| SANDERS MORRIS HARRIS GROUP INC Item 1A Risk Factors We face a variety of risks that are substantial and inherent in our businesses, including market, liquidity, credit, operational, legal, and regulatory risks |
| You should carefully consider the following risks and all of the other information in this Report, including the Consolidated Financial Statements and Notes thereto |
| The following are some of the more important factors that could affect our businesses |
| The securities brokerage, investment banking, financial advice, and asset management industries are highly competitive |
| If we are not able to compete successfully against current and future competitors, our business and results of operation will be adversely affected |
| The markets for our financial services and securities businesses are highly competitive |
| The principal competitive factors influencing our financial services businesses are: (1) professional staff, (2) reputation in the marketplace, (3) existing client relationships, (4) ability to commit capital to client transactions, and (5) mix of market capabilities |
| Our ability to compete effectively in our securities brokerage and investment banking activities is also influenced by the adequacy of our capital levels and by our ability to raise additional capital |
| We compete directly with many other national and regional full service broker-dealers and, to a lesser extent, with discount brokers, investment banking firms, investment advisers, securities subsidiaries of major commercial bank holding companies, and other companies offering financial services in the United States, globally, and through the internet |
| We also compete for asset management and fiduciary services with commercial banks, private trust companies, sponsors of mutual funds, insurance companies, financial planning firms, venture capital funds, private equity or hedge funds, and other asset managers |
| Many of our competitors have greater personnel and financial resources than we do |
| Larger competitors are able to advertise their products and services on a national or regional basis and may have a greater number and variety of products and distribution outlets for their products |
| In addition to competition from firms currently in the securities business, there has been increasing competition from others offering financial services, including automated trading and other services based on technological innovations |
| Also, some competitors have more extensive investment banking activities than we do and, therefore, may possess a relative advantage in accessing deal flow and capital |
| -9- _________________________________________________________________ [56]Back to Table of Contents Increased pressure created by current or future competitors, individually or collectively, could materially and adversely affect our business and results of operations |
| Increased competition may result in reduced revenue and loss of market share |
| Further, as a strategic response to changes in the competitive environment, we may from time to time make certain pricing, service, or marketing decisions or acquisitions that also could materially and adversely affect our business and results of operations |
| We cannot assure you that we will be able to compete successfully against current and future competitors |
| In addition, new technologies and the expansion of existing technologies may increase the competitive pressures on us |
| Competition also extends to the hiring and retention of highly skilled employees |
| A competitor may be successful in hiring away an employee or group of employees, which may result in our losing business formerly serviced by them |
| Such competition can also raise our costs of hiring and retaining the key employees we need to effectively execute our business plan |
| We may experience reduced revenue due to downturns or disruptions in the securities markets that reduce market volumes, securities prices, and liquidity, which can also cause counterparties to fail to perform |
| The securities business is, by its nature, subject to significant risks, particularly in volatile or illiquid markets, including: (1) the risk of trading losses, (2) losses resulting from the ownership or underwriting of securities, (3) counterparty failure to meet commitments, (4) customer fraud, (5) employee fraud, (6) issuer fraud, (7) errors and misconduct, (8) failure in connection with the processing of securities transactions, and (9) customer litigation |
| As an investment banking and securities firm, changes in the financial markets or economic conditions in the United States and elsewhere in the world could adversely affect our business in many ways |
| The securities business is directly affected by many factors, including market, economic, and political conditions; broad trends in business and finance; investor sentiment and confidence in the financial markets; legislation and regulation affecting the national and international business and financial communities; currency values; inflation; the availability and cost of short-term and long-term funding and capital; the credit capacity or perceived creditworthiness of the securities industry in the marketplace; the level and volatility of equity prices and interest rates; and technological changes and events |
| These and other factors can contribute to lower price levels for securities and illiquid markets |
| A market downturn could lead to a decline in the volume of transactions that we execute for our customers and, therefore, to a decline in the revenues we receive from commissions and spreads |
| Unfavorable financial or economic conditions would likely reduce the number and size of transactions in which we provide underwriting, financial advisory, and other services |
| Our corporate finance revenues, in the form of financial advisory and underwriting fees, are directly related to the number and size of the transactions in which we participate and would therefore be adversely affected by a sustained market downturn |
| Lower price levels of securities may result in reduced management fees calculated as a percentage of assets managed |
| Fluctuations in market activity could impact the flow of investment capital into or from assets under management and supervision and the way customers allocate capital among money market, equity, fixed income, or other investment alternatives, which could negatively impact our asset management business |
| In periods of low volume or price levels, profitability is further adversely affected because certain of our expenses remain relatively fixed |
| Sudden sharp declines in market values of securities can result in illiquid markets and the failure of counterparties to perform their obligations, which could make it difficult for us to sell securities, hedge securities positions, and invest funds under management |
| Market declines could also increase claims and litigation, including arbitration claims from customers |
| In such markets, we may incur reduced revenue or losses in our principal trading, market making, investment banking, and advisory services activities |
| We are also subject to risks inherent in extending credit to the extent our clearing brokers permit our customers to purchase securities on margin |
| The margin risk increases during rapidly declining markets when collateral values may fall below the amount our customer owes us |
| Any resulting losses could adversely affect our business, financial condition, and operating results |
| -10- _________________________________________________________________ [57]Back to Table of Contents There are market, credit, and liquidity risks associated with our market making, principal trading, arbitrage, and underwriting activities |
| We may experience significant losses if the value of our marketable security positions deteriorates |
| We conduct securities trading, market making, and investment activities for our own account, which subjects our capital to significant risks |
| These activities often involve the purchase, sale, or short sale of securities as principal in markets that are characterized as relatively illiquid or that may be particularly susceptible to rapid fluctuations in liquidity and price |
| These market conditions could limit our resale of purchased securities or the repurchase of securities sold short |
| These risks involve market, credit, counterparty, and liquidity risks, which could result in losses for us |
| Market risk relates to the risk of fluctuating values and the ability of third parties to whom we have extended credit to repay us |
| Counterparty risk relates to whether a counter-party on a transaction will fulfill its contractual obligations, which may include delivery of securities or payment of funds |
| Liquidity risk relates to our inability to liquidate assets or redirect illiquid investments |
| In our underwriting and merchant banking, asset management, and other activities, we may have large position concentrations in securities of, or commitments to, a single issuer or issuers engaged in a specific industry |
| As an underwriter, we may incur losses if we are unable to resell the securities we committed to purchase or if we are forced to liquidate our commitment at less than the agreed purchase price |
| Also, the trend, for competitive and other reasons, toward larger commitments on the part of lead underwriters means that, from time to time, as an underwriter (including a co-manager), we may retain significant position concentrations in individual securities |
| These concentrations increase our exposure to specific credit and market risks |
| Our business is dependent on the services of skilled professionals and may suffer if we lose the services of our executive officers or other skilled professionals |
| We depend on the continuing efforts of our executive officers and senior management |
| That dependence may be intensified by our decentralized operating strategy |
| If executive officers or members of senior management leave us, until we attract and retain qualified replacements, our business or prospects could be adversely affected |
| We derive our financial services revenues from the efforts of senior management and retail investment executives, and research, investment banking, retail and institutional sales, trading, asset management, and administrative professionals |
| Our future success depends, in a large part, on our ability to attract, recruit, and retain qualified financial services professionals |
| Demand for these professionals is high and their qualifications make them particularly mobile |
| These circumstances have led to escalating compensation packages in the industry |
| Up front payments, increased payouts, and guaranteed contracts have made recruiting these professionals more difficult and can lead to departures by current employees |
| From time to time we have experienced, and we may in the future experience, losses of sales and trading, research, and investment banking professionals and have difficulty in hiring and retaining highly skilled employees |
| Departures can also cause client defections due to close relationships between clients and the professionals |
| If we are unable to retain our key employees or attract, recruit, integrate, or retain other skilled professionals in the future, our business could suffer |
| We generally do not have employment agreements with our employees or senior executive officers |
| We attempt to retain our employees with incentives such as the issuance of stock subject to continued employment |
| These incentives, however, may be insufficient in light of increasing competition for experienced professionals in the securities industry, particularly if our stock price declines or fails to appreciate sufficiently to be a competitive source of a portion of a professional’s compensation |
| Litigation and potential securities laws liabilities may adversely affect our business and may, in turn, negatively affect the market price of our common stock |
| Many aspects of our business involve substantial risks of liability, litigation, and arbitration, which could adversely affect us |
| In the normal course of business, we have been and may be named as defendants or co-defendants in civil litigation and arbitration proceedings arising from our business activities as a broker-dealer |
| Some of these risks include potential liability under securities or other laws for materially false or misleading statements made in connection with securities and other transactions, potential liability for the advice we provide to participants in corporate transactions, and disputes over the terms and conditions of complex trading arrangements |
| Certain of the actual and threatened legal actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages |
| These risks often may be difficult to assess or quantify and their existence and magnitude often remain unknown for substantial periods of time |
| The plaintiffs in litigation or arbitration may allege misconduct by our investment executives, claiming, for example, that investments sold by them were unsuitable for the plaintiffs’ portfolios, or that they engaged in excessive trading in the plaintiffs’ accounts |
| Substantial liabilities from these matters could occur and could have a material financial effect or cause significant reputational harm to us, which in turn could seriously harm our business |
| -11- _________________________________________________________________ [58]Back to Table of Contents In recent years, there has been a substantial amount of litigation involving the securities brokerage industry, including class action lawsuits seeking substantial damages and other suits seeking punitive damages |
| Companies engaged in the underwriting of securities, as we are, are subject to substantial potential liability, including for material misstatements or omissions in prospectuses and other communications in underwritten offerings of securities or statements made by securities analysts |
| These liabilities can arise under federal securities laws, similar state statutes, and common law doctrines |
| The risk of liability may be higher for an underwriter that, like us, is active in the underwriting of securities offerings for emerging and middle-market companies, because of the higher degree of risk and volatility associated with the securities of these companies |
| In some cases, the issuers that would otherwise be the primary defendants in such cases are bankrupt or in financial distress |
| The defense of these or any other lawsuits or arbitration proceeding may divert the efforts and attention of our management and staff, and we may incur significant legal expense in defending litigation or arbitration proceedings |
| We are highly dependent on proprietary and third party systems, so systems failures could significantly disrupt our business, which may, in turn, negatively affect the market price of our common stock |
| Operational risks may disrupt our business, result in regulatory action against us, or limit our growth |
| Our business is highly dependent on our ability to process, on a daily basis, a large number of transactions across numerous and diverse markets, and the transactions we process have become increasingly complex |
| Consequently, we rely heavily on our communications and financial, accounting, and other data processing systems, including systems provided by our clearing brokers and service providers |
| We face operational risk across all or our business activities, including revenue generating activities (eg, risks arising from mistakes made in the confirmation or settlement of transactions or from transactions not being properly recorded, evaluated, or accounted) and support functions (eg, information technology and facilities management) |
| We also face the risk of operational failure or termination of any of the clearing brokers, exchanges, or other financial intermediaries we use to facilitate our securities transactions, and as our interconnectivity with our clients grows, we will increasingly face the risk of operational failure with respect to our clients’ systems |
| Any such failure or termination could adversely affect our ability to effect transactions, service our clients, and manage our exposure to risk |
| If any of these systems do not operate properly or are disabled, we could suffer financial loss, a disruption of our business, liability to clients, regulatory intervention, or reputational damage |
| Any failure or interruption of our systems, the systems of our clearing broker, or third party trading systems could cause delays or other problems in our securities trading activities, which could have a material adverse effect on our operating results |
| In addition, our clearing brokers provide our principal disaster recovery system |
| Despite the contingency plans and facilities we and our clearing brokers have in place, our ability to conduct business may be adversely impacted by a disruption in the infrastructure that supports our and their businesses and communities in which we are located |
| This may include a disruption involving electrical, communications, transportation, or other services used by us, our clearing brokers, or third parties with whom we conduct business, terrorist activities, or health epidemics |
| These disruptions may occur, for example, as a result of events that affect the buildings we or such third parties occupy, or as a result of broader impact on the cities where those buildings are located |
| Nearly all of our employees in our primary locations, including Houston, New York, and Los Angeles, work in close proximity to another |
| If a disruption occurs in one location, our ability to service and interact with our clients may suffer and we may not be able to successfully implement contingency plans that depend on communication or travel |
| Our operations rely on the secure processing, storage, and transmission of confidential and other information in our computer systems and networks |
| Although we take protective measures and endeavor to modify them as circumstances warrant, our computer systems, software, and networks may be vulnerable to unauthorized access, computer viruses, or other malicious code, and other events that could have a security impact |
| If one or more of such events occur, this potentially could jeopardize our or our clients’ confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our clients’ or third parties’ operations, which could result in significant losses or reputational damage |
| We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or fully covered through any insurance maintained by us |
| -12- _________________________________________________________________ [59]Back to Table of Contents Our securities broker-dealer, investment advisor, trust company, and athlete management subsidiaries are subject to substantial regulations |
| If we fail to comply with these regulations, our business will be adversely affected |
| Our businesses are subject to extensive regulation under both federal and state laws |
| Sanders Morris Harris is registered as a broker-dealer with the SEC and the NASD; SMH Capital Advisors, Salient Capital Management, and Charlotte Capital are registered with the SEC as investment advisors; and Salient Trust Co |
| LTA, is licensed as a trust company by the Texas Banking Commissioner |
| All of the agents and contract advisors employed by Select Sports Group Holdings, LLC must be certified by the National Football League Players Association |
| The SEC is the federal agency responsible for the administration of federal securities laws |
| In addition, self-regulatory organizations, principally the NASD, NASD Regulation, Inc, and the securities exchanges, and state securities commissions are actively involved in the regulation of broker-dealers |
| Broker-dealers are subject to regulations that cover all aspects of the securities business, including sales methods, trade 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 |
| The SEC, NASD, other self-regulatory organizations, and state securities commissions may conduct administrative proceedings that can result in: (1) censure, fines, or civil penalties; (2) issuance of cease-and-desist orders; (3) deregistration, suspension, expulsion of a broker-dealer or investment advisor; (4) suspension or disqualification of the broker-dealer’s officers or employees; or (5) other adverse consequences |
| The imposition of any penalties or orders against us could have a material adverse effect on our operating results and financial condition |
| Investment banking and brokerage businesses have experienced increased scrutiny at both the state and federal level and the cost of compliance and the potential liability for non-compliance has increased as a result |
| Additional legislation and regulations, changes in rules imposed by regulatory authorities, self-regulatory organizations, and exchanges or changes in the interpretation or enforcement of existing laws and rules adversely affect our business and profitability |
| Our financial services businesses may be materially affected not only by regulations applicable to our subsidiaries as financial market intermediaries, but also by regulations of general application |
| For example, the volume of our underwriting, merger and acquisition, and principal investment business in a given period could be affected by existing and proposed tax legislation, antitrust policy, and other governmental regulations and policies (including the interest rate policies of the Federal Reserve Board), and changes in interpretation or enforcement of existing laws and rules that affect the business and financial communities |
| Our ability to comply with laws and rules relating to our financial services business depends in large part upon maintaining a system to monitor compliance, and our ability to attract and retain qualified compliance personnel |
| Although we believe we are in material compliance with these laws and regulations, we may not be able to comply in the future |
| Any noncompliance could have a material adverse effect on our business |
| In recent years, there have been industry-wide and other investigations by federal and state authorities concerning certain investment products including mutual funds, hedge funds, and equity indexed insurance; certain brokerage practices including use of soft dollar accounts; and prime brokerage services for hedge fund managers |
| We have received requests for information and have been fully cooperating with those authorities |
| While we believe that we comply with applicable legal and regulatory requirements, we cannot predict the course that these inquiries and areas of focus may take or the impact that any new laws or regulations governing these activities may have on our business |
| The business operations of Sanders Morris Harris and Salient Trust may face limitations due to net capital requirements |
| As a registered broker-dealer, Sanders Morris Harris Inc |
| is subject to the net capital rules administered by the SEC and NASD These rules, which specify minimum net capital requirements for registered broker-dealers and NASD members, are designed to assure that broker-dealers maintain adequate net capital in relation to their liabilities and the size of their customers’ business |
| These requirements have the effect of requiring that a substantial portion of a broker-dealer’s assets be kept in cash or highly liquid investments |
| Failure to maintain the required net capital may subject a firm to suspension or revocation of its registration by the SEC and suspension or expulsion by the NASD and other regulatory bodies |
| Compliance with these net capital rules could limit operations that require extensive capital, such as underwriting or trading activities |
| Additionally, our trust subsidiary, Salient Trust, is required to maintain minimum net capital of dlra1dtta5 million |
| -13- _________________________________________________________________ [60]Back to Table of Contents Our inability to access funds from our subsidiaries could adversely affect our ability to meet our obligations We are a holding company and, therefore, depend on dividends, distributions, and other payments from our subsidiaries to fund dividend payments and to fund all payments on our obligations, including debt obligations |
| As noted above, Sanders Morris Harris and Salient Trust are subject to net capital and other laws that authorize regulatory bodies to block or reduce the flow of funds from those subsidiaries to us |
| Regulatory action of that kind may limit our ability to pay dividends, implement our strategies, pay interest or repay principal on our debt, and redeem or repurchase our outstanding shares |
| In addition, a change in these net capital rules or new rules affecting the scope, coverage, calculation, or amount of the net capital requirements, or a significant operating loss or significant charge against net capital, could have similar effects |
| In addition, to the extent that we hold equity interests in our regulated or unregulated subsidiaries, our rights as an equity holder to the assets of such subsidiaries are subject to the satisfaction of the claims of the creditors of such subsidiaries |
| We may be unable to fully integrate future acquisitions or joint ventures into our business and systems |
| We expect to grow in part through acquisitions and joint ventures |
| To the extent we make acquisitions or enter into combinations or joint ventures, we face numerous risks and uncertainties combining or integrating the relevant businesses and systems, including the need to combine accounting and data processing systems and management controls and to integrate relationships with clients and business partners |
| In the case of joint ventures, we are subject to additional risks and uncertainties that we may be dependent upon, and subject to liability, losses, or reputational damage relating to, systems, controls, and personnel that are not under our control |
| In addition, conflicts or disagreements between us and our joint venture partners may negatively impact the benefits to be achieved by the joint venture |
| We may experience fluctuations in our quarterly and annual operating results due to the nature of our business and therefore fail to meet profitability expectations |
| Our revenues and operating results may fluctuate from quarter to quarter and from year to year due to a combination of factors |
| These factors include: (1) the number of underwriting and merger and acquisition transactions completed by our clients and the level and timing of fees we receive from those transactions; (2) the level of institutional and retail brokerage transactions and the level of commissions we receive from those transactions; (3) levels of assets under management; (4) changes in the market valuations of investments held by proprietary investment funds that we organized and manage and of companies in which we have invested as a principal; (5) the timing of recording of asset management fees and special allocations of income, if any; (6) the realization of profits and losses on principal investments; (7) variations in expenditures for personnel, consulting, and legal expenses; and (8) the expenses of establishing any new business units, including marketing and technology expenses; and (9) the adverse determination or settlement of a lawsuit or arbitration proceeding |
| Our revenues from an underwriting transaction are recorded only when the underwriting is completed |
| Revenues from merger or acquisition transactions are recorded only when the retainer fees are received or the transaction closes |
| Accordingly, the timing of recognition of revenue from a significant transaction can materially affect our quarterly and annual operating results |
| We have a certain level of fixed costs in our investment banking operations |
| As a result, we could experience losses in these operations if demand for our services is lower than expected |
| Our common stock price may be volatile, which could adversely affect the value of your shares |
| Our common stock may trade at prices below your purchase price |
| The market price of our common stock may be subject to significant fluctuations in response to many factors, including: (1) our perceived prospects, (2) the perceived prospects of the securities and financial services industries in general, (3) differences between our actual financial results and those expected by investors and analysts, (4) changes in securities analysts’ recommendations or projections, (5) our announcements of significant contracts, milestones, or acquisitions, (6) sales of our common stock, (7) changes in general economic or market conditions, including condition in the securities brokerage and investment banking markets, (8) changing conditions in the industry of one of our major client groups, and (9) fluctuations in stock market price and volume |
| Any one of the factors noted herein could have an adverse effect on the value of our common stock |
| Our common stock may trade at prices below your purchase price |
| Also, the stock markets periodically experience significant price and volume volatility which may affect the market price of our common stock for reasons unrelated to us or our operating performance |
| If these or other factors cause the price of our common stock to fluctuate, our common stock may trade at prices significantly below your purchase price |