ITEM 1. BUSINESS
Throughout this Annual Report, unless the context otherwise requires, the terms "GFI", "Company", "we", "us" and "our" refer to GFI Group Inc. and its consolidated subsidiaries.
Our Business
Introduction
We are a leading intermediary and provider of trading technologies and support services to the global over-the-counter ("OTC") and listed markets. We founded our business in 1987 and were incorporated under the laws of the State of Delaware in 2001 to be a holding company for our subsidiaries. We provide brokerage and trade execution services, clearing services, market data and trading platform and other software products to institutional customers in markets for a range of fixed income, financial, equity and commodity instruments. We provide execution services for our institutional wholesale customers by either matching their trading needs with counterparties having reciprocal interests or directing their orders to an exchange or other trading venue. We have focused historically on more complex, and often less commoditized, markets for sophisticated financial instruments, primarily OTC derivatives, that offer an opportunity for higher commissions per transaction than the markets for more standardized financial instruments. In recent years, we have developed other businesses that complement our brokerage of OTC derivatives, such as cash bond and futures contracts brokerage services, clearing services and analytical and trading software businesses. We have been recognized by various industry publications as a leading provider of institutional brokerage and other services for a broad range of products in the fixed income, financial, equity and commodity markets on which we focus.
We offer our customers a hybrid brokerage approach, combining a range of telephonic and electronic trade execution services, depending on the nature of the products and the specific needs of our customers. We complement our hybrid brokerage capabilities with decision support services, such as value-added data and analytics products, real-time electronic auctions, fixing and matching sessions and post-transaction services, such as straight-through processing ("STP"), clearing links and trade and portfolio management services.
Headquartered in New York, GFI was founded in 1987 and employs more than 2,000 people with additional offices in London, Paris, Nyon, Dublin, Madrid, Sugar Land (TX), Hong Kong, Tel Aviv, Dubai, Manila, Seoul, Tokyo, Singapore, Sydney, Cape Town, Santiago, Bogota, Buenos Aires, Lima and Mexico City. We have more than 2,500 brokerage, software and market data customers, including commercial and investment banks, corporations, insurance companies, asset managers and hedge funds.
During 2013, many of the financial markets in which we provide our services continued to be subject to major regulatory overhaul, as regulators and legislators in the United States and abroad have proposed and, in some instances, have adopted, a slate of regulatory changes that call for, among other things, central clearing of certain derivatives, greater transparency and reporting of derivatives transactions, mandatory trading of certain derivatives transactions on regulated exchanges or swap execution facilities and the required or increased use of electronic trading system technologies. In the United States, The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") was signed into law in July 2010. The Dodd-Frank Act creates a new form of regulated entity known as a Swap Execution Facility (referred to herein as a "SEF") and mandates that all cleared swaps trade on either an exchange or a SEF. GFI Swaps Exchange LLC, one of our subsidiaries, was temporarily registered as a SEF with the Commodity Futures Trading Commission ("CFTC") in September 2013. The regulatory implications and risks associated with registration and operation of a
SEF, are discussed throughout this Form 10-K, including under the heading "Recent Derivative Market Developments" below and under "Item 1A
ITEM 1A. RISK FACTORS
Risks Related to Our Business and Competitive Environments.
Economic, political and market factors beyond our control could reduce trading volumes, securities and commodities prices and demand for our brokerage and clearing services, which could harm our business and our profitability.
Difficult market conditions, economic conditions and geopolitical uncertainties have in the past adversely affected and may in the future adversely affect our business and profitability. Our business and the brokerage and financial services industry in general are directly affected by national and international economic and political conditions, broad trends in business and finance, the level and volatility of interest rates, substantial fluctuations in the volume and price levels of securities, commodities and financial transactions and changes in and uncertainty regarding tax and other laws. In each of the three years in the period ended December 31, 2013, over 70% of our revenues were generated by our brokerage operations. As a result, our revenues and profitability are likely to decline significantly during periods of low trading volume in the financial markets in which we offer our services. The financial markets and the global financial services business are, by their nature, risky and volatile and are directly affected by many national and international factors that are beyond our control. Any one of the following factors, among others, may cause a substantial decline in the United States and global financial markets in which we offer our services, resulting in reduced trading volumes. These factors include:
•economic and political conditions in the United States, Europe and elsewhere in the world;
•concerns over inflation and wavering institutional and consumer confidence levels;
•the availability of cash for investment by our customers and their clients;
•concerns over the credit default or bankruptcy of one or more sovereign nations or corporate entities;
•the level and volatility of interest rates and foreign currency exchange rates;
•the level and volatility of trading in certain equity and commodity markets;
•the level and volatility of the difference between the yields on corporate securities being traded and those on related benchmark securities (which difference we refer to as credit spreads); and
•concerns about terrorism and war;
Declines in the volume of trading in the markets in which we operate generally result in lower revenue from our brokerage and clearing businesses. In addition, although less common, some of our brokerage revenues are determined on the basis of the value of transactions or on credit spreads. Therefore, declines in the value of instruments traded in certain market sectors or the tightening of credit spreads could result in lower revenue for our brokerage business. Our profitability is adversely affected by a decline in revenue because a portion of our costs are fixed. For these reasons, decreases in trading volume or declining prices or credit spreads are likely to have an adverse effect on our business, financial condition or results of operations.
Because competition for the services of highly qualified and skilled brokers is intense, we may not be able to attract and retain the brokers we need to support our business or we may be required to incur additional expenses to do so.
We strive to provide high-quality brokerage services that allow us to establish and maintain long-term relationships with our customers. Our ability to continue to provide these services and maintain these relationships depends, in large part, upon our brokers. As a result, we must attract and retain highly qualified brokerage personnel. Competition for the services of brokers is intense, especially for brokers with extensive experience in the specialized markets in which we participate or may seek to enter. If we are unable to hire highly qualified brokers, we may not be able to enter new brokerage markets or develop new products. If we lose one or more of our brokers in a particular market in which we participate, our revenues may decrease and we may lose market share in that particular market.
We may not be successful in our efforts to recruit and retain highly qualified and skilled brokerage personnel. If we fail to attract new personnel or to retain and motivate our current personnel, or if we incur increased costs associated with attracting and retaining personnel (such as sign-on or guaranteed bonuses to attract new personnel or retain existing personnel), our business, financial condition and results of operations may suffer.
In addition, recruitment and retention of qualified staff could result in substantial additional costs. We pursue our rights through litigation when competitors hire our employees who are under contract with us. We are currently involved in legal proceedings with our competitors relating to the recruitment of employees. An adverse settlement or judgment related to these or similar types of claims could have a material adverse effect on our financial condition or results of operations. Regardless of the outcome of these claims, we generally incur significant expense and management time dealing with these claims.
We operate in a rapidly evolving business and technological environment and we must adapt our business and keep up with technological innovation in order to compete effectively.
The pace of change in our industry is extremely rapid. Operating in such a fast paced business environment involves a high degree of risk. Our ability to succeed and compete effectively will depend on our ability to adapt effectively to these changing market conditions and to keep up with technological innovation.
To remain competitive, we must continue to enhance and improve the responsiveness, functionality, accessibility and other features of our hybrid brokerage systems, network distribution systems and other
technologies and functionalities. The financial services industry is characterized by rapid technological change, changes in use and client requirements and preferences, frequent product and service introductions employing new technologies and the emergence of new and complex regulatory requirements, industry standards and practices that could render our existing practices, technology and systems obsolete. In more liquid markets, development by our competitors of new electronic or hybrid trade execution, STP, affirmation, confirmation or clearing functionalities or products that gain acceptance in the market could give those competitors a "first mover" advantage that may be difficult for us to overcome. Our success will depend, in part, on our ability to:
•develop, test and implement hybrid or electronic brokerage systems that meet regulatory and customer requirements, are desired and adopted by our customers and/or increase the productivity of our brokers;
•enhance our existing services;
•develop or acquire new services and technologies that address the increasingly sophisticated and varied needs of our existing and prospective customers; and
•respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis.
The development of proprietary brokerage systems and other technology to support our business entails significant technological, financial and business risks. Changes in existing laws and regulations, including those being proposed and implemented under the Dodd-Frank Act, may require us to develop and maintain new brokerage systems, services or functionalities in order to meet the standards set forth in such regulations or as may be required by regulators, such as the CFTC or SEC. Further, the adoption of new Internet, networking or telecommunications technologies may require us to devote substantial resources to modify, adapt and defend our services. We may not successfully implement new technologies or adapt our hybrid brokerage systems and transaction-processing systems to meet our clients' requirements or emerging regulatory or industry standards.
We may not be able to respond in a timely manner to changing market conditions or client requirements or successfully defend any challenges to any technology we develop. If we are unable to anticipate and respond to the demand for new services, functionalities, products and technologies on a timely and cost-effective basis, and to adapt to technological advancements and changing standards, we may be unable to compete effectively, which could negatively affect our business, financial condition or results of operations.
We face substantial competition that could negatively impact our market share and our profitability.
The financial services industry generally, and the wholesale and inter-dealer brokerage businesses in which we are engaged in particular, is very competitive, and we expect competition to continue to intensify in the future. Our current and prospective competitors include:
•other large inter-dealer brokerage firms;
•small brokerage firms that focus on specific products or regional markets;
•securities, futures and derivatives exchanges, swap execution facilities and electronic communications networks;
•in certain equity and corporate fixed income markets, traditional cash product broker-dealers, including large, medium and smaller sized financial service firms;
•with regard to our Kyte business, futures commissions merchants and other firms providing settlement and clearing services; and
•other providers of data and analytics products, including those that offer varying forms of electronic trading of the types of financial instruments in which we specialize.
Some of our competitors offer a wider range of services, have broader name recognition, have greater financial, technical, marketing and other resources than we have and have larger client bases than we do. Some of them may be able to respond more quickly to new or evolving opportunities, technologies and client requirements than we can, and may be able to undertake more extensive marketing activities. Our competitors often seek to hire our brokers, which could result in a loss of brokers by us or in increased costs to retain our brokers. In addition to the competitors described above, our large institutional clients may increase the amount of trading they do directly with each other rather than through us, or they may decrease their trading of certain OTC products in favor of exchange-traded products, such as futures contracts. In either case, our revenues could be adversely affected. If we are not able to compete successfully in the future, our business, financial condition and results of operations would be adversely affected.
We have experienced intense price competition in our brokerage business and clearing services in recent years. Some competitors may offer brokerage or clearing services to clients at lower prices than we are offering, which may force us to reduce our prices or to lose market share and revenue. In addition, as the historical markets for OTC products shift to become more commoditized due, in part, to central clearing, electronic execution and the impartial access provided by SEFs and Designated Contract Markets, 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 or who have a broader customer base.
We increasingly compete with exchanges for the execution of trades in certain products. If a financial instrument for which we provide brokerage services becomes listed on an exchange or if an exchange introduces a competing product to the products we broker in the OTC market, the need for our services in relation to that instrument could be significantly reduced and our business, financial condition and results of operations could be adversely affected.
For example, during 2012, derivatives exchanges and other market participants began migrating toward alternatives to swaps that are more widely used, such as futures contracts, and there was a general market move in the U.S. commodities markets towards futures contracts instead of OTC swaps. If this trend were to continue or become more broadly accepted, the need for our services could be reduced and our financial condition and results of operations could be adversely affected.
The migration of OTC swaps to exchange-traded markets may impact volumes, liquidity and demand for our services in certain markets.
New regulation in the United States and abroad, including the Dodd-Frank Act, has resulted in a convergence of the traditional OTC market and the exchange traded futures market, as certain OTC products are required to and become centrally cleared and traded via an exchange or SEF. As the convergence of the OTC and exchange traded markets continues, the resulting OTC or SEF market for these products may be less robust, there may be less volume and liquidity in these markets and there may be less demand for our services. In those cases where an OTC swaps market migrates to an exchange traded futures market, such as what occurred during 2012 in many U.S. commodities markets, our ability to continue to provide brokerage services for the resultant futures markets will be subject to the block-trade and other rules of the applicable exchanges. If a significant number of the OTC swaps markets in which we provide brokerage services transition to an exchange traded futures market or if the block-trade and other rules of the applicable exchanges are too restrictive, our business could be significantly reduced and our business, financial condition and results of operations could be adversely affected.
Consolidation and layoffs in the banking and financial services industries could materially adversely affect our business, financial condition and results of operations.
In recent years, there has been substantial consolidation and convergence among companies in the banking and financial services industries. Continued consolidation or significant layoffs in the financial services industry could result in a decrease in the number of traders for whom we are able to provide brokerage services, which may reduce our trading volumes. In addition, continued consolidation could lead to the exertion of additional pricing pressure by our customers and our competitors, impacting the commissions we generate from our brokerage services. Following the enactment of the Dodd-Frank Act in the United States, many banks have reduced, spun off or are in the process of spinning off their proprietary trading operations due to the increased regulations, costs and uncertainty involved with such operations. It is not yet clear what affect this will have on our transaction volumes, revenues and business or whether we will be able to successfully compete for the business of any new entities created as a result of these spinoffs.
Further, the recent consolidation among regulated exchanges, and expansion by these firms into derivative and other non-equity trading markets, will increase competition for customer trades and place additional pricing pressure on commissions and spreads. These developments have increased competition from firms with potentially greater access to capital resources than us. Finally, consolidation among our competitors other than exchange firms could result in increased resources and product or service offerings for our competitors. If we are not able to compete successfully in the future, our business, financial condition and results of operations could be materially adversely affected.
If we are unable to continue to identify and exploit new market opportunities, our ability to maintain and grow our business may be adversely affected.
When a new intermediary enters our markets or the markets become more liquid, the resulting competition or increased liquidity may lead to lower commissions. This may result in a decrease in revenue in a particular market even if the volume of trades we handle in that market has increased. As a result, we seek to broker more trades and increase market share in existing markets and to seek out new markets in which we can charge higher commissions. Pursuing this strategy requires significant management attention and broker expense. We may not be able to attract new clients or successfully enter new markets. If we are unable to continue to identify and exploit new market opportunities on a timely and cost-effective basis, our revenues may decline, which would adversely affect our profitability.
Financial or other problems experienced by our clients or third parties could affect the markets in which we provide brokerage services. In addition, any disruption in the key derivatives markets in which we provide services could affect our brokerage revenues.
Problems experienced by third parties could also affect the markets in which we provide brokerage services. In recent years, an increasing number of financial institutions have reported losses or significant exposures tied to write-downs of mortgage and asset backed securities, government securities, structured credit products and other derivative instruments and investments. As a result, there is an increased risk that one of our clients, counterparties, third-party clearing firms or reference entities whose securities we broker could fail, shut down, file for bankruptcy or be unable to satisfy their obligations under certain derivative contracts. The failure of a significant number of counterparties or a counterparty that holds a significant amount of derivatives exposure, or which has significant financial exposure to, or reliance on, the mortgage, asset backed, sovereign debt or related markets, could have a material adverse effect on the trading volume and liquidity in a particular market for which we provide brokerage services or on the broader financial markets. The occurrence of any of these events or failures by our customers, clearing firms or reference entities could adversely affect our financial condition and results of operations. In addition, in recent years, a significant percentage of our business, directly or indirectly, results from trading activity by hedge funds. Hedge funds typically
employ a significant amount of leverage to achieve their results and, in the past, certain hedge funds have had difficulty managing this leverage, which has resulted in market-wide disruptions. During the economic turmoil of the last few years, many hedge funds have significantly decreased their leverage or have gone out of business. If this deleveraging continues or one or more hedge funds that was a significant participant in a derivatives market experiences problems in the future, that derivatives market could be adversely affected and, accordingly, our brokerage revenues in that market will likely decrease.
Our brokerage, clearing and execution business exposes us to certain client and counterparty credit risks.
We generally provide brokerage services to our clients in the form of either agency or matched principal transactions. In agency transactions, we charge a commission for connecting buyers and sellers and assisting in the negotiation of the price and other material terms of the transaction. After all of the material terms of a transaction are agreed upon, we identify the buyer and seller to each other and leave them to settle the trade directly. We are exposed to credit risk for commissions we bill to clients for our agency brokerage services. In executing matched principal transactions, we are exposed to the risk that one of the counterparties to a transaction may fail to fulfill its obligations, as described in further detail in the Risk Factor captioned "The securities settlement process exposes us to risks that may impact our liquidity and profitability. In addition, liability for unmatched principal trades could adversely affect our results of operations and statement of financial condition." Our clients may default on their obligations to us arising from either agency or principal transactions due to disputes, bankruptcy, lack of liquidity, operational failure or other reasons. Any losses arising from such defaults could have a material adverse effect on our financial condition or results of operations.
We also have credit and counterparty risk in certain situations where we provide clearing and execution services. We provide agency clearing services through our relationships with general clearing member firms and/or exchanges. In these instances, our accounts at such institutions are used, in our name, to provide access to clearing services for our customers. Credit risk arises from the possibility that we may suffer losses due to the failure of our customers or other counterparties to satisfy their financial obligations to us or in a timely manner. We may be materially and adversely affected in the event of a significant default by our customers or counterparties. Credit risks we face include, among others:
•exposure to a customer's inability or unwillingness to meet obligations, including when adverse market movements result in a trading loss and the customer's posted margin is insufficient to satisfy the deficit. Such margin deficiencies may be caused by a failure to monitor client positions and accurately evaluate risk exposures, which may lead to our failure to require clients to post adequate initial margin or to increase variation margin, as necessary, to keep pace with market movements and subsequent account deficits;
•exposure to counterparties with whom we place funds, including those of our customers, such as when we post margin with exchanges and clearing members;
•exposure to counterparties with whom we trade; and
•market risk exposure due to delayed or failed settlement, which, if not corrected, could become our responsibility as an agency clearing broker. In addition, we have market risk exposure on matched and unmatched principal transactions until offsetting trades are executed and settled.
Customers and counterparties that owe us money or securities may default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other reasons. Our reputation may be damaged if we are associated with a customer or counterparty that defaults, even if we do not have any direct losses from such an event. For further detail see the Risk Factor captioned "The securities settlement process exposes us to risks that may impact our liquidity and profitability. In addition,
liability for unmatched principal trades could adversely affect our results of operations and statement of financial condition."
We have adopted policies and procedures to identify, monitor and manage our credit risk, in both agency and principal transactions, through reporting and control procedures and by monitoring credit standards applicable to our clients. These policies and procedures, however, may not be fully effective. Some of our risk management methods depend upon the evaluation of information regarding markets, clients or other matters that are publicly available or otherwise accessible by us. That information may not, in all cases, be accurate, complete, up-to-date or properly evaluated. If our policies and procedures are not fully effective or we are not always successful in monitoring or evaluating the credit risks to which we are, or may, be exposed, our financial condition or results of operations could be adversely affected. In addition, our insurance policies are unlikely to provide coverage for these risks.
In addition, concerns about, or a default by, one institution could lead to significant liquidity problems, losses or defaults by other institutions, which in turn could adversely affect us. We may also be adversely affected if settlement, clearing or payment systems become unavailable, fail or are subject to systemic delays for any reason outside our control.
In certain instances, we may extend credit to our clearing customers for margin requirements, which subjects us to credit risks, and if we are unable to liquidate a customer's position if the margin collateral becomes insufficient, we may suffer a loss.
In certain instances, we may provide credit for margin requirements to customers; therefore, we are subject to risks inherent in extending credit. Our credit risks include the risk that the value of the collateral we hold could fall below the amount of a customer's indebtedness. This risk can be amplified in any situation where the market for the underlying instrument is rapidly declining. Agreements with customers that have margin accounts permit us to liquidate their positions in the event that the amount of margin collateral becomes insufficient. Despite those agreements and our risk management policies with respect to margin, we may be unable to liquidate the customers' positions for various reasons, or at a price sufficient to cover any deficiency in a customer's account. If we were unable to liquidate a position at a price sufficient to cover any deficiency or if a customer was unable to post additional margin, we could suffer a loss.
Certain of our clearing customers may choose to obtain a direct relationship with a clearing member, an exchange or a clearinghouse as their operations grow, in which case, we would lose the revenues generated by such customers.
We market our clearing services to our existing customers on the strength of our relationship with certain clearing members and exchanges and on our ability to perform related back-office functions at a lower cost than the customers could perform these functions themselves. As our customers' operations grow, they may consider the option of obtaining a direct relationship with a clearing member, clearinghouse or exchange themselves in an effort to save costs. If our customers choose to obtain their clearing services directly from a clearing member or through other means, we would lose their revenue and our business could be adversely affected.
Risks Related to Our Operations.
We operate in a highly regulated industry and we may face restrictions with respect to the way we conduct certain of our operations.
Our business is subject to increasingly extensive governmental and other regulations and our relationships with our clients may subject us to increasing regulatory scrutiny. These regulations are designed to protect public interests generally rather than our stockholders. The SEC, FINRA, CFTC and other agencies extensively regulate the United States financial services industry, including much of
our operations in the United States. Some of our international operations are subject to similar regulations in their respective jurisdictions, including regulations overseen by the FCA in the United Kingdom, the AMF in France, the SFC in Hong Kong, the MAS in Singapore, the Ministry of Finance and Economy in Korea and the SVS in Chile. These regulatory bodies are responsible for safeguarding the integrity of the securities and other financial markets and protecting the interests of investors in those markets. Most aspects of our business are subject to extensive regulation, including:
•the way we deal with clients;
•capital requirements;
•financial and reporting practices;
•required recordkeeping and record retention procedures;
•the licensing of employees;
•the conduct of directors, officers, employees and affiliates;
•systems and control requirements;
•restrictions on marketing, gifts and entertainment; and
•client identification and anti-money laundering requirements.
If we fail to comply with any of these laws, rules or regulations, we may be subject to censure, fines, cease-and-desist orders, suspension of business, suspensions of personnel or other sanctions, including revocation of our registrations with FINRA, withdrawal of our authorizations from the FCA or revocation of our registrations with other similar international agencies to whose regulation we are subject. For example, several of GFI Securities LLC's equity and corporate bond brokerage desks have experienced issues relating to reporting trades to FINRA on a timely basis, which is required by FINRA rules. This subsidiary has also paid fines for trade reporting in recent years and is currently being reviewed by FINRA for similar issues relating to trade reporting. For more details on recent disciplinary proceedings, see "Item 3 - Legal Proceedings."
Our authority to operate as a broker in a jurisdiction is dependent on continued registration or authorization in that jurisdiction or the maintenance of a proper exemption from such registration or authorization. Our ability to comply with all applicable laws and rules is largely dependent on our compliance, credit approval, audit and reporting systems and procedures, as well as our ability to attract and retain qualified compliance, credit approval, audit and risk management personnel. Our systems and procedures may not be sufficiently effective to prevent a violation of all applicable rules and regulations. In addition, the growth and expansion of our business may create additional strain on our compliance systems and procedures and has resulted, and we expect will continue to result, in increased costs to maintain and improve these systems.
In addition, because our industry is heavily regulated, regulatory approval may be required in order to continue or expand our business activities and we may not be able to obtain the necessary regulatory approvals. Even if approvals are obtained, they may impose restrictions on our business or we may not be able to continue to comply with the terms of the approvals or applicable regulations. The implementation of unfavorable regulations or unfavorable interpretations of existing regulations by courts or regulatory bodies could require us to incur significant compliance costs or cause the development or continuation of business activities in affected markets to become impractical. For a further description of the regulations which may limit our activities, see "Item 1 - Business-Regulation."
Some of our subsidiaries are subject to regulations regarding changes in control of their ownership. These regulations generally provide that regulatory approval must be obtained in connection with any
transaction resulting in a change in control of the subsidiary, which may include changes in control of GFI Group Inc. As a result of these regulations, our future efforts to sell shares or raise additional capital may be delayed or prohibited in circumstances in which such a transaction would give rise to a change in control as defined by the applicable regulatory body.
Broad changes in laws or regulations or in the application of such laws and regulations may have an adverse effect on our ability to conduct our business.
The financial services industry, in general, is heavily regulated. Proposals for legislation further regulating the financial services industry are continually being introduced in the United States Congress, in state legislatures and by foreign governments. The government agencies that regulate us continuously review legislative and regulatory initiatives and may adopt new or revised laws and regulations and have broad powers to investigate and enforce compliance and punish noncompliance with their rules, regulations and industry standards of practice. In light of recent conditions in the global financial markets and economy, regulators have increased their focus on the regulation of the financial services industry. We are unable to predict which of these initiatives will be implemented or in what form, or whether any additional or similar changes to statutes or regulations, including the interpretation or implementation thereof, will occur in the future. Any such action could affect us in substantial and unpredictable ways and could have an adverse effect on our business, financial condition and results of operations.
We are also affected by the policies adopted by the Federal Reserve and international central banking authorities, which may directly impact our cost of funds for capital raising and investment activities and may impact the value of financial instruments we hold. In addition, such changes in monetary policy may affect the credit quality of our customers or increase the cost for our customers to trade the products for which we provide brokerage services. Changes in domestic and international monetary policy are beyond our control and are difficult to predict.
Additionally, there has been increased regulation in the U.S. and Europe requiring more transparency in the OTC markets. The Dodd-Frank Act was passed in the United States in July 2010 and regulators in Europe have enacted similar legislation. For a detailed description of the Dodd-Frank Act, see the Risk Factor captioned "Failure to qualify as a SEF could significantly impact our business, financial condition and results of operations. Even if we qualify as a SEF, we will incur significant additional costs, our revenues may be lower than in the past and our financial condition and results of operations may be adversely affected."
The EMIR reporting requirements commenced from February 12, 2014. EMIR requires that the details of new, modified or terminated OTC derivatives contracts be reported to a registered trade repository and that standard OTC derivative contracts be cleared through central counterparties ("CCPs"). Counterparties are also required to comply with certain risk mitigation requirements (e.g. timely confirmations, daily mark to market, portfolio compression and reconciliation and dispute resolution).
It is difficult to predict the effect these new laws and regulations will have on our business, but they may have an adverse effect on our operations or our ability to maintain our position as a provider of execution and brokerage services for many of the OTC products for which we have traditionally acted as an intermediary.
Failure to continue to qualify as a SEF could significantly impact our business, financial condition and results of operations. Even if we qualify as a SEF, we will incur significant additional costs, our revenues may be lower than in the past and our financial condition and results of operations may be adversely affected.
The Dodd-Frank Act created a new type of regulated entity known as a SEF and mandated that certain cleared swaps (subject to an exemption from the clearing requirement) trade on either an
exchange or SEF. The list of swaps that will be required to be cleared and therefore executed through a SEF encompasses a vast number of swaps that have been traditionally executed OTC by wholesale brokers such as ourselves. Certain portions of the Dodd-Frank Act were effective immediately, while other portions will be effective only following rulemaking by the CFTC and SEC and an extended transition period. GFI Swaps Exchange LLC, one of our subsidiaries, was temporarily registered as a SEF with the CFTC in September 2013. Subject to final rulemaking by the SEC, we also expect to establish and operate a security-based SEF.
The CFTC and SEC have each issued proposed rules, some of which are now final, relating to the requirements for registering and operating as a SEF. However, certain of these rules are not yet final and are still subject to revision and therefore, the impact of the rules is not able to be predicted. The rules relating to SEFs require, among other things, that an entity would have to comply with certain core principles to maintain registration as a SEF. These principles generally relate to trading and product requirements, compliance and audit-trail obligations, governance and disciplinary requirements, operational capabilities, surveillance obligations and financial information and resource requirements. In addition, SEFs will be required to maintain certain trading systems that meet the minimum functionality requirements set by the CFTC and SEC for trading in certain OTC derivatives that are required to be cleared.
While there continues to be uncertainty about the exact impact of these changes, we do know that the Company will be subject to a more complex regulatory framework going forward, and that there will be significant costs to prepare for and to comply with these ongoing regulatory requirements. We will incur increased legal fees, personnel expenses and other costs, as we work to analyze and implement the necessary legal structure for registration. There will also be significant costs related to the development, operation and enhancement of our technology relating to trade execution, trade reporting, surveillance, compliance and back-up and disaster recovery plans designed to meet the requirements of the regulators.
In addition, it is not clear at this point what the impact of these rules and regulations will be on the markets in which we currently provide our services. During the continued implementation of the Dodd-Frank Act and related rules, the markets for cleared and non-cleared swaps may continue to be less robust, there may be less volume and liquidity in these markets and there may be less demand for our services. There may also be a preference of market participants to trade certain swaps on an exchange, rather than a SEF, or to trade standardized derivatives, such as futures, in lieu of swaps.
Certain banks and other institutions will be limited in their conduct of proprietary trading and will be further limited or prohibited from trading in certain derivatives. The new rules, including the restrictions on the trading activities for certain banks and large institutions, could materially impact transaction volumes and liquidity in these markets and our revenues, financial condition and business would be adversely impacted as a result.
If we fail to continue to qualify as a SEF under any of these proposed rules, we will be unable to maintain our position as a provider of execution and brokerage services in the markets for many of the OTC products for which we have traditionally acted as an intermediary. This would have a broad impact on our business and could have a material adverse effect on our financial condition and results of operations.
Our regulated subsidiaries are subject to risks associated with net capital requirements, and we may not be able to engage in operations that require significant capital.
Many aspects of our business are subject to significant capital requirements. The SEC, CFTC, FINRA, FCA, NFA and various other domestic and international regulatory agencies have stringent rules and regulations with respect to the maintenance of specific levels of net capital by regulated entities
Generally, net capital is defined as its net worth plus qualified subordinated debt less deductions for certain types of assets. While we expect to continue to maintain levels of capital in excess of regulatory minimums, there can be no assurance that this will be the case in the future. If we fail to maintain the required capital levels, we may be required to suspend our regulated operations during any period in which we are not in compliance with capital requirements, and may be subject to suspension or revocation of registration by the applicable regulator or withdrawal of authorization or other disciplinary action from domestic and international regulators, which would have a material adverse effect on our business. If these net capital rules are changed or expanded, or if there is an unusually large charge against net capital, operations that require the intensive use of capital would be limited. Also, our ability to withdraw capital from our regulated subsidiaries is subject to restrictions, which in turn could limit our ability to pay dividends, repay debt or purchase shares of our common stock. A large operating loss or charge against net capital could adversely affect our ability to expand or even maintain our present levels of business, which could have a material adverse effect on our business. In addition, we may become subject to net capital requirements in other foreign jurisdictions in which we currently operate or which we may enter.
In addition, we are required to maintain capital with our clearing firms, prime brokers and futures commission merchants and at clearing organizations of which we are a member. The amount of capital to be maintained is dependent on a number of factors, including the rules established by the clearing organization, the types of products to be cleared and the volume and size of positions to be cleared. If we fail to maintain the capital required by these clearing organizations and firms, our ability to clear through these clearing organizations and firms may be impaired, which may adversely affect our ability to process trades.
We cannot predict our future capital needs or our ability to obtain additional financing. For a further discussion of our net capital requirements, see "Item 1 - Business-Regulation" and Note 20 to the Consolidated Financial Statements.
Our risk management policies might not be effective, which could harm our business.
To manage the significant risks inherent in our business, we must maintain effective policies, procedures and systems that enable us to identify, monitor and control our exposure to financial, market, credit, legal, reputational and operational risks. For a description of our risk management approach, see "Item 7A. Quantitative and Qualitative Disclosure About Market Risk." This risk management function requires, among other things, that we properly record and verify many thousands of transactions and events each day, and that we continuously monitor and evaluate the size and nature of our or our clients' positions and the associated risks. In light of the high volume of transactions, it is impossible for us to review and assess every single transaction or to monitor at every moment in time our or our customers' positions and the associated risks.
We must rely upon our analysis of information regarding markets, personnel, clients or other matters that is publicly available or otherwise accessible to us. That information may not in all cases be accurate, complete, up-to-date or properly analyzed. Furthermore, we rely on a combination of technical and human controls and supervision that are subject to error and potential failure, the challenges of which are exacerbated by the 24-hour-a-day, global nature of our business.
Our risk-management methods are based on internally developed controls, observed historical market behavior and what we believe to be industry practices. However, our methods may not adequately prevent future losses, particularly as they may relate to extreme market movements or events for which little or no historical precedent exists or our risk management efforts may be insufficient. Thus, our risk-management methods may prove to be ineffective because of their design, their implementation or the lack of adequate, accurate or timely information. Our risk management methods may also fail to identify a risk or understand a risk that might result in losses. If our
risk-management policies and efforts are ineffective, we could suffer losses that could have a material adverse effect on our financial condition or operating results. Additionally, we could be subject to litigation, particularly from our clients, and sanctions or fines from regulators.
The securities settlement process exposes us to risks that may impact our liquidity and profitability. In addition, liability for unmatched principal trades could adversely affect our results of operations and statement of financial condition.
Through our subsidiaries, we provide brokerage services by executing transactions for our clients. A significant number of these transactions are "matched principal transactions" in which we act as a "middleman" by serving as a counterparty to both a buyer and a seller in matching reciprocal back-to-back trades. These transactions, which generally involve cash equities and bonds, are then settled through clearing institutions with which we have a contractual relationship.
In executing matched principal transactions, we are exposed to the risk that one of the counterparties to a transaction may fail to fulfill its obligations, either because it is not matched immediately or, even if matched, one party fails to deliver the cash or securities it is obligated to deliver. Our focus on less commoditized markets exacerbates this risk for us because transactions in these markets tend to be more likely not to settle on a timely basis. Adverse movements in the prices of securities that are the subject of these transactions can increase our risk. In addition, widespread technological or communication failures, as well as actual or perceived credit difficulties or the insolvency of one or more large or visible market participants, could cause market-wide credit difficulties or other market disruptions. These failures, difficulties or disruptions could result in a large number of market participants not settling transactions or otherwise not performing their obligations.
We are subject to financing risk in these circumstances because if a transaction does not settle on a timely basis, the resulting unmatched position may need to be financed, either directly by us or through one of our clearing organizations at our expense. These charges may be recoverable from the failing counterparty, but sometimes are not. Finally, in instances where the unmatched position or failure to deliver is prolonged or widespread due to rapid or widespread declines in liquidity for an instrument, there may also be regulatory capital charges required to be taken by us, which depending on their size and duration, could limit our business flexibility or even force the curtailment of those portions of our business requiring higher levels of capital.
In the process of executing matched principal transactions, miscommunications and other errors by our clients or us can arise whereby a transaction is not completed with one or more counterparties to the transaction, leaving us with either a long or short unmatched position. These unmatched positions are referred to as "out trades," and they create a potential liability for our subsidiary involved in the trade. If an out trade is promptly discovered and there is a prompt disposition of the unmatched position, the risk to us is usually limited. If the discovery of an out trade is delayed, the risk is heightened by the increased possibility of intervening market movements prior to disposition. Although out trades usually become known at the time of, or later on the day of, the trade, it is possible that they may not be discovered until later in the settlement process. When out trades are discovered, our policy is generally to have the unmatched position disposed of promptly (usually on the same day and generally within three days), whether or not this disposition would result in a loss to us. The occurrence of out trades generally rises with increases in the volatility of the market and, depending on their number and amount, such out trades have the potential to have a material adverse effect on our financial condition and results of operations. In addition, the use of our electronic brokerage platforms for products that we broker on a matched principal basis, such as CreditMatch®, can present these risks because of the potential for erroneous entries by our clients or brokers coupled with the potential that such errors will not be discovered promptly.
We are exposed to market risk from principal transactions entered into by some of our desks.
We generally execute orders on a matched principal basis by entering into one side of a customer trade and entering into an offsetting trade with another party relatively quickly (often within minutes and generally on the same trading day). However, we may take unmatched positions for our own account primarily to facilitate the execution of existing customer orders. While we seek to minimize our exposure to market risk by entering into offsetting trades or a hedging transaction relatively quickly (often within minutes and generally on the same trading day), we may not always enter into an offsetting trade on the same trading day and any hedging transaction we may enter into may not fully offset our exposure. Therefore, although any unmatched positions are intended to be held short term, we may not entirely offset market risk and may be exposed to market risk for several days or more or to a partial extent or both. Our exposure varies based on the size of the overall positions, the terms and liquidity of the instruments brokered, and the amount of time the positions are held before we dispose of the position.
Although the significant majority of our principal trading is done on a "matched principal" basis, we have authorized a limited number of our desks to enter into principal investing transactions in which we commit our capital within predefined limits, either to facilitate customer trading activities or to engage in principal trading for our own account. These principal positions may ultimately be matched against a customer order or through a market intermediary, either in the short term (such as the same trading day) or we may hold these positions for several days or more. The number and size of these transactions may affect our results of operations in a given period and we may also incur losses from these trading activities due to market fluctuations and volatility from quarter to quarter. To the extent that we have long positions in any of those markets, a downturn in the value of those positions could result in losses from a decline in the value of those long positions. Conversely, to the extent that we have sold assets we do not own (i.e., have short positions) in any of those markets, an upturn in those markets could expose us to significant losses as we attempt to cover our short positions by acquiring assets in a rising market. In addition, in the event that one of our desks enters into principal transactions that exceed their authorized limit and we are unable to dispose of the position promptly, we could suffer losses that could have a material adverse effect on our financial condition or operating results.
Due to the factors described above, including the nature of the position and access to the market on which it trades, we may not be able to match a position or effectively hedge our exposure and often may hold a position overnight or longer that has not been hedged. To the extent these principal positions are not disposed of intra-day, we mark these positions to market. Adverse movements in the securities underlying these positions or a downturn or disruption in the markets for these positions could result in a substantial loss. In addition, any principal gains and losses resulting from these positions could on occasion have a disproportionate positive or negative effect, on our financial condition and results of operations for any particular reporting period.
We have equity investments or profit sharing interests in entities whose primary business is proprietary trading. These investments could expose us to losses that would adversely affect our net income and the value of our assets.
We have equity investments or profit sharing interests in entities whose primary business is proprietary trading. The accounting treatment applied for these investments varies depending on a number of factors, including, but not limited to, our percentage ownership or profit share and whether we have any influence or control over the relevant entity. Under certain accounting standards, any losses experienced by these entities on their investment activities would adversely impact our net income and the value of these assets. In addition, if these entities were to fail and cease operations, we could lose the entire value of our investment and the stream of any shared profits from trading.
Our investments in expanding our brokerage and clearing services, hybrid brokerage systems and market data and software businesses may not produce substantial revenue or profit.
We have made, and expect to continue to make, significant investments in our brokerage, clearing, market data and software services, including investments in personnel, technology and infrastructure, in order to pursue new growth opportunities. With respect to our brokerage services and hybrid brokerage systems, we may not receive significant revenue and profit from the development of a new brokerage desk or hybrid brokerage system or the revenue we do receive may not be sufficient to cover the start-up costs of the new desk or the substantial development expenses associated with creating a new hybrid brokerage system. Even when our personnel hires and systems are ultimately successful, there is typically a transition period before these hires or systems become profitable or increase productivity. In some instances, our clients may determine that they do not need or prefer a hybrid brokerage system and the period before the system is successfully developed, introduced and adopted may extend over many months or years. The successful introduction of hybrid brokerage systems in one market or country does not ensure that the same system will be used or favored by clients in similar markets or other countries. Our continued expansion of brokerage personnel and systems to support new growth opportunities results in ongoing transition periods that could adversely affect the levels of our compensation and expense as a percentage of brokerage revenue.
With respect to our investment in clearing, settlement and back-office services, we may not produce significant revenues or profits. In addition, any revenues we do receive may not be sufficient to cover our invested capital or start-up costs. With respect to these services, we may incur significant costs developing and maintaining systems for back-office, risk management and exchange and clearing connections with relevant exchanges and clearing firms. In addition, this business may involve significant management effort to expand. If we are unable to generate sufficient revenue to cover the fixed costs associated with this business, our financial condition or results of operations could be adversely affected.
With respect to our market data and software businesses, which includes our Trayport and FENICS operations, we may incur substantial development, sales and marketing expenses and expend significant management effort to create a new product or service. Even after incurring these costs, we ultimately may not sell any or sell only small amounts of these products or services. Consequently, if revenue does not increase in a timely fashion as a result of these expansion and development initiatives, the up-front costs associated with them may exceed the related revenue and reduce our working capital and income.
If we are unable to manage the risks of international operations effectively, our business could be adversely affected.
We provide services and products to clients globally through offices in Europe, the Middle East, Africa, South America and Asia and we may seek to further expand our operations in the future. On a geographic basis, approximately 61%, 30% and 9% of our total revenues for the each of the years ended December 31, 2013 and 2012, were generated by our operations in Europe, the Middle East and Africa (EMEA), the Americas, which include operations in South America, and Asia-Pacific, respectively. There are certain additional risks inherent in doing business in international markets, particularly in the regulated brokerage industry. These risks include:
•additional regulatory requirements;
•difficulties in recruiting and retaining personnel and managing the international operations;
•potentially adverse tax consequences, tariffs and other trade barriers;
•adverse labor laws; and
•reduced protection for intellectual property rights.
Our international operations also expose us to the risk of fluctuations in currency exchange rates. For example, a substantial portion of our revenue from our London office, our largest international office, is received in Euros and U.S. Dollars, whereas many of our expenses from our London operations are payable in British Pounds. Our risk management strategies relating to exchange rates may not prevent us from suffering losses that would adversely affect our financial condition or results of operations.
Our international operations are also subject to the political, legal and economic risks associated with politically unstable and less developed regions of the world, including the risk of war and other international conflicts and actions by governmental authorities, insurgent groups, terrorists and others. In addition, we are required to comply with the laws and regulations of foreign governmental and regulatory authorities of each country in which we conduct business. These may include laws, rules and regulations, including registration requirements. For example, in Europe, the European Commission published a formal proposal for the regulation of OTC derivatives, central clearing parties and trade repositories in September 2010, which is referred to as the EMIR. The proposed rules were issued in September of 2012 and became operational in the first quarter of 2014. Our compliance with these laws and regulations may be difficult and time consuming and may require significant expenditures and personnel requirements, and our failure to be in compliance would subject us to legal and regulatory liabilities.
We may also experience difficulty in managing our international operations because of, among other things, competitive conditions overseas, established domestic markets, language and cultural differences and economic or political instability. For example, global markets and economic conditions have been negatively impacted by the ability of certain E.U. member states to service their sovereign debt obligations. The continued uncertainty over the outcome of the E.U. governments' financial support programs and the possibility that other E.U. member states may experience similar financial troubles could further disrupt global markets. In particular, it has and could in the future disrupt equity markets and result in volatile bond yields on the sovereign debt of E.U. members. This has also had an impact on the creditworthiness of customers and counterparties and has and may continue to limit the number of customers we are willing to do business with in this region. Any of these factors could have a material adverse effect on the success of our international operations or limit our ability to grow our international operations and, consequently, on our business, financial condition and operating results.
We may be exposed to risk from our operations in emerging market countries, including counterparty risks exposure.
Our businesses and operations are increasingly expanding into new regions, including emerging markets, and we expect this trend to continue. We have entered into an increasing number of matched principal transactions with counterparties domiciled in countries in the Middle East, Latin America, Eastern Europe and Asia. Transactions with these counterparties are generally in instruments or contracts of sovereign or corporate issuers located in the same country or region as the counterparty. This exposes us to a higher degree of sovereign or convertibility risk than in more stable or developed countries. In addition, these risks may be correlated risks. A correlated risk arises when the counterparty's inability to meet its obligations will also correspond to a decline in the value of the instrument traded. In the case of a sovereign convertibility event or outright default, the counterparty to the trade may be unable to pay or transfer payment of an instrument purchased out of the country when the value of the instrument has declined due to the default or convertibility event. Various emerging market countries have experienced severe economic and financial disruptions, including significant devaluations of their currencies, defaults or threatened defaults on sovereign debt, capital and currency exchange controls, and low or negative growth rates in their economies. These conditions could have an adverse impact on our businesses and increased volatility in financial markets generally.
Through our risk management procedures, we monitor the creditworthiness of emerging countries and counterparties on an ongoing basis and when the risk of inconvertibility or sovereign default is deemed to be too great, correlated transactions or all transactions may be restricted or suspended. However, there can be no assurance that our procedures will be effective in controlling these risks, which, if not successfully controlled, could result in a loss that could have a material adverse effect on our financial condition and operating results.
We may have difficulty managing our expanding operations effectively.
We have significantly expanded our business activities and operations over the last several years, which have placed, and are expected to continue to place, a significant strain on our management and resources. Continued expansion into new markets and regions will require continued investment in management and other personnel, facilities, information technology infrastructure, financial and management systems and controls and regulatory compliance controls. The expansion of our international operations, particularly our Asia-Pacific and South American operations, involves additional challenges that we may not be able to meet, such as the difficulty in effectively managing and staffing these operations and complying with the increased regulatory requirements associated with operating in new jurisdictions.
We may not be successful in implementing all of the processes that are necessary to support these initiatives, which could result in our expenses increasing faster than our revenues, causing our operating margins and profitability to be adversely affected, or it could result in us having insufficient controls in our operations for a period of time. Accordingly, this expansion, if not properly managed, could result in a loss that could have a material adverse effect on our financial condition and operating results.
In the event of employee misconduct or error, our business may be harmed.
Employee misconduct or error could subject us to legal liability, financial losses and regulatory sanctions and could seriously harm our reputation and negatively affect our business. Misconduct by employees could include engaging in improper or unauthorized transactions or activities, failing to properly supervise other employees or improperly using confidential information. Employee errors, including mistakes in executing, recording or processing transactions for customers, could cause us to enter into transactions that clients may disavow and refuse to settle, which could expose us to the risk of material losses even if the errors are detected and the transactions are unwound or reversed. If our clients are not able to settle their transactions on a timely basis, the time in which employee errors are detected may be increased and our risk of material loss could be increased. The risk of employee error or miscommunication may be greater for products that are new or have non-standardized terms. It is not always possible to deter employee misconduct or error, and the precautions we take to detect and prevent this activity may not be effective in all cases.
Brokerage services involve substantial risks of liability, and we therefore may become subject to risks of litigation.
Many aspects of our business, and the businesses of our clients, involve substantial risks of liability. Dissatisfied clients may make claims regarding quality of trade execution, improperly settled trades or mismanagement against us. We may become subject to these claims as the result of failures or malfunctions of our trading systems or other brokerage services provided by us, and third parties may seek recourse against us. We attempt to limit our liability to our customers through the use of written or "click-through" agreements, but we do not have such agreements with many of our clients. We could incur significant legal expenses defending claims, even those without merit. An adverse resolution of any lawsuit or claim against us could result in our obligation to pay substantial damages.
If we acquire other companies or businesses, or if we hire new brokerage personnel, we may have difficulty integrating their operations.
To achieve our strategic objectives, we have acquired or invested in, and in the future may seek to acquire or invest in, other companies and businesses. We also may seek to hire brokers for new or existing brokerage desks. These acquisitions or new hires may be necessary in order for us to enter into or develop new product areas or trading systems. Acquisitions and new hires entail numerous risks, including:
•difficulties in the assimilation of acquired personnel, operations, services or products;
•diversion of management's attention from other business concerns;
•assumption of, or exposure to, known and unknown material liabilities of acquired companies or businesses, strategic alliances, collaborations or joint ventures;
•litigation and/or arbitration related to the hiring of brokerage personnel;
•the decrease in our cash reserves, the increased cost of borrowing funds or the dilution resulting from issuances of our equity securities, in each case as consideration to finance the purchase price of any significant acquisitions;
•to the extent that we pursue business opportunities outside the United States, exposure to political, economic, legal, regulatory, operational and other risks that are inherent in operating in a foreign country, including risks of possible nationalization, expropriation, price controls, capital controls, exchange controls and other restrictive governmental actions, as well as the outbreak of hostilities;
•the up-front costs associated with recruiting brokerage personnel, including when establishing a new brokerage desk, such as significant signing bonuses or contractual guarantees of a minimum level of compensation;
•failure to achieve financial or operating objectives; and
•potential loss of clients or key employees of acquired companies and businesses.
In addition, we expect to face competition for acquisition targets and/or joint venture partners, which may limit the number of acquisitions and growth opportunities and could lead to higher acquisition prices. We may not be able to successfully identify, acquire or manage profitably additional businesses or integrate businesses without substantial costs, delays or other operational or financial difficulties.
If we fail to manage these risks as we make acquisitions or make new hires, our profitability may be adversely affected, and we may never realize the anticipated benefits of the acquisitions or hires. In addition, entering into new businesses may require prior approval from regulators. Our ability to obtain timely approval from applicable regulators may hinder our ability to successfully enter new businesses.
Seasonal fluctuations in trading may cause our quarterly operating results to fluctuate.
In the past, our business has experienced seasonal fluctuations, reflecting reduced trading activity during summer months, particularly in August. We also generally experience reduced activity in December due to seasonal holidays. As a result, our quarterly operating results may not be indicative of the results we expect for the full year. Our operating results may also fluctuate quarter to quarter due to a variety of factors beyond our control, such as conditions in the global financial markets, terrorism, war and other economic and political events. Furthermore, we may experience reduced revenues in a quarter due to a decrease in the number of business days in that quarter compared to prior years.
Computer systems failures, capacity constraints, breaches of security and natural or other disasters could prevent us from operating parts of our business or otherwise damage our reputation or business.
We internally support and maintain many of our computer systems, brokerage platforms and networks. Our failure to monitor, maintain or, if necessary, replace these systems, brokerage platforms and networks in a timely and cost-effective manner could have a material adverse effect on our ability to conduct our operations.
We also rely and expect to continue to rely on third parties to supply and maintain various computer systems, trading platforms and communications systems, such as telephone companies, internet service providers, data processors, clearing organizations, software and hardware vendors and back-up services. Our systems, or those of our third party providers, may fail or operate slowly, causing one or more of the following:
•unanticipated disruptions in service to our clients;
•slower response times;
•delays in our clients' trade execution;
•failed settlement of trades;
•decreased client satisfaction with our services or brokerage platforms;
•incomplete, untimely or inaccurate accounting, recording, reporting or processing of trades;
•financial losses;
•litigation or other client claims; and
•regulatory sanctions.
We may experience systems or office failures from power or telecommunications outages, acts of God, war, terrorism, human error, natural disasters, fire, sabotage, hardware or software malfunctions or defects, computer viruses, intentional acts of vandalism or similar events. Additionally, our business continuity or disaster recovery plans and related systems may not be effective to deal with such events and the failure of such plans or systems may have a material adverse effect on our business. Any system failure that causes an interruption in service or decreases the responsiveness of our service, including failures caused by client error or misuse of our systems, could damage our reputation, business and brand name. In addition, if security measures contained in our systems are breached as a result of third-party actions, employee error, malfeasance, or otherwise, our reputation may be damaged and our business could suffer.
If systems maintained by us or third parties malfunction, our clients or other third parties may seek recourse against us. We could incur significant legal expenses defending these claims, even those which we may believe to be without merit. An adverse resolution of any lawsuits or claims against us could result in our obligation to pay substantial damages and could have a material adverse effect on our financial condition or results of operations.
If one or more of our offices were destroyed, damaged or unusable for a period of time we may suffer a loss of revenue, experience business interruption in that region or incur expenses to relocate or repair the affected office to the extent not covered by insurance. If any of these were to occur, it could have a material adverse effect on our financial condition or results of operations.
We may not be able to protect our intellectual property rights or may be prevented from using intellectual property necessary for our business.
Our business depends in part on whether we are able to maintain the proprietary aspects of our technology and to operate without infringing on the proprietary rights of others. We rely primarily on trade secret, contract, copyright, trademark and patent law to protect our proprietary technology. However, these protections may not be adequate to prevent third parties from copying or otherwise obtaining and using our proprietary technology without authorization or otherwise infringing on our rights.
We may also face claims of infringement that could interfere with our ability to use technology that is material to our business operations. We may face limitations or restrictions on the distribution of some of the market data generated by our brokerage desks, which may limit the comprehensiveness and quality of the data we are able to distribute or sell.
In addition, in the past several years, there has been proliferation of so-called "business method patents" applicable to the computer and financial services industries. There has also been a substantial increase in the number of such patent applications filed. Under current law, United States patent applications remain secret for 18 months and may, depending upon where else such applications are filed, remain secret until a patent is issued. In light of these factors, it is not economically practicable to determine in advance whether our products or services may infringe the present or future patent rights of others. In addition, although we take steps to protect our technology, we may not be able to protect our technology from disclosure or from other developing technologies that are similar or superior to our technology. Any failure to protect our intellectual property rights could materially and adversely affect our business and financial condition.
If we are unable to adequately protect our intellectual property rights or if we infringe on the rights of others, we could become involved in costly disputes and may be required to pay royalties or enter into license agreements with third parties.
In the future, we may have to rely on litigation to enforce our intellectual property rights, protect our trade secrets, determine the validity and scope of the proprietary rights of others or defend against claims of infringement or invalidity. This litigation could result from claims that we are violating the rights of others or may be necessary to enforce our own rights. Any such litigation would be time consuming and expensive to defend or resolve and would result in the diversion of the resources and attention of management, and the outcome of any such litigation cannot be accurately predicted. Any adverse determination in such litigation could subject us to significant liabilities or require us to pay royalties or enter into license agreements with third parties, which we may not be able to obtain on terms acceptable to us or at all.
We depend on third-party software licenses. The loss of any of our key licenses could adversely affect our ability to provide our brokerage services.
We license software from third parties, some of which is integral to our execution services, hybrid brokerage systems and our business. These licenses are generally terminable if we breach our obligations under the licenses or if the licensor gives us notice in advance of the termination. If any of these relationships were terminated, or if any of these third parties were to cease doing business, we may be forced to spend significant time and money to replace the licensed software. These replacements may not be available on reasonable terms, if at all. A termination of any of these relationships could have a material adverse effect on our financial condition and results of operations.
Risks Related to Our Liquidity and Financing Needs
Our liquidity and financial condition could be adversely affected by United States and international markets and economic conditions.
Liquidity is essential to our business and is of particular importance to our trading business. Any perceived liquidity issues may affect our clients' and counterparties' willingness to engage in brokerage transactions with us. In addition, our business is dependent upon the availability of adequate regulatory and clearing capital. Clearing capital is the amount of cash, guarantees or similar collateral that we must provide or deposit with our third party clearing organizations in support of our obligations under our contractual clearing arrangements with these organizations. Historically, these needs have been satisfied from internally generated funds, investments from our stockholders and lines of credit made available by commercial banking institutions.
Our liquidity could be impaired due to circumstances that we may be unable to control, such as a general market disruption or an operational problem that affects our clients, third parties or us. Further, our ability to sell assets to generate liquidity may be impaired if other market participants are seeking to sell similar assets at the same time.
Our ability to raise capital in the long-term or short-term debt capital markets or the equity capital markets has been and could continue to be adversely affected by conditions in the United States and international markets and economy. Global market and economic conditions have been, and continue to be, disrupted and volatile. In particular, our cost and availability of raising debt capital may be adversely affected by illiquid credit markets and wider credit spreads. As a result of concern about the stability of the markets, the strength of counterparties and other factors, including the continued impact of the Dodd-Frank Act and other pending legislation and regulatory proposals, many lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers in the financial industry. In addition, our credit rating may impact our ability to obtain to raise additional long or short term capital. See the Risk Factor captioned "Our business may be adversely affected by a reduction in our credit ratings." To the extent we need to raise additional capital, including for acquisitions or meeting increased capital requirements arising from growth in our brokerage business, we may not be able to obtain such additional financing on acceptable terms or on a timely basis, if at all. If we cannot raise additional capital on acceptable terms, we may not be able to develop or enhance our business, take advantage of future opportunities or acquisitions, respond to competitive pressure or meet contractual, regulatory or other unanticipated requirements and as a result, our ability to conduct our business may be materially adversely affected.
Our business may be adversely affected by a reduction in our credit ratings.
There are a number of factors that might contribute to the possibility of having our credit rating downgraded by one or more credit rating agencies, including our profitability and results of operations and the general condition of the economy and the global markets in which we provide our services. In the event of a downgrade of our credit rating by one or more credit rating agencies, our business may be adversely affected.
Our 8.375% Senior Notes, which were issued in July 2011 and will mature in July 2018 ("8.375% Senior Notes"), contain a provision that allows for the applicable per annum interest rate to increase up to a maximum of 200 basis points over the original interest rate if our credit rating is downgraded. The cumulative effect of our credit rating downgrades following the issuance of our 8.375% Senior Notes has resulted in an increase in the interest rate to the maximum rate per annum.
Concerns about our credit ratings may limit our ability to pursue acquisitions and, to the extent we pursue acquisitions that affect our credit ratings, our business may suffer. To avoid placing our credit rating at risk, we may need to limit the growth of our business, or we may even need to reduce our
operations or other expenses to improve profitability. A credit-rating downgrade could also compel us to raise additional capital on unfavorable terms, which could result in substantial additional interest or other expenses and lower earnings. If we were forced to raise equity capital, that action could result in substantial dilution to our existing shareholders.
The financial maintenance covenants in our Credit Agreement could limit the manner in which we conduct our business, and we may be unable to engage in favorable business activities or finance future operations or capital needs as a result.
We are party to a credit agreement with Bank of America N.A. and certain other lenders (the "Credit Agreement"). Pursuant to an assignment and assumption entered into by and among our lenders under the Credit Agreement, the maturity of the $18.75 million of the lender commitments that was to mature in December 2013 has been extended to December 2015. As a result, the Credit Agreement provides for $75 million in lender commitments that mature in December 2015. Under our Credit Agreement, we are required to satisfy and maintain specified financial ratios. Our ability to meet those financial ratios can be affected by events beyond our control, and there can be no assurance that we will meet those ratios. An adverse development affecting our business could require us to seek waivers or amendments of covenants, alternative or additional sources of financing or reductions in expenditures. We cannot assure you that such waivers, amendments or alternative or additional financings could be obtained or, if obtained, would be on terms acceptable to us. A failure to comply with the covenants contained in our Credit Agreement could result in an event of default thereunder or under other agreements, which, if not cured or waived could have a material adverse effect on our business, financial condition and results of operations. In the event of any default under our Credit Agreement, the lenders may not be required to lend any additional amounts to us, or could elect to declare all indebtedness outstanding, together with any accrued and unpaid interest and fees, to be due and payable and terminate all commitments to extend further credit. Such actions by the lenders could cause cross defaults under our other indebtedness, including the indenture governing our 8.375% Senior Notes.
Risks Related to Owning Our Stock
Jersey Partners has significant voting power and may take actions that may not be in the best interest of our other stockholders.
Jersey Partners Inc. ("JPI"), in which our executive chairman and founder, Michael Gooch, is the controlling shareholder, owns approximately 38% of our outstanding common stock. Our chief executive officer, Colin Heffron, is also a minority shareholder of JPI. As a result, through JPI, Michael Gooch has the ability to exert substantial influence over all matters requiring approval by our stockholders, including the election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets and other corporate transactions. This concentration of control could be disadvantageous to other stockholders with interests different from those of Michael Gooch. This concentration of voting power may have the effect of delaying or impeding actions that could be beneficial to our other stockholders, including actions that may be supported by our Board of Directors. The trading price for our common stock could be adversely affected if investors perceive disadvantages to owning our stock as a result of this significant concentration of share ownership.
Provisions of our certificate of incorporation and bylaws, agreements to which we are a party, regulations to which we are subject and provisions of our equity incentive plans could delay or prevent a change in control of our company and entrench current management.
Our second amended and restated certificate of incorporation and bylaws may be deemed to have an anti-takeover effect and may delay, deter or prevent a change of control of us, such as a tender offer or takeover proposal that might result in a premium over the market price for our common stock.
In addition, certain of these provisions make it more difficult to bring about a change in the composition of our board of directors, which could result in entrenchment of current management. For example, our second amended and restated certificate of incorporation and bylaws:
•provide for a classified board of directors;
•do not permit our stockholders to remove members of our board of directors other than for cause;
•do not permit stockholders to act by written consent or to call special meetings;
•require certain advance notice for director nominations and other actions to be taken at annual meetings of stockholders;
•require supermajority stockholder approval with respect to extraordinary transactions such as mergers and certain amendments to our certificate of incorporation and bylaws (including in respect of the provisions set forth above); and
•authorize the issuance of "blank check" preferred stock by our board of directors without stockholder approval, which could discourage a takeover attempt.
Under our Credit Agreement and our 8.375% Senior Notes, a change in control may lead the lenders to exercise remedies such as acceleration of the loan and, in the case of the Credit Agreement, termination of their obligations to fund additional advances.
Our brokerage businesses are heavily regulated and some of our regulators require that they approve transactions which could result in a change of control, as defined by the then-applicable rules of our regulators. The requirement that this approval be obtained may prevent or delay transactions that would result in a change of control.
In addition, our equity incentive plans contain provisions pursuant to which our Board may, in its discretion, determine to accelerate the vesting of outstanding options or restricted stock units in the event of a change of control. If the Board determines to accelerate the vesting of these unvested grants, it could have the effect of dissuading potential acquirers from pursuing merger discussions with us.
If we fail to maintain effective internal control over financial reporting as required by Section 404 of the Sarbanes-Oxley Act, it may have an adverse effect on our business.
We are subject to the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 ("SOX") and the applicable SEC rules and regulations that require our management to conduct an annual assessment and to report on the effectiveness of our internal controls over financial reporting. In addition, our independent registered public accounting firm must issue an attestation report addressing the operating effectiveness of the Company's internal controls over financial reporting.
While our internal controls over financial reporting currently meet all of the standards required by SOX, failure to maintain an effective internal control environment could have a material adverse effect on our business, financial condition and results of operations. We cannot be certain as to our ability to continue to comply with the requirements of SOX. If we are not able to continue to comply with the requirements of SOX in a timely manner or with adequate compliance, we may be subject to sanctions or investigation by regulatory authorities, including the SEC. In addition, should we identify a material weakness, there can be no assurance that we would be able to remediate such material weakness in a timely manner in future periods. Moreover, if we are unable to assert that our internal control over financial reporting is effective in any future period (or if our auditors are unable to express an opinion on the effectiveness of our internal controls), we could lose investor confidence in the accuracy and
completeness of our financial reports, and incur significant expenses to restructure our internal controls over financial reporting, which may have a material adverse effect on our Company.
We cannot provide assurance that we will continue to declare and pay dividends at all or in any particular amounts and we may elect not to pay dividends in the future.
Our Board of Directors has approved a policy of paying quarterly dividends, subject to available cash flow from operations, other considerations and the determination by our Board of Directors of the amount. However, there is no assurance that we will continue to declare and pay dividends at all or in any particular amounts and we may elect not to pay dividends in the future. Our dividend policy may be affected by, among other things, our earnings, financial condition, future capital requirements, level of indebtedness, contractual restrictions with respect to the payment of dividends, the issuance of special dividends from time to time, changes in tax rates and our determination to make certain investments or acquisitions. Our ability to declare a dividend is also subject to the limits imposed by Delaware corporate law and our Credit Agreement.
The market price of our common stock may fluctuate in the future, and future sales of our shares could adversely affect the market price of our common stock.
The market price of our common stock has fluctuated in the past and may fluctuate in the future depending upon many factors, including our actual results of operations and perceived prospects and the prospects of the financial marketplaces in general, differences between our actual financial and operating results and those expected by investors and analysts, changes in analysts' recommendations or projections, seasonality, changes in general valuations for companies in our business segment, changes in general economic or market conditions and broad market fluctuations.
Future sales of our common stock also could adversely affect the market price of our common stock. If our existing stockholders sell a large number of shares, or if we issue a large number of shares of our common stock in connection with future acquisitions, strategic alliances, new or amended equity incentive plans or otherwise, the market price of our common stock could decline significantly. Moreover, the perception in the public market that our stockholders, including JPI, might sell shares of common stock could depress the market price of our common stock.
As of December 31, 2013, we had registered under the Securities Act of 1933, as amended (the "Securities Act"), an aggregate of 139,164 shares of our common stock which are reserved for issuance upon the exercise of outstanding options under our 2002 Stock Option Plan. In addition, as of December 31, 2013, we had registered under the Securities Act an aggregate of 38,200,000 shares of our common stock available for issuance under our 2008 Equity Incentive Plan in connection with existing and new grants of restricted stock units, stock options or similar types of equity compensation awards to our employees. Based on outstanding grants at December 31, 2013, there are 5,234,834 shares of our common stock available for future grants of awards under the 2008 Equity Incentive Plan. These shares can be sold in the public market upon issuance, subject to any vesting requirements and restrictions under the securities laws applicable to resale by affiliates. These sales might impact the liquidity of our common stock and might have a dilutive effect on existing stockholders making it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate.
We may be required to recognize impairments of our goodwill or other intangible assets, which could adversely affect our results of operations or financial condition.
Accounting standards require periodic testing for the impairment of goodwill and intangible assets and any such non-cash charges in the future could have a material impact on our stockholders equity and our results of operations during a particular period. For example, in the fourth quarter of 2013, we
recorded an $18.9 million goodwill impairment charge in our Clearing and Backed Trading reporting unit and a $0.7 million impairment charge related to identifiable intangible assets in our Americas brokerage reporting unit.
The determination of the value of goodwill and intangible assets requires management to make estimates and assumptions that affect our consolidated financial statements. We are required to test goodwill for impairment annually, or in interim periods if certain events occur indicating that the carrying value may be impaired. We assess potential impairments to intangible assets when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. Our judgments regarding the existence of impairment indicators and future cash flows related to goodwill and intangible assets are based on several factors which include: the operational performance of any acquired businesses, management's current business plans which factor in current market conditions, market capitalization, the trading price of our common stock and trading volumes, as well as other factors. Management uses discounted cash flow analysis in their impairment assessments, which involves the subjective selection and interpretation of data inputs, and given market conditions at the testing date, can include a very limited amount of observable market inputs available in determining the model.
Changes to our business plans, increased macroeconomic weakness, declines in operating results and decreased market capitalization may result in our having to perform an interim goodwill impairment test or an intangible asset impairment test. These types of events and the resulting analysis could result in further goodwill or intangible asset impairment charges in future periods.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
We have offices in the United States, Europe, Latin America, Asia, the Middle East and South Africa. Our executive headquarters are located at 55 Water Street, New York, New York 10041, where we occupy approximately 89,000 square feet of leased space, pursuant to a lease that expires in December 2027. Our largest office outside of the New York metropolitan area is our U.K. headquarters, which is located in London at 1 Snowden Street, EC2 2DQ, where we occupy approximately 44,000 square feet pursuant to a lease that expires in March 2025.
Our U.S. operations also lease office space in Sugar Land (TX) and Iselin (NJ). Our foreign operations lease office space in London, Paris, Nyon, Madrid, Hong Kong, Seoul, Singapore, Manila, Sydney, Cape Town, Santiago, Bogota, Buenos Aires, Lima, Dubai, Dublin, Tel Aviv, Tokyo and Mexico City. We believe our facilities will be adequate for our operations for the next twelve months. The properties we occupy are used across all of our business segments, as well as for corporate purposes.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, we are, and have been in the past, involved in, litigations, claims and arbitrations that involve claims for substantial amounts. These proceedings have generally involved either proceedings against our competitors in connection with employee hires, or claims from former employees in connection with the termination of their employment from us. There is also potential for client claims alleging the occurrence of errors in the execution of brokerage transactions. We are also currently, and have been in the past, involved in examinations, investigations or proceedings by government agencies and self-regulatory organizations. These examinations or investigations could result in substantial fines or administrative proceedings that could result in censure, the issuance of cease and desist orders, the suspension or expulsion of a broker dealer and its affiliated persons, officers or employees or other similar consequences.
One of our European subsidiaries is currently defending a claim that they improperly hired a number of employees of a competitor over a period of time. Although the case is in its preliminary stages, the claimant is seeking a multi-million dollar award. We intend to vigorously defend against this action and believe that we have substantial defenses to the claims and damages asserted against us.
Based on currently available information, the outcomes of our outstanding legal proceedings are not expected to have a material adverse impact on our financial position. However, the outcome of any such matters may be material to our results of operations or cash flows in a given period. It is not presently possible to determine our ultimate exposure to these matters and there is no assurance that the resolution of our outstanding matters will not significantly exceed any reserves accrued by us.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information for Common Stock
Our common stock has been listed on the New York Stock Exchange Euronext ("NYSE Euronext") under the symbol "GFIG" since October 5, 2010. Prior to that date our common stock was listed on the Nasdaq Global Select Market since January 26, 2005. Prior to that time, there was no public market for our common stock. Set forth below, for each of the last eight fiscal quarters, is the low and high sales prices per share of our common stock as reported on NYSE Euronext in the first quarter of 2012 through the fourth quarter of 2013.
Holders of Record
As of February 28, 2014, we had approximately 32 holders of record of our common stock.
Dividend Policy
Prior to 2008, we retained all earnings for investment in our business. In February 2008, our Board of Directors approved a policy of paying quarterly dividends, subject to available cash flow from operations, other considerations and the determination by our Board of Directors of the amount.
Any declaration and payment of dividends will be at the discretion of our Board of Directors and will depend upon, among other things, our earnings, financial condition, capital requirements, level of indebtedness, contractual restrictions with respect to the payment of dividends, and other considerations that our Board of Directors deems relevant. The Board's ability to declare a dividend is also subject to limits imposed by Delaware corporate law. In addition, our subsidiaries are permitted to pay dividends to us subject to (i) certain regulatory restrictions related to the maintenance of minimum net capital in those of our subsidiaries that are subject to net capital requirements imposed by applicable law or regulation, and (ii) general restrictions imposed on dividend payments under the jurisdiction of incorporation or organization of each subsidiary. Finally, our Credit Agreement limits our ability to pay dividends in certain circumstances without the approval of our lenders and any instruments governing our future indebtedness may also contain various covenants that limit our ability to pay dividends.
Stock Performance Graph
The following performance graph shows a comparison, from December 31, 2008 through December 31, 2013, of the cumulative total return for our common stock, the NYSE Composite Index, the Nasdaq Other Financial Index and our peer group. The peer group is comprised of ICAP Plc, Tullet Prebon Plc, Compagnie Financiere Tradition, MarketAxess Holdings Inc., BGC Partners Inc., Deutsche Börse Group, ICE and the CME Group Inc.
The performance graph assumes that the value of the initial investment in the Company's common stock, each index and the peer group was $100 on December 31, 2008 and that all dividends have been reinvested. Such returns are based on historical results and are not intended to suggest future performance. The returns of each company within the peer group have been weighted according to their respective stock market capitalization for purposes of arriving at a peer group average.
COMPARISON OF CUMULATIVE TOTAL RETURN
Equity Compensation Plan Information
For the information concerning securities authorized for issuance under our equity compensation plans, see Part III "Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters" in this Form 10-K.
Purchase of Equity Securities
The table below sets forth the information with respect to purchases made by the Company of its common stock during the quarterly period ended December 31, 2013.
Issuer Purchases of Equity Securities
(a)Under our 2008 Equity Incentive Plan, we withhold shares of common stock to satisfy minimum statutory tax withholding obligations arising on the vesting and settlement of restricted stock units. When we withhold these shares, we are required to remit to the appropriate taxing authorities the market price of the shares withheld, which could be deemed a purchase of the shares of our common stock by us on the date of withholding.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial data for the five years ended December 31, 2013. This selected consolidated financial data should be read in conjunction with "Item 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes thereof in Part II-Item 8 hereof. This discussion contains forward-looking statements. Actual results could differ materially from the results discussed in these forward-looking statements. Please see "Forward-Looking Statements" and "Risk Factors" for a discussion of some of the uncertainties, risks and assumptions associated with these statements.
Business Environment
As a leading provider of wholesale brokerage services, clearing services and electronic execution and trading support products for global financial markets, our results of operations are impacted by a number of external market factors, including market volatility and transactional volumes, the organic growth or contraction of the derivative and cash markets in which we provide our brokerage services, the particular mix of transactional activity in our various products, the competitive and regulatory environment in the various jurisdictions and markets in which we operate and the financial condition of the dealers, hedge funds, traders and other market participants to whom we provide our services. Outlined below are management's observations of these external market factors during the most recent fiscal period. The factors outlined below are not the only factors that impacted our results of operations for the most recent fiscal period, and additional or other factors may impact, or have different degrees of impact, on our results of operations in future periods.
Market Volumes and Volatility
Recent Activity in Underlying Markets. We believe that overall market volatility was lower in the year ended December 31, 2013 as compared to 2012 and that lower volatility led, in part, to decreased trading volumes for the year. We also believe that trading volumes were adversely impacted by the broad market uncertainties surrounding the CFTC-regulated SEFs compliance deadline in October 2013. These factors led to difficult trading conditions in the second half of 2013.
The level of organic growth or contraction in the OTC derivatives markets we serve, as well as our market share within any particular market, has historically been difficult to measure on a timely basis as there are only a few independent, objective measures of the outstanding notional amount of OTC derivatives, all of which are published retrospectively and do not measure transactional volumes. Therefore, to help gauge growth or contraction in any particular quarter or year, management has looked to the published results of large OTC derivatives dealers and certain futures and derivative exchanges as potential indicators of transactional activity in the related OTC derivative markets. In future periods, as SEFs and swap data repositories report their daily trading volumes pursuant to applicable CFTC regulations, management expects such data to provide an indication of overall market size and our relative market share within such derivative markets.
OTC market volumes generally declined across most asset classes during the year ended December 31, 2013, as compared to the year ended December 31, 2012. OTC markets continued to confront regulatory, market and economic uncertainties, as well as continuing low short-term interest rates globally. The level of the Chicago Board Options Exchange Volatility Index ("VIX"), on average, was approximately 20% lower during the year ended December 31, 2013 when compared to the prior year. Similarly, the BAML Global Financial Stress Index was, on average, substantially lower during 2013 when compared to 2012. We believe that these indexes provide valuable proxies for the overall volatility across our four brokerage product categories. However, it should be noted that volatility events can affect each of our product categories to varying degrees.
Fixed Income Volumes. Our fixed income product category is comprised of revenues related to the brokerage of cash and derivative fixed income products. Fixed income volumes typically correlate with
fluctuations in interest rates, market volatility and the level of bond issuances. BrokerTec, a leading electronic trading platform in the fixed income market, reported increased average daily volumes ("ADV") of 8% in 2013 vs. 2012. Similarly, the Securities Industry and Financial Markets Association ("SIFMA") reported an increase in the ADV of U.S. corporate debt of 8% and an increase in corporate bond issuance of 1% for the year ended December 31, 2013, as compared to the prior year. However, ICE reported a 15% decline in its credit default swap trade execution revenues compared with the prior year. Despite some of these positive metrics, dealer banks and wholesale brokers generally reported declines in their fixed income revenues for 2013, as compared to the prior year, which they attributed to difficult trading conditions. In comparison, our brokerage revenues from fixed income products declined 7% in the year ended December 31, 2013, as compared to the prior year.
Interest Rate and Foreign Exchange Volumes. Our financial product category largely consists of revenues related to the brokerage of foreign exchange and interest rate derivative products. Foreign exchange volumes generally increased for the year ended December 31, 2013, compared to the same period in the prior year, primarily driven by volatility in the first half of the year from diverging U.S. and Japanese monetary policy. It should be noted that market conditions were notably different in the latter half of the year with lower market volatility and regulatory uncertainty negatively impacting volumes. CME foreign exchange futures ADVs increased 5% in 2013, as compared to 2012, while EBS, an electronic trading platform for spot currencies, reported a 6% decrease in volumes year over year. Reported volumes for interest rate products generally increased during the year ended December 31, 2013, as compared to 2012, with CME reporting a 22% increase in interest rate futures ADVs in 2013, as compared to the prior year. Our brokerage revenues from financial products increased 4% in the year ended December 31, 2013, compared to the prior year.
Equity Volumes. Our equity product category consists of revenues related to the brokerage of cash equity and equity derivative products. Equity derivative volumes in Europe and the U.S. generally declined in 2013, due to lower market volatility. International Securities Exchange's equity derivative volumes declined 5%, and Eurex European equity derivative volumes decreased 6% in 2013 as compared to the prior year. ADVs for NYSE Euronext's U.S. cash products declined 11% while its European cash products decreased 5%, year over year. Our brokerage revenues from equity products declined 14% from the prior year.
Commodity Volumes. Our commodity product category consists of revenues related to the brokerage of a wide range of energy products, and to a lesser extent, other commodity products. We believe that overall energy notional volumes declined in the U.S. from a year ago due to regulatory, market and economic uncertainty. CME's Energy futures ADVs decreased 1% in 2013 from the prior year, while ICE's energy futures volumes increased 1%. In addition, the annual average rate per contract ("RPC") declined approximately 13% and 4% for CME and ICE, respectively, when compared to the prior year. We believe that the decline in RPC was due to product mix, the introduction of mini contracts which trade in a smaller notional value than standard energy contracts and volume/pricing incentives. Our brokerage revenues from commodity products declined 13% in 2013.
Clearing Services Volumes. Our Kyte subsidiary's clearing operations are subject to many of the same drivers that influence OTC market volumes. Although market-wide trading volumes were generally lower in 2013, Kyte's clearing revenues increased by 18%, largely due to increased trading activity and the mix of products and exchanges utilized by existing clearing service customers. Kyte's clearing services revenues include the exchange fees that Kyte charges to its clients but then passes on to the exchanges.
Competitive and Regulatory Environment
Another major external market factor affecting our business and results of operations is competition, which may take the form of competitive pressure on the commissions we charge for our services or competition for qualified personnel with extensive experience in the specialized markets we serve. We currently compete for the services of skilled brokerage personnel with other wholesale market participants and, more broadly, we compete for the services of highly qualified technology development personnel. We believe that the demand for productive brokers has lessened in recent periods, as the wholesale brokerage industry has been impacted by lower trading volumes and sluggish trading conditions in certain markets we serve. However, we believe that there is increased competition to provide brokerage services to a smaller number of market participants in the near term as dealers continue to exit or reduce their proprietary trading operations.
In addition, we believe that the continued regulatory uncertainty in certain markets has resulted in lower trading volumes and fewer participants in these markets. GFI Swaps Exchange LLC, our SEF platform, was temporarily registered as a SEF by the CFTC in September 2013 and many of the rules governing the operation of a multi-lateral trading platform for swaps in the U.S. became effective on October 2, 2013. The requirements for SEF trading are still in their infancy and there remains significant confusion regarding the interpretation of these regulations and their cross-border application. This continues to create uncertainty and depressed volumes, as market participants work to understand how to structure their global business and trading. Additionally, the SEC has not yet finalized its rules for security-based SEFs, nor has it published a timetable for the finalization and implementation of such rules. However, in the long run, we remain optimistic that the regulatory reform of recent years, including requirements for enhanced regulatory transparency, central clearing and efficient execution, will benefit and enable growth in the global derivatives markets.
Technology Development
Over the past year, we have continued to expand our proprietary electronic trade execution capabilities for our SEF and non-SEF businesses, as well as the number of users of our hybrid electronic trading platforms. We believe the impact of the Dodd-Frank Act will encourage the growth of hybrid electronic trading for a number of products we broker and we believe that our technological capability will position us well in the future as regulatory rules are finalized and implemented. For example, revenues from our electronic matching sessions have approximately tripled in cash fixed income products and doubled in fixed income derivatives in the fourth quarter of 2013 compared to the same quarter of 2012.
The provision of electronic trade execution requires increasingly complex systems and infrastructures and new regulations may require new business models. Our continued success will depend on our ability to enhance and improve our existing platforms and services, develop and/or license new products and technologies that address the increasingly sophisticated needs of the markets and respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis.
Financial Overview
Our results of operations are significantly impacted by the amount of revenues we generate and the amount of compensation and benefits we provide to our employees. The following factors had a
significant impact on our revenues and employee costs during the three year period ended December 31, 2013:
Our total revenues decreased 2.5% to $901.5 million for the year ended December 31, 2013 from $924.6 million for the year ended December 31, 2012. The main factors contributing to this decrease in our revenues were:
•Regulatory uncertainty surrounding the SEF compliance deadline in October of 2013, which we believe led to lower trading volumes in the second half of 2013, compared to the same period in the prior year;
•Lower volatility in many of the markets in which we provide brokerage services which adversely impacted trading volumes; and
•The reduction in brokerage personnel headcount and the closure of certain unprofitable brokerage desks globally.
Partially offsetting the above factors were the following factors that we believe positively affected our brokerage and other revenues:
•Increased clearing services revenues due to a variation in the mix of products and exchanges utilized by our new and existing clearing service customers;
•Contributions from investments in new brokerage desks and offices focused on certain fixed income and financial products;
•Increased customer usage of our electronic trading platforms and matching sessions; and
•The continued strong performance of our Trayport and FENICS® subsidiaries, which led to an increase in our software, analytics and market data revenue.
The most significant component of our cost structure is employee compensation and benefits, which includes salaries, amortization of sign-on and retention bonuses, incentive compensation and related employee benefits and taxes. Our employee compensation and benefits expense decreased 5.5% to $516.2 million for the year ended December 31, 2013 from $546.5 million for the year ended December 31, 2012.
Our compensation and employee benefits for all employees have both a fixed and a variable component. Base salaries and benefit costs are primarily fixed for all employees, while performance bonuses constitute the variable portion of our compensation and employee benefits. Within overall compensation and employee benefits, the employment cost of our brokerage personnel is the key component. Bonuses for brokerage personnel are primarily based on individual performance and/or the operating results of their related brokerage desk. Additionally, a portion of our bonus expense is subject to contractual guarantees that may require us to make bonus payments to brokers regardless of their performance in any particular period. For many of our brokerage employees, bonuses constitute a significant component of their overall compensation. Broker performance bonuses decreased to $151.6 million for the year ended December 31, 2013 from $170.4 million for the year ended December 31, 2012.
Further, we may pay sign-on bonuses to certain newly-hired brokers and retention bonuses to certain of our existing brokers who agree to long-term employment agreements. These bonuses may be paid in the form of cash or restricted stock units ("RSUs"), or a combination of the two, and are typically expensed over the term of the related employment agreement for cash bonuses and the related service period for RSUs, which is generally two to four years. These employment agreements typically contain provisions requiring the repayment of all or a portion of the cash payment and forfeiture provisions for unvested RSUs should the employee voluntarily terminate his or her employment or if the employee's employment is terminated for cause during the initial term of the agreement. Sign-on
and retention bonuses, when granted, also increase the fixed component of our compensation and employee benefits expense for the remainder of the term over which such bonus is earned by the employee. Compensation expense resulting from the amortization of broker sign-on and retention bonuses was $34.5 million for the year ended December 31, 2013, as compared to $34.6 million for the year ended December 31, 2012.
Results of Consolidated Operations
The following table sets forth our consolidated results of operations for the periods indicated:
The following table sets forth our consolidated results of operations as a percentage of our revenues, net of interest and transaction-based expenses for the periods indicated:
Year Ended December 31, 2013 Compared to the Year Ended December 31, 2012
Net Loss
GFI's net loss for the year ended December 31, 2013 increased $10.0 million to $20.0 million from a net loss of $10.0 million for the year ended December 31, 2012. Total revenues decreased by $23.1 million, or 2.5%, to $901.5 million in 2013 from $924.6 million in the prior year. The net decrease in total revenues was primarily due to lower brokerage revenues, which decreased $50.1 million, or 7.2%, largely due to the factors set forth above under the "Financial Overview" section, partially offset by higher Clearing services revenues due to increased trading activity and a
variation in the mix of products and exchanges utilized by new and existing clearing service customers of our Kyte subsidiary.
Total interest and transaction-based expenses increased $17.0 million to $154.5 million in 2013. The increase was primarily due to higher transaction fees on clearing services at our Kyte subsidiary, due to the same factors mentioned above and discussed in more detail below under the heading "Interest and Transaction-Based Expenses".
Total expenses, excluding interest and transaction-based expenses, decreased by $20.0 million, or 2.5%, to $768.3 million for 2013. The decrease was primarily due to lower performance bonus expense on lower brokerage revenues in 2013, as well as lower costs due to initiatives implemented during the past two years to rationalize our cost structure including, (i) lower salary expense on reduced brokerage personnel headcount, (ii) lower costs for communications and market data and (iii) lower travel and promotion expenses. Partially offsetting these decreases was an aggregate non-cash impairment charge of $19.6 million in 2013.
Revenues
The following table sets forth the changes in revenues for the year ended December 31, 2013, as compared to the same period in 2012 (dollars in thousands, except percentage data):
*Denotes % of revenues, net of interest and transaction-based expenses
**Denotes % change in 2013 as compared to 2012
Brokerage Revenues-We offer our brokerage services in four broad product categories: fixed income, equity, financial, and commodity. Below is a discussion of our brokerage revenues by product category for the year ended December 31, 2013 as compared to 2012.
•Broker productivity (defined as total brokerage revenues during the period divided by average monthly brokerage personnel headcount for the period) across all product categories was $560 thousand for 2013 and remained relatively unchanged when compared to 2012.
•Fixed income product brokerage revenues decreased $12.6 million, or 6.7%, in 2013 compared to 2012. Revenues from cash fixed income products decreased approximately 3.9% and revenues from fixed income derivative products decreased by 11.0% in the year. The overall decrease in
fixed income product revenue was largely due to lower market volatility and regulatory concerns partially offset by additional revenues from the hiring of new fixed income brokerage personnel. Our average monthly brokerage personnel headcount for fixed income products increased by 9 to 330 employees in 2013.
•Equity product brokerage revenues decreased $19.2 million, or 14.2%, in 2013. The decrease was primarily attributable to lower cash equity and equity derivative trading volumes in Europe and the U.S., and reduced brokerage personnel headcount in this product category. The revenue decline generally correlates with the volume declines in the equity exchange markets. Our average monthly brokerage personnel headcount for equity products decreased by 35 to 182 employees in 2013.
•Financial product brokerage revenues increased $6.8 million, or 3.7%, in 2013. The increase was primarily attributable higher market volatility in the first half of 2013 related to divergent monetary policy in the U.S. and Japan. This increase was partially offset by reduced brokerage personnel headcount in this product category and regulatory concerns in the latter half of 2013. Our average monthly brokerage personnel headcount for financial products decreased by 22 to 369 employees in 2013.
•The decrease in commodity product brokerage revenues of $25.0 million, or 13.4%, in 2013 was due, in part, to lower energy trading volumes in the U.S. and reduced brokerage personnel headcount in this product category. We believe that trading volumes in commodity products were impacted by (i) uncertainty surrounding the regulatory landscape for certain market participants and transactions, and (ii) the reduced trading operations of certain commodities dealers. The revenue decline generally correlates with the revenue decline across OTC and exchange markets in this product category. Our average monthly brokerage personnel headcount for commodity products decreased by 36 to 272 employees in 2013.
Clearing Services Revenue
•Clearing services revenues increased by 17.9% to $21.1 million for 2013, due to an increase in the number of trades cleared by our Kyte subsidiary. Clearing services revenues consist of fees charged to our clearing service customers for clearing, settlement and other services. Kyte also incurs exchange fees on behalf of its customers, which Kyte then charges to its customers, and are therefore included in equal amounts in both revenues and expenses.
Other Revenues
•Other revenues were comprised of the following (dollars in thousands):
Other revenues increased by $5.9 million to $116.9 million for the year ended December 31, 2013. This increase was largely related to (i) an increase in software revenues at our Trayport and FENICS® subsidiaries, due to expansion of their customer base and their products and services offered, and (ii) a net increase of $5.7 million related to the remeasurement of foreign currency transactions and balances, including a translation gain on the liquidation of a foreign subsidiary of $1.6 million. Foreign currency remeasurement gains and losses result from the remeasurement of asset and liability balances that are denominated in currencies other than the functional currency of the business unit involved in such transactions.
Offsetting this increase in Other revenues was (i) a net decrease of $4.1 million in net realized and unrealized gains (losses) related to foreign currency forward contracts and (ii) a net decrease of $1.8 million in Other, which was due, in large part, to a decrease in our estimated future purchase commitment to acquire the residual 30% equity interest in Kyte when compared to the prior year.
Interest and Transaction-Based Expenses
•The increase in total interest and transaction-based expenses of $16.9 million in 2013 was primarily due to an increase in the number of trades cleared by our Kyte subsidiary. Kyte pays to use the services of third parties who act as general clearing members of clearing houses in order to clear cash and derivative products for its customers. Kyte also incurs exchange fees on each trade, which they pass through to their customers and which are therefore included in equal amounts in both revenues and expenses. The gross margin on clearing services revenues remained consistent at 3.6% for the year.
Expenses
The following table sets forth the changes in expenses for the year ended December 31, 2013 as compared to the same period in 2012 (dollars in thousands, except percentage data):
*Denotes % of revenues, net of interest and transaction-based expenses
**Denotes % change in 2013 as compared to 2012
Compensation and Employee Benefits
•The $30.3 million decrease in compensation and employee benefits expense for 2013 was primarily due to (i) lower broker performance bonus expense resulting from lower brokerage revenues, (ii) lower salary expense on reduced brokerage personnel headcount and (iii) initiatives implemented in the last two years to rationalize our aggregate compensation expense and increase the flexibility of our compensation arrangements.
•Total compensation and employee benefits, as a percentage of revenues, net of interest and transaction-based expenses, decreased to 69.1% in 2013 from 69.4% in the prior year.
•Performance bonus expense represented 35.3% and 36.7% of total compensation and employee benefits expense for the years 2013 and 2012, respectively. A portion of our bonus expense is subject to contractual guarantees that may require us to make bonus payments to brokers regardless of their performance in any particular period. Additionally, sign-on and retention bonus expense, which includes the amortization of cash sign-on and retention bonuses initially paid in prior periods, represented 7.1% and 7.0% of total compensation and employee benefits expense for 2013 and 2012, respectively.
All Other Expenses
•The decrease in communications and market data expense of $6.9 million for 2013 was primarily due to a reduction in brokerage headcount, as well as cost savings initiatives implemented during the past two years.
•The decrease in travel and promotion expense of $5.0 million in 2013 was predominantly due to a reduction in brokerage headcount and our efforts to reduce travel and promotion expense.
•The increase in rent and occupancy expense of $4.7 million was primarily due to a gain of $3.2 in the prior year related to an adjustment of a loss accrual on a sublease of our former headquarters.
•During 2013, we recorded non-cash charges of $19.6 million related to the impairment of goodwill and certain intangible assets. The most significant of these charges was a non-cash, pre-tax charge of $18.9 million recorded during the fourth quarter of 2013 within our Clearing and Backed Trading reporting unit. This impairment was largely due to a decrease in the forecasted cash flows of our Kyte subsidiary, reflecting a decrease in the expected revenues and margins previously estimated by management.
Income Taxes
•We recorded a benefit from income taxes of $2.3 million for the year ended December 31, 2013, as compared to a provision for income taxes of $8.4 million for the year ended December 31, 2012. The net decrease in income taxes was primarily due to: (i) changes in the geographic mix of our profits, (ii) a tax benefit under the American Taxpayer Relief Act of 2012 related to taxes previously provided for, (iii) a tax benefit arising from a change in our view about the deductibility of a reserve previously deemed nondeductible, as a result of new information received in the first quarter of 2013 and (iv) the release of a reserve in a foreign subsidiary where the statute of limitations has now expired.
Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011
Net Loss
GFI's net loss for the year ended December 31, 2012 increased $6.8 million to $10.0 million from a net loss of $3.2 million for the year ended December 31, 2011. Total revenues decreased by $90.9 million, or 9.0%, to $924.6 million in the year ended December 31, 2012 from $1.02 billion in the prior year. The decrease in total revenues was primarily due to lower brokerage revenues, which decreased $101.1 million, or 12.7%, partially offset by a net increase in "Other Revenues," as described in more detail below.
Total interest and transaction-based expenses increased $2.8 million to $137.5 million in 2012. The increase resulted from higher transaction fees on clearing services at our Kyte subsidiary primarily due to the mix of products and exchanges utilized by existing and new customers.
Total expenses, excluding interest and transaction-based expenses, decreased by $92.4 million, or 10.5%, to $788.3 million for 2012 from $880.7 million for 2011. The decrease in total other expenses was largely attributable to a decrease in compensation and employee benefits expense, which resulted primarily from (i) lower performance bonus expense as a result of lower brokerage revenues and (ii) initiatives implemented during the latter part of 2011 and throughout 2012 to reduce our aggregate compensation expense. The decrease was also due to lower travel and promotion expenses and professional fees.
Revenues
The following table sets forth the changes in revenues for the year ended December 31, 2012, as compared to the same period in 2011(dollars in thousands, except percentage data):
*Denotes % of revenues, net of interest and transaction-based expenses
**Denotes % change in 2012 as compared to 2011
Brokerage Revenues-We offer our brokerage services in four broad product categories: fixed income, equity, financial, and commodity. Below is a discussion of our brokerage revenues by product category for the year ended December 31, 2012.
•Broker productivity (defined as total brokerage revenues during the period divided by average monthly brokerage personnel headcount for the period) across all product categories was $562 thousand for 2012 and decreased by approximately 13.1% as compared to 2011.
•Fixed income product brokerage revenues decreased $46.2 million, or 19.7%, in 2012 compared to 2011. Revenues from fixed income derivative and cash products decreased approximately 34.4% and 5.9%, respectively, as compared to the year ended December 31, 2011. This decrease was partially due to lower trading volumes attributable, in part, to pending reform in the swaps market, as well as poor global economic conditions, continued low interest rates, market uncertainty and the ongoing sovereign debt issues in the Eurozone. Our average monthly brokerage personnel headcount for fixed income products decreased by 21 to 321 in 2012.
•Equity product brokerage revenues decreased $39.0 million, or 22.3%, in 2012 compared to 2011. The decrease was primarily attributable to reduced cash equity and equity derivative trading volumes in the U.S. and Europe. This decrease was consistent with the decline in equity volumes reported in the broader exchange-traded cash and derivatives markets. Our average monthly brokerage personnel headcount for equity products decreased by 27 to 217 in 2012.
•Financial product brokerage revenues decreased $6.6 million, or 3.5%, in 2012 compared to 2011. The decrease was primarily due to slow trading conditions in emerging markets in Latin America and Asia, partially offset by revenues from our new brokerage desks in France and Switzerland, which commenced operations in October of 2011. Our average monthly brokerage personnel headcount for financial products increased by 58 to 391 in 2012.
•Commodity product brokerage revenues decreased $9.2 million, or 4.7%, in 2012 compared to 2011. We believe that this decrease was largely attributable to regulatory uncertainty as it relates to the U.S. energy markets and the conversion of OTC swaps to exchange-traded futures contracts in many North American energy products during the fourth quarter of 2012. Partially offsetting this decrease was an increase in commodity brokerage revenues due to growth in certain energy and metals businesses and the addition of new desks in the U.S. and Europe. Our average monthly brokerage personnel headcount for commodity products decreased by 3 to 308 in 2012.
Clearing Services Revenue
•Clearing services revenues increased by 4.7%, or $5.3 million, in 2012 to $118.0 million due to a variation in the mix of products and exchanges utilized by our new and existing clearing service customers partially offset by a decrease in the number of trades cleared by our Kyte subsidiary. Clearing services revenues are related solely to the operations of Kyte and consist of fees charged to our clearing service customers for clearing, settlement and other services. Kyte also incurs exchange fees on behalf of its customers, which Kyte then charges to its customers, and are therefore included in equal amounts in both revenues and expenses.
Other Revenues
•Other revenues were comprised of the following (dollars in thousands):
Other revenues increased by $4.9 million to $111.0 million for the year ended December 31, 2012 from $106.1 million for the year ended December 31, 2011. This increase was largely related to an increase in our software, analytics and market data revenues of $10.5 million, which was primarily attributable to an increase in software revenues at our Trayport subsidiary, due to expansion of their customer base and products and services offered. Other revenues also increased due to a $2.4 million increase in net realized and unrealized gains related to foreign currency forward contracts used to hedge certain non-U.S. dollar assets and revenues. Partially offsetting these increases was a $3.4 million net decrease in Other revenues related to the remeasurement of foreign currency transactions and balances and a net decrease of $1.9 million in net earnings of unconsolidated businesses. The foreign currency remeasurement gains and losses result from the remeasurement of asset and liability balances that are denominated in currencies other than the functional currency of the business unit involved in such transactions.
Interest and Transaction-Based Expenses
•The increase in total interest and transaction-based expenses of $2.8 million for the year ended December 31, 2012 was due to an increase in transaction fees on clearing services of $5.4 million which are entirely related to the clearing operations of our Kyte subsidiary. This increase was primarily due to a variation in the mix of products and exchanges utilized by our new and existing clearing service customers partially offset by a decrease in the number of trades cleared. Kyte pays to use the services of third parties who act as general clearing members of clearing houses in order to clear cash and derivative products for its customers. Kyte also incurs exchange fees on behalf of its clients, which are mostly pass-through costs and are therefore included in equal amounts in both revenues and expenses. This increase was partially offset by a decrease in transaction fees on brokerage services of $1.7 million due to a decrease in brokerage revenues executed on a matched principal basis, for which we typically incur transaction-based expenses, such as clearing fees.
Expenses
The following table sets forth the changes in expenses for the year ended December 31, 2012 as compared to the same period in 2011 (dollars in thousands, except percentage data):
*Denotes % of revenues, net of interest and transaction-based expenses
**Denotes % change in 2012 as compared to 2011
Compensation and Employee Benefits
•The $80.9 million decrease in compensation and employee benefits expense for 2012 was primarily due to lower broker performance bonus expense resulting from lower brokerage revenues and initiatives implemented in the latter part of 2011 and throughout 2012 to reduce our aggregate compensation expense. Compensation expense was also higher in 2011 due to a $19.4 million charge taken in that year related to severance and other restructuring expenses.
•Total compensation and employee benefits as a percentage of revenues, net of interest and transaction-based expenses, decreased to 69.4% in 2012 from 71.2% in the prior year.
•Performance bonus expense represented 36.7% and 43.3% of total compensation and employee benefits expense for the year ended December 31, 2012 and 2011, respectively. A portion of our bonus expense is subject to contractual guarantees that may require us to make bonus payments to brokers regardless of their performance in any particular period. Additionally, sign-on and
retention bonus expense, which includes the amortization of cash sign-on and retention bonuses initially paid in prior periods, represented 7.0% and 7.7% of total compensation and employee benefits expense for the years 2012 and 2011, respectively.
All Other Expenses
•The decrease in travel and promotion expense of $4.2 million was due, in large part, to the low volume trading environment that persisted throughout 2012 and a reduction in brokerage personnel headcount, as well as cost savings initiatives implemented in 2011 and 2012.
•The decrease in rent and occupancy expense of $1.0 million was primarily due to a gain of $3.2 million related to an adjustment of a loss accrual on a sublease of our former headquarters, partially offset by the renewal of our office lease in the U.K. in the fourth quarter of 2011 at a higher rent.
•The decrease in professional fees of $4.2 million for 2012 as compared to 2011 was partially due to a decrease in our global audit fee in the current year as well as lower consulting fees associated with regulatory compliance in the U.K.
•The increase in interest on borrowings of $1.1 million was due to the July 2011 issuance of $250.0 million of 8.375% Senior Notes, which led to an increase in borrowings outstanding and a higher average effective interest rate on long-term debt obligations during the year ended December 31, 2012. This increase was largely offset by $6.0 million in bond redemption costs recognized in the third quarter of 2011 associated with our July 2011 redemption of the entire $60.0 million principal amount of our then-outstanding 7.17% senior secured notes, which were due in January 2013 ("7.17% Senior Notes").
•Our provision for income taxes increased to $8.4 million in 2012 compared to $2.6 million in 2011, primarily due to (i) additional U.S. tax expense related to certain international profits and (ii) the establishment of valuation allowances against deferred tax assets in jurisdictions where we have determined they are unlikely to be utilized. The increased tax rate was partially offset by (i) the impact of a decrease in the statutory corporate tax rate in the U.K, (ii) a release of an unrecognized tax benefit from 2008, 2009, and 2010 where the position has now been resolved with the relevant tax authority and (iii) a reconciliation of prior year estimates against tax return filings.
Results of Segment Operations
Based on the nature of our operations, products and services in each geographic region, we determined that we have four reportable segments: (i) Americas Brokerage, (ii) Europe, Middle East and Africa ("EMEA") Brokerage, (iii) Asia Brokerage and (iv) Clearing and Backed Trading. Our brokerage operations provide brokerage services in four broad product categories: fixed income, financial, equity and commodity. Our Clearing and Backed Trading segment encompasses our clearing, risk management, settlement and other back-office services, as well as the capital we provide to start-up trading groups, small hedge funds, market-makers and individual traders. All Other includes the results of our software, analytics and market data operations. All Other also includes revenues and expenses that are not directly assignable to one of our reportable segments, primarily consisting of indirect costs related to our brokerage segments as well as all our corporate business activities.
The following tables summarize our Total revenues, Revenues, net of interest and transaction-based expenses, Other expenses and Income (loss) before income taxes by segment:
Segment Results for the Year Ended December 31, 2013 Compared to the Year Ended December 31, 2012
Total Revenues
•Total revenues for Americas Brokerage decreased $14.7 million, or 5.3%, to $261.7 million in 2013. Total revenues for EMEA Brokerage decreased $32.0 million, or 9.5%, to $306.5 million for the year. Total revenues for Asia Brokerage decreased $4.3 million, or 6.1%, to $67.6 million for the year ended December 31, 2013 from $71.9 million for the year ended December 31, 2012. Total revenues for our three brokerage segments decreased by $51.0 million, or 7.4%, to $635.8 million for 2013. The decrease in total revenues for our brokerage segments was primarily due to the factors described above under "Year Ended December 31, 2013 Compared to the Year Ended December 31, 2012."
•Total revenues for Clearing and Backed Trading increased $16.4 million, or 10.3%, to $176.3 million for 2013. The increase was due primarily to an increase in clearing services revenues as a result of an increase in the number of trades cleared by our Kyte subsidiary, as well as a variation in the products and exchanges utilized by their clearing service customers.
•Total revenues included in All Other primarily consisted of revenues generated from sales of software, analytics and market data. Total revenues for All Other increased by $11.4 million, or 14.6%, to $89.3 million for the year ended December 31, 2013. This increase was due, in large part, to an increase in software revenues at our Trayport and FENICS® subsidiaries due to the expansion of their customer base and the products and services offered. Also contributing to the increase was a net gain on revaluation of balances denominated in currencies other than their functional currency, including a translation gain on the liquidation of a foreign subsidiary. Partially offsetting this increase was a net decrease in realized and unrealized gains (losses) related to foreign currency forward contracts used to hedge certain non-U.S. dollar assets, liabilities and anticipated revenues and expenses denominated in foreign currencies.
Total interest and transaction-based expenses
•Total interest and transaction-based fees for our three brokerage segments decreased by $3.3 million, or 13.9%, to $20.4 million in 2013. This decline was consistent with the net decline in our revenues for those products for which we incur transaction-based fees.
•Total interest and transaction-based fees for our Clearing and Backed Trading segment increased by $20.2 million to $135.5 million in 2013 from $115.3 million in the prior year primarily due an increase in the number of trades cleared by our Kyte subsidiary, as well as variations in the mix of products and exchanges utilized by existing and new clearing service customers.
Other Expenses
•Other expenses for Americas Brokerage decreased $11.9 million, or 6.2%, to $181.0 million for the year ended December 31, 2013. Other expenses for EMEA Brokerage decreased $30.3 million, or 12.3%, to $215.1 million for the year. Other expenses for Asia Brokerage decreased $5.0 million, or 8.9%, to $51.7 million for the year. Total Other expenses for our three brokerage segments decreased by $47.2 million, or 9.5%, to $447.8 million for the year ended December 31, 2013. The decrease across all brokerage segments was due, in large part, to a decrease in compensation and employee benefits expense resulting from lower performance bonus expense on lower brokerage revenues for 2013 and lower salary expense due to reduced brokerage personnel headcount. The decrease was also due to global initiatives we implemented during the last two years to rationalize our aggregate compensation expense and increase the flexibility of our compensation arrangements.
•For our brokerage segments, we record certain direct expenses, including compensation and employee benefits; however, we do not allocate certain expenses that are managed separately at the corporate level to these operating segments. The unallocated costs including rent and occupancy, depreciation and amortization, professional fees, interest and other expenses are included in the expenses for All Other described below. Management does not believe that allocating these costs to our brokerage segments is optimal for evaluating the performance of its brokerage segments.
•Other expenses for Clearing and Backed Trading increased $19.3 million, or 50.9%, to $57.2 million in 2013. The increase was primarily due to a goodwill impairment charge taken in the fourth quarter of 2013 of $18.9 million. The increase was also partially due to higher performance bonus expense as a result of increased trading revenues for this segment. These increases were slightly offset by a decrease in communications and market data expenses for this segment.
•Other expenses in All Other increased by $7.9 million, or 3.1%, to $263.3 million in 2013. The increase was primarily due to an increase in compensation and employee benefits expense related to increased technology headcount to support our electronic brokerage and software
development efforts. The increase was also due to (i) an increase in interest expense relating to our senior notes as a result of rating agency downgrades and (ii) a $3.2 million gain in 2012 related to an adjustment of a loss accrual on a sublease of our former headquarters. Partially offsetting these increases were decreases in Other expenses, travel and promotion and communications and market data due to cost savings initiatives implemented in the past two years to reduce expenses.
Segment Results for the Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011
Total Revenues
•Total revenues for Americas Brokerage decreased $37.1 million, or 11.8%, to $276.4 million in 2012. Total revenues for EMEA Brokerage decreased $47.5 million, or 12.3%, to $338.5 million in 2012. Total revenues for Asia Brokerage decreased $11.0 million, or 13.3%, to $71.9 million in 2012. Total revenues for our three brokerage segments decreased by $95.6 million, or 12.2%, to $686.8 million for the year ended December 31, 2012 from $782.4 million for the year ended December 31, 2011. The decrease in total revenues for our brokerage segments was primarily due to the factors described above under "Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011."
•Total revenues for Clearing and Backed Trading decreased $5.0 million, or 3.0%, to $159.9 million in 2012. The decrease was due, in large part, to a decrease in equity earnings of unconsolidated businesses, a decrease in brokerage revenues at Kyte, lower clearing services revenues due to a variation in the mix of products and exchanges utilized by our new and existing clearing service customers and a decrease in the number of trades cleared by our Kyte subsidiary.
•Total revenues from All Other increased by $9.7 million, or 14.2%, to $77.9 million in 2012. This increase was due, in large part, to an increase in software, analytics and market data revenues at our Trayport subsidiary due to growth in its customer base, as well as new product offerings.
Total interest and transaction-based expenses
•Total interest and transaction-based fees for our three brokerage segments decreased by $1.5 million, or 6.0%, to $23.7 million in 2012. This decrease was primarily due to a decrease in brokerage revenues executed on a matched principal basis, for which we incur transaction-based expenses.
•Total interest and transaction-based fees for our Clearing and Backed Trading segment increased by $4.5 million to $115.3 million in 2012 primarily due to variations in the mix of products and exchanges utilized by existing and new clearing service customers partially offset by a market-wide decrease in trading volumes. Other Expenses
•Other expenses for Americas Brokerage decreased $25.4 million, or 11.6%, to $192.9 million in 2012. Other expenses for EMEA Brokerage decreased $41.3 million, or 14.4%, to $245.4 million in 2012. Other expenses for Asia Brokerage decreased $10.6 million, or 15.8%, to $56.7 million in 2012. Total Other expenses for our three brokerage segments decreased by $77.3 million, or 13.5%, to $495.0 million for the year ended December 31, 2012 from $572.3 million for the year ended December 31, 2011. The decrease was primarily due to lower broker performance bonus expense resulting from lower brokerage revenues and initiatives implemented in the latter part of 2011 and throughout 2012 to reduce our aggregate compensation expense. The decrease was
also due to a $19.4 million charge taken in 2011 related to severance and other restructuring expenses.
•For our brokerage segments, we record certain direct expenses, including compensation and employee benefits; however, we do not allocate certain expenses that are managed separately at the corporate level to these operating segments. The unallocated costs including rent and occupancy, depreciation and amortization, professional fees, interest and other expenses are included in the expenses for All Other described below. Management does not believe that allocating these costs to our brokerage segments is optimal for evaluating the performance of its brokerage segments.
•Other expenses for Clearing and Backed Trading decreased $7.0 million to $37.9 million in 2012. This decrease was due, in large part, to a decrease in compensation and employee benefits due to lower variable compensation expense.
•Other expenses in All Other decreased by $8.1 million, or 3.1%, to $255.4 million in 2012. The decrease was due, in large part, to a decrease in compensation and employee benefits due to lower variable compensation expense for back office personnel and a decrease in professional fees for 2012 as compared to 2011, primarily due to a decrease in our global audit fee in the current year, as well as lower consulting fees associated with regulatory compliance in the U.K.
Quarterly Results of Operations
The following table sets forth, by quarter, our unaudited Statement of Operations data for the period from January 1, 2012 to December 31, 2013. Results of any period are not necessarily indicative of results for a full year and may, in certain periods, be affected by seasonal fluctuations in our business.
The following table sets forth our quarterly results of operations as a percentage of our Revenues, net of interest and transaction-based expenses, for the indicated periods:
The tables below detail our brokerage revenues by product category in dollars and as a percentage of our total brokerage revenues for the indicated periods.
Liquidity and Capital Resources
Cash and cash equivalents consist of cash and highly liquid investments with original maturities of three months or less. At December 31, 2013, we had $174.6 million of cash and cash equivalents compared to $227.4 million at December 31, 2012. Included in these amounts are $89.5 million and $165.1 million of cash and cash equivalents held by subsidiaries outside of the United States at December 31, 2013 and December 31, 2012, respectively. We have historically asserted the intent to indefinitely reinvest, with very limited exceptions, the unremitted profits of our foreign subsidiaries. We continue to assert that our historic profits earned in foreign subsidiaries are indefinitely reinvested, however, management has concluded that profits earned in certain overseas subsidiaries commencing from January 1, 2013 will ultimately be repatriated to the United States and we will accrue additional income taxes, if any, on such international profits. For profits earned during the year ended December 31, 2013 that are not permanently reinvested, we will not incur a material United States tax charge and we continue to believe we will not incur a material charge on the repatriation of profits in the future.
In addition, included within Receivables from brokers, dealers and clearing organizations are cash balances which represent amounts clearing customers have on deposit with Kyte, our subsidiary which provides clearing services. Kyte deposits these amounts with third parties who act as general clearing members of clearing houses in order to clear cash and derivative products for Kyte's customers. These amounts, while due to us from the general clearing members, ultimately represent cash payable to our clearing customers. Also included within Receivables from brokers, dealers and clearing organizations are cash, including deposits, held at clearing organizations and exchanges to facilitate settlement and clearance of matched principal transactions, and spreads on matched principal transactions that have not yet been remitted from clearing organizations and exchanges. We estimate that cash held at clearing organizations, net of amounts owed to our clearing customers and net of clearing customer cash included within Cash and cash equivalents, was $52.4 million and $19.6 million as of December 31, 2013 and December 31, 2012, respectively.
The following table summarizes our cash position as of December 31, 2013 and 2012, respectively.
We believe that, based on current levels of operations, our cash from operations, together with our current cash holdings and available borrowings under our credit agreement with Bank of America N.A. and certain other lenders (the "Credit Agreement"), will be sufficient to fund our operations for at least the next twelve months. Poor financial results, unanticipated expenses or unanticipated acquisitions or strategic investments could give rise to additional financing requirements sooner than we expect. There can be no assurance that equity or debt financing will be available when needed or, if available, that the financing will be on terms satisfactory to us and not dilutive to our then-current stockholders.
Sources and Uses of Cash
The following table sets forth our cash flows from operating activities, investing activities and financing activities for the indicated periods.
Net cash provided by operating activities was $19.0 million for the year ended December 31, 2013 compared with net cash provided by operating activities of $48.7 million for the year ended December 31, 2012, a net decrease in cash provided by operating activities of $29.7 million. The decrease in cash provided by operating activities was primarily due to a $26.7 increase in cash used for working capital in the year ended December 31, 2013. Such items include changes in (i) payables to clearing service customers, (ii) accounts receivable, (iii) accrued compensation and accounts payable, (iv) receivables from/payables to brokers, dealers, and clearing organizations, and (v) other assets and liabilities, largely attributable to deferred tax assets and interest payable. The decrease was also due to an increase in net loss before attribution to non-controlling stockholders of $9.5 million, from $9.6 million for the year ended December 31, 2012 to $19.1 million for the year ended December 31, 2013. Partially offsetting these uses of cash was a $6.5 million increase in non-cash items that reconcile net loss to net cash used in operating activities for the year ended December 31, 2013, as compared to the same period in the prior year. Such items include impairment charges, the mark-to-market of a future purchase commitment, depreciation and amortization, share-base compensation, change in deferred income taxes and net losses (gains) on foreign exchange derivative contracts.
Net cash provided by operating activities was $48.7 million for the year ended December 31, 2012 compared with $4.6 million for the year ended December 31, 2011, a net increase of $44.1 million. The increase in cash provided by operating activities is primarily due to a $63.1 million reduction in working
capital employed in the business for the year ended December 31, 2012 relative to the same period in 2011. Such items include changes in (i) payables to clearing service customers, (ii) accounts receivable, (iii) accrued compensation and accounts payable, (iv) receivables from/payables to brokers, dealers, and clearing organizations, and (v) other assets and other liabilities, largely attributable to a decrease in cash sign-on and retention bonuses paid. Partially offsetting this net reduction in working capital was an increase of $7.1 million in net loss before attribution to non-controlling stockholders from $2.6 million for the year ended December 31, 2011 to $9.6 million for the year ended December 30, 2012, and a $6.4 million decrease in non-cash items that reconcile net loss to net cash used in operating activities for the year ended December 31, 2013 as compared to the same period in the prior year.
Net cash used in investing activities for the year ended December 31, 2013 was $42.1 million compared to $15.5 million for the year ended December 31, 2012, an increase of $26.6 million. The increase in net cash used in investing activities was primarily related to (i) an increase in purchases of equity method investments of $10.6 million (ii) an increase in business acquisitions of $5.8 million (iii) an increase of cash paid for property, equipment and leasehold improvements of $6.5 million and (iv) an increase of $5.0 million in net payments due to the settlement of foreign exchange derivative hedge contracts.
Net cash used in investing activities for the year ended December 31, 2012 was $15.5 million compared to $46.3 million for 2011. The decrease in cash used for investing activities was related to (i) a decrease of $9.1 million in net payments due to the settlement of foreign exchange derivative hedge contracts, (ii) a decrease in purchases of cost and equity method investments of $8.2 million, (iii) a decrease in purchases of property, equipment and leasehold improvements of $4.8 million, (iv) the issuance of note receivables of $5.0 million in the year ended December 31, 2011 and (v) the purchase of $3.3 million of intangible assets in the year ended December 31, 2011.
Net cash used in financing activities for the year ended December 31, 2013 was $30.1 million compared to $55.1 million for the year ended December 31, 2012, a decrease of $25.0 million. This decrease in net cash used was primarily due to a decrease in the purchase of treasury stock during the year ended December 31, 2013 and a decrease in cash dividends paid for the year ended December 31, 2013 resulting from the acceleration of the payment of the dividend for the fourth quarter 2012 to December 2012.
Net cash used in financing activities for the year ended December 31, 2012 was $55.1 million compared to $26.4 million in 2011. This increase was primarily due to the net proceeds of $250.0 million from the issuance of our 8.375% Senior Notes in July 2011, net of $8.8 million in debt issuance costs, and net of the repayments of all outstanding amounts under our Credit Agreement and all aggregate principal amounts of our then-outstanding 7.17% Senior Notes, which were due in January 2013. This increase was also due to an increase of $5.4 million in cash dividends paid due to the accelerated dividend declared and paid in December 2012. These increases were offset by net decreases of $22.9 million in purchases of treasury stock. See Note 8 to our Consolidated Financial Statements in Part II-Item 8 for further discussion of our short-term borrowings and long-term debt obligations.
Regulatory Requirements
Our liquidity and available cash resources are, in part, restricted by the regulatory capital requirements of certain of our material operating subsidiaries, including GFI Securities LLC, Amerex Brokers LLC, GFI Swaps Exchange LLC, GFI Securities Limited, GFI Brokers Limited, The Kyte Group Limited, Kyte Broking Limited, GFI (HK) Securities LLC, GFI (HK) Brokers Ltd, GFI Group PTE Ltd and GFI Korea Money Brokerage Limited. These operating subsidiaries are subject to minimum capital requirements and/or licensing and financial requirements imposed by their respective market regulators. In addition, these subsidiaries may be prohibited from repaying the borrowings of
their parents or affiliates, paying cash dividends, making loans to their parent or affiliates or otherwise entering into transactions, in each case, that result in a significant reduction in their regulatory capital position without prior notification or approval from their principal regulator. See Note 20 to the Consolidated Financial Statements for further details on our regulatory requirements.
Short and Long Term Debt
Our outstanding debt at December 31, 2013 and December 31, 2012 consists of $240.0 million of our 8.375% Senior Notes and $10.0 million of borrowings under our Credit Agreement. As of December 31, 2013, the available borrowing capacity under our Credit Agreement was $65.0 million. The 8.375% Senior Notes mature in July 2018 and the Credit Agreement matures in December 2015. See Note 8 to the Consolidated Financial Statements for further details on our debt.
Credit Ratings
As of December 31, 2013, we maintained the following public long-term credit ratings and associated outlooks:
Credit ratings and outlooks can be revised at any time if such rating agency decides the circumstances warrant a revision. In addition, a reduction in our rating may affect the availability of future debt financing and the terms that are available to us.
On January 18, 2013, Moody's Investor Services lowered its credit rating on our 8.375% Senior Notes two notches to B1, which increased our applicable per annum interest, effective January 19, 2013, by an additional 50 basis points. On April 19, 2013, Fitch lowered its credit rating on our 8.375% Senior Notes two notches to BB and revised its outlook from Stable to Negative. This credit rating downgrade by Fitch increased our applicable per annum interest, effective July 19, 2013, by an additional 50 basis points. On June 26, 2013, Standard & Poor's ("S&P") further lowered its credit rating on our 8.375% Senior Notes one notch to B+ and revised its outlook from Negative to Stable. This credit rating downgrade by S&P increased our applicable per annum interest by an additional 25 basis points, effective July 19, 2013.
The cumulative effect of downgrades to our credit rating by the various rating agencies subsequent to the issuance of our 8.375% Senior Notes increased the per annum interest rate on the 8.375% Senior Notes by 200 basis points over the original interest rate, which is the maximum increase permitted under the indenture. The increased interest rate equates to $4.8 million in additional interest expense per annum, based on the aggregate amount of outstanding principal as of December 31, 2013.
Dividends Paid
Prior to 2008, we retained all earnings for investment in our business. In February 2008, our Board of Directors approved a policy of paying quarterly dividends, subject to available cash flow from operations, other considerations and the determination of the amount by our Board of Directors. In December 2012, our Board of Directors declared a dividend for the fourth quarter of 2012 on an accelerated basis. The dividend was declared and paid in December 2012 and we, therefore, did not pay a cash dividend during the first quarter of 2013. Cash dividends paid for the year ended December 31, 2013, 2012, and 2011 were approximately $18.2 million $29.6 million and $24.2 million, respectively.
Common Stock
We may purchase additional shares of our common stock on the open market from time to time in accordance with a stock repurchase program authorized by our Board of Directors. See Note 10 to our Consolidated Financial Statements in Part II-Item 8 for further discussion of the stock repurchase program.
Contractual Obligations and Commitments
The following table summarizes certain of our contractual obligations as of December 31, 2013:
(1)The amounts listed under Interest on Long-term debt includes increases to our applicable per annum interest on our 8.375% Senior Notes that were effective as a result of downgrades to our credit rating by the various credit agencies in 2012 and 2013. In the event that our credit ratings are subsequently increased or decreased, the applicable per annum interest could change and the amounts disclosed in this table would change; provided, however, the applicable per annum interest rate cannot increase by more than 200 basis points over the original interest rate, which is the maximum increase permitted under the indenture. See Note 8 to the Consolidated Financial Statements for further details.
(2)The amounts listed under Purchase Obligations include agreements for quotes with various information service providers. Additionally, such amounts include purchase commitments for capital expenditures. See Note 13 to our Consolidated Financial Statements for further discussion.
We have unrecognized tax benefits of approximately $8.7 million, excluding interest of $1.2 million. Due to the uncertainty of the amounts to be ultimately paid as well as the timing of such payments, all liabilities for uncertain tax positions that have not been paid are excluded from the Contractual Obligations and Commitments table.
We have contingent consideration liabilities with an aggregate estimated fair value of $4.3 million as of December 31, 2013. Due to the uncertainty of the amounts to be ultimately paid, these liabilities have been excluded from the Contractual Obligations and Commitments table.
Off-Balance Sheet Arrangements
The Company did not have any off-balance sheet arrangements at December 31, 2013, as defined in Item 303(A)(4)(ii) of SEC Regulation S-K.
Critical Accounting Policies and Estimates
General
This Management's Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements which have been prepared in accordance with U.S. generally accepted accounting principles, which require us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our estimates and judgments on historical experience and on various other factors that we believe are reasonable under the circumstances. We believe that the accounting estimates employed and the resulting balances are reasonable; however, actual results may differ materially from these estimates under different assumptions or conditions.
An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made; if different estimates reasonably could have been used; or if changes in the estimate that are reasonably likely to occur periodically could materially impact the financial statements. We believe that our application of the policies discussed below involve significant levels of judgment, estimates and complexity in the preparation of our Consolidated Financial Statements.
Fair Value of Financial Instruments
Certain of our assets and liabilities are carried at fair value, the majority of which are measured at fair value on a recurring basis. Fair value is defined as the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the exit price). Financial instruments owned and Financial instruments sold, not yet purchased are recorded at fair value, and included in Other Assets and Other liabilities, respectively. Contingent consideration and Future purchase commitments, if any, are also recorded at fair value, and included in Other liabilities.
Our financial assets and liabilities recorded at fair value have been categorized into a three-level fair value hierarchy in accordance with ASC 820-10, based on the transparency and priority of inputs, where Level 1 uses quoted prices in active markets, Level 2 generally uses either broker quotes or other than quoted prices that are observable for that asset or liability, and Level 3 uses valuation techniques that incorporate significant unobservable inputs.
Fair value is a market based measure; therefore, when market observable inputs are not available, our judgment is applied to reflect those judgments that a market participant would use in valuing the same asset or liability. The type and level of judgment required is largely dependent on the amount of observable market information available. The valuation of financial instruments classified in Level 3 of the fair value hierarchy involves the greatest amount of management judgment. In arriving at an estimate of fair value for a Level 3 instrument, management must determine the appropriate model to use and then asses all relevant valuation inputs. These unobservable valuation inputs and assumptions may differ by investment and in the application of our valuation methodologies. The use of different methods or changes in assumptions in determining fair value could result in a different estimate of fair value at the reporting date.
For further disclosures on the fair value definition, Level 1, Level 2, Level 3 and related valuation techniques, see Note 2 and Note 16 in our Consolidated Financial Statements.
Variable Interest Entities
We determine whether we hold any interests in entities deemed to be a variable interest entity ("VIE"). A VIE is an entity that lacks one or more of the following characteristics (i) the total equity
investment at risk is sufficient to enable the entity to finance its activities independently and (ii) the equity holders have the power to direct the activities of the entity that most significantly impact its economic performance, the obligation to absorb the losses of the entity and the right to receive the residual returns of the entity. We have a controlling financial interest and will consolidate a VIE if we are the primary beneficiary.
The primary beneficiary is the party that has both (i) the power to direct the activities of the VIE that most significantly impact the economic performance of the entity and (ii) the obligation to absorb losses of the entity that could be potentially significant to the VIE or the right to receive benefits from the entity that could be potentially significant.
As of December 31, 2013, we hold interests in certain VIEs. One of these VIEs is consolidated because it was determined that we are the primary beneficiary of this VIE because: (1) we provided the majority of the start-up capital and (2) we have consent rights on activities that we believe would most significantly impact the economic performance of the entity. The remaining VIEs are not consolidated as it was determined that we are not the primary beneficiary, most commonly due the determination that we lacked significant equity ownership and voting power. We reassess our initial evaluation of whether an entity is a VIE when certain events occur, such as changes in economic ownership and voting power. We reassess our determination of whether we are the primary beneficiary of a VIE on an ongoing basis based on current facts and circumstances.
Capitalization of Software Development Costs
We capitalize certain costs of software developed or obtained for internal use in accordance with ASC 350, Intangibles-Goodwill and Other. We capitalize software development costs when application development begins and it is probable that the project will be completed and the software will be used as intended. Costs associated with preliminary project stage activities, maintenance and all other post implementation stage activities are expensed as incurred. Our policy provides for the capitalization of certain payroll and payroll-related costs for employees who are directly associated with internal use computer software projects, as well as external direct costs of materials and services associated with developing or obtaining internal use software. Capitalized personnel costs are limited to time directly spent on such projects. Capitalized costs are ratably amortized, using the straight-line method, over the estimated useful lives, which are typically over three years. Our judgment as to which costs to capitalize, when to begin capitalizing such costs and what period to amortize the costs over, may materially affect our results of operations. If management determines that the fair value of the software is less than the carrying value, an impairment loss would be recognized in an amount equal to the difference between the fair value and the carrying value.
Goodwill and Intangible Assets
Goodwill is required to be tested for impairment at least annually and more frequently when indicators of impairment exist. All of our goodwill is allocated to our reporting units and the goodwill impairment tests are performed at the reporting unit level. We have determined our reporting units to be Americas Brokerage, EMEA Brokerage, Asia Brokerage, Clearing and Backed Trading, Trayport, and FENICS. ASC 350 gives companies the option to perform a qualitative assessment to determine whether it is more likely than not (a likelihood of greater than 50 percent) that the fair value of its reporting unit is less than its carrying amount. If it is determined, based on the qualitative assessment, that it is more likely than not that the fair value of its reporting unit is less than its carrying amount, or if the company decides to exercise its unconditional option to bypass the qualitative assessment, then the company would proceed to a two-step quantitative impairment test. In the first step, the fair value of each reporting unit is compared with its carrying value, including goodwill and allocated intangible assets. If the fair value is in excess of the carrying value, the goodwill for the reporting unit is considered not to be impaired. If the fair value is less than the carrying value, then a second step is performed in order to measure the amount of the impairment loss, if any, which is based on comparing the implied fair value of the reporting unit's goodwill to the fair value of the net assets of the reporting unit.
We allocate Assets, including goodwill and intangible assets, and liabilities to our reporting units in determining the carrying amount of each respective reporting unit. The assets and liabilities are allocated to our reporting units based on based on how our businesses are managed and how those assets and liabilities are deployed in managing the business. Intangible assets are allocated to a reporting unit based on either specifically identifying a particular intangible asset as pertaining to a reporting unit or, if shared among reporting units, based on an assessment of the reporting unit's benefit from the intangible asset in order to generate results.
Based on the results of the annual impairment tests performed during 2012, no goodwill impairment was recognized for any of our reporting units during that year. During 2013, there were no events or changes in circumstances identified that warranted interim impairment testing.
During the fourth quarter of 2013, we performed a qualitative assessment on our Trayport and FENICS reporting units and concluded that it is more likely than not that the fair value of each reporting unit is greater than its carrying amount. For the Americas Brokerage, EMEA Brokerage, and Clearing and Backed Trading reporting units, we elected to bypass the qualitative assessment and perform a two-step goodwill impairment test. Based on the first step of the annual impairment, we concluded that the fair value of the EMEA brokerage reporting unit was substantially in excess of its carrying values while the Americas Brokerage reporting unit's fair value exceeded its carrying value by less than 10%. We also concluded that the carrying value of our Clearing and Backed Trading reporting unit exceeded its fair value and therefore, the second step of the impairment test was required in order to determine the implied fair value of the reporting units' goodwill. The results of the second step of the assessment showed that the carrying value of the reporting unit's goodwill of $41.1 million exceeded the implied fair value of its goodwill of $22.2 million resulting in an impairment charge of $18.9 million. The impairment was largely due to a decrease in the forecasted cash flows of this segment, reflecting a decrease in the expected revenues and margins we estimated during the budgeting and forecasting process in the fourth quarter of 2013. The decrease in expected cash flows was primarily due to additional regulatory compliance, the continued low interest rate environment and lower trading volumes. Subsequent to recording this goodwill impairment charge and foreign currency translation, a goodwill balance of $23.3 million remained in our Clearing and Backed Trading reporting unit at December 31, 2013.
We estimated the fair value of both our Clearing and Backed Trading and Americas Brokerage reporting units using a weighted average of both the market and income approaches. Under the market
approach, the fair value of each reporting unit was based on applying market multiples to its estimated projected revenues and earnings. Key assumptions included management's budgeted statement of operations for the year ended December 31, 2014 and estimated growth rate assumptions for future periods, a range of forward market multiples of comparable companies and a reasonable control premium to apply to the derived market multiples. The applicable multiples were selected based on the similarities and differences between each of those reporting units and the guideline companies in the same sector, including profitability, growth prospects, size, as well as overall risks. The estimated control premium was determined based upon general consideration of premiums paid in individual transactions over a period of time. Under the income approach, the fair values of the reporting units were based on the present value of estimated future cash flows of each respective reporting unit. Key assumptions used in estimating these cash flows included applying business growth rate assumptions to future cash flows over a period of time and an estimated terminal value thereafter. We discounted the resulting expected cash flows of each reporting unit using an estimated weighted average cost of capital, applicable to that reporting unit, to arrive at a present value amount that approximates fair value.
Changes in these estimates and assumptions could materially affect the determination of fair value and/or goodwill impairment evaluation for each of these reporting units in the future. As a result of continued economic uncertainty and current market dynamics, determining whether an impairment of the goodwill asset exists is increasingly difficult and requires management to exercise significant judgment. In addition, to the extent that securities valuations or trading volumes are depressed for prolonged periods of time and market conditions stagnate or worsen as a result of local or global economic conditions, the revenues and profitability of our Americas Brokerage and Clearing and Backed Trading reporting units may be adversely affected. In addition, control premiums, industry earnings multiples and discount rates are impacted by economic conditions. As a result, subsequent impairment tests may be more frequent and be based upon more negative assumptions and future cash flow projections, which may result in an impairment of our Americas Brokerage reporting unit or further impairment of our Clearing and Backed Trading reporting unit, at such time. Any impairment could materially reduce the recorded amount of goodwill with a corresponding charge to our earnings.
Subsequent to November 1, 2013, the date at which our annual impairment test was completed, no events or changes in circumstances occurred which would indicate any goodwill impairment through the filing date of this Form 10-K.
Contingencies
In the normal course of business, we have been named as defendants in various lawsuits and proceedings and have been involved in certain regulatory examinations. Additional actions, investigations or proceedings may be brought from time to time in the future. We are subject to the possibility of losses from these various contingencies. Considerable judgment is necessary to estimate the probability and amount of any loss from such contingencies. An accrual is made when it is probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. We accrue a liability for the estimated costs of adjudication or settlement of asserted and unasserted claims existing as of the balance sheet date. We have recorded reserves for certain contingencies to which we may have exposure, such as reserves for certain income tax and litigation contingencies and contingencies related to the employer portion of National Insurance Contributions in the U.K. We disclose asserted claims when it is at least reasonably possible that an asset had been impaired or a liability had been incurred as of the date of the financial statements and unasserted claims when it is considered probable that a claim will be asserted and there is a reasonable possibility that the outcome will be unfavorable.
Income Taxes
In accordance with ASC 740, Income Taxes, ("ASC 740") we provide for income taxes using the asset and liability method under which deferred income taxes are recognized for the estimated future tax effects attributable to temporary differences and carryforwards that result from events that have been recognized either in the financial statements or the income tax returns, but not both. The measurement of current and deferred income tax liabilities and assets is based on provisions of enacted tax laws. Valuation allowances are recognized if, based on the weight of available evidence, it is more likely than not that some portion of the deferred tax assets will not be realized. Our interpretation of complex tax law may impact our measurement of current and deferred income taxes.
We are subject to regular examinations by the Internal Revenue Service, taxing authorities in foreign countries, and states in which we have significant business operations. We regularly assess the likelihood of additional assessments in each taxing jurisdiction resulting from on-going and subsequent years' examinations. We record uncertain tax positions in accordance with ASC 740 on the basis of a two-step process whereby (1) we determine whether it is more likely than not that a tax position will be sustained based on the technical merits of the position, and (2) for those tax positions that are more likely than not to be sustained, we recognize the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant taxing authority.
In 2013, management has concluded that profits earned commencing January 1, 2013 in certain overseas subsidiaries will ultimately be repatriated to the U.S. and we will accrue additional U.S. taxes, if any, on such international profits. Prior to January 1, 2013, we historically asserted the intention to indefinitely reinvest the undistributed earnings of our foreign subsidiaries and therefore have not provided for any U.S. income tax on such international earnings, in accordance with ASC 740.
Recent Accounting Pronouncements
Refer to Note 2 to our Consolidated Financial Statements for a discussion of new accounting pronouncements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISLOSURES ABOUT MARKET RISK
Risk Management
In the normal course of business, we are exposed to various risks, including foreign currency exposure risk, interest rate risk, credit risk, market risk and operational risk. Top-level oversight of our risk management resides with the Risk Policy Committee of the Board of Directors. We also utilize several management committees made up of key executives with responsibility for identifying and managing risk. Specialized risk functions, such as our credit risk, compliance, internal audit and Sarbanes-Oxley compliance departments, perform regular monitoring and testing procedures to provide management with assurance regarding the design and operating effectiveness of risk control policies and procedures. Finally, business managers play an integral role in risk management by maintaining the processes and control activities designed to identify, mitigate, and report risk.
The various risks that may impact the Company, certain of our risk management procedures, and a sensitivity analysis estimating the effects of changes in fair values for exposures relating to foreign currency and interest rate exposures are outlined below.
Foreign Currency Exposure Risk
We are exposed to risks associated with changes in foreign exchange rates related to our international operations. As foreign currency exchange rates change, the U.S. Dollar equivalent of revenues and expenses denominated in foreign currencies change. Our U.K. operations generate a large majority of their revenues in U.S. Dollars and Euros but pay a significant amount of their expenses in
British Pounds. We enter into foreign exchange forward contracts ("Foreign Exchange Derivative Contracts") to mitigate our exposure to foreign currency exchange rate fluctuations. At December 31, 2013 and 2012, we had no Foreign Exchange Derivative Contracts that were designated as foreign currency cash flow hedges. We do not use derivative contracts for speculative purposes.
We are also exposed to counterparty credit risk for nonperformance of Foreign Exchange Derivative Contracts and in the event of nonperformance, to market risk for changes in currency rates. The counterparties with whom we execute foreign exchange derivative contracts are major international financial institutions. We monitor our positions with, and the credit quality of, these financial institutions and we do not anticipate nonperformance by the counterparties.
While our international results of operations, as measured in U.S. Dollars, are subject to foreign exchange rate fluctuations, we do not consider the related risk to be material to our results of operations. If the Euro strengthened against the U.S. Dollar by 10% and the British Pound Sterling weakened by 10% against the U.S. Dollar, the net impact to our net income would be a reduction of approximately $4.9 million as of December 31, 2013.
Interest Rate Risk
We are exposed to changes in market interest rates that impact our variable-rate short-term borrowings that may be outstanding under our Credit Agreement from time to time. As of December 31, 2013, we had $10.0 million outstanding under our Credit Agreement. If interest rates were to increase by 0.5%, the annual impact to our net income would be a reduction of less than $0.1 million. As of December 31, 2013, the interest rate on our entire $240.0 million long-term debt was comprised of a fixed-rate. Fluctuations in market interest rates will have no impact on the amount of interest we must pay on these fixed-rate debt obligations.
Credit Risk
Credit risk arises from potential non-performance by counterparties of our matched principal business, as well as from nonpayment of commissions by customers of our agency brokerage business. We also have credit and counterparty risk in certain situations where we provide clearing and execution services. We provide agency clearing services though our relationships with general clearing member firms and/or exchanges. In these instances, our accounts at such institutions are used, in our name, to provide access to clearing services for our customers. Credit risk arises from the possibility that we may suffer losses due to the failure of our customers or other counterparties to satisfy their financial obligations to us or in a timely manner.
We have established policies and procedures to manage our exposure to credit risk. We maintain a thorough credit approval process to limit our exposure to counterparty risk and employ stringent monitoring to control the market and counterparty risk from our matched principal business. Our brokers may only execute transactions for clients that have been approved by our credit committee following review by our credit department. Our credit approval process includes verification of key financial information and operating data and anti-money laundering verification checks. Our credit review process may include consideration of independent credit agency reports and a visit to the entity's premises, if necessary. We have developed and utilize a proprietary, electronic credit risk monitoring system.
Credit approval is granted by our credit committee, which is comprised of senior management and representatives from our compliance, finance and legal departments. Credit approval is granted subject to certain trading limits and may be subject to additional conditions, such as the receipt of collateral or other credit support. Our credit risk department assists the credit committee in the review of any proposed counterparty by conducting diligence on such party and by continuing to review such counterparties for continued credit approval on at least an annual basis. These results are reviewed by
the credit committee. Maintenance procedures include reviewing current audited financial statements and publicly available information on the client, collecting data from credit rating agencies where available and reviewing any changes in ownership, title or capital of the client. For our agency business, our approval process includes the requisite anti-money laundering and know-your-customer verifications.
Market Risk
We are exposed to market risk associated with our principal transactions and, in certain instances, in the provision of clearing services. Through our subsidiaries, we conduct both matched principal and principal trading businesses, primarily involving fixed income and equity securities, but also for certain listed derivative products.
In matched principal transactions, we act as a "middleman" by serving as counterparty on one side of a customer trade and entering into an offsetting trade with another party relatively quickly (often within minutes and generally on the same trading day). These transactions are then settled through a third-party clearing organization. Settlement typically occurs within one to three business days after the trade date. Cash settlement of the transaction occurs upon receipt or delivery of the underlying instrument that was traded. In a limited number of circumstances, we may settle a principal transaction by physical delivery of the underlying instrument.
In executing matched principal transactions, we are exposed to the risk that one of the counterparties to a transaction may fail to fulfill its obligations, either because it is not matched immediately or, even if matched, one party fails to deliver the cash or securities it is obligated to deliver. Certain of the less liquid or OTC markets in which we provide our services exacerbate this risk for us because transactions in these markets are less likely to settle on a timely basis. Adverse movements in the prices of securities that are the subject of these transactions can increase our risk. In addition, widespread technological or communication failures, as well as actual or perceived credit difficulties or the insolvency of one or more large or visible market participants, could cause market-wide credit difficulties or other market disruptions. These failures, difficulties or disruptions could result in a large number of market participants not settling transactions or otherwise not performing their obligations.
We are subject to financing risk in these circumstances because if a transaction does not settle on a timely basis, the resulting unmatched position may need to be financed, either directly by us or through one of our clearing organizations at our expense. These charges may be recoverable from the failing counterparty, but sometimes are not. Finally, in instances where the unmatched position or failure to deliver is prolonged or pervasive due to rapid or widespread declines in liquidity for an instrument, there may also be regulatory capital charges required to be taken by us, which depending on their size and duration, could limit our business flexibility or even force the curtailment of those portions of our business requiring higher levels of capital. Credit or settlement losses of this nature could adversely affect our financial condition or results of operations.
In the process of executing matched principal transactions, miscommunications and other errors by us or our clients can arise whereby a transaction is not completed with one or more counterparties to the transaction, leaving us with either a long or short unmatched position. These unmatched positions are referred to as "out trades," and they create a potential liability for us. If an out trade is promptly discovered and there is a prompt disposition of the unmatched position, the risk to us is usually limited. If the discovery of an out trade is delayed, the risk is heightened by the increased possibility of intervening market movements prior to disposition. Although out trades usually become known at the time of, or later on the day of, the trade, it is possible that they may not be discovered until later in the settlement process. When out trades are discovered, our policy is generally to have the unmatched position disposed of promptly (usually on the same day and generally within three days), whether or
not this disposition would result in a loss to us. The occurrence of out trades generally rises with increases in the volatility of the market and, depending on the number and amount, such out trades have the potential to have a material adverse effect on our financial condition and results of operations.
Liability for unmatched trades could adversely affect our results of operations and balance sheet. Although the significant majority of our principal trading is done on a "matched principal" basis, we may take unmatched positions for our own account generally in response to customer demand, primarily to facilitate the execution of existing customer orders. While we seek to minimize our exposure to market risk by entering into offsetting trades or a hedging transaction relatively quickly (often within minutes and generally on the same trading day), we may not always enter into an offsetting trade on the same trading day and any hedging transaction we may enter into may not fully offset our exposure. Therefore, although any unmatched positions are intended to be held short term, we may not entirely offset market risk and may be exposed to market risk for several days or more or to a partial extent or both.
Additionally, we have authorized a limited number of our desks to enter into principal investing transactions in which we commit our capital within predefined limits, either to facilitate customer trading activities or to engage in principal trading for our own account. These principal positions may ultimately be matched against a customer order or through a market intermediary, either in the short term (such as the same trading day) or we may hold these positions for several days or more. The number and size of these transactions may affect our results of operations in a given period and we may also incur losses from these trading activities due to market fluctuations and volatility from quarter to quarter. We are currently subject to covenants in our Credit Agreement, which generally limit the aggregate amount of securities which we may trade for our own account to 7.5% of our consolidated capital. To the extent that we own assets, i.e., have long positions, in any of those markets, a downturn in the value of those assets or in those markets could result in losses from a decline in the value of those long positions. Conversely, to the extent that we have sold assets we do not own, i.e., have short positions, in any of those markets, an upturn in those markets could expose us to significant losses as we attempt to cover our short positions by acquiring assets in a rising market. To the extent these securities positions are not disposed of intra-day, we mark these positions to market.
In certain instances, we may provide credit for margin requirements to customers, secured by collateral in a customer's account. In such cases, we are exposed to the market risk that the value of the collateral we hold could fall below the amount of a customer's indebtedness. This risk can be amplified in any situation where the market for the underlying security is rapidly declining. Agreements with customers that have margin accounts permit us to liquidate their securities in the event that the amount of margin collateral becomes insufficient. Despite those agreements and our risk management policies with respect to margin, we may be unable to liquidate a customer's positions for various reasons, or at a price sufficient to cover any deficiency in a customer's account. If we were unable to liquidate a position at a price sufficient to cover any deficiency or if a customer was unable to post additional margin, we may suffer a loss.
Adverse movements in the securities underlying these positions or a downturn or disruption in the markets for these positions could result in a substantial loss. In addition, principal gains and losses resulting from these positions could on occasion have a disproportionate effect, positive or negative, on our financial condition and results of operations for any particular reporting period.
In addition to entering into offsetting trades or a hedging transaction, we also monitor market risk exposure from our matched principal and principal trading business, including regularly monitoring concentration of market risk to financial instruments, countries or counterparties and regularly monitoring trades that have not settled within prescribed settlement periods or volume thresholds. Additionally, market risks are monitored and mitigated by the use of our proprietary, electronic risk
monitoring system, which provides management with daily credit reports in each of our geographic regions that analyze credit concentration and facilitates the regular monitoring of transactions against key risk indicators.
Operational Risk
Operational risk refers to the risk of financial or other loss, or potential damage to our reputation, resulting from inadequate or failed internal processes, people, resources, systems or from external events. We may incur operational risk across the full scope of business activities and support functions. We have operational risk polices that are designed to reduce the likelihood and impact of operational incidents as well as to mitigate legal, regulatory and reputational risk. Primary responsibility for the management of operational risk resides with the business managers, risk and control functions, and various management committees through the use of processes and controls designed to identify, assess, manage, mitigate and report operational risk. For additional discussions of our operational risks, see "Item 1A - Risks Related to Our Operations."
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reports of Independent Registered Public Accounting Firms
Consolidated Statements of Financial Condition
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Loss
Consolidated Statements of Cash Flows
Consolidated Statements of Changes in Stockholders' Equity
Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
GFI Group Inc.
In our opinion, the accompanying consolidated statement of financial condition and the related consolidated statements of operations, comprehensive loss, cash flows and changes in stockholders' equity present fairly, in all material respects, the financial position of GFI Group Inc. and its subsidiaries at December 31, 2013 and December 31, 2012, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
New York, New York
March 13, 2014
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
GFI Group Inc.
New York, New York
We have audited the accompanying consolidated statements of operations, comprehensive loss, cash flows and changes in stockholders' equity of GFI Group Inc. and subsidiaries (the "Company") for the year ended December 31, 2011. Our audit also included the financial statement schedule listed in the Index at Item 15 for the period ended December 31, 2011. These consolidated financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the consolidated financial statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of GFI Group Inc. and subsidiaries for the year ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule for the period ended December 31, 2011, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ Deloitte & Touche LLP
New York, New York
March 15, 2012 (March 12, 2013 as to Note 2, Summary of Significant Accounting Policies-Recent Accounting Pronouncements-ASU No. 2011-05 Presentation of Comprehensive Income)
GFI GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands except share and per share amounts)
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
(1)Amounts are net of (provision for) benefit from income taxes of $(462), $(69) and $547 for the years ended December 31, 2013, 2012 and 2011, respectively.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(In thousands)
Non-Cash Investing and Financing Activities:
Included within the purchase price of the Company's acquisition of Contigo Limited in 2013 was contingent consideration with an estimated net present value of £2,458 (or approximately $3,942), which was recorded as a liability within Other liabilities. See Note 5 for further information. The Company did not have any non-cash investing and financing activity during the year ended December 31, 2012. During the year ended December 31, 2011, the Company recorded a $1,084 debit to Additional paid in capital with respect to the cancellation of 276,625 shares of the Company's common stock in connection with the exchange of the Company's membership interest in an equity method investment for a convertible senior secured promissory note.
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands)
See notes to consolidated financial statements
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands except share and per share amounts)
1. ORGANIZATION AND BUSINESS
The Consolidated Financial Statements include the accounts of GFI Group Inc. and its subsidiaries (collectively, "GFI" or the "Company"). The Company, through its subsidiaries, provides wholesale brokerage and trade execution services, clearing services, and trading system software products to institutional clients in markets for a range of fixed income, financial, equity and commodity products. The Company complements its brokerage and trade execution capabilities with value-added services, such as market data and analytical software products for trader and back-office support, which it licenses primarily to companies in the financial services industry. As of December 31, 2013, Jersey Partners, Inc. ("JPI") owned approximately 38% of the Company's outstanding shares of common stock. The Company's executive chairman, Michael Gooch, is the controlling shareholder of JPI.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation-The Company's Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and the disclosure of contingencies in the Consolidated Financial Statements. Certain estimates and assumptions relate to the accounting for acquired goodwill and intangible assets, fair value measurements, compensation accruals, tax assets and liabilities, and the potential outcome of litigation matters. Management believes that the estimates utilized in the preparation of the Consolidated Financial Statements are reasonable and prudent. Actual results could differ materially from these estimates.
Certain amounts in the Consolidated Statements of Cash Flows for the years ended December 30, 2012 and 2011 have been reclassified to conform to the current year presentation.
Consolidation Policies
General-The Consolidated Financial Statements include the accounts of the Company, its wholly-owned subsidiaries and subsidiaries that are treated as such and other entities in which the Company has a controlling financial interest. For consolidated subsidiaries that are less than wholly-owned, equity interests that are not owned by the Company are referred to as non-controlling interests. The portion of net income attributable to non-controlling interests for such subsidiaries is presented as Net income attributable to non-controlling interests on the Consolidated Statements of Operations, and the portion of the stockholders' equity of such subsidiaries is presented as Non-controlling interests in the Consolidated Statements of Financial Condition and Consolidated Statement of Changes in Stockholders' Equity. All intercompany transactions and balances have been eliminated.
Variable Interest Entities-The Company determines whether it holds any interests in entities deemed to be a variable interest entity ("VIE"). A VIE is an entity that lacks one or more of the following characteristics (i) the total equity investment at risk is sufficient to enable the entity to finance its activities independently and (ii) the equity holders have the power to direct the activities of the entity that most significantly impact its economic performance, the obligation to absorb the losses of the entity and the right to receive the residual returns of the entity. The Company has a controlling financial interest and will consolidate a VIE if it is the primary beneficiary.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The primary beneficiary is the party that has both (i) the power to direct the activities of the VIE that most significantly impact the economic performance of the entity and (ii) the obligation to absorb losses of the entity that could be potentially significant to the VIE or the right to receive benefits from the entity that could be potentially significant.
As of December 31, 2013, the company holds interests in certain VIEs. One of these VIEs is consolidated because it was determined that the Company is the primary beneficiary of this VIE because (1) the Company provided the majority of the VIE's start-up capital and (2) the Company has consent rights regarding those activities that the Company believes would most significantly impact the economic performance of the entity. The remaining VIEs are not consolidated as it was determined that the Company is not the primary beneficiary based on the level of equity ownership and voting power. The Company reassesses its evaluation of whether an entity is a VIE when certain events occur, such as changes in economic ownership and voting power. The Company reassesses its determination of whether it is the primary beneficiary of a VIE on an ongoing basis based on current facts and circumstances. See Note 18 for disclosures on Variable Interest Entities.
Cash and Cash Equivalents-Cash and cash equivalents consist of cash and highly liquid investments purchased with an original maturity of three months or less.
Cash and Securities Segregated Under Federal and Other Regulations-The Company holds cash and securities representing funds received in connection with customer trading activities. The Company's subsidiaries are required to satisfy regulations mandated by their primary regulators to segregate or set aside cash or equivalent securities to satisfy regulations, promulgated to protect customer assets.
Accounts Receivable-Accounts receivable largely represents commissions due from brokers, dealers, banks and other financial and nonfinancial institutions for the execution of securities, commodities, foreign exchange and other derivative brokerage transactions. Also, included within Accounts receivable are the billed portion of existing contracts from customers related to the licensing, support and maintenance of software, analytics and market data, as well as any unbilled but earned portion of any services provided to such customers. In estimating the allowance for doubtful accounts, management considers the length of time receivables are past due and historical experience. In addition, if the Company is aware of a client's inability to meet its financial obligations, a specific provision for doubtful accounts is recorded in the amount of the estimated losses that will result from the inability of that client to meet its financial obligation. Accounts receivable are presented net of allowance for doubtful accounts of approximately $1,958 and $1,710 as of December 31, 2013 and 2012, respectively.
Receivables from and Payables to Brokers, Dealers and Clearing Organizations-Receivables from and payables to brokers, dealers and clearing organizations primarily represent: (i) principal transactions for which the stated settlement dates have not yet been reached, (ii) principal transactions which have not settled as of their stated settlement dates, (iii) cash, including deposits, held at clearing organizations and exchanges in support of the Company's clearing business and to facilitate settlement and clearance of matched principal transactions and (iv) the spread on matched principal transactions that have not yet been remitted from/to clearing organizations and exchanges.
Property, Equipment and Leasehold Improvements-Property, equipment and leasehold improvements are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
calculated using the straight-line method, generally over three to seven years. Property and equipment are depreciated over their estimated useful lives. Leasehold improvements are amortized over the shorter of the remaining term of the respective lease to which they relate or the remaining useful life of the leasehold improvement. Internal and external costs incurred in developing or obtaining computer software for internal use are capitalized in accordance with Accounting Standards Codification ("ASC") 350 Intangibles-Goodwill and Other ("ASC 350"), and are amortized on a straight-line basis over the estimated useful life of the software, generally three years. General and administrative costs related to developing or obtaining such software are expensed as incurred.
Goodwill and Intangible Assets-Goodwill represents the excess of the purchase price allocation over the fair value of tangible and identifiable intangible net assets acquired. The goodwill associated with each business combination is allocated to the related reporting units, which are determined based on how the Company's businesses are managed and how they are reviewed by the Company's chief operating decision maker. Other intangible assets are recorded at their fair value upon completion of a business combination or certain other transactions.
In accordance with ASC 350, goodwill and other intangible assets with indefinite lives are not amortized, but instead are periodically tested for impairment. The Company reviews goodwill and other intangible assets with indefinite lives for impairment on an annual basis as of November 1 of each fiscal year or whenever an event occurs or circumstances change that could reduce the fair value of a reporting unit below its carrying amount.
Intangible assets with definite lives are amortized on a straight-line basis over their estimated useful lives. See Note 6 for further information.
Prepaid Bonuses and Forgivable Employee Loans-Prepaid bonuses and forgivable loans to employees are stated at historical value net of amortization when the agreement between the Company and the employee provides for the return of proportionate amounts of the bonus or loan outstanding if employment is terminated in certain circumstances prior to the end of the term of the agreement. Amortization is calculated using the straight-line method over the term of the contract, which is generally two to four years, and is recorded in Compensation and employee benefits. The Company generally expects to recover the unamortized portion of prepaid bonuses and forgivable loans when employees voluntarily terminate their employment or if their employment is terminated for cause prior to the end of the term of the agreement. The prepaid bonuses and forgivable loans are included in Other assets in the Consolidated Statements of Financial Condition. At December 31, 2013 and 2012, the Company had prepaid bonuses of $23,499 and $31,847, respectively. At December 31, 2013 and 2012, the Company had forgivable employee loans and advances to employees of $24,109 and $31,655, respectively. Amortization of prepaid bonuses and forgivable employee loans for the years ended December 31, 2013, 2012 and 2011 was $26,095, $26,549 and $33,652, respectively, and is included within Compensation and employee benefits.
Investments-When the Company does not have a controlling financial interest in an entity but can exert significant influence over the entity's operating and financial policies, the investment is accounted for under the equity method of accounting in accordance with ASC 323-10, Investments-Equity Method and Joint Ventures ("ASC 323-10"). Significant influence generally exists when the Company owns 20% to 50% of the entity's common stock or in-substance common stock. The Company initially records the
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
investment at cost and adjusts the carrying amount each period to recognize its share of the earnings or losses of the investee based on the percentage of ownership. See Note 19 for further information. Investments for which the Company does not have the ability to exert significant influence over operating and financial policies are generally accounted for using the cost method of accounting in accordance with ASC 325-10, Investments-Other ("ASC 325-10"). At December 31, 2013 and 2012, the Company had cost method investments of $5,087 and $4,671, respectively, included within Other assets. The fair value of the Company's cost method investments are not estimated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value. The Company monitors its equity and cost method investments for indicators of impairment each reporting period.
The Company accounts for its marketable equity securities and its debt securities in accordance with ASC 320-10, Investments-Debt and Equity Securities. Investments that are owned by the Company's broker-dealer subsidiaries are recorded at fair value with realized and unrealized gains and losses reported in net loss. Investments designated as available-for-sale that are owned by the Company's non broker-dealer subsidiaries are recorded at fair value with unrealized gains or losses reported as a separate component of other comprehensive income (loss), net of tax. The fair value of the Company's available-for-sale securities was $5,465 and $3,356 as of December 31, 2013 and 2012, respectively, and is included within Other assets.
Fair Value of Financial Instruments-In accordance with ASC 820-10, Fair Value Measurements and Disclosures ("ASC 820-10"), the Company estimates fair values of financial instruments using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment in interpreting market data and, accordingly, changes in assumptions or in market conditions could adversely affect the estimates. The Company also discloses the fair value of its financial instruments in accordance with the fair value hierarchy as set forth by ASC 820-10. See Note 16 for further information.
Fair Value Option-In accordance with ASC 825-10-25, Financial Instruments-Recognition, upon the acquisition of The Kyte Group Limited and Kyte Capital Management Limited (collectively "Kyte"), the Company elected the fair value option to account for its future commitment to purchase the remaining 30% equity interest in Kyte. See Note 5 for further discussion regarding this future purchase commitment.
The fair value option election allows companies to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities. Any change in fair value for assets and liabilities for which the election is made is to be recognized in earnings as they occur. The fair value option election is permitted on an instrument by instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument.
The primary reason for electing the fair value option on the then future commitment to purchase the remaining 30% equity interest in Kyte was to timely reflect economic events in earnings, as management's assessment of the future purchase commitment value was driven by Kyte's earnings or losses subsequent to the initial acquisition date and net present value at a specific point in time.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Derivative Financial Instruments-The Company enters into derivative transactions for a variety of reasons, including managing its exposure to risk arising from changes in foreign currency, facilitating customer trading activities and, in certain instances, to engage in principal trading for the Company's own account. Derivative assets and liabilities are carried on the Consolidated Statements of Financial Condition at fair value, with changes in the fair value recognized in the Consolidated Statements of Operations. Contracts entered into to manage risk arising from changes in foreign currency are recognized in Other income, net and contracts entered into to facilitate customer transactions and principal trading are recognized in Principal transactions. Derivatives are reported on a net-by-counterparty basis when management believes that a legal and enforceable right of offset exists under these agreements. See Note 17 for further information.
Payables to Clearing Services Customers-Payables to clearing services customers include amounts due on cash and margin transactions, including futures contracts, executed on behalf of customers.
Revenue Recognition
Brokerage Transactions-The Company provides brokerage services to its clients in the form of either agency or principal transactions. In agency transactions, the Company charges commissions for executing transactions between buyers and sellers. Agency commission revenues and related expenses are recognized on a trade date basis. These revenues are presented in "Agency Commissions". Principal transactions revenue is primarily derived from matched principal and principal trading transactions. Principal transactions revenues and related expenses are recognized on a trade date basis. The Company earns revenue from principal transactions on the spread between the buy and sell price of the security that is brokered. In matched principal transactions, the Company simultaneously agrees to buy instruments from one customer and sell them to another customer. These revenues are presented in "Principal Transactions". In the normal course of its matched principal and principal trading businesses, the Company may hold security positions overnight. These positions are marked to market on a daily basis.
Clearing Services Revenues-The Company charges fees to customers for clearing services provided for cash and derivative transactions. Clearing services revenues are recorded on a trade date basis as customer transactions occur and are presented net of any customer negotiated rebates.
Software, Analytics and Market Data-Software revenue consists primarily of fees charged for Trayport electronic trading software, which are typically billed on a subscription basis and are recognized ratably over the term of the subscription period, which ranges from one to five years. Analytics revenue consists primarily of software license fees for FENICS® pricing tools which are typically billed on a subscription basis, and is recognized ratably over the term of the subscription period, which is generally three years. Market data revenue primarily consists of subscription fees and fees from customized one-time sales. Market data subscription fees are recognized on a straight-line basis over the term of the subscription period, which ranges from one to two years. Market data revenue from customized one-time sales is recognized upon delivery of the data. The Company markets its software, analytics and market data products through its direct sales force and, in some cases, indirectly through resellers. In general, the Company's license agreements for such products do not provide for a right of return.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Other Income, net-Included within Other income, net on the Company's Consolidated Statements of Operations are revaluations of foreign currency derivative contracts, realized and unrealized transaction gains and losses on certain foreign currency denominated items and gains and losses on certain investments and interest income earned on short-term investments.
For the year ended December 31, 2013, one of the Company's clearing customers accounted for approximately 11% and 0% of the Company's Total revenues and Revenues, net of interest and transaction-based expenses, respectively. No other single customer accounted for 10% or more of the Company's Total revenues for the year ended December 31, 2013. There were no customers that accounted for 10% or more of Total revenues for the years ended December 31, 2012 and 2011.
Compensation and Employee Benefits-The Company's compensation and employee benefits have both a fixed and variable component. Base salaries and benefit costs are primarily fixed for all employees while bonuses constitute the variable portion of compensation and employee benefits. The Company may pay certain performance bonuses in restricted stock units ("RSUs"). The Company also may grant sign-on and retention bonuses for certain newly-hired or existing employees who agree to long-term employment agreements.
In 2011, the Company recorded a charge of $19,443 to Compensation and employee benefits that primarily related to severance costs and the restructuring of certain employment agreements.
Share-Based Compensation-The Company accounts for share-based compensation in accordance with ASC 718 Compensation-Stock Compensation ("ASC 718"). This accounting guidance requires measurement of compensation expense for equity-based awards at fair value and recognition of compensation expense over the service period, net of estimated forfeitures. In all periods presented, the only share-based compensation expense recognized by the Company has been RSUs. The Company determines the fair value of RSUs based on the number of units granted and the grant date fair value of the Company's common stock, measured as of the closing price on the date of grant. See Note 12 for further information.
Income Taxes-In accordance with ASC 740, Income Taxes ("ASC 740"), the Company provides for income taxes using the asset and liability method under which deferred income taxes are recognized for the estimated future tax effects attributable to temporary differences and carryforwards that result from events that have been recognized either in the financial statements or the income tax returns, but not both. The measurement of current and deferred income tax assets and liabilities is based on provisions of enacted tax laws. Valuation allowances are recognized if, based on the weight of available evidence, it is more likely than not that some portion of the deferred tax assets will not be realized. Management applies the more likely than not criteria prior to recognizing a financial statement benefit for a tax position taken (or expected to be taken) in a tax return. The Company recognizes interest and/or penalties related to income tax matters in interest expense and other expense, respectively. In 2013, management has concluded that profits earned commencing January 1, 2013 in certain overseas subsidiaries will ultimately be repatriated to the U.S. and the Company will accrue additional U.S. taxes, if any, on such international profits. Prior to January 1, 2013, the Company has historically asserted the intention to indefinitely reinvest the undistributed earnings of its foreign subsidiaries and therefore have not provided for any U.S. income tax on such international earnings, in accordance with ASC 740. See Note 9 for further information.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Treasury Stock-The Company accounts for Treasury stock using the cost method. Treasury stock held by the Company may be reissued with respect to vested RSUs in qualified jurisdictions. The Company's policy is to account for these shares as a reduction of Treasury stock on a first-in, first-out basis.
Foreign Currency Translation Adjustments and Transactions-Assets and liabilities of foreign subsidiaries having non-U.S. dollar functional currencies are translated at the period end rates of exchange, and revenue and expenses are translated at the average rates of exchange for the period. Gains or losses resulting from translating the foreign currency financial statements are reflected in foreign currency translation adjustments and are reported as a separate component of Comprehensive loss and included in Accumulated other comprehensive income (loss) in the Consolidated Statement of Changes in Stockholders' Equity. The revaluation of asset and liability balances that are denominated in currencies other than the functional currency of the business unit involved in such transactions is reflected in Other Income, net in the Consolidated Statements of Operations. Net gains (losses) resulting from remeasurement of foreign currency transactions and balances for the years ended December 31, 2013, 2012 and 2011 were $2,039, $(3,635) and $(220), respectively.
During the year ended December 31, 2013, the Company reclassified a $1,645 foreign currency translation gain out of Accumulated other comprehensive income and into the Consolidated Statement of Operations. The amount was included within Other income, net and was reclassified during the current period due to the substantial liquidation of a foreign subsidiary, to which this gain was related. The reclassification had no effect on the Benefit from income taxes on the Consolidated Statement of Operations.
Recent Accounting Pronouncements-In December 2011, the Financial Accounting Standards Board ("FASB") issued ASU No. 2011-11 Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities ("ASU 2011-11"). ASU 2011-11 requires additional disclosure about financial instruments and derivatives instruments that are subject to netting arrangements to assist users of the financial statements in understanding the effect of those arrangements on its financial position. In January 2013, the FASB issued an amendment to ASU 2011-11, ASU No. 2013-01 Balance Sheet (Topic 210): Clarifying the Scope of Disclosure about Offsetting Assets and Liabilities ("ASU 2013-01"). ASU 2013-01 clarifies that the scope of ASU 2011-11 applies to derivatives accounted for in accordance with ASC 815- Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with Balance Sheet (Topic 210) guidance, Derivatives and Hedging (Topic 815) guidance, or subject to an enforceable master netting arrangement or similar agreement. The new disclosures are required for reporting periods beginning on or after January 1, 2013, including retrospectively for all comparative periods presented. The adoption of this ASU did not have a material impact on the Company's Consolidated Financial Statements. See Note 17 for further information.
In February 2013, the FASB issued ASU No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income ("ASU 2013-02"), regarding the reporting of reclassifications out of accumulated other comprehensive income. The new guidance does not change the current requirements for reporting net income or other comprehensive income in financial statements. However, it requires companies to present the effects on the line items of net income of significant
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
amounts reclassified out of accumulated other comprehensive income if the item reclassified is required to be reclassified to net income in its entirety during the same reporting period. Presentation should occur either on the face of the income statement where net income is presented or in the notes to the financial statements. The standard was effective for annual periods, and interim periods within those periods, beginning after December 15, 2012. See Summary of Significant Accounting Policies, "Foreign Currency Translation Adjustments and Transactions", for impact on the Consolidated Financial Statements during the year ended December 31, 2013.
In March 2013, the FASB issued ASU No. 2013-05, "Foreign Currency Matters" (ASU 2013-05"), which clarifies the accounting for the cumulative translation adjustment when a parent either sells or transfers a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a foreign subsidiary or group of assets. ASU 2013-05 provides that the parent should release cumulative translation adjustment 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. This guidance is effective for the Company's fiscal year beginning January 1, 2014, and is to be applied prospectively. The adoption of ASU 2013-05 is not expected to have a material impact on the Company's consolidated financial statements.
In July 2013, the FASB issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists ("ASU 2013-11"). ASU 2013-11 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss or tax credit carryforward, unless such tax loss or credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes resulting from the disallowance of a tax position. In the event that the tax position is disallowed 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 shall be presented in the financial statements as a liability and shall not be combined with deferred tax assets. The guidance is effective for annual reporting periods beginning after December 15, 2013, and interim periods within those annual periods, and is to be applied prospectively. The Company is currently evaluating the impact of our pending adoption of ASU 2013-11 on the Company's Consolidated Financial Statements.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
3. RECEIVABLES FROM AND PAYABLES TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS
Amounts receivable from and payable to brokers, dealers and clearing organizations consisted of the following:
Substantially all fail to deliver and fail to receive balances at December 31, 2013 have subsequently settled at the contracted amounts. All fail to deliver and fail to receive balances at December 31, 2012 have subsequently settled at the contracted amounts.
In addition to the balances above, the Company had Payables to clearing services customers of $177,523 and $139,627 at December 31, 2013 and 2012, respectively. These amounts represent cash payable to the Company's clearing customers, that is held at the Company's third party general clearing members and are included within Cash and cash equivalents, Cash and securities segregated under federal and other regulations, or Receivables from brokers, dealers and clearing organizations as follows:
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
4. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Property, equipment and leasehold improvements consist of the following:
Depreciation and amortization expense on property, equipment and leasehold improvements for the years ended December 31, 2013, 2012 and 2011 was $19,370, $20,207 and $21,476, respectively.
5. ACQUISITIONS
The Kyte Group Limited and Kyte Capital Management Limited
On July 1, 2010, the Company acquired a 70% equity ownership interest in Kyte. At the time of the acquisition, the Company agreed to purchase the residual 30% equity interest for a cash payment on a date three years following the closing (the "Future Purchase Commitment") with the purchase price to be determined based on certain performance metrics for Kyte during this three year period. During the third quarter of 2013, the Company and the selling shareholders of Kyte determined that the purchase price for the residual 30% equity interest was zero and the Company completed its acquisition of the remaining 30%. Kyte has been included in the Consolidated Financial Statements as a wholly-owned subsidiary since the acquisition date, with a liability recorded for the Future Purchase Commitment. Subsequent changes in the fair value of the Future Purchase Commitment were recorded in Other income, net in the Consolidated Statements of Operations.
Included as part of the initial purchase price was £5,000 (or approximately $7,592) that was deposited into an escrow account with a third-party escrow agent and 1,339,158 contingently issuable shares of the Company's common stock. The Company was also required to pay an additional cash amount to the selling shareholders of Kyte equal to the total cash dividends the selling shareholders would have received if the 1,339,158 contingently issuable shares had been outstanding as of the initial purchase date of July 1, 2010. The escrow funds, additional cash payment and contingently issuable shares were paid and issued to the selling shareholders of Kyte during the third quarter of 2013 in connection with the final determination of the Future Purchase Commitment and the waiver of certain conditions relating to one of Kyte's investments in a third party.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
5. ACQUISITIONS (Continued)
Contigo Limited
On November 14, 2013, the Company acquired 100% equity ownership interest in Contigo Limited, a provider of trading, portfolio risk management and logistics software for the energy industry. The purchase price was comprised of £3,000 in cash (or approximately $4,811) and contingent consideration with an estimated net present value of £2,458 (or approximately $3,942), which has been recorded as a liability within Other liabilities. Subsequent changes in the estimated fair value of the contingent consideration are recorded in Other income, net in the Consolidated Statement of Operations. The payment of the contingent consideration, if expected financial results are met by Contigo, would not significantly impact the Company's financial position, results of operations or cash flows.
This acquisition was accounted for as a business combination under the acquisition method. Accordingly, the assets acquired, including identifiable intangible assets, specifically Contigo Limited's developed technology, and liabilities assumed were recorded at their respective fair values as of the date of acquisition. The purchase price of $8,753 exceeded the estimated fair value of the identifiable net assets acquired of $4,662, resulting in Goodwill of approximately $4,091 included within the Statement of Financial Condition. Included within the identifiable net assets acquired was intangible assets of approximately $5,550 related to developed technology, see Note 6 for further details. The results of the acquired company have been included within the consolidated financial statements since the date of the acquisition.
6. GOODWILL AND INTANGIBLE ASSETS
Goodwill-Changes in the carrying amount of the Company's goodwill for the years ended December 31, 2013 and 2012 were as follows:
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
6. GOODWILL AND INTANGIBLE ASSETS (Continued)
(1)During the fourth quarter of 2013, the Company recorded a $1,820 income tax benefit with a corresponding increase to Goodwill within the Company's All other category. The adjustment was related to deferred tax liabilities associated with the amortization of an identifiable intangible asset acquired in conjunction with a prior acquisition. This identifiable intangible asset was fully amortized during the year ended December 31, 2013.
(2)During the fourth quarter of 2012, the Company identified an error in its Consolidated Financial Statements for the years ended December 31, 2011 and 2010 related to the 2010 acquisition of Kyte. The adjustment was based on information available to management during the initial measurement period, but was not corrected during that period. The error resulted in an overstatement of both Goodwill and Non-controlling interests. In accordance with authoritative guidance issued by the FASB, the Company corrected this error in the current period by adjusting both Goodwill and Non-controlling interests by $945. The Company believes this error was immaterial to all periods affected.
Goodwill is required to be tested for impairment at least annually and more frequently when indicators of impairment exist. All of the Company's goodwill is allocated to its reporting units and the goodwill impairment tests are performed at the reporting unit level. The Company determined its reporting units to be Americas Brokerage, EMEA Brokerage, Asia Brokerage, Clearing and Backed Trading, Trayport, and FENICS.
ASC 350 gives companies the option to perform a qualitative assessment to determine whether it is more likely than not (a likelihood of greater than 50 percent) that the fair value of its reporting unit is less than its carrying amount. If it is determined, based on the qualitative assessment, that it is more likely than not that the fair value of its reporting unit is less than its carrying amount, or if the company decides to exercise its unconditional option to bypass the qualitative assessment, then the company would proceed to a two-step quantitative impairment test. In the first step, the fair value of each reporting unit is compared with its carrying value, including goodwill and allocated intangible assets. If the fair value is in excess of the carrying value, the goodwill for the reporting unit is considered not to be impaired. If the fair value is less than the carrying value, then a second step is performed in order to measure the amount of the impairment loss, if any, which is based on comparing the implied fair value of the reporting unit's goodwill to the fair value of the net assets of the reporting unit.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
6. GOODWILL AND INTANGIBLE ASSETS (Continued)
Assets, including goodwill and intangible assets, and liabilities are allocated to the reporting units for determining the carrying amount of each respective reporting unit. The assets and liabilities are allocated to a reporting unit based on how the Company's businesses are managed and how those assets and liabilities are deployed in managing the business. Intangible assets are allocated to a reporting unit based on either specifically identifying a particular intangible asset as pertaining to a reporting unit or, if shared among reporting units, based on an assessment of the reporting unit's benefit from the intangible asset in order to generate results.
Based on the results of the annual impairment tests performed during 2012, no goodwill impairment was recognized for any of the Company's reporting units during that year. During 2013, there were no events or changes in circumstances identified that warranted interim impairment testing.
As of November 1, 2013, the Company performed a qualitative assessment on its Trayport and FENICS reporting units and concluded that it is more likely than not that the fair value of each reporting unit is greater than its carrying amount. For the Americas Brokerage, EMEA Brokerage, and Clearing and Backed Trading reporting units, the Company elected to bypass the qualitative assessment and perform a two-step goodwill impairment test. Based on the first step of the annual impairment, management concluded that the fair value of the EMEA brokerage reporting unit was substantially in excess of its carrying value while the Americas Brokerage reporting unit's fair value exceeded its carrying value by less than 10%. Management also concluded that the carrying value of the Company's Clearing and Backed Trading reporting unit exceeded its fair value and therefore, the second step of the impairment test was required in order to determine the implied fair value of the reporting units' goodwill. The results of the second step of the assessment showed that the carrying value of the reporting unit's goodwill of $41,064 exceeded the implied fair value of its goodwill of $22,146 resulting in an impairment charge of $18,918. The impairment was largely due to a decrease in the forecasted cash flows of this segment, reflecting a decrease in the expected revenues and margins as estimated by management during the Company's budgeting and forecasting process in the fourth quarter of 2013. The decrease in expected cash flows was primarily due to additional regulatory compliance, the continued low interest rate environment and lower trading volumes. Subsequent to recording this goodwill impairment charge and foreign currency translation, a goodwill balance of $23,259 remained in the Clearing and Backed Trading reporting unit at December 31, 2013.
The Company estimated the fair value of both the Clearing and Backed Trading and Americas Brokerage reporting units using a weighted average of both the market and income approaches. Under the market approach, the fair value of each reporting unit was based on applying market multiples to its estimated projected revenues and earnings. Key assumptions included management's budgeted statement of operations for the year ended December 31, 2014 and estimated growth rate assumptions for future periods, a range of forward market multiples of comparable companies and a reasonable control premium to apply to the derived market multiples. The applicable multiples were selected based on the similarities and differences between each of those reporting units and the guideline companies in the same sector, including profitability, growth prospects, size, as well as overall risks. The estimated control premium was determined based upon general consideration of premiums paid in individual transactions over a period of time. Under the income approach, the fair values of the reporting units were based on the present value of estimated future cash flows of each respective reporting unit. Key assumptions used in estimating these cash flows included applying business growth
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
6. GOODWILL AND INTANGIBLE ASSETS (Continued)
rate assumptions to future cash flows over a period of time and an estimated terminal value thereafter. The Company discounted the resulting expected cash flows of each reporting unit using an estimated weighted average cost of capital, applicable to that reporting unit, to arrive at a present value amount that approximates fair value.
Changes in these estimates and assumptions could materially affect the determination of fair value and/or goodwill impairment evaluation for each of these reporting units in the future. As a result of continued economic uncertainty and current market dynamics, determining whether an impairment of the goodwill asset exists is increasingly difficult and requires management to exercise significant judgment. In addition, to the extent that securities valuations or trading volumes are depressed for prolonged periods of time and market conditions stagnate or worsen as a result of local or global economic conditions, the revenues and profitability of the Company's Americas Brokerage and Clearing and Backed Trading reporting units may be adversely affected. In addition, control premiums, industry earnings multiples and discount rates are impacted by economic conditions. As a result, subsequent impairment tests may be more frequent and be based upon more negative assumptions and future cash flow projections, which may result in an impairment of the Company's Americas Brokerage reporting unit or further impairment of the Company's Clearing and Backed Trading reporting unit, at such time. Any impairment could materially reduce the recorded amount of goodwill with a corresponding charge to the Company's earnings.
Subsequent to November 1, 2013, no events or changes in circumstances occurred which would indicate any goodwill impairment through the filing date of this Form 10-K.
Intangible Assets-Intangible assets consisted of the following:
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
6. GOODWILL AND INTANGIBLE ASSETS (Continued)
During 2013, the Company recorded an increase in intangible assets subject to amortization of $7,350, primarily resulting from developed technology acquired in connection with the acquisition of Contigo Limited. The components of definite-lived intangible assets acquired during 2013 and their respective weighted-average amortizable period were: $5,550-Core technology (7 years), $1,470-Customer relationships (6 years), and $330-Non-compete agreements (5 years).
Additionally, during 2013, the Company recorded an impairment charge related to Customer relationships in the Americas brokerage segment. The amount of this impairment was $684 and was included within Impairment of goodwill and intangibles.
Intangible amortization expense for the years ended December 31, 2013, 2012 and 2011 was $9,640, $11,293 and $12,190, respectively.
At December 31, 2013, expected amortization expense for the definite lived intangible assets is as follows:
7. OTHER ASSETS AND OTHER LIABILITIES
Other assets consisted of the following:
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
7. OTHER ASSETS AND OTHER LIABILITIES (Continued)
Other liabilities consisted of the following:
8. SHORT-TERM BORROWINGS AND LONG-TERM DEBT
The Company had outstanding debt obligations as of December 31, 2013 and 2012 as follows:
The Company's debt obligations are carried at historical amounts. The fair value of the Company's Long-term debt, categorized within Level 2 of the fair value hierarchy, is measured primarily using pricing service data from external providers. The carrying amounts and estimated fair values of the Company's Long-term debt obligations were as follows:
8.375% Senior Notes
In July 2011, the Company issued $250,000 in aggregate principal amount of 8.375% Senior Notes (the "8.375% Senior Notes") due 2018 in a private offering (the "Offering") to qualified institutional buyers pursuant to Rule 144A and to certain persons in offshore transactions pursuant to Regulation S, each under the Securities Act of 1933, as amended (the "Securities Act"). The notes were priced to investors at 100% of their principal amount, and mature in July 2018. Interest on these notes is payable, semi-annually in arrears on the 19th of January and July. Transaction costs of approximately $9,100 related to the 8.375% Senior Notes were deferred and are being amortized over the term of the notes. On December 21, 2011, the Company completed an exchange offer for the 8.375% Senior Notes
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
8. SHORT-TERM BORROWINGS AND LONG-TERM DEBT (Continued)
whereby it exchanged $250,000 in aggregate principal amount of the 8.375% Senior Notes for 8.375% Senior Notes that are registered under the Securities Act.
On January 18, 2013, Moody's Investor Services lowered its credit rating on the Company's 8.375% Senior Notes two notches to B1, which increased the Company's applicable per annum interest, effective January 19, 2013, by an additional 50 basis points. On April 19, 2013, Fitch Ratings, Inc. ("Fitch") further lowered its credit rating on the Company's 8.375% Senior Notes two notches to BB and revised its outlook from Stable to Negative. This credit rating downgrade by Fitch increased our applicable per annum interest by an additional 50 basis points, effective July 19, 2013. On June 26, 2013, Standard & Poor's ("S&P") further lowered its credit rating on the Company's 8.375% Senior Notes one notch to B+ and revised its outlook from Negative to Stable. This credit rating downgrade by S&P increased the Company's applicable per annum interest by an additional 25 basis points, effective July 19, 2013.
The cumulative effect of all such downgrades to the Company's credit rating by the various rating agencies subsequent to the issuance of our 8.375% Senior Notes resulted in 200 basis points penalty interest, which is the maximum increase permitted under the indenture. The additional 200 basis points of interest equates to $4,800 in additional interest expense per annum, based on the aggregate amount of outstanding principal as of December 31, 2013.
In March 2013, the Company repurchased $10,000 principal amount of its 8.375% Senior Notes on the open market for an aggregate purchase price of $9,602, including accrued interest and sales commissions. The Company funded the repurchase of these notes with borrowings under its Credit Agreement.
At December 31, 2013 and December 31, 2012, unamortized deferred financing fees related to the 8.375% Senior Notes of $5,669 and $7,205, respectively, were recorded within Other assets and the Company was in compliance with all applicable covenants.
Credit Agreement
In March 2013, the Company entered into an amendment to its second amended and restated credit agreement (as amended, the "Credit Agreement") with Bank of America, N.A. and certain other lenders. The Credit Agreement provided for maximum revolving loans of up to $75,000 until December 2013, at which time $18,750 of the lender commitments were due to mature and the remaining $56,250 of lender commitments were due to mature in December 2015.
In December, 2013, the various lenders under the Credit Agreement executed an assignment and assumption agreement pursuant to which the extending lenders under the Credit Agreement assumed the lender commitments of the non-extending lender and the Company has consented to the assignment. As a result, the borrowing capacity will remain at $75,000 until the Credit Agreement matures in December 2015. The Credit Agreement provides for up to $50,000 for letters of credit.
At December 31, 2012, the Credit Agreement provided for maximum revolving loans of up to $129,500, with $50,000 for letters of credit.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
8. SHORT-TERM BORROWINGS AND LONG-TERM DEBT (Continued)
Revolving loans may be either base rate loans or Eurocurrency rate loans. Eurocurrency rate loans bear interest at the annualized rate of one-month LIBOR plus the application margin and base rate loans bear interest at a rate per annum equal to a prime rate plus the applicable margin. Letter of credit fees per annum are equal to the applicable margin times the outstanding amount drawn under such letter of credit. As long as no default has occurred under the Credit Agreement, the applicable margin for base rate and Eurocurrency rate loans and letters of credit is based on a matrix that varies with a ratio of outstanding debt to EBITDA, as defined in the Credit Agreement.
The weighted average interest rate of the outstanding loans under the Credit Agreement was 3.41% at December 31, 2013. At December 31, 2013 and December 31, 2012, unamortized deferred financing fees related to the Credit Agreement of $1,117 and $869, respectively, were recorded within Other assets.
The Credit Agreement contains certain financial and other covenants. The Company was in compliance with all applicable covenants at December 31, 2013 and 2012.
9. INCOME TAXES
The components of the (benefit from) provision for income taxes are as follows:
The Company had pre-tax income from foreign operations of $6,224, $31,571 and $37,589 for the years ended December 31, 2013, 2012 and 2011, respectively. Pre-tax loss from domestic operations was $(27,569), $(32,828) and $(37,507) for the years ended December 31, 2013, 2012 and 2011, respectively.
Deferred income taxes reflect the net tax effects of temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
9. INCOME TAXES (Continued)
that will be in effect when such differences are expected to reverse. Significant components of the Company's gross deferred tax assets and liabilities are set forth below:
As a result of certain realization requirements of ASC 718, the table of deferred tax assets and liabilities shown above does not include certain deferred tax assets as of December 31, 2013 and 2012 that arose directly from tax deductions related to equity compensation in excess of compensation expense recognized for financial reporting purposes. Stockholders' Equity will be increased by $1,911 when such deferred tax assets are ultimately realized. The Company uses tax law ordering when determining when excess tax benefits have been realized.
Cumulative undistributed earnings of foreign subsidiaries were approximately $285,723 at December 31, 2013. U.S. income and foreign withholding taxes have not been recognized on the excess of the amount for financial reporting over the tax basis of investments in foreign subsidiaries that are essentially permanent in duration. This amount becomes taxable upon a repatriation of assets from the subsidiary or a sale or liquidation of the subsidiary. Management concluded that earnings from certain foreign subsidiaries commencing from January 1, 2013 will ultimately be repatriated and will provide U.S. tax on those amounts. The Company has determined that the historic undistributed earnings prior to 2013 from our foreign subsidiaries, are indefinitely reinvested and, accordingly, no U.S. income taxes have been provided.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
9. INCOME TAXES (Continued)
The valuation allowance relates primarily to the inability to utilize net operating losses ("NOLs") and foreign tax credits in various tax jurisdictions. The Company had the following net operating loss carryforwards as of December 31, 2013:
The U.S. NOLs are subject to annual limitations on utilization and will begin to expire in 2017. The foreign NOLs are subject to annual limitations on utilization and will begin to expire in 2014. Further, the Company has $2,020 of foreign tax credit carryforwards at December 31, 2013 that will begin to expire in 2014. The Company continues to monitor the realizability of these losses and believes it is more likely than not that the tax benefits associated with these losses will be realized to the extent a valuation allowance has not been established. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized and, when necessary, a valuation allowance is established. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences become deductible. Management considers the following possible sources of taxable income when assessing the realization of deferred tax assets:
•future reversals of existing taxable temporary differences;
•future taxable income exclusive of reversing temporary differences and carryforwards;
•taxable income in prior carryback years; and
•tax planning strategies.
The assessment regarding whether a valuation allowance is required or should be adjusted also considers all available positive and negative evidence, including, but not limited to, the following:
•the nature, frequency, and severity of any recent losses;
•the duration of statutory carryforward periods;
•historical experience with tax attributes expiring unused; and
•the Company's estimated near- and medium-term financial outlook.
The Company has incurred a cumulative net loss, on a book basis, for the last three years. The majority of the Company's Deferred tax assets are in the U.S. and as a result, the Company is relying on certain prudent and feasible tax planning strategies, as defined in ASC 740, that would be implemented, if necessary, to prevent a Deferred tax asset from expiring. The tax planning strategy that the Company will implement is a sale of certain intellectual property held in the U.S. to a related party or externally with a right to continue to use the intellectual property and the sale of certain non-core assets. The Company believes such sales would, based on current valuations, generate sufficient profits to utilize the U.S. Deferred tax assets.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
9. INCOME TAXES (Continued)
The corporate statutory U.S. federal tax rate was 35.0% for the three years presented. A reconciliation of the Company's (benefit from) provision for income taxes and the statutory tax rate is as follows:
(1)Valuation allowance provided for deferred taxes related to state and local taxes, capital loss and charitable contribution carryforwards.
(2)This amount represents the impact related solely to foreign taxes such as (i) non-deductible expenses, including an $18,918 impairment of goodwill, (ii) valuation allowances and (iii) a $1,820 income tax benefit related to deferred tax liabilities associated with an identifiable intangible asset acquired in conjunction with a prior acquisition. This identifiable intangible asset was fully amortized during the year ended December 31, 2013.
Income tax expense of approximately $1,911, $2,213 and $1,764 from the exercise of stock options and the vesting of RSUs was recorded directly to additional paid-in capital in 2013, 2012 and 2011, respectively.
Total unrecognized tax benefits as of December 31, 2013 were approximately $9,839, including interest of $1,163, all of which could affect the effective income tax rate in future periods. A
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
9. INCOME TAXES (Continued)
reconciliation of the beginning and ending amount of unrecognized tax benefits, showing only items of movement, is as follows:
The Company is under continuous examination by the Internal Revenue Service (the "IRS") and other tax authorities in certain countries, such as the U.K., and states in which the Company has significant business operations, such as New York. The Company is currently under examination by the IRS covering tax years 2004-2010. Also, the Company is currently at various levels of field examination with respect to audits with New York State and New York City for tax years 2006-2008. The resolutions of these audits are not expected to be material to the Company's Consolidated Financial Statements. The Company has substantially concluded all U.S. federal, state and local income tax matters for years prior to 2004.
In the U.K., the Company is in discussion with tax authorities regarding whether certain compensation expenses were deductible by the Company in prior years. The Company believes that the resolution of this tax matter will not have a material effect on the Consolidated Statement of Financial Condition, although a resolution could have a material impact on the Company's Consolidated Statement of Operations for a particular future period and on the Company's effective income tax rate for any period in which such resolution occurs. The Company has established a liability for unrecognized tax benefits that the Company believes is adequate in relation to the potential for additional assessments. Once established, the Company adjusts unrecognized tax benefits only when more information is available or when an event occurs necessitating a change.
The Company recognizes interest and penalties related to income tax matters in interest expense and other expense, respectively. As of December 31, 2013 and 2012, the Company had approximately $1,163 and $1,050, respectively, of accrued interest related to uncertain tax positions.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
10. STOCKHOLDERS' EQUITY
Share Issuance
During 2013 and 2012, the Company issued 4,570,832 and 3,952,172 shares of common stock, respectively, in connection with the exercise of stock options and vesting of RSUs. The Company received total cash proceeds of $910 and $30 in 2013 and 2012, respectively, in connection with the exercise of stock options. In 2013, 1,339,158 contingently issuable shares were issued to the selling shareholders of Kyte in connection with the final determination of the Future Purchase Commitment and the waiver of certain conditions relating to one of Kyte's investments in a third party.
Common Stock
Each holder of the Company's common stock is entitled to one vote per share on all matters submitted to a vote of stockholders. Subject to the rights of holders of the Company's preferred stock, if any, the holders of shares of the Company's common stock are entitled to receive dividends when, as and if declared by the Company's Board of Directors.
On each of May 31, August 30, and November 29, 2013 the Company paid a cash dividend of $0.05 per share, which, based upon the number of shares outstanding on the record date for such dividends, totaled $5,999, $6,096 and $6,142, respectively. In December 2012, the Company's Board of Directors declared a dividend for the fourth quarter of 2012 on an accelerated basis. The dividend was declared and paid in December 2012 and the Company, therefore, did not pay a cash dividend during the first quarter of 2013. On each of March 30, May 31, August 31, November 30 and December 27, 2012 the Company paid a cash dividend of $0.05 per share, which, based upon the number of shares outstanding on the record date for such dividends, totaled $5,897, $5,991, $5,873, $5,901, and $5,904, respectively.
Preferred Stock
As of December 31, 2013 and 2012, the Company had one class of preferred stock with 5,000,000 shares authorized and none issued.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
10. STOCKHOLDERS' EQUITY (Continued)
Treasury Stock
In August 2007, the Company's Board of Directors authorized the Company to implement a stock repurchase program to repurchase a limited number of shares of the Company's common stock. Under the repurchase plan, the Board of Directors authorized the Company to repurchase shares of the Company's common stock on the open market in such amounts as determined by the Company's management, provided, however, such amounts are not to exceed, during any calendar year, the number of shares issued upon the exercise of stock options plus the number of shares underlying grants of RSUs that are granted or which management reasonably anticipates will be granted in such calendar year. During the year ended December 31, 2013, the Company did not repurchase any of its common stock. During the year ended December 31, 2012, the Company repurchased 3,107,469 shares of its common stock on the open market at an average price of $3.17 per share and for a total cost of $9,939, including sales commissions. These repurchased shares were recorded at cost as Treasury stock in the Consolidated Statements of Financial Condition.
On December 28, 2012, the Company and JPI entered into a stock purchase agreement pursuant to which the Company purchased 993,377 shares of common stock held by JPI at a price of $3.02 per share for a purchase price of $3,000. The review and approval of this stock purchase agreement was delegated by the Company's Board of Directors to its Audit Committee, comprised of solely independent directors, which approved such stock purchase agreements. These repurchased shares were recorded at cost as Treasury stock in the Consolidated Statements of Financial Condition.
During the years ended December 31, 2013 and 2012, the Company reissued 729 and 932,198 shares of its Treasury stock, respectively, in relation to the settlement of vested RSUs. The reissuance of these shares is accounted for as a reduction of Treasury stock on a first-in, first-out basis. The total amounts reduced from Treasury stock relating to the settlement of RSUs during the years ended December 31, 2013 and 2012 were $2 and $11,839, respectively.
11. LOSS PER SHARE
Basic loss per share for common stock is calculated by dividing net loss available to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted loss per share is calculated by dividing net loss by the sum of: (i) the weighted average number of shares outstanding, (ii) outstanding stock options and RSUs (using the "treasury stock" method when the impact of such options and RSUs would be dilutive), and (iii) any contingently issuable shares when dilutive.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
11. LOSS PER SHARE (Continued)
Basic and diluted loss per share for the years ended December 31, 2013, 2012 and 2011 were as follows:
As a result of the net loss for the years ended December 31, 2013, 2012 and 2011, the following stock options, RSUs and contingently issuable shares outstanding were excluded from the computation of diluted loss per share for each respective period, as their inclusion would be anti-dilutive:
12. SHARE-BASED COMPENSATION
The Company maintains the Amended and Restated GFI Group Inc. 2008 Equity Incentive Plan, which was approved by the Company's stockholders on June 6, 2013 (as amended and restated, the "2008 Equity Incentive Plan") which permits the grant of non-qualified stock options, incentive stock options, stock appreciation rights, shares of restricted stock, restricted stock units and performance units to employees, non-employee directors or consultants. The Company issues shares from authorized but unissued shares and authorized and issued shares reacquired and held as treasury shares, which are reserved for issuance upon the vesting of RSUs granted pursuant to the 2008 Equity Incentive Plan. As of December 31, 2013, the Company had stock options outstanding under the GFI Group 2002 Stock Option Plan (the "GFI Group 2002 Plan"), and none outstanding under the GFInet Inc. 2000 Stock Option Plan (the "GFInet 2000 Plan"). No additional grants will be made under these option plans.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
12. SHARE-BASED COMPENSATION (Continued)
As of December 31, 2013, there were 5,234,834 shares of common stock available for future grants of awards under the 2008 Equity Incentive Plan.
Restricted Stock Units
The fair value of RSUs is based on the closing price of the Company's common stock on the date of grant and is recorded as compensation expense over the service period, net of estimated forfeitures. The following is a summary of RSU transactions under both the 2008 Equity Incentive Plan and the 2004 Equity Incentive Plan:
The weighted average grant-date fair value of RSUs granted during 2013 was $3.71 per unit, compared with $3.55 per unit for the same period in the prior year. Total compensation expense and related income tax benefits recognized in relation to RSUs are as follows:
The Company has modified the vesting terms of RSU grants for certain employees in connection with the termination of their employment. As a result of these modifications, the Company recorded incremental compensation expense totaling $716, $255 and $2,210 during 2013, 2012, and 2011, respectively.
At December 31, 2013, total unrecognized compensation cost related to the RSUs prior to the consideration of expected forfeitures was approximately $49,046 and is expected to be recognized over a weighted-average period of 1.51 years. The total fair value of RSUs vested during the years ended December 31, 2013, 2012 and 2011 was $29,860, $31,514 and $27,407, respectively.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
12. SHARE-BASED COMPENSATION (Continued)
Stock Options
The following is a summary of stock options outstanding under both the GFI Group 2002 Plan and the GFInet 2000 Plan:
As of December 31, 2013, 2012, and 2011, there was no unrecognized compensation cost related to stock options.
The total intrinsic value of options exercised for the years ended December 31, 2013, 2012 and 2011 was $431, $2 and $52, respectively. Additionally, the total intrinsic value of options outstanding and exercisable at December 31, 2013 was $66.
13. COMMITMENTS AND CONTINGENCIES
Operating Leases-The Company has non-cancelable operating leases, principally for office space, that expire on various dates through 2027. At December 31, 2013, the future minimum rental commitments under such leases are as follows:
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
13. COMMITMENTS AND CONTINGENCIES (Continued)
Many of the leases for office space contain escalation clauses that require payment of additional rent to the extent of increases in certain operating and other costs. In addition, certain of the Company's leases grant a free rent period, which is amortized over the lease term. The accompanying Consolidated Statements of Operations reflect all rent expense on a straight-line basis over the term of the leases. Rent expense under the leases for the years ended December 31, 2013, 2012 and 2011 was $18,230, $13,465 and $15,252, respectively, and is included within Rent and occupancy.
Purchase Obligations-The Company has various unconditional purchase obligations. These obligations are for the purchase of market data from a number of information service providers during the normal course of business. As of December 31, 2013, the Company had total purchase commitments for market data of approximately $27,057, with $18,356 due within the next twelve months and $8,701 due between one to three years. Additionally, the Company had other purchase commitments of $6,263, primarily related to network implementations in the U.S. and U.K., and $1,077 for hosting and software license agreements. Of these other purchase commitments, approximately $4,932 is due within the next twelve months.
Contingencies-In the normal course of business, the Company and certain subsidiaries included in the consolidated financial statements are, and have been in the past, involved in various lawsuits and proceedings and are, and have been in the past, involved in certain regulatory examinations. These legal proceedings are at varying stages of adjudication, arbitration or investigation and involve a wide variety of claims. In view of the inherent difficulty of predicting the outcome of such litigation and regulatory matters, particularly where the claimants seek very large or indeterminate damages or where the matters present novel legal theories, the Company generally cannot predict what the eventual outcome of the pending matters will be, what the timing of the ultimate resolution of these matters will be, or what the eventual loss, fines or penalties, if any, relating to each matter may be.
The Company is subject to the possibility of losses from these various contingencies. Considerable judgment is necessary to estimate the probability and amount of any loss from such contingencies. In accordance with applicable accounting guidelines, an accrual is made when it is probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. Where a loss contingency is not both probable and estimable, the Company does not establish an accrued liability. One of the Company's European subsidiaries is currently defending a claim that they improperly hired a number of employees of a competitor over a period of time. Although the case is in its preliminary stages, the claimant is seeking a multi-million dollar award. The Company intends to vigorously defend against this action and believe that it has substantial defenses to the claims and damages asserted against it.
The Company is subject to regular examinations by various tax authorities in jurisdictions in which the Company has significant business operations. The Company regularly assesses the likelihood of additional tax assessments that may result from these examinations in each of the tax jurisdictions. A tax accrual has been established, which the Company believes to be adequate in relation to the potential for additional tax assessments. Once established, the accrual may be adjusted based on new information or events. The imposition of additional tax assessments, penalties or fines by a tax authority could have a material impact on the Company's effective tax rate.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
13. COMMITMENTS AND CONTINGENCIES (Continued)
Additionally, the Company has recorded reserves for certain contingencies to which it may have exposure, such as contingencies related to the employer portion of National Insurance Contributions in the U.K.
Based on currently available information, the outcome of the Company's outstanding legal proceedings are not expected to have a material adverse impact on the Company's financial position. However, the outcome of any such matters may be material to the Company's results of operations or cash flows in a given period. It is not presently possible to determine the Company's ultimate exposure to these matters and there is no assurance that the resolution of the Company's outstanding matters will not significantly exceed any reserves accrued by the Company.
The purchase price paid in connection with the acquisition of Contigo Limited, the purchase price included contingent consideration with an estimated net present value of £2,458 (or approximately $3,942). Subsequent changes in the estimated fair value of the contingent consideration will recorded in Other income, net in the Consolidated Statement of Operations and the estimated fair value of the Contingent consideration as of December 31, 2013 is included within Other liabilities in the Statement of Financial Condition. See Note 16 for further information.
Risks and Uncertainties-The Company primarily generates its revenues by executing and facilitating transactions for counterparties. Revenues for these services are transaction based. As a result, the Company's revenues will likely vary based upon the trading volumes of the various securities, commodities, foreign exchange and other cash and derivative markets in which the Company provides its services.
Guarantees-The Company, through its subsidiaries, is a member of certain exchanges and clearing houses. Under the membership agreements, members are generally required to guarantee certain obligations. To mitigate the performance risks of its members, the exchanges and clearing houses may, from time to time, require members to post collateral, as well as meet certain minimum financial standards. The Company's maximum potential liability under these arrangements cannot be quantified. However, management believes that the potential for the Company to be required to make payments under these arrangements is unlikely. Accordingly, no contingent liability is recorded in the Consolidated Statements of Financial Condition for these arrangements.
14. RETIREMENT PLANS
In the United States, the Company has established the GFI Group 401(k) plan, pursuant to the applicable provisions of the Internal Revenue Code. It is available to all eligible U.S. employees and is subject to the provisions of the Employee Retirement Income Security Act of 1974. Employees may voluntarily contribute a portion of their compensation, not to exceed the statutory limits. The Company did not make any contributions to the plan for the years ended December 31, 2013, 2012 or 2011.
In Europe, the Company has established six defined contribution plans pursuant to applicable local laws of their respective countries. Employees of certain European subsidiaries may voluntarily designate a portion of their monthly compensation to be contributed, which the Company matches up to a certain percentage. The Company has made aggregate contributions of $2,432, $1,859 and $1,461 in
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
14. RETIREMENT PLANS (Continued)
2013, 2012 and 2011, respectively, for these defined contribution plans, recorded in Compensation and employee benefits.
15. MARKET AND CREDIT RISKS
Market Risk
The Company, through its subsidiaries, operates as a wholesale broker. The Company provides brokerage services to its customers through agency or principal transactions. Agency brokerage transactions facilitated by the Company are settled between the counterparties on a give-up basis. In matched principal transactions, the Company is interposed between buyers and sellers and the transactions are cleared through various clearing organizations. In the event of counterparty nonperformance, the Company may be required to purchase or sell financial instruments at unfavorable market prices, which may result in a loss to the Company. The Company does not anticipate nonperformance by counterparties. The Company may also enter into principal investing transactions in which the Company commits its capital within predefined limits, either to facilitate customer trading activities or to engage in principal trading for the Company's own account. To the extent that the Company owns assets (i.e. has long positions) in fluctuating markets, a downturn in the value of those assets or in those markets could result in losses from a decline in the value of those long positions. Conversely, to the extent that the Company has sold assets that the Company does not own (i.e. has short positions) in any of those markets, an upturn in those markets could expose the Company to significant losses as the Company attempts to cover short positions in a rising market.
Unsettled transactions (i.e., securities failed-to-receive and securities failed-to-deliver) are attributable to matched principal transactions executed by subsidiaries and are recorded at contract value. Cash settlement is achieved upon receipt or delivery of the security. In the event of nonperformance, the Company may purchase or sell the security in the market and seek reimbursement for losses from the contracted counterparty.
In certain instances, the Company may provide credit for margin requirements to customers, secured by collateral in a customer's account. In such cases, the Company is exposed to the market risk that the value of the collateral the Company holds could fall below the amount of a customer's indebtedness. This risk can be amplified in any situation where the market for the underlying instrument is rapidly declining. Agreements with customers that have margin accounts permit the Company to liquidate their positions in the event that the amount of margin collateral becomes insufficient. Despite those agreements and the Company's risk management policies with respect to margin, the Company may be unable to liquidate a customer's positions for various reasons, or at a price sufficient to cover any deficiency in a customer's account. If the Company were unable to liquidate a position at a price sufficient to cover any deficiency or if a customer was unable to post additional margin, the Company may suffer a loss.
Credit Risk
Credit risk arises from potential non-performance by counterparties of our matched principal business, as well as from nonpayment of commissions by customers of our agency brokerage business. The Company also has credit and counterparty risk in certain situations where it provides clearing and
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
15. MARKET AND CREDIT RISKS (Continued)
execution services. The Company provides agency clearing services through its relationships with general clearing member firms and/or exchanges. In these instances, the Company's accounts at such institutions are used, in its name, to provide access to clearing services for its customers. Credit risk arises from the possibility that the Company may suffer losses due to the failure of its customers or other counterparties to satisfy their financial obligations to the Company or in a timely manner.
The Company has established policies and procedures to manage its exposure to credit risk. The Company maintains a thorough credit approval process to limit its exposure to counterparty risk and employs stringent monitoring to control the market and counterparty risk from its matched principal business. The Company's brokers may only execute transactions for clients that have been approved by the Company's credit committee following review by the Company's credit department. The Company's credit approval process includes verification of key financial information and operating data and anti-money laundering verification checks. The Company's credit review process may include consideration of independent credit agency reports and a visit to the entity's premises, if necessary. The Company has developed and utilizes a proprietary, electronic credit risk monitoring system.
Credit approval is granted by the Company's credit committee, which is comprised of senior management and representatives from its compliance, finance and legal departments. Credit approval is granted subject to certain trading limits and may be subject to additional conditions, such as the receipt of collateral or other credit support. The Company's credit risk department assists the credit committee in the review of any proposed counterparty by conducting diligence on such party and by continuing to review such counterparties for continued credit approval on at least an annual basis. These results are reviewed by the credit committee. Maintenance procedures include reviewing current audited financial statements and publicly available information on the client, collecting data from credit rating agencies where available and reviewing any changes in ownership, title or capital of the client. For the Company's agency business, the approval process includes the requisite anti-money laundering and know-your-customer verifications.
16. FAIR VALUE OF FINANCIAL INSTRUMENTS
Certain of the Company's assets and liabilities are carried at fair value or contracted amounts that approximate fair value. Assets and liabilities that are recorded at contracted amounts approximating fair value consist primarily of receivables from and payables to brokers, dealers and clearing organizations and payables to clearing services customers. These receivables and payables to brokers, dealers and clearing organizations are short-term in nature, and following December 31, 2013, substantially all have settled at the contracted amounts. The Company's marketable equity securities, included in Other assets, are recorded at fair value based on their quoted market price. The Company's investments that are accounted for under the cost and equity methods are investments in companies that are not publicly traded and for which no established market for their securities exists. The fair value of these investments is only estimated if there are identified events or changes in circumstances that may have a significant adverse effect on the carrying value of the investment.
The Company's financial assets and liabilities recorded at fair value have been categorized based upon a fair value hierarchy in accordance with ASC 820-10. In accordance with ASC 820-10, the Company has categorized its financial assets and liabilities, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy as set forth below.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
16. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
Level 1-Financial assets and liabilities whose values are based on unadjusted quoted prices for identifiable assets or liabilities in an active market that the company has the ability to access at the measurement date (examples include active exchange-traded equity securities, listed derivatives, and most U.S. Government and agency securities).
Level 2-Financial assets and liabilities whose values are based on quoted prices in markets where trading occurs infrequently or whose values are based on quoted prices of instruments with similar attributes in active markets. Level 2 inputs include the following:
•Quoted prices for identifiable or similar assets or liabilities in non-active markets (examples include corporate and municipal bonds which trade infrequently); and
•Inputs other than quoted prices that are observable for substantially the full term of the asset or liability (examples include interest rate and currency swaps).
Level 3-Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management's own assumptions about the assumptions a market participant would use in pricing the asset or liability.
Valuation Techniques
A description of the valuation techniques applied to the Company's major categories of assets and liabilities measured at fair value on a recurring basis are as follows:
U.S. Treasury Securities-U.S. Treasury securities are valued using quoted market prices. Valuation adjustments are not applied. Accordingly, U.S. Treasury securities are generally categorized in Level 1 of the fair value hierarchy.
Equity Securities-Equity securities include mostly exchange-traded securities and are valued based on quoted market prices. Accordingly, exchange-traded equity securities are generally categorized in Level 1 of the fair value hierarchy. Non-exchange traded equity securities are measured primarily using broker quotations, pricing service data from external providers and prices observed for recently executed market transactions. Non-exchange traded equity securities are generally categorized within Level 2 of the fair value hierarchy.
Corporate Bonds-Corporate bonds are measured primarily using broker quotations, pricing service data from external providers and prices observed for recently executed market transactions. Corporate bonds are generally categorized in Level 2 of the fair value hierarchy.
Foreign government bonds-Foreign government bonds are mostly valued using quoted market prices. Accordingly, foreign government bonds are generally categorized in Level 1 of the fair value hierarchy.
Derivative Contracts-Derivative contracts include instruments such as foreign exchange, commodity, fixed income and equity derivative contracts.
Listed Derivative Contracts-Listed derivatives that are actively traded are valued based on quoted prices from the exchange and are categorized in Level 1 of the fair value hierarchy.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
16. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
OTC Derivative Contracts-OTC derivative contracts include forwards, swaps, and options contracts related to foreign currencies. Depending on the product and the terms of the transaction, the fair value of OTC derivative products can be either observed or modeled using a series of techniques and model inputs from comparable benchmarks, including closed-form analytic formulas, such as the Black-Scholes option-pricing model, and simulation models or a combination thereof. Many pricing models do not entail material subjectivity because the methodologies employed do not necessitate significant judgment, and the pricing inputs are observed from actively quoted markets. In the case of more established derivative products, the pricing models used by the Company are widely accepted by the financial services industry. OTC derivative products valued by the Company using pricing models generally fall into this category and are categorized in Level 2 of the fair value hierarchy.
Equity warrants-Non-exchange traded equity warrants are classified within Level 3 of the fair value hierarchy and are measured using the Black-Scholes model with key inputs impacting the valuation including the underlying security price, implied volatility, dividend yield, interest rate curve, strike price and maturity date.
Convertible Note Receivable, Available-For-Sale-During the fourth quarter of 2011, the Company exchanged its membership interest in a third party brokerage firm for a convertible senior secured promissory note in that company. This security was previously measured using valuation techniques involving quoted prices of or market data for comparable companies, including credit ratings, peer company ratios and discounted cash flow analyses. As the inputs used in estimating the fair value of this convertible debt security were both unobservable and significant to the overall fair value measurement of this asset, the asset was categorized within Level 3 of the fair value hierarchy. During the three months ended September 30, 2012, the third party brokerage firm notified the Company that they had immediate liquidity concerns and that there was the prospect of insolvency in the near future. Based upon this information, the Company determined its estimated fair value of the convertible senior secured promissory note to be zero.
Future Purchase Commitment-In connection with the acquisition of 70% of the equity ownership interests in Kyte, the Company agreed to purchase the residual 30% equity interest in Kyte. The purchase price for the residual 30% equity interest was determined to be zero in the third quarter of 2013. Beginning with the initial acquisition date and continuing up until the final settlement of the Future Purchase Commitment during the third quarter of 2013, an estimate of the payment for the residual 30% interest was determined pursuant to a formula based on Kyte's forecasted and actual earnings and losses. The inputs used in estimating the fair value of this Future Purchase Commitment were both unobservable and significant to the overall fair value measurement of this liability. Therefore, the liability was categorized in Level 3 of the fair value hierarchy.
Contingent Consideration-The category consists primarily of contingent consideration related to two of the Company's acquisitions.
On November 1, 2009, the Company completed the acquisition of a retail energy brokerage business. This contingent liability is remeasured at fair value and is based on estimated future collections of accounts receivable through the first quarter of 2014 related to the earnings of the acquired business through October 31, 2013.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
16. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
On November 14, 2013, the Company completed the acquisition of Contigo, a provider of trading, portfolio risk management and logistics software for the energy industry. This contingent liability, which will be settled in a combination of cash and up to 50% of the Company's common stock at the Company's discretion, will be remeasured at fair value and is based on different measures of the acquired business' future financial performance, including revenues and operating margins, from May 1, 2014 through April 30, 2015.
The inputs used in estimating the fair value of these contingent considerations are both unobservable and significant to the overall fair value measurement of this liability, therefore the liability is categorized in Level 3 of the fair value hierarchy.
In the years ended December 31, 2013 and 2012, the Company did not have any material transfers amongst Level 1, Level 2, and Level 3.
Financial Assets and Liabilities measured at fair value on a recurring basis as of December 31, 2013 are as follows:
Excluded from the table above is variation margin on net long derivative contracts related to exchange traded futures in the amount of $388 included within Receivables from brokers, dealers and
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
16. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
clearing organizations. Also excluded from the table above is variation margin on net short derivative contracts related to exchange traded futures in the amount of $596 included within Payables to brokers, dealers and clearing organizations.
Financial Assets and Liabilities measured at fair value on a recurring basis as of December 31, 2012 are as follows:
(1)Represents the impact of netting on a net-by-counterparty basis.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
16. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
Excluded from the table above is initial and variation margin on net long derivative contracts related to exchange traded futures in the amount of $49 and net short derivative contracts related to exchange traded futures in the amount of $14,986. These amounts were included within Receivables from brokers, dealers and clearing organizations.
Changes in Level 3 Financial Assets and Liabilities measured at fair value on a recurring basis for the year ended December 31, 2013 are as follows:
(1)Realized and unrealized gains (losses) are reported in Other income, net in the Consolidated Statements of Operations.
Changes in Level 3 Financial Assets and Liabilities measured at fair value on a recurring basis for the year ended December 31, 2012 are as follows:
(1)Realized and unrealized gains (losses) are reported in Other income, net in the Consolidated Statements of Operations.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
16. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
Quantitative Information about Level 3 Fair Value Measurements
The following table presents quantitative information about the significant unobservable inputs utilized by the Company in the fair value measurement of Level 3 Assets and Liabilities measured at fair value on a recurring basis.
(a)As of December 31, 2013 and December 31, 2012, each asset and liability type consists of one instrument.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
16. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
(b)The Company's estimate of Contingent Consideration as of December 31, 2013 was based on the acquired business' projected future financial performance, including revenues and operating margins, from May 1, 2014 through April 30, 2015.
(c)To determine the estimated price per convertible unit, the Company estimated the fair value of a non-controlling interest in the entity utilizing a discounted cash flow, appropriate discount rate and combined discount for lack of control and marketability.
(d)The Company's estimate of the Future Purchase Commitment as of December 31, 2012 was based on Kyte's projected earnings through June 30, 2013. In estimating the fair value, the Company utilized post-tax projected earnings for the remaining period through June 30, 2013.
Valuation Processes-Level 3 Measurements-Depending on the instrument, the Company utilizes a valuation technique, including discounted cash flow methods, option pricing methods and present value methods, as indicated above. Valuations are generally conducted by the Company, with consultation of a third-party valuation expert to develop the valuation model when the asset or liability is initially recorded. Each reporting period, the Company updates unobservable inputs utilizing relevant published information, where applicable. The Company has a formal process to review changes in fair value for satisfactory explanation.
Sensitivity Analysis-Level 3 Measurements
Equity derivative contracts-The significant unobservable inputs used in the fair value of the Company's equity derivative contracts are the expected volatility and an estimated share price. Significant increases (decreases) in expected volatility or estimated share price would result in a higher (lower) fair value measurement.
Future purchase commitment-Prior to September 30, 2013, the Future Purchase Commitment relating to Kyte was settled and therefore, there is no sensitivity to the inputs used in determining its fair value. As of December 31, 2012, the significant unobservable inputs used in the fair value of the Company's Future Purchase Commitment for the residual 30% equity interest in Kyte were the discount rate and forecasted financial information. Significant increases (decreases) in the discount rate would have resulted in a lower (higher) fair value measurement. Significant increases (decreases) in the forecasted financial information would have resulted in a higher (lower) fair value measurement.
Contingent consideration-The significant unobservable inputs used in the fair value in the Company's contingent consideration are the discount rate and forecasted financial information. Significant increases (decreases) in the discount rate would have resulted in a lower (higher) fair value measurement. Significant increases (decreases) in the forecasted financial information would have resulted in a higher (lower) fair value measurement.
For all significant unobservable inputs used in the fair value measurement of all Level 3 assets and liabilities, a change in one of the inputs would not necessarily result in a directionally similar change in the other.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
17. DERIVATIVE FINANCIAL INSTRUMENTS
The Company uses foreign exchange derivative contracts, including forward contracts and foreign currency swaps, to reduce the effects of fluctuations in certain assets and liabilities denominated in foreign currencies. The Company also hedges a portion of its foreign currency exposures on anticipated foreign currency denominated revenues and expenses by entering into forward foreign exchange contracts. As of December 31, 2013 and December 31, 2012, none of these contracts were designated as foreign currency cash flow hedges under ASC 815-10, Derivatives and Hedging ("ASC 815-10").
The Company provides brokerage services to its customers for exchange-traded and over-the-counter derivative products, which include futures, forwards and options contracts. The Company may enter into principal transactions for exchange-traded and over-the-counter derivative products to facilitate customer trading activities or to engage in principal trading for the Company's own account.
The Company monitors market risk exposure from its matched principal business and principal trading business by regularly monitoring its concentration of market risk to financial instruments, countries or counterparties and regularly monitoring trades that have not settled within prescribed settlement periods or volume thresholds. Additionally, market risks are monitored and mitigated by the use of the Company's proprietary, electronic risk monitoring system, which provides daily credit reports in each of the Company's geographic regions that analyze credit concentration and facilitates the regular monitoring of transactions against key risk indicators.
For certain derivative contracts, the Company has entered into agreements with counterparties that allow for the netting of positions. The Company reports these derivative contracts on a net-by-counterparty basis when management believes that a legal and enforceable right of offset exists under these agreements.
Fair values of derivative contracts on a gross and net basis as of December 31, 2013 and December 31, 2012 are as follows:
(1)Reflects futures and options on futures contracts within Receivables from brokers, dealers and clearing organizations and options and forwards contracts within Other assets.
(2)Reflects futures and options on futures contracts within Payables to brokers, dealers and clearing organizations and options and forwards contracts within Other liabilities.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
17. DERIVATIVE FINANCIAL INSTRUMENTS (Continued)
As of December 31, 2013 and December 31, 2012, the Company had outstanding forward foreign exchange hedge contracts with a combined notional value of $86,170 and $96,234, respectively. Approximately $27,659 and $26,390 of these forward foreign exchange contracts represents a hedge of Euro-denominated and Swiss franc-denominated balance sheet positions at December 31, 2013 and December 31, 2012, respectively. The remaining outstanding forward foreign exchange contracts are hedges of anticipated future cash flows.
In addition to the Company's outstanding forward foreign exchange hedge contracts, the following table includes the outstanding long and short notional amounts on a gross basis of derivative financial instruments as of December 31, 2013 and December 31, 2012:
The following is a summary of the effect of derivative contracts on the Consolidated Statements of Operations for the year ended December 31, 2013 and 2012:
(1)For the year ended December 31, 2013, approximately $2,130 of losses on foreign exchange derivative contracts were included within Other income, net and approximately $287 of losses on foreign currency options were included within Principal transactions. For the year ended December 31, 2012, approximately $2,011 of losses on foreign exchange derivative contracts were included within Other income, net and approximately $4,333 of gains on foreign currency options were included within Principal transactions.
(2)For the year ended December 31, 2013, approximately $14 of losses on equity derivative contracts were included within Other income, net and approximately $88 of losses on equity derivative contracts were included within Principal transactions. For the year ended December 31, 2012, approximately $2,475 of losses on equity derivative contracts were included within Other income, net and approximately $1,320 of gains on equity derivative contracts were included within Principal transactions.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
17. DERIVATIVE FINANCIAL INSTRUMENTS (Continued)
The following is a summary of derivative contracts, by counterparty, including the gross amounts offset in the Consolidated Statements of Financial Position as of December 31, 2013:
(1)The total reconciles to the aggregate of total derivative contracts in the fair value measurements table and the variation margin on exchange traded futures for the respective periods; both reflected in Note 16. Derivative assets and derivative liabilities are reflected within Other assets and Other Liabilities, respectively, with the exception of futures and options on futures contracts. Futures and options on futures contracts are included within Receivables from and Payables to brokers, dealers, and clearing organizations, as applicable.
(2)As of December 31, 2013, the Company does not have any derivative positions under a master netting agreement that are not netted.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
17. DERIVATIVE FINANCIAL INSTRUMENTS (Continued)
The following is a summary of derivative contracts, by counterparty, including the gross amounts offset in the Consolidated Statements of Financial Position as of December 31, 2012:
(1)The total reconciles to the aggregate of total derivative contracts in the fair value measurements table and the variation margin on exchange traded futures for the respective periods; both reflected in Note 16. Derivative assets and derivative liabilities are reflected within Other assets and Other Liabilities, respectively, with the exception of futures and options on futures contracts. Futures and options on futures contracts are included within Receivables from and Payables to brokers, dealers, and clearing organizations, as applicable.
(2)As of December 31, 2012, the Company does not have any derivative positions under a master netting agreement that are not netted.
18. VARIABLE INTEREST ENTITIES
Non-consolidated VIEs
The Company holds interests in certain VIEs that it does not consolidate. The Company has determined that it is not the primary beneficiary, mostly due to a lack of significant economic interest, voting power and/or power to direct the activities that would most significantly impact the economic performance of the VIE.
As of December 31, 2013 and December 31, 2012, the Company had certain variable interests in non-consolidated VIEs in the form of direct equity interests, a convertible note and a non-recourse loan. The carrying amount of these VIEs was $3,954 as of December 31, 2013 and $4,438 as of December 31, 2012, and was recorded within Other assets. These VIEs include a technology provider with a proprietary financial application, trading entities in which the Company has provided initial capital to fund trading activities, investment fund managers and a commodity pool operator. The Company also provides clearing and other administrative services to certain of these non-consolidated
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
18. VARIABLE INTEREST ENTITIES (Continued)
VIEs. The maximum exposure to loss on these VIEs was $4,592 and $4,438 as of December 31, 2013, and December 31, 2012, respectively.
As of December 31, 2013 and December 31, 2012, the Company had certain variable interests in non-consolidated VIEs in the form of trading margin accounts in which the Company had an economic interest in profits and losses and has provided initial capital to fund trading activities. The Company also provided clearing and other administrative services to these non-consolidated VIEs. The carrying amount of these VIEs was $1,653 as of December 31, 2013 and $9,784 as of December 31, 2012, and was recorded within Receivables from brokers, dealers and clearing organizations. The maximum exposure to loss of these VIEs was $1,653 and $10,703 as of December 31, 2013, and December 31, 2012, respectively.
The Company has not recorded any liabilities with respect to non-consolidated VIEs.
Consolidated VIEs
In December 2010, Kyte invested in a limited company that is focused on developing a proprietary trading business. The limited company is a VIE and it was determined that the Company is the primary beneficiary of this VIE because the Company, through Kyte, was the provider of the majority of this VIE's start-up capital and has the power to direct the activities of this VIE that most significantly impact its economic performance, primarily through its voting percentage and consent rights on the activities that would most significantly influence the entity. The consolidated VIE had total assets of $8,953 at December 31, 2013 and $6,428 as of December 31, 2012, which primarily consisted of clearing margin. There were no material restrictions on the consolidated VIE's assets. The consolidated VIE had total liabilities of $2,652 and $1,558 as of December 31, 2013, and December 31, 2012, respectively.
19. EQUITY METHOD AND SIMILAR INVESTMENTS
The Company has investments accounted for under the equity method (see Note 2) with an aggregate carrying value of $36,976 and $26,743, at December 31, 2013 and 2012, respectively, and which are included in Other assets. Included within Equity in net earnings of unconsolidated businesses was $1,376, $575 and $1,223 in 2013, 2012 and 2011, respectively, related to these investments. The Company also provides clearing and other administrative services to certain of these equity method investments.
As of December 31, 2013, the Company had 10 investments accounted for under the equity method, which individually, or in the aggregate, are not material to the consolidated financial statements of the Company.
Investments accounted for under the equity method included the following:
•Investments in a number of unconsolidated U.K. trading operations acquired in the July 1, 2010 acquisition of Kyte and investments made by Kyte subsequent to the Company's acquisition; and
•Investments in a number of U.S. based brokerage, trading and investment firms.
The Company also has certain investments in brokerage businesses in which the Company has a contractual right to receive a percentage of revenues, less certain direct expenses. The Company
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
19. EQUITY METHOD AND SIMILAR INVESTMENTS (Continued)
accounts for these investments in a manner similar to the equity method of accounting. Included within Equity in net earnings of unconsolidated businesses was $6,790, $7,994 and $9,243 in 2013, 2012 and 2011, respectively, related to these entities.
For material investments in which the Company has a contractual right to receive a percentage of revenues, less certain direct expenses, the Total revenues, Direct expenses and Net revenues, on an aggregate basis, for the year ended December 31, 2013 and 2012 was as follows:
The Company's contractual share of these affiliates' operating results, on an aggregate basis, for the years ended December 31, 2013 and 2012 was $5,893 and $6,798, respectively. The aforementioned investees report on a different fiscal year end than the Company. Therefore, the Company has made certain estimates with the summarized financial information provided by management of these equity method investments to align the fiscal year-ends. The summarized financial information was prepared in accordance with U.K. GAAP. The Company has determined the amounts disclosed in the above table are not materially different than if these amounts were prepared in accordance with U.S. GAAP.
The Company reviews investments accounted for under the equity method for decline in value that may be other than temporary. During the years ended December 31, 2013, and 2012, the Company did not record any write-downs related to equity method investments.
20. REGULATORY REQUIREMENTS
Many of the Company's material operating subsidiaries are subject to regulatory restrictions and minimum capital requirements, which may restrict the Company's ability to withdraw capital from its subsidiaries.
Certain domestic subsidiaries of the Company are registered as a broker-dealer, swap execution facility or introducing broker and therefore are subject to the applicable rules and regulations of the Securities Exchange Commission (the "SEC") and the Commodity Futures Trading Commission ("CFTC"). Certain foreign subsidiaries are also registered as introducing brokers with the CFTC. These rules contain uniform minimum net capital requirements, as defined, and also require a significant part of the registrants' assets be kept in relatively liquid form. As of December 31, 2013, each of the Company's subsidiaries that are subject to these regulations had net capital in excess of their minimum capital requirements.
Certain of the Company's European subsidiaries are regulated by the Financial Conduct Authority ("FCA") and must maintain financial resources (as defined by the FCA) in excess of FCA's total financial resources requirement. As of December 31, 2013, each of these European subsidiaries had financial resources in excess of their requirements.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
20. REGULATORY REQUIREMENTS (Continued)
Certain other subsidiaries of the Company are subject to similar regulatory and other requirements in the jurisdictions in which they operate and as of December 31, 2013 each was in compliance with its regulatory capital requirements.
The regulatory requirements referred to above may restrict the Company's ability to withdraw capital from its regulated subsidiaries. As of December 31, 2013, the Company had the following aggregate regulatory capital, in individually regulated entities, in each of its operating regions:
The regulatory requirements set forth in the table above include aggregated amounts held in individually regulated entities in each of the Company's operating regions, calculated by entity, to comply with the requirements of various regulators for capital requirements in each of those entities. In situations where the Company is subject to the requirements of multiple regulators, the Company has included the more onerous capital requirement in the table above.
21. SEGMENT AND GEOGRAPHIC INFORMATION
In accordance with ASC 280-10, Segment Reporting ("ASC 280-10") and based on the nature of the Company's operations, products and services in each geographic region, the Company determined that it has four reportable segments: (i) Americas Brokerage, (ii) Europe, Middle East and Africa ("EMEA") Brokerage, (iii) Asia Brokerage and (iv) Clearing and Backed Trading. The Company's brokerage operations provide brokerage services in four broad product categories: fixed income, financial, equity and commodity. The Clearing and Backed Trading segment encompasses the Company's clearing, risk management, settlement and other back-office services, as well as the capital we provide to start-up trading groups, small hedge funds, market-makers and individual traders. Information about other business activities is disclosed in an "All Other" category. All Other includes the results of the Company's software, analytics and market data operations. All Other also includes revenues and expenses that are not directly assignable to one of the Company's reportable segments, primarily consisting of indirect costs related to the Company's brokerage segments as well as all of the Company's corporate business activities.
The accounting policies of the segments are the same as those described above in Note 2-Summary of Significant Accounting Policies. The Company evaluates performance of the operating segments based on income (loss) before income taxes, which it defines as revenues less direct expenses.
Revenues within each brokerage segment include revenues that are directly related to providing brokerage services along with interest and other income (loss) directly attributable to the operating segment. Revenues within the Clearing and Backed Trading segment primarily include revenues that are directly related to providing clearing services along with the Company's share of profit (loss) on trading activity from capital investments. The Company's Clearing and Backed Trading segment incurs exchanges fees on behalf of its clients, which are reflected within Interest and transaction-based
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
21. SEGMENT AND GEOGRAPHIC INFORMATION (Continued)
expenses. The reimbursement of these fees from the Company's clients is reflected within Total Revenues. Therefore, the Company evaluates the top-line performance of its Clearing and Backed Trading segment using Revenues, net of interest and transaction-based expenses.
Direct expenses of the operating segments are those expenses that are directly related to providing the brokerage or clearing services and trading activities of the operating segments and include compensation expense related to the segment management and staff, communication and market data, travel and promotion, and certain professional fees and other expenses that are directly incurred by the operating segments. However, the Company does not allocate to its brokerage operating segments certain expenses that it manages separately at the corporate level. The unallocated costs include rent and occupancy, depreciation and amortization, professional fees, interest on borrowings and other expenses and are included in All Other, as management primarily evaluates the performance of its brokerage segments before allocation of these indirect costs. Certain indirect costs are included in the Company's Clearing and Backed Trading reportable segment, consistent with management's evaluation of that segment.
Selected financial information for the Company's reportable segments is presented below for periods indicated:
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
21. SEGMENT AND GEOGRAPHIC INFORMATION (Continued)
In addition, with the exception for goodwill, the Company does not identify or allocate assets by operating segment, nor does its chief operating decision maker evaluate operating segments using discrete asset information. See Note 6 for goodwill by reportable segment.
For the years ended December 31, 2013, 2012, and 2011, the U.K. is the only individual foreign country that accounts for 10% or more of the Company's total revenues and total long-lived assets. Information regarding revenue for the years ended December 31, 2013, 2012, and 2011, and information regarding long-lived assets (defined as property, equipment, leasehold improvements and software inventory) in geographic areas as of December 31, 2013 and 2012 are as follows:
Revenues are attributed to geographic areas based on the location of the particular subsidiary of the Company which generated the revenues.
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
22. PARENT COMPANY INFORMATION
The following presents the Parent company only's Condensed Statements of Financial Condition, Operations, Comprehensive Loss, and Cash Flows:
Parent Company Only
Condensed Statements of Financial Condition
(In thousands, except share and per share data)
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
22. PARENT COMPANY INFORMATION (Continued)
Parent Company Only
Condensed Statements of Operations and Comprehensive Loss
(In thousands)
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
22. PARENT COMPANY INFORMATION (Continued)
Parent Company Only
Condensed Statements of Cash Flows
(In thousands)
Guarantees
From time to time, the Company provides guarantees, on behalf of its subsidiaries, to clients for the purpose of providing credit enhancement for such clients. Such guarantees generally provide that
GFI GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands except share and per share amounts)
22. PARENT COMPANY INFORMATION (Continued)
the Company will guarantee the performance of all liabilities, obligations and undertakings owed by such subsidiary with respect to matched principal transactions entered into by such subsidiary with the relevant client. These guarantees are generally terminable on less than 30 days' notice. The Company has not recorded any contingent liability in the condensed financial statements for these guarantees and believes that the occurrence of any events that would trigger payments under these guarantees is remote.
Advances to Subsidiaries
As of December 31, 2013, 2012 and 2011, the Parent company had receivables from subsidiaries of $119,630, $189,189 and $258,951, respectively, related primarily to the allocation of funds received, from notes payable and the issuance of equity securities to subsidiaries to fund working capital.
23. SUBSEQUENT EVENTS
In February 2014, the Board of Directors declared a quarterly cash dividend of $0.05 per share payable on March 28, 2014 to stockholders of record on March 14, 2014.
Subsequent events have been evaluated for recording and disclosure in the notes to the Consolidated Financial Statements through the filing date of this Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls
As of the end of the period covered by this report, the Company's management carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act). Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Form 10-K.
Management's Report on Internal Control Over Financial Reporting
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Internal control over financial reporting is a process designed under the supervision of the Company's principal executive and principal financial officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company's financial statements for external purposes in accordance with generally accepted accounting principles.
The Company's internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company's management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2013. In making this assessment, the Company's management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (1992). Based on its assessment and the COSO criteria, management believes that, as of December 31, 2013, the Company maintained effective internal control over financial reporting.
The Company's independent registered public accounting firm has audited and issued their auditor's report on management's assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2013. That report appears on Page 98 of this Form 10-K.
Change in Internal Controls
In addition, the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the Company's internal controls over financial reporting (as defined in Rule 13A-15(f) of the Exchange Act) and determined that there have been no changes in
our internal controls over financial reporting during the fourth quarter of 2013 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required to be furnished pursuant to this item will be set forth under the captions "Election of Directors" and "Executive Officers" in the registrant's proxy statement (the "Proxy Statement") to be furnished to stockholders in connection with the 2014 Annual Meeting of Stockholders which we expect will be held on June 5, 2014, and is incorporated herein by reference.
The information required to be furnished pursuant to this item with respect to compliance with Section 16(a) of the Exchange Act will be set forth under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement, and is incorporated herein by reference.
We have adopted a Code of Business Conduct and Ethics that applies to all directors, officers and employees. We have also adopted a Code of Business Conduct and Ethics that is applicable to the Company's senior financial and accounting officers (including the chief executive officer, chief financial officer and corporate controller). A copy of these codes are posted on the Company's website, www.gfigroup.com, under the section "Investor Relations-Corporate Governance." In the event the Company substantively amends or waives a provision of its Codes of Business Conduct and Ethics, the Company intends to disclose the amendment or waiver on the Company's website as well.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required to be furnished pursuant to this item will be set forth under the caption "Executive Compensation" in the Proxy Statement, and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required to be furnished pursuant to this item will be set forth under the captions "Security Ownership of Certain Beneficial Owners," "Security Ownership of Directors and Executive Officers" and "Equity Compensation Plan Information" in the Proxy Statement, and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required to be furnished pursuant to this item will be set forth under the caption "Certain Relationships and Related Party Transactions and Director Independence" in the Proxy Statement, and is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required to be furnished pursuant to this item will be set forth under the caption "Fees Paid to Independent Auditors" in the Proxy Statement, and is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements. See Index to Financial Statements on page 97.
(a)(2) Financial Statement Schedules. We have included Schedule II-Valuation and Qualifying Accounts on page 163. All other schedules are omitted as they are not applicable, or the information required is included in the Financial Statements or notes thereto.
(a)(3) Exhibits. The following Exhibits are filed as part of this Report as required by Regulation S-K. Exhibits 10.2 through 10.22 are management contracts or compensatory plans or arrangements.
(*)Previously filed.
(**)Filed with this Annual Report on Form 10-K and included in Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Statements of Financial Condition as of December 31, 2013 and December 31, 2012, (ii) the Consolidated Statements of Operations for the years ended December 31, 2013, 2012, and 2011 (iii) the Consolidated Statements of Comprehensive Loss for the years ended December 31, 2013, 2012, and 2011, (iv) the Consolidated Statements of Cash Flows for the years ended December 31, 2013, 2012 and 2011, (v) the Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2013, 2012, and 2011 and (vi) Notes to Consolidated Financial Statements.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report on Form 10-K for the fiscal year ended December 31, 2013 to be signed on its behalf by the undersigned, thereunto duly authorized, on the 13th day of March, 2014.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report on Form 10-K has been signed by the following persons in the capacities and on the dates indicated.
Schedule II
GFI GROUP INC. AND SUBSIDIARIES
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
(a)For all periods it includes the effects for exchange rate changes.
(b)Net adjustments to the reserve accounts for write-offs and credits issued during the years.