LPL Financial Holdings Inc.
LPL Investment Holdings Inc. (Form: 10-12G, Received: 04/30/2007 17:10:34)

As filed with the Securities and Exchange Commission on April 30, 2007

File No. 333-    

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10

GENERAL FORM FOR REGISTRATION OF SECURITIES
Pursuant to Section 12(b) or (g) of the Securities Exchange Act of 1934

LPL Investment Holdings Inc.

(Exact Name of Registrant as Specified in its Charter)

Delaware

 

20-3717839

(State or Other Jurisdiction of
Incorporation or Organization)

 

(IRS Employer
Identification No.)

 

One Beacon Street, Floor 22
Boston, MA 02108
(617) 423-3644

(Address, Including Zip Code, and Telephone Number, Including
Area Code, of Registrant’s Principal Executive Offices)


With copies to:

Stephanie L. Brown, Esq.

Stephan Feder, Esq.

Chad D. Perry, Esq.

Simpson Thacher & Bartlett LLP

LPL Investment Holdings Inc.

425 Lexington Avenue

One Beacon Street, Floor 22

New York, NY 10017

Boston, MA 02108

(212) 455-2000

(617) 423-3644

 

 


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

Securities to be registered pursuant to Section 12(g) of the Act: Bonus Credits to Purchase Common Stock, par value $0.01 per share

 




TABLE OF CONTENTS

 

Page

Item 1.

Business

2

 

Item 1A.

Risk Factors

19

 

Item 2.

Financial Information

33

 

Item 3.

Properties

59

 

Item 4.

Security Ownership by Certain Beneficial Owners and Management

59

 

Item 5.

Directors and Executive Officers

60

 

Item 6.

Executive Compensation

63

 

Item 7.

Certain Relationships and Related Transactions, and Director Independence

72

 

Item 8.

Legal Proceedings

73

 

Item 9.

Market Price of and Dividends on Holdings’ Common Equity and Related Stockholder Matters

74

 

Item 10.

Recent Sales of Unregistered Securities

75

 

Item 11.

Description of Registrant’s Securities to be Registered

76

 

Item 12.

Indemnification of Directors and Officers

80

 

Item 13.

Financial Statements and Supplementary Data

81

 

Item 14.

Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

81

 

Item 15.

Financial Statements and Exhibits

82

 

 


Neither this registration statement nor any prior or subsequent communications from us, our board of directors (the “Board”) or any of our shareholders, members, directors, officers, employees or agents, should be construed as investment, legal, accounting, regulatory or tax advice.

No person has been authorized to give any information or to make any representation in connection with us or the bonus credits other than those contained in this registration statement and, if given or made, such information or representations must not be relied on as having been authorized by us. Neither the delivery of this registration statement nor the issue of bonus credits after the date hereof shall under any circumstances create any implication or constitute any representation that our affairs have not changed since the date hereof or that information herein is correct as of any date subsequent to the date of this registration statement.

In considering the performance information contained herein, readers should bear in mind that past performance is not necessarily indicative of future results, and there can be no assurance that we will achieve comparable results or that targeted returns will be met.

As used in this registration statement “we,” “our,” “ours,” “us” and the “Company” refer collectively to LPL Investment Holdings Inc. and its subsidiaries, “Holdings” refers to LPL Holdings, Inc. and its subsidiaries and  “LPL” and “Linsco” refer to one of our operating subsidiaries, Linsco/Private Ledger Corp. All references to “dollars” or “$” herein refer to United States dollars.




SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This registration statement includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (“Exchange Act”). Forward-looking statements include statements concerning our expectations, plans, objectives, goals, strategies, future events, future revenue or performance, capital expenditures, financing needs, plans or intentions relating to acquisitions, business trends and other information that is not historical information and, in particular, appear under the headings “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” When used in this registration statement, the words “could,” “estimate,” “expect,” “anticipate,” “project,” “plan,” “intend,” “believe,” “goal,” “forecast” and variations of such words or similar expressions are intended to identify forward-looking statements. All forward-looking statements, including, without limitation, management’s examination of historical operating trends, are based upon our current expectations and various assumptions. Our expectations, beliefs and projections are expressed in good faith and we believe there is a reasonable basis for them. However, there can be no assurance that our expectations, beliefs and projections will result or be achieved.

There are a number of risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements contained in this registration statement. These risks and uncertainties are set forth in this registration statement, including under the heading “Risk Factors.” Such risks, uncertainties and other important factors include, among others:

·        our dependency on our ability to attract and retain experienced and productive independent financial advisors;

·        our ability to successfully integrate acquisitions;

·        the economy and financial markets, including changes to interest rates;

·        the performance of the investment products and services our financial advisors recommend or distribute;

·        the competitive nature of our business;

·        the regulated nature of our business;

·        the failure to comply with net capital requirements;

·        the failure to maintain adequate errors and omissions insurance coverage;

·        the misconduct and errors by our employees and our financial advisors;

·        our potential financial exposure resulting from errors in the securities settlement process;

·        the failure of our risk management policies and procedures to fully mitigate our risk exposure in all market environments or against all types of risks;

·        the vulnerability of our networks to security risks;

·        the failure to maintain technological capabilities, the difficulties in upgrading our technology platform or the introduction of a competitive platform;

·        the disruption of our disaster recovery plans and procedures in the event of a catastrophe;

·        our ability to recruit and retain qualified employees;

·        our dependency on key senior management personnel;

·        the loss of any or all of our marketing relationships with manufacturers of investment products;




·        our ability to execute on our business strategy; and

·        our reliance on our clearing service bureau.

There may be other factors not presently known to us or which we currently consider to be immaterial that may cause our actual results to differ materially from the forward-looking statements.

All forward-looking statements and projections attributable to us or persons acting on our behalf apply only as of the date of this registration statement and are expressly qualified in their entirety by the cautionary statements included in this registration statement. We undertake no obligation to publicly update or revise forward-looking statements, including any of the projections presented herein, to reflect events or circumstances after the date made or to reflect the occurrence of unanticipated events.

EXPLANATORY NOTE

LPL Investment Holdings Inc. is filing this registration statement on Form 10 pursuant to Section 12(g) of the Exchange Act as it has in excess of 500 holders of its bonus credits to purchase its common stock. The bonus credits are subject to significant restrictions on transfer described herein. See “Description of Registrant’s Securities to be Registered.” Because of such restrictions, there is no market for the bonus credits and none is expected to develop.

ITEM 1.                 BUSINESS

Our Business

We are a leading provider of technology and infrastructure services to independent financial advisors (“IFAs”) and to financial institutions who employ financial advisors (collectively, IFAs and financial advisors are defined as “FAs”). As of December 31, 2006, we provided our services to over 7,000 licensed FAs in over 3,100 branch offices. In addition, we have been ranked as the largest independent broker-dealer in the United States for each of the past 11 years based on total revenues (source: Financial Planning ). We provide access to a broad array of financial products and services for our FAs to market to their clients, as well as extensive training and a comprehensive technology and service platform to enable our FAs to more efficiently operate their business. Our strategy is to build long-term relationships with our IFAs and financial institutions who employ financial advisors by offering innovative technologies, training and high-quality services that will enable them to grow their client base. We have expanded our portfolio of products through strategic acquisitions of other financial services companies such as our trust company, our mortgage company, and our insurance agency. We believe that providing these additional services further aligns us with the interests of our FAs by providing them with an expanded array of services to offer their clients, thereby enabling their clients to diversify their investments.

We believe that our substantial scale enables us to offer our IFAs and financial institutions who employ financial advisors industry leading products and services together with attractive economics. In addition, unlike traditional brokerage firms which combine product distribution and product manufacturing within a single company, we operate on an open architecture product platform with independent research on a vast number of investments and no proprietary investment products. Through our research department, FAs have access to independent research on mutual funds, separate accounts, annuities, alternative investments, fixed-income securities, asset allocation strategies, financial markets and the economy. As a consequence, we believe our IFAs and financial institutions who employ financial advisors are able to recommend products selected on the basis of their clients’ financial needs and objectives, without being influenced by potential product manufacturing bias.

The core of our strategy is to build technologies that enable our IFAs and financial institutions who employ financial advisors to more profitably manage the complexity of their business. We view our IFAs and financial institutions who employ financial advisors as partners and work with them to best understand

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their operating environment. This approach, developed over more than 20 years of servicing, is integral to our culture and to our initiatives.

Overview of Principal Service Channels

We view our principal channels as the IFA channel and the Third-Party Services (“Third-Party Services”) channel. In the IFA channel, we provide our services directly to IFAs. In the Third-Party Services channel, we contract with financial institutions who in turn permit us to offer our services to financial advisors they employ.

IFA Services

Our IFAs, who are not in our Third-Party Services channel, exclusively use our platform for all the brokerage and fee-based advisory services they offer. These IFAs are licensed with us, but they are independent contractors who maintain their own office and general support staff. Our IFAs generally have many years of industry experience and generally join us from other brokerage institutions, including wirehouses, regional broker-dealers, banks, insurance companies, and other independent broker-dealers.

Third-Party Services

We believe we are one of the nation’s largest providers of independent, non-proprietary, third-party investment services to banks and credit unions. We have provided investment programs to banks, thrift institutions and credit unions since the early 1990s. In addition, we recently expanded our Third-Party Services through a new program in which we offer clearing, custody and other services to large financial institutions, including insurance companies.

On January 2, 2007, we acquired UVEST Financial Services Group, Inc. (“UVEST”). Headquartered in Charlotte, North Carolina, UVEST offers investment and insurance programs to community and regional banks and credit unions. We believe that the combination of UVEST’s service, expertise and experienced management, together with our scale and broad array of products and services, will allow us to offer the most comprehensive third-party, non-proprietary financial advisory services and programs to the financial services channel.

A History of Creative Growth

Innovative Service

We have been offering innovative service, programs, and technology solutions to our IFAs for almost 20 years. In 1991, we launched Strategic Asset Management (“SAM”), which today is the third-largest mutual fund wrap program in the country according to Cerulli Associates, Inc. This has been followed by other advisory platforms such as Manager Select, Optimum Market Portfolios and Personal Wealth Portfolios. As of December 31, 2006, the total assets in these programs exceeded $50 billion, making us the ninth largest (based on assets) provider of advisory services in the financial service industry as of that date.

In 2000, we became self-clearing. The primary benefits of moving to self-clearing were to speed up processing, improve service, reduce costs and otherwise provide business efficiencies. We believe, however, that our self-clearing capability also enables us to offer technology services to other financial service providers, thereby providing us with an additional business line and source of revenue.

Self-clearing has also enabled us to create increasingly complex investment advisory programs. For example, control over trade execution and access to trade data in our self-clearing environment allowed us to develop our asset allocation models used across a wide range of investment programs. Our investment advisory platforms incorporate mutual funds and separate accounts managed by leading third-party asset managers, individual securities and alternative asset classes. The comprehensive and automated nature of

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the platforms have made it attractive for many of our IFAs and financial institutions who employ financial advisors to “outsource” investment management to us allowing the IFAs and financial institutions who employ financial advisors to dedicate a majority of their time building relationships and helping clients meeting their goals.

Technology Services

Throughout our history, we have believed that robust technology solutions are vital to our IFAs efficiency and productivity. To illustrate our belief, in 1997 we launched BranchNet, our proprietary branch-level processing and business management platform. BranchNet enables our IFAs and financial institutions who employ financial advisors to automate time consuming processes such as opening and managing accounts, executing transactions and rebalancing accounts. In addition to our basic BranchNet package, many of our IFAs and financial institutions who employ financial advisors subscribe to premium features such as performance reporting, financial planning, and customized websites. We have continuously invested in upgrading BranchNet, including the addition of Notifications in 2005, which allows us to alert IFAs and financial institutions who employ financial advisors electronically of time-sensitive operational and trading issues and the addition in 2006 of branch office document imaging capability.

In addition to providing our IFAs with technology solutions, we have undertaken a long-term home office platform initiative to provide an innovative interface and work flow for our employees, including system transparency for all key business managers. We believe that creating a more flexible technological environment for our own employees will be a critical component in supporting our future growth.

Our Scaleable Platform

We have invested significantly in the development of our core operating and technology platforms and intend to continue to do so in the future. We believe that we are well-positioned to enjoy the benefits of platform scalability, which will allow us to add IFAs and financial institutions who employ financial advisors without significant incremental costs. As a result, our revenue and earnings growth is driven primarily by the growth in total advisors and growth in the revenue and profitability of their practices. In addition, scale also enhances our negotiating position with our suppliers. To the extent our scale enables us to reduce costs and incrementally increase profitability, we are in a position to share some of those benefits with FAs. For instance, in 2006, we were able to offer an increased advisor production bonus for IFAs.

Our scale has allowed us to expand our research capabilities. The wide array of expert commentary, research and recommendations our research group provides to our IFAs and financial institutions who employ financial advisors allows FAs to reduce time and resources dedicated to implementing asset allocation strategies and to research.

Our scale also allows us to invest substantial resources in training programs in order to assist our IFAs and financial institutions in our Third-Party Services channel enhance their profitability. We offer extensive training on a nationwide basis on topics including platforms, technology, marketing and practice management, among others. We also provide a comprehensive online library of training modules.

Our Competitive Strengths

Leading Market Position

We have been the largest independent broker-dealer in the United States for the past eleven years as measured by total revenues (Source: Financial Planning). As of December 31, 2006, we had approximately 7,000 FAs and approximately $126.0 billion in assets networked and under administration. Our scale has allowed us to invest substantial resources in our technology and service infrastructure, product platforms

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and compliance systems. As a result, we believe we offer a market leading value proposition that enables us to attract and retain experienced and productive FAs.

FA Focused Culture

We believe that a key element of our success has been our unique corporate culture which focuses on improving the underlying businesses of our FAs. While other brokerage firms also devote significant resources to their efforts in product manufacturing, investment banking or proprietary trading, our primary focus for over 20 years has been and continues to be our FAs. As a result of this unconflicted focus on FAs, we believe our FA retention rates are among the highest in the industry.

We believe our branch development staff is the largest recruiting force among all independent broker-dealers in the United States and recruits from a broader variety of sources—including wirehouses, regional broker-dealers, banks, insurance companies, and other independent broker-dealers—than our competitors.

Attractive Value Proposition for IFAs

We believe the combination of our attractive payout structure with our market leading product and service platform enables our IFAs to earn more income per dollar of client assets invested than IFAs with other firms. Like other independent broker-dealers, we pay a greater share of brokerage commissions and advisory fees to our IFAs than employee-based broker-dealers. While IFAs licensed through independent broker-dealers must pay for their own office expenses, we believe that for most IFAs, the higher payouts more than offset these incremental costs, enabling them to increase their take-home pay. In addition, unlike employees of wirehouses or regional broker-dealers, IFAs can build substantial equity value in their practices. We believe the combination of higher net payouts and the ability to build equity value make the independent model more attractive for many IFAs. Furthermore, among independent broker-dealers, we believe our comprehensive product and service platform enables our IFAs and financial institutions who employ financial advisors to operate their businesses at a lower cost. For example, BranchNet, our proprietary advisor software, enables our IFAs and financial institutions who employ financial advisors to automate time consuming processes such as opening and managing accounts, executing transactions, maintaining books and records and rebalancing accounts.

In addition to offering attractive economics to our IFAs and financial institutions who employ financial advisors, we believe we enable our IFAs and financial institutions who employ financial advisors to more effectively serve their clients. For example, our open architecture platform and research offering enable our IFAs and financial institutions who employ financial advisors to make unbiased, informed recommendations to their clients across a broad array of products and services. We also offer our IFAs and financial institutions who employ financial advisors the largest fee-based advisory platform among all independent broker-dealers (as measured by assets), an offering that addresses increasing client demand for fee-based advisory services.

Diverse, Stable and Profitable Business

Diversified Revenue

As of December 31, 2006, no single IFA or branch office accounted for more than 1% of our revenues. In addition, we have a geographically diverse national presence with IFAs in all 50 states and the District of Columbia.

In addition, our Third-Party Services channel has created opportunities to garner significant revenue from servicing other broker-dealers under a wide range of business models. These opportunities exist along a spectrum that runs from providing complete investment programs to smaller financial institutions to

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providing some combination of front-end processing and back office technology to larger financial services firms.

Business Stability

Our recurring revenues include, among others, advisory fees charged to clients, asset-based fees, 12b-1 fees, fees related to our cash sweep programs, interest earned on margin accounts, and technology and service fees charged to our IFAs. We believe these revenue sources are more stable and less dependent on market conditions than transaction-related commissions. The proportion of our total revenue that is recurring has grown significantly, from approximately 46% for the year ended December 31, 2000 to approximately 62% for the year ended December 31, 2006.

In addition, the stability of our business is further enhanced by our limited reliance on margin lending. For the year ended December 31, 2006, interest from margin lending represented only 1.3% of our total revenue.

Controllable and Scaleable Cost Structure

In contrast to a traditional employee-based model, our IFAs are independent contractors who bear their own office and related expenses. As a result, we manage a flexible and controllable cost structure in which approximately 78.9% of our costs are production-related (commissions and advisory fees and brokerage, clearing and exchange costs) expenses (substantially all of which are variable) and approximately 37.3% of the remaining costs are personnel related (compensation and benefits) as measured for the year ended December 31, 2006. As a result, we have been able to profitably manage our business through challenging market conditions in the past.

In addition, we have invested significantly in the development of our core operating and technology platforms and intend to continue to invest in and enhance our platforms in the future. We believe that we are well-positioned to enjoy the benefits of platform scalability, which will allow us to add IFAs and financial institutions without significant incremental costs.

Stron g Growth Model

We have a long history of successfully growing our business. From the year ended December 31, 1996 through the year ended December 31, 2006, we grew our revenue at a compound annual growth rate (“CAGR”) of 19.4%.

Sales Growth from Newly Recruited IFAs and Mature IFAs

We typically recruit experienced IFAs who were previously licensed with other broker-dealers and have established client bases of their own. As a result, newly recruited IFAs are initially focused on transitioning client assets from their prior firms to us. We expect newly recruited IFAs to return to the approximate production levels they achieved with their prior firms within three years of joining us. As a result, a significant portion of our near term revenue growth in a given year is driven by the size of the recruiting classes and the growth in mature IFA’s practices. One way we measure the growth of our IFAs is through our definition of mature advisor growth (“MAG”). Mature advisors are those that have been with us for at least three years and who are still active at the end of the calendar year. MAG is a measure of this subset of IFAs’ year-over-year change in total production. For the year ended December 31, 2006, MAG was approximately 15% over the previous year ended December 31, 2005.

A substantial portion of our long-term growth is driven by our ability to recruit and retain new IFAs, including financial advisors who work in financial institutions through our financial institution services

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division. We have made a strong organizational commitment to the recruitment process. In addition, we have been successful at retaining our most productive IFAs.

Sales Growth from our Third-Party Services Channel

We continue to work with select institutions that maintain their own broker-dealer. On December 15, 2006, we entered into agreements with a large, global insurance company pursuant to which we agreed to (1) provide brokerage, clearing and custody services on a fully disclosed basis; (2) offer our investment advisory programs and platforms; and (3) provide technology and additional processing and related services to its financial advisors and customers. We expect to begin to provide services to this company in the second half of 2007.

In addition, we continue to provide our product and service platform to financial advisors associated with over 400 independent financial service providers nationwide, including within banks, thrift institutions and credit unions. We work with independent financial service providers under two basic platforms—one in which IFAs are employed by financial institutions and the other in which IFAs operate independent practices located on the premises of financial institutions. We have dedicated compliance and legal resources to address the various sales practice and regulatory issues that are associated with operating non-deposit investment programs on-site at independent financial service providers. For the year ended December 31, 2006, approximately 9% of our commission and advisory revenue was generated from the IFAs associated with independent financial service providers.

On January 2, 2007, we acquired all of the outstanding capital stock of UVEST, which provides independent, non-proprietary third-party brokerage services to financial institutions. The purchase price was approximately $79.60 million in cash, $50.00 million of which was financed through additional borrowings under our senior credit facility, and approximately $10.81 million in shares of common stock. By combining UVEST and our financial institution services division, we expect to benefit from its complementary best practices and create a premier provider with a comprehensive platform, products and support for banks, credit unions and other financial institutions. UVEST is based in Charlotte, NC and provides products and support to approximately 700 IFAs affiliated with over 300 institutions. In 2006, UVEST generated total net revenues of $142.40 million and net income of $6.10 million.

The FA market remains large, fragmented and growing. We believe there is a large addressable pool of FAs from which we can recruit. We expect to capitalize on this market opportunity by leveraging our strong reputation and recruiting infrastructure to continue to grow our recruiting classes. Given the scale of our operations, we have historically been able to add new FAs at an attractive return on capital.

Experienced and Committed Management Team

Our senior management team has an average of nine years of experience with us and extensive experience in the industry. The management team and our IFAs currently own approximately 26.3% of our company on a fully diluted basis.

Our Business Strategies

Increase the Number of our IFAs and Financial Institutions Who Employ Financial Advisors

Recruiting and retaining IFAs and financial institutions who employ financial advisors is critical to achieving our growth objectives. We believe our recruiting staff is the largest among independent broker-dealers, and that our geographically diverse, hands-on recruiting capabilities are unparalleled. We have built a strong reputation among IFAs and financial institutions who employ financial advisors in the United States, ensuring that FAs who contemplate a migration to the independent model strongly consider

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us. We continue to leverage our strong market position to identify, screen, and add experienced and productive FAs.

We continue to improve our attractive value proposition to IFAs and financial institutions who employ financial advisors to maintain our strong track record in retaining FAs.

Continue To Improve Our Service Infrastructure to Enable Our IFAs and Financial Institutions to Continue to Grow Their Businesses

We focus on further developing infrastructure and services to enable our IFAs and financial institutions who employ financial advisors to capitalize on market opportunities and deepen their existing client relationships. For instance, we have expanded our initial service capabilities to provide mortgages, insurance and trust services. We believe our service offering is now among the broadest in the industry and should allow our IFAs and financial institutions who employ financial advisors to capture a greater share of their existing clients’ business and attract new clients.

We believe that our technology and service platform, including BranchNet, our proprietary advisor software system, provides us with a significant competitive advantage because it enables our FAs to efficiently manage their practices. We continue to enhance the functionality of BranchNet and other related technologies. For example, we recently have started to offer our IFAs an integrated software application that will enable them to electronically image branch office records, thereby reducing record retention costs and improving access to records.

Leverage Scale and Market Leadership

As the size of our FA base continues to expand, we will seek to further consolidate our buying power and lower our FAs’ and our costs. With our increasing scale, we have an enhanced ability to economically invest in technology and broaden our value added services more efficiently across our FA base. If successful, we expect to increase our profit margins, as well as those of our FAs.

We also expect our scale to create additional opportunities to provide our product and service platform to IFAs associated with selected institutions that maintain their own broker-dealer. As a result of our scale, we anticipate the opportunity to increase the number of FAs to whom we provide services, whether indirectly through institutions who employ them or directly through acquisitions.

Further develop Third-Party Services as Source of Revenue

We believe we have opportunities for further revenue growth by leveraging both our clearing capability and BranchNet, our state-of-the-art proprietary business processing technology, in the Third-Party Services channel. We expect to offer these services to financial service providers under a variety of business models, including full service investment programs, front-end processing technology in addition to clearing services, and front-end processing as an add-on to incumbent clearing platforms. We believe that our proprietary BranchNet processing technology and our automated investment platforms, that will automatically re-allocate assets across a wide range of best-in-class managers, are key components of our value proposition as we seek to develop this business.

In 2006 we began to offer large institutions in the insurance industry with customized access to our clearing services and proprietary processing and business management technology. On December 15, 2006, we contracted with our first client in this area, a large, global insurance company, to provide clearing and processing services to its FAs engaged in business in the United States.

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Our IFAs

Our IFAs are either independent financial advisors or financial advisors associated with an independent financial service provider. Our IFAs who are not associated with an independent financial service provider exclusively use our platform for all the brokerage and fee-based advisory services they offer. These IFAs are licensed with us, but they are independent contractors who maintain their own branch office and general support staff. These IFAs generally have many years of industry experience and generally join us from other brokerage institutions, including wirehouses, regional broker-dealers, banks, insurance companies, and other independent broker-dealers. They focus primarily on clients in the growing mass affluent market, defined as households with income above $50,000 and investable assets between $100,000 and $1,000,000. We believe that traditional brokerage firms typically focus on higher net worth individuals, and, as a result, the mass affluent market is currently under-served. Therefore, we believe that the demand for the services of IFAs who target the mass affluent will continue to grow rapidly. We believe that our IFAs are well positioned to capitalize on this industry growth, particularly as the baby boomer generation approaches retirement and increasingly demands financial advice. We have grown the number of our IFAs at a CAGR of more than 12.2% over the past five years from approximately 4,000 IFAs at year-end 2001 to approximately 7,000 at year-end 2006.

In a typical branch office there are two IFAs and a licensed assistant. Each of our IFAs enters into the same contract with us that addresses, among other matters, commission payout ratios to IFAs, as well as their compliance obligations.

We believe that our strong commitment to our IFAs is core to our success and our corporate culture is distinguished by its focus on improving the business of our IFAs. Our primary focus for over 20 years has been and continues to be our IFAs, which drives our innovative and customer-oriented approach. We believe our IFA retention rates are among the highest in the industry.

FA Recruiting and Training

Recruiting

We believe that our branch development staff is the largest recruiting force among all independent broker-dealers in the United States and recruits from a broader variety of sources than our competitors. We recruit FAs nationally through multiple channels, including wirehouses, regional broker-dealers, banks, insurance companies, and other independent broker-dealers.

The FA market remains large, fragmented and growing. We believe there is a large addressable pool of IFAs from which we can recruit. We seek to capitalize on this market opportunity by leveraging our strong reputation and recruiting infrastructure to continue to add experienced and productive FAs. Given the strength and scale of our operations, we have historically been able to add new FAs profitably.

We seek to recruit FAs who are business leaders with strong industry experience and a track record of regulatory compliance. We screen all potential FAs through background and credit checks as well as a detailed review of a FA’s historical product sales, disciplinary records, employment history and outside business activities.

Finally, to further facilitate our recruiting efforts, our Transition Services Group provides assistance to our IFAs on establishing their independent practices and migrating their client accounts to our platform. Once a IFA has joined us, our Business Development Group helps that IFA run its business as efficiently as possible.

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Training

We invest substantial resources in our training programs in order to achieve the following goals:

·        to enhance IFA performance and satisfaction;

·        to help our IFAs use our technology and services more effectively;

·        to enhance the competitiveness of our IFAs in the marketplace;

·        to educate our IFAs about our product and service platforms; and

·        to help our IFAs with regulatory compliance procedures.

Our IFAs can access our training programs in a variety of ways, including regional and national sales and training events, live web casts and online training modules. As an example, we annually host our National Sales and Education Conference, the largest of its kind among independent broker-dealers. This conference offers our IFAs opportunities to expand their industry and product knowledge, earn continuing education credits, understand recent changes in compliance regulations, and participate in hands-on training for newly offered technologies.

Products and Services

Independent Financial Advisors Products and Services

Our Independent Financial Advisors segment provides our IFAs access to a platform of non-proprietary, high-quality products for their clients, including fixed and variable annuities, mutual funds and alternative investments, as well as full-service stock and bond trading. This segment also provides our IFAs with a fee-based advisory platform that enables them to build comprehensive customized portfolios of investments for their clients. In the past two years, this segment has started offering our insured cash account program (“ICA Program”), which is a bank deposit sweep program for eligible taxable accounts held at us. Unlike other brokerage firms which combine product distribution and product manufacturing within a single company, we operate on an open architecture product platform with no proprietary investment products. Our IFAs are able to recommend products selected on the basis of their clients’ financial needs and objectives without being influenced by potential product manufacturing biases. To help our IFAs meet their clients’ needs with suitable options, we have developed relationships with many industry leading providers of investment and insurance products.

Commission-Based Products

Commission-based products are those for which we and our IFAs receive an up-front commission and, for certain products, a trail commission. Our brokerage offerings include fixed and variable annuities, mutual funds, general securities, alternative investments and insurance.

·        Fixed and Variable Annuities .   We provide to our IFAs access to a wide variety of variable annuity products, including products that feature guaranteed levels of income, accumulation and death benefits. We also provide our IFAs with a broad suite of fixed annuity products, including immediate and deferred annuities.

·        Mutual Funds .   We provide to our IFAs access to a broad set of mutual fund products across a diverse range of investment styles.

·        General Securities .   We provide to our IFAs transaction execution services to their clients for securities such as equities, options and fixed income securities.

·        Alternative Investments .   We provide to our IFAs access to hedge “funds of funds,” REITs, structured notes and private placements.

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Fee-Based Advisory Platform

In addition to commission-based products, we provide a fee-based advisory platform. In our fee-based advisory platform, we and our IFAs receive an annual fee based on a percentage of client assets under management. We believe that increasing industry demand for fee-based services, as well as our IFAs’ commitment to building the fee-based portion of their business, has enabled us to rapidly grow this business. We believe that the migration towards our fee-based advisory platform encourages higher value-added interactions between our IFAs and their clients.

We have multiple proprietary programs for our IFAs and their clients to choose from, including:

·        Strategic Asset Management (SAM ).   Introduced in 1991, Strategic Asset Management is a fee-based investment program that allows the creation of comprehensive, customized client portfolios managed individually by our IFAs. The SAM platform provides access to no-load/load-waived mutual funds, stocks, bonds, conservative option strategies, UITs and a no-load, multi-manager variable annuity. Our research department provides model portfolio allocations, mutual fund and fixed income recommendations and access to third-party equity research to assist the IFA using the SAM platform. The SAM assets under management were approximately $44 billion as of December 31, 2006.

·        Manager Select .   Introduced in 1996. Manager Select is a fee-based separately managed account program that provides high net-worth clients the ability to access leading institutional money managers. Separate accounts provides for benefits such as the direct ownership of securities, portfolio customization, improved tax efficiency and cost transparency. Our research department provides money manager oversight and recommendations, as well as asset allocation guidelines for clients with a range of investment objectives. The Manager Select assets under management were $3.9 billion as of December 31, 2006.

·        Optimum Market Portfolios (OMP ).   Introduced in 2003, the Optimum Market Portfolios program utilizes the Optimum family of mutual funds which are sub-advised by best in class money managers. Our research department has created a range of asset allocation models with the flexibility to meet the financial goals of a large range of clients. We provide automated portfolio rebalancing to our IFAs and their clients for all OMP accounts. The OMP assets were $1.6 billion as of December 31, 2006.

·        Personal Wealth Portfolios (PWP ).   Introduced in July 2005, the Personal Wealth Portfolios program is a research-driven open architecture program that combines multiple investment styles using mutual funds and institutional separate account money managers in a single account. Our research department provides manager monitoring and oversight and asset allocation models. We also provide rebalancing, tax management capabilities and enhanced reporting. The PWP assets under management were approximately $666 million as of December 31, 2006.

ICA Program

Our ICA Program is a bank deposit sweep program for eligible taxable accounts held at us. Under the ICA Program, available cash balances (from securities transactions, dividend and interest payments, and other activities) in eligible accounts are automatically deposited into interest bearing Federal Deposit Insurance Corporation (“FDIC”) insured deposit accounts at one or more banks or other depository institutions. The deposit accounts at each bank are eligible for insurance by the FDIC for up to $100,000 in principal and accrued interest per depositor (and up to $250,000 for an individual retirement account and certain other retirement accounts). Our ICA Program offers available banks into which funds are deposited for up to $1 million for individual accounts ($2 million for joint accounts) with FDIC insurance coverage of these amounts.

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Other Products and Services

We have selectively expanded our services to include insurance services, mortgage services and trust services to enable our IFAs to provide a comprehensive array of products and services to address their clients’ needs. We have expanded these services both organically and through select acquisitions, as described below. Our Other reporting segment includes the results of our Trust Services, Mortgage Services, Insurance Services and Affiliated Advisory Services business segments.

Trust Services

In February 2003, we acquired PTC Holdings Inc. and its wholly owned subsidiary, The Private Trust Company, N.A., (“PTC”), a non-depository national banking association. These services enable our IFAs to assist their clients with management of intergenerational wealth transfers. In addition, PTC also provides retirement account custodial services. Our IFAs and their clients work directly with PTC and their staff who have backgrounds in law, accounting, banking, investment management tax and business.

Mortgage Services

In June 2004, we acquired Innovex Mortgage Inc. (“Innovex”) which provides a comprehensive mortgage services for the residential properties of our IFAs’ clients. Innovex enables our IFAs to build relationships by offering their clients mortgage solutions by originating, underwriting and funding a variety of mortgage and home equity loan products to suit the needs of the borrowers. Through Innovex, we provide mortgage brokerage and lending services in 46 states and the District of Columbia. Innovex either originates residential mortgage loans internally through a warehouse line of credit facility or externally as a broker for other banks. We have an agreement with certain third-party financial institutions to purchase loans originated internally as long as they meet certain criteria, generally within 30 days from funding.

Insurance Services

In June 2004, we acquired WS Griffith Associates, Inc., a brokerage general agency (which we subsequently renamed Linsco/Private Ledger Insurance Associates, Inc.), which provides access to a broad range of life, disability and long-term care products provided by multiple carriers. The agency’s services include a comprehensive range of products, advanced case design, point of sale service and product support. LPL Insurance Services works closely with leading insurance carriers to enable our IFAs to meet a broad range of their clients’ insurance needs.

Affiliated Advisory Services

Our subsidiary Independent Advisors Group, Inc. (“IAG”) offers a private labeled investment advisory platform for customers of FAs working for other financial service providers.

IFA Support

Through strategic investments in our technology platform, we have automated most of our IFAs’ operational functions, allowing them to transact and monitor their business more efficiently and lowering the cost of execution for both us and our IFAs. Our IFAs use our resources daily for their practices. Our systems enable our IFAs to seamlessly interface with our back office, thereby efficiently providing them with the necessary tools with which to serve their clients. We also provide our IFAs with independent research on investment products and asset allocation models. We provide a strong compliance infrastructure and licensing assistance to our IFAs. We believe our proprietary technology and service platform provides us with a significant competitive advantage.

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Software

The foundation of our IFA software is BranchNet, a proprietary platform in which we have made significant investments over the past 15 years. BranchNet provides our IFAs with tools to manage and grow their practices. For example, it enables our IFAs to automate time consuming processes such as opening and managing accounts, executing transactions and rebalancing accounts. In addition to our basic BranchNet package, many of our IFAs subscribe to premium features such as performance reporting, financial planning, and customized websites. We intend to continue our development of the BranchNet platform and other related technologies that will increase our IFAs’ efficiency and related profitability. We recently started to offer our IFAs an integrated software application that will enable them to electronically image branch office records, thereby reducing record retention costs and improving access to records. Recent developments in 2007 include, among others, the release of online order entry for variable annuity transaction processing.

Clearing Services

Our brokerage and trading platforms provide comprehensive transaction processing and account administration for mutual funds, equities, fixed income securities, options and other securities. We launched our self-clearing platform in 2000, utilizing Thomson’s Beta Systems for our books and records system, which addresses all important facets of securities transaction processing, including order routing, trading support, execution and clearing, position keeping, regulatory and tax compliance and reporting, and investment accounting and recordkeeping.

Our decision to become a self clearing broker-dealer has allowed us to manage our cost structure, and service levels more effectively. Our self-clearing platform has enabled us to have better control of data and to facilitate platform development, allowing us to further enhance the quality of services we provide to our IFAs. In addition, we believe self-clearing provides our IFAs with efficient and reliable trade processing and financial reporting, enabling them to focus their efforts on serving their clients.

Service Center

Our San Diego and Charlotte based service center fields inbound questions from our IFAs, providing them with a single, centralized source to obtain assistance with their clients’ brokerage, advisory and retirement accounts. Our experienced staff of approximately 160 employees receives ongoing training that enables them to provide consistent and accurate information. Unlike many FAs licensed at brokerage firms that outsource clearing services, our IFAs can access a single point of contact to resolve questions for their clients. As a result, our staff resolves approximately 91% of inbound queries on the first contact.

Research

We provide IFAs with independent research on mutual funds, separate accounts, annuities, alternative investments, fixed income securities, asset allocation strategies, financial markets and the economy. They develop asset allocation models for our fee-based advisory programs and provide in-depth analysis on a vast number of investments. We believe these research resources are critical to our success and provide us with a notable competitive advantage. Our research department has developed recommended lists of mutual funds, separate accounts and variable annuity sub-accounts. The research process combines quantitative and qualitative screening factors, without considering in any way any financial arrangements or business relationships between us and product manufacturers. The entire suite of published research analysis, commentary recommendations, third-party research data and analytical tools is available real time to IFAs.

Compliance and Registration

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The primary function of our compliance department is to develop policies and procedures designed to ensure that we, our employees, and our IFAs conduct business in a manner that complies with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”), the states, the National Association of Securities Dealers, Inc. (“NASD”), the Commodities Futures Trading Commission (“CFTC”) and other self-regulatory organizations of which we are a member. We have made a strong commitment to this business function and have grown our compliance and registration staff from 68 employees in 2002 to approximately 140 employees in 2006. In fulfilling this function, the compliance area is divided into the following groups:

·        Surveillance Group .   Responsible for daily electronic monitoring of our brokerage activities.

·        Advisory Compliance Group .   Responsible for the daily electronic monitoring of our investment advisory activities.

·        Branch Audit Group .   Responsible for the annual inspection of all branch offices.

·        Advertising Compliance Group .   Responsible for reviewing all advertising, sales literature and correspondence prepared by our IFAs.

·        Supervision Group .   Responsible for the supervision of branch office managers.

We use our proprietary advisory surveillance software to monitor advisory accounts for metrics such as performance relative to market indices, concentrated holdings, inactivity, margin levels, trade count and excessive management fees. With respect to our brokerage accounts, we utilize automated surveillance reporting to review trading activity and perform general suitability reviews.

The primary function of our registration department is to license all of our IFAs to enable them to engage in brokerage, advisory and insurance related activities. The registration staff is also responsible for the processing of our corporate licenses used by us and our subsidiaries, to engage in brokerage, commodities, advisory and insurance business. In addition, the registration department is responsible for administering our NASD mandated continuing education program and for tracking IFA completion of continuing education requirements.

Account Protection

Our Securities Investor Protection Corporation (“SIPC”) membership provides account protection up to a maximum of $500,000 per client account, of which $100,000 may be in cash. Additionally, through Lloyds of London, our accounts have additional securities coverage of $99.5 million per client account, subject to a $500 million aggregate firm limit. The account protection applies when a SIPC firm fails financially and is unable to meet obligations to securities clients, but it does not protect against losses from the rise and fall in the market value of investments.

Disaster Recovery

We have developed a comprehensive business continuity plan that covers business disruptions of varying severity and scope. The plan addresses the potential loss of a geographic area, building, staff, data, systems and/or our telecommunications. We subject our business continuity plan to review and testing on an ongoing basis and update it as necessary. Under our business continuity plan, we expect to continue to be able to do business and resume operations with minimal service impacts. However, under certain scenarios, the time that it would take for us to recover and to resume operations may significantly increase depending on the extent of the disruption and the number of personnel affected.

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Competition

We compete with a variety of financial institutions to attract and retain experienced and productive FAs and financial institutions who employ them. These financial institutions include clearing and processing firms, broker-dealers, asset managers insurance companies, and banks. We believe our primary competitors include Merrill Lynch & Co., Inc., Morningstar, Inc., Charles Schwab & Co., Inc., Wachovia Securities, Inc., SEI Investments Development, Inc., National Financial Services, LLC, Pershing, LLC, Primevest Financial Services, Inc. and Raymond James Financial, Inc., among others. We believe that our strong value proposition for our IFAs and financial institutions that employ financial advisors allows us to differentiate ourselves versus competitors.

Our IFAs compete for clients and administered assets with brokerage firms, banks, insurance companies, asset management and investment advisory firms. In addition, they also compete with a number of firms offering on-line financial services and discount brokerage services, usually with lower levels of service and fees, to individual clients. Factors affecting our IFAs’ competitiveness include pricing levels, the breadth and quality of the products and advisory programs they offer, as well as the strength and continuity of their client relationships. In addition, the proper functioning of the service platform we provide to our IFAs, such as software, processing, compliance and registration, is critical to our IFAs’ ability to compete effectively.

Employees

As of December 31, 2006, we had 1,423 employees. None of our employees are subject to collective bargaining agreements governing their employment with us. Our continued growth is dependent, in part, on our ability to recruit and retain skilled technical sales and professional personnel. We believe that our relationships with our employees are excellent.

Regulation

Our businesses, as well as the financial services industry generally, are subject to extensive regulation. As a matter of public policy, securities regulatory bodies are charged with safeguarding the integrity of the securities and other financial markets and with protecting the interests of customers participating in those markets, not with protecting the interests of our stockholders or creditors. The SEC is the federal agency responsible for the administration of the federal securities laws, while the CFTC is the federal agency responsible for the administration of the federal commodities laws. The exchanges, the NASD and the National Futures Association (“NFA”) are self-regulatory bodies composed of members, such as our broker-dealer subsidiary, that have agreed to abide by the respective bodies’ rules and regulations. Each of these regulatory bodies may examine the activities of, and may expel, fine and otherwise discipline, member firms and their registered representatives. The laws, rules and regulations comprising this framework of regulation and the interpretation and enforcement of existing laws, rules and regulations are constantly changing. The effect of any such changes cannot be predicted and may impact the manner of operation and profitability of our company.

Broker-Dealer Regulation

LPL is registered as a broker-dealer with the SEC, a member of the NASD, conducts business as a broker-dealer in all 50 states and the District of Columbia, is a member of various self-regulatory organizations, the Boston Stock Exchange (“BSE”), and a participant of various clearing organizations, including The Depository Trust Company (“DTC”), the National Securities Clearing Corporation (“NSCC”), and Options Clearing Corporation.

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UVEST is registered as a broker-dealer with the SEC and is a member of the NASD. Similar to LPL, UVEST conducts business on a national basis, however it acts as an introducing firm, using Pershing, LLC, for securities clearing and custody functions.

Broker-dealers are subject to regulations covering all aspects of the securities business, including sales and trading practices, public offerings, publication of research reports, use and safekeeping of customers’ funds and securities, capital structure, record-keeping and the conduct of directors, managers, officers and employees. Broker dealers are also regulated by securities administrators in those states where they do business. Compliance with many of the regulations applicable to us involves a number of risks because regulations are subject to varying interpretations. Regulators make periodic examinations and review annual, monthly and other reports on our operations, track record and financial condition. Violations of regulations governing a broker-dealer’s actions could result in censure, fine, the issuance of cease-and-desist orders, the suspension or expulsion from the securities industry of such broker-dealer or its officers or employees, or other similar consequences. The rules of the MSRB, which are enforced by the NASD, apply to the municipal securities activities of LPL and UVEST.

The broker-dealer business activities that each of LPL and UVEST may conduct are limited by their membership agreements with the NASD, their primary self-regulator. The membership agreement may be amended by application to include additional business activities. This application process is time-consuming and may not be successful. As a result, we may be prevented from entering new potentially profitable businesses in a timely manner, or at all. In addition, as a member of the NASD, we are subject to certain regulations regarding changes in control of our ownership. NASD Rule 1017 generally provides, among other things, that NASD approval must be obtained in connection with any transaction resulting in a change in our equity ownership that results in one person or entity directly or indirectly owning or controlling 25% or more of our equity capital, and would include a change in control of our parent company. As a result of these regulations, our future efforts to sell shares or raise additional capital may be delayed or prohibited by the NASD.

Our margin lending is regulated by the Federal Reserve Board’s restrictions on lending in connection with customer purchases and short sales of securities, and NASD rules also require such subsidiaries to impose maintenance requirements on the value of securities contained in margin accounts. In many cases, our margin policies are more stringent than these rules.

Investment Advisor Regulation

As investment advisors registered with the SEC, LPL, UVEST and IAG are subject to the requirements of the Investment Advisers Act of 1940 and the SEC’s regulations thereunder, as well as to examination by the SEC’s Staff. Such requirements relate to, among other things, fiduciary duties to clients, performance fees, maintaining an effective compliance program, solicitation arrangements, conflicts of interest, advertising, limitations on agency cross and principal transactions between an advisor and advisory clients, recordkeeping and reporting requirements, disclosure requirements and general anti-fraud provisions. In addition, LPL, UVEST and IAG are subject to the Employee Retirement Income Security Act of 1974, as amended, or ERISA, and to regulations promulgated thereunder, insofar as they are a “fiduciary” under ERISA with respect to benefit plan clients. ERISA and applicable provisions of the Internal Revenue Code of 1986, as amended (the “Code”), impose certain duties on persons who are fiduciaries under ERISA, prohibit certain transactions involving ERISA plan clients and provide monetary penalties for violations of these prohibitions. The failure to comply with these requirements could have a material adverse effect on our business.

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Commodities and Futures Regulation

LPL is licensed as a futures commission merchant (“FCM”) and commodity pool operator with the CFTC and is a member of the NFA. Although licensed as a FCM and a commodity pool operator, LPL’s futures activities are limited to conducting business as a guaranteed introducing broker. LPL is regulated by the CFTC and NTA, of which it is a member. Violations of the rules of the CFTC and the NFA could result in remedial actions including fines, registration terminations or revocations of exchange memberships. As a guaranteed introducing broker, LPL clears commodities and futures products through ADM Investor Services International Limited (“ADM”), and all commodities accounts and related client positions are held by ADM.

Trust Regulation

Our subsidiary, PTC, is a non-depository national banking association. PTC was chartered in 1994 and was acquired by us in February of 2003. As a limited purpose national bank, PTC is regulated and regularly examined by the Office of the Comptroller of the Currency (“OCC”). PTC files reports with the OCC within 30 days after the conclusion of each calendar quarter. Because the powers of PTC are limited to providing fiduciary services and investment advice, it does not have the power or authority to accept deposits or make loans. For this reason, trust assets under PTC’s management are not insured by the Federal Deposit Insurance Corporation.

As PTC is not a “bank” as defined under the Bank Holding Company Act of 1956, neither its parent, PTC Holdings nor the Company is regulated by the Board of Governors of the Federal Reserve System as a bank holding company.

Because PTC is a national bank regulated by the OCC, many common corporate activities require approval of or are subject to regulations promulgated by the OCC. These include aspects of day to day operations which are subject to such OCC regulations and policies and procedures adopted by PTC, prior approval of any material change in the business plan of PTC, including direct or indirect changes in control of its parent, the opening of additional full service fiduciary offices (as opposed to representative trust office that only require a post-notice filing), any merger or acquisition directly by PTC, as opposed to us, maintenance of capital standards and numerous other items. In connection with the Acquisition (as defined below), the OCC required PTC to enter into an operating agreement that required us to provide the OCC with quarterly financial reporting and to seek prior OCC approval to any modification of PTC’s business plan and imposed certain restrictions on the ability of PTC to pay dividends. PTC was previously party to an operating agreement with the OCC during the period from 2003 until 2004, and based on our experience, we do not expect that the terms of the new operating agreement will materially and adversely affect our operations. Under the new operating agreement, the OCC conditioned its approval of the Acquisition on an agreement by PTC to maintain certain levels of capital. Currently, PTC has agreed to maintain its capital level at not less than $10 million of Tier I capital, which the board of directors of PTC deems adequate for the current operation of its business. PTC also agreed to maintain liquid assets equal to the greater of $8 million or its projected operating expenses for the next twenty-four months (plus any additional expenses during that time period). We also agreed to establish a letter of credit in favor of PTC in an amount equal to $10 million.

The declaration of dividends by PTC is limited. Generally, a national bank may declare a dividend, without approval of the OCC, if the total of the dividends declared by such institution in a calendar year does not exceed the total of its net profits for that year less any dividends paid in that year combined with its retained profits for the preceding two years.

PTC operates in a highly competitive industry. It competes with national and state banks, savings and loan associations, securities dealers, insurance companies, investment companies, and personal financial planners as well as other financial institutions.

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Mortgage Brokerage Regulation

Our subsidiary Innovex Mortgage, Inc. provides mortgage brokerage and/or lending services in 46 states (excluded states are Nevada, New York, New Jersey and Virginia). Innovex was acquired by us in 2004 and has been approved as a Title II non-supervised mortgagee by the U.S. Department of Housing and Urban Development (“HUD”), and it maintains mortgage brokerage or mortgage lending licenses or similar authorizations in those states in which its business requires it to do so, Innovex is governed by mortgage, brokerage and banking laws and regulations in each state in which it is doing business, and such laws and regulations may change frequently and are subject to interpretation by each of the individual regulators. Violations by Innovex of any state or federal regulations, including while Innovex was under control of its prior owners, could result in fines, payment of restitution, revocations of its licenses or other authorizations, and in some circumstances, impairment of the enforceability of its loans or the validity of its liens.

Regulatory Capital

The SEC, NASD, CFTC and the NFA have stringent rules and regulations with respect to the maintenance of specific levels of net capital by regulated entities. Generally, a broker-dealer’s capital is net worth plus qualified subordinated debt less deductions for certain types of assets. The Net Capital Rule under the Exchange Act requires that at least a minimum part of a broker-dealer’s assets be maintained in a relatively liquid form. As a guaranteed introducing broker for commodities and futures that is also a registered broker-dealer, CFTC rules require us to comply with higher net capital requirements of The Net Capital Rule under the Exchange Act. If applicable net capital rules are changed or expanded, or if there is an unusually large charge against our net capital, our operations requiring the intensive use of capital would be limited. A large operating loss or charge against our net capital could adversely affect our ability to expand or even maintain these current levels of business, which could have a material adverse effect on our business and financial condition.

The SEC, NASD, CFTC and HUD impose rules that require notification when net capital falls below certain predefined criteria. These rules also dictate the ratio of debt to equity in the regulatory capital composition of a broker-dealer, and constrain the ability of a broker-dealer to expand its business under certain circumstances. If a broker-dealer fails to maintain the required net capital, it may be subject to suspension or revocation of registration by the applicable regulatory agency, and suspension or expulsion by these regulators ultimately could lead to the broker-dealer’s liquidation. Additionally, the net capital rule and certain NASD rules impose requirements that may have the effect of prohibiting a broker-dealer from distributing or withdrawing capital, and that require prior notice to the SEC and the NASD for certain capital withdrawals. All of our subsidiaries that are subject to net capital rules have been (with the exception of Innovex, which was briefly below its HUD required net capital January 2004 through March 2004 due to an accounting interpretation), and currently are, in compliance with those rules and have net capital in excess of the minimum requirements.

Anti-Money Laundering

The USA PATRIOT Act of 2001 (the “PATRIOT Act”) contains anti-money laundering and financial transparency laws and mandates the implementation of various new regulations applicable to broker-dealers, FCMs and other financial services companies, including standards for verifying customer identification at account opening and obligations to monitor customer transactions and detect and report suspicious activities to the U.S. government. Financial institutions subject to the PATRIOT Act generally must have anti-money laundering procedures in place, implement specialized employee training programs, designate an anti-money laundering compliance officer and are audited periodically by an independent party to test the effectiveness of compliance. We have established policies, procedures and systems designed to comply with these regulations.

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Privacy

We use information about our clients to provide personalized services. Regulatory activity in the areas of privacy and data protection continues to grow worldwide and is generally being driven by the growth of technology and related concerns about the rapid and widespread dissemination and use of information. We must comply with these information-related regulations, to the extent applicable, among others. Such regulations may constrain our ability to market our services to our current clients and to access additional clients. In addition, we must ensure that we properly safeguard our client information.

The 1999 Gramm-Leach-Bliley Act (“GLBA”) requires disclosure of a financial institution’s privacy policies and practices and affords customers (as defined in the GLBA) the right to “opt out” of an institution’s transmission of information to unaffiliated third parties (with certain exceptions). GLBA also requires financial institutions to safeguard customer information. We will continue our efforts to safeguard the data entrusted to us in accordance with applicable law and our internal data protection policies, including taking steps to reduce the potential for identity theft, while seeking to collect and use data to properly achieve our business objectives and to best serve our clients. LPL is further subject to state privacy and data security laws, which if more strict than the federal standard under GLBA will apply in addition to the GLBA standard.

The Fair Credit Reporting Act of 1970 (“FCRA”), as amended, regulates our obtaining and disclosing consumer reports periodically obtained regarding our IFAs. The 2003 Fair and Accurate Credit Transactions Act (“FACT Act”) significantly amended the FCRA, including making permanent and adding to the preemption of state laws regarding certain activities involving consumer reports. The extent to which the FCRA preempts state law is currently the subject of litigation. In addition, the FACT Act amended the FCRA by adding new provisions designed to prevent or reduce the incidence of identify theft and to improve the accuracy of consumer report information. The FACT Act also requires any company that receives consumer “eligibility” information from an affiliate to permit the consumer to opt out of having that information used to market the company’s products to the consumer, subject to certain exceptions. This provision has not yet taken effect, as the rules implementing it have not been finalized.

Regulatory Actions

On October 13, 2005, we received a “Wells” notice from the NASD’s Department of Enforcement. The notice advised us that the NASD staff had made a preliminary determination to recommend disciplinary action for potential violations of NASD Conduct Rule 2210. The staff alleged that we failed to maintain adequate supervisory procedures regarding the exchange of variable annuities. On December 21, 2006, the NASD accepted our Corrective Action Statement and Letter of Acceptance, Waiver and Consent (“AWC”) with respect to the matter. Under the AWC, and without admitting or denying the findings, we consented to a fine of $300,000. See “Legal Proceedings.”

ITEM 1A.         R ISK FACTORS

Risk Factors Related to our Business

We depend on our ability to attract and retain experienced and productive IFAs and financial institutions who employ financial advisors.

Our ability to attract and retain experienced and productive IFAs and financial institutions who employ financial advisors has contributed significantly to our growth and success, and our strategic plan is premised upon continued growth in the number of our IFAs. If we fail to attract new IFAs and financial institutions who employ financial advisors or to retain and motivate our current IFAs and financial institutions who employ financial advisors, our business, results of operations or financial condition may suffer.

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We devote considerable efforts to recruiting experienced and productive FAs. The market for experienced and productive FAs is highly competitive. In attracting FAs, we compete directly with a variety of financial institutions such as wirehouses, regional broker-dealers, banks, insurance companies and other independent broker-dealers. There can be no assurance that we will be successful in our efforts to recruit the FAs needed to achieve our growth objectives.

We also devote considerable resources to encouraging our IFAs and financial institutions who employ financial advisors to remain with us. Our contracts with our IFAs are mutually terminable upon 30 days’ notice. As a result, IFAs licensed with us may in the future leave us at any time to pursue other opportunities. Although our level of payout is designed to discourage attrition, there can be no assurance that we will be successful in retaining such IFAs, the loss of whom, and the loss of whose clients, will also result in a loss of income to us.

Further, as competition for experienced and productive FAs increases, there may be competitive pressure to increase the share of commissions and advisory fees we pay to our IFAs and financial institutions who employ financial advisors. Any such increase could have a material adverse effect on our business, results of operations, cash flows or financial condition.

We depend on FAs’  ability to grow their businesses.

Our financial results are influenced by the growth of our FAs’ and related financial institutions’ businesses. The growth of their businesses has been affected by a variety of factors that are both external and internal to the financial advisory industry, including general economic conditions. If FAs are not able to grow their businesses, our business, results of operations, cash flows or financial condition may suffer.

The performance of our business is correlated with the economy and financial markets, and a slowdown or downturn in the economy or financial markets could adversely affect our business, results of operations, cash flows or financial condition.

Our financial results are influenced by the willingness or ability of clients to maintain or increase their investment activities in the financial products offered by us. As a result, general economic and market factors can affect our commission and fee revenue. For example, a decrease in stock prices can:

·        reduce new investments by both new and existing clients in financial products that are linked to the stock market, such as variable life insurance, variable annuities, mutual funds and managed accounts;

·        reduce trading activity, thereby affecting our brokerage commissions;

·        reduce the value of assets under management, thereby reducing asset-based fee income; and

·        motivate clients to withdraw funds from their accounts, reducing assets under management, advisory fee revenue, and asset-based fee income.

General economic and market factors may also slow the rate of growth, or lead to a decrease in the size, of the mass affluent market.

Because clients can withdraw their assets on short notice, poor performance of the investment products and services may have a material adverse effect on our business, results of operations, cash flows or financial condition.

Clients can reduce the aggregate amount of assets under management or shift their funds to other types of accounts with different rate structures for any of a number of reasons, including investment performance and personal client liquidity needs. Poor performance of the investment products and services that we offer relative to the performance of other products available in the market or the

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performance of other investment management firms tends to result in the loss of accounts. The decrease in revenue that could result from such an event could have a material adverse effect on our business, results of operations, cash flows or financial condition.

Our business is competitive and, if we are unable to compete effectively, our business, results of operations, cash flows or financial condition may be adversely affected.

We compete directly with a variety of financial institutions to attract and retain experienced and productive FAs. These financial institutions include wirehouses, regional broker-dealers, banks, insurance companies, and other independent broker-dealers. Recent consolidation in the financial services industry has created stronger competitors, some of whom have greater financial resources. This may allow our competitors to respond more quickly to new technologies and changes in market demand, to devote greater resources to developing and promoting their services, and to make more attractive offers to potential FAs. In addition, the passage of the Gramm-Leach-Bliley Act in 1999 reduced barriers to large institutions providing a wide range of financial services products and services. See “Business—Competition” for a listing of some of our more prominent competitors.

We may experience pricing pressures in the future as some of our competitors seek to obtain increased market share by reducing fees. Some competitors may offer 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. If we are not able to compete successfully in the future, our business, results of operations, cash flows or financial condition could be adversely affected.

Our business is highly regulated and the failure to comply with applicable regulations could result in penalties, temporary or permanent prohibitions on our activities and reputational harm, any of which could have a material adverse effect on our business, results of operations, cash flows or financial condition.

Our business is subject to extensive United States regulation and supervision, including regarding securities and investment advisory services. LPL and UVEST are registered as broker-dealers and investment advisers with the SEC, are members of the NASD, do business as broker-dealers and investment advisers in all 50 states and the District of Columbia, and are members of various self-regulatory organizations. In addition, LPL is a member of the NSCC and the DTC. LPL is also registered as a FCM and a commodity pool operator with the CFTC.

The SEC, NASD, CFTC, various securities and futures exchanges and other U.S. governmental or regulatory authorities continuously review legislative and regulatory initiatives and may adopt new or revised laws and regulations. There can also be no assurance that existing regulations will not change or that Federal, state or foreign agencies will not attempt to further regulate our business. These legislative and regulatory initiatives may affect the way in which we conduct our business and may make our business less profitable. Recently, federal, state and other regulatory authorities have focused on, and continue to devote substantial attention to, the mutual fund and variable annuity industries. It is difficult at this time to predict whether changes resulting from new laws and regulations will affect these industries or our business and, if so, to what degree. For example, there have recently been suggestions from regulatory agencies and other industry participants that mutual fund fees paid under Rule l2b- l of the Investment Company Act of 1940, as amended, in exchange for distributing certain mutual funds should be reconsidered and potentially reduced or eliminated. Similarly, there have been recent suggestions from regulatory agencies that fees derived from marketing arrangements between product manufacturers and distributors should be reduced or restructured. In addition, changes in legislation and regulatory law may reduce the amount of commission or compensation permitted to be derived from investment products offered by independent broker-dealers. An industry-wide reduction or restructuring of Rule l2b-1 fees, amounts we receive under marketing arrangements or amounts permitted to be received from investment products could have a material adverse effect on our business, results of operations, cash flows or financial condition.

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Our ability to conduct business in the jurisdictions in which we currently operate depends on our compliance with the laws, rules and regulations promulgated by federal regulatory bodies and the regulatory authorities in each of these jurisdictions. Our ability to comply with all applicable laws, rules and regulations is largely dependent on our establishment and maintenance of compliance, audit and reporting systems and procedures, as well as our ability to attract and retain qualified compliance, audit and risk management personnel. While we have adopted policies and procedures reasonably designed to comply with all applicable laws, rules and regulations, these systems and procedures may not be fully effective, and there can be no assurance that regulators or third parties will not raise material issues with respect to our past or future compliance with applicable regulations. We face the risk of intervention by regulatory authorities, including extensive examination and surveillance activity and adoption of costly or restrictive new regulations. In the case of actual or alleged non-compliance with regulations, we could be subject to investigations and administrative proceedings that may result in substantial penalties. Any failure to comply with applicable laws and rules could adversely affect our business, results of operations, cash flows or financial condition.

We also are subject to various laws, regulations, and rules setting forth requirements regarding privacy and data protection. If our policies, procedures and systems are found to not comply with these requirements, we could be subject to regulatory actions or litigation that could have a material adverse effect on our business, results of operations, cash flows or financial condition.

Recently, a class action complaint was filed against other broker-dealers alleging various causes of action arising out of their bank deposit sweep programs with their affiliated banks. In this class action complaint, allegations were, among others, that the disclosures by the broker and dealers were false and misleading and that the firms concealed material information from customers. Although we believe our ICA Program differs from the named broker-dealers’ programs, there has been significant scrutiny under these programs. If we are not able to offer our ICA Program, it could have a material adverse effect on our business, results of operations, cash flows or financial condition.

We are subject to various regulatory capital requirements, which, if not complied with, could result in the restriction of the ongoing conduct, growth, or even liquidation of parts of our business.

The SEC, NASD and CFTC have extensive rules and regulations with respect to capital requirements. The net capital rule under the Exchange Act requires that at least a minimum part of a broker-dealer’s assets be maintained in a relatively liquid form. For example, as a guaranteed introducing broker for commodities and futures that is also a registered broker-dealer, CFTC rules require us to comply with higher net capital requirements of the net capital rule. Our ability to withdraw capital from LPL could be restricted, which in turn could limit our ability to fund operations, repay debt and redeem or purchase shares of our outstanding 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.

Our business is subject to risks related to litigation and arbitration actions.

From time to time, we are subject to legal proceedings arising out of our business operations, including lawsuits, arbitration claims, regulatory and or governmental subpoenas, investigations and actions, and other claims. Many of our legal claims are client initiated and involve the purchase or sale of investment securities. In our investment advisory programs, we have fiduciary obligations that require us and our IFAs to act in the best interests of our IFAs’ clients. We may face liabilities for actual or claimed breaches of these fiduciary duties. The outcome of these actions cannot be predicted, and although we believe we have adequate insurance coverage for these matters (see “—Our errors and omissions insurance coverage may be inadequate or expensive”), no assurance can be given that such legal proceedings would not have a material adverse effect on our business, results of operations, cash flows or financial condition.

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Our errors and omissions insurance coverage may be inadequate or expensive.

We are subject to arbitration claims in the ordinary course of business resulting from alleged and actual errors and omissions in effecting securities transactions, rendering investment advice and making insurance sales. These activities may involve substantial amounts of money. Since errors and omissions claims against us may allege our liability for all or part of the amounts in question, claimants may seek large damage awards. These claims can involve significant defense costs. Errors and omissions could include, for example, failure, whether negligently or intentionally, to effect securities transactions on behalf of our IFAs or their clients, failure to disclose material information relating to the investment, breach of fiduciary duty and unsuitable investment recommendations. It is not always possible to prevent or detect activities giving rise to claims, and the precautions we take may not be effective in all cases.

We have mandatory errors and omissions insurance coverage to protect us and our IFAs against the risk of liability resulting from alleged and actual errors and omissions. Recently, premium and deductible costs associated with this insurance have increased, coverage terms have become far more restrictive and the number of insurers in this market has decreased. In 2006, LPL increased its deductible from $45,000 per claim to $250,000 per claim. This means that we bear increased economic risk for any claims. While we endeavor to purchase coverage that is appropriate to our assessment of our risk, we are unable to predict with certainty the frequency, nature or magnitude of claims for direct or consequential damages. Our business, results of operations, cash flows or financial condition may be negatively affected if in the future our insurance proves to be inadequate or unavailable. In addition, errors and omissions claims may harm our reputation or divert management resources away from operating our business.

Misconduct and errors by our employees and our IFAs could harm our business, results of operations, cash flows or financial condition.

Misconduct and errors by our employees and our IFAs could result in violations of law by us, regulatory sanctions and/or serious reputational or financial harm. Misconduct and errors could include:

·        errors in executing securities transactions;

·        hiding unauthorized or unsuccessful activities resulting in unknown and unmanaged risks or losses;

·        improperly using or disclosing confidential information;

·        recommending securities that are not suitable;

·        engaging in fraudulent or otherwise improper activity;

·        engaging in unauthorized or excessive trading; or

·        otherwise not complying with laws or our control procedures.

We cannot always deter misconduct and errors by our employees and our IFAs, and the precautions we take to prevent and detect this activity may not be effective in all cases. Prevention and detection among our IFAs, who are not employees of LPL and tend to be located in small, decentralized offices, present additional challenges. There cannot be any assurance that misconduct and errors by our employees and IFAs will not lead to a material adverse effect on our business, results of operations, cash flows or financial condition.

The securities settlement process exposes us to risks that may impact our liquidity and profitability.

We provide clearing services and trade processing for our IFAs and their clients and, in the future, certain financial institutions. Broker-dealers that clear their own trades are subject to substantially more regulatory requirements than brokers that outsource these functions to third-party providers. Errors in performing clearing functions, including clerical, technological and other errors related to the handling of

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funds and securities held by us on behalf of clients, could lead to censures, fines or other sanctions imposed by applicable regulatory authorities as well as losses and liability in related lawsuits and proceedings brought by our IFAs’ clients and others. Any unsettled securities transactions or wrongly executed transactions may expose our IFAs and us to adverse movements in the prices of such securities.

Our business could be materially adversely affected as a result of the risks associated with acquisitions and investments .

As part of our business strategy, we seek to acquire businesses that offer complementary products, services or technologies. These acquisitions are accompanied by the risks commonly encountered in an acquisition of a business, which may include, among other things:

·        the effect of the acquisition on our financial and strategic position and reputation;

·        the failure of an acquired business to further our strategies;

·        the failure of the acquisition to result in expected benefits, which may include benefits relating to enhanced revenues, technology, human resources, costs savings, operating efficiencies and other synergies;

·        the difficulty and cost of integrating the acquired business, including costs and delays in implementing common systems and procedures and costs and delays caused by communication difficulties or geographic distances between the two companies’ sites;

·        the assumption of liabilities of the acquired business, including litigation-related liability;

·        the potential impairment of acquired assets;

·        the lack of experience in new markets, products or technologies or the initial dependence on unfamiliar supply or distribution partners;

·        the diversion of our management’s attention from other business concerns;

·        the impairment of relationships with customers or suppliers of the acquired business or our customers or suppliers;

·        the potential loss of key employees of the acquired company; and

·        the potential incompatibility of business cultures.

These factors could have a material adverse effect on our business, results of operations, cash flows or financial condition. To the extent that we issue shares of our common stock or other rights to purchase our common stock in connection with any future acquisition, existing shareholders may experience dilution and our earnings per share may decrease. On January 2, 2007, we acquired all of the outstanding capital stock of UVEST . We are currently integrating the operations of UVEST with ours. We cannot assure that we will be able to successfully integrate these operations, and even if we do so, we may be unable to realize the benefits we expect to obtain as a result of that integration, including projected cost reductions, in a given period or no a definitive basis.

In addition to the risks commonly encountered in the acquisition of a business as described above, we may also experience risks relating to the challenges and costs of closing a transaction. Further, the risks described above may be exacerbated as a result of managing multiple acquisitions at the same time. We also may invest in businesses that offer complementary products, services or technologies. These investments would be accompanied by risks similar to those encountered in an acquisition of a business.

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Our risk management policies and procedures may not be fully effective in mitigating our risk exposure in all market environments or against all types or risks.

We have adopted policies and procedures to identify, monitor and manage our risks, including, among other things, establishing our Enterprise Risk Management Group with internal audit function. These policies and procedures, however, may not be fully effective. Some of our risk evaluation methods depend upon information provided by others and public information regarding markets, clients or other matters that are otherwise accessible by us. In some cases, however, that information may not be accurate, complete or up-to-date. Also, because our IFAs work in small, decentralized offices, additional risk management challenges may exist. If our policies and procedures are not fully effective or we are not always successful capturing all risks to which we are or may be exposed, our business could be materially adversely affected.

If the counterparties to the derivative instruments we use to hedge our business risks default, we may be exposed to risks we had sought to mitigate, which could adversely affect our results of operations, cash flows or financial condition.

We use a variety of derivative instruments to hedge several business risks. If our counterparties fail to honor their obligations under the derivative instruments, our hedges of the related risk will be ineffective. That failure could have an adverse effect on our financial condition and results of operations, cash flows that could be material.

As a public company we would incur substantial additional costs to comply with securities laws, rules and regulations, including, in particular, Section 404 of the Sarbanes Oxley Act of 2002.

We have not previously operated as a public company and currently have no intention to register our common stock. As a public company subject to the reporting requirements of the Exchange Act and the Sarbanes Oxley Act of 2002, or Sarbanes Oxley, we would be required, among other things, to file periodic reports relating to our business and financial condition. In addition, Section 404 of Sarbanes Oxley would require us to include a report with our annual report on Form 10-K that must include management’s assessment of the effectiveness of our internal control over financial reporting as of the end of the applicable fiscal year and disclosure of any material weaknesses in internal control that we have identified. Additionally, our independent registered public accounting firm would be required to issue a report on management’s assessment of our internal control over financial reporting and their evaluation of the operating effectiveness of our internal control. Our assessment would require us to make subjective judgments and our independent registered public accounting firm might not agree with our assessment. Achieving compliance with Section 404 within the prescribed period would require us to incur significant costs and expend significant time and management resources. If we were unable to complete the work necessary for our management to issue its management report in a timely manner, or if we were unable to complete any work required for our management to be able to conclude that our internal control over financial reporting were operating effectively, we and our independent registered public accounting firm would be unable to conclude that our internal control over financial reporting is effective as of December 31, 2008. As a result, investors could lose confidence in our reported financial information or public filings, which could have an adverse effect on the trading price of our stock or lead to stockholders litigation. In addition, our independent registered public accounting firm might not agree with our management’s assessment or conclude that our internal control over financial reporting were not operating effectively. The new laws, rules and regulations might also make it more difficult for us to attract and retain qualified independent members of the Board and qualified executive officers.

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Our networks m ay be vulnerable to security risks.

The secure transmission of confidential information over public networks is a critical element of our operations. Our application service provider systems maintain and process confidential data on behalf of FAs and their clients, some of which is critical to FAs’ business operations. For example, our brokerage systems maintain account and trading information for clients. If our application service provider systems are disrupted or fail for any reason, or if our systems or facilities are infiltrated or damaged by unauthorized persons, clients could experience data loss, financial loss, harm to reputation and significant business interruption. If such a disruption or failure occurs, we may be exposed to unexpected liability, clients may withdraw their assets, our reputation may be tarnished, and there could be a material adverse effect on our business, results of operations, cash flows or financial condition.

We have not experienced significant network security problems in the past. However, our networks may be vulnerable to unauthorized access, computer viruses and other security problems in the future. Persons who circumvent security measures could wrongfully use our confidential information or our clients’ confidential information or cause interruptions or malfunctions in our operations. We may be required to expend significant additional resources to protect against the threat of security breaches or to alleviate problems caused by any breaches. We may not be able to implement security measures that will protect against all security risks.

Failure to maintain technological capabilities, difficulties in upgrading our technology platform, or the introduction of a competitive platform could have a material adverse effect on our business, results of operations, cash flows or financial condition.

We believe that our technology platform, particularly our BranchNet system, is one of our competitive strengths. Our future success will depend in part on our ability to anticipate and adapt to technological advancements required to meet the changing demands of our FAs. In particular, the emergence of new industry standards and practices could render our existing systems obsolete or uncompetitive. Any upgrades or expansions may require significant expenditures of funds and may also increase the probability that we will suffer system degradations and failures. There cannot be any assurance that we will have sufficient funds to adequately update and expand our networks, nor can there be any assurance that any upgrade or expansion attempts will be successful and accepted by our current and prospective IFAs and financial institutions who employ FAs. Our failure to adequately update and expand our systems and networks could have a material adverse effect on our business, results of operations, cash flows or financial condition.

In addition, we believe our extensive prior investments in our proprietary technology platform and the scale advantage these investments have created enable us to add new IFAs without significant incremental costs. If a reasonably priced, competitive system became available to broker-dealers generally, and to smaller broker-dealers particularly, our scale advantage could be adversely affected. Our BranchNet system was developed over a period of more than ten years and at significant cost. There can be no assurance, however, that a competitive system cannot be developed that would provide broker-dealers with the ability to offer a competitive platform at an economical price.

Disruption of our disaster recovery plans and procedures in the event of a catastrophe could adversely affect our business, results of operations, cash flows or financial condition.

We have made a significant investment in our infrastructure, and our operations are dependent on our ability to protect the continuity of our infrastructure against damage from catastrophe or natural disaster, breach of security, loss of power, telecommunications failure or other natural or man-made events. A catastrophic event could have a direct negative impact on us by adversely affecting our employees or facilities, or an indirect impact on us by adversely affecting our IFAs, clients, financial institutions who

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employ FAs, the financial markets or the overall economy. While we have implemented business continuity and disaster recovery plans, it is impossible to fully anticipate and protect against all potential catastrophes. In addition, the location of our headquarters and a disaster recovery site in San Diego, California increases our vulnerability to certain natural disasters. If our business continuity and disaster recovery plans and procedures were disrupted or unsuccessful in the event of a catastrophe, we could experience a material adverse interruption of our operations.

Our ability to provide financial services to our IFAs, financial institutions who employ FAs and clients, and to create and maintain comprehensive tracking and reporting of client accounts depends on our capacity to store, retrieve and process data, manage significant databases and expand and periodically upgrade our information processing capabilities. Interruption or loss of our information processing capabilities could have a material adverse effect on our business, results of operations, cash flows or financial condition.

We do not currently maintain interruption insurance.

Our future success depends on our ability to recruit and retain qualified employees.

Our success and future growth depends upon our ability to attract and retain qualified employees. There is significant competition for qualified employees in the broker-dealer industry. We may not be able to retain our existing employees or fill new positions or vacancies created by expansion or turnover. The loss or unavailability of these individuals could have a material adverse effect on our business, results of operations, cash flows or financial condition.

We depend on key senior management personnel.

Our success depends upon the continued services of our key senior management personnel, including our executive officers and senior managers. The loss of one or more of our key senior management personnel, and the failure to recruit a suitable replacement or replacements, could have a material adverse effect on our business, results of operations, cash flows or financial condition.

A loss of our marketing relationships with a variety of leading manufacturers of investment products could harm our business, results of operations, cash flows or financial condition.

We operate on an open architecture product platform with no proprietary investment products. To help our IFAs meet their clients’ needs with suitable options, we have relationships with many industry leading providers of investment and insurance products. We have sponsorship agreements with some manufacturers of fixed and variable annuities and mutual funds that, subject to the survival of certain terms and conditions, may be terminated upon 30 days’ notice. If we lose our relationships with one or more of these manufacturers, our business, results of operations, cash flows or financial condition may be materially and adversely affected.

A change in our clearing service bureau relationship could adversely affect our business, results of operations, cash flows or financial condition.

We have used Thomson’s Beta Systems as our clearing service bureau since 2000. If we had to change the clearing service bureau we use, we would experience a disruption to our business. Although we believe we have the resources to make such a transition with minimal disruption, we cannot predict the costs and time for a conversion to a new system. There cannot be any assurance that the disruption caused by a change in our clearing service bureau relationship would not have a material adverse affect on our business, results of operations, cash flows or financial condition.

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Changes in U.S. federal income tax law could make some of the products distributed by our IFAs less attractive to clients.

Some of the products distributed by our IFAs enjoy favorable treatment under current U.S. federal income tax law. Changes in U.S. federal income tax law could make some of these products less attractive to clients and could have a material adverse affect on our business, results of operations, cash flows or financial condition.

Failure to comply with ERISA regulations could result in penalties against us.

We are subject to the Employee Retirement Income Security Act of 1974, or ERISA, and to regulations promulgated thereunder, insofar as we act as a “fiduciary” under ERISA with respect to benefit plan clients. ERISA and applicable provisions of the Internal Revenue Code impose duties on persons who are fiduciaries under ERISA, prohibit specified transactions involving ERISA plan clients and provide monetary penalties for violations of these prohibitions. Our failure to comply with these requirements could result in significant penalties against us that could have a material adverse effect on our business, results of operations, cash flows or financial condition (or, in a worst case, severely limit the extent to which we could act as fiduciaries for any plans under ERISA).

Our substantial indebtedness could adversely affect our financial health and may limit our ability to use debt to fund future capital needs.

We have a significant amount of indebtedness. At December 31, 2006, we had total indebtedness of $1.34 billion.

Our substantial indebtedness could have important consequences to you. For example, it could:

·        increase our vulnerability to general adverse economic and industry conditions;

·        require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, and other general corporate purposes;

·        limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

·        place us at a competitive disadvantage compared to our competitors that have less debt; and

·        limit our ability to borrow additional funds.

Furthermore, if an event of default were to occur with respect to our credit agreement or other indebtedness, our creditors could, among other things, accelerate the maturity of our indebtedness.

Our ability to make scheduled payments on or to refinance indebtedness obligations depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control.

We may not be able to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness. If our cash flows and capital resources are insufficient to fund our debt service obligations, we could face substantial liquidity problems and could be forced to sell assets, seek additional capital or seek to restructure or refinance our indebtedness. These alternative measures may not be successful or feasible. Our credit agreement restricts our ability to sell assets. Even if we could consummate those sales, the proceeds that we realize from them may not be adequate to meet any debt service obligations then due.

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In addition, as a result of reduced operating performance or weaker than expected financial condition, rating agencies may downgrade our senior subordinated notes , which would adversely affect the value of our common shares.

We will be able to incur additional indebtedness or other obligations in the future, which would exacerbate the risks discussed above.

Our senior secured credit agreement permits us to incur additional indebtedness. Although the amended and restated credit agreement contains restrictions on the incurrence of additional indebtedness, these restrictions are subject to a number of significant qualifications and exceptions, and the indebtedness incurred in compliance with these restrictions could be substantial. Also, these restrictions do not prevent us from incurring obligations that do not constitute “indebtedness” as defined in the amended and restated credit agreement. To the extent new debt or other obligations are added to our currently anticipated debt levels, the substantial indebtedness risks described above would increase. We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under such indebtedness, which may not be successful.

Restrictions under certain of our indebtednesses may prevent us from taking actions that we believe would be in the best interest of our business.

Certain of our indebtedness contain customary restrictions on our activities, including covenants that restrict us from:

·        incurring additional indebtedness or issuing disqualified stock or preferred stock;

·        paying dividends on, redeeming or repurchasing our capital stock;

·        making investments or acquisitions;

·        creating liens;

·        selling assets;

·        restricting dividends or other payments to us;

·        guaranteeing indebtedness;

·        engaging in transactions with affiliates; and

·        consolidating, merging or transferring all or substantially all of our assets.

We are also required to meet specified financial ratios. These restrictions may prevent us from taking actions that we believe would be in the best interest of our business. Our ability to comply with these restrictive covenants will depend on our future performance, which may be affected by events beyond our control. If we violate any of these covenants and are unable to obtain waivers, we would be in default under the applicable agreements and payment of the indebtedness could be accelerated. The acceleration of our indebtedness under one agreement may permit acceleration of indebtedness under other agreements that contain cross default or cross acceleration provisions. If our indebtedness is accelerated, we may not be able to repay that indebtedness or borrow sufficient funds to refinance it. Even if we are able to obtain new financing, it may not be on commercially reasonable terms or on terms that are acceptable to us. If our indebtedness is in default for any reason, our business, results of operations, cash flows and financial condition could be materially and adversely affected. In addition, complying with these covenants may also cause us to take actions that are not favorable to holders of the common stock and may make it more difficult for us to successfully execute our business strategy and compete against companies who are not subject to such restrictions.

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Risk Factors Related to Our Bonus Credits and Our Common Stock

The bonus credits are subject to several restrictions, including, without limitation, no voting rights and restrictions on transfer.

Our bonus credits have no voting rights. The holder of a bonus credit is not entitled to voting rights, unless its bonus credit becomes vested and is converted into shares of our common stock.

The bonus credits are not transferable other than by will or by the laws of descent and distribution upon death of the holder of the bonus credit, unless otherwise permitted by the Board, which has not permitted any transfer of bonus credit to date and will not permit any transfer for the foreseeable future. There is and there will be no market or periodically available process or methodology that would allow holders of bonus credits to receive any consideration or compensation for the bonus credits at any time. In the case of termination of the holder of bonus credit’s agreement with us prior to the final vesting date of such holder’s bonus credits, the unvested bonus credits are automatically forfeited. In the case of termination of the holder of bonus credit’s agreement with us in connection with its retirement from the securities industry at the age of 65 or older, the unvested bonus credits will become vested. However, if the holder ceases to remain retired from the securities industry without our consent, the bonus credits that vested as a result of the retirement and are still outstanding will be immediately forfeited to us.

There is no public market for the common stock, and none is expected to develop.

There is no public market for our common stock, and we do not expect any market to develop. Our common stock is subject to significant restrictions on transfer. In general, our organizational documents grant us a right of first refusal in the event of any proposed voluntary or involuntary transfer of beneficial ownership of any share of our capital stock. In addition, we currently have no plans to register our common stock.

Holdings does not expect to pay dividends on our common stock in the foreseeable future.

Holdings is a holding company with no business operations of its own. As a result, Holdings depends on its operating subsidiaries for cash to make dividend payments. Deterioration in the financial conditions, earnings or cash flow of our significant subsidiaries for any reason could limit or impair their ability to pay cash dividends or other distributions to Holdings. Holdings may also need to contribute additional capital to improve the capital ratios of certain of its subsidiaries, which could also affect the ability of these subsidiaries to pay dividends.

In addition, the terms of certain of the outstanding indebtedness of Holdings’ subsidiaries substantially restrict our ability to pay dividends. See “Management’s Discussion and Analysis of Our Financial Condition and Results of Operations—Indebtedness.” There cannot be any assurance that agreements governing the current and future indebtedness of Holdings or its subsidiaries will permit Holdings or its subsidiaries to provide our common shareholder with sufficient dividends, distributions or loans.

Accordingly, the restrictions above would limit Holdings’ ability to make dividend payments to our holders of common stock, and investors must be prepared to rely on sales of their common stock after price appreciation to earn an investment return, which may never occur, particularly in view of our transfer restrictions applicable to our common stock.

Securities laws and regulations regulate the ability of many of our subsidiaries (such as our brokerage subsidiary) to pay dividends or make other distributions. See “Business—Regulation.”

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Any determination to pay dividends in the future will be made at the discretion of the Board and will depend on our results of operations, cash flows, financial conditions, contractual restrictions, restrictions imposed by applicable law and other factors the Board deems relevant.

The Majority Holders control us and may have conflicts of interest with us or you in the future.

Investment funds associated with or designated by the Majority Holders indirectly own through their ownership in our parent company, approximately 60% of our capital stock, on a fully-diluted basis. Although our executive team has the contractual ability to terminate their employment agreements and receive certain payments if the Majority Holders enter into a transaction our executive team does not approve, the Majority Holders have significant influence over corporate transactions.

Additionally, the Majority Holders are in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us. One or more of the Majority Holders may also pursue acquisition opportunities that may be complementary to our business and, as a result. those acquisition opportunities may not be available to us. So long as investment funds associated with or designated by the Majority Holders continue to indirectly own a significant amount of the outstanding shares of our common stock, even if such amount is less than 50%, the Majority Holders will continue to be able to strongly influence or effectively control our decisions.

If we are unable to receive shareholder consent we may not be able to amend our certificate of incorporation prior to conducting an initial public offering of our common stock, which will have an adverse effect on our ability to consummate an initial public offering.

We anticipate that we will need to amend our certificate of incorporation prior to conducting an initial public offering. We cannot assure you that we will be able to obtain the requisite shareholder approval to amend our certificate of incorporation. If we are unable to obtain the requisite approval, it will have an adverse effect on our ability to consummate an initial public offering. We also cannot assure you which provisions of our certificate of incorporation will be amended, but they may be changes that would have an adverse effect on you as a stockholder.

In addition, we currently do not meet the listing requirements of either the New York Stock Exchange or the NASDAQ with respect to various governance requirements and will have to make various changes to our governance procedures prior to seeking any such listing. It is possible that we may not be successful in listing our common stock on a national stock exchange in case we decide conduct an initial public offering, in which our ability to consummate such initial public offering would be adversely affected.

Future issuances or sales of our securities in the public market could cause our stock price to fall.

We may issue securities in the public market in the future and may do so in a manner that results in substantial dilution for our stockholders. In addition, we may issue debt from time to time that ranks in preference to our common stock in the event of a liquidation or winding up or that is secured by an interest in some or all of our assets. Sales of common stock by existing stockholders in the public market, our issuances of new securities or debt, or the expectation that any of these events might occur could materially and adversely affect the market price of our common stock.

If our stock price fluctuates, your bonus credits could lose a significant part of their value.

The price of our stock, and therefore the value of our bonus credit, may be influenced by many factors, some of which are beyond our control, including those described above under “—Risks Related to Our Business” and the following:

·        our dependency on our ability to attract and retain experienced and productive FAs;

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·        our ability to successfully integrate acquisitions;

·        the economy and financial markets, including changes to interest rates;

·        the performance of the investment products and services our IFAs and our financial institutions recommend or distribute;

·        the competitive nature of our business;

·        the regulated nature of our business;

·        the failure to comply with regulatory capital requirements;

·        the failure to maintain adequate errors and omissions insurance coverage;

·        the misconduct and errors by our employees and our IFAs;

·        our potential financial exposure resulting from errors in the securities settlement process;

·        the failure of our risk management policies and procedures to fully mitigate our risk exposure in all market environments or against all types of risks;

·        the vulnerability of our networks to security risks;

·        the failure to maintain technological capabilities, the difficulties in upgrading our technology platform or the introduction of a competitive platform;

·        the disruption of our disaster recovery plans and procedures in the event of a catastrophe;

·        our ability to recruit and retain qualified employees;

·        our dependency on key senior management personnel;

·        the loss of any or all of our marketing relationships with manufacturers of investment products;

·        our ability to execute on our business strategy; and

·        our reliance on our clearing service bureau.

Even factors that do not specifically relate to our company may materially reduce the price of our common stock, regardless of our operating performance.

Provisions of our senior secured credit agreement could discourage an acquisition of us by a third party.

Certain provisions of our credit agreement could make it more difficult or more expensive for a third party to acquire us. Upon the occurrence of certain transactions constituting a change of control, all indebtedness under our credit agreement may be accelerated and become due.

Anti-takeover provisions of our certificate of incorporation and bylaws may reduce the likelihood of any potential change of control or unsolicited acquisition proposal that you might consider favorable.

Provisions of our certificate of incorporation and bylaws could deter, delay or prevent a third-party from acquiring us, even if doing so would benefit our stockholders. These provisions include:

·        staggered board of directors;

·        the absence of cumulative voting in the election of directors;

·        limitations on who may call special meetings of stockholders; and

·        advance notice requirements for stockholder proposals.

32




I tem 2.                 FINANCIAL INFORMATION

Selected Financial and Other Data

The following table sets forth our selected historical financial information as of and for the periods presented. The selected historical data for the years ended December 31, 2004 to 2006 have been derived from our audited historical consolidated financial statements and related notes included elsewhere in this registration statement. The selected historical data for the years ended December 31, 2002 and 2003 have been derived from our audited historical consolidated financial statements and related notes not included in this registration statement. The selected historical financial information presented below should be read in conjunction with the information included under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our historical consolidated financial statements and related notes included elsewhere in this registration statement. The following financial data are not necessarily indicative of the results to be expected for the full year or any future period.

 

 

For the Year Ended December 31,

 

 

 

2006

 

2005

 

2004

 

2003

 

2002

 

 

 

(in thousands)

 

Consolidated statements of income data:

 

 

 

 

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

Commissions

 

$

890,489

 

$

744,939

 

$

640,128

 

$

521,940

 

$

448,049

 

Advisory

 

521,058

 

399,363

 

301,090

 

209,536

 

193,751

 

Asset based fees

 

147,364

 

107,726

 

89,561

 

68,631

 

59,012

 

Transaction and other fees

 

134,496

 

125,844

 

104,168

 

87,850

 

75,875

 

Interest income

 

28,402

 

17,719

 

12,829

 

10,822

 

12,704

 

Other

 

18,127

 

11,705

 

9,609

 

10,289

 

7,403

 

Total revenues

 

1,739,936

 

1,407,296

 

1,157,385

 

909,068

 

796,794

 

Expenses:

 

 

 

 

 

 

 

 

 

 

 

Production expenses

 

1,231,105

 

999,301

 

821,688

 

643,396

 

565,444

 

Compensation and benefits

 

137,401

 

142,372

 

127,997

 

98,306

 

90,075

 

General & administrative

 

120,891

 

116,943

 

92,725

 

75,482

 

59,830

 

Depreciation & amortization

 

65,348

 

17,854

 

15,798

 

12,014

 

8,440

 

Other

 

4,921

 

12,712

 

29,826

 

35,446

 

13,462

 

Total non-interest expenses

 

1,559,666

 

1,289,182

 

1,088,034

 

864,644

 

737,251

 

Interest expense from operations

 

301

 

976

 

1,447

 

1,464

 

595

 

Interest expense from senior credit facilities and subordinated notes

 

125,103

 

1,388

 

 

 

 

Total expenses

 

1,685,070

 

1,291,546

 

1,089,481

 

866,108

 

737,846

 

Income from continuing operations before income taxes

 

54,866

 

115,750

 

67,904

 

42,960

 

58,948

 

Provision for income taxes

 

21,224

 

46,461

 

32,552

 

26,598

 

23,052

 

Income from continuing operations

 

33,642

 

69,289

 

35,352

 

16,362

 

35,896

 

Loss from discontinued operations

 

 

(26,200

)

 

 

 

Net income

 

$

33,642

 

$

43,089

 

$

35,352

 

$

16,362

 

$

35,896

 

 

33




 

 

 

As of December 31,

 

 

 

2006

 

2005

 

2004

 

2003

 

2002

 

 

 

(in thousands, except otherwise indicated)

 

Consolidated Statements of financial condition data:

 

 

 

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

245,163

 

$

134,592

 

$

113,439

 

$

147,515

 

$

129,782

 

Receivables

 

468,170

 

377,932

 

302,584

 

240,481

 

217,374

 

Fixed assets, net

 

121,594

 

134,764

 

63,035

 

70,268

 

61,986

 

Total assets

 

2,797,544

 

2,638,486

 

606,145

 

556,446

 

465,170

 

Bank loans payable

 

 

 

25,049

 

30,855

 

29,236

 

Notes payable

 

1,344,375

 

1,345,000

 

 

 

 

Drafts payable

 

104,344

 

88,230

 

86,080

 

65,911

 

69,185

 

Payable to customers

 

294,574

 

195,106

 

149,882

 

143,899

 

105,013

 

Total liabilities

 

2,170,662

 

2,050,062

 

408,894

 

353,321

 

278,778

 

Total shareholders’ equity

 

626,882

 

588,424

 

197,251

 

203,125

 

186,392

 

 

 

 

As of and For the Year Ended December 31,

 

 

 

2006

 

2005

 

2004

 

2003

 

2002

 

Other financial and operating data:

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

$

508,831

 

$

407,995

 

$

335,697

 

$

265,672

 

$

231,350

 

Number of advisors (#)

 

7,006

 

6,481

 

5,843

 

5,036

 

4,369

 

Capital Expenditures

 

23,038

 

19,424

 

14,336

 

20,362

 

35,654

 

 

34




Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

Statements made in this document, other than statements of historical information, are forward-looking statements that are made pursuant to the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934. These forward-looking statements may sometimes be identified by words such as “believe,” “expect,” “may,” “looking forward,” “we plan,” “could,” or “anticipate.”  Although we believe these statements to be true and reasonable at the time they are made, we can give no assurance that these plans, expectations, or beliefs will be achieved. Important factors that could cause actual results to differ materially from our forward-looking statements are set forth under the heading “Factors That May Affect Future Operating Results.”  We do not undertake to update any forward-looking statements that may be made.

Our Business

We are a leading provider of technology and back-office infrastructure to FAs. We provide access to a broad array of financial products and services for our IFAs to market to their clients, as well as a comprehensive technology and service platform to enable our IFAs to more efficiently operate their practices. Our strategy is to build long-term relationships with our IFAs by offering innovative technologies and high-quality services that will enable them to nurture and grow their client base.

Our revenues are primarily derived from commissions and fees from products and advisory services offered by our IFAs to their clients, a substantial portion of which we pay to our IFAs. Furthermore, we also receive fees from product manufacturers as well as various administrative fees from our IFAs and their clients for the use of our proprietary technology and service platform.

We offer our wide range of services through four complementary business segments:  Independent Financial Advisors, Trust Services, Mortgage Services, Insurance Services, and Affiliated Advisory Services. Together, our business segments offer our IFAs access to a brokerage platform of non-proprietary, best-of-breed products for their clients, including fixed and variable annuities, mutual funds, life insurance, alternative investments and mortgages, as well as full-service stock and bond trading.

Our Independent Financial Advisors segment offers our IFAs access to a brokerage platform of non-proprietary, best-of-breed products for their clients, including fixed and variable annuities, mutual funds and alternative investments, as well as full-service stock and bond trading. The Independent Financial Advisors segment also provides our IFAs with a fee-based advisory platform that enables them to build comprehensive, customized portfolios of investments for their clients. In addition, our Independent Financial Advisors segment provides our IFAs with a comprehensive array of infrastructure support and services, including trade processing and clearing automated portfolio rebalancing, proprietary advisor software (BranchNet), independent research, a client centric service center, training programs and compliance support. Our Trust Services segment enables our IFAs to assist their clients with management of intergenerational wealth transfers. The Mortgage Services segment provides comprehensive mortgage services for the residential properties of our IFAs’ clients. Our Insurance Services segment provides our IFAs with access to a broad range of life, disability and long-term care products provided by multiple carriers. Finally, our Affiliated Advisory Services Segment offers a private labeled investment advisory platform for customers of financial advisors working for other financial institutions.

For reporting purposes under accounting principles generally accepted in the United States of America (“GAAP”), we have two segments:

·        Independent Financial Advisors, and

·        Other.

35




Our Independent Financial Advisors segment includes the results of our primary operating subsidiary, Linsco, a regulated broker-dealer. For the year ended December 31, 2006, this segment comprised more than 98% of our consolidated revenues. Our Other segment consists of our remaining operating segments and includes the results of our remaining operating subsidiaries:  PTC, Innovex, Linsco/Private Ledger Insurance Associates, Inc., and IAG.

Our business model, together with our scale, allows us to gain significant recurring revenue. Between 2004 and 2006, our recurring revenues were 54%, 59% and 62%, respectively, of overall revenue. This recurring revenue comes from advisory fees charged to clients, asset-based fees, 12b-1 fees, fees related to our cash sweep programs, interest earned on margin accounts and technology and service fees charged to our IFAs.

We view our principal channels as the IFA channel and the Third-Party Services channel. In the IFA channel, we provide our services directly to IFAs. In the Third-Party Services channel, we contract with financial institutions who in turn permit us to offer our services to their financial advisors.

The Company was acquired through a leveraged merger transaction on December 28, 2005. Activities as of December 28, 2005 and for the prior periods are for those of the predecessor company. Due to the immaterial amounts between the period December 28, 2005 and December 31, 2005, all operations and cash flows for calendar year 2005 are considered to be those of the predecessor company’s financial results.

EBITDA

Management uses EBITDA (unaudited) to measure operating performance. EBITDA is defined as income (loss) before minority interest earnings and cumulative change in accounting plus interest, taxes, depreciation and amortization. EBITDA is not a recognized term under GAAP and does not purport to be an alternative to net income as a measure of operating performance or to cash flows from operating activities as a measure of liquidity. Additionally, EBITDA is not intended to be a measure of free cash flow available for management’s discretionary use, as it does not consider certain cash requirements such as interest payments, tax payments and debt service requirements. Management believes EBITDA is helpful in highlighting trends because EBITDA excludes the results of decisions that are outside the control of operating management and can differ significantly from company to company depending on long-term strategic decisions regarding capital structure, the tax jurisdictions in which companies operate and capital investments. In addition, EBITDA provides more comparability between our historical results and results that reflect purchase accounting and the new capital structure. Management compensates for the limitations of using non-GAAP financial measures by using them to supplement GAAP results to provide a more complete understanding of the factors and trends affecting the business than GAAP results alone. Because not all companies use identical calculations, these presentations of EBITDA may not be comparable to other similarly titled measures of other companies. Adjusted EBITDA (unaudited) is defined as EBITDA further adjusted to exclude non-cash share based compensation expense calculated in accordance with GAAP. We believe that the inclusion of a supplementary adjustment to EBITDA applied in presenting Adjusted EBITDA is appropriate to provide additional information to investors about certain material non-cash items that we believe do not reflect our operating performance .

36




Set forth below is our EBITDA and Adjusted EBITDA for the years ended December 31, 2004, 2005 and 2006 and a reconciliation of EBITDA to income from continuing operations, the most closely analogous GAAP measure:

 

 

Year Ended December 31,

 

 

 

2006

 

2005

 

2004

 

 

 

(in thousands)

 

Income from continuing operations

 

$

33,642

 

$

69,289

 

$

35,352

 

Interest expense (1)

 

125,103

 

1,388

 

 

Income tax expense

 

21,224

 

46,461

 

32,552

 

Depreciation and amortization

 

65,348

 

17,854

 

15,798

 

EBITDA

 

245,317

 

134,992

 

83,702

 

Non-cash share based compensation expense

 

2,878

 

8,807

 

20,463

 

Adjusted EBITDA

 

$

248,195

 

$

143,799

 

$

104,165

 


(1)            Interest expense excludes interest incurred for brokerage and mortgage lending operations.

Factors That May Affect Future Operating Results

The following factors may affect our financial performance:

Recruitment and Development of Financial Advisors

Our revenues are impacted by our ability to grow our existing IFAs’ businesses and to continue to grow the number of our licensed IFAs and financial institutions who employ financial advisors.

·         Mature advisor growth.   Growth from mature IFAs represents the growth in commission and advisory revenues of IFAs who have been licensed with us for three or more years. In addition, we have been successful at retaining our most productive IFAs.

·         Sales growth from newly recruited IFAs.   We typically recruit experienced IFAs who were previously licensed with other broker-dealers and have established client bases of their own. As a result, newly recruited IFAs are initially focused on transitioning client assets from their prior firms to us. We expect newly recruited IFAs to return to the approximate production levels they achieved with their prior firms within three years of joining us. As a result, a portion of our near-term revenue growth in a given year is driven by the size of the recruiting classes of the prior two years. For example, the recruiting classes of 2004 and 2005 contributed to revenue growth in 2006.

Recurring Revenue

One of our core strategic objectives is to earn an increasing share of our revenues from recurring sources. Our recurring revenues include advisory fees charged to clients, 12b-1 fees, asset-based fees, fees related to our cash sweep programs, interest earned on margin accounts and technology and service fees charged to our IFAs. We believe these revenue sources are more stable and less dependent on market conditions than transaction-related commissions.

In addition, the stability of our business is further enhanced by our limited reliance on margin lending. Our interest from margin lending represented only 1.3%, 1.0%, and 1.0%, respectively, of our total revenues for the years ended December 31, 2006, 2005, and 2004. Furthermore, we have experienced no losses from write-offs of margin loans over the past five years.

37




The table below shows the recurring revenue components of our significant revenue categories for the periods indicated below:

 

 

% of Total Revenue

 

 

 

Year Ended December 31,

 

 

 

2006

 

2005

 

2004

 

Advisory fee revenue

 

30.0

%

28.4

%

26.0

%

12b-1 fee revenue

 

10.7

%

10.4

%

9.6

%

Asset-based fee revenue

 

8.5

%

7.7

%

7.8

%

Fee revenue

 

5.4

%

5.9

%

5.0

%

Variable and group trail and life insurance renewal revenue

 

5.2

%

4.8

%

4.1

%

Margin interest and other revenue

 

1.7

%

1.6

%

1.6

%

Total recurring revenue

 

61.5

%

58.8

%

54.1

%

 

Scale of Operations

As the size of our financial advisor base continues to expand, we will seek to further consolidate our buying power and lower our IFAs and our costs. With our increasing scale, we have an enhanced ability to economically invest in technology and broaden our value added services more efficiently across our financial advisor base. If successful, we expect to increase our profit margins, as well as those of our IFAs.

General Economic and Market Factors

Our financial results are influenced by the willingness or ability of our IFAs clients to maintain or increase their investment activities in the financial products offered by our IFAs. As a result, general economic and market factors can affect our commission and fee revenue. The performance of our business is correlated with the economy and financial markets, and a slowdown or downturn in the economy or financial markets could adversely affect our business, results of operations, cash flows or financial condition.

Significant Events & Acquisitions

We have made and will continue to consider acquisitions to supplement our organic growth. We intend to strengthen our position in the industry through additional strategic acquisitions and we believe that these acquisitions will enhance our ability to increase the number of IFAs as well as broaden our portfolio of products. Future acquisitions may be funded through the issuance of debt, existing cash, equity securities or a combination thereof.

Subsequent Events

On March 2, 2007, we entered into a definitive agreement with an insurance company to acquire all of the outstanding equity of three of its broker-dealers for approximately $97.10 million. We expect to finance a portion of the purchase price with the issuance of additional debt on our existing credit facility. This transaction is expected to close promptly following receipt of regulatory approvals and satisfaction of customary closing conditions. We anticipate making a 338(h)(10) election for the transaction, which will allow us to treat the stock purchase as an asset purchase for tax purposes.

On February 8, 2007, Moody’s rating service announced that it raised our corporate family rating to ‘B1’ with a positive outlook, from ‘B2’ stable. As a result of the upgrade, we received a step-down of 0.25% in the applicable interest rate margin for the senior secured term loan facility of our senior secured credit facilities, reducing the applicable interest rate margin for Eurodollar rate borrowings under such facility from 2.75% to 2.50%.

38




On January 2, 2007, we acquired all of the outstanding stock of UVEST, which provides independent non-proprietary third-party brokerage services to financial institutions, for approximately $79.60 million in cash and $10.81 million in shares of our common stock. We financed $50.00 million of the purchase price with borrowings under our senior secured term loan facility. We anticipate making a 338(h)(10) election for the transaction, which will allow us to treat the stock purchase as an asset purchase for tax purposes. On January 29, 2007, we made an additional capital contribution of $1.50 million to fund working capital.

Significant Events in 2005

On December 28, 2005, LPL Holdings, Inc. (“LPLH”) and subsidiaries was acquired through a merger transaction with BD Acquisition Inc., a wholly owned subsidiary of Holdings (previously named BD Investment Holdings, Inc.). LPLIH was formed by investment funds affiliated with TPG Partners IV, L.P. and Hellman & Friedman Capital Partners V, L.P. The acquisition was accomplished through the merger of BD Acquisition, Inc. with and into LPLH with LPLH being the surviving entity (the “Acquisition”). As a result of the Acquisition, LPLH became a wholly owned subsidiary of LPLIH.

The Company refers to the above transactions, the Acquisition and the payment of any costs related to these transactions collectively herein as the “Transaction”.

In connection with the Transaction, we incurred significant additional indebtedness, including $550.0 million aggregated principal amount of notes and $795.00 million of borrowing under our senior secured credit facility. As a result of this additional indebtedness, we incurred significant amounts of ongoing interest costs. As a result of the Transaction, we also recorded significant amounts of intangible assets and additional basis in fixed assets (see Note 3 to the consolidated financial statements), which result in ongoing amortization and depreciation expenses. These ongoing expenses along with the significant debt issuance, legal, accounting, and stock option costs are not directly comparable to similar costs incurred prior to the Transaction.

On October 27, 2005, we sold all of our interests in GPA. The results of GPA’s operations have been consolidated with ours since January 1, 2005 according to accounting rules for variable interest entities. Due to the unusual and infrequent nature of this transaction, the operating results and financial position of GPA have been presented as “Discontinued Operations” in our consolidated financial statements.

During the fourth quarter of 2005, we determined that the goodwill related to Innovex was impaired. Such determination was based on its continued losses, and lower than anticipated revenue growth. Accordingly, we recorded a charge of $3.16 million to reduce the carrying value of its existing goodwill to our estimated fair value of zero.

On August 2, 2005, we sold transportation assets, repaid a related bank loan, and ceased certain activities conducted by our wholly owned subsidiary, Glenoak, LLC.

Significant Events in 2004

In June 2004, we completed the acquisition of a Innovex, a mortgage company which provides comprehensive mortgage services for the residential properties of our IFAs’ clients. Innovex enables our IFAs to build relationships by offering their clients mortgage solutions by originating, underwriting and funding a variety of mortgage and home equity loan products to suit the needs of the borrowers. Through Innovex, we provide mortgage brokerage and lending services in 46 states. Innovex either originates residential mortgage loans internally through a warehouse line of credit facility or externally as a broker for other banks. We have an agreement with certain third party financial institutions to purchase loans originated internally as long as they meet certain criteria, generally within 30 days from funding.

39




In June 2004, the Company completed an acquisition of a broker-dealer, a brokerage general agency, as well as certain assets and rights of another broker-dealer. These acquisitions provide Linsco with strategic service and recruiting relationships to IFAs of those entities, as well as access to an affiliated brokerage general agency for insurance products. As a result of this acquisition, approximately 300 IFAs transferred to Linsco. We now operate the brokerage general agency under the name Linsco/Private Ledger Insurance Associates, Inc. The acquired broker-dealer was subsequently dissolved.

Critical Accounting Policies

Our discussion and analysis of our operating results as presented in the above tables are based on our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. Note 2 to our consolidated financial statements for the year ended December 31, 2006 contains a summary of our critical accounting policies, many of which make use of estimates and assumptions. We believe that of our critical accounting policies, the following are noteworthy because they are based on estimates and assumptions that require complex, subjective judgments that can materially impact reported results. Changes in these estimates or assumptions could materially impact our financial condition and results of operation.

Commission Revenues and Expenses

We record commissions received from mutual funds, annuity, insurance, equity, fixed income, direct investment, option and commodity transactions on a trade-date basis. Commissions also include mutual fund and variable annuity trails, which are recognized as earned. Due to the significant volume of mutual fund and variable annuity purchases and sales transacted by IFAs directly with product manufacturers, management must estimate a portion of its upfront commission and trail revenues for each accounting period for which the proceeds have not yet been received. These estimates are based primarily on the volume of transactions in previous periods as well as cash receipts in the current period. Because we record commissions payable based upon standard payout ratios for each product as it accrues for commission revenue, any adjustment between actual and estimated commission revenue will be offset in part by the corresponding adjustment to commission expense.

Legal Reserves

We record reserves for legal proceedings in accounts payable and accrued liabilities in our consolidated statements of financial condition. The determination of these reserve amounts requires significant judgment on the part of management. Management considers many factors including, but not limited to, the amount of the claim, the amount of the loss in the client’s account, the basis and validity of the claim, the possibility of wrongdoing on the part of an IFA, likely insurance coverage, previous results in similar cases, and legal precedents and case law. Each legal proceeding is reviewed with counsel in each accounting period and the reserve is adjusted as deemed appropriate by management. Any change in the reserve amount is recorded as professional services in our consolidated statements of income .

Valuation of Goodwill and Other Intangibles

Goodwill represents the cost of acquired companies in excess of the fair value of net tangible assets at acquisition date. In accordance with Statements of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets , goodwill is not amortized, but tested annually for impairment, or more frequently if certain events having a material impact on our value occur.

Intangible assets, which consist of relationships with IFAs, are amortized over their estimated useful lives. We evaluate the remaining useful lives of other intangible assets each reporting period to determine whether events and circumstances warrant a revision to the remaining period of amortization. Intangible

40




assets are tested for potential impairment whenever events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable in accordance with SFAS No. 144, Accounting for the Impairment of Disposal of Long-Lived Assets. An impairment loss, calculated as the difference between the estimated fair value and the carrying value of an asset or asset group, is recognized if the estimated fair value is less than the corresponding carrying value.

Income Taxes

In preparing the financial statements, we estimate the income tax expense based on the various jurisdictions where we conduct business. We must then assess the likelihood that the deferred tax assets will be realized. A valuation allowance is established to the extent that it is more likely than not that such deferred tax assets will not be realized. When we establish a valuation allowance or modify the existing allowance in a certain reporting period, we generally record a corresponding increase or decrease to tax expense in the statements of income. Management makes significant judgments in determining the provision for income taxes, the deferred tax assets and liabilities and any valuation allowances recorded against the deferred tax asset. Changes in the estimate of these taxes occur periodically due to changes in the tax rates, changes in the business operations, implementation of tax planning strategies, resolution with taxing authorities of issues where we have previously taken certain tax positions and newly enacted statutory, judicial and regulatory guidance. These changes, when they occur, affect accrued taxes and can be material to our operating results for any particular reporting period.

We evaluate all available evidence about asserted and unsettled income tax contingencies and unasserted income tax contingencies caused by uncertain income tax positions taken in our income tax returns filed with the Internal Revenue Service and state and local tax authorities. Contingencies we believe are estimable and probable of payment, if successfully challenged by such tax authorities, are accrued for under the provisions of SFAS No. 5, Accounting for Contingencies. Refer to “Recent Accounting Pronouncements” for our discussion of accounting for uncertainty of income taxes.

Valuation and Accounting for Financial Derivatives

We periodically use financial derivative instruments, such as interest rate swaps, to protect us against changing market prices or interest rates and the related impact to our assets, liabilities, or cash flows. We also evaluate our contracts and commitments for terms that qualify as embedded derivatives. All derivatives are reported at their corresponding fair value in our consolidated statements of financial condition.

Financial derivative instruments expected to be highly effective hedges against changes in cash flows are designated as such upon entering into the agreement. At each reporting date, we reassess the effectiveness of the hedge to determine whether or not it can continue to use hedge accounting. Under hedge accounting, we record the increase or decrease in fair value of the derivative, net of tax impact, as other comprehensive income or losses. If the hedge is not determined to be a perfect hedge, yet still considered highly effective, we will calculate the ineffective portion and record the related change in its fair value as additional interest income or expense in the consolidated statements of income. Amounts accumulated in other comprehensive income are generally reclassified into earnings in the same period or periods during which the hedged forecasted transaction affects earnings.

Share-Based Compensation

On January 1, 2006, we adopted SFAS 123R (Revised), Share Based Payments , (“SFAS 123R”). SFAS 123R requires the recognition of the fair value of share-based compensation in net income. We recognize share-based compensation expense over the requisite service period of the individual grants, which generally equals the vesting period. Prior to January 1, 2006, we accounted for employee equity awards

41




using Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees , (“APB 25”) and related interpretations in accounting for share-based compensation. We adopted the provisions of SFAS 123R using the prospective transition method, whereby we will continue to account for nonvested equity awards to employees outstanding at December 31, 2005 using APB 25, and apply SFAS 123R to all awards granted or modified after that date.

The risk-free interest rates are based on the implied yield available on U.S. Treasury constant maturities in effect at the time of the grant with remaining terms equivalent to the respective expected terms of the options. We elected to use the shortcut approach in accordance with SEC Staff Accounting Bulletin No. 107, Share-Based Payment , to develop the estimate of the expected term. Expected volatility is calculated based on companies of similar growth and maturity and our peer group in the industry in which we do business because we do not have sufficient historical volatility data. We will continue to use peer group volatility information until our historical volatility is relevant to measure expected volatility for future option grants. The dividend yield of zero is based on the fact that we have no present intention to pay cash dividends. In the future, as we gain historical data for volatility in our stock and the actual term over which employees hold its options, expected volatility and the expected term may change, which could substantially change the grant-date fair value of future awards of stock options and, ultimately, compensation recorded on future grants.

We assumed an annualized forfeiture rate of 0.27% for our options based on a combined review of industry and employee turnover data, as well as an analytical review performed of historical pre-vesting forfeitures occurring over the previous year. Under the true-up provisions of SFAS 123R, we will record additional expense if the actual forfeiture rate is lower than estimated, and will record a recovery of prior expense if the actual forfeiture is higher than estimated.

The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no restrictions and are fully transferable and negotiable in a free trading market. This model does not consider the employment, transfer or vesting restrictions that are inherent in our employee stock options. It also includes highly subjective assumptions based on long-term predictions and the average life of each unit and stock option grant. Because our share-based payments have characteristics significantly different than those of freely traded options, and because changes in the subjective input assumptions can materially affect the output produced by the model, it and or other existing valuation models may not be reliable single measures of the fair values of our share-based payments.

42




Operating Results for The Year Ended December 31, 2006 Compared With The Year Ended December 31, 2005

 

 

Year Ended December 31,

 

 

 

 

 

 

 

2006

 

2005

 

$ Change

 

% Change

 

 

 

(in thousands)

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

Commissions

 

$

890,489

 

$

744,939

 

$

145,550

 

 

19.5

%

 

Advisory fees

 

521,058

 

399,363

 

121,695

 

 

30.5

%

 

Asset-based fees

 

147,364

 

107,726

 

39,638

 

 

36.8

%

 

Transaction and other fees

 

140,895

 

125,844

 

15,051

 

 

12.0

%

 

Other

 

40,130

 

29,424

 

10,706

 

 

36.4

%

 

Total revenues

 

1,739,936

 

1,407,296

 

332,640

 

 

23.6

%

 

Expenses

 

 

 

 

 

 

 

 

 

 

 

Production

 

1,231,105

 

999,301

 

231,804

 

 

23.2

%

 

Compensation and benefits

 

137,401

 

142,372

 

(4,971

)

 

(3.5)

%

 

General and administrative

 

120,891

 

116,943

 

3,948

 

 

3.4

%

 

Depreciation and amortization

 

65,348

 

17,854

 

47,494

 

 

266.0

%

 

Other

 

4,921

 

12,712

 

(7,791

)

 

(61.3)

%

 

Total non-interest expenses

 

1,559,666

 

1,289,182

 

270,484

 

 

21.0

%

 

Interest expense from operations

 

301

 

976

 

(675

)

 

(69.2)

%

 

Interest expense from senior credit facilities and subordinated notes

 

125,103

 

1,388

 

123,715

 

 

8913.2

%

 

Total expenses

 

1,685,070

 

1,291,546

 

393,524

 

 

30.5

%

 

Income from continuing operations before income taxes

 

54,866

 

115,750

 

(60,884

)

 

(52.6)

%

 

Provision for income taxes

 

21,224

 

46,461

 

(25,237

)

 

(54.3)

%

 

Income from continuing operations

 

33,642

 

69,289

 

(35,647

)

 

(51.4)

%

 

Loss from discontinued operations

 

 

(26,200

)

26,200

 

 

n/a

 

 

Net income

 

$

33,642

 

$

43,089

 

$

(9,447

)

 

(21.9)

%

 

 

Our income from continuing operations before income taxes for the year ended December 31, 2006 was $54.87 million, down 52.6% from $115.75 million for the year ended December 31, 2005. The decrease was primarily due to $123.72 million of additional interest expense from senior secured credit facilities and $47.37 million of additional depreciation and amortization expense primarily attributable to the Transaction. Excluding the additional interest expense and additional depreciation and amortization expense resulting from the Transaction (as discussed in the previous sentence), our pre-tax income increased $110.20 million, or 93.7%, to $227.86 million for the year ended December 31, 2006, compared with $117.66 million for the year ended December 31, 2005. These earnings were primarily driven by strong revenue growth. We achieved total revenue growth of $332.64 million or 23.6% for the year ended December 31, 2006 compared to the corresponding period in the prior year. The increase in revenue was mainly driven by continued growth among mature IFAs (an advisor who has been with LPL at least three years), growth among recently recruited IFAs, and an 8.1% net increase in the number of overall IFAs. The operating results for the year ended December 31, 2005 also include the discontinued operations of our variable interest entities, GPA Group, Inc. and Global Portfolio Advisors, Ltd. (collectively referred to as “GPA”). We sold our investment in GPA on October 27, 2005 (See Notes 6 and 12).

43




The following table sets forth certain amounts included in our consolidated statements of income for the periods indicated.

 

 

Year Ended December 31,

 

 

 

  2006  

 

  % of Total  

 

  2005  

 

  % of Total  

 

Commision revenue by product category (in millions)

 

 

 

 

 

Annuities

 

$

383.99

 

 

43.1

%

 

$

299.81

 

 

40.2

%

 

Mutual funds

 

309.18

 

 

34.7

%

 

265.97

 

 

35.7

%

 

Equities

 

61.01

 

 

6.9

%

 

57.69

 

 

7.8

%

 

Alternative investments

 

59.22

 

 

6.7

%

 

54.66

 

 

7.3

%

 

Insurance

 

47.30

 

 

5.3

%

 

38.18

 

 

5.1

%

 

Fixed income

 

28.66

 

 

3.2

%

 

25.82

 

 

3.5

%

 

Other

 

1.13

 

 

0.1

%

 

2.81

 

 

0.4

%

 

Total commission revenue

 

$

890.49

 

 

100.0

%

 

$

744.94

 

 

100.0

%

 

 

Revenue

Summary .   In addition to the explanations provided below, in each case, the increase in revenue was mainly driven by continued sales growth reflecting a 15% increase in mature IFAs production as well as the addition of new IFAs. Our overall IFA base increased from 6,481 to 7,006, or 8.1%, from December 31, 2005 to December 31, 2006, respectively.

·        Commission revenue .   Commission-based revenues represent the gross commissions generated by our IFAs, primarily from commissions earned on the sale of various products such as fixed and variable annuities, mutual funds, general securities, alternative investments and insurance. We also earn trailing commission type revenues (such as 12(b)-1 fees) on mutual funds and variable annuities held by clients of our IFAs. Trail commissions are recurring in nature and are earned based on the current market value of previously purchased investments.

Commission revenue increased $145.55 million, or 19.5%, to $890.49 million for the year ended December 31, 2006 compared to $744.94 million for the year ended December 31, 2005, led primarily by increases in commissions on the sale of annuities and mutual funds. Commission revenues from the sale of annuities and mutual funds grew $127.39 million or 22.5% during the year ended December 31, 2006.

·        Advisory fees .   Advisory fee revenues represent fees charged by us and our IFAs, to clients based on the value of assets under management.

Advisory fees increased $121.70 million, or 30.5%, to $521.06 million for the year ended December 31, 2006, compared with $399.36 million for the year ended December 31, 2005. This increase was primarily due to a 15% increase in mature IFAs and a trend among our IFAs to provide a higher percentage of fee-based advisory services to their clients. Consequently, this trend is driving an increase in recurring revenues as a percentage of total revenue. Advisory revenue as a percentage of commission and advisory revenue was 36.9% for the year ended December 31, 2006 as compared to 34.9% for the year ended December 31, 2005.

·        Asset-based and other product fees .   Asset-based and other product fees are comprised of the following:

Fees from cash sweep vehicles.    Pursuant to contractual arrangements, uninvested cash balances in client accounts are swept into either third-party money market funds or deposit accounts at various banks, for which we receive fees, including administrative and record keeping fees based on account type and the invested balances.

44




Sponsorship fees.    We receive fees from certain product manufacturers in connection with programs that support our marketing and sales-force education and training efforts.

Sub-transfer agency fees.    We earn fees on mutual fund assets for which we provide administrative and recordkeeping services as a sub-transfer agent.

Networking fees.    Our networking fees represent fees paid to us by mutual fund and annuity product manufacturers in exchange for administrative and recordkeeping services that we provide to clients of our IFAs. Networking fees are correlated to the number of positions we administer, not the value of assets under administration.

Asset-based and other product fees increased $39.64 million, or 36.8%, to $147.36 million for the year ended December 31, 2006, compared with $107.73 million for the year ended December 31, 2005. The increase was led by a $21.73 million, or 50.4%, increase in fees from our cash sweep vehicles primarily attributable to increased customer balances.

·        Transaction and other fees .   Revenues earned from transaction and other fees primarily consist of the following categories:

Transaction fees and ticket charges.    We charge fees for executing transactions in fee-based advisory client accounts. We also charge ticket charges to our IFAs for executing brokerage transactions.

Subscription fees.    We earn subscription fees for the software and technology services that we provide to our IFAs.

IRA custodian fees.    We earn fees for the IRA custodial services we provide on client accounts.

Financial advisor contract and license fees.    We earn monthly administrative fees from all IFAs licensed with us. We also charge IFAs regulatory licensing fees.

Conference fees.    We charge product manufacturers fees for participating in our training and marketing conferences for our IFAs.

Small/inactive account fees.    We charge fees for services related to client accounts that fail to meet certain specified thresholds of size or activity.

Transaction and other fees increased $15.05 million, or 12.0%, to $140.90 million for the year ended December 31, 2006, compared with $125.84 million for the year ended December 31, 2005. The increase is attributed primarily to the 8.1% growth in our advisory base and an increase in trade volume. Specifically, our total trade volume increased by 1.3 million, or 25.0%, to 6.5 million for the year ended December 31, 2006 compared to 5.2 million for the year ended December 31, 2005 primarily attributable to an increase in the number of customer accounts.

·        Other revenue.   Other revenue includes marketing re-allowances from certain product manufacturers as well as interest income from client margin accounts and cash equivalents.

O ther revenue increased $10.71 million, or 36.4%, to $40.13 million for the year ended December 31, 2006, compared with $29.42 million for the year ended December 31, 2005. This increase was primarily attributed to a $10.68 million increase in interest revenue on our margin accounts and overnight investments, driven by higher interest rates (average effective rates of 5.02% in 2006 vs. 3.11% in 2005) and margin account balances which increased by approximately 25%.

45




Expenses

·        Production expenses .   Production expenses consist of commissions and advisory fees as well as brokerage, clearing, and exchange fees. We pay out the majority of commissions and advisory fees received from sales or services provided by our IFAs. Substantially all of these pay-outs are variable and are correlated to the revenues generated by each financial advisor.

Production expenses increased $231.80 million, or 23.2%, to $1,231.11 million during the year ended December 31, 2006, compared with $999.30 million for the year ended December 31, 2005. This increase was consistent with the 23.4% increase in total commission and advisory fee revenues.

·        Compensation and benefits .   Compensation and benefits represent compensation-related expenses, including stock-based compensation for our employees, including temporary employees and consultants.

Compensation and benefits decreased $4.97 million, or 3.5%, to $137.40 million for the year ended December 31, 2006, from $142.37 million for the year ended December 31, 2005. The decrease is primarily attributed to a $21.68 million or 88.3% decline in share-based compensation expense (see Note 18 to our consolidated financial statements) primarily resulting from the Transaction. This decrease is partially offset by a $10.53 million or 13.0% increase in payroll, a $3.51 million increase in discretionary bonus and a $2.13 increase in outside personnel. The average number of full-time employees increased by 187, or 17.3%, to 1,269 for the year ended December 31, 2006, compared to 1,082 for the year ended December 31, 2005.

·        General and administrative expenses .   General and administrative expenses include promotional fees, occupancy and equipment, communications and data processing, regulatory fees, and professional services.

General and administrative expenses increased $3.95 million, or 3.4%, to $120.89 million for the year ended December 31, 2006, from $116.94 million for the year ended December 31, 2005. This increase is attributable to increases in equipment, occupancy, promotional and communications that are primarily attributable with our firm’s growth which were offset by approximately $13.86 million of professional fees incurred in the prior year in connection with the Transaction.

·        Depreciation and amortization .   Depreciation expense is related to our capital assets such as office equipment and technology. Amortization expense is primarily related to the amortization of other intangible assets and internally developed software.

Depreciation and amortization expense increased $47.49 million, or 266.0%, to $65.35 million for the year ended December 31, 2006, compared with $17.85 million for the year ended December 31, 2005. This increase was driven by $47.37 million of additional amortization recognized on intangible assets and internally developed software recorded in conjunction with the Transaction.

·        Other expenses .   Other expenses include reimbursement expenses, bank fees and other miscellaneous expenses.

Other expenses decreased $7.79 million, or 61.3%, to $4.92 million for the year ended December 31, 2006, from $12.71 million for the year ended December 31, 2005. Remediation efforts for Class B and Class C mutual fund share transactions (see Note 17 to our consolidated financial statements) resulted in a $2.97 million reduction of costs that had previously been estimated and accrued for. If we were to exclude the reversal of the accrual associated with the remediation efforts, other general expenses would have decreased $4.82 million, or 37.9% primarily reflecting a $3.16 million goodwill impairment charge related to Innovex in the prior year.

46




·        Interest expenses .   Interest expense includes operating interest expense related to brokerage operations and mortgage lending, and non-operating interest expense for debt coverage related to the Transaction.

Interest expense increased $123.04 million to $125.40 million for the year ended December 31, 2006, compared with $2.36 million for the year ended December 31, 2005. The increase was primarily due to an additional $123.72 million of non-operating interest expense from senior credit facilities and subordinated notes related to the Transaction.

·        Provision for Income Taxes .   Provision for income taxes decreased $25.24 million, or 54.3% to $21.22 million for the year ended December 31, 2006, compared with $46.46 million for the year ended December 31, 2005. The decrease in income tax expense was primarily related to the decrease in pre-tax income from continuing operations over comparable periods. Our effective tax rate for 2006 was 38.7% as compared to 40.1% for 2005. The increased tax rate for 2005 was primarily related to non-deductible Transaction costs.

Operating Results for The Year Ended December 31, 2005 Compared With The Year Ended December 31, 2004

 

 

Year Ended December 31,

 

 

 

 

 

 

 

2005

 

2004

 

$ Change

 

% Change

 

 

 

(in thousands)

 

 

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

Commissions

 

$

744,939

 

$

640,128

 

$

104,811

 

 

16.4

%

 

Advisory fees

 

399,363

 

301,090

 

98,273

 

 

32.6

%

 

Asset-based fees

 

107,726

 

89,561

 

18,165

 

 

20.3

%

 

Transaction and other fees

 

125,844

 

104,168

 

21,676

 

 

20.8

%

 

Other

 

29,424

 

22,438

 

6,986

 

 

31.1

%

 

Total revenues

 

1,407,296

 

1,157,385

 

249,911

 

 

21.6

%

 

Expenses

 

 

 

 

 

 

 

 

 

 

 

Production

 

999,301

 

821,688

 

177,613

 

 

21.6

%

 

Compensation and benefits

 

142,372

 

127,997

 

14,375

 

 

11.2

%

 

General and administrative

 

116,943

 

92,725

 

24,218

 

 

26.1

%

 

Depreciation and amortization

 

17,854

 

15,798

 

2,056

 

 

13.0

%

 

Other

 

12,712

 

29,826

 

(17,114

)

 

(57.4

)%

 

Total non-interest expenses

 

1,289,182

 

1,088,034

 

201,148

 

 

18.5

%

 

Interest expense from operations

 

976

 

1,447

 

(471

)

 

(32.6

)%

 

Interest expense from senior credit facilities and subordinated notes

 

1,388

 

 

1,388

 

 

n/a

 

 

Total expenses

 

1,291,546

 

1,089,481

 

202,065

 

 

18.5

%

 

Income from continuing operations before income taxes

 

115,750

 

67,904

 

47,846

 

 

70.5

%

 

Provision for income taxes

 

46,461

 

32,552

 

13,909

 

 

42.7

%

 

Income from continuing operations

 

69,289

 

35,352

 

33,937

 

 

96.0

%

 

Loss from discontinued operations

 

(26,200

)

 

(26,200

)

 

n/a

 

 

Net income

 

$

43,089

 

$

35,352

 

$

7,737

 

 

21.9

%

 

 

Our income from continuing operations was $69.29 million in 2005, up 96.0% from $35.35 million in 2004. We achieved revenue growth of 21.6% for the year ended December 31, 2005. The increase in revenue was mainly driven by continued sales growth from mature IFAs, growth among recently

47




recruited IFAs who are returning to their prior levels of production, and a 10.9% net increase in the number of IFAs.

The following table sets forth certain amounts included in our consolidated statements of income for the periods indicated.

 

 

Year Ended December 31,

 

Commision revenue by product category (in millions)

 

 

 

2005

 

% of Total

 

2004

 

% of Total

 

Annuities

 

$

299.81

 

 

40.2

%

 

$

248.00

 

 

38.7

%

 

Mutual funds

 

265.97

 

 

35.7

%

 

230.00

 

 

35.9

%

 

Equities

 

57.69

 

 

7.8

%

 

55.90

 

 

8.7

%

 

Alternative investments

 

54.66

 

 

7.3

%

 

44.80

 

 

7.0

%

 

Insurance

 

38.18

 

 

5.1

%

 

35.00

 

 

5.5

%

 

Fixed income

 

25.82

 

 

3.5

%

 

23.40

 

 

3.7

%

 

Other

 

2.81

 

 

0.4

%

 

3.03

 

 

0.5

%

 

Total commission revenue

 

$

744.94

 

 

100.0

%

 

$

640.13

 

 

100.0

%

 

 

Revenue

Summary.    In addition to the explanations provided below, in each case, the increase in revenue was mainly driven by continued growth from mature IFAs, growth among recently recruited IFAs who are returning to their prior levels of production, and the addition of new IFAs. Specifically, our IFAs grew 10.9% to 6,481 as of December 31, 2005 from 5,843 as of December 31, 2004.

·        Commission revenue .   Commission revenue increased $104.81 million, or 16.4%, to $744.94 million for the year ended December 31, 2005 compared to $640.13 million for the year ended December 31, 2004, led primarily by increases in commissions derived from the sale of annuities and mutual funds. In 2005, annuity commissions grew 20.9% while mutual fund commissions grew 15.7%.

·        Advisory fees .   Advisory fees increased $98.27 million, or 32.6%, to $399.36 million for the year ended December 31, 2005, compared with $301.09 million for the year ended December 31, 2004. This increase was primarily due to the trend among our IFAs towards providing fee-based advisory services to their clients. Advisory revenue as a percentage of commission and advisory revenue was 34.9% for the year ended December 31, 2005 as compared to 32.0% for the same period in 2004.

·        Asset-based and other product fees .   Asset-based and other product fees increased $18.17 million, or 20.3%, to $107.73 million for the year ended December 31, 2005, compared with $89.56 million for the year ended December 31, 2004. This increase was primarily due to a higher percentage of assets held in money market funds, sponsorship program fees, sub-transfer agency fees, and networking fees.

·        Transaction and other fees .   Transaction and other fees increased $21.68 million, or 20.8%, to $125.84 million for the year ended December 31, 2005, compared with $104.17 million for the year ended December 31, 2004. This increase was primarily due to increases in transaction revenue, IRA custodian fees, and technology fees collected from IFAs and conference services revenue.

·        Other revenue.   Other revenue increased $6.99 million, or 31.1%, to $29.42 million for the year ended December 31, 2005, compared with $22.44 million for the year ended December 31, 2004. This increase was primarily due to a $4.89 million increase in interest revenue.

48




Expenses

·        Production expenses .   Production expenses increased $177.61 million, or 21.6%, to $999.30 million for the year ended December 31, 2005, compared with $821.69 million for the year ended December 31, 2004. This increase was consistent with the growth of our commission and advisory fee revenue.

·        Compensation and benefits .   Compensation and benefits increased $14.38 million, or 11.2%, to $142.37 million for the year ended December 31, 2005, compared with $128.00 million for the year ended December 31, 2004. Primary reasons for this increase include a $5.91 million increase in stock compensation expense incurred in connection with the Transaction, in addition to employee growth, merit-based pay increases, higher health care costs, and increased spending on outside services. The average number of full-time employees increased by 18.4% for the year ended December 31, 2005.

·        General and administrative expenses .   General and administrative expenses increased $24.22 million, or 26.1%, to $116.94 million for the year ended December 31, 2005, compared with $92.73 million for the year ended December 31, 2004. This increase was mainly due to increases in professional fees and to a lesser extent promotional expenses ($13.86 million of which related to the Transaction). All other expenses such as occupancy, equipment, communications, and other increased at a rate consistent with our growth.

·        Depreciation and amortization .   Depreciation and amortization expense increased $2.06 million, or 13.0%, to $17.85 million for the year ended December 31, 2005, compared with $15.80 million for the year ended December 31, 2004. This increase was primarily driven by $1.50 million of amortization expense in 2005 mainly related to the June 2004 acquisitions of three broker-dealers.

·        Other expenses .   Other expenses decreased $17.11 million, or 57.4%, to $12.71 million for the year ended December 31, 2005, from $29.83 million for the year ended December 31, 2004. Primary reasons for this decrease include an $11.00 million decrease in regulatory fines and related expenses, a $3.16 million goodwill impairment charge related to Innovex and $1.61 million of other expenses from the Transaction offset by a $12.23 million write-down in 2004 for our non-marketable investment in GPA, which did not recur in 2005 because of our change in accounting (see Note 6 in the notes to consolidated financial statements).

·        Interest expenses .   Interest expense increased $.91 million, or 63.4%, to $2.36 million for the year ended December 31, 2005 from $1.45 million for the year ended December 31, 2004, primarily due to $1.39 million of non-operating interest expense from senior credit facilities and subordinated notes related to the Transaction.

·        Provision for Income Taxes .   Provision for income taxes increased $13.91 million, or 42.7% to $46.46 million for the year ended December 31, 2005, compared with $32.55 million for the year ended December 31, 2004. The increase in income tax expense was primarily related to the increase in pre-tax income from continuing operations over comparable periods. Our effective tax rate for 2005 was 40.1% as compared to 47.9% for 2004. The increased tax rate for 2004 was primarily related to an increase in the valuation allowance against a deferred tax asset resulting from an investment in GPA.

Segment Information

Our Independent Financial Advisors segment, which represents approximately 99.1% of consolidated revenues in 2006 and approximately 98.9% of consolidated revenues in both 2005 and 2004, provides a full range of brokerage, investment advisory and infrastructure services to IFAs and financial institutions in the United States. Our other four segments provide an investment advisory platform, trust and related

49




custodial services, mortgage brokerage and underwriting services, and fixed insurance services, respectively, almost entirely to clients of Linsco’s IFAs. These other four entities do not, individually or in the aggregate, meet the segment reporting requirements under SFAS 131 “Disclosures about Segments of an Enterprise and Related Information”, and consequently have been aggregated as “Other” for reporting purposes. Certain corporate assets and expenses at our holding company have not been allocated to our operating segments as they are not used by our chief operating decision maker in assessing segment performance or in deciding how to allocate resources.

2006 vs. 2005

Revenues at our Independent Financial Advisors segment increased $331.98 million, or 23.9%, to $1,723.85 million for the year ended December 31, 2006 from $1,391.87 million for the year ended December 31, 2005 driven mainly by continued growth among our mature IFAs, growth among our recently recruited IFAs, and an 8.1% net increase in the overall number of IFAs. Revenues for our other segment increased by $2.87 million, or 14.1%, to $23.19 million for the year ended December 31, 2006 from $20.32 million for the year ended December 31, 2005, due primarily to an increase in commissions generated from life insurance applications offset by a decline in the volume of loans processed due primarily to rising interest ratings.

Income from continuing operations before income taxes in our Independent Financial Advisors segment increased by $85.77 million, or 59.8%, to $229.27 million for the year ended December 31, 2006 from $143.50 million for the year ended December 31, 2005, attributed mainly to the revenue growth discussed above. Our other segments increased by $3.49 million, or 177.2%, to $1.52 million for the year ended December 31, 2006 from ($1.97) million for the year ended December 31, 2005, due primarily to a goodwill impairment charge of $3.16 million recorded in 2005. Additionally, other corporate expenses, which were not allocated to either of our operating segments but impact consolidated income from continuing operations before income taxes, decreased $150.13 million over the same period. The decrease is due primarily to interest from our debt, as well as depreciation and amortization of finite lived intangibles, both resulting from the Transaction.

2005 vs. 2004

Revenues at our Independent Financial Advisors segment increased by $247.45 million, or 21.6% to $1,391.87 million for the year ended December 31, 2005 from $1,144.42 million for the year ended December 31, 2004, driven mainly by continued growth among our mature IFAs, sales growth among our recently recruited IFAs, and a 10.9% net increase in the overall number of IFAs. Revenues for our other segment increased by $6.34 million, or 45.3% to $20.32 million for the year ended December 31, 2005 from $13.98 million for the December 31, 2004, primarily related to revenues earned by our mortgage company and general brokerage agency, both which were acquired in June 2004.

Income from continuing operations before income taxes at our Independent Financial Advisors segment increased by $51.10 million, or 55.3% to $143.50 million for the year ended December 31, 2005 from $92.40 million for the year ended December 31, 2004, attributed mainly to growth in our gross margin. Our other segments decreased by $2.09 million, to ($1.97) million for the year ended December 31, 2005 from $.12 million primarily as a result of the non-cash goodwill impairment charge discussed above.

Recent Accounting Pronouncements

Accounting for Fair Value Option of Financial Assets and Liabilities

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option of Financial Assets and Financial Liabilities (“SFAS 159”). This standard permits entities to choose to measure many financial

50




instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact that the adoption of SFAS 159 will have on our consolidated statements of financial condition, statements of income, and cash flows.

Accounting for Fair Value Measurements

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). This standard provides guidance for using fair value to measure assets and liabilities. Under SFAS 157, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. In this standard, the FASB clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, SFAS 157 establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data; for example, the reporting entity’s own data. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy. The provisions of SFAS 157 are effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating the impact that the adoption of SFAS 157 will have on our consolidated statements of financial condition, statements of income, or cash flows.

Accounting for Uncertainty in Income Taxes

In June 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes . FIN 48 requires that the tax effects of a position be recognized only if it is “more-likely-than-not” to be sustained based solely on its technical merits as of the reporting date. The more-likely-than-not threshold represents a positive assertion by management that a company is entitled to the economic benefits of a tax position. If a tax position is not considered more-likely-than-not to be sustained based solely on its technical merits, no benefits of the position are to be recognized. Moreover, the more-likely-than-not threshold must continue to be met in each reporting period to support continued recognition of a benefit. At adoption, companies must adjust their financial statements to reflect only those tax positions that are more-likely-than-not to be sustained as of the adoption date. Any necessary adjustment would be recorded directly to retained earnings in the period of adoption and reported as a change in accounting principle. FIN 48 is effective for fiscal years beginning after December 15, 2006. We have substantially completed our valuation of FIN 48 and have estimated the impact of its adoption on our consolidated financial statements as a reduction to retained earnings of approximately $3.50 million to $4.50 million.

Liquidity and Capital Resources

Summary of Changes in Cash and Cash Equivalents

Net cash provided by operating activities from continuing operations for the year ended December 31, 2006 and December 31, 2005 was $139.26 million and $118.00 million, respectively. The increase is primarily attributed to growth in our gross margin and a $53.34 million tax benefit related to stock options exercised in the prior year resulting from the Transaction. These increases were largely offset by interest costs related to the senior notes issued in conjunction with the Transaction and a change in taxes

51




receivable/payable of approximately $108.45 million which was also associated with tax deductible events related to the Transaction. The remainder of change in cash provided by operating activities is attributed to the net fluctuations in various other operating asset and liability accounts.

Net cash used in investing activities in continuing operations for the year ended December 31, 2006 and December 31, 2005 was $30.41 million and $1.75 million, respectively. The increase is principally due to non-recurring cash proceeds from the sale of fixed assets of $20.31 million received during the year ended December 31, 2005.

Net cash provided by financing activities for the year ended December 31, 2006 was $1.72 million as compared to financing activities used in continuing operations for year ended December 31, 2005 of $86.04 million. The difference is due primarily to $55.09 million of dividends paid to stockholders and $25.05 million for the repayment of bank loans during the year ended December 31, 2005, but not during 2006.

Operating Capital Requirements

Our primary requirement for working capital relates to funds we loan to clients for trading done on margin and funds we are required to maintain at clearing organizations to support clients’ trading activities. We require that clients deposit funds with us in support of their trading activities and we hypothecate securities held as margin collateral, which we in turn use to lend to clients for margin transactions and deposit with our clearing organizations. These activities account for the majority of our working capital requirements, which are primarily funded directly or indirectly by clients. Our other working capital needs are primarily limited to regulatory capital requirements and software development, which we have satisfied in the past from internally generated cash flows.

Notwithstanding the self-funding nature of our operations, we may sometimes be required to fund timing differences arising from the delayed receipt of client funds associated with the settlement of client transactions in securities markets. Historically, these timing differences were funded either with internally generated cash flow or, if needed, with funds drawn under short-term borrowing facilities, including both committed unsecured lines of credit and uncommitted lines of credit secured by client securities. We also may borrow up to $100.00 million for working capital and other general corporate purposes under the revolving credit facility which has been provided under our senior secured credit facilities. Currently, $10.00 million of such facility is being utilized to support the issuance of an irrevocable letter of credit issued for the benefit of PTC. Additionally, Linsco, our broker-dealer subsidiary, continues to utilize uncommitted lines which are secured by client securities to fund margin loans, and our mortgage broker/banking subsidiary, Innovex continues to use a warehouse line of credit to facilitate its mortgage loan origination business.

Linsco, a registered broker-dealer, is subject to the uniform net capital requirements of the Securities and Exchange Commission and the National Association of Securities Dealers, and minimum financial requirements of the Commodity Futures Trading Commission. Linsco computes its net capital requirements under the alternative method provided for by the SEC’s rules, which require that it maintain net capital equal to the greater of $250,000 or 2% of aggregate client related debit items. The net capital rule also provides that equity capital may not be withdrawn or cash dividends paid if resulting net capital would be less than 5% of aggregate customer related debit items. As a matter of policy, we maintain excess regulatory capital to provide liquidity during periods of unusual market volatility or customer activity.

Innovex, a Housing and Urban Development approved Title II nonsupervised mortgagee, is required to have a net worth of at least $250,000 and must maintain liquid assets of 20% of its net worth, up to a maximum amount of $100,000.

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PTCH is subject to various regulatory capital requirements. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our consolidated financial statements.

Funding for purposes other than working capital requirements, including capital expenditures and acquisitions, has historically been provided for from internally generated cash flow. Future funding for these needs may also come from our new revolving credit facility.

Liquidity Assessment

We believe that, based on current levels of operations and anticipated growth, cash flow from operations, together with other available sources of funds, including revolving credit borrowings under our senior secured credit facilities will be adequate to satisfy our working capital needs, the payment of all of our obligations, and the funding of anticipated capital expenditures, for the foreseeable future. Our conclusion is based on recent levels of net cash flow from our operations of approximately $139.26 million and the significant additional borrowing capacity that exists under our revolving credit facility.

Our ability to meet our debt service obligations and reduce our total debt will depend upon our future performance which, in turn, will be subject to general economic, financial, business, competitive, legislative, regulatory and other conditions, many of which are beyond our control. In addition, our operating results, cash flow and capital resources may not be sufficient for repayment of our indebtedness in the future. Some risks that could materially adversely affect our ability to meet our debt service obligations include, but are not limited to, general economic conditions and economic activity in the financial markets. The performance of our business is correlated with the economy and financial markets, and a slowdown or downturn in the economy or financial markets could adversely affect our business, results of operations, cash flows or financial condition.

If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay investments, seek additional capital or restructure or refinance our indebtedness, including the senior unsecured subordinated notes as discussed below. These measures may not be successful and may not permit us to meet our scheduled debt service obligations. In the absence of sufficient cash flows and capital resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. However, our new senior secured credit facilities and the indenture governing the notes offered hereby will restrict our ability to dispose of assets and the use of proceeds from any such dispositions. We may not be able to consummate those dispositions or to obtain the proceeds that we could realize from them and, in any event, the proceeds may not be adequate to meet any debt service obligations then due.

Indebtedness

As of December 31, 2006, we had outstanding $794.38 million of borrowings under our senior secured credit facilities and $550.00 million of senior unsecured subordinated notes. The senior secured credit facilities also include a $100.00 million revolving credit facility, of which $90.00 million was available as of December 31, 2006, for future borrowings. We also maintain uncommitted lines of credit, which have an unspecified limit, primarily dependent on our ability to provide sufficient collateral. The lines were utilized during the year, however there were no balances outstanding as of December 31 2006. Additionally, in an effort to mitigate interest rate risk, we entered into an interest rate swap agreement to hedge the variability on $495.00 million of our floating rate senior secured credit facilities.

Senior Secured Credit Facilities

The senior secured credit facilities provide senior secured financing of $794.38 million, consisting of a $100.00 million revolving credit facility for working capital, investment and general corporate needs. This

53




facility expires on December 28, 2011. Of the $100.00 million, $10.00 million is currently being utilized to support the issuance of an irrevocable letter of credit issued for the benefit of PTC.

Interest Rate and Fees

Borrowings under the senior secured credit facilities will bear interest at a rate equal to, at our option, either (a) LIBOR for deposits in the dollars plus an applicable margin or (b) the higher of (1) the prime rate of The Bank of New York and (2) the federal funds effective rate plus 0.50%, plus an applicable margin. The applicable margin for borrowings is currently, (x) under the revolving credit facility, 1.00% with respect to base rate borrowings and 2.00% with respect to LIBOR borrowings and (y) under the senior secured term loan facility, 1.50% with respect to base rate borrowings and 2.50% with respect to LIBOR borrowings. The applicable margin on the senior secured term loan facility may be changed depending on what our leverage ratio is or how our credit is rated by Moody’s Investors Services, Inc.

In addition to paying interest on outstanding principal under the senior secured credit facilities, we are required to pay a commitment fee to the lenders under the revolving credit facility in respect of the unutilized commitments thereunder. The commitment fee rate is currently 0.375% per annum, but is subject to changes depending on what our leverage ratio is. We must also pay customary letter of credit fees.

Prepayments

The senior secured credit facilities (other than the revolving credit facility) will require us to prepay outstanding senior secured term loans, subject to certain exceptions, with:

·        50% (which percentage will be reduced to 25% if our total leverage ratio is 5.00x or less and to 0% if our total leverage ratio is 4.00x or less) of our annual excess cash flow, adjusted for, among other things, changes in our net working capital;

·        100% of the net cash proceeds of all nonordinary course asset sales or other dispositions of property, if we do not (1) reinvest or commit to reinvest those proceeds in assets to be used in our business or to make certain other permitted investments within 15 months as long as such reinvestment is completed within 180 days; and

·        100% of the net cash proceeds of any incurrence of debt, other than proceeds from debt permitted under the senior secured credit facilities.

The foregoing mandatory prepayments will be applied to scheduled installments of principal of the senior secured term loan facility in direct order.

We may voluntarily repay outstanding loans under the senior secured credit facilities at any time without premium or penalty, other than customary “breakage” costs with respect to LIBOR loans.

Amortization

We are required to repay the loans under the senior secured term loan facility in equal quarterly installments in aggregate annual amounts equal to 1% of the original funded principal amount of such facility, with the balance being payable on the final maturity date of such facility.

Principal amounts outstanding under the revolving credit facilities are due and payable in full at maturity.

Guarantee and Security —The senior secured facilities are secured primarily through pledges of the capital stock in our subsidiaries.

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Certain Covenants and Events of Default

The senior secured credit facilities will contain a number of covenants that, among other things, restrict, subject to certain exceptions, our ability to:

·        incur additional indebtedness;

·        create liens;

·        enter into sale and leaseback transactions;

·        engage in mergers or consolidations;

·        sell or transfer assets;

·        pay dividends and distributions or repurchase our capital stock;

·        make investments, loans or advances;

·        prepay certain subordinated indebtedness;

·        make certain acquisitions;

·        engage in certain transactions with affiliates;

·        make capital expenditures;

·        amend material agreements governing certain subordinated indebtedness; and

·        change our lines of business.

In addition, the senior secured credit facilities will require us to maintain the following financial covenants:

·        a minimum interest coverage ratio; and

·        a maximum total leverage ratio.

Interest Rate Swaps

The senior secured credit facilities will also contain certain customary affirmative covenants and events of default, including a change of control Interest Rate Swaps—On January 30, 2006, we entered into five interest rate swap agreements (“Swaps”). An interest rate swap is a financial derivative instrument whereby two parties enter into a contractual agreement to exchange payments based on underlying interest rates. We use the Swaps to hedge the variability on our floating rate for approximately $495.00 million of our senior secured notes. We are required to pay the counterparty to the agreement fixed interest payments on a notional balance, and in turn, receive variable interest payments on that notional balance. Payments are settled quarterly on a net basis. As of December 31, 2006, we assessed the Swaps as being highly effective and we expect them to continue to be highly effective. While approximately $300.00 million of our senior secured notes remains unhedged as of December 31, 2006, the risk of variability on our floating interest rate is mitigated by our ability to provide margin interest loans to our customers. At December 31, 2006, our receivable from customers for margin loan activity was approximately $311.00 million.

Senior Unsecured Subordinated Notes —The notes are due in 2015, and bear interest at 10.75% per annum. Interest payments are payable semi-annually in arrears. We are not required to make mandatory redemption or sinking fund payments with respect to the notes and at December 31, 2006, the entire $550.00 million was still outstanding. The senior unsecured subordinated notes are subject to certain financial and non-financial covenants. As of December 31, 2006, we were in compliance with all such covenants.

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Contractual Obligations

The following table provides information with respect to our commitments and obligations as of December 31, 2006:

 

 

 

 

 

 

 

 

Payments due by period

 

 

 

Total

 

< 1 year

 

1-3 years

 

4-5 years

 

> 5 years

 

 

 

(in thousands)

 

Mortgage Loan Origination

 

$

12,110

 

$

12,110

 

$

 

$

 

$

 

Mortgage Loan Sales

 

(16,504

)

(16,504

)

 

 

 

Operating Lease Obligations (2)

 

69,222

 

9,852

 

21,911

 

20,383

 

17,076

 

Senior Secured Credit Facilities and Senior Unsecured Notes (1)(3)

 

1,344,375

 

7,944

 

15,888

 

15,888

 

1,304,655

 

Fixed Interest Payments

 

532,125

 

59,125

 

118,250

 

118,250

 

236,500

 

Interest Rate Swap Agreements (3)

 

85,272

 

23,759

 

40,258

 

19,678

 

1,577

 

Total contractual cash obligations

 

$

2,026,600

 

$

96,286

 

$

196,307

 

$

174,199

 

$

1,559,808

 


(1)            Note 14 and 16 of our consolidated financial statements provides further detail on these debt obligations.

(2)            Note 17 of our audited consolidated financial statements provides further detail on operating lease obligations.

(3)            Our senior credit facilities bear interest at floating rates. Of the $794.38 million outstanding at December 31, 2006, we have hedged the variable rate cash flows using interest rate swaps of $495.00 million of principle (see Note 15 of our consolidated financial statements). No payments are shown for the unhedged ($299.38 million) portion of the senior credit facilities as the timing of principal payments and amounts of interest paid will vary (see Note 14 of our consolidated financial statements for more information).

Other Commitments and Contingencies

Guarantees —We occasionally enter into certain types of contracts that contingently require it to indemnify certain parties against third-party claims. These contracts primarily relate to real estate leases under which we may be required to indemnify property owners for claims and other liabilities arising from its use of the applicable premises. The terms of these obligations vary, and because a maximum obligation is not explicitly stated, we have determined that it is not possible to make an estimate of the amount that we could be obligated to pay under such contracts.

Linsco also provides guarantees to securities clearing houses and exchanges under their standard membership agreements, which require a member to guarantee the performance of other members. Under these agreements, if a member becomes unable to satisfy its obligations to the clearing houses and exchanges, all other members would be required to meet any shortfall. Our liability under these arrangements is not quantifiable and may exceed the cash and securities we posted as collateral. However, the potential requirement for us to make payments under these agreements is remote. Accordingly, no liability has been recognized for these transactions.

Litigation —We have been named as a defendant in various legal actions, including arbitrations. In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases in which claimants seek substantial or indeterminate damages, we cannot predict with certainty what the eventual loss or range of loss related to such matters will be. We believe, based on current knowledge, after consultation with counsel, and consideration of insurance, if any, that the outcome of such matters will not have a material adverse effect on our results of operations, cash flows or financial condition.

Regulatory —In May 2005, we entered into an Acceptance Waiver and Consent (“AWC”) with the NASD regarding certain sales of Class B and Class C mutual fund shares. In its investigation, the NASD questioned whether certain sales of Class B and Class C mutual fund shares since January 1, 2002, were

56




appropriate on the basis of cost differences among share classes. The AWC provides for payment to clients impacted by certain transactions and imposition of a monetary penalty. In December 2005, the AWC was counter signed by the NASD and we paid a fine of $2.40 million.

In 2006, we remediated certain transactions occurring since January 1, 2001, based on the criteria outlined in the AWC. Refunds and transaction remediation totaled $2.37 million, all of which had been accrued for in prior years. Unused accruals of $2.97 million were reversed during the year as estimates were adjusted for final payments and for the expiration of the positive consent period required for customers to elect remediation.

Interest Rate and Loan Commitments —Innovex enters into written commitments to originate loans whereby the interest rate on the loan is determined prior to funding; these commitments are referred to as interest rate lock commitments (“IRLCs”). IRLCs on loans are considered to be derivatives and as of December 31, 2006, we had a committed principal of $12.11 million.

IRLCs, as well as closed loans held-for-sale, expose Innovex to interest rate risk. Innovex manages this risk by entering into corresponding forward sales agreements with investors on a best-efforts basis. Innovex determined that such best-effort forward sales commitments meet the definition of a derivative and as of December 31, 2006, we had a committed principal of $16.50 million.

Positive and negative increases to the fair value of IRLC’s and forward sales agreements are recognized in other assets and accrued liabilities, with unrealized gains or losses recorded in other income.

Other Commitments —As of December 31, 2006, we received collateral primarily in connection with customer margin loans with a market value of approximately $404.19 million, which we can sell or repledge. Of this amount, approximately $150.52 million has been pledged or sold as of December 31, 2006; $100.38 million was pledged to a bank in connection with an unutilized secured margin line of credit, $35.26 million was pledged to various clearing organizations, and $14.88 million was loaned to the DTC through participation in our Stock Borrow Program. As of December 31, 2005, we received collateral primarily in connection with customer margin loans with a market value of approximately $309.45 million, which we can sell or repledge. Of this amount, approximately $42.64 million has been pledged or sold as of December 31, 2005; $36.04 million was pledged to various clearing organizations and $6.59 million was loaned to the DTC through participation in our Stock Borrow Program.

On December 15, 2006, Linsco entered into agreements with a large global insurance company pursuant to which we agreed to provide brokerage, clearing, and custody services on a fully disclosed basis; offer our investment advisory programs and platforms; and provide technology and additional processing and related services to its financial advisors and customers. The term of the agreements are five years, subject to additional 24-month extensions. Termination fees may be payable by a terminating or breaching party depending on the specific cause leading to termination. Services are expected to begin August 2007.

Innovex sells its mortgage loans without recourse. It is usually required by the buyers (investors) of these loans to make certain representations concerning credit information, loan documentation and collateral. Innovex has not repurchased any loans during years ended December 31, 2006 or 2005.

As part of its brokerage operations, Linsco periodically enters into when-issued and delayed delivery transactions on behalf of its customers. Settlement of these transactions after December 31, 2006 did not have a material effect on our consolidated statements of financial condition.

Off-balance Sheet Arrangements

At December 31, 2006, we did not have any off-balance sheet arrangements as that term is defined in Item 303 of Regulation S-X of the Securities Act that are likely to have a current or future material effect

57




on our financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.

Market Risk

We bear some market risk on margin transactions affected for our IFAs’ clients. In margin transactions, we extend credit to clients, collateralized by cash and securities in the client’s account. As our IFAs execute margin transactions on behalf of their clients, we may incur losses if clients do not fulfill their obligations, the collateral in the client’s account is insufficient to fully cover losses from such investments, and our IFAs fail to reimburse us for such losses. The risk of default depends on the creditworthiness of the client. To minimize this risk we assess the creditworthiness of the clients and monitor the margin level daily. Clients are required to deposit additional collateral, or reduce positions, when necessary.

We also have market risk on the fees we earn that are based on the market value of assets in certain client accounts and for which ongoing fees or commissions are paid. We do not enter into derivatives or other similar financial instruments for trading or speculative purposes. We do not lend securities that we hold as collateral in margin accounts.

We are exposed to market risk associated with changes in interest rates. As of December 31, 2006, all of the outstanding debt under our senior secured credit facilities, $795.00 million, was subject to floating interest rate risk. To provide some protection against potential rate increases associated with our floating senior secured credit facilities, in January 2006 we entered into derivative instruments in the form of Swaps covering a significant portion ($495.00 million) of our senior secured indebtedness. The Swaps qualify for hedge accounting under SFAS 133 “ Accounting for Derivative Instruments and Hedging Activities .” Accordingly, any interest rate differential is reflected in an adjustment to interest expense over the lives of the Swaps. While the unhedged portion of our senior secured debt is subject to increases in interest rates, we believe that this risk is offset with variable interest rates associated with customer borrowings. At December 31, 2006, we had $300.00 million in unhedged senior secured borrowings, the variable cost of which is offset by variable interest income on $311.00 million of customer borrowings. Because of this relationship, and our expectation for outstanding balances in the future, we do not believe that a short-term change in interest rates would have a material impact on our income before taxes. We do not anticipate any material changes in our primary market risk exposures in 2007. For a discussion of such Swaps, see Note 15 to our consolidated financial statements.

Operational risk generally refers to the risk of loss resulting from our operations, including, but not limited to, improper or unauthorized execution and processing of transactions, deficiencies in our technology or financial operating systems and inadequacies or breaches in our control processes. We operate in diverse markets and are reliant on the ability of our employees and systems to process a large number of transactions. These risks are less direct than credit and market risk, but managing them is critical, particularly in a rapidly changing environment with increasing transaction volumes. In the event of a breakdown or improper operation of systems or improper action by employees, we could suffer financial loss, regulatory sanctions and damage to our reputation. Business continuity plans exist for critical systems, and redundancies are built into the systems as deemed appropriate. In order to mitigate and control operational risk, we have developed and continue to enhance specific policies and procedures that are designed to identify and manage operational risk at appropriate levels throughout our organization and within various departments. These control mechanisms attempt to ensure that operational policies and procedures are being followed and that our employees operate within established corporate policies and limits.

We have established various committees of the Board of Directors to manage the risks associated with our business. Our Audit Committee was established for the primary purpose of overseeing (i) the integrity of our financial statements, (ii) our compliance with legal and regulatory requirements that may impact our financial statements or financial operations, (iii) the independent auditor’s qualifications and

58




independence and (iv) the performance of our independent auditor and internal audit function. Our Compensation and Human Resources Committee was established for the primary purpose of (i) overseeing our efforts to attract, retain and motivate members of our senior management team in partnership with the Chief Executive Officer, (ii) to carry out the Board’s overall responsibility relating to the determination of compensation for all executive officers, (iii) to oversee all other aspects of our compensation and human resource policies and (iv) to oversee our management resources, succession planning and management development activities.

In addition to various committees, we have written policies and procedures that govern the conduct of business by our IFAs and employees, our relationship with clients and the terms and conditions of our relationships with product manufacturers. Our client and financial advisor policies address the extension of credit for client accounts, data and physical security, compliance with industry regulation and codes of ethics to govern employee and financial advisor conduct among other matters.

Item 3.                 Properties

Our corporate headquarters are located in Boston, Massachusetts where we lease approximately 36,000 square feet of space and in San Diego, California where we lease approximately 316,000 square feet of space. Our subsidiary Innovex, located in San Diego, California, leases approximately 3,000 square feet of space from LPL. Our subsidiary PTC Holdings, Inc., located in Cleveland, Ohio, leases approximately 6,000 square feet of space. Our subsidiary UVEST Financial Services Group, Inc., located in Charlotte, North Carolina, leases approximately 42,000 square feet of space, and we lease approximately 82,000 additional square feet of space to house our East coast operations center located in Charlotte. We own approximately 4.5 acres feet of land in San Diego. We believe that our existing properties are adequate for the current operating requirements of our business and that additional space will be available as needed.

ITEM 4.                 SECURITY OWNERSHIP BY CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth certain information regarding the beneficial ownership of our common stock as of April 30, 2007 by (i) each beneficial owner of more than five percent of our outstanding common stock and (ii) each of our current directors and named executive officers. Unless otherwise indicated, the address for each of the individuals listed below is: c/o LPL Investment Holdings Inc., One Beacon Street, Floor 22, Boston, MA 02108.

Name of Beneficial Owner

 

 

 

Amount and Nature of 
Beneficial Ownership of
Common Stock
(4)
(#)

 

Percentage of Common Stock
(%)

 

Hellman & Friedman Investment Funds (1)(2)

 

 

3,421,018.51

 

 

 

41.29

 

 

TPG Partners, IV, L.P. (1)(3)

 

 

3,421,018.51

 

 

 

41.29

 

 

Mark S. Casady (1)

 

 

260,474.00

 

 

 

3.05

 

 

C. William Maher (1)

 

 

14,692.00

 

 

 

0.18

 

 

Steven M. Black (1)

 

 

153,512.00

 

 

 

1.82

 

 

William E. Dwyer (1)

 

 

125,876.64

 

 

 

1.50

 

 

Esther M. Stearns (1)

 

 

166,984.00

 

 

 

1.98

 

 

Jeffrey A. Goldstein (1)

 

 

3,421,018.51

 

 

 

41.29

 

 

Douglas M. Haines (1)

 

 

3,421,018.51

 

 

 

41.29

 

 

James S. Putnam (1)

 

 

48,696.95

 

 

 

0.59

 

 

Richard P. Schifter (1)

 

 

3,421,018.51

 

 

 

41.29

 

 

Jeffrey E. Stiefler (1)

 

 

 

 

 

 

 

Allen R. Thorpe (1)

 

 

3,421,018.51

 

 

 

41.29

 

 

All directors and executive officers as a group (13 persons)

 

 

7,839,227.57

 

 

 

86.04

%

 

(footnotes on following page)

59





(1)            Parties to our stockholders’ agreement. See “Certain Relationship and Related Transaction—Stockholders’ Agreement.”

(2)            Common stock beneficially owned through the funds Hellman & Friedman Capital Partners V, L.P., Hellman & Friedman Capital Partners V (Parallel), L.P. and Hellman & Friedman Capital Associates V, L.P. The address for each of these funds is c/o Hellman & Friedman LLC, One Maritime Plaza, 12 th  Fl., San Francisco, CA 94111.

(3)            The address for TPG Partners, IV, L.P. is c/o Texas Pacific Group, 301 Commerce Street, Suite 3300, Fort Worth, TX 76102.

(4)            For purposes of this table, a person or group is deemed to have ‘‘beneficial ownership” of any shares as of a given date which such person has voting power, investment power, or has the right to acquire within 60 days after such date. For purposes of computing the percentage of outstanding shares held by each person or group of persons named above on a given date, any security which such person or persons has the right to acquire within 60 days after such date is deemed to be outstanding, but is not deemed to be outstanding for the purpose of computing the percentage of ownership of any other person. Except as otherwise noted, each beneficial owner of more than five percent of any of our common stock, and each director and executive officer has sole voting and investment power over the shares reported.

Changes in Control

See “Management’s Discussion and Analysis of our Financial Condition and Results of Operations—Indebtedness—Senior Secured Credit Facilities” for arrangements the operation of which may at a subsequent date result in a change of our control.

I tem 5.                 DIRECTORS AND EXECUTIVE OFFICERS

Set forth below is certain information concerning the individuals that currently serve as members of the Board, as well as the executive officers of LPL, as of April 30, 2007.

Name

 

 

 

Age

 

Position (1)

Mark S. Casady

 

46

 

Chief Executive Officer and Chairman

Jeffrey A. Goldstein

 

53

 

Director

Douglas M. Haines

 

40

 

Director

James S. Putnam

 

52

 

Director, Vice-Chairman

Richard P. Schifter

 

53

 

Director

Jeffrey E. Stiefler

 

59

 

Director

Allen R. Thorpe

 

35

 

Director

Steven M. Black

 

50

 

Managing Director, Chief Risk Officer

Stephanie L. Brown

 

54

 

Managing Director, General Counsel

William E. Dwyer

 

49

 

Managing Director, National Sales

C. William Maher

 

45

 

Managing Director, Chief Financial Officer

Esther M. Stearns

 

46

 

President and Chief Operating Officer

Joseph P. Tuorto

 

49

 

Managing Director, Chief Compliance Officer


(1)            Directors and executive officers are elected for generally elected for terms that expire on the date of the following annual shareholders’ meeting and board of directors’ meeting, respectively. The term of office of the current directors and executive officers expires at such meetings to be held in December 2007.

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The following information provides a brief description of the business experience of each director and executive officer.

Mark S. Casady—Chief Executive Officer and Chairman

Mr. Casady has been our Chief Executive Officer and Chairman since March 2007. He joined us in 2002 as Chief Operating Officer, became our President in April 2003 and became our Chief Executive Office, President and Chairman in December 2005. Before joining the firm in 2002, Mr. Casady was Managing Director, Mutual Fund Group for Deutsche Asset Management, Americas—formerly Scudder Investments. He joined Scudder in 1994 and held roles as Managing Director—Americas; Head of Global Mutual Fund Group; Head of Defined Contribution Services; and was a member of the Scudder, Stevens and Clark Board of Directors and Management Committee. He is also Chairman of the Board and a member of the Compensation Committee of Percipio Capital Management LLC. Mr. Casady received his B.S. from Indiana University and his M.B.A from DePaul University.

Jeffrey A. Goldstein—Director

Mr. Goldstein joined Hellman & Friedman as a managing director in 2004 and has been our director since December 2005. Before joining Hellman & Friedman, Mr. Goldstein was Managing Director, Chief Financial Officer and Member of the Management Committee of the World Bank. Prior to his tenure at the World Bank, Mr. Goldstein was Co-Chairman of BT Wolfensohn and a member of the Bankers Trust Company Management Committee. Earlier in his career, Mr. Goldstein taught economics at Princeton University and worked at the Brookings Institution. Mr. Goldstein is also a member of the Board of Arch Capital Group Ltd. and AlixPartners LLP. Mr. Goldstein also serves as a member of the Board of Trustees and Chairman of the Investments Committee of Vassar College, member of the Board of Directors of International Center for Research on Women and member of the Council on Foreign Relations. He was Trustee and past President of Big Brothers Big Sisters of New York City and was trustee of the German Marshall Fund of the United States. He received his B.A. from Vassar College and his Ph.D., M.Phil., and M.A. in economics from Yale University.

Douglas Marshall Haines—Director

Mr. Marshall Haines has been a principal of TPG Capital since 2004 and our director since December 2005. From 1993 to 2003 Mr. Haines was a principal at Bain Capital. Mr. Haines received his bachelor’s degree from the University of California at Berkeley and his M.B.A. from Harvard Business School. Mr. Haines also serves as a director of Fidelity National Information Services and Direct General.

James S. Putnam—Director and Vice Chairman

Mr. Putnam has been Chief Executive Officer of GPA since 2004 having served on the Board of Directors of GPA since 1998, and has been our director and vice-chairman since December 2005. Mr. Putnam was Managing Director of National Sales, responsible for branch development, marketing, corporate communications mutual fund and annuity sales. Mr. Putnam began his securities career as a retail representative with Dean Witter Reynolds in 1979. Mr. Putnam received his B.A. from Western Illinois University.

Richard P. Schifter—Director

Mr. Schifter has been a partner at TPG Capital since 1994. Prior to joining Texas Pacific Group, Mr. Schifter was a partner at the law firm of Arnold & Porter in Washington, D.C., where he specialized in bankruptcy law and corporate restructuring. Mr. Schifter joined Arnold & Porter in 1979 and was a partner from 1986 through 1994. Mr. Schifter is a member of the District of Columbia Bar and graduated cum laude from the University of Pennsylvania Law School in 1978. He received a B.A. with distinction from

61




George Washington University in 1975. Mr. Schifter currently serves on the Boards of Directors of Gate Gourmet Group, Bristol Group, LPL Holdings Inc., Direct General Corporation, Ariel Reinsurance Company Ltd,  and Airline Partners Australia, and on the Board of Overseers of the University of Pennsylvania Law School. He is also a member of the Boards of Directors of the Washington Chapter of the American Jewish Committee, Youth, I.N.C.,  (Improving Non-profits for Children), and The Eco-Enterprise Fund of the Nature Conservancy.

Jeffrey E. Stiefler—Director

Mr. Stiefler has been Senior Vice-President of Intuit Corp. and President of Intuit’s financial institutions division since February 2007, and our director since May 2006. Previously, Mr. Stiefler was Chairman, President and Chief Executive Officer of Digital Insight Corp. from 2003 to 2007. Prior to joining Digital Insight, Mr. Stiefler served as an adviser for North Castle Partners, a private equity firm, from 2001 to 2003, as Vice Chairman of Walker Digital Corporation from 2000 to 2001, as President of Telephony@Work, a private technology company, from 2001 to 2002, and as an operating partner for McCown DeLeeuw & Company from 1995 to 2000, where he also served as Chairman or Chief Executive Officer for several service-outsourcing companies. Before that, he was President and Director of American Express Company. Mr. Stiefler also serves as a director of Education Lending Group, Inc., a provider of financial aid products. Mr. Stiefler received his B.A. from Williams College and an M.B.A. from Harvard Business School.

Allen R. Thorpe—Director

Mr. Thorpe has been a managing director at Hellman & Friedman since 2004 and our director since October 2005. Prior to joining that firm in 1999, Mr. Thorpe was a vice-president of Pacific Equity Partners in Sydney and a manager at Bain & Company in Sydney. Mr. Thorpe currently also serves as a director of Mitchell International, Inc., Mondrian Investment Partners, Gartmore, Artisan Partners Limited Partnership, and Vertafore, Inc. and serves as the Chairman of the Board of Directors of the Bay Area Video Coalition. Mr. Thorpe received his bachelor’s degree from Stanford University and his M.B.A. from Harvard Business School, where he was a Baker Scholar.

Steven M. Black—Managing Director, Chief Risk Officer

Mr. Black joined us in 1998, as Senior Vice President, Clearing Services and in June of 2001, he became Managing Director of Operations and became Managing Director of Operations and Trading in 2004. In 2006, Mr. Black was made Chief Risk Officer and has the responsibility for Sarbanes-Oxley compliance, internal audits and implementation of an enterprise-wide risk management process. Mr. Black attended Stockton State College.

Stephanie L. Brown—Managing Director, General Counsel

Ms. Brown joined us in 1989 and has been responsible for the legal department throughout her tenure at LPL. From 1989 to 2004 Ms. Brown was responsible as well for Compliance and Registration. Prior to joining LPL in 1989, Ms. Brown was an associate attorney with the law firm of Kelley Drye & Warren in Washington, D.C., specializing in corporate and securities law. Ms. Brown received her B.A. degree cum laude from Bryn Mawr College and her J.D. from the Catholic University of America. Ms. Brown is a member of the District of Columbia and Commonwealth of Massachusetts Bars.

William E. Dwyer—Managing Director, National Sales

Mr. Dwyer joined us in 1992, became Managing Director, Branch Development in 2002, became Managing Director, National Sales in 2005 and has been responsible for overseeing recruitment, branch office development and transition services of new IFAs joining LPL. In addition, Mr. Dwyer is responsible

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for national recruitment advertising. Mr. Dwyer also serves on the Board of Big Brothers of Massachusetts Bay since 1999 and has held the position of Executive Vice Chairman since 2001. He received his B.A. from Boston College.

C. William Maher—Managing Director, Chief Financial Officer

Mr. Maher joined us in 2005 from Nicholas Applegate Capital Management where he spent the last six years as Chief Financial Officer and Managing Director, responsible for formulating financial policy and planning as well as ensuring the effectiveness of the financial functions within the firm. Mr. Maher is a member of the Board of Directors of The Greater China Fund, Inc. and a member of its Audit Committee. Mr. Maher received his B.A. from Rutgers University and his M.B.A. from Rutgers Graduate School of Management.

Esther M. Stearns—President and Chief Operating Officer

Ms. Stearns joined us in 1996 as Chief Information Officer. In 2003, she became Chief Operating Officer, and she has been our President since March 2007. Ms. Stearns is responsible for management of our operations, delivery of service and technology to our advisors and business planning for strategic initiatives. Prior to joining LPL, she was a Vice President of Information Systems at Charles Schwab & Co., Inc. Ms. Stearns worked at Charles Schwab since 1982 in operations as well as managed the surveillance, internal control and credit departments. She received her B.A. from the University of Chicago.

Joseph P. Tuorto—Managing Director, Chief Compliance Officer

Mr. Tuorto joined us as Senior Vice President as head of compliance in 2004 from Raymond James where he was CCO. He is responsible for the compliance and registration departments. He became our Managing Director and CCO in December 2005. He received his B.A. from the University of South Florida and an M.B.A. from the University of Tampa.

ITEM 6.   EXECUTIVE COMPENSATION

Compensation of Directors

Outside directors who are not affiliated with us receive cash compensation for their service as members of the Board. All directors are reimbursed for reasonable out-of-pocket expenses incurred in connection with their attendance at meetings of the Board and committee meetings. None of our officers receives any compensation for serving as a director or as a director or chair of a committee of the Board.

The following table sets forth the compensation for each of the members of the Board received from us for service on the Board for the fiscal year ended December 31, 2006.

Name

 

 

 

Fees Earned
or Paid in
Cash
($)

 

Stock
Awards
($)

 

Option
Awards
($)

 

Non-Equity
Incentive Plan
Compensation
($)

 

Change in
Pension
Value and
Nonqualified
Deferred
Compensation
Earnings

 

All Other
Compensation
($)
(1)

 

Total
($)

 

Jeffrey Stiefler

 

 

6,250

 

 

 

 

 

80,964

 

 

 

 

 

 

 

 

 

 

87,214

 

Jeffrey A. Goldstein

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Douglas M. Haines

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

James S. Putnam

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Richard P. Schifter

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allen R. Thorpe

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

63




Summary Executive Compensation Table

The following table sets forth information concerning the total compensation for the fiscal year ended December 31, 2006 for the persons who serve as the chief executive officer, chief financial officer, and the three most highly compensated executive officers of our company. These individuals are referred to as “named executive officers” in other parts of this registration statement.

Name and
Principal Position

 

 

 

Year

 

Salary
($)
(1)

 

Bonus
($)
(2)

 

Stock
Awards
($)

 

Option
Awards
($)

 

Non-
Equity
Incentive
Plan
Compensation
($)

 

Change in
Pension
Value
(4)
and Non-
qualified
Deferred
Compensation
Earnings
($)

 

All
Other
Compensation
($)

 

Total
($)

 

Mark S. Casady (3)

 

 

2006

 

 

750,000

 

1,475,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

25,353

(4)

 

2,250,353

 

Chairman;
CEO

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

C. William Maher

 

 

2006

 

 

375,000

 

450,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

30,416

(5)

 

855,416

 

Managing Director;
CFO

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Steven M. Black

 

 

2006

 

 

415,000

 

575,000