Société Générale Corporate and Investment Banking, Cohen & Company Securities, et al.  Northern Rock (Asset Management) PLC (“Northern Rock”), Plaintiff, served the Summons with Notice on Defendants on October 3, 2013, and, on November 12, 2013, Northern Rock filed its complaint alleging fraud, fraudulent inducement, fraudulent concealment, breach of contract, negligent misrepresentation, and unjust enrichment in connection with Northern Rock’s investment in Kleros Preferred Funding VIII, Ltd., a collateralized debt obligation.  The relief sought by Northern Rock under these various legal theories includes damages, rescission, and disgorgement, as well as costs and

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attorneys’ fees.  CCS and CIRA filed a motion to dismiss the complaint in lieu of an answer on January 27, 2014.  Northern filed its opposition on March 4, 2014.  The Company intends to defend the action vigorously.

In addition to the matters set forth above, the Company is a party to various routine legal proceedings and regulatory inquiries arising out of the ordinary course of the Company’s business. Management believes that the results of these routine legal proceedings and regulatory matters will not have a material adverse effect on the Company’s financial condition, or on the Company’s operations and cash flows. However, the Company cannot estimate the legal fees and expenses to be incurred in connection with these routine matters and, therefore, is unable to determine whether these future legal fees and expenses will have a material impact on the Company’s operations and cash flows. It is the Company’s policy to expense legal and other fees as incurred.

ITEM  4.MINE SAFETY DISCLOSURES.

Not Applicable.

 

 

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PART II

ITEM  5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Market Information for Our Common Stock and Dividends

The closing price of our Common Stock was $2.46 on February 28, 2014. We had 15,123,059 shares of Common Stock outstanding held by approximately 43 holders of record as of March 1, 2014.

Commencing on March 22, 2004, our Common Stock began trading on the NYSE under the symbol “SFO.” On October 6, 2006, upon completion of our merger with Alesco Financial Trust and our name change from Sunset Financial Resources, Inc. to Alesco Financial Inc., our NYSE symbol was changed to “AFN.”

On December 16, 2009, we effectuated a 1-for-10 reverse stock split immediately prior to consummation of the Merger. Upon completion of the Merger, our name changed from Alesco Financial Inc. to Cohen & Company Inc., we moved our listing of Common Stock from the New York Stock Exchange to the NYSE MKT LLC (formerly known as NYSE Amex LLC), and our trading symbol was changed to “COHN.”

Effective January 21, 2011, we changed our name to Institutional Financial Markets, Inc. and our Common Stock began trading on the NYSE MKT LLC under the symbol “IFMI.”

The following sets forth the high and low sale prices of our Common Stock for the quarterly period indicated as reported on the NYSE Amex LLC from January 1, 2012 to December 31, 2013 and the cash dividends declared per share:

 

 

 

During 2012, the Company declared a $0.02 dividend on each of March 6, 2012, May 3, 2012, August 8, 2012, and November 7, 2012, respectively, payable to stockholders of record as of March 20, 2012, May 17, 2012, August 22, 2012, and November 19, 2012, respectively, payable on April 3, 2012, May 31, 2012, September 5, 2012, and December 3, 2012, respectively.

During 2013, the Company declared a $0.02 dividend on each of February 28, 2013, May 10, 2013, August 6, 2013, and October 31, 2013, respectively, payable to stockholders of record as of March 14, 2013, May 24, 2013, August 21, 2013, and November 15,2013, respectively, payable on March 28, 2013, June 7, 2013, September 4, 2013, and November 29, 2013, respectively.

On March 4, 2014, the Company’s Board of Directors declared a $0.02dividend payable to stockholders of record as of March 18, 2014, payable on April 1, 2014.

Effective January 1, 2010, the Company ceased to qualify as a REIT and, therefore, is not required to make any dividends or other distributions to its stockholders. The Company’s Board of Directors has the power to decide to increase, reduce, or eliminate dividends in the future. The Board’s decision will depend on a variety of factors, including business, financial and regulatory considerations as well as any limitations under Maryland law or imposed by any agreements governing indebtedness of the Company.

 

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Unregistered Sales of Equity Securities

None.

Issuer Purchases of Equity Securities

 

 

(1)Purchases were made in connection with vesting of restricted shares issued to employees for employee tax withholding purposes.  

(2)On August 3, 2007, our Board of Directors authorized us to repurchase up to $50 million of our Common Stock from time to time in open market purchases or privately negotiated transactions. The repurchase plan was publicly announced on August 7, 2007. 

 

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ITEM 6. SELECTED FINANCIAL DATA.

The following selected financial data is derived from our audited consolidated financial statements as of and for the years ended December 31, 2013, 2012, 2011, 2010, and 2009. In accordance with U.S. GAAP, the Merger was accounted for as a reverse acquisition with Cohen Brothers as the accounting acquirer. Our consolidated financial statements as of December 31, 2013, 2012, 2011, 2010, and 2009 and for each of the five years in the period ended December 31, 2013 include the historical operations of Cohen Brothers (or its predecessors) from January 1, 2009 through to December 16, 2009 and the combined operations of the combined company from December 17, 2009 through to December 31, 2013.

You should read this selected financial data together with the more detailed information contained in our consolidated financial statements and related notes and “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” beginning on page 46.  

 

 

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(1)On December 16, 2009, Cohen Brothers completed the Merger in accordance with the terms of the Merger Agreement, pursuant to which the Merger Sub merged with and into Cohen Brothers, with Cohen Brothers (now IFMI, LLC) as the surviving entity and a majority owned subsidiary of the Company. The Company also made certain acquisitions during the periods presented.  See notes 1 and 4 to our consolidated financial statements included in this Annual Report on Form 10-K.

(2)During the year ended December 31, 2010, we recognized an impairment charge of $5,607 related to the Cira SCM goodwill. The charge was included in the consolidated statements of operations as impairment of goodwill and was reflected as component of operating expenses. See note 12 to our consolidated financial statements included in this Annual Report on Form 10-K.

(3)Other income / (expense) is comprised of the following:

 

 

 

The gain / (loss) from repurchase of debt was comprised of the following:

(a) During 2010, we repurchased $6,644 notional amount of our 7.625% Contingent Convertible Senior Notes due 2027 (the “Old Notes”) from unrelated third parties for $5,596. We recognized a gain from repurchase of debt of $923 for the year ended December 31, 2010.

(b) In August 2010, CCS completed a cash offer to purchase all of the outstanding subordinated notes payable that were tendered. A total of $8,081 principal amount of subordinated notes payable (representing 85% of the outstanding subordinated notes payable) were tendered prior to the expiration of the offer to repurchase on August 26, 2010. CCS accepted for purchase all of the subordinated notes tendered pursuant to the offer to repurchase for a total purchase price of $6,762, including accrued interest. We recognized a gain from repurchase of debt of $1,632 for the year ended December 31, 2010.

(c) In November 2011, we repurchased $1,025 aggregate principal amount of Old Notes from unrelated third parties for $988 including accrued interest. We recognized a gain from repurchase of debt of $33 which was included as a separate component of non-operating income / (expense) in the Company’s consolidated statements of operations.

(d) In March 2012, we repurchased $150 aggregate principal amount of the Old Notes from an unrelated third party for $151, including accrued interest of $4. We recognized a gain from repurchase of debt of $3, which was included as a separate component of non-operating income / (expense) in the Company’s consolidated statements of operations.

(e) In September 2012, we repurchased $1,177 principal amount of outstanding subordinated notes payable from an unrelated third party for $1,139, including accrued cash interest and paid in kind interest of $50. We recognized a gain from repurchase of debt of $83, net of expenses, which was included as a separate component of non-operating income / (expense) in the Company’s consolidated statements of operations.

(f) In October 2013, we repurchased $5,000 principal amount of the 10.50% Contingent Convertible Senior Notes Due 2027 (“New Notes”) from an unrelated third party for par plus accrued interest.  The loss represented the recognition of the remaining unamortized discount on the New Notes. 

See note 17 to our consolidated financial statements included in this Annual Report on Form 10-K.

Other income / (expense) comprised the following:

(a) During the second quarter of 2012, CCS and the Liquidation Trustee in the Sentinel litigation reached an agreement in principle to settle such litigation. The settlement agreement called for CCS to make an initial payment of $3,000 and an additional payment of $2,250 in the future. As a result of the settlement agreement, we accrued a contingent liability of $4,357 representing the initial payment of $3,000, the discounted present value of the future payment of $1,978, partially offset by additional estimated insurance proceeds receivable of $621. This expense was included in the statement of operations for the year ended December 31, 2012 as a component of non-operating income / (expense). See note 13 to our consolidated financial statements included in this Annual Report on Form 10-K.

(b) On February 27, 2009, we sold three CLO management contracts comprising substantially all of our middle market loan-U.S. (Emporia) business line to an unrelated third party. We received net proceeds from this sale, after the payment of certain expenses, of approximately $7,258. In addition, we were entitled to certain contingent payments based on the amount of subordinated management fees received by the unrelated third party under the sold CLO management contracts in an amount not to exceed an additional $1,500. We recorded the gain on the sale of CLO management contracts of $7,746 for the year ended December 31, 2009 in the consolidated statement of operations which included: (i) net proceeds from sale of $7,258; and (ii) $529 in proceeds from contingent payments received after the sale, net of (iii) $41 of expenses incurred. We recorded the contingent payments that were received from an unrelated third party of the subordinated fee (of up to $1,500) as additional gain as such payments were actually received. We recorded $971 of these contingent payments during the year ended December 31, 2010. As of June 30, 2010, we reached the maximum limit of additional fees we could receive under these contracts. Therefore, we no longer recorded any additional gain on these contracts subsequent to June 30, 2010.

 

(4)Historical earnings (loss) per common share/ data presented prior to the Merger date was retroactively restated based on the exchange ratio (0.57372) of shares issued in the Merger between AFN and Cohen Brothers.

(5)The redeemable non-controlling interest represents the equity interests of PrinceRidge which were not owned by us. The members of PrinceRidge had the right to withdraw from PrinceRidge and require PrinceRidge to redeem the interests for cash over a contractual payment period. The Company accounted for these interests as temporary equity under Accounting Series Release 268 (“ASR 268”). These interests are shown outside of permanent equity of IFMI in its consolidated balance sheet as redeemable non-controlling interest. Since December 31, 2013, the Company has owned 100% of PrinceRidge and no redeemable non-controlling interest remains outstanding.  See notes 3-O and 18.

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 ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

“Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based on our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On a regular basis, we evaluate these estimates, including fair value of financial instruments. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates.

All amounts in this disclosure are in thousands (except share and per share data) unless otherwise noted.

Overview

We are a financial services company specializing in credit-related fixed income investments. We were founded in 1999 as an investment firm focused on small-cap banking institutions, but have grown to provide an expanding range of capital markets, investment banking, and asset management solutions to institutional investors, corporations, and other small broker dealers. We are organized into three business segments: Capital Markets, Asset Management, and Principal Investing.

•  Capital Markets: Our Capital Markets business segment consists primarily of credit-related fixed income sales, trading, and financing, as well as new issue placements in corporate and securitized products, and advisory services. Our fixed income sales and trading group provides trade execution to corporate investors, institutional investors, and other smaller broker-dealers. We specialize in a variety of products, including but not limited to: corporate bonds, ABS, MBS, RMBS, CDOs, CLOs, CBOs, CMOs, municipal securities, TBAs, SBA loans, U.S. government bonds, U.S. government agency securities, brokered deposits and CDs for small banks, and hybrid capital of financial institutions including TruPS, whole loans, and other structured financial instruments. We had offered execution and brokerage services for equity derivative products until December 31, 2012, when we sold our equity derivatives brokerage business to a newly formed entity owned by two of our former employees. See note 5 to our consolidated financial statements included in this Annual Report on Form 10-K. As of December 31, 2013, we carried out our capital market activities primarily through our subsidiaries: JVB and CCPR in the United States, and CCFL in Europe. See the discussion below regarding the merger of JVB and CCPR in 2014.

•Asset Management: Our Asset Management business segment manages assets within CDOs, permanent capital vehicles, managed accounts, and investment funds (collectively, “Investment Vehicles”). A CDO is a form of secured borrowing. The borrowing is secured by different types of fixed income assets such as corporate or mortgage loans or bonds. The borrowing is in the form of a securitization, which means that the lenders are actually investing in notes backed by the assets. In the event of default, the lenders will have recourse only to the assets securing the loan. Our Asset Management business segment includes our fee-based asset management operations, which include on-going base and incentive management fees. As of December 31, 2013, we had approximately $5.7 billion in AUM of which 94%, or $5.4 billion, was in CDOs.

•  Principal Investing:  Historically, our Principal Investing business segment has been comprised primarily of our investments in Investment Vehicles we manage, as well as investments in structured products, and the related gains and losses that they generate. In 2014, the Company sold all of its interest in Star Asia and Star Asia Special Situations Fund (see Sale of Star Asia and Other Related Entities below).  On a going forward basis, the Company’s principal investing activities may include more investments in entities it does not manage. 

We generate our revenue by business segment primarily through:

Capital Markets:

•our trading activities, which include execution and brokerage services, securities lending activities, riskless trading activities, as well as gains and losses (unrealized and realized) and income and expense earned on securities classified as trading;

•new issue and advisory revenue comprised of (a) origination fees for corporate debt issues originated by us; (b) revenue from advisory services; and (c) new issue revenue associated with arranging and placing the issuance of newly created debt, equity, and hybrid financial instruments;

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Asset Management:

•  asset management fees for our on-going asset manager services provided to various Investment Vehicles, which may include fees both senior and subordinate to the securities issued by the Investment Vehicle;

•incentive management fees earned based on the performance of the various Investment Vehicles; and

•  income or loss from equity method affiliates. 

Principal Investing:

•gains and losses (unrealized and realized) and income and expense earned on securities, primarily in investments in Investment Vehicles we manage, classified as other investments, at fair value; and

•  income or loss from equity method affiliates.

Business Environment

Our business is materially affected by economic conditions in the financial markets, political conditions, broad trends in business and finance, changes in volume and price levels of securities transactions, and changes in interest rates, all of which can affect our profitability and are unpredictable and beyond our control. These factors may affect the financial decisions made by investors and companies, including their level of participation in the financial markets and their willingness to participate in corporate transactions. Severe market fluctuations or weak economic conditions could continue to reduce our trading volume and revenues, could negatively affect our ability to generate new issue and advisory revenue, and adversely affect our profitability.

The markets remain uneven and vulnerable to changes in investor sentiment. We believe the general business environment will continue to be challenging into the foreseeable future.  

A portion of our revenues is generated from net trading activity. We engage in proprietary trading for our own account, provide securities financing for our customers, as well as execute “riskless” trades with a customer order in hand resulting in limited market risk to us. The inventory of securities held for our own account, as well as held to facilitate customer trades, and our market making activities are sensitive to market movements.

A portion of our revenues is generated from new issue and advisory engagements. The fees charged and volume of these engagements are sensitive to the overall business environment.

A portion of our revenues is generated from management fees. Our ability to charge management fees and the amount of those fees is dependent upon the underlying investment performance and stability of the Investment Vehicles. If these types of investments do not provide attractive returns to investors, the demand for such instruments will likely fall, thereby reducing our opportunity to earn new management fees or maintain existing management fees.  As of December 31, 2013,  94% of our existing AUM were CDOs. The creation of CDOs and permanent capital vehicles has depended upon a vibrant securitization market. Since 2008, volumes within the securitization market have dropped significantly and have not recovered since that time. Consequently, we have been unable to complete a new securitization since 2008.

A portion of our revenues is generated from our principal investing activities. Therefore, our revenues are impacted by the underlying operating results of these investments. As of December 31, 2013, we had $26,877 of other investments, at fair value representing our principal investment portfolio. Of this amount, $26,325, or 97.9%, was comprised of the following investment funds and permanent capital vehicles: Star Asia, EuroDekania, Tiptree, and the Star Asia Special Situations Fund. Furthermore, the investment in Star Asia is our largest single principal investment and, as of December 31, 2013, had a fair value of $17,104, representing 64% of the total amount of other investments, at fair value. Star Asia seeks to invest in Asian commercial real estate structured finance products, including CMBS, corporate debt of REITs and real estate operating companies, whole loans, mezzanine loans, and other commercial real estate fixed income investments, and in real property located in Japan. Therefore, our results of operations and financial condition will be significantly impacted by the financial results of these. See Sale of Star Asia and Other Related Entities below.

Margin Pressures in Corporate Bond Brokerage Business

Performance in the financial services industry in which we operate is highly correlated to the overall strength of the economy and financial market activity. Overall market conditions are a product of many factors beyond our control and can be unpredictable. These factors may affect the financial decisions made by investors, including their level of participation in the financial markets. In turn, these decisions may affect our business results. With respect to financial market activity, our profitability is sensitive to a variety of factors including the volatility of the equity and fixed income markets, the level and shape of the various yield curves, and the volume and value of trading in securities.

 

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Since 2010, both margins and volumes in certain products and markets within the corporate bond brokerage business have decreased materially as competition has increased and general market activity has declined. Further, we continue to expect that competition will increase over time, resulting in continued margin pressure.

Our response to this margin compression has included: (i) building a diversified securitized product trading platform; (ii) expanding our European capital markets business; (iii) acquiring new product lines; and (iv) monitoring our fixed costs. Beginning in the second half of 2012, we began to undertake cost-cutting initiatives by merging support functionality among and across many of our subsidiaries and business lines including the merger of CCPR and JVB discussed separately below. However, there can be no certainty that these efforts will be sufficient. If insufficient, we will likely see a decline in profitability. In January 2014, we completed the combination of our two U.S. broker-dealers (see Consolidation of CCPR and JVB below). 

During 2013, we experienced a reduction in the value of our trading inventory.  The mark to market losses in the trading inventory related to rising interest rates and coincided with the U.S. Federal Reserve’s announcement that it may begin to taper its quantitative easing programs.  In addition, beginning in June 2013, we experienced a reduction in trading volumes as well.  The volume reduction was broad based but was most noticeable in our agency new issue and trading business and our TBA origination business.  We may experience reduced trading volumes in the future as a result of market uncertainty surrounding U.S. Federal Reserve quantitative easing programs. 

Legislation Affecting the Financial Services Industry

In July 2010, the federal government passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act significantly restructures and intensifies regulation in the financial services industry, with provisions that include, among other things, the creation of a new systemic risk oversight body (i.e., the Financial Stability Oversight Council), expansion of the authority of existing regulators, increased regulation of and restrictions on OTC derivatives markets and transactions, broadening of the reporting and regulation of executive compensation, expansion of the standards for market participants in dealing with clients and customers, and regulation of fiduciary duties owed by municipal advisors or conduit borrowers of municipal securities. In addition, Section 619 of the Dodd-Frank Act (known as the “Volker Rule”) and section 716 of the Dodd-Frank Act (known as the “swaps push-out rule”) limit proprietary trading of certain securities and swaps by certain banking entities. Although we are not a banking entity and are not otherwise subject to these rules, some of our clients and many of our counterparties are banks or entities affiliated with banks and will be subject to these restrictions.  These sections of the Dodd-Frank Act and the regulations that are adopted to implement them could negatively affect the swaps and securities markets by reducing their depth and liquidity and thereby affect pricing in these markets.  Further, the Dodd-Frank Act as a whole and the intensified regulatory environment will likely alter certain business practices and change the competitive landscape of the financial services industry, which may have an adverse effect on our business, financial condition and results of operations.  We will continue to monitor all applicable developments in the implementation of Dodd-Frank and expect to adapt successfully to any new applicable legislative and regulatory requirements.

Recent Events

Investment by Mead Park Capital and CBF

On September 25, 2013, we issued shares of our Common Stock and the 8.0% Convertible Notes to Mead Park Capital Partners LLC (“Mead Park Capital”) and EBC 2013 Family Trust (“EBC”), as assignee of CBF, and raised a total of $13,746. See notes 4 and 17 to our consolidated financial statements included in this Annual Report on Form 10-K.  

Repurchase of New Notes

On October 28, 2013, we repurchased $5,000 aggregate principal amount of the New Notes from an unrelated third party for $5,238, including accrued interest of $238.  Holders of the New Notes have the right to require us to repurchase those notes on May 15, 2014.  As a result of this, the outstanding principal amount of New Notes has been reduced from $8,121 to $3,121. 

Consolidation of CCPR and JVB

Effective January 31, 2014, we merged CCPR and JVB. The merged broker-dealer subsidiary will operate going forward under the JVB name.   In connection with this merger, we reduced our workforce by approximately 20% by eliminating certain redundant and non-core business lines.  See Liquidity and Capital Resources – Consolidation of CCPR and JVB below for additional details relating to the consolidation of CCPR and JVB.

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Sale of Star Asia and Other Related Entities

On February 20, 2014, we announced the completion of the sale of all of our ownership interests in Star Asia, Star Asia Special Situations Fund, Star Asia Manager, Star Asia Capital Management, SAA Manager, and SAP GP (the “Star Asia Group”).  We received an initial upfront payment of $20,043.   We will receive contingent payments equal to 15% of certain revenues generated by Star Asia Manager, SAA Manager, SAP GP, Star Asia Capital Management, and certain affiliated entities  for a period of at least four years.  See note 31 to our consolidated financial statements included in this Annual Report on Form 10-K.

Consolidated Results of Operations

The following section provides a comparative discussion of our consolidated results of operations for the specified periods. The period-to-period comparisons of financial results are not necessarily indicative of future results.

Year Ended December 31, 2013 Compared to the Year Ended December 31, 2012 

The following table sets forth information regarding our consolidated results of operations for the years ended December 31, 2013 and 2012.  

 

 

Revenues

Revenues decreased by $37,723, or 40%, to $57,517 for the year ended December 31, 2013 from $95,240 for the year ended December 31, 2012. As discussed in more detail below, the change was comprised of (i) a decrease of $30,958 in net trading; (ii) a  

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decrease of $3,369 in asset management revenue; (iii) an increase of $1,397 in new issue and advisory revenue; and (iv) a decrease of $4,793 in principal transactions and other income.

Net Trading

Net trading revenue decreased by $30,958, or 45%, to $38,528 for the year ended December 31, 2013 from $69,486 for the year ended December 31, 2012.     The following table provides detail on net trading revenue by operation:

 

 

The decline in trading revenue was significant and broad-based.  The decline in revenue in JVB was primarily due to the decline in trading revenue earned in the following asset classes: agency securities, treasury securities, and municipal bonds. The decline in revenue in PrinceRidge and other capital markets was primarily due to a decline in trading revenue in agency securities, treasury securities, municipal bonds, high yield corporate bonds, and structured products.  The decrease in revenue in CCFL was primarily due to a decrease in overall trading volumes. 

 

Effective January 31, 2014, we merged CCPR and JVB. The merged broker-dealer subsidiary will operate going forward under the JVB name.   In connection with this merger, we reduced our workforce by approximately 20% by eliminating certain redundant and non-core business lines. 

Our net trading revenue includes unrealized gains on our trading investments, as of the applicable measurement date that may never be realized due to changes in market or other conditions not in our control.  This may adversely affect the ultimate value realized from these investments. In addition, our net trading revenue also includes realized gains on certain proprietary trading positions. Our ability to derive trading gains from such trading positions is subject to overall market conditions. Due to volatility and uncertainty in the capital markets, the net trading revenue recognized during the year ended December 31, 2013 may not be indicative of future results. Furthermore, some of the assets included in the Investments-trading line of our consolidated balance sheets represent level 3 valuations within the FASB fair value hierarchy. Level 3 assets are carried at fair value based on estimates derived using internal valuation models and other estimates. See notes 8 and 9 to our consolidated financial statements included in this Annual Report on Form 10-K. The fair value estimates made by us may not be indicative of the final sale price at which these assets may be sold.

Asset Management

Assets Under Management

Our AUM equals the sum of: (1) the gross assets included in CDOs that we have sponsored and manage; plus (2) the NAV of the permanent capital vehicles and investment funds we manage; plus (3) the NAV of other accounts we manage. Our calculation of AUM may differ from the calculations used by other asset managers and, as a result, this measure may not be comparable to similar measures presented by other asset managers. This definition of AUM is not necessarily identical to a definition of AUM that may be used in our management agreements.

 

 

 

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Asset management fees decreased by $3,369, or 15%, to $19,803 for the year ended December 31, 2013, as compared to $23,172 for the year ended December 31, 2012, as discussed in more detail below. The following table provides a more detailed comparison of the two periods:

CDOs

Asset management revenue from company-sponsored CDOs decreased by $7,501 to $14,228 for the year ended December 31, 2013, as compared to $21,729 for the year ended December 31, 2012. The following table summarizes the periods presented by asset class:

 

Asset management fees for TruPS and insurance company debt – U.S. declined primarily because,  effective February 23, 2013, we no longer provide any services related to the Alesco X through XVII securitizations.  On July 29, 2010, we entered into an agreement with an unrelated third party whereby we sold the management rights and responsibilities related to the Alesco X through XVII securitizations.  In connection with this agreement, we entered into a services agreement pursuant to which we provided certain services to the purchaser.  This services agreement expired on February 23, 2013.  We will continue to receive certain incentive payments through February 23, 2017, if the management fees earned by the third party exceed certain thresholds.  We will continue to recognize these incentive payments, if any, as earned.  

Asset management fees for high grade and mezzanine ABS declined by $257 primarily because the average AUM in the deals in this asset class declined due to defaults of the underlying assets, repayments of the underlying assets, and liquidations of certain CDOs.  This decrease was partially offset by an increase of $385 primarily related to a final fee earned in conjunction with our resignation as manager of one securitization. 

Asset management fees for TruPS and insurance company debt – Europe declined primarily because we received a final CDO asset management fee for one of our European deals during the third quarter of 2012.  The total revenue recorded during 2012 related to this one European CDO was $3,862. 

Asset management fees for broadly syndicated loans –Europe represent revenue from a single CLO.  Prior to August 2012, we served as the junior manager of this CLO and we shared management fees evenly with the lead manager.  In August 2012, we became the

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lead manager (and remained junior manager).  As a result of becoming lead manager, we earn all of the management fees related to this CLO which has caused the increase in asset management fees from broadly syndicated loans – Europe.

A significant portion of our managed CDOs have stopped paying subordinated management fees due to diversion of cash flows called for within the CDO governing documents.  See “Critical Accounting Policies and Estimates – Revenue Recognition – Asset Management” beginning on page 74 for discussion of our accounting policy regarding recognition of revenue related to subordinated management fees. 

Other

Other asset management revenue increased by $4,132 to $5,575 for the year ended December 31, 2013, as compared to $1,443 for the year ended December 31, 2012.

 

Of the increase in other asset management revenue, $2,329 was due to the acquisition of Star Asia Manager which was effective March 1, 2013.  Prior to the acquisition, we owned 50% of Star Asia Manager and treated the investment as an equity method investment.  The remaining increase was due to increased separate account asset management revenues including incentive fees earned.  See notes 4 and 31 to our consolidated financial statements included in this Annual Report on Form 10-K.  

New Issue and Advisory Revenue

New issue and advisory revenue increased by $1,397, or 28%, to $6,418 for the year ended December 31, 2013, as compared to $5,021 for the year ended December 31, 2012.

Our new issue and advisory revenue has been, and we expect will continue to be, volatile. We earn revenue from a limited number of engagements. Therefore, a small change in the number of engagements can result in large fluctuations in the revenue recognized. Further, even if the number of engagements remains consistent, the average revenue per engagement can fluctuate considerably. Finally, our revenue is generally earned when an underlying transaction closes (rather than on a monthly or quarterly basis). Therefore, the timing of underlying transactions increases the volatility of our revenue recognition.

Principal Transactions and Other Income

Principal transactions and other income decreased by $4,793 to ($7,232) for the year ended December 31, 2013, as compared to ($2,439) for the year ended December 31, 2012.  

 

 

Change in fair value of other investments, at fair value

Change in fair value of other investments, at fair value decreased by $5,116 to ($11,400) for the year ended December 31, 2013, as compared to ($6,284) for the year ended December 31, 2012. 

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For 2012, the change in fair value of our investment in EuroDekania was primarily the result of the change in the underlying NAV of EuroDekania.  For 2013, we purchased shares of EuroDekania for less than the NAV which resulted in a gain of $766.  The remaining change in fair value for 2013 was the result of the change in the underlying NAV of EuroDekania. 

Star Asia is an investment fund that is exposed to changes in its value due to the performance of its underlying investments. The value of our investment in Star Asia has also been impacted by the fact that Star Asia’s investments are primarily denominated in Japanese Yen and Star Asia itself does not hedge against currency fluctuations. The following table shows the change in the value of our investment in Star Asia and how it was impacted by these items:

 

 

On February 20, 2014, we announced the completion of the sale of the Star Asia Group which includes Star Asia. See note 31 to our consolidated financial statements included in this Annual Report on Form 10-K.

Foreign exchange: This line item represents the impact to fair value of our investment in Star Asia from currency fluctuations. This is because Star Asia’s investments are primarily denominated in Japanese Yen, and Star Asia itself does not hedge against currency fluctuations. Accordingly, we were exposed to increases and decreases in the value of our investment in Star Asia that result from fluctuations of the Japanese Yen as compared to the U.S. Dollar.

As of December 31, 2013, our long exposure to the Japanese Yen was 3.2 billion Japanese Yen and our Japanese Yen hedge was 1.25 billion Japanese Yen.  The spot rate of the U.S. Dollar to Japanese Yen was $105.31 as of December 31, 2013,  and, as a result our un-hedged portion of Star Asia was $18.8 million. We had no hedge in place at December 31, 2012.  As of December 31, 2012, our long exposure to Japanese Yen was 4.2 billion Yen. The spot rate of U.S. Dollar to Japanese Yen was 86.75 as of December 31, 2012, which means our un-hedged portion of Star Asia was $49.0 million.

In conjunction with the sale of the Star Asia Group in February 2014, we extinguished our existing yen hedge.  Going forward we should not have material exposure to the Japanese Yen. 

Underlying investment values: This line item represents the changes to the fair value of our investment in Star Asia exclusive of the impact of foreign currency changes or other changes specifically identified in the table above.   As described in more detail in note 31 to our consolidated financial statements included in this Annual Report on Form 10-K, we sold our investment in Star Asia in February 2014 along with our investment in the remaining entities in the Star Asia Group.  As a result, as of December 31, 2013, we determined the fair value of our investment in Star Asia by utilizing a valuation model that took into account the terms and conditions of the sale in February 2014. 

 

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Effective June 30, 2013, we changed the way we calculate the fair value of our investment in Tiptree.  Previously, we carried our investment at the underlying NAV of the fund.  However, Tiptree completed a  reorganization during 2013.  As a result of the reorganization, our investment in Tiptree can be exchanged into shares of Tiptree Financial, Inc. based on a stated exchange ratio (which is generally fixed, but can be adjusted for certain events like stock dividends or stock splits).  Tiptree Financial Inc. is publicly traded OTC.  Therefore, beginning June 30, 2013, we calculate the fair value of our investment in Tiptree by using the closing over the counter price for Tiptree Financial Inc. and adjusting for the exchange ratio.  The decline in the fair value of our investment was primarily due to this change in method of calculating the fair value of our investment.

In December 2012, we made an investment in the Star Asia Special Situations Fund. As of December 31, 2012, we carried our investment in the Star Asia Special Situations Fund at the NAV of the underlying fund.  As described in more detail in note 31 to our consolidated financial statements included in this Annual Report on Form 10-K, we sold our investment in Star Asia Special Situations Fund in February 2014, along with our investment in the remaining entities of the Star Asia Group.  As a result, as of December 31, 2013, we determined the fair value of our investment in Star Asia Special Situations Fund by utilizing a valuation model that took into account the terms and conditions of the sale in February 2014. 

Dividends, interest, and other

Dividends, interest, and other increased by $2,009 to $4,167 for the year ended December 31, 2013, as compared to $2,158 for the year ended December 31, 2012. Prior the Merger, AFN had entered into an arrangement whereby it guaranteed a portion of a particular loan that was owned by the Alesco XIV securitization.  This arrangement was accounted for as a guarantee and we recorded a liability of $1,084 at the Merger Date.  In May 2013, the underlying loan was paid off in full by the borrower and our guarantee was extinguished.  We recorded other revenue of $1,084 in the second quarter of 2013 and wrote off the liability.    See note 26 to our consolidated financial statements included in this Annual Report on Form 10-K.      The remaining increase in dividends interest and other was primarily comprised of: (i) $1,015 increase from our revenue share arrangement with Strategos Capital Management LLC; and (ii) $90 decrease in all other income, net.

Operating Expenses

Operating expenses decreased by $16,324, or 17%, to $78,621 for the year ended December 31, 2013 , as compared to $94,945 for the year ended December 31, 2012. As discussed in more detail below, the change was comprised of (i) a decrease of $15,784 in compensation and benefits; (ii) an increase of $22 in business development, occupancy, and equipment; (iii) a decrease of $624 in subscriptions, clearing, and execution; (iv) a decrease of $38 of professional fees and other operating; and (v) an increase of $100 of depreciation and amortization. 

Compensation and Benefits

Compensation and benefits decreased by $15,784, or 25%, to $47,167 for the year ended December 31, 2013, as compared to $62,951 for the year ended December 31, 2013.  

 

 

Cash compensation and benefits in the table above is primarily comprised of salary, incentive compensation, and benefits.  Cash compensation and benefits decreased by $14,356 to $45,220 for the year ended December 31, 2013, as compared to $59,576 for the year ended December 31, 2012. This decrease was primarily a result of a decrease in incentive compensation which is tied to revenue and operating profitability.  Our total headcount decreased from 197 at December 31, 2012, to 148 at December 31, 2013.  From time to time, we pay employees severance when they are terminated without cause. These severance payments are included within cash compensation in the table above.

Equity-based compensation increased by $676 to $1,947 for the year ended December 31, 2013, as compared to $1,271 for the year ended December 31, 2012.  There were three major components of this change:

 

First, during the year ended December 31, 2012, we recognized a reduction in equity based compensation of $1,158 related to the forfeiture of equity based grants to Michael T. Hutchins and John P. Costas (the former chief executive officer and former chairman, respectively, of PrinceRidge) in July 2012. Second, we recognized $1,605 less in reversals of equity compensation expense in the year ended December 31, 2013, as compared to the year ended December 31, 2012 due to forfeitures and employees failing to meet their performance targets.  Finally, we recognized a reduction in other equity compensation expense of $2,087 primarily as a result of employee grants becoming fully vested or forfeited after December 31, 2012, net of new grants after December 31, 2012.  See note 20 to our consolidated financial statements included in this Annual Report on Form 10-K.

Business Development, Occupancy, and Equipment

Business development, occupancy, and equipment increased by $22, or 0%, to $5,817 for the year ended December 31, 2013, as compared to $5,795 for the year ended December 31, 2012. The increase was primarily due to an increase in technology support expenditures of $461 and one time rent expense of $245, partially offset by a net decrease in other business development, occupancy, and equipment expenses of $684.  As part of our cost savings measures, we terminated a significant portion of our in-house information technology staff and outsourced those services to third party providers.  The one time rent expense was the result of net rent expense acceleration resulting from the closure of unused office space in connection with the merger of JVB and CCPR. 

Subscriptions, Clearing, and Execution

Subscriptions, clearing, and execution decreased by $624, or 5%, to $10,822 for the year ended December 31, 2013, as compared to $11,446 for the year ended December 31, 2012.   The decrease was comprised of (i) a decrease in subscriptions and dues of $961 primarily due to cost savings measures; (ii) a decrease in clearing and execution of $489 primarily the result of lower trading volumes; partially offset by (iii) an increase of $826 due to termination costs incurred from the elimination of duplicative subscriptions in connection with the merger of JVB and CCPR. 

Professional Fees and Other Operating Expenses

Professional fees and other operating expenses decreased by $38, or 0%, to $13,410 for the year ended December 31, 2013, as compared to $13,448 for the year ended December 31, 2012.  

Depreciation and Amortization

Depreciation and amortization increased by $100, or 8%, to $1,405 for the year ended December 31, 2013, as compared to $1,305 for the year ended December 31, 2012. This increase was comprised of (i) an increase of $287 related to depreciation and amortization incurred by Star Asia Manager after its acquisition by us in 2013; (ii) partially offset by a decrease of $187 related to fixed assets becoming fully depreciated. 

Non-Operating Income and Expense

Interest Expense, net

Interest expense, net increased by $461, or 12%, to $4,193 for the year ended December 31, 2013, as compared to $3,732 for the year ended December 31, 2012. The increase was comprised of (i)  an increase of $203 related to the issuance of the 8.0% Convertible Notes; (ii) a decrease of $912 of interest income, net related to the reduction in the amount owed to withdrawing partners of PrinceRidge which was recorded in 2012; (iii) an increase in interest expense of $55 relating to the amortization of the discount attributable to a payment made by us to Sentinel Management Group, Inc. (“Sentinel”) in connection with the settlement of certain litigation matters involving our former U.S. broker-dealer, Cohen & Company Securities, LLC and Sentinel (the “Sentinel Litigation”);  (iv) $10 of other increases in interest expense; partially offset by  (v) a decrease of $464 of interest incurred on the convertible senior notes (comprised of our 7.625% Contingent Convertible Senior Notes due 2027 (“Old Notes”) and New Notes) due to repurchases and redemptions of the Old Notes; (vi) a reduction of $119 of interest incurred on the subordinated notes payable due to repayments and repurchases of these notes; (vii) a reduction of $136 of interest incurred on the junior subordinated notes as a result of

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the interest rate on one of the two issuances changing from a fixed rate to a lower variable rate beginning in July 31, 2012.   See notes 17 and 18 to our consolidated financial statements included in this Annual Report on Form 10-K.  

Other Income (Expense), net

Other income (expense), net was ($15) for the year ended December 31, 2013 as compared to ($4,271) for the year ended December 31, 2012.  For 2012, other income (expense), net represented expense of $4,357 related to the settlement of the Sentinel Litigation, partially offset by a gain on repurchase of debt of $86.  For 2013, the other income (expense), net represented a loss on the repurchase of debt. 

Income / (Loss) from Equity Method Affiliates

Income from equity method affiliates decreased by $3,224, or 64% to $1,828 for the year ended December 31, 2013, as compared to $5,052 for the year ended December 31, 2012. Income or loss from equity method affiliates represents our share of the related entities’ earnings.

 

See notes 4, 15, and 29 to our consolidated financial statements included in this Annual Report on Form 10-K.

On February 20, 2014, we announced the completion of the sale of the Star Asia Group which includes Star Asia Manager, SAA Manager and Star Asia Capital Management.  As of December 31, 2013, we had no interest in the earnings of Star Asia SPV and Star Asia Opportunity II.  Star Asia Opportunity is in liquidation and a small additional distribution is expected in 2014. See note 31 to our consolidated financial statements included in this Annual Report on Form 10-K.

 

Income Tax Expense / (Benefit)

The income tax expense / (benefit) was ($3,565) for the year ended December 31, 2013 as compared to ($615) for the year ended December 31, 2012. The tax benefit realized in 2013 was comprised of: (i) a deferred tax benefit of $2,074 primarily from changes in the expected reversal patterns of our deferred tax liability as well as changes in the expiration timeframes of our carry forward assets; (ii) a tax benefit of $1,402 representing the recognition of a previously unrecognized tax benefit that became effectively settled during the period; and (iii) other miscellaneous net tax benefit of $89. The tax expense realized by us in 2012 was primarily the result of a deferred tax benefit which resulted from changes in the reversal pattern of our deferred tax liabilities as well as changes in our state and local tax rate as a result of changes in the jurisdictions in which we operate.  See discussion of Pennsylvania income tax assessment and other information in note 21 to our consolidated financial statements included in this Annual Report on Form 10-K.  

Net Income / (Loss) Attributable to the Non-controlling Interest

Net income / (loss) attributable to the non-controlling interest for the years ended December 31, 2013 and 2012 was comprised of the non-controlling interest related to member interests in the Operating LLC other than interests held by us for the relevant periods. In addition, net income / (loss) attributable to the non-controlling interest also included non-controlling interest related to entities that were consolidated but not wholly owned by the Operating LLC.

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(1)Non-controlling interest is recorded on a monthly basis. Because earnings are recognized unevenly throughout the year and the non-controlling interest percentage may change during the period, the average effective non-controlling interest percentage may not equal the percentage at the end of any period or the simple average of the beginning and ending percentages.

 

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Year ended December 31, 2012 Compared to the Year ended December 31, 2011 

 

The following table sets forth information regarding our consolidated results of operations for the years ended December 31, 2012 and 2011.  

 

 

 

Revenues

Revenues decreased by $5,091, or 5%, to $95,240 for the year ended December 31, 2012, as compared to $100,331 for the year ended December 31, 2011. As discussed in more detail below, the change was comprised of (i) a decrease of $3,681 in net trading revenue; (ii)  an increase of $1,474 in asset management revenue; (iii) an increase of $1,436 in new issue and advisory revenue; and (iv) a decrease of $4,320 in principal transactions and other income.

Net Trading

Net trading revenue decreased by $3,681, or 5%, to $69,486 for the year ended December 31, 2012, as compared to $73,167 for the year ended December 31, 2011.     The following table provides detail on net trading revenue by operation.

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  The increase in revenue in JVB was primarily due to an increase in trading revenue associated with U.S. agency and structured product new issues. The increase in revenue in CCFL was primarily due to an increase in structured product trading. The decline in PrinceRidge and other capital markets was primarily due to the decline in trading revenue earned from trading in securitized products such as CDOs and CLOs.

Our net trading revenue includes unrealized gains on our trading investments, as of the applicable measurement date, that may never be realized due to changes in market or other conditions not in our control that may adversely affect the ultimate value realized from these investments. In addition, our net trading revenue also includes realized gains on certain proprietary trading positions. Our ability to derive trading gains from trading positions is subject to overall market conditions. Due to volatility and uncertainty in the capital markets, the net trading revenue recognized during the year ended December 31, 2012, may not be indicative of future results. Furthermore, some of the assets included in the Investments — trading line of our consolidated balance sheets represent level 3 valuations within the FASB fair value hierarchy. Level 3 assets are carried at fair value based on estimates derived using internal valuation models and other estimates. The fair value estimates made by us may not be indicative of the final sale price at which these assets may be sold.

 

Asset Management

 

Asset management fees increased by $1,474, or 7%, to $23,172 for the year ended December 31, 2012, as compared to $21,698 for the year ended December 31, 2011, as discussed in more detail below. The following table provides a more detailed comparison of the two periods:

 

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CDOs

Asset management revenue from company-sponsored CDOs increased by $2,674 to $21,729 for the year ended December 31, 2012, as compared to $19,055 for the year ended December 31, 2011. The following table summarizes the periods presented by asset class:

 

 

Asset management fees for TruPS and insurance company debt of United States companies decreased primarily because the average AUM in this asset class declined as a result of the continued decline of the collateral balances due to deferrals, defaults, and prepayments of the underlying assets.

On July 29, 2010, we entered into a Master Transaction Agreement (the “Master Transaction Agreement”) pursuant to which we sold to an unrelated third party the collateral management rights and responsibilities arising after the sale relating to the Alesco X through XVII securitizations. In connection with the Master Transaction Agreement, we entered into a three-year Services Agreement (the “Services Agreement”) pursuant to which we provided certain services to the purchaser. $4,664 of the cash received up front was recognized as deferred revenue and was amortized into revenue over the life of the Services Agreement. In addition, the Master Transaction Agreement calls for additional payments to be made to us on a quarterly basis through February 23, 2017, if the management fees earned by the third party exceed certain thresholds.

During the year ended December 31, 2012 and 2011, we recognized $6,514 and $6,768, respectively, in revenue for the Alesco X through XVII securitizations that is included in the TruPS and insurance company debt — U.S. in the table above. Of these amounts, $680 and $570 represent incentive payments received from the third party under the Master Transaction Agreement during the years ended December 31, 2012 and 2011, respectively. As of December 31, 2012, we have the potential to earn additional incentive payments (through February of 2017) if certain performance hurdles are met. Not including any potential incentive fees, we recognized an additional $1,157 in revenue in 2013 through February 2013 when the services agreement expired per its terms. Beginning March 2013, with the exception of potential incentive payments, we will stop recognizing revenue from the Alesco X through Alesco XVII securitizations.

Asset management fees for high grade and mezzanine ABS declined primarily because of the continued decline of the collateral balances due to defaults, and repayments of certain underlying assets, as well as the liquidation of certain CDOs.

Asset management fees for TruPS and insurance company debt of European companies increased due to the receipt of a final CDO asset management fee for the Xenon CDO during the third quarter of 2012. This fee was earned in connection with the agreed upon resignation of CCFL as asset manager of the Xenon CDO and CCFL agreeing to forego certain collateral manager rights, unique to the Xenon CDO, related to the auction provisions of the CDO. This fee was approved by the relevant security holders of the Xenon CDO. This one-time final asset management fee more than offset declines in the underlying collateral balances as a result of lower foreign exchange rates, as well as the occurrence of certain prepayments and defaults. The total revenue recorded during the year ended December 31, 2012, related to the Xenon CDO, including the final CDO asset management fee, was $3,862. No asset management revenue will be earned on the Xenon CDO going forward as a result of the resignation.

Asset management fees for broadly syndicated loans of European companies represent revenue from a single CLO. Prior to August 2012, we served only as the junior manager of this CLO and we shared the management fees evenly with the lead manager. In August 2012, we became lead manager (and remained as junior manager). Subsequent to becoming the lead manager, we earn all of the management fees related to this CLO. For the year ended December 31, 2012, $567 represented fees earned as lead manager and the remaining amount represented fees earned as junior manager.

Other

Other asset management revenue decreased by $1,200 to $1,443 for the year ended December 31, 2012, as compared to $2,643 for the year ended December 31, 2011.  The decrease was comprised of a decrease related to Deep Value of $452 and a decrease in separate accounts and other of $748. 

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The decrease in Deep Value revenue was primarily the result of the sale of our investment advisory agreements relating to the Deep Value funds to the SCM Buyer, a newly formed entity owned by two former Company employees on March 29, 2011. Pursuant to the terms of the sale, we are entitled to 10% of all revenue, net of certain expenses, earned by the SCM Buyer between March 29, 2011 and December 31, 2014. This revenue sharing arrangement is recorded as a component of principal transactions and other income going forward. See notes 5 and 12 to our consolidated financial statements included in this Annual Report on Form 10-K.

The net decrease of $748 from separate accounts and other was primarily comprised of (a) a decrease of $335 relating to certain managed accounts sold to the SCM Buyer in 2011 as part of the transaction described above, and (b) a net decrease in fees earned primarily from other accounts of $413.

New Issue and Advisory Revenue

New issue and advisory revenue increased by $1,436, or 40%, to $5,021 for the year ended December 31, 2012 from $3,585 for the year ended December 31, 2011.

Our revenue earned from new issue and advisory has been, and we expect will continue to be, volatile. We earn revenue from a limited number of engagements. Therefore, a small change in the number of engagements can result in large fluctuations in the revenue recognized. Further, even if the number of engagements remains consistent, the average revenue per engagement can fluctuate considerably. Finally, our revenue is generally earned when an underlying transaction closes (rather than on a monthly or quarterly basis). Therefore, the timing of underlying transactions increases the volatility of our revenue recognition.

Principal Transactions and Other Income

Principal transactions and other income decreased by $4,320, or 230%, to ($2,439) for the year ended December 31, 2012, as compared to $1,881 for the year ended December 31, 2011.  

 

 

 

 

 

Change in fair value of other investments, at fair value

Change in fair value of other investments, at fair value decreased by $7,788 to ($6,284) for the year ended December 31, 2012, as compared to $1,504 for the year ended December 31, 2011. 

 

 

 

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During the second quarter of 2011, we acquired 353,244 additional shares of EuroDekania at an amount less than the underlying NAV of EuroDekania. Accordingly, this investment resulted in a gain. Of the total gain recorded for the year ended December 31, 2011, $365 represented unrealized gains recognized on the newly purchased shares and $214 represented the change in the underlying NAV of EuroDekania. During the fourth quarter of 2012, we acquired 17,663 additional shares of EuroDekania at an amount less than the underlying NAV. For the year ended December 31, 2012, the decrease in the value of our investment in EuroDekania was comprised of $342 resulting from changes in the underlying NAV of EuroDekania, partially offset by the gain of $11 resulting from the purchase of shares at an amount below the underlying NAV.

Star Asia is an investment fund that is exposed to changes in its value due to the performance of its underlying investments. The value of our investment in Star Asia was impacted by the following items: (a) during 2011 and 2012, we acquired shares of Star Asia from unrelated third party investors at amounts less than the underlying NAV of Star Asia; (b) in 2011, certain of Star Asia’s investments were impacted by the earthquake, tsunami, and nuclear disaster in Japan that occurred during the first quarter; and (c) Star Asia’s investments are primarily denominated in Japanese Yen and Star Asia itself does not hedge against currency fluctuations. The following table shows the change in the value of our investment in Star Asia and how it was impacted by these items:

  

Purchase or receipt of shares for below NAV: During 2011, we purchased 226,074 shares directly from unrelated third parties for $351. All of these purchases were made at amounts below Star Asia’s NAV. During 2012, we purchased 53,863 shares directly from unrelated third parties for $85. All of these purchases were made at amounts below Star Asia’s NAV.

Foreign exchange: These amounts represent the impact to fair value of our investment in Star Asia from currency fluctuations. This is because Star Asia’s investments are primarily denominated in Japanese Yen and Star Asia itself does not hedge against currency fluctuations. During the period from January 1, 2011 through to October 31, 2011, and the period from April 30, 2012 through to November 5, 2012, we had hedged a portion of our investment in Star Asia and recorded the gains or losses as a component of principal transactions. However, as of December 31, 2012 and 2011, we were un-hedged. There was no Japanese Yen hedge in place during the first quarter of 2012. During that period, Star Asia experienced negative mark-to-market loss due to exchange rate movement. From April 30, 2012 to November 5, 2012, a hedge was in place. During that period, Star Asia experienced gains due to exchange rate movement (but less than the losses during the first quarter). Accordingly, for the year ended December 31, 2012, we experienced both a loss on the hedge and a mark-to-market loss on our investment in Star Asia due to exchange rate movements.

During the fourth quarter of 2011, we terminated all of our Japanese Yen hedges. As of December 31, 2011, our long exposure to the Japanese Yen was 3.9 billion Japanese Yen. The spot rate of U.S. Dollar to Japanese Yen was 77.44 as of December 31, 2011, and, as a result, our un-hedged portion of Star Asia was $50.7 million. During the fourth quarter of 2012, we terminated all of our Yen hedges. As of December 31, 2012, our long exposure to Japanese Yen was 4.2 billion Yen. The spot rate of U.S. Dollar to Japanese Yen was 86.75 as of December 31, 2012, which means our un-hedged portion of Star Asia was $49.0 million.

In conjunction with the sale of the Star Asia Group, we extinguished our existing yen hedge.  Going forward we should not have material exposure to the Japanese Yen. 

Earthquake, tsunami, nuclear disaster: During the year ended December 31, 2011, certain of Star Asia’s investments were adversely impacted by the earthquake, tsunami, and nuclear disaster in Japan that occurred during the first quarter of 2011.

Underlying investment values: This line item represents the impact to the fair value of our investment in Star Asia from changes in the underlying net investment values of Star Asia’s investments, net of debt, exclusive of the impact of foreign currency changes.

In June 2011, MFCA became a wholly owned subsidiary of Tiptree. We exchanged 1,000,200 shares of MFCA for 111,133 shares of Tiptree. See notes 3-F and 8 to our consolidated financial statements included in this Annual Report on Form 10-K. We carry our investment in Tiptree at the NAV of the underlying fund. We carried our investment in MFCA at the NAV of the underlying fund.

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In December 2012, we made an investment in the Star Asia Special Situations Fund. As of December 31, 2012, we carried our investment in the Star Asia Special Situations Fund at the NAV of the underlying fund.

As of June 30, 2011, Deep Value completed its liquidation. We carried our investment in Deep Value at the NAV of the underlying fund. The fund was substantially liquidated in the fourth quarter of 2010; the 2011 change in NAV was primarily attributable to wind down costs of the fund.

We carried our investment in the Duart Fund at the NAV of the underlying fund. Effective December 31, 2010, we submitted a redemption notice to the Duart Fund to redeem 100% of our capital and received our redemption in April 2011.

The change in other investments of $2,223 was comprised of (i) an overall net increase of $572 to changes in fair value of certain warrants and options we held as of December 31, 2012 and 2011; and (ii) a net increase of $21 to changes in fair value of other investments; partially offset by (iii) $2,816 related to certain investments in securitizations that were sold for a gain during the first quarter of 2011.

Gain on sale of cost method investment

During the third quarter of 2012, we recognized a gain of $1,687 related to the sale of an equity interest in a private company that we were accounting for under the cost method.

Loss on other assets

During the year ended December 31, 2011, we recognized a loss of $1,170 related to the impairment of certain miscellaneous assets.

Dividends, interest, and other

Dividends, interest, and other increased by $611 to $2,158 for the year ended December 31, 2012, as compared to $1,547 for the year ended December 31, 2011.  The change in dividend, interest and other income of $611 was primarily related to increases from (i) foreign currency gains of $579; (ii) our revenue share arrangement related to the SCM Buyer of $97 which was not in place until March 29, 2011; (iii) dividends and interest income received on our investments in other investments, at fair value of $626; and (iv) miscellaneous income of $136; partially offset by decreases in other income of (v) $501 from our revenue share arrangement related to Non-Profit Preferred Funding I securitization (“NPPF I”) that was primarily a result of defaults within the securitization, which resulted in a deferral of the subordinated management fee during 2012; and (vi) $326 recognized in 2011 related to the reversal of the contingent liability due to JVB based on the attainment of certain performance targets that were not attained during the performance period. See notes 4, 5 and 12 to our consolidated financial statements included in this Annual Report on Form 10-K.

Operating Expenses

Operating expenses decreased by $23,551, or 20%, to $94,945 for the year ended December 31, 2012 , as compared to $118,496 for the year ended December 31, 2011. As discussed in more detail below, the change was comprised of (i) a decrease of $15,276 in compensation and benefits; (ii) a decrease of $770 in business development, occupancy, and equipment; (iii) a decrease of $579 in subscriptions, clearing, and execution; (iv) a decrease of $5,993 of professional fees and other operating; and (v) a decrease of $933 of depreciation and amortization. 

Compensation and Benefits

Compensation and benefits decreased by $15,276, or 20%, to $62,951 for the year ended December 31, 2012 from $78,227 for the year ended December 31, 2011.  

 

 

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Cash compensation and benefits in the table above is primarily comprised of salary, incentive compensation and benefits. The decrease in cash compensation and benefits was the result of the decrease in incentive compensation, which is tied to revenue and operating profitability and reduced headcount. Our total headcount decreased from 237 at December 31, 2011 to 197 at December 31, 2012.

 

From time to time, we pay employees severance when they are terminated without cause. These severance payments are included in cash compensation in the table above.

On July 19, 2012, PrinceRidge, IFMI, and the Operating LLC entered into a Separation, Release and Repurchase Agreement with each of Michael T. Hutchins, the former CEO of PrinceRidge and member of the Board of Managers of PrinceRidge GP, and John P. Costas, the former Chairman of the Board of Managers of PrinceRidge GP, whereby (i) PrinceRidge repurchased all of the equity and profit units in PrinceRidge held by Messrs. Hutchins and Costas; (ii) Messrs. Hutchins and Costas resigned as employees of PrinceRidge and as members of the Board of Managers of PrinceRidge GP; (iii) Messrs. Hutchins and Costas agreed to forfeit all of their unvested equity awards both from PrinceRidge and IFMI; and (iv) Messrs. Hutchins and Costas withdrew as members of PrinceRidge GP and as partners of CCPRH. Daniel G. Cohen, our Vice Chairman (formerly our Chairman and CEO), was subsequently appointed as Chairman of the Board of Managers of PrinceRidge GP and CEO of PrinceRidge by the Board of Managers of PrinceRidge GP. PrinceRidge repurchased Mr. Costas’ and Mr. Hutchins’ equity and profit units for an aggregate of $8,234. PrinceRidge recorded compensation expense of $2,104 and a reduction of temporary equity of $6,130 related to the repurchase of these units. This compensation expense is broken out separately in the table above.

In the second quarter of 2011, we incurred an expense of $3,000 for cash compensation owed to the former CEO of our Capital Markets business segment and a current member of our Board of Directors, Christopher Ricciardi, as a result of an amendment to his employment agreement. This compensation expense is broken out separately in the table above.

Compensation and benefits includes equity based compensation that decreased by $6,403, or 83%, to $1,271 for the year ended December 31, 2012, as compared to $7,674 for the year ended December 31, 2011. There were three major components of this change:

 

 

First, in year ended December 31, 2012, we recognized a reduction in equity based compensation of $1,158 related to the forfeiture of equity based grants to Michael T. Hutchins and John P. Costas (the former chief executive officer and former chairman, respectively, of PrinceRidge) in July 2012. In 2011, we recognized expense of $1,158 related to these grants.

Second, we recognized $1,800 of expense attributable to an award of 360,000 restricted shares granted during the first half of 2011 to our former president and current member of our Board of Directors, Mr. Ricciardi, which was fully expensed during the first half of 2011 as a result of his amended employment agreement. In October 2011, Mr. Ricciardi forfeited the 360,000 shares of restricted stock in exchange for a cash payment of $745, which represented the cash equivalent value of the Common Stock in accordance with the defined terms of Mr. Ricciardi’s amended employment agreement.

Finally, we recognized a reduction in other equity compensation expense of $2,287 primarily as a result of employee grants becoming fully vested or forfeited after December 31, 2011, net of new grants after December 31, 2011. 

Business Development, Occupancy, and Equipment

Business development, occupancy, and equipment decreased by $770, or 12%, to $5,795 for the year ended December 31, 2012, as compared to $6,565 for the year ended December 31, 2011.  The decrease was primarily due to decreases in business development expenses, such as promotion, advertising, travel and entertainment, of $228 and in rent expense of $626; partially offset by an increase in other expenses associated with occupancy and equipment of $84. Included in the rent for the year ended December 31, 2011 was $459 of costs incurred by us for the termination or subletting of office leases during the third quarter of 2011 as part of our cost saving measures following the acquisition of PrinceRidge. The decreases for the year ended December 31, 2012, as compared to the year

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ended December 31, 2011, are primarily due to our cost saving measures instituted following the acquisition of PrinceRidge in May 2011.

Subscriptions, Clearing, and Execution

Subscriptions, clearing, and execution decreased by $579, or 5%, to $11,446 for the year ended December 31, 2012, as compared to $12,025 for the year ended December 31, 2011.  The decrease included a decrease of $222 in subscriptions primarily a result of a reduction in our employee headcount as well as cost saving measures implemented and a decrease in clearing and execution costs of $357.

Professional Fees and Other Operating Expenses

Professional fees and other operating expenses decreased by $5,993, or 31%, to $13,448 for the year ended December 31, 2012 from $19,441 for the year ended December 31, 2011.  The decrease included a reduction in legal and professional fees of $4,462, which was primarily the result of legal expenses incurred in 2011 related to the acquisitions of JVB and PrinceRidge, and a reduction of $2,250 related to expense recorded in the fourth quarter of 2011 as a result of our contribution to a legal settlement involving Alesco X, a CDO previously managed by us, which resulted from a judgment against the CDO obtained by a third party; a decrease in other costs of $1,349; partially offset by an increase in consulting fees of $2,068. The increase in consulting fees was primarily due to the employment of certain consultants at CCFL. Prior to August 2012, CCFL was the junior manager of a CLO in Europe. In August 2012, CCFL became lead manager and remained junior manager. Subsequent to becoming the lead manager, we earn all of the management fees related to this CLO. These consulting fees are being incurred to assist CCFL in performing its lead manager services.

Depreciation and Amortization

Depreciation and amortization decreased by $933, or 42%, to $1,305 for the year ended December 31, 2012, as compared to $2,238 for the year ended December 31, 2011. The decline was primarily due to a decrease in depreciation expense related to certain property and equipment that was fully depreciated prior to January 1, 2012.

Non-Operating Income and Expense

Interest Expense, net

Interest expense decreased by $2,244, or 38%, to $3,732 for the year ended December 31, 2012, as compared to $5,976 for the year ended December 31, 2011.  This decrease was comprised of (a) a decrease of $570 of interest incurred on our bank debt, which we paid off and terminated during the fourth quarter of 2011; (b) a decrease of $582 of interest incurred on convertible senior notes (comprised of our Old Notes and our 10.50% Contingent Convertible Senior Notes Due 2027 (the “New Notes”) due to repurchases of Old Notes in November 2011 and March 2012, and redemptions of Old Notes in May 2012 and July 2012; (c) a decrease of $637 of interest incurred on our junior subordinated notes as a result of the interest rate on one of the two issuances changing from a fixed rate to a lower variable rate during the year; (d) a decrease of $38 of interest incurred on subordinated notes payable; partially offset by (e) an increase of $577 of interest income primarily related to the reduction of the amount owed to withdrawing partners of PrinceRidge in conjunction with the repurchase of mandatorily redeemable equity interests at a discount (see notes 17 and 18 to our consolidated financial statements included in this Annual Report on Form 10-K), which is recorded as interest income; (f) an increase of $109 related to the amortization of discount attributable to a settlement payable related to a legal settlement; and (g) an increase of $51 related to the interest on the promissory notes issued in connection with the repurchase of mandatorily redeemable equity interests that we paid in full in December 2012. See notes 17 and 18 to our consolidated financial statements included in this Form 10-K. During the year ended December 31, 2011, we also wrote off $134 of unamortized deferred financing costs to interest expense related to the termination of our bank debt in 2011.

Other Income (Expense), net

Other income (expense), net was ($4,271) for the year ended December 31, 2012 as compared to $33 for the year ended December 31, 2011.        For 2012, other income (expense), net represented expense of $4,357 related to the settlement of the Sentinel Litigation partially offset by a gain on repurchase of debt of $86.  For 2011, the other income (expense), net represented a gain on the repurchase of debt.  For additional information, see notes 13 and 17 to our consolidated financial statements included in this Annual Report on Form 10-K.

Income / (Loss) from Equity Method Affiliates

Income from equity method affiliates decreased  by $1,180, or 19% to $5,052 for the year ended December 31, 2012, as compared to $6,232 for the year ended December 31, 2011. Income or loss from equity method affiliates represents our share of the related entities’ earnings.

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See notes 4, 15, and 29 to our consolidated financial statements included in this Annual Report on Form 10-K.

 

Income Tax Expense / (Benefit)

The income tax expense / (benefit) was ($615) for the year ended December 31, 2012 as compared to income tax expense / (benefit) of ($1,149) for the year ended December 31, 2011.    The tax benefit realized by us in 2012 was primarily the result of a deferred tax benefit which resulted from changes in the reversal pattern of our deferred tax liabilities as well as changes in our state and local tax rate as a result of changes in the jurisdictions in which we operate.  The tax expense realized by us in 2011 was primarily the result of deferred tax benefit which resulted from changes in the reversal pattern of our deferred tax liabilities, changes in our state and local tax rate as a result of changes in the jurisdictions in which we operate, as well as changes in the expiration date of our carry forward assets.  See note 21 to our consolidated financial statements included in this Annual Report on Form 10-K.  

Net Income / (Loss) Attributable to the Non-controlling Interest

Net income / (loss) attributable to the non-controlling interest for the years ended December 31, 2012 and 2011 was comprised of the non-controlling interest related to member interests in the Operating LLC other than interests held by us for the relevant periods. In addition, net income / (loss) attributable to the non-controlling interest also included non-controlling interest related to entities that were consolidated but not wholly owned by the Operating LLC.  

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(1)Non-controlling interest is recorded on a monthly basis. Because earnings are recognized unevenly throughout the year and the non-controlling interest percentage may change during the period, the average effective non-controlling interest percentage may not equal the percentage at the end of any period or the simple average of the beginning and ending percentages.

 

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Liquidity and Capital Resources

Liquidity is a measurement of our ability to meet potential cash requirements including ongoing commitments to repay debt borrowings, make interest payments on outstanding borrowings, fund investments, and support other general business purposes. In addition, our United States and United Kingdom broker-dealer subsidiaries are subject to certain regulatory requirements to maintain minimum levels of net capital. Historically, our primary sources of funds have been our operating activities and general corporate borrowings. In addition, our trading operations have generally been financed by use of collateralized securities financing arrangements as well as margin loans.

Certain subsidiaries of the Operating LLC have restrictions on the withdrawal of capital and otherwise in making distributions and loans.  Currently, JVB is subject to net capital restrictions imposed by the SEC and FINRA that require certain minimum levels of net capital to remain in these subsidiaries. In addition, these restrictions could potentially impose notice requirements or limit our ability to withdraw capital above the required minimum amounts (excess capital) whether through a distribution or a loan. The recent merger of CCPR and JVB should result in a more efficient use of capital.  Although we will still be subject to these capital restrictions, it eases the burden somewhat by having one combined capital calculation as opposed to two separate ones in the case of JVB and CCPR.  CCFL is regulated by the Financial Conduct Authority (formerly known as the Financial Conduct Authority) in the United Kingdom (“FCA”) and must maintain certain minimum levels of capital. See note 23 to our consolidated financial statements included in this Annual Report on Form 10-K.  

See Liquidity and Capital Resources – Debt Financing and Liquidity and Capital Resources – Contractual Obligations below.

During the third quarter of 2010, our Board of Directors initiated a dividend of $0.05 per quarter, which was paid regularly through December 31, 2011. Beginning in 2012, our Board of Directors declared a dividend of $0.02 per quarter, which was paid regularly through the fourth quarter of 2013. Our Board of Directors has the power to decide to increase, reduce, or eliminate dividends in the future and such decision will depend on a variety of factors, including business, financial, and regulatory considerations as well as any limitations under Maryland law or imposed by any agreements governing our indebtedness. There can be no assurances that such dividends will be maintained or increased and, if maintained or increased, will not subsequently be discontinued.

Each time a cash dividend was declared by our Board of Directors, a pro rata distribution was made to the other members of the Operating LLC upon the payment of dividends to our stockholders.

On March 4, 2014, our Board of Directors declared a cash dividend of $0.02 per share, which will be paid on our Common Stock on April 1, 2014to stockholders of record on March 18, 2014. A pro rata distribution will be made to the other members of the Operating LLC upon the payment of the dividends to our stockholders. 

We filed a Registration Statement on Form S-3 on February 14, 2014, which has not yet been declared effective by the SEC. If and when declared effective, the registration statement will enable us to offer and sell, in the aggregate, up to $300,000 of debt securities, preferred stock (either separately or represented by depositary shares), or Common Stock (including, if applicable, any associated preferred stock purchase rights, subscription rights, stock purchase units and warrants, as well as units that include any of these securities). Further, if and when the registration statement is declared effective, certain of the securities issuable thereunder may be convertible into or exercisable or exchangeable for Common Stock or preferred stock of IFMI, and we will be able to offer and sell any of the securities issuable thereunder separately or together, in any combination with other securities. If and when declared effective, the registration statement will provide another source of liquidity in addition to the alternatives already in place. Further, any net proceeds from a sale of our securities under the registration statement could be used for our operations and for other general corporate purposes, including, but not limited to, capital expenditures, repayment or refinancing of borrowings, working capital, investments and acquisitions. If and when the registration statement is declared effective, it would expire on the third anniversary of the effective date.

 

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Cash Flows

We have four primary uses for capital:

(1) To fund the operations of our Capital Markets business segment: Our Capital Markets business segment utilizes capital (i) to fund securities inventory to facilitate client trading activities; (ii) for risk trading on the firm’s own account; (iii) to fund our collateralized securities lending activities; (iv) for temporary capital needs associated with underwriting activities; (v) to fund business expansion into existing or new product lines; and (vi) to fund any operating losses incurred.

(2) To fund investments: Our investments take several forms, including investments in securities and “sponsor investments” in permanent capital vehicles or investment funds. We may need to raise additional debt or equity financing in order to ensure we have the capital necessary to take advantage of attractive investment opportunities. In February, 2014, the Company sold its interest in Star Asia and Star Asia Special Situations Fund (See Sale of Star Asia and Other Related Entities above).  On a going forward basis, the Company’s principal investing activities may include more investments in entities it does not manage. 

(3) To fund mergers or acquisitions: We may opportunistically use capital to acquire other asset managers, individual asset management contracts, or financial services firms. To the extent our liquidity sources are insufficient to fund our future activities, we may need to raise additional funding through an equity or debt offering. No assurances can be given that additional financing will be available in the future, or that if available, such financing will be on favorable terms.

(4) To fund potential dividends and distributions: During the third quarter of 2010 and for each subsequent quarter through December 31, 2013, we have declared a dividend. A pro rata distribution has been paid to the other members of the Operating LLC upon the payment of any dividends to stockholders of IFMI.

If we are unable to raise sufficient capital on economically favorable terms, we may need to reduce the amount of capital invested for the uses described above, which may adversely impact earnings and our ability to pay dividends.

As of December 31, 2013 and December 31, 2012, we maintained cash and cash equivalents of $13,161 and $14,500, respectively. We generated cash from or used cash for the following activities:

 

 

 See the statement of cash flows in our consolidated financial statements. We believe our available cash and cash equivalents, as well as our investment in our trading portfolio and related borrowing capacity will provide sufficient liquidity to meet the cash needs of our ongoing operations in the near term. In February, 2014, we received $20,043 from the sale of the Star Asia Group.  We expect to make principal investments using these proceeds and potentially other available funds in investments that are not managed or sponsored by us. 

2013 Cash Flows

As of December 31, 2013, our cash and cash equivalents were $13,161, representing a decrease of $1,339 from December 31, 2012. The decrease was attributable to the cash used by operating activities of $8,231, the cash provided by investing activities of $2,941, the cash provided by financing activities of $4,032, and the decrease in cash caused by a  change in exchange rates of $81.  

The cash used by operating activities of $8,231 was comprised of (a) net cash outflows of $10,078 related to working capital fluctuations (b) net cash inflows of  $7,967 from trading activities comprised of our investments-trading, trading securities sold, not yet purchased, securities sold under agreement to repurchase, and receivables and payables from brokers, dealers and clearing agencies, as well as the changes in unrealized gains and losses on the investments-trading and trading securities sold, but not yet purchased; and (c)  net cash outflows from other earnings items of $6,120 (which represents net income or loss adjusted for the following non-cash operating items: other income / (expense), realized and unrealized gains and losses on other investments, income or loss from equity method affiliates, equity based compensation, depreciation, and amortization).

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The cash provided by investing activities of $2,941 was comprised of (a) $679 of cash acquired due to the acquisition of Star Asia Manager; (b) $2,082 of proceeds from sales and returns of principal from other investments, at fair value; (c) $3,094 in distributions received from equity method affiliates (see note 15 to our consolidated financial statements in this Annual Report on Form 10-K); net of (d) $2,035 of cash used to acquire other investments, at fair value which was comprised of $302 of additional investment in the Star Asia Special Situations Fund, $762 invested in a yen currency hedge, and $971 used to purchase shares of EuroDekania; (e) $30 of investment in equity method affiliates; and (f) $849 used to purchase furniture, equipment and leasehold improvements.    

The cash provided in financing activities of $4,032 was comprised of (a) $8,248 in proceeds for the issuance of convertible debt (see notes 4 and 17 to our consolidated financial statements included in this Annual Report on Form 10-K); (b) $5,051 in net proceeds from the private placement of equity (see note 4 to our consolidated financial statements included in this Annual Report on Form 10-K); net of (c) $6,072 for the repurchase and repayment of debt which includes $5,000 of repurchases of New Notes, $725 related to the Star Asia Manager note payable and $347 related to our subordinated notes payable; (d) $670 in payment of deferred financing costs in connection with the new convertible debt issued; (e) $153 used for the payment of employee tax obligations related to restricted stock vesting; (f) $789 of net redemptions for the redeemable non-controlling interests related to PrinceRidge; (g) $86 of repayments of mandatorily redeemable equity interests related to PrinceRidge; (h) $431 of distributions to non-controlling interests related to the Operating LLC; and (i) $1,066 in dividends to stockholders of IFMI. 

2012 Cash Flows

As of December 31, 2012, our cash and cash equivalents were $14,500, representing a net decrease of $3,721 as compared to December 31, 2011. The decrease was attributable to the cash provided by operating activities of $14,748, the cash provided by investing activities of $9,110, the cash used for financing activities of $27,717, and the effect of the increase of the exchange rate on cash of $138.

The cash provided by operating activities of $14,748 was comprised of (a) net cash outflows of $3,794 related to working capital fluctuations primarily comprised of net outflows of $497 related to a decrease in accrued compensation and net outflows of $392 related to the decrease in accounts payable and other liabilities and a net decrease of $2,905 in other working capital fluctuations; (b) $18,548 of net cash inflows from trading activities comprised of our investments-trading, trading securities sold, not yet purchased, securities sold under agreement to repurchase, and receivables and payables from brokers, dealers and clearing agencies, as well as the changes in unrealized gains and losses on the investments-trading and trading securities sold, but not yet purchased; and (c) a net cash outflow from other earnings items of $183 (which represents net income or loss adjusted for the following non-cash operating items: other income/(expense), realized and unrealized gains and losses on other investments, income or loss from equity method affiliates, equity based compensation, depreciation, and amortization).

As is described below in the financing section, we paid a total of $14,699 to acquire ownership interests in PrinceRidge that we did not previously own. As a result, our ownership of PrinceRidge increased from 70% to 98%. We financed these payments primarily by reducing the amount of capital we had invested in our trading items. This was the main reason for the $18,548 of net inflows from trading activities described in the previous paragraph.

The cash provided by investing activities of $9,110 was comprised of (a) cash received of $12,093 from our equity method affiliates (see note 15 to our consolidated financial statements included in this Annual Report on Form 10-K); (b) cash proceeds of $379 from the return of principal and sale of other investments, at fair value; (c) cash proceeds from the sale of a cost method investment of $1,937; partially offset by (d) the purchase of additional furniture and leasehold improvements of $193; (e) the investment in equity method affiliates of $4,716 (see note 15 to our consolidated financial statements included in this Annual Report on Form 10-K); and (f) the purchase of other investments, at fair value of $390.

 

The cash used in financing activities of $27,717 was comprised of (a) the repurchase of $150 notional amount of Old Notes for $147; (b) the redemption of $10,210 notional amount of Old Notes for $10,210; (c) the purchase of $1,177 principal amount of subordinated notes payable for $1,089; (d) the payment in full of the promissory notes issued in connection with the repurchase of mandatorily redeemable equity interests for $4,824 (see note 17 to our consolidated financial statements included in this Annual Report on Form 10-K); (e) repayments of PrinceRidge mandatorily redeemable equity interests of $3,723; (f) IFMI non-controlling interest distributions of $420; (g) IFMI dividends to our stockholders of $953; (h) the net redemption of the redeemable non-controlling interest of $6,152 to withdrawing partners from PrinceRidge (see note 18 to our consolidated financial statements included in this Annual Report on Form 10-K); and (i) the payment of $199 for employees’ tax obligations to taxing authorities related to the vesting of equity-based awards.

2011 Cash Flows

As of December 31, 2011, our cash and cash equivalents were $18,221, representing a net decrease of $25,725 as compared to December 31, 2010. The decrease was attributable to the cash used by operating activities of $6,299, the cash used for investing

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activities of $6,704, and the cash used for financing activities of $12,796, partially offset by the effect of the increase of the exchange rate on cash of $74.

The cash used by operating activities of $6,299 was comprised of (a) net cash outflows of $8,150 related to working capital fluctuations primarily comprised of net outflows of $10,942 related to a decrease in accrued compensation payable offset by other working capital fluctuations; (b) $17,180 of net cash inflows from trading activities comprised of our investments-trading, trading securities sold, not yet purchased, securities sold under agreement to repurchase, and receivables and payables from brokers, dealers and clearing agencies as well as the unrealized gains and losses on the investments-trading and trading securities sold, but not yet purchased; and (c) a decrease in cash generated from other earnings items of $14,900 (which represented net income or loss adjusted for the following non-cash operating items: other income/(expense), realized and unrealized gains and losses on other investments, income or loss from equity method affiliates, equity based compensation, depreciation, and amortization).

The cash used in investing activities of $6,704 was comprised of (a) the cash consideration paid, net of cash acquired, for the acquisition of JVB of $14,956; (b) the investment of $5,021 in equity method affiliates (see note 15 to our consolidated financial statements included in this Annual Report on Form 10-K); (c) the purchase of other investments, at fair value of $3,068, specifically the purchase of additional shares of Star Asia in the amount of $351 directly from unrelated third parties during 2011, the purchase of additional shares of EuroDekania in the amount of $533, and the purchase of other investments, which consisted primarily of a Japanese Yen currency forward contract, of $2,184; and (d) the purchase of additional furniture and leasehold improvements of $470 related to the New York and Philadelphia offices and the CCFL office in the United Kingdom; partially offset by (e) cash proceeds from the return of principal of $3,898, which was comprised of $3,821 from our investment in the Duart Fund, $19 from the final liquidation of the first Deep Value fund, and $58 from our investments in certain residential loans; (f) cash received from the sale of other investments of $3,810 comprised of $2,816 from the sale of certain investments in securitizations and $994 from the termination of the Japanese Yen currency forward contracts that were classified as other investments, at fair value on the consolidated balance sheets; (g) cash received of $6,954 from equity method affiliates (see note 15 to our consolidated financial statements included in this Annual Report on Form 10-K); and (h) the cash acquired in the acquisition of PrinceRidge of $2,149.

The cash used in financing activities of $12,796 was comprised of (a) the repayment of $6,976 of outstanding borrowings on our secured credit facility entered into on July 29, 2010 between our subsidiary, Dekania Investors, LLC, and T.D. Bank, N.A, which we subsequently terminated in December 2011; (b) the repurchase of $1,025 notional amount of Old Notes for $984; (c) distributions to the IFMI non-controlling interest holders of $1,054; (d) IFMI dividends to our stockholders of $2,115; (e) the payment of $107 for the redemption of the membership units of the Operating LLC by one of the non-controlling interest holders; (f) the acquisition of Common Stock for treasury of $1,488; and (g) the payment of $72 for employees’ tax obligations to taxing authorities related to the vesting of equity-based awards. In the case of (g), the total shares withheld were determined based on the value of the restricted stock award on the applicable vesting date based on the closing price of our Common Stock. These net share settlements reduced and retired the number of shares that would have otherwise been issued as a result of the vesting and did not represent an expense to us.

 

Regulatory Capital Requirements

As of December 31, 2013, three of our subsidiaries are licensed securities dealers in the United States or the United Kingdom. As broker-dealers, our subsidiaries, JVB and CCPR, are subject to the Uniform Net Capital Rule in Rule 15c3-1 under the Exchange Act, and our London-based subsidiary, CCFL, is subject to the regulatory supervision and requirements of the FCA. The amount of net assets that these subsidiaries may distribute is subject to restrictions under these applicable net capital rules. These subsidiaries have historically operated in excess of minimum net capital requirements. Our minimum capital requirements at December 31, 2013 were as follows:

 

 

 

We operate with more than the minimum regulatory capital requirement in our licensed broker-dealers and at December 31, 2013, total net capital, or the equivalent as defined by the relevant statutory regulations, in our licensed broker-dealers totaled $28,629. See note 23 to our consolidated financial statements included in this Annual Report on Form 10-K.  

In addition, our licensed broker-dealers are generally subject to capital withdrawal notification and restrictions. As previously noted, we merged CCPR and JVB effective January 31, 2014. 

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Securities Financing

We maintain repurchase agreements with various third party financial institutions. There is no maximum limit as to the amount of securities that may be transferred pursuant to these agreements, and transactions are approved on a case-by-case basis. The repurchase agreements do not include substantive provisions other than those covenants and other customary provisions contained in standard master repurchase agreements. The repurchase agreements generally require us to transfer additional securities to the counterparty in the event the value of the securities then held by the counterparty in the margin account falls below specified levels and contain events of default in cases where we breach our obligations under the agreement. We receive margin calls from our repurchase agreement counterparties from time to time in the ordinary course of business. To date, we have maintained sufficient liquidity to meet margin calls, and we have never been unable to satisfy a margin call, however, no assurance can be given that we will be able to satisfy requests from our counterparties to post additional collateral in the future. See note 11 to our consolidated financial statements included in this Annual Report on Form 10-K.  

If there were an event of default under a repurchase agreement, our counterparty would have the option to terminate all repurchase transactions existing with us and make any amount due from us to the counterparty payable immediately. Repurchase obligations are full recourse obligations to us. If we were to default under a repurchase obligation, the counterparty would have recourse to our other assets if the collateral was not sufficient to satisfy our obligations in full.

Our clearing brokers provide securities financing arrangements including margin arrangements and securities borrowing and lending arrangements. These arrangements generally require us to transfer additional securities or cash to the clearing broker in the event the value of the securities then held by the clearing broker in the margin account falls below specified levels and contain events of default in cases where we breach our obligations under such agreements.

An event of default under the clearing agreement would give our counterparty the option to terminate our clearing arrangement. Any amounts owed to the clearing broker would be immediately due and payable. These obligations are recourse to us. Furthermore, a termination of our clearing arrangements would result in a significant disruption to our business and would have a significant negative impact on our dealings and relationship with our customers.

The following table presents our period end balance, average monthly balance, and maximum balance at any month end for receivables under resale agreements and securities sold under agreements to repurchase.

 

 

Fluctuations in the balance of our repurchase agreements from period to period and intraperiod are dependent on business activity in those periods. The fluctuations in the balances of our receivables under resale agreements over the periods presented were impacted by our clients’ desires to execute collateralized financing arrangements through the repurchase market or other financing products.

Average balances and period end balances will fluctuate based on market and liquidity conditions and we consider such intraperiod fluctuations as typical for the repurchase market. Month-end balances may be higher or lower than average period balances.

Debt Financing

As of December 31, 2013, we had the following sources of debt financing other than securities financing arrangements: (1) contingent convertible senior notes, comprised of the New Notes and the 8.0% Convertible Notes; (2) junior subordinated notes payable to the following two special purpose trusts: (a) Alesco Capital Trust I and (b) Sunset Financial Statutory Trust I.  

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See note 17 to our consolidated financial statements included in this Annual Report on Form 10-K for a discussion of our outstanding debt.

The following table summarizes our long-term indebtedness and other financing outstanding:

 

 

 

(1)Represents the holder’s earliest put date and our earliest redemption date. The contractual maturity for the New Notes is May 2027.

We may redeem all or part of the $3,121 aggregate principal amount of the New Notes for cash on or after May 20, 2014, at a redemption price equal to the principal amount of the New Notes, plus accrued and unpaid interest and additional interest, if any, to, but excluding, the repurchase date. The holders of the New Notes may require us to repurchase all or a portion of the New Notes for cash on May 15, 2014; May 15, 2017; and May 15, 2022 for a repurchase price equal to the principal amount of the New Notes, plus accrued and unpaid interest and additional interest, if any, to, but excluding, the repurchase date. The holders of the New Notes are required to provide notice to us of their plan to redeem the New Notes at any time during the 30 days prior to May 15, 2014; May 15, 2017; and May 15, 2022.

(3)The outstanding par represents the total par amount of the junior subordinated notes held by two separate variable interest entity (“VIE”) trusts. We do not consolidate these trusts. We hold $1,489 par value of these junior subordinated notes, comprised of $870 par value of junior subordinated notes related to Alesco Capital Trust I and $619 par value of junior subordinated notes related to Sunset Financial Statutory Trust I. These notes have a carrying value of $0. Therefore, the net par value held by third parties is $48,125.

(4)Comprised of 9% paid currently and 3% paid in kind. The subordinated note payable was fully repaid in June 2013. 

(5)Represents the interest rate as of the last day of the reporting period. 

 

As previously disclosed, on October 28, 2013, we repurchased $5,000 aggregate principal amount of New Notes from an unrelated third party for $5,238, including accrued interest of $238.  Holders of New Notes have the right to require us to repurchase those notes on May 15, 2014.  As a result, the outstanding principal amount of New Notes has been reduced from $8,121 to $3,121. 

Off-Balance Sheet Arrangements

There were no material off balance sheet arrangements as of December 31, 2013. 

Contractual Obligations

The table below summarizes our significant contractual obligations as of December 31, 2013 and the future periods in which such obligations are expected to be settled in cash. Our junior subordinated notes are assumed to be repaid on their respective maturity

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dates. The New Notes are assumed to be repaid on May 15, 2014, which represents the earliest date that the holders of the New Notes may require us to repurchase such notes for cash. Also, we have assumed that the 8.0% Convertible Notes are not converted prior to maturity.  Excluded from the table are obligations that are short-term in nature, including trading liabilities and repurchase agreements.

 

 

 

(1)Assumes the New Notes are repurchased on May 15, 2014. Interest includes amounts payable during the period the New Notes are outstanding at an annual rate of 10.50%.

(2)Assumes the 8.0% Convertible Notes are not converted prior to maturity. 

(3)The interest on the junior subordinated notes related to Alesco Capital Trust I is variable. The interest rate of 4.2461% (based on a 90-day LIBOR rate as of December 31, 2013 plus 4.00%) was used to compute the contractual interest payment in each period noted. The interest on the junior subordinated notes related to Sunset Financial Statutory Trust I is variable. The interest rate of 4.39161% (based on a 90-day LIBOR rate as of December 31, 2013 plus 4.15%) was used to compute the contractual interest payment in each period noted.

We believe that we will be able to continue to fund our current operations and meet our contractual obligations through a combination of existing cash resources and other sources of credit. Due to the uncertainties that exist in the economy, we cannot be certain that we will be able to replace existing financing or find sources of additional financing in the future.

Critical Accounting Policies and Estimates

Our accounting policies are essential to understanding and interpreting the financial results in our consolidated financial statements. Our industry is subject to a number of highly complex accounting rules and requirements many of which place heavy burdens on management to make judgments relating to our business. We encourage readers of this Form 10-K to read all of our critical accounting policies, which are included in note 3 to our consolidated financial statements included herein for a full understanding of these issues and how the financial statements are impacted by these judgments. Certain of these policies are considered to be particularly important to the presentation of our financial results because they require us to make assumptions and estimates about future events, and apply judgments that affect the reported amounts of assets, liabilities, revenues, expenses and the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that management believes to be relevant at the time our consolidated financial statements are prepared. On a regular basis, management reviews the accounting policies, assumptions, estimates and judgments to ensure that our financial statements are presented fairly and in accordance with U.S. GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.

 We consider the accounting policies discussed below to be the policies that are the most impactful to our financial statements and also subject to significant management judgment.

Valuation of Financial Instruments

How fair value determinations impact our financial statements

All of the securities we own that are classified as investments-trading, securities sold, not yet purchased, or other investments, at fair value are recorded at fair value with changes in fair value (both unrealized and realized) recorded in earnings.

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Unrealized and realized gains and losses on securities classified as investments-trading are recorded in net trading in the consolidated statement of operations. Unrealized and realized gains and losses on securities classified as other investments, at fair value, in the consolidated balance sheets are recorded as a component of principal transactions and other income in the consolidated statements of operations.

If the investment is expected to be managed by employees of our Capital Markets business segment, the investment is classified as investments-trading. Otherwise, the investment is classified as other investments, at fair value. In general, investments-trading represent securities acquired in the secondary market while other investments, at fair value represent investments obtained in primary issuances or as investments in investment vehicles managed by us.

In addition, we may hold, from time to time, trading securities sold, not yet purchased which represent our obligations to deliver the specified security at the contracted price, thereby creating a liability to purchase the security in the market at prevailing prices. Unrealized and realized gains and losses on trading securities sold, not yet purchased are recorded in net trading in the consolidated statements of operations.

How we determine fair value for securities

We account for our investment securities at fair value under various accounting literature, including Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 320, Investments — Debt and Equity Securities (“FASB ASC 320”), pertaining to investments in debt and equity securities and the fair value option of financial instruments in FASB ASC 825, Financial Instruments (“FASB ASC 825”). We also account for certain assets at fair value under the applicable industry guidance, namely FASB ASC 946, Financial Services-Investment Companies (“FASB ASC 946”).

The determination of fair value is based on quoted market prices of an active exchange, independent broker market quotations, market price quotations from third party pricing services, or, when independent broker quotations or market price quotations from third party pricing services are unavailable, valuation models prepared by our management. These models include estimates and the valuations derived from them could differ materially from amounts realizable in an open market exchange.

Fair Value Hierarchy — We adopted the fair value measurement provisions in FASB ASC 820, Fair Value Measurements and Disclosures (“FASB ASC 820”) applicable to financial assets and financial liabilities effective January 1, 2008 (except for certain provisions related to nonfinancial assets and nonfinancial liabilities for which we adopted effective January 1, 2009). FASB ASC 820 defines fair value as the price that would be received to sell the asset or paid to transfer the liability between market participants at the measurement date (“exit price”). An exit price valuation will include margins for risk even if they are not observable. In accordance with FASB ASC 820, we categorize our financial instruments, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the hierarchy under FASB ASC 820 are described below:

 

 

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

Financial instruments carried at contract amounts and have short-term maturities (one year or less) are repriced frequently or bear market interest rates. Accordingly, those contracts are carried at amounts approximating fair value. Financial instruments carried at contract amounts on our consolidated balance sheets include receivables from and payables to brokers, securities purchased under agreements to resell (“reverse repurchase agreements” or “receivables under resale agreements”) and sales of securities under agreements to repurchase (“repurchase agreements”).

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How we determine fair value for investments in investment funds and similar vehicles

Substantially all of our other investments, at fair value represent investments in investment funds and other non-publicly traded entities. Substantially all of these entities have the attributes of investment companies as described in FASB ASC 946-15-2. We estimate the fair value of these entities using the reported net asset value per share as of the reporting date in accordance with the “practical expedient” provisions related to investments in certain entities that calculated net asset value per share (or its equivalent) included in FASB ASC 820 for all entities except Star Asia. We generally classify these estimates within either level 2 of the valuation hierarchy if our investment in the entity is currently redeemable or level 3, if our investment is not currently redeemable.

In the case of Star Asia, prior to December 31, 2013, we utilized a valuation model to determine fair value, which used a market approach and the fair value was generally classified within level 3 of the valuation hierarchy. Star Asia accounts for itself as an investment company as described in ASC 946, Financial Services — Investment Companies. As an investment company, Star Asia carries its assets at fair value and reports NAV per share to its investors. However, Star Asia issued subordinated debt securities in 2009 at a significant discount to par. Upon issuance, Star Asia did not elect the fair value option for these liabilities and was not required to do so under ASC 946. Over time, it is our assessment that the fair value of the subordinated debt securities has diverged from its carrying value. Because Star Asia’s published NAV is calculated using the amortized cost of these subordinated debt securities, we have concluded it would be appropriate to adjust Star Asia’s reported NAV to recalculate it as if Star Asia’s subordinated debt were recorded at fair value as opposed to its historical amortized cost. We estimate the fair value of Star Asia’s subordinated debt securities by projecting the remaining debt cash outflows and discounting them at an estimated market rate as of the reporting date, which is derived from similar non-investment grade long term subordinated debt issuances.

As is described in more detail in note 31 to our consolidated financial statements included in this Annual Report on Form 10-K, the Company sold its investment in Star Asia in February 2014 along with its investment in Star Asia Special Situations Fund and other related entities.  Therefore, the Company determined the fair value of its investment in Star Asia by utilizing a valuation model that took into account the terms and conditions of the sale in February 2014, as opposed to the valuation model described in the immediately preceding two paragraphs (which was used historically by the Company).

Derivative Financial Instruments

We do not utilize hedge accounting for our derivatives. Accordingly, all derivatives are carried at fair value with unrealized and realized gains recognized in earnings.

If the derivative is expected to be managed by employees of our Capital Markets business segment, or is a hedge for an investment classified as investments-trading, the derivative will be carried as a component of investments-trading if an asset or securities sold, not yet purchased if a liability. If the derivative is a hedge for an investment carried as a component of other investments, at fair value, the derivative will be recorded in other investments, at fair value. We may, from time to time, enter into derivatives to manage our risk exposures (i) arising from fluctuations in foreign currency rates with respect to our investments in foreign currency denominated investments; (ii) arising from our investments in floating rate investments; and (iii) arising from our facilitation of mortgage-backed trading. Derivatives entered into by us, from time to time, may include (i) foreign currency forward contracts; (ii) EuroDollar futures; and (iii) purchase and sale agreements of TBAs. TBAs are forward mortgage-backed securities whose collateral remain “to be announced” until just prior to the trade settlement. TBAs are accounted for as derivatives under FASB ASC 815 when either of the following conditions exists: (i) when settlement of the TBA trade is not expected to occur at the next regular settlement date (which is typically the next month), or (ii) a mechanism exists to settle the contract on a net basis. Otherwise, TBAs are recorded as a standard security trade. The settlement of these transactions is not expected to have a material effect on our consolidated financial statements.

We determine the fair value of our derivatives the same way we do for all securities utilizing the methods described above.

Derivatives involve varying degrees of off-balance sheet risk, whereby changes in the level or volatility of interest rates or market values of the underlying financial instruments may result in changes in the value of a particular financial instrument in excess of its carrying amount. Depending on our investment strategy, realized and unrealized gains and losses are recognized in principal transactions and other income or in net trading in our consolidated statements of operations on a trade date basis.

Accounting for Income Taxes

We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

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We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. In making such a determination, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations. In the event we were to determine that we would be able to realize our deferred income tax assets in the future in excess of their net recorded amount, we would make an adjustment to the valuation allowance which would reduce the provision for income taxes.

Our policy is to record penalties and interest as a component of provision for income taxes in our consolidated statements of operations.

 

Our majority owned subsidiary, the Operating LLC, is treated as a pass through entity for U.S. federal income tax purposes and in most of the states in which we do business. The Operating LLC is subject to entity level taxes in certain state and foreign jurisdictions. However, as a result of the Merger, we acquired significant deferred tax assets and liabilities and now have significant tax attributes. Effective as of January 1, 2010, we began to be treated as a C corporation for U.S. federal and state income tax purposes. With the Merger we inherited significant deferred tax assets.

As is shown in note 21 to the consolidated financial statements contained herein, we currently have significant unrecognized deferred tax assets. These assets are unrecognized because we have recorded valuation allowances as we have determined that it is not more likely than not that we will realize the benefits of these tax assets. However, this determination is ongoing and subject to change. If we were to change this determination in the future, a significant tax benefit would be recognized as a component of earnings.

Revenue Recognition

Net trading: Net trading includes: (i) all gains, losses and income (interest and dividends) from securities classified as investments-trading and trading securities sold, not yet purchased; (ii) interest income and expense from collateralized securities transactions; and (iii) commissions and riskless trading profits. Riskless principal trades are transacted through our proprietary account with a customer order in hand, resulting in little or no market risk to us. Transactions are recognized on a trade date basis. The investments classified as trading are carried at fair value. The determination of fair value is based on quoted market prices of an active exchange, independent broker market quotations, market price quotations from third party pricing services, or, when independent broker quotations or market price quotations from third party pricing services are unavailable, valuation models prepared by our management. The models include estimates and the valuations derived from them could differ materially from amounts realizable in an open market exchange. Net trading is reduced by interest expense, which is directly incurred to purchase income generating assets related to trading activities. Such interest expense is recorded on an accrual basis.

Asset management: Asset management revenue consists of CDO asset management fees, fees earned for management of our permanent capital vehicles and investment funds, fees earned under a service arrangement with another CDO asset manager, and other asset management fees. CDO asset management fees are earned for providing ongoing asset management services to the applicable trust. In general, we earn a senior asset management fee, a subordinated asset management fee and an incentive asset management fee.

The senior asset management fee is generally senior to all the securities in the CDO capital structure and is recognized on a monthly basis as services are performed. The senior asset management fee is generally paid on a quarterly basis.

The subordinated asset management fee is an additional payment for the same services, but has a lower priority in the CDO cash flows. If the trust experiences a certain level of asset defaults, these fees may not be paid. There is no recovery by the trust of previously paid subordinated asset management fees. It is our policy to recognize these fees on a monthly basis as services are performed. The subordinated asset management fee is generally paid on a quarterly basis. However, if we determine that the subordinated asset management fee will not be paid (which generally occurs on the quarterly payment date), we will stop recognizing additional subordinated asset management fees on that particular trust and will reverse any subordinated asset management fees that are accrued and unpaid. We will begin accruing the subordinated asset management fee again if payment resumes and, in management’s estimate, continued payment is reasonably assured. If payments were to resume but we were unsure of continued payment, we would recognize the subordinated asset management fee as payments were received and would not accrue on a monthly basis.

The incentive management fee is an additional payment, made typically after five to seven years of the life of a CDO, which is based on the clearance of an accumulated cash return on investment (“Hurdle Return”), received by the most junior CDO securities holders. It is an incentive for us to perform in our role as asset manager by minimizing defaults and maximizing recoveries. The incentive management fee is not ultimately determined or payable until the achievement of the Hurdle Return by the most junior CDO securities holders. We do not recognize incentive fee revenue until the Hurdle Return is achieved and the amount of the incentive management fee is determinable and payment is reasonably assured.

Other asset management fees represent fees earned for the base and incentive management of other investment vehicles that we manage.

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New issue and advisory: New issue and advisory revenue includes: (i) origination fees for corporate debt issues originated by us; (ii) revenue from advisory services; and (iii) new issue revenue associated with arranging the issuance of newly created debt, equity and hybrid financial instruments. New issue and advisory revenue is recognized when all services have been provided and payment is earned.

Principal transactions and other income: Principal transactions include all gains, losses, and income (interest and dividend) from securities or loans classified as other investments, at fair value, in the consolidated balance sheets.

The investments classified as other investments, at fair value, are carried at fair value. The determination of fair value is described in the valuation of financial instruments section above. Dividend income is recognized on the ex-dividend date.

Other income / (loss) includes foreign currency gains and losses, interest earned on cash and cash equivalents, and other miscellaneous income.

Variable Interest Entities

FASB ASC 810, Consolidation (“FASB ASC 810”) contains the guidance surrounding the definition of variable interest entities (“VIEs”), the definition of variable interests, and the consolidation rules surrounding VIEs. In general, VIEs are entities in which equity investors lack the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. We have variable interests in VIEs through our management contracts and investments in various securitization entities including CLOs and CDOs.

Once it is determined that we hold a variable interest in a VIE, FASB ASC 810 requires that we perform a qualitative analysis to determine (i) which entity has the power to direct the matters that most significantly impact the VIEs financial performance; and (ii) if we have the obligation to absorb the losses of the VIE that could potentially be significant to the VIE or the right to receive the benefits of the VIE that could potentially be significant to the VIE. The entity that has both of these characteristics is deemed to be the primary beneficiary and required to consolidate the VIE. This assessment must be done on an ongoing basis.

We classify the VIEs we are involved with into two groups: (i) VIEs managed by us; and (ii) VIEs managed by third parties. In the case of the VIEs that we have been involved with, we have generally concluded that the entity that manages the VIE has the power to direct the matters that most significantly impact the VIEs financial performance. This is not a blanket conclusion as it is possible for an entity other than a manager to have the power to direct such matters. However, for all the VIEs we were involved with as of December 31, 2013, we have drawn this conclusion.

 

In the case where we have an interest in a VIE managed by a third party, we have concluded that we are not the primary beneficiary because we do not have the power to direct the VIEs’ activities. In the case of an interest in a VIE managed by us, we will perform an additional qualitative analysis to determine if our interest (including any investment as well as any management fees that qualify as variable interests) could absorb losses or receive benefits that could potentially be significant to the VIE. This analysis considers the most optimistic and pessimistic scenarios of potential economic results that could reasonably be experienced by the VIE. Then, we compare the benefit it would receive (in the optimistic scenario) or the losses it would absorb (in the pessimistic scenario) as compared to all benefits and losses absorbed by the VIE in total. If the benefits or losses absorbed by us were significant as compared to total benefits and losses absorbed by all the variable interest holders, then we would conclude that we are the primary beneficiary.

We have variable interests in various securitizations but we have determined that we are not the primary beneficiary and therefore are not consolidating the securitization VIEs. The maximum potential financial statement loss we would incur if the securitization vehicles were to default on all of their obligations would be (a) the loss of value of the interests in securitizations that we hold in our inventory at the time (see note 16 to our consolidated financial statements included in this Annual Report on Form 10-K), and (b) any management fee receivables in the case of managed VIEs.

Recent Accounting Pronouncements

The following is a list of recent accounting pronouncements that, we believe, will have a continuing impact on our financial statements going forward. For a more complete list of recent pronouncements, see note 3-U to our consolidated financial statements included in this Annual Report on Form 10-K.

In February 2013, the FASB issued ASU No. 2013-04, Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date, which requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date, as the sum of the following: (a) the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors; and (b) any additional amount the reporting entity expects to pay on behalf of its co-obligors. Examples of obligations within the scope of this ASU include debt arrangements, other contractual obligations, and settled litigation and judicial rulings. The guidance in this ASU also requires an entity to disclose the nature and amount of the obligation as well as other information about those obligations. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The amendments in this ASU should be applied retrospectively to all prior periods presented for

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those obligations resulting from joint and several liability arrangements within the ASU’s scope that exist at the beginning of the entity’s fiscal year of adoption. An entity may elect to use hindsight for the comparative periods presented in the initial year of adoption (if it changed its accounting as a result of adopting the guidance) and shall disclose that fact. The use of hindsight would allow an entity to recognize, measure, and disclose obligations resulting from joint and several liability arrangements within the scope of this ASU in comparative periods using information available at adoption rather than requiring an entity to make judgments about what information it had in each of the prior periods to measure the obligation. Early adoption is permitted. We adopted the provisions of ASU 2013-04 effective January 1, 2014 and the adoption of the provisions did not have an effect on the our consolidated financial position and results of operations. 

 

In March 2013, the FASB issued ASU No. 2013-05, Foreign Currency Matters (Topic 830): Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity, which addresses the accounting for the cumulative translation adjustment when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity. When a reporting entity (parent) ceases to have a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business (other than a sale of in substance real estate or conveyance of oil and gas mineral rights) within a foreign entity, the parent is required to apply the guidance in Subtopic 830-30 to release any related cumulative translation adjustment into net income. Accordingly, the cumulative translation adjustment should be released into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. For an equity method investment that is a foreign entity, the partial sale guidance in Section 830-30-40 still applies, specifically, a pro rata portion of the cumulative translation adjustment should be released into net income upon a partial sale of such an equity method investment. However, this treatment does not apply to an equity method investment that is not a foreign entity. In those instances, the cumulative translation adjustment is released into net income only if the partial sale represents a complete or substantially complete liquidation of the foreign entity that contains the equity method investment. Additionally, the amendments in this ASU clarify that the sale of an investment in a foreign entity includes both (1) events that result in the loss of a controlling financial interest in a foreign entity (that is, irrespective of any retained investment) and (2) events that result in an acquirer obtaining control of an acquiree in which it held an equity interest immediately before the acquisition date (sometimes referred to as a step acquisition). Accordingly, the cumulative translation adjustment should be released into net income upon the occurrence of those events. For public entities, the ASU is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. We adopted the provisions of ASU 2013-05 effective January 1, 2014, and the adoption of the provisions did not have an effect on our consolidated financial statements or financial statement disclosures.

 

In June 2013, the FASB issued ASU No. 2013-08, Financial Services-Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements, which changes the approach to the investment company assessment in Topic 946, clarifies the characteristics of an investment company, and provides comprehensive guidance for assessing whether an entity is an investment company. The amendments require an investment company to measure non-controlling ownership interests in other investment companies at fair value rather than using the equity method of accounting.  The amendments also require the following additional disclosures: (a) the fact that the entity is an investment company and is applying the guidance in Topic 946, (b) information about changes, if any, in an entity’s status as an investment company, and (c) information about financial support provided or contractually required to be provided by an investment company to any of its investees.  The amendments in this ASU are effective for an entity’s interim and annual reporting periods in fiscal years that begin after December 15, 2013. Earlier application is prohibited. We have investments in the equity securities of investment funds and other non-publicly traded entities that have the attributes of investment companies as currently described in FASB ASC 946-15-2.  We adopted the provisions of this ASU effective January 1, 2014, and the adoption of the provisions did not have an effect on our consolidated financial position and results of operations.

 

In July 2013, the FASB issued ASU No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, which provides guidance on the presentation of unrecognized tax benefits.  This ASU applies to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date.  An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows: to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets.  This ASU is effective prospectively for reporting periods beginning after December 15, 2013, with early adoption permitted.  We adopted the provisions of this ASU effective January 1, 2014, and the adoption of the provisions did not have an effect on our consolidated financial statements.

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ITEM  7a.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

All amounts in this section are in thousands unless otherwise noted.

Market Risk

Market risk is the risk of economic loss arising from the adverse impact of market changes to the market value of our trading and investment positions. Market risk is inherent to both derivative and non-derivative financial instruments, and accordingly, the scope of our market risk management procedures extends beyond derivatives to include all market risk sensitive financial instruments. For purposes of analyzing the components of market risk, we have broken out our investment portfolio into three broad categories, plus debt:

 

Fixed Income Securities: We hold, from time to time, the following securities: U.S. Treasury securities, U.S. government agency MBS, U.S. government agency debt securities, CMOs, non-government MBS, corporate bonds, non-redeemable and redeemable preferred stock, municipal bonds, certificates of deposits, SBA loans, residential loans, whole loans, and unconsolidated investments in the middle and senior tiers of securitization entities and TruPS. We attempt to mitigate our exposure to market risk by entering into economic hedging transactions, which may include TBAs. The fixed income category can be broadly broken down into two subcategories: fixed rate and floating rate.

Floating rate securities are not in themselves particularly sensitive to interest rate risk. Because they generally accrue income at a variable rate, the movement in interest rates typically does not impact their fair value. Fluctuations in their current income due to variations in interest rates are generally not material to us. Floating rate fixed income securities are subject to other market risks such as: default risk of the underlying issuer, changes in issuer’s credit spreads, prepayment rates, investor demand and supply of securities within a particular asset class or industry class of the ultimate obligor. The sensitivity to any individual market risk can be difficult to quantify.

The fair value of fixed rate securities is sensitive to changes in interest rates. However, fixed rate securities that have low credit ratings or represent junior interests in securitizations are not particularly interest rate sensitive. In general, when we acquire interest rate sensitive securities, we enter into an offsetting short position for a similar fixed rate security. Alternatively, we may enter into other interest rate hedging arrangements such as interest rate swaps or Eurodollar futures. We measure our net interest rate sensitivity by determining how the fair value of our net interest rate sensitive assets would change as a result of a 100 basis points (“bps”) adverse shift across the entire yield curve. Based on this analysis, as of December 31, 2013, we would incur a loss of $4,225 if the yield curve rises 100 bps across all maturities and a gain of $4,216 if the yield curve falls 100 bps across all maturities. As of December 31, 2012, we would incur a loss of $6,284 if the yield curve rises 100 bps across all maturities and a gain of $6,264 if the yield curve falls 100 bps across all maturities.

Equity Securities: We hold equity interests in the form of investments in investment funds, permanent capital vehicles, and equity instruments of publicly traded companies. These investments are subject to equity price risk. Equity price risk results from changes in the level or volatility of underlying equity prices, which affect the value of equity securities or instruments that in turn derive their value from a particular stock. We attempt to reduce the risk of loss inherent in our inventory of equity securities by closely monitoring those security positions. However, since we generally make investments in our investment funds and permanent capital vehicles in order to facilitate third party capital raising (and hence increase our AUM and asset management fees), we may be unwilling to sell these positions as compared to investments in unaffiliated third parties. We have one permanent capital vehicle investment that is denominated in Euros, and we had an investment fund denominated in Japanese Yen, and another permanent capital vehicle that is denominated in U.S. Dollars, but for which the underlying net assets are primarily based in Japanese Yen. The fair values of these investments are subject to change as the spot foreign exchange rate between these currencies and the U.S. Dollar (our functional currency) fluctuates. We may, from time to time, enter into foreign exchange rate derivatives to hedge all or a portion of this risk. We measure our net equity price sensitivity and foreign currency sensitivity by determining how the net fair value of our equity price sensitive and foreign exchange sensitive assets would change as a result of a 10% adverse change in equity prices or foreign exchange rates. Based on this analysis, as of December 31, 2013, our equity price sensitivity was $2,636 and our foreign exchange currency sensitivity was $1,498.  As of December 31, 2012, our equity price sensitivity was $3,799 and our foreign exchange currency sensitivity was $4,888.

Other Securities: These investments are primarily made up of residual interests in securitization entities. The fair value of these investments will fluctuate over time based on a number of factors including, but not limited to: liquidity of the investment type, the credit performance of the individual assets and issuers within the securitization entity, the asset class of the securitization entity and the relative supply of and demand for investments within that asset class, credit spreads in general, the transparency of valuation of the assets and liabilities of the securitization entity, and investors’ view of the accuracy of ratings prepared by the independent rating agencies. The sensitivity to any individual market risk cannot be quantified.

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Debt: In addition to the risks noted above, we incur interest rate risk related to our debt obligations. We have debt that accrues interest at either variable rates or fixed rates. As of December 31, 2013, a 100 bps change in the three month LIBOR would result in a change in our annual cash paid for interest in the amount of $481. A 100 bps adverse change in the market yield to maturity would result in an increase in the fair value of the debt in the amount of $2,827 as of December 31, 2013.  

Counterparty Risk and Settlement Risk:

We are subject to counterparty risk primarily in two areas: our collateralized securities transactions described in note 11 to our consolidated financial statements included in this Annual Report on Form 10-K, and our TBA activities (where we enter into offsetting TBA trades in order to assist clients in hedging their mortgage portfolios) described in note 10 to our consolidated financial statements included in Item 1 in this Annual Report on Form 10-K. With respect to the matched book repo financing activities, our risk is that the counterparty does not fulfill its obligation to repurchase the underlying security when it is due. In this case, we would typically liquidate the underlying security, which may result in a loss if the security has declined in value in relation to the balance due from the counterparty under the reverse repurchase agreement.

 

With respect to our TBA hedging activities, our risk is that the counterparty does not settle the TBA trade on the scheduled settlement date. In this case, we would have to execute the trade, which may result in a loss based on market movement in the value of the underlying trade between its initial trade date and its settlement date (which in the case of TBAs can be as long as 90 days). If we were to incur a loss under either of these activities, we have recourse to the counterparty pursuant to the underlying agreements.

Finally, we have general settlement risk in all of our regular way fixed income and equity trading activities. If a counterparty fails to settle a trade, we may incur a loss in closing out the position and would be forced to try to recover this loss from the counterparty. If the counterparty has become insolvent or does not have sufficient liquid assets to reimburse us for the loss, we may not get reimbursed.

How we manage these risks

Market Risk

We seek to manage our market risk by utilizing our underwriting and credit analysis processes that are performed in advance of acquiring any investment. In addition, we continually monitor our investments—trading and our trading securities sold, not yet purchased on a daily basis and our other investments on a monthly basis. We perform an in-depth monthly analysis on all our investments and our risk committee meets on a monthly basis to review specific issues within our portfolio and to make recommendations for dealing with these issues. In addition, our broker-dealers have an assigned chief risk officer that reviews the firm’s positions and trading activities on a daily basis.

Counterparty Risk

We seek to manage our counterparty risk through two major tools. First, we perform a credit assessment of each counterparty to ensure the counterparty has sufficient equity, liquidity, and profitability to support the level of trading or lending we plan to do with them. Second, we require counterparties to post cash or other liquid collateral (“margin”) in the case of changes in the market value of the underlying securities or trades on an ongoing basis.

In the case of collateralized securities financing transactions, we will generally lend less than the market value of the underlying security initially. The difference between the amount lent and the value of the security is referred to as the haircut. We will seek to maintain this haircut while the loan is outstanding. If the value of the security declines, we will require the counterparty to post margin to offset this decline. If the counterparty fails to post margin, we will sell the underlying security. The haircut serves as a buffer against market movements to prevent or minimize a loss.

 

In the case of TBA hedging, we also require counterparties to post margin with us in the case of the market value of the underlying TBA trade declining. If the counterparty fails to post margin, we will close out the underlying trade. In the case of TBA hedging, we will sometimes obtain initial margin or a cash deposit from the counterparty which serves a purpose similar to the haircut as an additional buffer against losses. However, some of our TBA hedging activities are done without initial margin or cash deposits.

ITEM  8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The financial statements of the Company, the related notes and schedules to the financial statements, together with the Report of Independent Registered Public Accounting Firm thereon, are set forth beginning on page F-1 of this Annual Report on Form 10-K and are incorporated herein by reference.

ITEM  9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

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ITEM 9A. CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

We have established and maintain disclosure controls and procedures that are designed to ensure that material information relating to the Company (and its consolidated subsidiaries) required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, who certify our financial reports and to other members of senior management and the Board of Directors. Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Exchange Act) as of December 31, 2013. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures were effective at December 31, 2013.

 

   Management’s Annual Report on Internal Control Over Financial Reporting

Our management 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 Exchange Act. 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 risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2013. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) as described in the original (1992) version in Internal Control-Integrated Framework. Based on this assessment, management believed that, as of December 31, 2013, our internal control over financial reporting was effective.

This Annual Report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s auditors pursuant to rules of the SEC that permit us to provide only management’s report in this Annual Report.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting during the quarter ended December 31, 2013 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

ITEM  9B.OTHER INFORMATION.

None.

 

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PART III

Item  10.Directors, Executive Officers and Corporate Governance.

Our Board of Directors has adopted the Code of Conduct applicable to all directors, officers, and employees of the Company. The Code of Conduct is available on our website at www.ifmi.com/investorrelations/gov_conduct.asp and the Company intends to satisfy the disclosure requirements under Item 5.05 of the SEC’s Current Report on Form 8-K regarding amendments to, or waivers from, the Code of Conduct by posting such information on its website. 

The information required by Item 10 is included in the sections entitled “Executive Officers,” “Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance,” and “Corporate Governance and Board of Directors Information” in the Company’s definitive Proxy Statement, to be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934 in connection with the Company’s 2014 Annual Meeting of Stockholders and is incorporated herein by reference.

Item  11.Executive Compensation.

The information required by Item 11 is included in the Section entitled “Executive Compensation” in the Company’s definitive Proxy Statement, to be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934 in connection with the Company’s 2014 Annual Meeting of Stockholders and is incorporated herein by reference.

Item  12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The information required by Item 12 with respect to the “Security Ownership of Certain Beneficial Owners and Management” is included in the Company’s definitive Proxy Statement, to be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934 in connection with the Company’s 2014 Annual Meeting of Stockholders and is incorporated herein by reference.

Equity Compensation Plan Information

The Company’s 2006 Long-Term Incentive Plan was approved by our stockholders at the special meeting held on October 6, 2006. The 2006 Long-Term Incentive Plan was amended on April 26, 2007, and again on June 18, 2008.

Following the Merger in December 2009, our Board of Directors assumed the Cohen Brothers, LLC 2009 Equity Award Plan (the “2009 Equity Award Plan”) from Cohen Brothers on December 16, 2009. The 2009 Equity Award Plan expired upon the vesting of restricted units of the Operating LLC on December 16, 2012. In December 2012, the Company’s Vice Chairman (formerly our Chairman and Chief Executive Officer of the Company), Daniel G. Cohen transferred to the Company 116,595 restricted shares of the Company’s Common Stock to the Company in order to satisfy his obligation to fund the equity vesting under the 2009 Equity Award Plan pursuant to the Equity Plan Funding Agreement.

The Company’s 2010 Long-Term Incentive Plan was approved by our stockholders at the annual meeting held on December 10, 2010. The 2010 Long-Term Incentive Plan was amended on April 18, 2011, amended and restated on March 8, 2012 and again on November 30, 2013 (subject to stockholder approval at the Company’s 2014 Annual Meeting of Stockholders).

 

The following table provides information regarding the 2006 Long-Term Incentive Plan and the 2010 Long-Term Incentive Plan as of December 31, 2013:

 

 

 

(1)Excludes 2,500,000 options with a weighted exercise price of $4.20 granted to Lester R. Brafman, our Chief Executive Officer, in November 2013, which is subject to our stockholder’s approval of the November 2013 amendment and restatement of the 2010 Long-Term Incentive Plan at the Company’s 2014 Annual Meeting of Stockholders. 

See note 20 to our consolidated financial statements included in this Annual Report on Form 10-K for further information regarding the 2006 Long-Term Incentive Plan, the 2009 Equity Award Plan and the Equity Plan Funding Agreement, and the 2010 Long-Term Incentive Plan.

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The remainder of the information required by Item 12 is included in the Section entitled “Share Ownership of Certain Beneficial Owners and Management” in the Company’s definitive Proxy Statement, to be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934 in connection with the Company’s 2014 Annual Meeting of Stockholders and is incorporated herein by reference.

Item  13.Certain Relationships and Related Transactions, and Director Independence.

The information required by Item 13 is included in the Sections entitled “Certain Relationships and Related Party Transactions” and “Corporate Governance and Board of Directors Information — Director Independence” in the Company’s definitive Proxy Statement, to be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934 in connection with the Company’s 2014 Annual Meeting of Stockholders and is incorporated herein by reference.

Item  14.Principal Accounting Fees and Services.

The information required by Item 14 is included in the Sections entitled “Principal Accounting Firm Fees” in the Company’s definitive Proxy Statement, to be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934 in connection with the Company’s 2014 Annual Meeting of Stockholders and is incorporated herein by reference.

 

 

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PART IV

ITEM  15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

(a) Documents filed as a part of this Annual Report on Form 10-K:

(1) The following financial statements of the Company are included in Part II, Item 8 of this Annual Report on Form 10-K:

 

 

 

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(b) Exhibit List

The following exhibits are filed as part of this Annual Report on Form 10-K:

 

*Filed herewith.

**Data required by FASB Accounting Standards Codification 260, “Earnings per Share,” is provided in note 24 to our consolidated financial statements included in this Annual Report on Form 10-K.

***Furnished herewith.

+Constitutes a management contract or compensatory plan or arrangement.

#Schedules and exhibits have been omitted pursuant to Item 601(b)(2) of Regulation S-K. Institutional Financial Markets, Inc. hereby undertakes to furnish supplementally copies of any of the omitted schedules or exhibits upon request by the SEC.

†Confidential treatment has been requested for portions of this document. An unredacted version of this exhibit has been filed separately with the Securities and Exchange Commission.

(c) The financial statement schedules listed in the Index to Consolidated Financial Statements and Financial Statement Schedules listed under Item 15.1(a) are included under Item 8 and are presented beginning on page F-1 of this Form 10-K. 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, or is not present in amount sufficient to require submission of the schedule, and therefore have been omitted.

 

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INSTITUTIONAL FINANCIAL MARKETS, INC.

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.

DATE: March 7, 2014

 

 

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 and on the dates indicated.

 

 

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