| LADENBURG THALMANN FINANCIAL SERVICES INC ITEM 1A RISK FACTORS You should carefully consider all of the material risks described below regarding our company |
| Our business, financial condition or results of operation could be materially adversely affected by any of these risks |
| 9 _________________________________________________________________ [18]Table of Contents We have incurred, and may continue to incur, significant operating losses |
| We incurred significant losses from operations during each of the past five years |
| We cannot assure you that we will be able to achieve or sustain revenue growth, profitability or positive cash flow on either a quarterly or annual basis or that profitability, if achieved, will be sustained |
| Although we believe that we have enough regulatory capital to sustain operating activities through December 31, 2006, if we are unable to achieve or sustain profitability, we may not be financially viable in the future and may have to curtail, suspend or cease operations |
| If we are unable to repay our outstanding indebtedness obligations when due, our operations may be materially adversely affected |
| Currently, we have an aggregate of approximately dlra5cmam700cmam000 of indebtedness, of which dlra5cmam000cmam000 owed to our former parent is due on December 31, 2006 and approximately dlra666cmam000 from our clearing broker is scheduled to be forgiven in November 2006 |
| However, if the clearing agreement is terminated for any reason prior to the loan maturity date, the loan, less any amount that has been forgiven through the date of the termination, plus interest, must be repaid on demand |
| We cannot assure you that our operations will generate funds sufficient to repay these or other future debt obligations as they come due |
| Our failure to repay our indebtedness and make interest payments as required by our debt obligations could have a material adverse affect on our operations |
| We are currently subject to extensive securities regulation and the failure to comply with these regulations could subject us to penalties or sanctions |
| The securities industry and our business is subject to extensive regulation by the SEC, state securities regulators and other governmental regulatory authorities |
| We are also regulated by industry self-regulatory organizations, including the NYSE, the NASD and the Municipal Securities Rulemaking Board |
| The regulatory environment is also subject to change and we may be adversely affected as a result of new or revised legislation or regulations imposed by the SEC, other federal or state governmental regulatory authorities, or self-regulatory organizations |
| We also may be adversely affected by changes in the interpretation or enforcement of existing laws and rules by these governmental authorities and self-regulatory organizations |
| Ladenburg is a registered broker-dealer with the SEC and a member firm of the NYSE Broker-dealers are subject to regulations which cover all aspects of the securities business, including: • sales methods and supervision; • trading practices among broker-dealers; • use and safekeeping of customers’ funds and securities; • capital structure of securities firms; • record keeping; and • the conduct of directors, officers and employees |
| 10 _________________________________________________________________ [19]Table of Contents Compliance with many of the regulations applicable to us involves a number of risks, particularly in areas where applicable regulations may be subject to varying interpretation |
| The requirements imposed by these regulators are designed to ensure the integrity of the financial markets and to protect customers and other third parties who deal with us |
| Consequently, these regulations often serve to limit our activities, including through net capital, customer protection and market conduct requirements |
| Much of the regulation of broker-dealers has been delegated to self-regulatory organizations, principally the NASD Regulation, Inc, the regulatory arm of the NASD, and the NYSE, which are our primary regulatory agencies |
| NASD Regulation and the NYSE adopt rules, subject to approval by the SEC, that govern its members and conducts periodic examinations of member firms’ operations |
| If we are found to have violated an applicable regulation, administrative or judicial proceedings may be initiated against us that may result in: • censure; • fine; • civil penalties, including treble damages in the case of insider trading violations; • the issuance of cease-and-desist orders; • the deregistration or suspension of our broker-dealer activities; • the suspension or disqualification of our officers or employees; or • other adverse consequences |
| The imposition of any of these or other penalties could have a material adverse effect on our operating results and financial condition |
| We may incur significant losses from trading and investment activities due to market fluctuations and volatility |
| We generally maintain trading and investment positions in the equity markets |
| To the extent that we own assets, ie, have long positions, in those markets, a downturn 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 that we do not own, ie, have short positions, in any of those markets, an upturn in those markets could expose us to potentially unlimited losses as we attempt to cover our short positions by acquiring assets in a rising market |
| We may from time to time have a trading strategy consisting of holding a long position in one security and a short position in another security from which we expect to earn revenues based on changes in the relative value of the two securities |
| If, however, the relative value of the two securities changes in a direction or manner that we did not anticipate or against which we are not hedged, we might realize a loss 11 _________________________________________________________________ [20]Table of Contents in those paired positions |
| In addition, we maintain trading positions that can be adversely affected by the level of volatility in the financial markets, ie, the degree to which trading prices fluctuate over a particular period, in a particular market, regardless of market levels |
| We may need to raise additional funds in the near future |
| Our capital requirements continue to be adversely affected by our inability to generate cash from operations |
| We have been forced to rely on borrowings and equity offerings in order to generate working capital for our operations |
| Accordingly, we may need to seek to raise additional capital through other available sources, including through equity offerings or borrowing additional funds on a short-term basis from third parties, including our current shareholders and clearing broker |
| As of December 31, 2005, we had cash and cash equivalents of approximately dlra10cmam936cmam000 |
| Accordingly, if we continue to be unable to generate cash from operations and are unable to find sources of funding, it would have an adverse impact on our liquidity and operations |
| We may be prohibited from underwriting securities due to capital limits |
| From time to time, our underwriting activities may require that we temporarily receive an infusion of capital for regulatory purposes |
| This is predicated on the amount of commitment Ladenburg makes for each underwriting |
| In the past, we borrowed such funds from our current shareholders or clearing firm |
| Should we no longer be able to receive such funding from these sources, and if there are no other viable sources available, it would have an adverse impact on our ability to generate profits, recruit financial consultants and retain existing customers |
| Our expenses may increase due to unresolved real estate commitments |
| We have ceased using our Madison Avenue (New York City) office space and have subleased the entire premises to various sub-tenants |
| Should any of the sub-tenants not renew or renew for a sub-rental less than Ladenburg’s lease commitments, or not pay their rent for an extended period of time, it may have a material adverse effect on Ladenburg’s financial position and liquidity |
| Our business could be adversely affected by a downturn in the financial markets |
| As a securities broker-dealer, our business is materially affected by conditions in the financial markets and economic conditions generally, both in the United States and elsewhere around the world |
| Many factors or events could lead to a downturn in the financial markets including war, terrorism, natural catastrophes and other types of disasters |
| These types of events could cause people to begin to lose confidence in the financial markets and their ability to function effectively |
| If the financial markets are unable to effectively prepare for these types of events and ease public concern over their ability to function, our revenues are likely to decline and our operations will be adversely affected |
| Our revenues may decline in adverse market or economic conditions |
| In prior years, unfavorable financial and economic conditions have reduced the number and size of the transactions in which we provide underwriting services, merger and acquisition consulting and other services |
| Our investment banking revenues, in the form of financial advisory and underwriting fees, are 12 _________________________________________________________________ [21]Table of Contents directly related to the number and size of the transactions in which we participate and therefore may be adversely affected by any downturn in the securities markets |
| Additionally, downturn in market conditions may lead to a decline in the volume of transactions that we are able to execute for our customers and, therefore, to a decline in the revenues that we would otherwise receive from commissions and spreads |
| Should these adverse financial and economic conditions appear and persist for any extended period of time, we will incur a decline in transactions and revenues that we receive from commissions and spreads |
| We depend on our senior employees and the loss of their services could harm our business |
| Our success is dependent in large part upon the services of several of our senior executives and employees, including those of Ladenburg |
| We do not maintain and do not intend to obtain key man insurance on the life of any executive or employee |
| If our senior executives or employees terminate their employment with us and we are unable to find suitable replacements in relatively short periods of time, our operations may be materially and adversely affected |
| We face significant competition for professional employees |
| From time to time, individuals we employ may choose to leave our company to pursue other opportunities |
| We have experienced losses of registered representatives, trading and investment banking professionals in the past, and the level of competition for key personnel remains intense |
| We cannot assure you that the loss of key personnel will not occur again in the future |
| The loss of a registered representative or a trading or investment banking professional, particularly a senior professional with a broad range of contacts in an industry, could materially and adversely affect our operating results |
| Our principal shareholders including our directors and officers control a large percentage of our shares of common stock and can significantly influence our corporate actions |
| At the present time, our executive officers, directors and companies that these individuals are affiliated with beneficially own approximately 49dtta3prca of our common stock |
| Accordingly, these individuals and entities will be able to significantly influence most, if not all, of our corporate actions, including the election of directors and the appointment of officers |
| Additionally, this ownership of our common stock may make it difficult for a third party to acquire control of us, therefore possibly discouraging third parties from seeking to acquire us |
| A third party would have to negotiate any possible transactions with these principal shareholders, and their interests may be different from the interests of our other shareholders |
| This may depress the price of our common stock |
| The American Stock Exchange may delist our common stock from quotation on its exchange |
| Our common stock is currently quoted on the American Stock Exchange |
| In order to continue quotation of our common stock, we must maintain certain financial, distribution and stock price levels |
| Generally, we must maintain a minimum amount in shareholders’ equity (usually between dlra2cmam000cmam000 and dlra4cmam000cmam000) and a minimum number of public shareholders (usually 300 shareholders or 200cmam000 shares held by our non-affiliates) |
| Additionally, our common stock cannot have what is deemed to be a “low selling price” as determined by the Exchange |
| 13 _________________________________________________________________ [22]Table of Contents On March 27, 2006, the last reported sale price of our common stock was dlra0dtta95 |
| If the Exchange determines that this is a “low selling price,” it may require us to effect a reverse split or suspend or remove our common stock from listing on the Exchange |
| In determining whether a reverse split or suspension or removal is appropriate, the Exchange will consider all pertinent factors including market conditions in general, the number of shares outstanding, plans which may have been formulated by management, applicable regulations of the state or country of incorporation or of any governmental agency having jurisdiction over the company and the relationship to other Exchange policies regarding continued listing |
| If the Exchange delists our common stock from trading on its exchange, we could face significant material adverse consequences including: • a limited availability of market quotations for our common stock; • a determination that our common stock is a “penny stock” which will require brokers trading in our common stock to adhere to more stringent rules and possibly resulting in a reduced level of trading activity in the secondary trading market for our common stock; • a limited amount of news and analyst coverage for our company; and • a decreased ability to issue additional securities or obtain additional financing in the future |
| We may lose customers and our revenues may decline due to our lack of online trading service capability |
| A growing number of brokerage firms offer online trading services to their customers in response to increased customer demand for these services |
| Currently, we are unable to offer online trading services, nor do we anticipate having such ability in the near future |
| Should we offer such services in the future, the services may not appeal to our current or prospective customers and these services may not be profitable |
| Our failure to commence online trading services in the near future could have a material adverse effect on our business including the loss of our existing customers to competitors that do offer these services |
| Additionally, if we commence online trading services but are unable to attract customers for those services, our revenues will decline |
| We rely on one primary clearing broker and the termination of the agreement with this clearing broker could disrupt our business |
| Ladenburg uses one clearing broker to process its securities transactions and maintain customer accounts on a fee basis |
| The clearing broker also provides billing services, extends credit and provides for control and receipt, custody and delivery of securities |
| In November 2002, we completed the Clearing Conversion and renegotiated our clearing agreement with this clearing broker |
| In addition, under the new clearing agreement, an affiliate of the clearing broker provided us with the Clearing Loans, aggregating to dlra3cmam500cmam000, with various terms and maturing at various dates through December 2006 |
| As scheduled, dlra1cmam500cmam000, dlra667cmam000 and dlra667cmam000 of the Clearing Loans were forgiven in November 2003, 2004 and 2005, respectively |
| The dlra666cmam000 remaining principal balance of the Clearing Loans and related accrued 14 _________________________________________________________________ [23]Table of Contents interest is scheduled to be forgiven in November 2006 |
| Upon the forgiveness of the Clearing Loans, the forgiven amount is accounted for as other revenue |
| However, if the clearing agreement is terminated for any reason prior to the loan maturity date, the loan, less any amount that has been forgiven through the date of the termination, plus interest, must be repaid on demand |
| Ladenburg depends on the operational capacity and ability of the clearing broker for the orderly processing of transactions |
| In addition, by engaging the processing services of a clearing firm, Ladenburg is exempt from some capital reserve requirements and other regulatory requirements imposed by federal and state securities laws |
| If the clearing agreement is terminated for any reason, we would be forced to find an alternative clearing firm |
| We cannot assure you that we would be able to find an alternative clearing firm on acceptable terms to us or at all |
| Our clearing broker extends credit to our clients and we are liable if the clients do not pay |
| Ladenburg permits its clients to purchase securities on a margin basis or sell securities short, which means that the clearing firm extends credit to the client secured by cash and securities in the clients’ account |
| During periods of volatile markets, the value of the collateral held by the clearing broker could fall below the amount borrowed by the client |
| If margin requirements are not sufficient to cover losses, the clearing broker sells or buys securities at prevailing market prices, and may incur losses to satisfy client obligations |
| Ladenburg has agreed to indemnify the clearing broker for losses it may incur while extending credit to its clients |
| We continually assess risk associated with each customer who is on margin credit and record an estimated loss when we believe collection from the customer is unlikely |
| We incurred losses from these arrangements, prior to any recoupment from our financial consultants, of dlra37cmam000 and dlra125cmam000 for the years ended December 31, 2005 and 2004, respectively |
| We are subject to various risks associated with the securities industry |
| As a securities broker-dealer, Ladenburg is subject to uncertainties that are common in the securities industry |
| These uncertainties include: • the volatility of domestic and international financial, bond and stock markets; • extensive governmental regulation; • litigation; • intense competition; • substantial fluctuations in the volume and price level of securities; and • dependence on the solvency of various third parties |
| As a result, revenues and earnings may vary significantly from quarter to quarter and from year to year |
| In periods of low volume, profitability is impaired because certain expenses remain relatively fixed |
| Ladenburg is much smaller and has much less capital than many competitors in the securities industry |
| In the event of a market downturn, our business could be adversely affected in many ways |
| Our revenues are 15 _________________________________________________________________ [24]Table of Contents likely to decline in such circumstances and, if we are unable to reduce expenses at the same pace, our profit margins would erode |
| Our risk management policies and procedures may leave us exposed to unidentified risks or an unanticipated level of risk |
| The policies and procedures we employ to identify, monitor and manage risks may not be fully effective |
| Some methods of risk management are based on the use of observed historical market behavior |
| As a result, these methods may not predict future risk exposures, which could be significantly greater than the historical measures indicate |
| Other risk management methods depend on evaluation of information regarding markets, clients or other matters that are publicly available or otherwise accessible by us |
| This information may not be accurate, complete, up-to-date or properly evaluated |
| Management of operational, legal and regulatory risk requires, among other things, policies and procedures to properly record and verify a large number of transactions and events |
| We cannot assure you that our policies and procedures will effectively and accurately record and verify this information |
| We seek to monitor and control our risk exposure through a variety of separate but complementary financial, credit, operational and legal reporting systems |
| We believe that we effectively evaluate and manage the market, credit and other risks to which we are exposed |
| Nonetheless, the effectiveness of our ability to manage risk exposure can never be completely or accurately predicted or fully assured |
| For example, unexpectedly large or rapid movements or disruptions in one or more markets or other unforeseen developments can have a material adverse effect on our results of operations and financial condition |
| The consequences of these developments can include losses due to adverse changes in inventory values, decreases in the liquidity of trading positions, higher volatility in earnings, increases in our credit risk to customers as well as to third parties and increases in general systemic risk |
| Credit risk exposes us to losses caused by financial or other problems experienced by third parties |
| We are exposed to the risk that third parties that owe us money, securities or other assets will not perform their obligations |
| These parties include: • trading counterparties; • customers; • clearing agents; • exchanges; • clearing houses; and • other financial intermediaries as well as issuers whose securities we hold |
| These parties may default on their obligations owed to us due to bankruptcy, lack of liquidity, operational failure or other reasons |
| This risk may arise, for example, from: 16 _________________________________________________________________ [25]Table of Contents • holding securities of third parties; • executing securities trades that fail to settle at the required time due to non-delivery by the counterparty or systems failure by clearing agents, exchanges, clearing houses or other financial intermediaries; and • extending credit to clients through bridge or margin loans or other arrangements |
| Significant failures by third parties to perform their obligations owed to us could adversely affect our revenues and perhaps our ability to borrow in the credit markets |
| Intense competition from existing and new entities may adversely affect our revenues and profitability |
| The securities industry is rapidly evolving, intensely competitive and has few barriers to entry |
| We expect competition to continue and intensify in the future |
| Many of our competitors have significantly greater financial, technical, marketing and other resources than we do |
| Some of our competitors also offer a wider range of services and financial products than we do and have greater name recognition and a larger client base |
| These competitors may be able to respond more quickly to new or changing opportunities, technologies and client requirements |
| They may also be able to undertake more extensive promotional activities, offer more attractive terms to clients, and adopt more aggressive pricing policies |
| We may not be able to compete effectively with current or future competitors and competitive pressures faced by us may harm our business |
| The precautions we take to prevent and detect employee misconduct may not be effective and we could be exposed to unknown and unmanaged risks or losses |
| We run the risk that employee misconduct could occur |
| Misconduct by employees could include: • employees binding us to transactions that exceed authorized limits or present unacceptable risks to us; • employees hiding unauthorized or unsuccessful activities from us; or • the improper use of confidential information |
| These types of misconduct could result in unknown and unmanaged risks or losses to us including regulatory sanctions and serious harm to our reputation |
| The precautions we take to prevent and detect these activities may not be effective |
| If employee misconduct does occur, our business operations could be materially adversely affected |
| Failure to comply with net capital requirements could subject us to suspension or revocation by the SEC or suspension or expulsion by the NASD and the NYSE Ladenburg is subject to the SEC’s net capital rule, which requires the maintenance of minimum net capital |
| We compute net capital under the alternate method permitted by the net capital rule |
| Under 17 _________________________________________________________________ [26]Table of Contents this method, Ladenburg is required to maintain net capital equal to dlra250cmam000 |
| At December 31, 2005, Ladenburg had regulatory net capital of dlra2cmam932cmam000, which exceeded its minimum net capital requirement by dlra2cmam682cmam000 |
| The net capital rule is designed to measure the general financial integrity and liquidity of a broker-dealer |
| In computing net capital, various adjustments are made to net worth, which exclude assets not readily convertible into cash |
| Additionally, the regulations require that certain assets, such as a broker-dealer’s position in securities, be valued in a conservative manner so as to avoid over-inflation of the broker-dealer’s net capital |
| The net capital rule requires that a broker-dealer maintain a certain minimum level of net capital |
| The particular levels vary in application depending upon the nature of the activity undertaken by a firm |
| Compliance with the net capital rule limits those operations of broker-dealers which require the intensive use of their capital, such as underwriting commitments and principal trading activities |
| The rule also limits the ability of securities firms to pay dividends or make payments on certain indebtedness such as subordinated debt as it matures |
| A significant operating loss or any charge against net capital could adversely affect the ability of a broker-dealer to expand or, depending on the magnitude of the loss or charge, maintain its then present level of business |
| The NASD and the NYSE may enter the offices of a broker-dealer at any time, without notice, and calculate the firm’s net capital |
| If the calculation reveals a deficiency in net capital, the NASD may immediately restrict or suspend certain or all of the activities of a broker-dealer, including its ability to make markets |
| Ladenburg may not be able to maintain adequate net capital, or its net capital may fall below requirements established by the SEC, and subject us to disciplinary action in the form of fines, censure, suspension, expulsion or the termination of business altogether |
| Risk of losses associated with securities laws violations and litigation |
| Many aspects of our business involve substantial risks of liability |
| An underwriter is exposed to substantial liability under federal and state securities laws, other federal and state laws, and court decisions, including decisions with respect to underwriters’ liability and limitations on indemnification of underwriters by issuers |
| For example, a firm that acts as an underwriter may be held liable for material misstatements or omissions of fact in a prospectus used in connection with the securities being offered or for statements made by its securities analysts or other personnel |
| In recent years, there has been an increasing incidence of litigation involving the securities industry, including class actions that seek substantial damages |
| Our underwriting activities will usually involve offerings of the securities of smaller companies, which often involve a higher degree of risk and are more volatile than the securities of more established companies |
| In comparison with more established companies, smaller companies are also more likely to be the subject of securities class actions, to carry directors and officers liability insurance policies with lower limits or not at all, and to become insolvent |
| Each of these factors increases the likelihood that an underwriter of a smaller companies’ securities will be required to contribute to an adverse judgment or settlement of a securities lawsuit |
| In the normal course of business, our operating subsidiaries have been and continue to be the subject of numerous civil actions and arbitrations arising out of customer complaints relating to our activities as a broker-dealer, as an employer and as a result of other business activities |
| In general, the cases involve various allegations that our employees had mishandled customer accounts |
| We believe that, based on our historical experience and the reserves established by us, the resolution of the claims presently pending will not have a material adverse effect on our financial condition |
| However, although we typically reserve an amount we believe will be sufficient to cover any damages assessed against us, we have in the past been assessed damages that exceeded our reserves |
| If we misjudged the amount of damages that may be assessed against us from pending or threatened claims, or if we are unable to adequately estimate the 18 _________________________________________________________________ [27]Table of Contents amount of damages that will be assessed against us from claims that arise in the future and reserve accordingly, our financial condition may be materially adversely affected |
| Possible additional issuances will cause dilution |
| While we currently have outstanding 141cmam590cmam529 shares of common stock (or 149cmam988cmam420 shares if our private placement to certain affiliates of ours and persons with direct and indirect relationships to us is approved by our shareholders on April 3, 2006), options to purchase a total of 22cmam637cmam770 shares of common stock and warrants to purchase a total of 200cmam000 shares of common stock, we are authorized to issue up to 200cmam000cmam000 shares of common stock and are therefore able to issue additional shares without being required under corporate law to obtain shareholder approval |
| At the April 3, 2006 special shareholders meeting, our shareholders will also be asked to approve an increase in the number of authorized shares of our common stock from 200cmam000cmam000 to 400cmam000cmam000 |
| If we issue additional shares, or if our existing shareholders exercise their outstanding options, our other shareholders may find their holdings drastically diluted, which if it occurs, means that they will own a smaller percentage of our company |
| We may issue preferred stock with preferential rights that may adversely affect your rights |
| The rights of our shareholders will be subject to and may be adversely affected by the rights of holders of any preferred stock that we may issue in the future |
| Our articles of incorporation authorize our board of directors to issue up to 2cmam000cmam000 shares of “blank check” preferred stock and to fix the rights, preferences, privilege and restrictions, including voting rights, of these shares without further shareholder approval |