UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
☑ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2020
Commission File No. 001-31720
PIPER SANDLER COMPANIES
(Exact Name of Registrant as specified in its Charter)
|(State or Other Jurisdiction of Incorporation or Organization)|| ||(IRS Employer Identification No.)|
|800 Nicollet Mall, Suite 900|| |
|(Address of Principal Executive Offices)|| ||(Zip Code)|
|(Registrant's Telephone Number, Including Area Code)|
|Securities registered pursuant to Section 12(b) of the Act:|
|Title of Each Class||Trading Symbol||Name of Each Exchange On Which Registered|
|Common Stock, par value $0.01 per share||PIPR||The New York Stock Exchange|
|Securities registered pursuant to Section 12(g) of the Act:|
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☑ No ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ☐ No ☑
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company, " and "emerging growth company" in Rule 12b-2 of the Exchange Act.
|Large accelerated filer ||☑||Accelerated filer|
|Smaller reporting company|
|Emerging growth company|
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act by the registered public accounting firm that prepared or issued its audit report. ☑
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑
The aggregate market value of the 17,366,955 shares of the Registrant's Common Stock, par value $0.01 per share, held by non-affiliates based upon the last sale price, as reported on the New York Stock Exchange, of the Common Stock on June 30, 2020 was approximately $1.0 billion.
As of February 19, 2021, the registrant had 18,262,868 shares of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Annual Report on Form 10-K incorporates by reference information (to the extent specific sections are referred to herein) from the Registrant's Proxy Statement for its 2021 Annual Meeting of Shareholders to be held on May 21, 2021.
TABLE OF CONTENTS
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K for the year ended December 31, 2020 (this "Form 10-K") contains forward-looking statements. Statements that are not historical or current facts, including statements about beliefs and expectations, are forward-looking statements. These forward-looking statements include, among other things, statements other than historical information or statements of current conditions and may relate to our future plans and objectives and results, and also may include our belief regarding the effect of various legal proceedings, as set forth under "Legal Proceedings" in Part I, Item 3 of this Form 10-K and in our subsequent reports filed with the Securities and Exchange Commission ("SEC"). Forward-looking statements involve inherent risks and uncertainties, and important factors could cause actual results to differ materially from those anticipated, including those factors discussed below under "Risk Factors" in Part I, Item 1A of this Form 10-K, as well as those factors discussed under "External Factors Impacting Our Business" included in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of this Form 10-K and in our subsequent reports filed with the SEC. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update them in light of new information or future events.
ITEM 1. BUSINESS.
Piper Sandler Companies ("Piper Sandler") is an investment bank and institutional securities firm, serving the needs of corporations, private equity groups, public entities, non-profit entities and institutional investors in the U.S. and internationally. Founded in 1895, Piper Sandler provides a broad set of products and services, including financial advisory services; equity and debt capital markets products; public finance services; equity research and institutional brokerage; fixed income services; and private equity strategies. Our headquarters are located in Minneapolis, Minnesota and we have offices across the United States and international locations in London, Aberdeen and Hong Kong.
We operate in one reportable segment providing investment banking and institutional sales, trading and research services for various equity and fixed income products.
•Investment Banking – For our corporate clients, we provide advisory services, which includes mergers and acquisitions; equity and debt private placements; and debt and restructuring advisory. We also help raise capital through equity and debt financings. We operate in the following focus sectors: healthcare; financial services; consumer; energy and renewables; diversified industrials and services; technology; and chemicals and materials, primarily focusing on middle-market clients. For our government and non-profit clients, we underwrite municipal issuances, provide municipal financial advisory and loan placement services, and offer various over-the-counter derivative products. Our public finance investment banking capabilities focus on state and local governments, cultural and social service non-profit entities, special districts, project financings, and the education, healthcare, hospitality, senior living and transportation sectors.
•Equity and Fixed Income Institutional Brokerage – We offer both equity and fixed income advisory and trade execution services for institutional investors and government and non-profit entities. Integral to our capital markets efforts, we have equity sales and trading relationships with institutional investors in North America and Europe that invest in our core sectors. Our research analysts provide investment ideas and support to our trading clients on approximately 900 companies. Fixed income services provides advice on balance sheet management, investment strategy and customized portfolio solutions. Our fixed income sales and trading professionals have expertise in municipal, corporate, mortgage, agency, treasury and structured product securities and cover a range of institutional investors. We principally engage in trading activities to facilitate customer needs.
•Alternative Asset Management Funds – We have created alternative asset management funds in merchant banking and energy in order to invest firm capital and to manage capital from outside investors.
In the third quarter of 2019, we sold our traditional asset management subsidiary, Advisory Research, Inc. ("ARI"). ARI's results have been presented herein as discontinued operations for all prior periods presented. For further information on our discontinued operations, see Note 5 to our consolidated financial statements in Part II, Item 8 of this Form 10-K.
Financial Information about Geographic Areas
As of December 31, 2020, the substantial majority of our net revenues and long-lived assets were located in the U.S.
Our business is subject to intense competition driven by large Wall Street and international firms, regional broker dealers, boutique and niche-specialty firms and alternative trading systems that effect securities transactions through various electronic venues. Competition is based on a variety of factors, including price, quality of advice and service, reputation, product selection, transaction execution, financial resources and investment performance. Many of our large competitors have greater financial resources than we have and may have more flexibility to offer a broader set of products and services than we can.
In addition, there is significant competition within the securities industry for obtaining and retaining the services of qualified employees. Our business is a human capital business, and attracting and retaining employees depends, among other things, on our company's culture, management, work environment, geographic locations and compensation.
Piper Sandler connects capital with opportunity to create value and build a better future, and our employees have been critical to achieving this mission throughout our 125-year operating history. We believe that great people working together as a team are our competitive advantage, and it is crucial that we continue to attract and retain talented employees. As part of these efforts, we strive to offer a competitive compensation and benefits program and training and development opportunities, foster a community where everyone feels included and empowered to do to their best work, and give employees the opportunity to give back to their communities.
As of December 31, 2020, we had 1,511 full-time employees, of which 1,451 were employed in the United States and 60 in the United Kingdom and Hong Kong. Approximately 1,130 of our employees were registered with the Financial Industry Regulatory Authority, Inc. ("FINRA") as of December 31, 2020. One key metric we use to benchmark our firm to industry peer companies is the number of investment banking managing directors. At December 31, 2020, we had 138 corporate investment banking managing directors.
Compensation and Benefits Program – Our compensation program is designed to attract, reward and retain employees who possess the skills necessary to support our business objectives and assist in the achievement of our strategic goals. We provide employees with competitive compensation packages that include base salary, annual incentive bonuses, length of service awards, and equity awards. For further information on the restricted shares we grant to employees as part of year-end compensation, see Note 20 to our consolidated financial statements in Part II, Item 8 of this Form 10-K. In addition to cash and equity compensation, we also offer benefits such as life and health (medical, dental and vision) insurance, paid time off, paid parental leave, health and wellness programs and a 401(k) plan. We believe our programs align both individual employees and long-term company performance with stockholder interests.
Training and Development – A core tenet of our talent system is to develop talent from within and to supplement with external candidates. We provide opportunities for employees to grow and build their careers through various training and development programs. We also have a talent and succession planning process, which is reviewed annually with our board of directors.
Diversity and Inclusion ("D&I") – At Piper Sandler, we believe that diverse teams with unique backgrounds, skills and experiences yield more innovative solutions. This is reflected in our commitment to attract, retain and develop a diverse and talented workforce in a high-quality, inclusive environment. We are focused on building an inclusive culture through a variety of initiatives supported by our D&I committee, including our hiring practices. Our employee networks also serve as a source of inclusion to support the acquisition of diverse talent both internally and externally. Each employee network is sponsored and supported by senior leaders across the firm.
Community Leadership – We are committed to contributing our talents and resources to serve the communities in which we live and work through the Piper Sandler Foundation, various charitable campaigns, employee programs and volunteerism. We believe that this commitment assists in our efforts to attract and retain employees.
As a participant in the financial services industry, our business is regulated by U.S. federal and state regulatory agencies, self-regulatory organizations ("SROs") and securities exchanges, and by foreign governmental agencies, financial regulatory bodies and securities exchanges. We are subject to complex and extensive regulation of most aspects of our business, including the manner in which securities transactions are effected, net capital requirements, recordkeeping and reporting procedures, relationships and conflicts with customers, the handling of cash and margin accounts, conduct, experience and training requirements for certain employees, and the manner in which we prevent and detect money-laundering and bribery activities. The regulatory framework of the financial services industry is designed primarily to safeguard the integrity of the capital markets and to protect customers, not creditors or shareholders.
The laws, rules and regulations comprising this regulatory framework can (and do) change frequently, as can the interpretation and enforcement of existing laws, rules and regulations. Conditions in the global financial markets and economy, including the 2008 financial crisis, caused legislators and regulators to increase the examination, enforcement and rule-making activity directed toward the financial services industry. The intensity of the regulatory environment may correlate with the level and nature of our legal proceedings for a given period, and increased intensity could have an adverse effect on our business, financial condition, and results of operations.
Our U.S. broker dealer subsidiary (Piper Sandler & Co.) is registered as a securities broker dealer with the SEC and is a member of various SROs and securities exchanges. In July 2007, the National Association of Securities Dealers and the member regulation, enforcement and arbitration functions of the New York Stock Exchange ("NYSE") consolidated to form FINRA, which now serves as the primary SRO of Piper Sandler & Co., although the NYSE continues to have oversight over NYSE-related market activities. FINRA regulates many aspects of our U.S. broker dealer business, including registration, education and conduct of our broker dealer employees, examinations, rulemaking, enforcement of these rules and the federal securities laws, trade reporting and the administration of dispute resolution between investors and registered firms. We have agreed to abide by the rules of FINRA (as well as those of the NYSE and other SROs), and FINRA has the power to expel, fine and otherwise discipline Piper Sandler & Co. and its officers, directors and employees. Among the rules that apply to Piper Sandler & Co. are the uniform net capital rule of the SEC (Rule 15c3-1) and the net capital rule of FINRA. Both rules set a minimum level of net capital a broker dealer must maintain and also require that a portion of the broker dealer's assets be relatively liquid. Under the applicable FINRA rule, FINRA may prohibit a member firm from expanding its business or paying cash dividends if resulting net capital falls below FINRA requirements. In addition, Piper Sandler & Co. is subject to certain notification requirements related to withdrawals of excess net capital. As a result of these rules, our ability to make withdrawals of capital from Piper Sandler & Co. may be limited. In addition, Piper Sandler & Co. is licensed as a broker dealer in each of the 50 states, requiring us to comply with applicable laws, rules and regulations of each state. Any state may revoke a license to conduct a securities business and fine or otherwise discipline broker dealers and their officers, directors and employees.
We also operate one entity that is authorized, licensed and regulated by the U.K. Financial Conduct Authority and registered under the laws of England and Wales, as well as an entity that is authorized, licensed and regulated by the Hong Kong Securities and Futures Commission and registered under the laws of Hong Kong. The U.K. Financial Conduct Authority and the Hong Kong Securities and Futures Commission regulate these entities (in their respective jurisdictions) in areas of capital adequacy, customer protection and business conduct, among others. We also have a subsidiary organized in Guernsey and regulated by the Guernsey Financial Services Commission ("GFSC").
Entities in the jurisdictions identified above are also subject to anti-money laundering regulations. Piper Sandler & Co. is subject to the USA PATRIOT Act of 2001, which contains anti-money laundering and financial transparency laws and mandates the implementation of various regulations requiring us to implement standards for verifying client identification at the time the client relationship is initiated, monitoring client transactions and reporting suspicious activity. Our entities in Hong Kong, the United Kingdom and Guernsey are subject to similar anti-money laundering laws and regulations. We are also subject to the U.S. Foreign Corrupt Practices Act as well as other anti-bribery laws in the jurisdictions in which we operate. These laws generally prohibit companies and their intermediaries from engaging in bribery or making other improper payments to foreign officials for the purpose of obtaining or retaining business or gaining an unfair business advantage.
We maintain subsidiaries that are registered as investment advisors with the SEC and subject to regulation and oversight by the SEC. Piper Jaffray Investment Management LLC ("PJIM"), PSC Capital Partners LLC, Piper Sandler Advisors LLC, Piper Heartland Healthcare Capital LLC and Piper Sandler Finance Management LLC are asset management subsidiaries and registered investment advisors. As registered investment advisors, these entities are subject to requirements that relate to, among other things, fiduciary duties to clients, maintaining an effective compliance program, solicitation agreements, conflicts of interest, recordkeeping and reporting requirements, disclosure requirements, limitations on agency cross and principal transactions between advisor and advisory clients, as well as general anti-fraud prohibitions. Piper Sandler & Co. is also a registered investment advisor and subject to these requirements. Parallel General Partners Limited is the general partner of several private equity limited partnerships; it and the limited partnerships are registered and regulated by the GFSC.
Certain of our businesses also are subject to compliance with laws and regulations of U.S. federal and state governments, non-U.S. governments, their respective agencies and/or various SROs or exchanges governing the privacy of client information. Any failure with respect to our practices, procedures and controls in any of these areas could subject us to regulatory consequences, including fines, and potentially other significant liabilities.
Information About our Executive Officers
Information regarding our executive officers and their ages as of February 19, 2021, are as follows:
|Chad R. Abraham||52||Chief Executive Officer|
|Debbra L. Schoneman||52||President|
|Timothy L. Carter||53||Chief Financial Officer|
|James P. Baker||53||Global Co-Head of Investment Banking and Capital Markets|
|Jonathan J. Doyle||55||Vice Chairman and Head of Financial Services Group|
|John W. Geelan||45||General Counsel and Secretary|
|R. Scott LaRue||60||Global Co-Head of Investment Banking and Capital Markets|
Chad R. Abraham is our chief executive officer, a position he has held since January 2018. He previously served as global co-head of investment banking and capital markets from October 2010 to December 2017. Prior to that, he served as head of equity capital markets since November 2005. Mr. Abraham joined Piper Sandler in 1991.
Debbra L. Schoneman is our president, a position she has held since January 2018. She previously served as chief financial officer from May 2008 to December 2017, and global head of equities from June 2017 to December 2017. Prior to that, she served as treasurer from August 2006 until May 2008; and as finance director of our corporate and institutional services business from July 2002 until July 2004 when the role was expanded to include our public finance services division. Ms. Schoneman joined Piper Sandler in 1990.
Timothy L. Carter is our chief financial officer, a position he has held since January 2018. He previously served as senior vice president of finance from May 2017 to December 2017. Prior to that, he served as treasurer from May 2008 to May 2017, chief accounting officer from 2006 to May 2008, and controller from 1999 to 2006. Mr. Carter joined Piper Sandler in 1995.
James P. Baker is our global co-head of investment banking and capital markets, a position he has held since January 2019. Prior to that, he served as our co-head of energy investment banking from February 2016 to December 2018. Mr. Baker joined Piper Sandler in February 2016 in connection with our acquisition of Simmons & Company International, where Mr. Baker was a managing director and leader of its midstream/downstream investment banking group.
Jonathan J. Doyle is our vice chairman, senior managing principal and head of the financial services group, a position he has held since January 2020. Mr. Doyle joined Piper Sandler in connection with our acquisition of Sandler O'Neill, where Mr. Doyle served as a senior managing principal.
John W. Geelan is our general counsel and secretary. He served as assistant general counsel and assistant secretary from November 2007 until becoming general counsel in January 2013. Mr. Geelan joined Piper Sandler in 2005.
R. Scott LaRue is our global co-head of investment banking and capital markets, a position he has held since October 2010. Prior to that, he served as global co-head of consumer investment banking from February 2010 to September 2010 and co-head of consumer investment banking from August 2004 to January 2010. Mr. LaRue joined Piper Sandler in 2003.
Our principal executive offices are located at 800 Nicollet Mall, Suite 900, Minneapolis, Minnesota 55402, and our general telephone number is (612) 303-6000. We maintain an Internet Web site at http://www.pipersandler.com. The information contained on and connected to our Web site is not incorporated into this Form 10-K. We make available free of charge on or through our Web site our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and all other reports we file with the SEC, as soon as reasonably practicable after we electronically file these reports with, or furnish them to, the SEC. Such reports are also available on the SEC's Web site at http://www.sec.gov. "Piper Sandler," the "Company," "registrant," "we," "us" and "our" refer to Piper Sandler Companies and our subsidiaries. The Piper Sandler logo and the other trademarks, tradenames and service marks of Piper Sandler mentioned in this report or elsewhere, including, but not limited to, PIPER SANDLERSM, PIPER JAFFRAY®, REALIZE THE POWER OF PARTNERSHIP®, SANDLER O'NEILL®, SANDLER O'NEILL & PARTNERS®, SANDLER O'NEILL MORTGAGE FINANCE®, TRSSM, TRS ADVISORSSM, SIMMONS ENERGY | A DIVISION OF PIPER SANDLERSM, SIMMONS ENERGY | A DIVISION OF PIPER JAFFRAY®, SIMMONS ENERGYSM, SIMMONS & COMPANY INTERNATIONAL®, SIMMONSCO-INTL®, PIPER SANDLER FINANCESM, PIPER JAFFRAY FINANCESM, PJIM®, PIPER SANDLER BIOINSIGHTSSM, PIPER JAFFRAY BIOINSIGHTSSM, BIOINSIGHTSSM, TAKING STOCK WITH TEENS®, HEALTHY ACTIVE AND SUSTAINABLE LIVING® and GUIDES FOR THE JOURNEY® are the property of Piper Sandler.
ITEM 1A. RISK FACTORS.
In the normal course of our business activities, we are exposed to a variety of risks. The principal risks we face in operating our business include: strategic risks, market risks, human capital risks, liquidity risks, credit risks, operational risks, and legal and regulatory risks. A full description of each of these principal areas of risk, as well as the primary risk management processes that we use to mitigate our risk exposure in each, is discussed below under the caption "Risk Management" included in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of this Form 10-K.
The following discussion sets forth the risk factors that we have identified in each area of principal risk as being the most material to our business, future financial condition, and results of operations. Although we discuss these risk factors primarily in the context of their potential effects on our business, financial condition or results of operations, you should understand that these effects can have further negative implications such as: reducing the price of our common stock; reducing our capital, which can have regulatory and other consequences; affecting the confidence that our clients and other counterparties have in us, with a resulting negative effect on our ability to conduct and grow our business; and reducing the attractiveness of our securities to potential purchasers, which may adversely affect our ability to raise capital and secure other funding or the prices at which we are able to do so. Further, additional risks beyond those discussed below and elsewhere in this Form 10-K or in other of our reports filed with, or furnished to, the SEC could adversely affect us. We cannot assure you that the risk factors herein or elsewhere in our other reports filed with, or furnished to, the SEC address all potential risks that we may face.
These risk factors also serve to describe factors which may cause our results to differ materially from those described in forward-looking statements included in this Form 10-K or in other documents or statements that make reference to this Form 10-K. Forward-looking statements, as further described in this Form 10-K under the heading "Cautionary Note Regarding Forward-Looking Statements," and other factors that may affect future results are discussed below under "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of this Form 10-K.
Strategic and Market Risk
Our business success depends in large part upon the strategic decisions made by our executive management, the alignment of business plans developed to act upon those decisions, and the quality of implementation of these business plans. Strategic risk represents the risk associated with our executive management failing to develop and execute on the appropriate strategic vision which demonstrates a commitment to our culture, leverages our core competencies, appropriately responds to external factors in the marketplace, and is in the best interests of our company. In setting out and executing upon a strategic vision for our business, we are faced with a number of inherent risks, including risks relating to external events and market and economic conditions, competition, and business performance that could all negatively affect our ability to execute on our strategic decisions and, therefore, our future financial condition or results of operations. The risks related to external events and overall market and economic conditions are referred to as market, or systemic, risk. The following are those material risk factors that we have identified that could pose a risk to our strategic vision, and the market risks that may impact execution of our strategy.
Developments in market and economic conditions have in the past adversely affected, and may in the future adversely affect, our business and profitability and cause volatility in our results of operations.
Economic and market conditions have had, and will continue to have, a direct and material impact on our results of operations and financial condition because performance in the financial services industry is heavily influenced by the overall strength of economic conditions and financial market activity. For example:
•Following the outbreak of the COVID-19 pandemic in March 2020, nearly every sector of the global and U.S. economy was negatively impacted. The uncertainty surrounding the effects and course of the pandemic, and the measures enacted to mitigate its spread, including travel restrictions, quarantines, stay-at-home orders, and business shutdowns resulted in almost unprecedented short-term dislocations in, and a slowdown of, global and U.S. economic activity. Business uncertainty over the length and severity of the pandemic and the timing of the eventual economic recovery resulted in a severe decline in our advisory (i.e., mergers and acquisitions) revenue during the second and third quarters of 2020. This decline was largely off-set by improved performance by our capital markets, institutional brokerage, and public finance businesses, which benefitted from accommodative market conditions created by the efforts of the U.S. federal government to support the markets and economy. Although we currently believe that the U.S. economy will continue to recover from COVID-19 and its related impacts in 2021, we also believe that the economic recovery and growth will be dependent on the trajectory of vaccine distribution and administration. Widespread concern or doubts in the market about the pace or ability of normal economic activity to resume, or the efficacy or adequacy of the government measures enacted to support the U.S. and global economy, could further erode
the outlook for macroeconomic conditions and business confidence, and negatively impact our equities investment banking revenues. In addition, to the extent that the primary sectors that are covered by our equities investment banking business take longer to recover due to the erosion of economic conditions in those sectors, such as the energy or consumer sectors, our equities investment banking business could continue to be negatively impacted even after other sectors begin to experience a recovery.
•Our equities investment banking revenue from our advisory and equity capital markets businesses is directly related to macroeconomic conditions and corresponding financial market activity. When the outlook for macroeconomic conditions is uncertain or negative, financial market activity generally tends to decrease, which can reduce our equities investment banking revenues. As an example, a significant portion of our equities investment banking revenues in recent years has been derived from advisory engagements in our focus sectors, and activity in this area is highly correlated to the macroeconomic environment and market conditions. Reduced expectations of U.S. economic growth and recovery from the COVID-19 pandemic or a further decline in the global macroeconomic outlook could cause financial market activity to decrease and negatively affect our equities investment banking revenues. In addition, global macroeconomic conditions and U.S. financial markets remain vulnerable to the potential risks posed by exogenous shocks in addition to COVID-19, which could include, among other things, political or social unrest or financial uncertainty in the United States and the European Union, complications involving terrorism and armed conflicts around the world, or other challenges to global trade or travel. More generally, because our business is closely correlated to the macroeconomic outlook, a significant deterioration in that outlook or an exogenous shock would likely have an immediate and significant negative impact on our equities investment banking business and our overall results of operations, as we experienced with the outbreak of COVID-19 in 2020.
•U.S. equity markets experienced severe volatility during 2020, with historic declines caused by the outbreak of COVID-19, followed quickly by dramatic increases on the basis of the response by the U.S. federal government to support the markets and economy as well as increased understanding of the impact and scope of the pandemic. Our equities capital markets business was able to take full advantage of these accommodative market conditions in the second half of the year as our clients sought to access U.S. equity markets at favorable valuations, which contributed positively to our operating results for the year. However, if volatility in the U.S. equity markets were to return or increase in 2021, whether due to the concerns about the course of the COVID-19 pandemic, the outlook for the U.S. or global economic recovery, or public equity valuations, or due to some other exogenous shock, companies may find it more difficult to raise capital from public equity markets, which could have a negative impact on our equity capital markets business and our overall results of operations. In addition, in 2020, the healthcare sector was a significant contributor to our equity capital markets results, and any significant equity market volatility or moderation that specifically impacts that sector for any reason, including concerns over equity valuations or negative developments that result from legislative or regulatory actions taken by the new U.S. presidential administration, could have a negative impact on our results of operations.
It is difficult to predict the economic and market conditions for 2021, which are dependent upon the pace of global and U.S. economic recovery from COVID-19 and geopolitical events globally. Our smaller scale and the cyclical nature of the economy and the financial services industry leads to volatility in our financial results, including our operating margins, compensation ratios, business mix, and revenue and expense levels. Our financial performance may be limited by the fixed nature of certain expenses, the impact from unanticipated losses or expenses during the year, our business mix, and the inability to scale back costs in a timeframe to match decreases in revenue-related changes in market and economic conditions. As a result, our financial results may vary significantly from quarter to quarter and year to year.
Developments in specific business sectors and markets in which we conduct our business, have in the past adversely affected, and may in the future adversely affect, our business and profitability.
Our results for a particular period may be disproportionately impacted by declines in specific sectors of the U.S. or global economy, or for certain products within the financial services industry, due to our business mix and focus areas. For example:
•Our equities investment banking business focuses on specific sectors, including healthcare, financial services, energy and renewables, consumer, diversified industrials and services, technology, and chemicals and materials. Volatility, uncertainty, or slowdowns in any of these sectors may adversely affect our business, sometimes disproportionately, and may cause volatility in the net revenues we receive from our corporate advisory and capital markets activities. Both the healthcare and financial services sectors are significant contributors to our overall results, and negative developments in either of these sectors, including but not limited to negative developments that result from legislative or regulatory actions taken by the new U.S. presidential administration, would materially and disproportionately
impact our equities investment banking results, even if general economic conditions were strong. In addition, we may not participate, or may participate to a lesser degree than other firms, in sectors that experience significant activity, such as real estate, and our operating results may not correlate with the results of other firms that participate in these sectors.
•Our public finance investment banking business depends heavily upon conditions in the municipal market. It focuses on investment banking activity in sectors that include state and local government, education, senior living, healthcare, transportation, and hospitality sectors, with an emphasis on transactions with a par value of $500 million or less. Concerns about U.S. economic growth or recovery from the COVID-19 pandemic could have a disproportionate impact on high-yield sectors, which could have a negative impact on our public finance business. Further, the enactment, or the threat of enactment, of any legislation that alters the financing alternatives available to local or state governments or tax-exempt organizations through the elimination or reduction of tax-exempt bonds could have a negative impact on our results of operations in these businesses.
•Our fixed income institutional business derives its revenue from sales and trading activity in the municipal and taxable markets and from hybrid preferreds and government agency products. Our operating results for our fixed income institutional business may not correlate with the results of other firms or the fixed income market generally because we do not participate in significant segments of the fixed income markets such as credit default swaps, corporate high-yield bonds, currencies or commodities.
Financing and advisory services engagements are transactional in nature and do not generally provide for subsequent engagements.
Even though we work to represent our clients at every stage of their lifecycle, we are typically retained on a short-term, engagement-by-engagement basis in connection with specific advisory or capital markets transactions. As a consequence, the timing of when fees are earned varies, and, therefore, our financial results from advisory and capital markets activities may experience volatility quarter to quarter based on equity market conditions as well as the macroeconomic business cycle more broadly. In particular, our revenues related to advisory transactions tend to be more unpredictable from quarter to quarter due to the one-time nature of the transaction and the size of the fee. As a result, high levels of revenue in one quarter will not necessarily be predictive of continued high levels of revenue in any subsequent period. If we are unable to generate a substantial number of new engagements and generate fees from the successful completion of those transactions, our business and results of operations could be adversely affected.
The number of anticipated investment banking transactions may differ from actual results.
The completion of anticipated investment banking transactions in our pipeline is uncertain and partially beyond our control, and our investment banking revenue is typically earned only upon the successful completion of a transaction. In most cases, we receive little or no payment for investment banking engagements that do not result in the successful completion of a transaction. For example, a client's acquisition transaction may be delayed or terminated because of a failure to agree upon final terms with the counterparty, failure to obtain necessary regulatory consents or director or stockholder approvals, failure to secure necessary financing, adverse market conditions or unexpected financial or other issues in the client's or counterparty's business. More importantly, anticipated advisory or capital markets transactions may be delayed or terminated as a result of a decline in or uncertainty surrounding market or economic conditions. If parties fail to complete a transaction on which we are advising or an offering in which we are participating, we earn little or no revenue from the transaction and may have incurred significant expenses (e.g., travel and legal expenses) associated with the transaction. Accordingly, our business is highly dependent on market and economic conditions as well as the decisions and actions of our clients and interested third parties, and the number of engagements we have at any given time (and any characterization or description of our deal pipelines) is subject to change and may not necessarily result in future revenues.
We may make strategic acquisitions, enter into new business opportunities, or engage in joint ventures, which could cause us to incur unforeseen expenses and have disruptive effects on our business and may not yield the benefits we expect.
We may grow in part through corporate development or similar activities that could include acquisitions, joint ventures and minority investment stakes, and entering into new lines of business. There are a number of risks associated with these activities. Costs or difficulties relating to a transaction, including integration of products, employees, technology systems, accounting systems and management controls, or entry into a new business line, may be difficult to predict accurately and be greater than expected causing our estimates to differ from actual results. Importantly, we may be unable to retain key personnel after a transaction, including personnel who are critical to the success of the ongoing business. We may incur unforeseen liabilities of
an acquired company or from entry into a new business line, that could impose significant and unanticipated legal costs on us. We will need to successfully manage these risks in order to fully realize the anticipated benefits of these transactions.
Longer-term, our corporate development activities may require increased costs in the form of management personnel, financial and management systems and controls and facilities, which, in the absence of continued revenue growth, could cause our operating margins to decline. In addition, when we acquire a business, a substantial portion of the purchase price is often allocated to goodwill and other identifiable intangible assets. Our goodwill and intangible assets are tested at least annually for impairment. If, in connection with that test, we determine that a reporting unit's fair value is less than its carrying value, we would be required to recognize an impairment to the goodwill associated with that reporting unit. More generally, any difficulties that we experience could disrupt our ongoing business, increase our expenses and adversely affect our operating results and financial condition. We also may be unable to achieve anticipated benefits and synergies from a transaction as fully as expected or within the expected time frame.
We may not be able to compete successfully with other companies in the financial services industry who often have significantly greater resources than we do.
The financial services industry remains highly competitive, and our revenues and profitability may suffer if we are unable to compete effectively. We generally compete on the basis of such factors as quality of advice and service, reputation, price, product selection, transaction execution and financial resources. Pricing and other competitive pressures in investment banking, including the use of multiple book runners, co-managers, and multiple financial advisors handling transactions, have affected and could continue to adversely affect our revenues.
We remain at a competitive disadvantage given our relatively small size compared to some of our competitors. Large financial services firms generally have a larger capital base, greater access to capital, and greater technology resources, affording them greater capacity for risk and potential for innovation, an extended geographic reach and flexibility to offer a broader set of products. For example, some of these firms are able to use their larger capital base to offer additional products or services to their investment banking clients, which can be a competitive advantage. With respect to our fixed income institutional brokerage and public finance investment banking businesses, it is more difficult for us to diversify and differentiate our product set, and our fixed income business mix currently is concentrated in the municipal market and to a lesser extent corporate credits, potentially with less opportunity for growth than other firms which have grown their fixed income businesses by investing in, developing and offering non-traditional products (e.g., credit default swaps, interest rate products and currencies and commodities).
Our institutional brokerage business is subject to pricing pressures.
The ability to execute trades electronically and through alternative trading systems and competitive pressures on our clients have increased the pressure on trading commissions and spreads within the equities institutional brokerage business over the past few years. We expect to continue to experience pricing and other competitive pressures in our equities and fixed income institutional brokerage businesses in the future. In addition, we will need to continue to invest in these businesses in order to continue to meet our clients’ needs and maintain sufficient scale.
Our inability to identify and address actual, potential, or perceived conflicts of interest may negatively impact our reputation and have a material adverse effect on our business.
We regularly address actual, potential or perceived conflicts of interest in our business, including situations where our services to a particular client or our own investments or other interests conflict, or are perceived to conflict, with the interests of another client. Appropriately identifying and dealing with conflicts of interest is complex and difficult, and we face the risk that our current policies, controls and procedures do not timely identify or appropriately manage such conflicts of interest. It is possible that actual, potential or perceived conflicts could give rise to client dissatisfaction, litigation or regulatory enforcement actions. Our reputation could be damaged if we fail, or appear to fail, to deal appropriately with potential or actual conflicts of interest. Client dissatisfaction, litigation, or regulatory enforcement actions arising from a failure to adequately deal with conflicts of interest, and the reputational harm suffered as a consequence, could have a material adverse effect on our business.
Damage to our reputation could harm our business.
Maintaining our reputation is critical to attracting and maintaining clients, customers, investors, and employees. If we fail to deal with, or appear to fail to deal with, issues that may give rise to reputational risk, such failure or appearance of failure could have a material adverse effect on our business and stock price. These issues include, but are not limited to, appropriately dealing with potential conflicts of interest, legal and regulatory requirements, ethical issues, money laundering, cybersecurity, and the proper identification of the strategic, market, human capital, liquidity, credit, operational, legal and regulatory risks inherent in our business and products.
Human Capital Risk
Our business is a human capital business, and, therefore, our future financial condition and results of operations are significantly dependent upon our employees and their actions. Our success depends on the skills, expertise, and performance of our employees. Human capital risks represent the risks posed if we fail to attract and retain qualified individuals who are motivated to serve the best interests of our clients, thereby serving the best interests of our company, as well as the risks posed if our culture fails to encourage such behavior. Human capital risk is also present where we fail to detect and prevent employees from acting contrary to our policies and procedures, for example, if an employee were to inadequately safeguard or misuse our clients' confidential information. Any failure by us in creating and maintaining a culture that emphasizes serving our clients' best interests or detecting or preventing employees from engaging in behaviors that run counter to that culture might lead to reputational damage for our firm. The following are those material human capital risk factors that we have identified that could pose a risk to us.
Our ability to attract, develop and retain highly skilled and productive employees, develop the next generation of our business leadership, and instill and maintain a culture of ethics is critical to the success of our business.
Historically, the market for qualified employees within the financial services industry has been marked by intense competition, and the performance of our business may suffer to the extent we are unable to attract, retain, and develop productive employees, given the relatively small size of our company and our employee base compared to some of our competitors and the geographic locations in which we operate. The primary sources of revenue in each of our business lines are fees earned on advisory and underwriting transactions and customer accounts managed by our employees, who have historically been recruited by other firms and in certain cases are able to take their client relationships with them when they change firms. In some areas of our business, a small number of employees are responsible for producing a significant amount of revenue, and the loss of any of these employees could adversely affect our results of operations.
Further, recruiting and retention success often depends on the ability to deliver competitive compensation, and we may be at a disadvantage to some competitors given our size and financial resources. Our inability or unwillingness to meet compensation needs or demands may result in the loss of some of our professionals or the inability to recruit additional professionals at compensation levels that are within our target range for compensation and benefits expense. Our ability to retain and recruit also may be hindered if we limit our aggregate annual compensation and benefits expense as a percentage of annual net revenues.
A vibrant and ethical corporate culture is critical to ensuring that our employees put our clients' interests first and are able to identify and manage potential conflicts of interest, while also creating an environment in which each of our employees feel empowered to develop and pursue their full potential. Our expectations for our corporate culture and ethics are instilled and maintained by the "tone at the top" set by our management and board of directors. Lapses in our corporate culture could lead to reputational damage or employee loss, either of which could adversely affect our results of operations.
Our business success depends in large part on the strategic decisions made by our leadership team, and the business plans developed and implemented by our senior business leaders. Our ability to identify, develop, and retain future senior business leaders, and our ability to develop and implement successful succession plans for our leadership team and other senior business leaders, is critical to our future success and results of operations.
Our inability to effectively integrate and retain personnel in connection with our acquisitions may adversely affect our financial condition and results of operations.
We invest time and resources in carefully assessing opportunities for acquisitions, and we have made acquisitions in the past several years to broaden the scope and depth of our human capital in various businesses. Despite diligence and integration planning, acquisitions still present certain risks, including the difficulties in integrating and bringing together different work
cultures and employees, and retaining those employees for the period of time necessary to realize the anticipated benefits of the acquisition. Difficulties in integrating our acquisitions, including attracting and retaining talent to realize the expected benefits of these acquisitions, may adversely affect our financial condition and results of operations.
Liquidity and Credit Risk
Two of our principal categories of risk as a broker dealer are liquidity and credit risk, each of which can have a material impact on our results of operations and viability as a business. We believe that the effective management of liquidity and credit is fundamental to the financial health of our firm. With respect to liquidity risk, it impacts our ability to timely access necessary funding sources in order to operate our business and our ability to timely divest securities that we hold in connection with our market-making and sales and trading activities. Credit risk, as distinguished from liquidity risk, is the potential for loss due to the default or deterioration in credit quality of a counterparty, customer, client, borrower, or issuer of securities we hold in our trading inventory. The nature and amount of credit risk depends on the type of transaction, the structure and duration of that transaction and the parties involved. The following are the material liquidity and credit risk factors that we have identified that could pose a risk to us.
An inability to access capital readily or on terms favorable to us could impair our ability to fund operations and could jeopardize our financial condition and results of operations.
Liquidity, or ready access to funds, is essential to our business. To fund our business, we rely on financing provided by Pershing LLC ("Pershing") under our fully disclosed clearing agreement, as well as bank financing, commercial paper, and other funding sources. The financing provided by Pershing is at Pershing's discretion (i.e., uncommitted) and could be denied without prior notice. To help mitigate this risk, during 2019, the Company issued $175 million of unsecured fixed rate senior notes as financing for general corporate purposes, including to finance a portion of our acquisition of Sandler O'Neill & Partners, L.P. in early 2020. In January 2021, we increased the size of our unsecured revolving credit facility from $50 million to $65 million, and we intend to use the facility for working capital and general corporate purposes. Our broker dealer subsidiary also renewed a $100 million committed credit facility in December 2020 for an additional twelve months.
Our access to funding sources, particularly uncommitted funding sources, is dependent on factors we cannot control, such as economic downturns, the disruption of financial markets, the failure or consolidation of other financial institutions, negative news about the financial industry generally or us specifically. We could experience disruptions with our credit facilities in the future, including the loss of liquidity sources and/or increased borrowing costs, if lenders or investors develop a negative perception of our short- or long-term financial prospects, which could result from decreased business activity. Our liquidity also could be impacted by the activities resulting in concentration of risk, including investments in specific markets or products without liquidity. Our access to funds also may be impaired if regulatory authorities take significant action against us, or if we discover that one of our employees has engaged in serious unauthorized or illegal activity.
In the future, we may need to incur debt or issue equity in order to fund our working capital requirements, as well as to execute our growth initiatives that may include acquisitions and other investments. Similarly, our access to funding sources may be contingent upon terms and conditions that may limit or restrict our business activities and growth initiatives. In addition, we currently do not have a credit rating, which could adversely affect our liquidity and competitive position by increasing our borrowing costs and limiting access to sources of liquidity that require a credit rating as a condition to providing funds.
If we are unable to obtain necessary funding, or if the funding we obtain is on terms and conditions unfavorable to us, it could negatively affect our business activities and operations, and our ability to pursue certain growth initiatives and make certain capital decisions, including the decision whether to pay future dividends to our shareholders, as well as our future financial condition or results of operations.
Concentration of risk increases the potential for significant losses.
Concentration of risk increases the potential for significant losses in our sales and trading, alternative asset management, merchant banking, credit underwriting and syndication platform, and underwriting businesses. We have committed capital to these businesses, and we may take substantial positions in particular types of securities and/or issuers. This concentration of risk may cause us to suffer losses even when economic and market conditions are generally favorable for our competitors. Further, disruptions in the credit markets can make it difficult to hedge exposures effectively and economically.
Our businesses, profitability and liquidity may be adversely affected by deterioration in the credit quality of, or defaults by, third parties who owe us money, securities or other assets.
The nature of our businesses exposes us to credit risk, or the risk that third parties who owe us money, securities or other assets will not perform their obligations. These parties may default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other reasons. Deterioration in the credit quality of securities or obligations we hold could result in losses and adversely affect our ability to rehypothecate or otherwise use those securities or obligations for liquidity purposes. A significant downgrade in the credit ratings of our counterparties could also have a negative impact on our results. Default rates, downgrades and disputes with counterparties as to the valuation of collateral tend to increase in times of market stress and illiquidity. Although we review credit exposures to specific clients and counterparties and to specific industries that we believe may present credit concerns, default risk may arise from events or circumstances that are difficult to detect or foresee. Also, concerns about, or a default by, one institution generally leads to losses, significant liquidity problems, or defaults by other institutions, which in turn could adversely affect our business.
Particular activities or products within our business expose us to increased credit risk, including inventory positions, interest rate swap contracts with customer credit exposure, counterparty risk with one major financial institution related to customer interest rate swap contracts without customer credit exposure, investment banking and advisory fee receivables, liquidity providers on variable rate demand notes we remarket, and similar activities. With respect to interest rate swap contracts with customer credit exposure, we have retained the credit exposure with four non-publicly rated counterparties totaling $24.0 million at December 31, 2020 as part of our matched-book interest rate swap program. In the event of a termination of the contract, the counterparty would owe us the applicable amount of the credit exposure. If our counterparty is unable to make its payment to us, we would still be obligated to pay our hedging counterparty, resulting in credit losses. Non-performance by our counterparties, clients and others, including with respect to our inventory positions and interest rate swap contracts with customer credit exposures, could result in losses, potentially material, and thus have a significant adverse effect on our business and results of operations.
In addition, reliance on revenues from hedge funds and hedge fund advisors, which are less regulated than many investment company and investment advisor clients, may expose us to greater risk of financial loss from unsettled trades than is the case with other types of institutional investors. Concentration of risk may result in losses to us even when economic and market conditions are generally favorable for others in our industry.
An inability to readily divest trading positions may result in financial losses to our business.
Timely divestiture of our trading positions, including equity, fixed income and other securities positions, can be impaired by decreased trading volume, increased price volatility, rapid changes in interest rates, concentrated trading positions, limitations on the ability to divest positions in highly specialized or structured transactions and changes in industry and government regulations. While we hold a security, we are vulnerable to valuation fluctuations and may experience financial losses to the extent the value of the security decreases and we are unable to timely divest or hedge our trading position in that security. The value may decline as a result of many factors, including issuer-specific, market or geopolitical events. In addition, in times of market uncertainty, the inability to divest inventory positions may have an impact on our liquidity as funding sources generally become more restrictive, which could limit our ability to pledge the underlying security as collateral. Our liquidity may also be impacted if we choose to facilitate liquidity for specific products and voluntarily increase our inventory positions in order to do so, exposing ourselves to greater market risk and potential financial losses from the reduction in value of illiquid positions.
Our underwriting and alternative asset management activities expose us to risk of loss.
We engage in a variety of activities in which we commit or invest our own capital, including underwriting and alternative asset management. In our role as underwriter for equity and fixed income securities, we commit to purchase securities from the issuer or one or more holders of the issuer's securities, and then sell those securities to other investors or into the public markets, as applicable. Our underwriting activities, including bought deal transactions and equity block trading activities, expose us to the risk of loss if the price of the security falls below the price we purchased the security before we are able to sell all of the securities that we purchased. For example, as an underwriter, or, with respect to equity securities, a block positioner, we may commit to purchasing securities from an issuer or one or more holders of the issuer's securities without having found purchasers for some or all of the securities. In those instances, we may find that we are unable to sell the securities at a price equal to or above the price at which we purchased the securities, or with respect to certain securities, at a price sufficient to cover our hedges. With respect to alternative asset management, our ability to withdraw our capital from these investments may be limited, and we may not be able to realize our investment objectives by sale or disposition at attractive prices, increasing our
risk of losses. Our joint venture entities that underwrite and syndicate client debt may hold a portion of such debt after syndication, and our invested capital is exposed to a risk of loss to the extent that the debt is ultimately not repaid.
Our results from these activities may vary from quarter to quarter. We may incur significant losses from our underwriting and alternative asset management due to equity or fixed income market fluctuations and volatility from quarter to quarter, or from a deterioration in specific business subsectors or the economy more generally. In addition, we may engage in hedging transactions that, if not successful, could result in losses; and the hedges we purchase to counterbalance market rate changes in certain inventory positions are not perfectly matched to the positions being hedged, which could result in losses.
Use of derivative instruments as part of our financial risk management techniques may not effectively hedge the risks associated with activities in certain of our businesses.
We use interest rate swaps, interest rate locks, U.S. Treasury bond futures and options, and equity option contracts as a means to manage risk in certain inventory positions and to facilitate customer transactions. With respect to risk management, we enter into derivative contracts to hedge interest rate and market value risks associated with our security positions, including fixed income inventory positions we hold both for facilitating client activity. The instruments currently use interest rates based upon the Municipal Market Data ("MMD"), London Interbank Offered Rate ("LIBOR") or Securities Industry and Financial Markets Association ("SIFMA") index. Generally, we do not hedge all of our interest rate risk. In addition, these hedging strategies may not work in all market environments and as a result may not be effective in mitigating interest rate and market value risk, especially when market volatility reduces the correlation between a hedging vehicle and the securities inventory being hedged.
There are risks inherent in our use of these products, including counterparty exposure and basis risk. Counterparty exposure refers to the risk that the amount of collateral in our possession on any given day may not be sufficient to fully cover the current value of the swaps if a counterparty were to suddenly default. Basis risk refers to risks associated with swaps where changes in the value of the swaps may not exactly mirror changes in the value of the cash flows they are hedging. We may incur losses from our exposure to derivative interest rate products and the increased use of these products in the future.
The use of estimates and valuations in measuring fair value involve significant estimation and judgment by management.
We make various estimates that affect reported amounts and disclosures. Broadly, those estimates are used in measuring fair value of certain financial instruments, investments in private companies, accounting for goodwill and intangible assets, establishing provisions for potential losses that may arise from litigation, and regulatory proceedings and tax examinations. Estimates are based on available information and judgment. Therefore, actual results could differ from our estimates and that difference could have a material effect on our consolidated financial statements. With respect to accounting for goodwill, we complete our annual goodwill and intangible asset impairment testing in the fourth quarter of each year or earlier if impairment indicators are present. Impairment charges resulting from this valuation analysis could materially adversely affect our results of operations.
Financial instruments and other inventory positions owned, and financial instruments and other inventory positions sold but not yet purchased, are recorded at fair value, and unrealized gains and losses related to these financial instruments are reflected on our consolidated statements of operations. The fair value of a financial instrument is the amount at which the instrument could be exchanged in a transaction between market participants at the measurement date. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments' complexity. Difficult market environments may cause financial instruments to become substantially more illiquid and difficult to value, increasing the use of valuation models. Our future results of operations and financial condition may be adversely affected by the valuation adjustments that we apply to these financial instruments.
Investments in private companies are valued based on an assessment of each underlying security, considering rounds of financing, third party transactions and market-based information, including comparable company transactions, trading multiples (e.g., multiples of revenue and earnings before interest, taxes, depreciation, and amortization ("EBITDA")) and changes in market outlook, among other factors. These valuation techniques require significant management estimation and judgment.
Operational risk is the risk of loss, or damage to our reputation, resulting from inadequate or failed processes, people and systems or from external events. Such loss or reputational damage could negatively impact our future financial condition and results of operations. The following are those material operational risk factors that we have identified that could pose a risk to us.
Our information and technology systems, including outsourced systems, are critical components of our operations, and failure of those systems or other aspects of our operations infrastructure may disrupt our business, cause financial loss and constrain our growth.
We typically transact thousands of securities trades on a daily basis across multiple markets. Our data and transaction processing, financial, accounting and other technology and operating systems are essential to this task. A system malfunction (due to hardware failure, capacity overload, security incident, data corruption, etc.) or mistake made relating to the processing of transactions could result in financial loss, liability to clients, regulatory intervention, reputational damage and constraints on our ability to grow.
We operate under a fully disclosed model for all of our clearing operations. In a fully disclosed model, we act as an introducing broker for most customer transactions and rely on a clearing broker dealer to handle clearance and settlement of our customers' securities transactions. The clearing services provided by our clearing broker dealer, Pershing, are critical to our business operations, and similar to other important outsourced operations, any failure by the clearing agent with respect to the services we rely on it to provide could significantly disrupt and negatively impact our operations and financial results. We also contract with third parties for market data services, which constantly broadcast news, quotes, analytics and other relevant information to our employees, as well as other critical data processing activities. In the event that any of these service providers fails to adequately perform such services or the relationship between that service provider and us is terminated, we may experience a significant disruption in our operations, including our ability to timely and accurately process transactions or maintain complete and accurate records of those transactions.
Adapting or developing our technology systems to meet new regulatory requirements, client needs, geographic expansion and industry demands also is critical for our business. The introduction of new technologies presents new challenges on a regular basis. We have an ongoing need to upgrade and improve our various technology systems, including our data and transaction processing, financial, accounting, risk management, compliance, and trading systems. This need could present operational issues or require significant capital spending. It also may require us to make additional investments in technology systems and may require us to reevaluate the current value and/or expected useful lives of our technology systems, which could negatively impact our results of operations.
In 2020, nearly 90% of our workforce transitioned to a work-from-home environment in response to the COVID-19 pandemic, which entailed significant investments and potentially presented heightened cybersecurity, information security, and operational risks which we needed to manage. Although we successfully managed that transition, a similar disruption in the infrastructure that supports our business due to fire, natural disaster, health emergency (e.g., a disease pandemic), power or communication failure, act of terrorism or war may affect our ability to service and interact with our clients. If we are not able to implement contingency plans effectively, any such disruption could harm our results of operations.
Protection of our sensitive and confidential information is critical to our operations, and failure of those systems may disrupt our business, damage our reputation, and cause financial losses.
Our clients routinely provide us with sensitive and confidential information. Secure processing, storage and transmission of confidential and other information in our internal and outsourced computer systems and networks is critically important to our business. We take protective measures and endeavor to modify them as circumstances warrant. However, our computer systems, software and networks, and those of our clients, vendors, service providers, counterparties and other third parties, may be vulnerable to unauthorized access, cyber attacks, security breaches, computer viruses or other malicious code, inadvertent, erroneous or intercepted transmission of information (including by e-mail), human error, and other events that could have an information security impact. We work with our employees, clients, vendors, service providers, counterparties and other third parties to develop and implement measures designed to protect against such an event, but we may not be able to fully protect against such an event, and do not have, and may be unable to put in place, secure capabilities with all of these third parties and we may not be able to ensure that these third parties have appropriate controls in place to protect the confidentiality of the information. If one or more of such events occur, this potentially could jeopardize our or our clients' or counterparties' confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or
those of third parties, or otherwise cause interruptions or malfunctions in our, our clients', our counterparties' or third parties' operations. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to reputational harm as well as litigation, regulatory penalties, and financial losses that are either not insured against or not fully covered through any insurance maintained by us.
A failure to protect our computer systems, networks and information, and our clients' information, against cyber attacks, data breaches, and similar threats could impair our ability to conduct our businesses, result in the disclosure, theft or destruction of confidential information, damage our reputation and cause significant financial and legal exposure.
Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. There have been several highly publicized cases involving financial services companies, consumer-based companies and other companies, as well as governmental and political organizations, reporting breaches in the security of their websites, networks or other systems. We have not been immune from such events. Some of the publicized breaches have involved sophisticated and targeted cyber attacks intended to obtain unauthorized access to confidential information, destroy data, disrupt or degrade service, sabotage systems or cause other damage, including through the introduction of computer viruses, malware, ransomware, phishing, denial-of-service, and other means. There have also been several highly publicized cases where hackers have requested "ransom" payments in exchange for not disclosing customer information.
A successful penetration or circumvention of the security of our systems could cause serious negative consequences for us, including significant disruption of our operations and those of our clients, customers and counterparties; misappropriation of our confidential information or that of our clients, customers, counterparties or employees; or damage to our computers or systems and those of our clients, customers and counterparties; and could result in violations of applicable privacy and other laws, financial loss to us or to our customers, loss of confidence in our security measures, customer dissatisfaction, significant litigation exposure and reputational harm, all of which could have a material adverse effect on us.
We continuously monitor and develop our systems to protect our technology infrastructure and data from misappropriation or corruption. Despite our efforts to ensure the integrity of our systems and information, we have not been and may not be able to anticipate, detect or implement effective preventive measures against all cyber threats, especially because the techniques used are increasingly sophisticated, change frequently, and are often not recognized until months after the attack. Cyber attacks can originate from a variety of sources, including third parties who are affiliated with foreign governments or employees acting negligently or in a manner adverse to our interests. Third parties may seek to gain access to our systems either directly or using equipment or security passwords belonging to employees, customers, third party service providers or other users of our systems. In addition, due to our interconnectivity with third party vendors, central agents, exchanges, clearing houses and other financial institutions, we could be adversely impacted if any of them are subject to a successful cyber attack or other information security event.
Although we take protective measures and endeavor to modify them as circumstances warrant, our computer systems, software and networks have been and may be vulnerable to unauthorized access, misuse, computer viruses or other malicious code and other events that could have a security impact. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities, exposures, or information security events. Due to the complexity and interconnectedness of our systems, the process of enhancing our protective measures can itself create a risk of systems disruptions and security issues.
The increased use of cloud technologies can heighten these and other operational risks. Certain aspects of the security of such technologies are unpredictable or beyond our control, and this lack of transparency may inhibit our ability to discover a failure by cloud service providers to adequately safeguard their systems and prevent cyber attacks that could disrupt our operations and result in misappropriation, corruption or loss of confidential and other information. In addition, there is a risk that encryption and other protective measures, despite their sophistication, may be defeated, particularly to the extent that new computing technologies vastly increase the speed and computing power available.
Risk management processes may not fully mitigate exposure to the various risks that we face.
We refine our risk management techniques, strategies and assessment methods on an ongoing basis. However, risk management techniques and strategies, both ours and those available to the market generally, may not be fully effective in identifying and mitigating our risk exposure in all economic market environments or against all types of risk. For example, we may fail to identify or anticipate particular risks that our systems are capable of identifying, or the systems that we use, and that are used within the industry generally, may not be capable of identifying certain risks, or every economic and financial outcome, or the specifics and timing of such outcomes. In addition, our risk management techniques and strategies seek to balance our ability to
profit from our market-making and investing positions with our exposure to potential losses. Some of our strategies for managing risk are based upon our use of observed historical market behavior. We apply statistical and other tools to these observations to quantify our risk exposure. Any failures in our risk management techniques and strategies to accurately quantify our risk exposure could limit our ability to manage risks. In addition, any risk management failures could cause our losses to be significantly greater than the historical measures indicate. Further, our quantified modeling does not take all risks into account. Our more qualitative approach to managing those risks could prove insufficient, exposing us to material unanticipated losses.
The financial services industry and the markets in which we operate are subject to systemic risk that could adversely affect our business and results.
Participants in the financial services industry and markets increasingly are closely interrelated as a result of credit, trading, clearing, technology and other relationships between them. A significant adverse development with one participant (such as a bankruptcy or default) may spread to others and lead to significant concentrated or market-wide problems (such as defaults, liquidity problems or losses) for other industry participants, including us. Further, the control and risk management infrastructure of the markets in which we operate often is outpaced by financial innovation and growth in new types of securities, transactions and markets. Systemic risk is inherently difficult to assess and quantify, and its form and magnitude can remain unknown for significant periods of time.
Failure to maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act could materially affect our business.
We have documented and tested our internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act"), which requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent auditors regarding our internal control over financial reporting. We are in compliance with Section 404 of the Sarbanes-Oxley Act as of December 31, 2020. However, if we fail to maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Failure to maintain an effective internal control environment could materially adversely affect our business.
Legal and Regulatory Risk
Legal and regulatory risk includes the risk of non-compliance with applicable legal and regulatory requirements and the loss to our reputation we may suffer as a result of failure to comply with laws, regulations, rules, related SRO standards and codes of conduct applicable to our business activities. It also includes the risk that legislation could reduce or eliminate certain business activities that we are currently engaged in, which could negatively impact our future financial condition or results of operation. The following are those material legal and regulatory risk factors that we have identified that could pose a risk to us.
Our industry is exposed to significant legal liability, which could lead to substantial damages.
We face significant legal risks in our businesses. These risks include potential liability under securities laws and regulations in connection with our capital markets, asset management and other businesses. The volume and amount of damages claimed in litigation, arbitrations, regulatory enforcement actions and other adversarial proceedings against financial services firms has historically been intense. Our experience has been that adversarial proceedings against financial services firms typically increase during and following a market downturn. We also are subject to claims from disputes with our employees and our former employees under various circumstances. Risks associated with legal liability often are difficult to assess or quantify and their existence and magnitude can remain unknown for significant periods of time, making the amount of legal reserves related to these legal liabilities difficult to determine and subject to future revision. Legal or regulatory matters involving our directors, officers or employees in their individual capacities also may create exposure for us because we may be obligated or may choose to indemnify the affected individuals against liabilities and expenses they incur in connection with such matters to the extent permitted under applicable law. In addition, like other financial services companies, we may face the possibility of employee fraud or misconduct. The precautions we take to prevent and detect this activity may not be effective in all cases and there can be no assurance that we will be able to deter or prevent fraud or misconduct. Exposures from and expenses incurred related to any of the foregoing actions or proceedings could have a negative impact on our results of operations and financial condition. In addition, future results of operations could be adversely affected if reserves relating to these legal liabilities are required to be increased or legal proceedings are resolved in excess of established reserves.
Our business is subject to extensive regulation in the jurisdictions in which we operate, and a significant regulatory action against our company may have a material adverse financial effect on, cause significant reputational harm to, or result in other collateral consequences for our company.
As a participant in the financial services industry, we are subject to complex and extensive regulation of many aspects of our business by U.S. federal and state regulatory agencies, SROs (including securities exchanges) and by foreign governmental agencies, regulatory bodies and securities exchanges. Specifically, our operating subsidiaries include broker dealer and related securities entities organized in the United States, the United Kingdom, and Hong Kong. Each of these entities is registered or licensed with the applicable local regulator and is subject to all of the applicable rules and regulations promulgated by those authorities. In addition, our asset management subsidiaries, PJIM, PSC Capital Partners LLC, Piper Sandler Advisors LLC, Piper Heartland Healthcare Capital LLC and Piper Sandler Finance Management LLC, as well as Piper Sandler & Co., are registered as investment advisors with the SEC and subject to the regulation and oversight by the SEC, and we have an additional asset management subsidiary subject to regulation in Guernsey.
Generally, the requirements imposed by our regulators are designed to ensure the integrity of the financial markets and to protect customers and other third parties who deal with us. These requirements are not designed to protect our shareholders. Consequently, broker dealer regulations often serve to limit our activities, through net capital, customer protection and market conduct requirements and restrictions on the businesses in which we may operate or invest. We also must comply with asset management regulations, including requirements related to fiduciary duties to clients, record-keeping and reporting and customer disclosures. Compliance with many of these regulations entails a number of risks, particularly in areas where applicable regulations may be newer or unclear. In addition, regulatory authorities in all jurisdictions in which we conduct business may intervene in our business and we, and our employees, could be fined or otherwise disciplined for violations or prohibited from engaging in some of our business activities.
Our business also subjects us to the complex income and payroll tax laws of the national and local jurisdictions in which we have business operations, and these tax laws may be subject to different interpretations by the taxpayer and the relevant governmental taxing authorities. We must make judgments and interpretations about the application of these inherently complex tax laws when determining the provision for income and other taxes. We are subject to contingent tax risk that could adversely affect our results of operations, to the extent that our interpretations of tax laws are disputed upon examination or audit, and are settled in amounts in excess of established reserves for such contingencies.
The effort to combat money laundering also has become a high priority in governmental policy with respect to financial institutions. The obligation of financial institutions, including ourselves, to identify their customers, watch for and report suspicious transactions, respond to requests for information by regulatory authorities and law enforcement agencies, and share information with other financial institutions, has required the implementation and maintenance of internal practices, procedures and controls which have increased, and may continue to increase, our costs. Any failure with respect to our programs in this area could subject us to serious regulatory consequences, including substantial fines, and potentially other liabilities. In addition, our international operations require compliance with anti-bribery laws, including the Foreign Corrupt Practices Act and the U.K. Bribery Act 2010. These laws generally prohibit companies and their intermediaries from engaging in bribery or making other improper payments to foreign officials for the purpose of obtaining or retaining business or gaining an unfair business advantage. While our employees and agents are required to comply with these laws, we cannot ensure that our internal control policies and procedures will always protect us from intentional, reckless or negligent acts committed by our employees or agents, which acts could subject our company to fines or other regulatory consequences that could disrupt our operations and negatively impact our results of operations.
Legislative and regulatory proposals could significantly curtail the revenue from certain products that we currently provide or otherwise have a material adverse effect on our results of operations.
Proposed changes in laws or regulations relating to our business could decrease, perhaps significantly, the revenue that we receive from certain products or services that we provide, or otherwise have a material adverse effect on our results of operations. Both the healthcare and financial services sectors are significant contributors to our overall results, and negative developments in either of these sectors, including but not limited to negative developments that result from legislative or regulatory actions taken by the new U.S. presidential administration, could negatively affect our results of operations, even if general economic conditions were strong.
The business operations that we conduct outside of the United States subject us to unique risks.
When we conduct business outside the United States, we are subject to risks, including, without limitation, the risk that we will be unable to provide effective operational support to these business activities, the risk of noncompliance with foreign laws and regulations, and the general economic and political conditions in countries where we conduct business, which may differ significantly from those in the United States. For example, the effect of Brexit is still developing and could require us to obtain additional regulatory licenses or impose new restrictions on our ability to conduct business in Europe.
Regulatory capital requirements may limit our ability to expand or maintain our present levels of business or impair our ability to meet our financial obligations.
We are subject to the SEC's uniform net capital rule (Rule 15c3-1) and the net capital rule of FINRA, which may limit our ability to make withdrawals of capital from Piper Sandler & Co., our U.S. broker dealer subsidiary. The uniform net capital rule sets the minimum level of net capital a broker dealer must maintain and also requires that a portion of its assets be relatively liquid. FINRA may prohibit a member firm from expanding its business or paying cash dividends if resulting net capital falls below its requirements. Underwriting commitments require a charge against net capital and, accordingly, our ability to make underwriting commitments may be limited by the requirement that we must at all times be in compliance with the applicable net capital regulations.
As Piper Sandler Companies is a holding company, it depends on dividends, distributions and other payments from our subsidiaries to fund its obligations. The regulatory restrictions described above may impede access to funds our holding company needs to make payments on any such obligations.
Other Risks to Our Shareholders
The following are additional risk factors that we have identified that could pose a material risk to us or our shareholders.
We may change our dividend policy at any time and there can be no assurance that we will continue to declare cash dividends.
Our current dividend policy is to pay quarterly and annual cash dividends to our shareholders in order to return between 30 percent and 50 percent of our adjusted net income from each fiscal year to shareholders. Although we expect to pay dividends to our shareholders in accordance with our dividend policy, we have no obligation to pay any dividend, and our dividend policy may change at any time without notice. The declaration and payment of dividends is at the discretion of our board of directors in accordance with applicable law after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs and capital uses, limitations imposed by our indebtedness, legal requirements and other factors that our board of directors deems relevant. As a result, we may not pay dividends at any rate or at all.
Our stock price may fluctuate as a result of several factors, including but not limited to, changes in our revenues, operating results, and return on equity.
We have experienced, and expect to experience in the future, fluctuations in the market price of our common stock due to factors that relate to the nature of our business, including but not limited to changes in our revenues, operating results, earnings per share, and return on equity. Our business, by its nature, does not produce steady and predictable earnings on a quarterly basis, which may cause fluctuations in our stock price that may be significant. Other factors that have affected, and may further affect, our stock price include changes in or news related to economic, political, or market events or conditions, changes in market conditions in the financial services industry, including developments in regulation affecting our business, a predominantly passive or quantitative shareholder base among the company's top twenty shareholders, failure to meet the expectations of market analysts, changes in recommendations or outlooks by market analysts, and aggressive short selling.
Provisions in our amended and restated certificate of incorporation and amended and restated bylaws and of Delaware law may prevent or delay an acquisition of our company, which could decrease the market value of our common stock.
Our amended and restated certificate of incorporation and amended and restated bylaws and Delaware law contain provisions that are intended to deter abusive takeover tactics by making them unacceptably expensive to the raider and to encourage prospective acquirors to negotiate with our board of directors rather than to attempt a hostile takeover. These provisions include limitations on our shareholders' ability to act by written consent and to call special meetings. Delaware law also imposes some restrictions on mergers and other business combinations between us and any holder of 15 percent or more of our outstanding
common stock. We believe these provisions protect our shareholders from coercive or otherwise unfair takeover tactics by requiring potential acquirors to negotiate with our board of directors and by providing our board of directors with more time to assess any acquisition proposal, and are not intended to make our company immune from takeovers. However, these provisions apply even if the offer may be considered beneficial by some shareholders and could delay or prevent an acquisition that our board of directors determines is not in the best interests of our company and our shareholders.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
ITEM 2. PROPERTIES.
As of February 19, 2021, we conducted our operations through 63 principal offices in 30 states, and the District of Columbia, and in London, Aberdeen and Hong Kong. All of our offices are leased. Our principal executive office is located at 800 Nicollet Mall, Suite 900, Minneapolis, Minnesota 55402 and, as of February 19, 2021, comprises approximately 124,000 square feet of space under a lease which expires November 30, 2025, with an early termination option effective January 31, 2023.
ITEM 3. LEGAL PROCEEDINGS.
Due to the nature of our business, we are involved in a variety of legal proceedings. These proceedings include litigation, arbitration and regulatory proceedings, which may arise from, among other things, underwriting or other transactional activity, client account activity, employment matters, regulatory examinations of our businesses and investigations of securities industry practices by governmental agencies and SROs. The securities industry is highly regulated, and the regulatory scrutiny applied to securities firms is intense, resulting in a significant number of regulatory investigations and enforcement actions and uncertainty regarding the likely outcome of these matters.
Litigation-related expenses include amounts we reserve and/or pay out as legal and regulatory settlements, awards or judgments, and fines. Parties who initiate litigation and arbitration proceedings against us may seek substantial or indeterminate damages, and regulatory investigations can result in substantial fines being imposed on us. We reserve for contingencies related to legal proceedings at the time and to the extent we determine the amount to be probable and reasonably estimable. However, it is inherently difficult to predict accurately the timing and outcome of legal proceedings, including the amounts of any settlements, judgments or fines. We assess each proceeding based on its particular facts, our outside advisors' assessment and our past experience with similar matters, and expectations regarding the current legal and regulatory environment and other external developments that might affect the outcome of a particular proceeding or type of proceeding. Subject to the foregoing, we believe, based on our current knowledge, after appropriate consultation with outside legal counsel and taking into account our established reserves, that pending legal actions, investigations and regulatory proceedings, will be resolved with no material adverse effect on our consolidated financial condition, results of operations or cash flows. However, there can be no assurance that our assessments will reflect the ultimate outcome of pending proceedings, and the outcome of any particular matter may be material to our operating results for any particular period, depending, in part, on the operating results for that period and the amount of established reserves. Reasonably possible losses in excess of amounts accrued at December 31, 2020 are not material. We generally have denied, or believe that we have meritorious defenses and will deny, liability in all significant cases currently pending against us, and we intend to vigorously defend such actions.
ITEM 4. MINE SAFETY DISCLOSURES.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Our common stock is listed on the New York Stock Exchange under the symbol "PIPR."
We had 10,167 shareholders of record and approximately 30,137 beneficial owners of our common stock as of February 19, 2021.
Our board of directors has approved a dividend policy with the intention of returning between 30 percent and 50 percent of our adjusted net income from the previous fiscal year to shareholders. This includes the payment of a quarterly and an annual special cash dividend, payable in the first quarter of each year.
Our board of directors has declared a special cash dividend on our common stock of $1.85 per share related to 2020 adjusted net income. This special dividend will be paid on March 12, 2021, to shareholders of record as of the close of business on March 3, 2021. Including this special cash dividend and the regular quarterly dividends totaling $1.25 per share paid during 2020, we will have returned $3.10 per share, or approximately 31 percent of our fiscal year 2020 adjusted net income to shareholders. In addition, our board of directors has declared a quarterly cash dividend on our common stock of $0.40 per share to be paid on March 12, 2021, to shareholders of record as of the close of business on March 3, 2021.
Our board of directors is free to change our dividend policy at any time. Restrictions on our U.S. broker dealer subsidiary's ability to pay dividends are described in Note 23 to the consolidated financial statements included in Part II, Item 8 of this Form 10-K.
Purchases of Equity Securities
The table below sets forth the information with respect to purchases made by or on behalf of Piper Sandler Companies or any "affiliated purchaser" (as defined in Rule 10b-18(a)(3) under the Exchange Act), of our common stock during the quarter ended December 31, 2020.
|Total Number of Shares||Approximate Dollar|
|Purchased as Part of||Value of Shares Yet to be|
|Total Number of||Average Price||Publicly Announced||Purchased Under the|
|Period||Shares Purchased||Paid per Share||Plans or Programs|
Plans or Programs (1)
|(October 1, 2020 to October 31, 2020)||— ||$||— ||— ||$||137 |
|(November 1, 2020 to November 30, 2020)||2,637 ||$||92.60 ||— ||$||137 |
|(December 1, 2020 to December 31, 2020)||— ||$||— ||— ||$||137 |
|Total||2,637 ||$||92.60 ||— ||$||137 |
(1)Effective January 1, 2020, our board of directors authorized the repurchase of up to $150.0 million of common stock through December 31, 2021.
Stock Performance Graph
This performance graph shall not be deemed "soliciting material" or to be "filed" with the SEC for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Exchange Act.
The following graph compares the performance of an investment in our common stock from December 31, 2015 through December 31, 2020, with the S&P 500 Index and the S&P 500 Diversified Financials Index. The graph assumes $100 was invested on December 31, 2015, in each of our common stock, the S&P 500 Index and the S&P 500 Diversified Financials Index and that all dividends were reinvested on the date of payment without payment of any commissions. The performance shown in the graph represents past performance and should not be considered an indication of future performance.
FIVE YEAR TOTAL RETURN FOR PIPER SANDLER COMPANIES COMMON STOCK,
THE S&P 500 INDEX AND THE S&P DIVERSIFIED FINANCIALS INDEX
|Piper Sandler Companies||$||100 ||$||179.46 ||$||217.54 ||$||172.52 ||$||213.72 ||$||277.06 |
|S&P 500 Index||100 ||111.96 ||136.40 ||130.42 ||171.49 ||203.04 |
|S&P 500 Diversified Financials||100 ||120.55 ||150.56 ||135.62 ||168.94 ||188.14 |
ITEM 6. SELECTED FINANCIAL DATA.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following information should be read in conjunction with the accompanying audited consolidated financial statements and related notes and exhibits included elsewhere in this Form 10-K. Certain statements in this Form 10-K may be considered forward-looking. See "Cautionary Note Regarding Forward-Looking Statements" in this Form 10-K for additional information regarding such statements and related risks and uncertainties.
Item 7 in this Form 10-K discusses our 2020 and 2019 results and the year-over-year comparisons between 2020 and 2019. Discussion of our 2018 results and the year-over-year comparisons between 2019 and 2018 can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on February 28, 2020.
Explanation of Non-GAAP Financial Measures
We have included financial measures that are not prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). These non-GAAP financial measures include adjustments to exclude (1) revenues and expenses related to noncontrolling interests, (2) interest expense on long-term financing from net revenues, (3) amortization of intangible assets related to acquisitions, (4) compensation and non-compensation expenses from acquisition-related agreements, (5) acquisition-related restructuring and integration costs and (6) discontinued operations. The adjusted weighted average diluted shares outstanding used in the calculation of non-GAAP earnings per diluted common share contains an adjustment to include the common shares for unvested restricted stock awards with service conditions granted pursuant to the acquisitions of SOP Holdings, LLC and its subsidiaries, including Sandler O'Neill & Partners, L.P. (collectively, "Sandler O'Neill") and The Valence Group ("Valence"). These adjustments affect the following financial measures: net revenues, compensation expenses, non-compensation expenses, income tax expense, net income applicable to Piper Sandler Companies, earnings per diluted common share, non-interest expenses, pre-tax income and pre-tax margin. Management believes that presenting these results and measures on an adjusted basis in conjunction with the corresponding U.S. GAAP measures provides the most meaningful basis for comparison of our operating results across periods and enhances the overall understanding of our current financial performance by excluding certain items that may not be indicative of our core operating results. The non-GAAP financial measures should be considered in addition to, not as a substitute for, measures of financial performance prepared in accordance with U.S. GAAP.
Overview of Operations – Our continuing operations principally consist of providing investment banking and institutional brokerage services to corporations, private equity groups, public entities, non-profit entities and institutional investors in the United States and Europe. We operate through one reportable business segment.
Investment banking services include financial advisory services, management of and participation in underwritings and municipal financing activities. Revenues are generated through the receipt of advisory and financing fees. Institutional sales, trading and research services focus on the trading of equity and fixed income products with institutions, government and non-profit entities. Revenues are generated through commissions and sales credits earned on equity and fixed income institutional sales activities, net interest revenues on trading securities held in inventory, profits and losses from trading these securities, and research checks as clients pay us for research services and corporate access offerings. Also, we have historically generated revenue through strategic trading activities, which focused on investments in municipal bonds; however, we ceased these activities in the first half of 2020. In order to invest firm capital and to manage capital from outside investors, we have created alternative asset management funds in merchant banking, which involve equity investments in late stage private companies, and in the energy sector, whose principal activity is to invest in oil and gas services companies headquartered in Europe. We receive management and performance fees for managing these funds, as well as investment gains and losses.
Discontinued Operations – Discontinued operations includes the operating results of ARI, our traditional asset management subsidiary which we sold in the third quarter of 2019. See Note 5 to our consolidated financial statements included in Part II, Item 8 of this Form 10-K for further discussion of our discontinued operations.
Our Business Strategy – Our long-term strategic objectives are to drive revenue growth, build a stronger and more durable platform, continue to gain market share, and maximize shareholder value. In order to meet these objectives, we are focused on the following:
•Continuing to transform our business through strategic investments and selectively adding partners who share our client-centric culture and who can leverage our platform to better serve clients;
•Growing our investment banking platform through market share gains, accretive combinations, developing internal talent, and continued sector and geographic expansion. We also believe there is an opportunity to capitalize on the strength of our U.S. franchises by expanding in Europe;
•Leveraging the scale within the equity brokerage and fixed income services platforms, driven by our recently expanded client base and product offerings, to grow market share; and
•Prudently managing capital to maintain our balance sheet strength with ample liquidity and flexibility through all market conditions.
Strategic Activities – During 2019 and 2020, we took the following important steps in the execution of our business strategy.
•On December 31, 2020, we completed the acquisition of TRS Advisors LLC ("TRS"), an advisory firm offering restructuring and reorganization services to companies in public, private and governmental settings. The transaction expands the scale of our restructuring advisory business.
•On April 3, 2020, we completed the acquisition of Valence, an investment bank offering mergers and acquisitions advisory services to companies and financial sponsors with a focus on the chemicals, materials and related sectors. The transaction adds a new industry sector and expands our presence in Europe.
•On January 3, 2020, we completed the acquisition of Sandler O'Neill, a full-service investment banking firm and broker dealer focused on the financial services industry. The acquisition of Sandler O'Neill is accretive to our advisory services revenues, diversifies and enhances scale in corporate financings, adds a differentiated fixed income services business, and increases scale in our equity brokerage business.
•On August 2, 2019, we completed the acquisition of Weeden & Co. L.P. ("Weeden & Co."). Weeden & Co. is a broker dealer focused on providing institutional clients with global trading solutions, specializing in best execution through the use of high-touch, low-touch and program trading capabilities. The transaction added enhanced trade execution capabilities and scale to our equity brokerage business.
|Year Ended December 31,|
|(Amounts in thousands, except per share data)||2020|
|Net revenues||$||1,238,213 ||$||834,566 ||48.4 ||%|
Compensation and benefits
|877,462 ||516,090 ||70.0 |
|292,203 ||199,497 ||46.5 |
|Income from continuing operations before income tax expense||68,548 ||118,979 ||(42.4)|
|Net income applicable to Piper Sandler Companies||40,504 ||111,711 ||(63.7)|
|Earnings per diluted common share||$||2.72 ||$||7.69 ||(64.6)|
|Ratios and margin|
| Compensation ratio||70.9 ||%||61.8 ||%|
| Non-compensation ratio||23.6 ||%||23.9 ||%|
| Pre-tax margin||5.5 ||%||14.3 ||%|
|Adjusted net revenues||$||1,234,960 ||$||825,645 ||49.6 ||%|
Adjusted compensation and benefits
|764,066 ||510,952 ||49.5 |
Adjusted non-compensation expenses
|220,606 ||176,458 ||25.0 |
|Adjusted operating income||250,288 ||138,235 ||81.1 |
Adjusted net income applicable to Piper Sandler Companies
|177,555 ||106,197 ||67.2 |
Adjusted earnings per diluted common share
|$||10.02 ||$||7.36 ||36.1 |
|Adjusted ratios and margin|
|Adjusted compensation ratio||61.9 ||%||61.9 ||%|
|Adjusted non-compensation ratio||17.9 ||%||21.4 ||%|
|Adjusted operating margin||20.3 ||%||16.7 ||%|
See the "Results of Operations" section for additional information.
(1)Reconciliation of U.S. GAAP to adjusted non-GAAP financial information
|Year Ended December 31,|
|(Amounts in thousands, except per share data)||2020||2019|
| Net revenues:|
|Net revenues – U.S. GAAP basis||$||1,238,213 ||$||834,566 |
|Revenue related to noncontrolling interests||(12,881)||(10,769)|
|Interest expense on long-term financing||9,628 ||1,848 |
|Adjusted net revenues||$||1,234,960 ||$||825,645 |
Compensation and benefits:
|Compensation and benefits – U.S. GAAP basis||$||877,462 ||$||516,090 |
Compensation from acquisition-related agreements
Adjusted compensation and benefits
|$||764,066 ||$||510,952 |
|Non-compensation expenses – U.S. GAAP basis||$||292,203 ||$||199,497 |
|Non-compensation expenses related to noncontrolling interests||(4,029)||(4,306)|
Acquisition-related restructuring and integration costs
Amortization of intangible assets related to acquisitions
Non-compensation expenses from acquisition-related agreements
|Adjusted non-compensation expenses||$||220,606 ||$||176,458 |
|Income from continuing operations before income tax expense:|
|Income from continuing operations before income tax expense – U.S. GAAP basis||$||68,548 ||$||118,979 |
|Revenue related to noncontrolling interests||(12,881)||(10,769)|
|Interest expense on long-term financing||9,628 ||1,848 |
|Non-compensation expenses related to noncontrolling interests||4,029 ||4,306 |
|Compensation from acquisition-related agreements||113,396 ||5,138 |
|Acquisition-related restructuring and integration costs||10,755 ||14,321 |
|Amortization of intangible assets related to acquisitions||44,728 ||4,298 |
|Non-compensation expenses from acquisition-related agreements||12,085 ||114 |
|Adjusted operating income||250,288 ||138,235 |
|Interest expense on long-term financing||(9,628)||(1,848)|
|Adjusted income before adjusted income tax expense||$||240,660 ||$||136,387 |
|Net income applicable to Piper Sandler Companies:|
|Net income applicable to Piper Sandler Companies – U.S. GAAP basis||$||40,504 ||$||111,711 |
|Adjustment to exclude net income from discontinued operations||— ||23,772 |
|Net income from continuing operations||$||40,504 ||$||87,939 |
|Compensation from acquisition-related agreements||85,940 ||4,124 |
|Acquisition-related restructuring and integration costs||8,712 ||10,770 |
|Amortization of intangible assets related to acquisitions||33,383 ||3,250 |
|Non-compensation expenses from acquisition-related agreements||9,016 ||114 |
|Adjusted net income applicable to Piper Sandler Companies||$||177,555 ||$||106,197 |
|Year Ended December 31,|
|(Amounts in thousands, except per share data)||2020||2019|
|Earnings per diluted common share:|
|Earnings per diluted common share – U.S. GAAP basis||$||2.72 ||$||7.69 |
|Adjustment to exclude net income from discontinued operations||— ||1.65 |
|Income from continuing operations||$||2.72 ||$||6.05 |
|Adjustment for inclusion of unvested acquisition-related stock||(1.89)||— |
|Adjustment related to participating shares (1)||— ||0.04 |
|$||0.83 ||$||6.09 |
|Compensation from acquisition-related agreements||5.76 ||0.29 |
|Acquisition-related restructuring and integration costs||0.58 ||0.75 |
|Amortization of intangible assets related to acquisitions||2.24 ||0.23 |
|Non-compensation expenses from acquisition-related agreements||0.61 ||0.01 |
|Adjusted earnings per diluted common share||$||10.02 ||$||7.36 |
|Weighted average diluted common shares outstanding:|
|Weighted average diluted common shares outstanding – U.S. GAAP basis||14,901 ||13,937 |
|Unvested acquisition-related restricted stock with service conditions||2,814 ||— |
|Adjusted weighted average diluted common shares outstanding||17,715 ||13,937 |
(1) A non-GAAP measure for which the adjustment related to participating shares excludes the impact of the annual special cash dividend paid in the first quarter.
The following table provides a summary of relevant market data over the past three years.
S&P 500 (a)
|3,756 ||3,231 ||2,507 ||16.2 ||%||28.9 ||%|
|12,888 ||8,973 ||6,635 ||43.6 ||%||35.2 ||%|
Mergers and Acquisitions - Middle Market
(number of transactions in U.S.) (b)
|2,971 ||3,009 ||3,051 ||(1.3)||%||(1.4)||%|
Public Equity Offerings
(number of transactions in U.S.) (c)
|1,285 ||887 ||979 ||44.9 ||%||(9.4)||%|
Initial Public Offerings
(number of transactions in U.S.) (d)
|436 ||206 ||226 ||111.7 ||%||(8.8)||%|
|U.S. Equity Capital Markets Fee Pool - Sub-$5 billion|
(dollars in millions) (e)
|$||9,014 ||$||4,379 ||$||5,009 ||105.8 ||%||(12.6)||%|
|Municipal Negotiated Issuances|
(number of transactions in U.S.) (f)
|8,861 ||7,505 ||5,872 ||18.1 ||%||27.8 ||%|
|Municipal Negotiated Issuances|
(value of transactions in billions in U.S.) (f)
|$||390 ||$||327 ||$||264 ||19.2 ||%||23.9 ||%|
Average CBOE Volatility Index (VIX)
|29 ||15 ||17 ||93.3 ||%||(11.8)||%|
NYSE Average Daily Number of Shares Traded
(millions of shares)
|2,402 ||1,690 ||1,708 ||42.1 ||%||(1.1)||%|
Nasdaq Average Daily Number of Shares Traded
(millions of shares)
|2,010 ||1,381 ||1,428 ||45.5 ||%||(3.3)||%|
10-Year Treasury Average Rate
|0.81 ||%||2.14 ||%||2.91 ||%||(62.1)||%||(26.5)||%|
|3-Month Treasury Average Rate||0.25 ||%||2.11 ||%||1.97 ||%||(88.2)||%||7.1 ||%|
Average 10-Year Municipal-Treasury Ratio (g)
|1.22 ||0.79 ||0.85 ||54.4 ||%||(7.1)||%|
(a)Data provided is at period end.
(b)Source: Refinitiv (transactions with reported deal value between $100 million and $1 billion and transactions with an undisclosed deal value that had a financial advisor).
(c)Source: Dealogic and Piper Sandler Equity Capital Markets (IPOs, follow-on offerings and convertible offerings with reported deal value greater than $10 million).
(d)Source: Dealogic and Piper Sandler Equity Capital Markets (offerings with reported deal value greater than $10 million).
(e)Source: Dealogic and Piper Sandler Equity Capital Markets (IPOs, follow-on offerings and convertible offerings with deal values greater than $10 million and PIPEs/RDs greater than $5 million for sub-$5 billion market cap issuers; SPAC IPO fees are represented as the standard two percent upfront fee unless noted differently on the IPO cover).
(f)Source: Refinitiv (sole/senior negotiated and private placement transactions).
(g)Calculated based on the 10-year Municipal Market Data (MMD) index rate divided by the 10-year treasury rate.
External Factors Impacting Our Business
Performance in the financial services industry in which we operate is highly correlated to the overall strength of economic conditions and financial market activity. Overall market conditions are a product of many factors, which are beyond our control, often unpredictable and at times inherently volatile. These factors may affect the financial decisions made by investors, including their level of participation in the financial markets. In turn, these decisions may affect our business results. With respect to financial market activity, our profitability is sensitive to a variety of factors, including the demand for investment banking services as reflected by the number and size of advisory transactions, equity and debt corporate financings, and municipal financings; the relative level of volatility of the equity and fixed income markets; changes in interest rates and credit spreads (especially rapid and extreme changes); overall market liquidity; the level and shape of various yield curves; the volume and value of trading in securities; and overall equity valuations.
Factors that differentiate our business within the financial services industry also may affect our financial results. For example, our capital markets business focuses on specific industry sectors while serving principally middle-market clientele. If the business environment for our focus sectors is impacted adversely, our business and results of operations could reflect these impacts. In addition, our business, with its specific areas of focus and investment, may not track overall market trends. Given the variability of the capital markets and securities businesses, our earnings may fluctuate significantly from period to period, and results for any individual period should not be considered indicative of future results.
Outlook for 2021
On March 11, 2020, the World Health Organization characterized the COVID-19 outbreak as a global pandemic. The COVID-19 pandemic has affected major economic and financial markets, and businesses and governments continue to face challenges associated with the economic conditions resulting from efforts to address it. Global macroeconomic conditions have been significantly impacted by the government-mandated closure of businesses and the subsequent reopening of the economy with new protocols for social interaction, supply chain and production disruptions, job losses, reduced consumer spending and sentiment, and a myriad of other factors.
The U.S. federal government passed legislation in the first and fourth quarters of 2020 attempting to mitigate some of the economic hardship caused by the COVID-19 pandemic, with the potential for additional legislation and stimulus measures in 2021. The U.S. Federal Reserve took extraordinary steps in 2020 to provide liquidity in the financial markets, including cutting the short-term benchmark interest rate to zero and launching a new round of quantitative easing. After historic volatility in the first quarter of 2020, equity markets rebounded and fixed income markets stabilized, aided by the record levels of federal monetary and fiscal support. In the third quarter of 2020, the U.S. Federal Reserve announced it would keep the benchmark interest rate at its current low level for an extended period of time, and maintained their quantitative easing measures.
After the unprecedented shock to the economy in 2020 from COVID-19, we expect the economy to improve in 2021, likely weighted towards the second half of the year. However, economic recovery and growth will be dependent on the trajectory of vaccine distribution and administration. The results of the recent U.S. elections will also influence future legislative actions and policies which, in part, may impact economic growth. Geopolitical and macroeconomic risks, such as uncertainties surrounding trade policy and other global economic conditions, remain in the background and will continue to have an ongoing impact to the U.S. and global economy.
Market conditions continued to be favorable for corporate capital raising in the fourth quarter of 2020 driven by strong investor demand and market valuations. We believe equity and debt capital raising activity will remain strong in 2021 albeit at reduced levels from 2020.
Advisory services revenues rebounded in the fourth quarter of 2020 from the trough we experienced during the third quarter of 2020. Advisory services activity is benefiting from increased CEO confidence and more clarity on a post-pandemic outlook. Market conditions remain conducive for activity in the middle market due to attractive valuations, low financing rates and an expectation of continued economic growth. Our pipeline is strong across our industry verticals.
In our equity brokerage business, revenues for 2020 reflected substantially increased levels of volatility and volumes. We believe our equity brokerage revenues will decline in 2021 as institutional trading volumes moderate from the elevated 2020 levels. We also expect the equity brokerage fee pool will be down in 2021.
The actions taken by the U.S. Federal Reserve to inject liquidity into the financial markets and to keep interest rates low allowed for stability in the fixed income markets after the first quarter of 2020. We anticipate less volatility in 2021 which will reduce volumes and commission spreads. We will continue to provide our clients with differentiated advice and analytics on repositioning balance sheets, maximizing yields and managing risk in the current market environment.
Our public finance underwriting business benefited from market stability, low yields, robust refinancing activity and strong investor demand in 2020. We believe that market issuance volumes in 2021 will moderate from the record levels in 2020, especially within the governmental space. Revenues from higher-yielding municipal offerings should increase as high yield investor demand has improved meaningfully. Issuer capital needs, interest rate yields, rate stability and client demand will continue to be the principal drivers of the level of municipal finance activity going forward.
Results of Operations
The following table provides a summary of the results of our operations on a U.S. GAAP basis and the results of our operations as a percentage of net revenues for the periods indicated.
|As a Percentage of|
|Net Revenues for the|
|Year Ended December 31,||Year Ended December 31,|
|(Amounts in thousands)||2020||2019||2018||v2019||v2018||2020||2019||2018|
|Investment banking||$||858,476 ||$||629,392 ||$||588,978 ||36.4 ||%||6.9 ||%||69.3 ||%||75.4 ||%||79.5 ||%|
|Institutional brokerage||357,753 ||167,891 ||124,738 ||113.1 ||34.6 ||28.9 ||20.1 ||16.8 |
|Interest income||13,164 ||26,741 ||32,749 ||(50.8)||(18.3)||1.1 ||3.2 ||4.4 |
|Investment income||23,265 ||22,275 ||11,039 ||4.4 ||101.8 ||1.9 ||2.7 ||1.5 |
|Total revenues||1,252,658 ||846,299 ||757,504 ||48.0 ||11.7 ||101.2 ||101.4 ||102.2 |
|Interest expense||14,445 ||11,733 ||16,551 ||23.1 ||(29.1)||1.2 ||1.4 ||2.2 |
|Net revenues||1,238,213 ||834,566 ||740,953 ||48.4 ||12.6 ||100.0 ||100.0 ||100.0 |
|Compensation and benefits||877,462 ||516,090 ||488,487 ||70.0 ||5.7 ||70.9 ||61.8 ||65.9 |
|Outside services||38,377 ||36,184 ||36,528 ||6.1 ||(0.9)||3.1 ||4.3 ||4.9 |
|Occupancy and equipment||54,007 ||36,795 ||34,194 ||46.8 ||7.6 ||4.4 ||4.4 ||4.6 |
|Communications||44,358 ||30,760 ||28,656 ||44.2 ||7.3 ||3.6 ||3.7 ||3.9 |
Marketing and business development
|13,472 ||28,780 ||26,936 ||(53.2)||6.8 ||1.1 ||3.4 ||3.6 |
|Deal-related expenses||38,072 ||25,823 ||25,120 ||47.4 ||2.8 ||3.1 ||3.1 ||3.4 |
|Trade execution and clearance||18,934 ||10,186 ||8,014 ||85.9 ||27.1 ||1.5 ||1.2 ||1.1 |
|Restructuring and integration costs||10,755 ||14,321 ||3,498 ||(24.9)||309.4 ||0.9 ||1.7 ||0.5 |
Intangible asset amortization
|44,728 ||4,298 ||4,858 ||940.7 ||(11.5)||3.6 ||0.5 ||0.7 |
|Other operating expenses||29,500 ||12,350 ||12,173 ||138.9 ||1.5 ||2.4 ||1.5 ||1.6 |
|Total non-interest expenses||1,169,665 ||715,587 ||668,464 ||63.5 ||7.0 ||94.5 ||85.7 ||90.2 |
|Income from continuing operations before income tax expense||68,548 ||118,979 ||72,489 ||(42.4)||64.1 ||5.5 ||14.3 ||9.8 |
|Income tax expense||19,192 ||24,577 ||18,046 ||(21.9)||36.2 ||1.5 ||2.9 ||2.4 |
|Income from continuing operations||49,356 ||94,402 ||54,443 ||(47.7)||73.4 ||4.0 ||11.3 ||7.3 |
|Income from discontinued operations, net of tax||— ||23,772 ||1,387 ||N/M||N/M||— ||2.8 ||0.2 |
|Net income||49,356 ||118,174 ||55,830 ||(58.2)||111.7 ||4.0 ||14.2 ||7.5 |
Net income/(loss) applicable to noncontrolling interests
|8,852 ||6,463 ||(1,206)||37.0 ||N/M||0.7 ||0.8 ||(0.2)|
|Net income applicable to Piper Sandler Companies||$||40,504 ||$||111,711 ||$||57,036 ||(63.7)||%||95.9 ||%||3.3 ||%||13.4 ||%||7.7 ||%|
N/M — Not meaningful
For the year ended December 31, 2020, we recorded net income from continuing operations applicable to Piper Sandler Companies of $40.5 million. Net revenues from continuing operations for the year ended December 31, 2020 increased 48.4 percent to $1.24 billion, compared with $834.6 million in the year-ago period, driven by record corporate financing revenues. Additionally, the acquisitions of Sandler O'Neill and Weeden & Co. have provided increased diversification and scale to our platform. In 2020, investment banking revenues increased 36.4 percent to $858.5 million, compared with $629.4 million in 2019, due to significantly higher corporate financing revenues, as well as increased municipal financing revenues. For the year ended December 31, 2020, institutional brokerage revenues were $357.8 million, up 113.1 percent compared with $167.9 million in 2019. The increase was due to the acquisitions of Weeden & Co. and Sandler O'Neill, as well as higher volatility in the financial markets, particularly in the first quarter of 2020, which drove higher trading volumes. In 2020, net interest expense was $1.3 million, compared to net interest income of $15.0 million in 2019. Net interest expense resulted from a decline in interest income on our long inventory positions combined with incremental interest expense on our long-term financing arrangements, which consist of our fixed rate senior notes issued on October 15, 2019, and the unsecured promissory notes we entered into on April 3, 2020 to fund a portion of the Valence purchase price. For the year ended December 31, 2020, investment income was $23.3 million, compared with $22.3 million in 2019. In 2020, we recorded lower gains on our investment and the noncontrolling interests in the merchant banking funds that we manage which were more than offset by higher gains on our other firm investments. Non-interest expenses from continuing operations were $1.17 billion for the year ended December 31, 2020, up 63.5 percent compared with $715.6 million in the prior year, primarily due to higher compensation and non-compensation expenses resulting from our recent acquisitions.
Consolidated Non-Interest Expenses from Continuing Operations
Compensation and Benefits – Compensation and benefits expenses, which are the largest component of our expenses, include salaries, incentive compensation, benefits, stock-based compensation, employment taxes, income associated with the forfeiture of stock-based compensation and other employee-related costs. A significant portion of compensation expense is comprised of variable incentive arrangements, including discretionary incentive compensation, the amount of which fluctuates in proportion to the level of business activity, increasing with higher revenues and operating profits. Other compensation costs, primarily base salaries and benefits, are more fixed in nature. The timing of incentive compensation payments, which generally occur in February, has a greater impact on our cash position and liquidity than is reflected on our consolidated statements of operations. We have granted restricted stock and restricted cash with service conditions as a component of our acquisition deal consideration, which is amortized to compensation expense over the service period.
The following table summarizes our future acquisition-related compensation expense for restricted stock and restricted cash with service conditions, as well as amounts estimated to be paid under earnout arrangements:
|(Amounts in thousands)|
For the year ended December 31, 2020, compensation and benefits expenses increased 70.0 percent to $877.5 million from $516.1 million in 2019. The increase in compensation and benefits expenses was driven by increased revenues and incremental headcount from the acquisitions of Sandler O'Neill and Valence, along with higher acquisition-related compensation related to restricted consideration and retention awards associated with these acquisitions. We also recorded additional compensation expense for an earnout associated with the acquisition of Weeden & Co. related to our expectations of achieving a net revenue target, as our equity brokerage business is outperforming initial projections. Compensation and benefits expenses as a percentage of net revenues was 70.9 percent in 2020, compared with 61.8 percent in 2019. The compensation ratio was impacted by increased acquisition-related compensation related to our recent acquisitions.
Outside Services – Outside services expenses include securities processing expenses, outsourced technology functions, outside legal fees, fund expenses associated with our consolidated alternative asset management funds and other professional fees. Outside services expenses were $38.4 million in 2020, up 6.1 percent compared with $36.2 million in 2019. The increase was due to incremental expenses related to the acquisition of Sandler O'Neill.
Occupancy and Equipment – For the year ended December 31, 2020, occupancy and equipment expenses increased 46.8 percent to $54.0 million, compared with $36.8 million in 2019. The increase was primarily the result of incremental expenses related to our recent acquisitions.
Communications – Communication expenses include costs for telecommunication and data communication, primarily consisting of expenses for obtaining third party market data information. For the year ended December 31, 2020, communication expenses increased 44.2 percent to $44.4 million, compared with $30.8 million for the year ended December 31, 2019 due to higher market data services expenses resulting from incremental headcount related to our recent acquisitions.
Marketing and Business Development – Marketing and business development expenses include travel and entertainment costs, advertising and third party marketing fees. In 2020, marketing and business development expenses decreased 53.2 percent to $13.5 million, compared with $28.8 million for the year ended December 31, 2019. The decrease was driven by lower travel and entertainment costs related to the COVID-19 pandemic. We anticipate that travel will begin to resume in the second half of 2021, resulting in increased travel and entertainment costs compared to 2020.
Deal-Related Expenses – Deal-related expenses include costs we incurred over the course of a completed investment banking deal, which primarily consist of legal fees, offering expenses, and travel and entertainment costs. For the year ended December 31, 2020, deal-related expenses increased 47.4 percent to $38.1 million, compared with $25.8 million for the year ended December 31, 2019. The amount of deal-related expenses is principally dependent on the level of deal activity and may vary from period to period as the recognition of deal-related costs typically coincides with the closing of a transaction. We closed on a record number of equity financing transactions in 2020, which resulted in higher deal-related expenses.
Trade Execution and Clearance – For the year ended December 31, 2020, trade execution and clearance expenses were $18.9 million, compared with $10.2 million for the year ended December 31, 2019. The increase in trade execution and clearance expenses was reflective of higher trading volumes.
Restructuring and Integration Costs – For the year ended December 31, 2020, we incurred acquisition-related restructuring and integration costs of $10.8 million. The expenses consisted of $4.4 million of transaction costs related to our recent acquisitions, $3.0 million of severance benefits, $0.9 million of contract termination costs and $2.5 million for vacated leased office space.
For the year ended December 31, 2019, we incurred acquisition-related restructuring and integration costs of $14.3 million related to the acquisitions of Weeden & Co. and Sandler O'Neill. The expenses consisted of $6.9 million of professional fees related to the transactions, $2.9 million of severance benefits, $2.8 million of contract termination costs and $1.7 million for vacated leased office space.
Intangible Asset Amortization – Intangible asset amortization includes the amortization of definite-lived intangible assets consisting of customer relationships, internally developed software and the trade name that we acquired from Simmons & Company International ("Simmons"). For the year ended December 31, 2020, intangible asset amortization was $44.7 million, compared with $4.3 million in 2019. The increase was due to incremental intangible asset amortization expense related to identifiable intangible assets associated with the acquisitions of Sandler O'Neill and Valence and a full year of intangible asset amortization expense related to Weeden & Co. In 2021, we anticipate incurring additional intangible asset amortization expense related to the acquisition of TRS and a full year of intangible asset amortization expense related to the acquisition of Valence.
Other Operating Expenses – Other operating expenses include insurance costs, license and registration fees, expenses related to our charitable giving program and litigation-related expenses, which consist of the amounts we reserve and/or pay out related to legal and regulatory matters. Other operating expenses were $29.5 million in 2020, compared with $12.4 million in 2019. In the first quarter of 2020, we recorded a $12.1 million fair value adjustment related to the earnout for former Weeden & Co. equity owners who did not transition to our platform. We recorded the full value of the projected earnout as the non-employee equity owners do not have service requirements. The increase was also due to higher expense related to our charitable giving program.
Income Taxes – For the year ended December 31, 2020, our provision for income taxes was $19.2 million. Excluding the impact of noncontrolling interests, our effective tax rate was 32.1 percent, which was driven by the impact of non-deductible covered employee compensation expense, partially offset by $2.4 million of income tax benefits related to the tax provisions in the Coronavirus Aid, Relief, and Economic Security Act.
For the year ended December 31, 2019, our provision for income taxes was $24.6 million, which included a $5.1 million tax benefit related to stock-based compensation awards vesting at values greater than the grant price. Excluding the impact of this benefit and noncontrolling interests, our effective tax rate was 26.4 percent.
Financial Performance from Continuing Operations
Our activities as an investment bank and institutional securities firm constitute a single business segment.
Throughout this section, we have presented results on both a U.S. GAAP and non-GAAP basis. Management believes that presenting results and measures on an adjusted, non-GAAP basis in conjunction with the corresponding U.S. GAAP measures provides a more meaningful basis for comparison of its operating results and underlying trends between periods, and enhances the overall understanding of our current financial performance by excluding certain items that may not be indicative of our core operating results. The non-GAAP results should be considered in addition to, not as a substitute for, the results prepared in accordance with U.S. GAAP.
The adjusted financial results exclude (1) revenues and expenses related to noncontrolling interests, (2) interest expense on long-term financing from net revenues, (3) amortization of intangible assets related to acquisitions, (4) compensation and non-compensation expenses from acquisition-related agreements and (5) acquisition-related restructuring and integration costs. For U.S. GAAP purposes, these items are included in each of their respective line items on the consolidated statements of operations.
Adjusted operating income and adjusted operating margin present the results of operations excluding the impact resulting from the consolidation of noncontrolling interests in alternative asset management funds. Consolidation of these funds results in the inclusion of the proportionate share of the income or loss attributable to the equity interests in consolidated funds that are not attributable, either directly or indirectly, to us (i.e., noncontrolling interests). This proportionate share is reflected in net income/(loss) applicable to noncontrolling interests in the accompanying consolidated statements of operations, and has no effect on our overall financial performance, as ultimately, this income or loss is not income or loss for us. Included in adjusted operating income and adjusted operating margin is the actual proportionate share of the income or loss attributable to us as an investor in such funds.
The adjusted, non-GAAP financial results also exclude amortization of intangible assets and compensation and non-compensation expenses from acquisition-related agreements. These amounts are excluded on a non-GAAP basis as they represent expenses specifically related to acquisitions that will eventually be fully amortized and therefore not part of our on-going operations. The acquisition-related restructuring and integration costs excluded from the adjusted financial results represent charges that resulted from severance benefits, contract termination costs, vacating redundant leased office space and professional fees related to the respective transactions. These restructuring and integration costs are excluded from our non-GAAP financial measures as they relate to acquisitions and excluding these amounts provides a better understanding of our core non-compensation expenses. Interest expense on long-term financing is an adjustment from net revenues as these arrangements were used to fund the Sandler O'Neill and Valence acquisitions. Management believes that presenting adjusted financial results excluding the acquisition-related amounts provides clarity on the financial results generated by the core operating components of our business.
The following table sets forth the adjusted, non-GAAP financial results and adjustments necessary to reconcile to our consolidated U.S. GAAP financial results for the periods presented:
|Year Ended December 31,|
|Adjustments (1)||Adjustments (1)|
|(Amounts in thousands)||Adjusted||Interests||Adjustments||GAAP||Adjusted||Interests||Adjustments||GAAP|
|Advisory services||$||443,327 ||$||— ||$||— ||$||443,327 ||$||440,695 ||$||— ||$||— ||$||440,695 |
|Corporate financing||295,333 ||— ||— ||295,333 ||105,256 ||— ||— ||105,256 |
|Municipal financing||119,816 ||— ||— ||119,816 ||83,441 ||— ||— ||83,441 |
Total investment banking
|858,476 ||— ||— ||858,476 ||629,392 ||— ||— ||629,392 |
|Equity brokerage||161,445 ||— ||— ||161,445 ||87,555 ||— ||— ||87,555 |
|Fixed income services||196,308 ||— ||— ||196,308 ||80,336 ||— ||— ||80,336 |
Total institutional brokerage
|357,753 ||— ||— ||357,753 ||167,891 ||— ||— ||167,891 |
|Interest income||13,164 ||— ||— ||13,164 ||26,741 ||— ||— ||26,741 |
|Investment income||10,384 ||12,881 ||— ||23,265 ||11,506 ||10,769 ||— ||22,275 |
|Total revenues||1,239,777 ||12,881 ||— ||1,252,658 ||835,530 ||10,769 ||846,299 |
|4,817 ||— ||9,628 ||14,445 ||9,885 ||— ||1,848 ||11,733 |
|Net revenues||1,234,960 ||12,881 ||(9,628)||1,238,213 ||825,645 ||10,769 ||(1,848)||834,566 |
|Non-interest expenses||984,672 ||4,029 ||180,964 ||1,169,665 ||687,410 ||4,306 ||23,871 ||715,587 |
|Pre-tax income||$||250,288 ||$||8,852 ||$||(190,592)||$||68,548 ||$||138,235 ||$||6,463 ||$||(25,719)||$||118,979 |
|Pre-tax margin||20.3 ||%||5.5 ||%||16.7 ||%||14.3 ||%|
(1) The following is a summary of the adjustments needed to reconcile our consolidated U.S. GAAP financial results to the adjusted, non-GAAP financial results:
Noncontrolling interests – The impacts of consolidating noncontrolling interests in our alternative asset management funds are not included in our adjusted financial results.
Other adjustments – The following items are not included in our adjusted financial results:
|Year Ended December 31,|
|(Amounts in thousands)||2020||2019|
|Interest expense on long-term financing||$||9,628 ||$||1,848 |
|Compensation from acquisition-related agreements||113,396 ||5,138 |
|Acquisition-related restructuring and integration costs||10,755 ||14,321 |
|Amortization of intangible assets related to acquisitions||44,728 ||4,298 |
|Non-compensation expenses from acquisition-related agreements||12,085 ||114 |
|180,964 ||23,871 |
|Total other adjustments||$||190,592 ||$||25,719 |
Net revenues on a U.S. GAAP basis increased 48.4 percent to $1.24 billion for the year ended December 31, 2020, compared with $834.6 million in the prior-year period. For the year ended December 31, 2020, adjusted net revenues were $1.23 billion compared with $825.6 million for the year ended December 31, 2019. The variance explanations for net revenues and adjusted net revenues are consistent on both a U.S. GAAP and non-GAAP basis unless stated otherwise.
Investment banking revenues comprise all of the revenues generated through advisory services activities, which includes mergers and acquisitions ("M&A"), equity and debt private placements, debt and restructuring advisory, and municipal financial advisory transactions. Collectively, equity and debt private placements and debt and restructuring advisory transactions are referred to as capital advisory transactions. Investment banking revenues also include equity and debt corporate financing activities and municipal financings.
In 2020, investment banking revenues were $858.5 million, up 36.4 percent compared with $629.4 million in the prior-year period. For the year ended December 31, 2020, advisory services revenues were $443.3 million, compared with $440.7 million in 2019. Incremental revenues from the addition of Sandler O'Neill to our platform offset the decline in revenues from a market-wide decrease as M&A activity slowed appreciably during the second and third quarters of 2020 as uncertainty around COVID-19 put many engagements on hold. We saw a rebound in activity in the fourth quarter of 2020 from the trough we experienced during the third quarter, due, in part, to increased CEO confidence and more clarity on a post-pandemic outlook. For the year ended December 31, 2020, corporate financing revenues were a record $295.3 million, up significantly compared with $105.3 million in the prior-year period, due to more completed and book run equity deals, and the addition of Sandler O'Neill to our platform, which book ran 37 debt offerings for financial services companies. Following a substantial halt to capital raising activity in March, market conditions became favorable for capital raising during the second quarter of 2020 driven by a sharp rebound in valuations for equities of certain industry groups combined with lower volatility and low new issue interest rates in debt markets, and these dynamics continued through the remainder of the year. Activity for us during the year was principally in the healthcare sector, and we completed 96 healthcare equity deals. Additionally, activity in the first quarter of 2019 was impacted by the U.S. federal government shut-down. Municipal financing revenues for the year ended December 31, 2020 were a record $119.8 million, up 43.6 percent compared with $83.4 million in the year-ago period. Despite a rapid decline in the level of activity in March due to significant volatility in the fixed income markets, low interest rates combined with strong investor demand drove record market issuance volumes in 2020. During 2020, the issuance activity was focused within the governmental space. The par amount of our negotiated municipal issuances increased approximately 55 percent in 2020 compared to an increase of approximately 19 percent for the industry.
The following table provides investment banking deal information:
|Year Ended December 31,|
|(Dollars in billions)||2020||2019|
|M&A transactions||158 ||140 |
|Capital advisory transactions||114 ||38 |
|Total equity transactions||137 ||74 |
|Book run equity transactions||99 ||50 |
|Total debt and preferred transactions||58 ||— |
|Book run debt and preferred transactions||37 ||— |
|Municipal negotiated issues|
|Aggregate par value||$||19.1 ||$||12.3 |
|Total issues||847 ||572 |
Institutional brokerage revenues comprise all of the revenues generated through trading activities, which consist of facilitating customer trades, executing competitive municipal underwritings and our strategic trading activities in municipal bonds. Our results may vary from quarter to quarter as a result of changes in trading margins, trading gains and losses, net interest spreads, trading volumes, the timing of payments for research services and the timing of transactions based on market opportunities.
For the year ended December 31, 2020, institutional brokerage revenues increased to $357.8 million, compared with $167.9 million in the prior-year period. Equity brokerage revenues were $161.4 million in 2020, up 84.4 percent compared with $87.6 million in 2019, reflecting the successful integration of our platform with Weeden & Co. This combination has expanded our client base, execution expertise and product capabilities, which we leveraged to find liquidity for our clients during the year. Additionally, market-wide volumes and volatility were higher compared to 2019. In the first quarter of 2020, increased volatility market-wide drove significantly higher volumes as investors repositioned in response to market uncertainty and fund outflows. Volumes were also elevated in the fourth quarter of 2020 as clients repositioned before and after the 2020 U.S. presidential election, and market indices traded higher driven by optimism on COVID-19 vaccine results and an economic recovery. For the year ended December 31, 2020, fixed income services revenues were $196.3 million, up 144.4 percent compared with $80.3 million in the prior-year period, due to the addition of Sandler O'Neill to our platform, strong client activity and solid execution in conducive markets. We continue to provide strategic advice on repositioning balance sheets, maximizing yields and managing risk in this low interest rate environment within a market with ample liquidity. Additionally, in the first quarter of 2020, the historically volatile quarter and higher volumes in municipals drove client activity as we provided liquidity to municipal bond funds which saw significant outflows by identifying buyers who took advantage of meaningfully higher yields. This strong client activity was partially offset by trading losses in municipal securities due to the sharp and sudden market dislocation.
Interest income represents amounts earned from holding long inventory positions. For the year ended December 31, 2020, interest income decreased 50.8 percent to $13.2 million, compared with $26.7 million in 2019, reflecting lower long inventory balances. We have focused on only carrying inventory where clients need liquidity within our areas of expertise.
Investment income includes realized and unrealized gains and losses on investments, including amounts attributable to noncontrolling interests, in our merchant banking and energy funds, as well as management and performance fees generated from those funds. For the year ended December 31, 2020, investment income was $23.3 million, compared to $22.3 million in 2019. In 2020, we recorded lower gains on our investment and the noncontrolling interests in the merchant banking funds that we manage. Lower equity valuations and an uncertain and challenging operating environment for some of our portfolio companies drove fair value adjustments in our merchant banking portfolio in the first half of 2020. These declines were more than offset by higher gains on our other firm investments. Excluding the impact of noncontrolling interests, adjusted investment income was $10.4 million in 2020 and $11.5 million in 2019.
Interest expense represents amounts associated with financing, economically hedging and holding short inventory positions, including interest paid on our long-term financing arrangements, as well as commitment fees on our line of credit and revolving credit facility. For the year ended December 31, 2020, interest expense increased to $14.4 million, compared with $11.7 million in the prior-year period. In 2020, we recorded incremental interest expense on our long-term financing arrangements, which consist of the $175 million of fixed rate senior notes we issued on October 15, 2019, and $20 million of unsecured promissory notes we entered into on April 3, 2020 to fund a portion of the Valence purchase price. The increase was partially offset by a decline in interest expense resulting from lower average short inventory balances. Excluding the impact of interest expense on long-term financing, adjusted interest expense was $4.8 million and $9.9 million for the years ended December 31, 2020 and 2019, respectively. The $20 million of unsecured promissory notes were repaid in early 2021, which will decrease interest expense on long-term financing.
Pre-tax margin for 2020 was 5.5 percent, down compared with 14.3 percent for 2019 due to the increased compensation ratio resulting from higher acquisition-related compensation expense. Adjusted pre-tax margin increased to 20.3 percent in 2020, compared with 16.7 percent in 2019. Adjusted pre-tax margin increased driven by the increased scale of our platform, the successful integration of the Sandler O'Neill and Weeden & Co. acquisitions, and significantly lower marketing and business development expenses due to reduced travel and entertainment costs related to the COVID-19 pandemic.
The following table sets forth the adjusted, non-GAAP financial results and adjustments necessary to reconcile to our consolidated U.S. GAAP financial results for the periods presented:
|Year Ended December 31,|
|Adjustments (1)||Adjustments (1)|
|(Amounts in thousands)||Adjusted||Interests||Adjustments||GAAP||Adjusted||Interests||Adjustments||GAAP|
|Advisory services||$||440,695 ||$||— ||$||— ||$||440,695 ||$||394,133 ||$||— ||$||— ||$||394,133 |
|Corporate financing||105,256 ||— ||— ||105,256 ||123,072 ||— ||— ||123,072 |
|Municipal financing||83,441 ||— ||— ||83,441 ||71,773 ||— ||— ||71,773 |
Total investment banking
|629,392 ||— ||— ||629,392 ||588,978 ||— ||— ||588,978 |
|Equity brokerage||87,555 ||— ||— ||87,555 ||77,110 ||— ||— ||77,110 |
|Fixed income services||80,336 ||— ||— ||80,336 ||47,628 ||— ||— ||47,628 |
Total institutional brokerage
|167,891 ||— ||— ||167,891 ||124,738 ||— ||— ||124,738 |
|Interest income||26,741 ||— ||— ||26,741 ||32,749 ||— ||— ||32,749 |
|Investment income||11,506 ||10,769 ||— ||22,275 ||7,418 ||3,621 ||— ||11,039 |
|Total revenues||835,530 ||10,769 ||— ||846,299 ||753,883 ||3,621 ||— ||757,504 |
|9,885 ||— ||1,848 ||11,733 ||11,649 ||— ||4,902 ||16,551 |
|Net revenues||825,645 ||10,769 ||(1,848)||834,566 ||742,234 ||3,621 ||(4,902)||740,953 |
|Non-interest expenses||687,410 ||4,306 ||23,871 ||715,587 ||628,850 ||4,827 ||34,787 ||668,464 |
|Pre-tax income||$||138,235 ||$||6,463 ||$||(25,719)||$||118,979 ||$||113,384 ||$||(1,206)||$||(39,689)||$||72,489 |
|Pre-tax margin||16.7 ||%||14.3 ||%||15.3 ||%||9.8 ||%|
(1) The following is a summary of the adjustments needed to reconcile our consolidated U.S. GAAP financial results to the adjusted, non-GAAP financial results:
Noncontrolling interests – The impacts of consolidating noncontrolling interests in our alternative asset management funds are not included in our adjusted financial results.
Other adjustments – The following items are not included in our adjusted financial results:
|Year Ended December 31,|
|(Amounts in thousands)||2019||2018|
|Interest expense on long-term financing||$||1,848 ||$||4,902 |
|Compensation from acquisition-related agreements||5,138 ||29,246 |
|Acquisition-related restructuring and integration costs||14,321 ||— |
|Amortization of intangible assets related to acquisitions||4,298 |