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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(MARK ONE)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED NOVEMBER 30, 1995
/ / Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 [No Fee Required]
Commission File Number 1-6817
Lehman Brothers Inc.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 13-2518466
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3 WORLD FINANCIAL CENTER 10285
NEW YORK, NEW YORK (Zip Code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 526-7000
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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10 3/4% Senior Subordinated Notes Due 1996 New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NONE
(Title of Class)
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 _X_ No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Sec.229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. _X_
As the registrant is a wholly-owned subsidiary of Lehman Brothers Holdings
Inc., none of the registrant's outstanding voting stock is held by
non-affiliates of the registrant. As of the date hereof, 1,006 shares of the
registrant's Common Stock. $.10 per share, were issued and outstanding.
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION J(1)(A)
AND (B) OF FORM 10-K AND THEREFORE IS FILING THIS FORM WITH A PORTION OF THE
REDUCED DISCLOSURE CONTEMPLATED THEREBY.
DOCUMENTS INCORPORATED BY REFERENCE:
None.
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PART I
ITEM 1. BUSINESS
GENERAL DEVELOPMENT OF BUSINESS
As used herein, "LBI" or the "Registrant" means Lehman Brothers Inc., a
Delaware corporation, incorporated on January 21, 1965. LBI and its subsidiaries
are collectively referred to as the "Company" or "Lehman Brothers". LBI is a
wholly owned subsidiary of Lehman Brothers Holdings Inc., a Delaware
corporation, which (together with its subsidiaries, where appropriate) is
referred to herein as "Holdings".
The Company is one of the leading global investment banks serving
institutional, corporate, government and high-net-worth individual clients and
customers. Its executive offices are located at 3 World Financial Center, New
York, New York 10285 and its telephone number is (212) 526-7000.
LEHMAN BROTHERS
Lehman Brothers is one of the leading global investment banks serving
institutional, corporate, government and high-net-worth individual clients and
customers. The Company's worldwide headquarters in New York are complemented by
offices in additional locations in the United States, Europe, the Middle East,
Latin and South America and the Asia Pacific region. Lehman Brothers also
operates a commodities trading and sales operation in London. Holdings provides
investment banking and capital markets services in Europe and Asia. The Company
is engaged primarily in providing financial services. Other businesses in which
the Company is engaged represent less than 10 percent of consolidated assets,
revenues or pre-tax income.
The Company's business includes capital raising for clients through
securities underwriting and direct placements; corporate finance and strategic
advisory services; merchant banking; securities sales and trading; asset
management; research; and the trading of foreign exchange, derivative products
and certain commodities. The Company acts as a market-maker in all major equity
and fixed income products in both the domestic and certain international
markets. Lehman Brothers is a member of all principal securities and commodities
exchanges in the United States, as well as the National Association of
Securities Dealers, Inc. ("NASD"). Holdings holds memberships or associate
memberships on several principal international securities and commodities
exchanges, including the London, Tokyo, Hong Kong, Frankfurt and Milan stock
exchanges.
Since 1990, Lehman Brothers has focused on a "client/customer-driven"
strategy. Under this strategy, Lehman Brothers concentrates on serving the needs
of major issuing and advisory clients and investing customers worldwide to build
an increasing "flow" of business that leverages the Company's research,
underwriting and distribution capabilities. Customer flow continues to be the
primary source of the Company's net revenues. Developing lead relationships with
issuing clients and investing customers is a central premise of the Company's
client/customer-driven strategy. Based on management's belief that each client
and customer directs a majority of its financial transactions to a limited
number of investment banks, Lehman Brothers' investment banking and
institutional and private client sales professionals focus on a targeted group
of clients and customers worldwide to identify and develop lead relationships.
The Company believes that such relationships position Lehman Brothers to receive
a substantial portion of its clients' and customers' financial business and
lessen the volatility of revenues generally associated with the financial
services industry.
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LEHMAN BUSINESSES
INVESTMENT BANKING
Lehman Brothers is a leading underwriter of equity and fixed income
securities in the public and private markets. The Company is also a prominent
advisor for corporations and governments around the world.
Investment Banking professionals are responsible for developing and
maintaining relationships with issuing clients, gaining a thorough understanding
of their specific needs and bringing together the full resources of Lehman
Brothers and Holdings to accomplish their financial objectives. Investment
Banking is organized into industry, product and geographic coverage groups,
enabling individual bankers to develop specific expertise in particular
industries and markets. Industry coverage groups include Consumer Products,
Financial Services, Financial Sponsors, Health Care, Industrials, Merchandising,
Natural Resources, Real Estate and Mortgage Finance, Technology, Media and
Telecommunications, Transportation and Utilities. Where appropriate, specialized
groups such as Equity Capital Markets, Debt Capital Markets, Mergers and
Acquisitions, Private Placements, Leveraged Finance, Derivatives, Liability
Management and Project Finance are integrated into the client coverage teams.
Lehman Brothers has a long history of providing strategic advisory services
to corporate, institutional and government clients around the world on a wide
range of financial matters, including mergers and acquisitions, divestitures,
leveraged transactions, takeover defenses, spin-offs, corporate reorganizations
and recapitalizations, tender and exchange offers, privatizations, opinion
letters and valuations. The Company's Mergers and Acquisitions group works
closely with product, industry and geographic coverage bankers around the world.
Merchant Banking. Through its Merchant Banking group, the Company and its
affiliates make equity and certain other investments in merger, acquisition,
restructuring and leveraged capital transactions, including leveraged buyouts,
either independently or in partnership with the Company's clients. Current
merchant banking investments held by the Company include both publicly traded
and privately held companies diversified on a geographic and industry basis.
Since 1989, the Company and its affiliates' principal method of making
merchant banking investments has been through a series of partnerships (the
"1989 Partnerships"), for which the Company and its affiliates act as general
partner, and in some cases as a limited partner. During the remaining life of
the 1989 Partnerships, the Company's merchant banking activities, with respect
to investments made by the 1989 Partnerships, will be directed toward selling or
otherwise monetizing such investments.
FIXED INCOME
Lehman Brothers actively participates in all key fixed income product areas.
The Company combines professionals from the sales, trading, financing,
derivatives and research areas of Fixed Income, together with investment
bankers, into teams to serve the financial needs of the Company's clients and
customers. The Company is a leading underwriter of new issues, and also makes
markets in these and other fixed income securities. The Company's global
presence facilitates client and customer transactions and provides liquidity in
marketable fixed and floating rate debt securities.
Fixed Income products consist of government, sovereign and supranational
agency obligations; money market products; corporate debt securities; mortgage
and asset-backed securities; emerging market securities; municipal and
tax-exempt securities; derivative products and research. In addition, the
Company's financing unit provides global access to cost efficient debt financing
sources, including repurchase agreements, for the Company and its clients and
customers.
Government and Agency Obligations. Lehman Brothers is one of the leaders
among the 37 primary dealers in U.S. Government securities, as designated by the
Federal Reserve Bank of New
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York, participating in the underwriting and market-making of U.S. Treasury
bills, notes and bonds, and securities of federal agencies.
Money Market Products. Lehman Brothers holds dominant market positions in
the origination and distribution of medium-term notes and commercial paper. The
Company and its affiliates have received global medium-term note mandates for
1,125 programs with a borrowing capacity of $1.6 trillion. The Company and its
affiliates are appointed dealers for approximately 750 commercial paper programs
on behalf of companies and government agencies worldwide. The Company is also a
major participant in the preferred stock market.
Corporate Debt Securities. Lehman Brothers engages in the underwriting and
market making of fixed and floating rate investment grade debt. The Company also
underwrites and makes markets in non-investment grade debt securities and bank
loans.
High Yield Securities and Bank Loans. In 1995, the Company expanded its high
yield debt business from both a strategic and an operational perspective. The
Company now provides a "one-stop" leveraged finance solution for corporate and
financial acquirers and high yield issuers.
Mortgage and Asset-Backed Securities. The Company is a leading underwriter
of and market maker in mortgage and asset-backed securities.
Emerging Market Securities. The Company is active in the trading,
structuring and underwriting of Latin American, Eastern European, and Asian
dollar and local currency instruments.
Municipal and Tax-Exempt Securities. Lehman Brothers is a major dealer in
municipal and tax-exempt securities, including general obligation and revenue
bonds, notes issued by states, counties, cities, and state and local
governmental agencies, municipal leases, tax-exempt commercial paper and put
bonds. Lehman Brothers is also a leader in the structuring, underwriting and
sale of tax-exempt and taxable securities and derivative products for city,
state, not-for-profit and other public sector clients.
Derivative Products. The Company offers a broad range of derivative product
services. Derivatives professionals are integrated into all of the Company's
major fixed income product areas to develop optimal issuance structures and
investment products for the Company's clients.
Lehman Brothers Financial Products Inc. ("LBFP"), the Company's triple-A
rated derivatives subsidiary, commenced trading with counterparties in July
1994. It exceeded expectations in 1995 in terms of notional volumes and number
of counterparties. This entity also received rating agency approval to double
the amount of products eligible for inclusion in the subsidiary.
Financing. The Company's Financing unit engages in three primary functions:
managing the Company's matched book activities, supplying secured financing to
customers, and providing funding for the Company's inventory positions. Matched
book funding involves lending cash on a short-term basis to institutional
customers collateralized by marketable securities, typically government or
government agency securities. The Company enters into these agreements in
various currencies and seeks to generate profits from the difference between
interest earned and interest paid. The Financing unit works with the Company's
institutional sales force to identify customers that have cash to invest and/or
securities to pledge to meet the financing and investment objectives of the
Company and its customers. Financing also coordinates with the Company's
treasury area to provide collateralized financing for a large portion of the
Company's securities and other financial instruments owned.
Fixed Income Research. Fixed Income research at Lehman Brothers encompasses
the full range of research disciplines: quantitative, economic, strategic,
credit, portfolio and market-specific analysis. Fixed Income research is
integrated with and supports the Company's investment banking, sales and trading
activities. An important objective of Fixed Income research is to have in place
high quality research analysts covering industry, geographic and economic
sectors that support the activities of the Company's clients and customers. The
Company and its affiliates' 200 specialists are based in New York, Toronto,
London, Tokyo and Hong Kong. Their expertise includes U.S., European and Asian
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government and agency securities, derivatives, sovereign issues, corporate
securities, high yield, asset-and mortgage-backed securities, commercial real
estate, emerging market debt and municipal securities.
Foreign Exchange. Through its foreign exchange operations, Lehman Brothers
seeks to provide its clients and customers with superior trading execution,
price protection and hedging strategies to manage volatility. The Company and
its affiliates, through operations in New York, London, Hong Kong, Singapore,
and Tokyo engage in trading activities in all major currencies and maintain a
24-hour foreign exchange market-making capability for clients and customers
worldwide. In addition to the Company's traditional client/customer-driven
foreign exchange activities, Lehman Brothers also trades foreign exchange for
its own account.
Commodities and Futures. Lehman Brothers engages in commodities and futures
trading through its market-making activities in metals as well as its activities
in exchange futures execution for its institutional and private clients. The
Company and its affiliates provide their clients with global market-making and
execution through its commodities and futures operations in New York, London,
Frankfurt, Singapore, Hong Kong and Tokyo.
EQUITIES
Lehman Brothers combines professionals from the sales, trading, financing,
derivatives and research areas of Equities, together with investment bankers,
into teams to serve the financial needs of the Company's equity clients and
customers. The Company's equity expertise and the integrated nature of the
Company's global operations enable Lehman Brothers to structure and execute
global equity transactions for clients worldwide. The Company is a leading
underwriter of initial public and secondary offerings of equity and
equity-related securities. Lehman Brothers also makes markets in these and other
securities, and executes block trades on behalf of clients and customers. The
Company also actively participates in assisting governments around the world in
raising equity capital as part of their privatization programs.
The Equities product group is responsible for the Company's equity
operations and all dollar and non-dollar equity and equity-related products
worldwide. These products include listed and over-the-counter ("OTC")
securities, American Depositary Receipts, convertibles, options, warrants and
derivatives.
Derivative Products. Lehman Brothers, in conjunction with affiliates, offers
equity derivative capabilities across a wide spectrum of products and
currencies, including domestic and international program trading, listed options
and futures, structured derivatives and convertible products.
Equity Research. The Equity Research department is integrated with and
supports the Company's investment banking, sales and trading activities. An
important objective of Equities research is to have in place high quality
research analysts covering industry and geographic sectors that support the
activities of the Company's clients and customers. The Equity Research
department is comprised of 250 professionals covering 26 industry sectors and
over 1,100 companies worldwide from locations in New York, London, Hong Kong and
Tokyo.
Equity Finance. Lehman Brothers operates a comprehensive Equity Financing
and Prime Broker business to provide liquidity to its clients and customers.
Margin lending for the purchase of equities and equity derivatives, securities
lending and short sale facilitation are among the main functions of the Equity
Financing group. The Prime Broker business engages in full operations, clearing
and processing services for that unit's customers.
ASSET MANAGEMENT
The Company's asset management activities provide investment management
services to institutional investors, individuals and small to mid-sized
institutions. At November 30, 1995, the Company
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and its affiliates had over $10 billion in assets under management. The Company
and its affiliates plan to focus on sponsoring and distributing more
sophisticated strategic funds attractive to high-net-worth individuals and
institutions. The Asset Management division also has developed individually
customized investment services through the Company's Private Client Services
group.
INSTITUTIONAL SALES
Institutional Sales serves the investing and liquidity needs of major
institutional investors worldwide and provides the distribution mechanism for
new issues and secondary market securities. Lehman Brothers maintains a network
of over 500 sales professionals in major locations around the world.
Institutional Sales focuses on the large institutional investors that constitute
the major share of global buying power in the financial markets. Lehman
Brothers' goal is to be considered one of the top three investment banks by such
institutional investors. By serving the needs of these customers, the Company
also gains insight into investor sentiment worldwide regarding new issues and
secondary products and markets, which in turn benefits the Company's issuing
clients.
Institutional Sales is organized into four distinct sales forces,
specialized by the following product types: Equities, Fixed Income, Foreign
Exchange/Commodities and Asset Management. Institutional Sales professionals
work together to coordinate coverage of major institutional investors through
customer teams. Depending on the size and investment objectives of the
institutional investor, a customer team can be comprised of from two to five
sales professionals, each specializing in a specific product. This approach
positions Lehman Brothers to understand and to deliver the full resources of the
Company to its customer base.
PRIVATE CLIENT SERVICES
The Company's Private Client Services Group serves the investment needs of
private investors with substantial assets as well as small and mid-sized
institutions. The group has a global presence with investment representatives
located in seven offices in North America and additional offices in major
financial centers in South America, Europe, the Middle East and Asia. The
Company's investment representatives provide investing customers with direct
access to Lehman Brothers' equity and fixed income product and research,
including capabilities in new issue and secondary product, foreign exchange and
derivatives. The Private Client Services group also enables the Company's
issuing clients to access a diverse, high-net-worth investor base throughout the
world. The group employs portfolio strategists within their organization to
optimize asset allocation requirements and to manage the specific asset classes
of their private clients.
OTHER BUSINESS ACTIVITIES
While Lehman Brothers concentrates on its client/customer-driven strategy,
the Company also participates in business opportunities such as arbitrage and
proprietary trading that leverage the Company's expertise, infrastructure and
resources. These businesses may generate substantial revenues but generally
entail a higher degree of risk as the Company trades for its own account.
Arbitrage. Lehman Brothers engages in a variety of arbitrage activities. In
traditional or "riskless" arbitrage, the Company seeks to benefit from temporary
price discrepancies that occur when a security is traded in two or more markets,
or when a convertible or derivative security is trading at a price disparate
from its underlying security. The Company's "risk" arbitrage activities involve
the purchase of securities at discounts from the expected values that would be
realized if certain proposed or anticipated corporate transactions (such as
mergers, acquisitions, recapitalizations, exchange offers, reorganizations,
bankruptcies, liquidations or spin-offs) were to occur. To the extent that these
anticipated transactions do not materialize in a manner consistent with the
Company's expectations, the Company is subject to the risk that the value of
these investments will decline. Lehman Brothers' arbitrage activities benefit
from the Company's presence in the global capital markets, access to
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advanced information technology, in-depth market research, proprietary risk
management tools and general experience in assessing rapidly changing market
conditions.
Proprietary Trading. Lehman Brothers engages in the trading of various
securities, derivatives, currencies and commodities for its own account. The
Company's proprietary trading activities bring together various research and
trading disciplines allowing it to take market positions, which at times may be
significant, consistent with the Company's expectations of future events (such
as movements in the level of interest rates, changes in the shape of yield
curves and changes in the value of currencies). The Company is subject to the
risk that actual market events will be different from the Company's
expectations, which may result in significant losses associated with such
proprietary positions. The Company's proprietary trading activities are
generally carried out in consultation with personnel from the relevant major
product area (e.g., mortgages, derivatives and foreign exchange).
TRADING SERVICES AND CORPORATE
The Company's Trading Services and Corporate divisions provide support to
its businesses through the processing of certain securities and commodities
transactions; receipt, identification and delivery of funds and securities;
safeguarding of customers' securities; and compliance with regulatory and legal
requirements. In addition, this staff is responsible for technology
infrastructure and systems development, treasury operations, financial control
and analysis, tax planning and compliance, internal audit, expense management,
career development and recruiting and other support functions.
In 1995, the Company made broad enhancements to its technology environment,
including the implementation of improved funding, credit, market risk and sales
support systems. The Company also made significant investments in its employees
through management training and career development initiatives and an expanded
recruitment program for analysts and associates.
On October 12, 1994, the Company and Bear Stearns Securities Corp. ("BSSC")
entered into an agreement pursuant to which BSSC agreed to process the
transactions previously cleared by Smith Barney (the "BSSC Agreement"). As a
result, the Company is now self-clearing, and the accounts previously carried by
Smith Barney are carried on the Company's books. The BSSC Agreement took effect
on February 17, 1995 and will run for a term of five years.
ONGOING COST REDUCTION EFFORT
Throughout 1995, Holdings and the Company took actions to reduce costs based
on Holdings' cost reduction efforts announced at year-end 1994. Throughout 1995,
Holdings achieved its cost reduction goals in personnel costs, non-personnel
costs and interest and tax expense. As a result of these efforts, the Company's
expense base has been permanently lowered. With respect to personnel costs, the
Company's total number of employees was reduced from approximately 6,950 at
fiscal year-end 1994 to approximately 6,200 at fiscal year-end 1995.
Non-personnel cost reductions were achieved as a result of a systematic and
comprehensive global review of all major expense categories.
RISK MANAGEMENT
As a leading global investment company, risk is an inherent part of all of
Lehman Brothers' businesses and activities. The extent to which Lehman Brothers
properly and effectively identifies, assesses, monitors and manages each of the
various types of risks involved in its trading, brokerage and investment banking
activities is critical to the success and profitability of the Company. The
principal types of risk involved in Lehman Brothers' activities are market
risks, credit or counterparty risks and transaction risks. Lehman Brothers has
developed a control infrastructure to monitor and manage each type of risk on a
global basis throughout the Company.
In its trading, market-making and underwriting activities, Lehman Brothers
is subject to risks relating to fluctuations in market prices and liquidity of
specific securities, instruments and derivative
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products, as well as volatility in market conditions in general. The markets for
these securities and products are affected by many factors, including the
financial performance and prospects of specific companies and industries,
domestic and international economic conditions (including inflation, interest
and currency exchange rates and volatility), the availability of capital and
credit, political events (including proposed and enacted legislation) and the
perceptions of participants in these markets.
Lehman Brothers' exposure to credit risks in its trading activities arise
from the possibility that a counterparty to a transaction could fail to perform
under its contractual commitment, resulting in Lehman Brothers incurring losses
in liquidating or covering its position in the open market.
In connection with its investment banking and product origination
activities, Lehman Brothers is exposed to risks relating to the merits of
proposed transactions. These risks involve not only the market and credit risks
associated with underwriting securities and developing derivative products, but
also potential liabilities under applicable securities and other laws which may
result from Lehman Brothers' role in the transaction.
The Company aims to reduce risk through the diversification of its products,
counterparties and activities in geographic regions. The Company accomplishes
this objective through allocating the usage of capital to each of its
businesses, establishing trading limits for individual products and traders, and
the approval of credit limits for individual counterparties including regional
concentrations. In addition, the Company is committed to employing qualified
personnel with expertise in each of its various businesses who are responsible
for the establishment of risk management policies and the continued review and
evaluation of these policies in light of changes in market conditions,
counterparty credit status, and the long- and short-term goals of the Company.
Senior management plays a critical role in the ongoing evaluation of risks,
including credit, market, operational and liquidity risks and makes necessary
changes in risk management policies in light of these factors.
The Company's risk management strategy is based on a multi-tier approach to
risk which includes many independent groups (i.e., risk management, finance,
legal, front office senior management, credit) being included in the risk
monitoring process. The Company's risk management department independently
reviews the Company's trading portfolios on a daily basis from a market risk
perspective which includes value at risk and other quantitative and qualitative
risk measurements and analyses. The risk management department has full time
professionals dedicated to each of the trading and geographic areas. The
Company's trade analysis department performs independent verification of the
prices of trading positions, regularly monitors the aging of inventory, and
performs daily review and analysis of the Company's profitability, by business
unit. The corporate credit department has the responsibility for establishing
and monitoring counterparty limits, structuring and approving specific
transactions, and establishing collateral requirements or other credit
enhancement features (such as financial covenants, guarantees or letters of
credit), when deemed necessary, to secure the Company's position. The Company's
Commitment Committee has the responsibility for reviewing and approving proposed
transactions involving the underwriting or placement of securities by Lehman
Brothers, while the Investment Committee performs a similar function in
reviewing and approving proposed transactions related to investments of capital
in connection with the Company's investment banking and merchant banking
activities. Additionally, the Company employs an internal audit department that
reports directly to the Company's Audit Committee and the Board of Directors.
This group performs periodic reviews to evaluate compliance with established
control processes. These reviews include performing tests on the accuracy of
inventory prices, compliance with established credit and trading limits, and
compliance with securities and other laws. The Company's control structure and
various control mechanisms are also subject to periodic reviews as a result of
examinations by the Company's external auditors as well as various regulatory
authorities.
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The Company seeks to ensure that it achieves adequate returns from each of
its business units commensurate with the risks assumed. To achieve this
objective, the Company periodically re-allocates capital to each of its
businesses based upon their ability to obtain returns consistent with
established guidelines as well as perceived opportunities in the marketplace and
the Company's long-term strategy.
NON-CORE ASSETS
Prior to 1990, the Company participated in a number of activities that are
not central to its current business as an institutional investment banking firm.
As a result of these activities, the Company carries on its balance sheet a
number of relatively illiquid assets (the "Non-Core Assets"), including a number
of individual real estate assets, limited partnership interests and a number of
smaller investments. Subsequent to their purchase, the values of certain of
these Non-Core Assets declined below the recorded values on the Company's
balance sheet, which necessitated the write-down of the carrying values of these
assets and corresponding charges to the Company's income statement. Certain of
these activities have resulted in various legal proceedings.
Since 1990, management has devoted substantial resources to reducing the
Company's Non-Core Assets. Between December 31, 1990 and November 30, 1995, the
Company's Non-Core Assets decreased from $1.1 billion in 1990 to approximately
$60 million in 1995. The value of the Company's Non-Core Assets includes
carrying value plus contingent exposures net of reserves. Management's intention
with regard to these Non-Core Assets is the prudent liquidation of these
investments as and when possible.
COMPETITION
All aspects of the Company's business are highly competitive. The Company
competes in domestic and international markets directly with numerous other
brokers and dealers in securities and commodities, investment banking firms,
investment advisors and certain commercial banks and, indirectly for investment
funds, with insurance companies and others.
The financial services industry has become considerably more concentrated as
numerous securities firms have either ceased operations or have been acquired by
or merged into other firms. In addition, several small and specialized
securities firms have been successful in raising significant amounts of capital
for their merger and acquisition activities and merchant banking investment
vehicles and for their own accounts. These developments have increased
competition from firms, many of whom have significantly greater equity capital
than the Company.
REGULATION
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. LBI and certain other subsidiaries
of Holdings are registered as broker-dealers and investment advisers with the
Commission and as such are subject to regulation by the Commission and by
self-regulatory organizations, principally the NASD and national securities
exchanges such as the NYSE, which has been designated by the Commission as LBI's
primary regulator, and the Municipal Securities Rulemaking Board. Securities
firms are also subject to regulation by state securities administrators in those
states in which they conduct business. LBI is a registered broker-dealer in all
50 states, the District of Columbia and the Commonwealth of Puerto Rico. The
Commission, self-regulatory organizations and state securities commissions may
conduct administrative proceedings, which may result in censure, fine, the
issuance of cease-and-desist orders or suspension or expulsion of a
broker-dealer or an investment adviser, its officers or employees.
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LBI is registered with the CFTC as a futures commission merchant and is
subject to regulation as such by the CFTC and various domestic boards of trade
and other commodity exchanges. The Company's U.S. commodity futures and options
business is also regulated by the National Futures Association, a not-for-profit
membership corporation which has been designated as a registered futures
association by the CFTC.
Holdings and the Company do business in the international fixed income,
equity and commodity markets and undertakes investment banking activities
through Holdings' subsidiaries. The U.K. Financial Services Act of 1986 (the
"Financial Services Act") governs all aspects of the United Kingdom investment
business, including regulatory capital, sales and trading practices, use and
safekeeping of customer funds and securities, record keeping, margin practices
and procedures, registration standards for individuals, periodic reporting and
settlement procedures. Pursuant to the Financial Services Act, Holdings and the
Company are subject to regulations administered by The Securities and Futures
Authority Limited, a self regulatory organization of financial services
companies (which regulates their equity, fixed income, commodities and
investment banking activities) and the Bank of England (which regulates their
wholesale money market, bullion and foreign exchange businesses).
The Company believes that it is in material compliance with regulations
described herein.
The Company anticipates regulation of the securities and commodities
industries to increase at all levels and for compliance therewith to become more
difficult. Monetary penalties and restrictions on business activities by
regulators resulting from compliance deficiencies are also expected to become
more severe.
CAPITAL REQUIREMENTS
As a registered broker-dealer, LBI is subject to the Commission's Rule
15c3-1 (the "Net Capital Rule") promulgated under the Securities Exchange Act of
1934, as amended (the "Exchange Act"). The Net Capital Rule requires LBI to
maintain net capital of not less than the greater of 2% of aggregate debit items
arising from customer transactions, as defined, or 4% of funds required to be
segregated for customers' regulated commodity accounts, as defined.
Compliance with the Net Capital Rule could limit those operations of LBI
that require the intensive use of capital, such as underwriting and trading
activities and the financing of customer account balances, and also could
restrict the ability of Holdings to withdraw capital from LBI, which in turn
could limit the ability of Holdings to pay dividends, repay debt and redeem or
purchase shares of its outstanding capital stock. See Footnote 8 of Notes to
Consolidated Financial Statements.
EMPLOYEES
As of November 30, 1995 the Company employed approximately 6,200 persons.
The Company considers its relationship with its employees to be good.
ITEM 2. PROPERTIES
The Company's headquarters occupy approximately 1,147,000 square feet of
space at 3 World Financial Center in New York, New York, which is owned by the
Company as tenants-in-common with American Express and various other American
Express subsidiaries.
Holdings entered into a lease for approximately 392,000 square feet for
offices located at 101 Hudson Street in Jersey City, New Jersey (the "Operations
Center"). The Operations Center is used by
9
systems, operations, and certain administrative personnel and contains certain
back-up trading systems. The lease term is approximately 16 years and commenced
in August 1994.
Most of the Company's other offices are located in leased premises, the
leases for which expire at various dates through the year 2007. During 1995, the
Company conducted a global review of its real estate requirements, and took an
occupancy-related real estate charge. See Note 17 to Consolidated Financial
Statements. The Company intends to sublet certain of these leased premises.
Facilities owned or occupied by the Company and its subsidiaries are believed to
be adequate for the purposes for which they are currently used and are well
maintained.
ITEM 3--LEGAL PROCEEDINGS
The Company is involved in a number of judicial, regulatory and arbitration
proceedings concerning matters arising in connection with the conduct of its
business. Such proceedings include actions brought against the Company and
others with respect to transactions in which the Company acted as an underwriter
or financial advisor, actions arising out of the Company's activities as a
broker or dealer in securities and commodities and actions brought on behalf of
various classes of claimants against many securities and commodities firms of
which the Company is one.
Although there can be no assurance as to the ultimate outcome, the Company
has denied, or believes it has a meritorious defense and will deny, liability in
all significant cases pending against it including the matters described below,
and intends to defend vigorously each such case. Although there can be no
assurance as to the ultimate outcome, based on information currently available
and established reserves, the Company believes that the eventual outcome of the
actions against it, including the matters described below, will not, in the
aggregate, have a material adverse effect on the consolidated financial
condition of the Company.
Bamaodah v. E.F. Hutton & Company Inc.
In April 1986, Ahmed and Saleh Bamaodah commenced an action against E.F.
Hutton & Company Inc., ("EFH") to recover all losses the Bamaodahs had incurred
since May 1981 in the trading of commodity futures contracts in a
nondiscretionary EFH trading account. The Dubai Civil Court ruled that the
trading of commodity futures contracts constituted illegal gambling under
Islamic law and that therefore the brokerage contract was void. In January 1987,
a judgment was rendered against EFH in the amount of $48,656,000. On January 5,
1991, the Dubai Court of Appeals affirmed the judgment. On March 22, 1992, the
Court of Cassation, Dubai's highest court, revoked and quashed the decision of
the Court of Appeals and ordered that the case be remanded to the Court of
Appeals for a further review. On April 26, 1994, the Dubai Court of Appeals
again affirmed the judgment of the Dubai Civil Court. The Company appealed the
judgment to the Court of Cassation, which reversed the Court of Appeals on
November 27, 1994 and ordered that a new expert be appointed to review the case.
A new expert has been appointed, with instructions to report back to the Court
of Cassation.
Actions Relating To First Capital Holdings Inc.
Derivative Actions. On or about March 29, 1991, two identical purported
shareholder derivative actions were filed, entitled Mentch v. Weingarten, et al.
and Isaacs v. Weingarten, et al. The complaints in these two actions, pending in
the Superior Court of the State of California, County of Los Angeles, are filed
allegedly on behalf of and naming as a nominal defendant First Capital Holdings
Inc. ("FCH"). Other defendants include Holdings, two former officers and
directors of FCH, Robert Weingarten and Gerry Ginsberg, the four outside
directors of FCH, Peter Cohen, Richard DeScherer, William L. Mack and Jerome H.
Miller (collectively, the "Outside Directors"), and Michael Milken. The
complaints alleged generally breaches of fiduciary duty, gross corporate
mismanagement and waste
10
of assets in connection with FCH's purchase of non-rated bonds underwritten by
Drexel Burnham Lambert Inc. and sought damages for losses suffered by FCH,
punitive damages and attorneys' fees. On January 30, 1996, these two actions
were dismissed.
Concurrent with the bankruptcy filing of FCH and the conservatorship and
receivership of its two life insurance subsidiaries, First Capital Life
Insurance Company ("First Capital Life") and Fidelity Bankers Life Insurance
Company ("Fidelity Bankers Life") (First Capital Life and Fidelity Bankers Life
collectively, the "Insurance Subsidiaries"), a number of additional actions were
instituted, naming one or more of Holdings, Lehman Brothers and American Express
as defendants (individually or collectively, as the case may be, the "American
Express Defendants").
Under the terms of an agreement between American Express and Holdings,
Holdings has agreed to indemnify American Express for liabilities which it may
incur in connection with any action (including any derivative action) relating
to FCH. In connection therewith, Holdings' indemnification obligation extends to
the below described actions.
FCH Shareholder and Agent Actions. Three actions were commenced in the
United States District Courts for the Southern District of New York and the
Central District of California allegedly as class actions on behalf of the
purchasers of FCH securities during certain specified periods, commencing no
earlier than May 4, 1988 and ending no later than May 31, 1991 (the "Shareholder
Class"). The complaints are captioned Larkin, et al. v. First Capital Holdings
Corp., et al., amended on May 15, 1991 to add American Express as a defendant,
Zachary v. American Express Company, et al., filed on May 20, 1991, and Morse v.
Weingarten, et al., filed on June 13, 1991 (the "Shareholder Class Actions").
The complaints raised claims under the federal securities laws and alleged that
the defendants concealed adverse material information regarding the finances,
financial condition and future prospects of FCH and made material misstatements
regarding these matters.
On July 1, 1991 an action was filed in the United States District Court for
the Southern District of Ohio entitled Benndorf v. American Express Company, et
al. The action was brought purportedly on behalf of three classes. The first
class is similar to the Shareholder Class; the second consisted of managing
general agents and general agents who marketed various First Capital Life
products from April 2, 1990 to the present and to whom it is alleged
misrepresentations were made concerning FCH (the "Agent Class"); and the third
class consists of Agents who purchased common stock of FCH through the First
Capital Life Non Qualified Stock Purchase Plan ("FSPP") and who have an interest
in the Stock Purchase Account under the FSPP (the "FSPP Class"). The complaint
raised claims similar to those asserted in the other Shareholder Class Actions,
along with additional claims relating to the FSPP Class and the Agent Class
alleging damages in marketing the products. In addition, on August 15, 1991,
Kruthoffer v. American Express Company, et al. was filed in the United States
District Court for the Eastern District of Kentucky, whose complaint was nearly
identical to the Benndorf complaint (collectively the "Agent Class Actions").
On November 14, 1991, the Judicial Panel on Multidistrict Litigation issued
an order transferring and coordinating for all pretrial purposes all related
actions concerning the sale of FCH securities, including the Shareholder Class
Action and Agent Class Actions, and any future filed "tag-along" actions, to
Judge John G. Davies of the United States District Court for the Central
District of California (the "California District Court"). The cases are
captioned In Re: First Capital Holdings Corporation Financial Products
Securities Litigation. MDL Docket No.-901 (the "MDL Action").
On January 18, 1993, an amended consolidated complaint (the "Third
Complaint") was filed on behalf of the Shareholder Class and the Agent Class.
The Third Complaint names as defendants American Express, Holdings, Lehman
Brothers, Weingarten and his wife, Palomba Weingarten, Ginsberg, Philip A.
Fitzpatrick (FCH's Chief Financial Officer), the Outside Directors and former
FCH outside directors Jeffrey B. Lane and Robert Druskin (the "Former Outside
Directors"), Fred
11
Buck (President of First Capital Life) and Peat Marwick. The complaint raises
claims under the federal securities law and the common law of fraud and
negligence. On March 10, 1993, the American Express defendants answered the
Third Amended Complaint, denying its material allegations.
On March 11, 1993, the California District Court entered an order granting
class certification to the Shareholder Class. The class consists of all persons,
except defendants, who purchased FCH common stock, preferred stock and
debentures during the period May 4, 1988 to and including May 10, 1991. It also
issued an order denying class certification to the Agent Class. The FSPP Class
action had been previously dropped by the plaintiffs.
The American Express Shareholder Action. On or about May 20, 1991, a
purported class action was filed on behalf of all shareholders of American
Express who purchased American Express common shares during the period beginning
August 16, 1990 to and including May 10, 1991. The case is captioned Steiner v.
American Express Company, et al. and was commenced in the United States District
Court for the Eastern District of New York. The defendants are Holdings,
American Express, James D. Robinson, III, Howard L. Clark, Jr., Harvey Golub and
Aldo Papone. The complaint alleges generally that the defendants failed to
disclose material information in their possession with respect to FCH which
artificially inflated the price of the common shares of American Express from
August 16, 1990 to and including May 10, 1991 and that such nondisclosure
allegedly caused damages to the purported shareholder class. The action has been
transferred to California and is now part of the MDL Action. The defendants have
answered the complaint, denying its material allegations.
American Express Derivative Action. On June 6, 1991, a purported shareholder
derivative action was filed in the United States District Court for the Eastern
District of New York, entitled Rosenberg v. Robinson, et al., against all of the
then-current directors of American Express. In January 1992, this action was
transferred by stipulation to be part of the MDL action. The complaint alleged
that the Board of Directors of American Express should have required Holdings to
divest its investment in FCH and to write down such investment sooner. In
addition, the complaint alleged that the failure to act constituted a waste of
corporate assets and caused damage to American Express' reputation. The
complaint sought a judgment declaring that the directors named as defendants
breached their fiduciary duties and duties of loyalty and requiring the
defendants to pay money damages to American Express, and remit their
compensation for the period in which the duties were breached, to pay attorneys'
fees and costs and other relief. The parties to the American Express Shareholder
Action and the American Express Derivative Action have entered into a settlement
agreement, subject to approval by the Court.
The Virginia Commissioner of Insurance Action. On December 9. 1992, a
complaint was filed in federal court in the Eastern District of Virginia by
Steven Foster, the Virginia Commissioner of Insurance as Deputy Receiver of
Fidelity Bankers Life. The Complaint names Holdings and Weingarten, Ginsberg and
Leonard Gubar, a former director of FCH and Fidelity Bankers Life, as
defendants. The action was subsequently transferred to California to be part of
the MDL Action. The Complaint alleges that Holdings acquiesced in and approved
the continued mismanagement of Fidelity Bankers Life and that it participated in
directing the investment of Fidelity Bankers Life assets. The complaint asserts
claims under the federal securities laws and asserts common law claims including
fraud, negligence and breach of fiduciary duty and alleges violations of the
Virginia Securities laws by Holdings. It allegedly seeks no less than $220
million in damages to Fidelity Bankers Life and its present and former
policyholders and creditors and punitive damages. Holdings has answered the
complaint, denying its material allegations.
Easton & Co. v. Mutual Benefit Life Insurance Co., et al.; Easton & Co. v.
Lehman Brothers Inc.
Lehman Brothers has been named as a defendant in two consolidated class
action complaints pending in the United States District Court for the District
of New Jersey (the "N.J. District Court").
12
Easton & Co. v. Mutual Benefit Life Insurance Co., et al. ("Easton I"), and
Easton & Co. v. Lehman Brothers Inc. ("Easton II"). The plaintiff in both of
these actions is Easton & Co., which is a broker-dealer located in Fort Lee, New
Jersey. Both of these actions allege federal securities law claims and pendent
common law claims in connection with the sale of certain municipal bonds as to
which Mutual Benefit Life Insurance Company ("MBLI") has guaranteed the payment
of principal and interest. MBLI is an insurance company which was placed in
rehabilitation proceedings under the supervision of the New Jersey Insurance
Department on or about July 16, 1991. In the Matter of the Rehabilitation of
Mutual Benefit Life Insurance Company, (Sup. Ct. N.J. Mercer County.)
Easton I was commenced on or about September 17, 1991. In addition to Lehman
Brothers, the defendants named in this complaint are MBLI, Henry E. Kates
(MBLI's former Chief Executive Officer) and Ernst & Young (MBLI's accountants).
The litigation is purportedly brought on behalf of a class consisting of all
persons and entities who purchased DeKalb, Georgia Housing Authority Multi-
Family Housing Revenue Refunding Bonds (North Hill Ltd. Project), Series 1991,
due November 30, 1994 (the "DeKalb Bonds") during the period from May 3, 1991
(when the DeKalb bonds were issued) through July 16, 1991. Lehman Brothers acted
as underwriter for this bond issue, which was in the aggregate principal amount
of $18.7 million. The complaint alleges that Lehman Brothers violated Section
10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, and seeks
damages in an unspecified amount or rescission. The complaint also alleges a
common law negligent misrepresentation claim against Lehman Brothers and the
other defendants.
Easton II was commenced on or about May 18, 1992, and names Lehman Brothers
as the only defendant. Plaintiff purports to bring this second lawsuit on behalf
of a class composed of all persons who purchased "MBLI-backed Bonds" from Lehman
Brothers during the period April 19, 1991 through July 16, 1991. The complaint
alleges that Lehman Brothers violated Section 10(b) and Rule 10b-5, and seeks
monetary damages in an unspecified amount, or rescission pursuant to Section
29(b) of the Exchange Act. The complaint also contains a common law claim of
alleged breach of duty and negligence.
On or about February 9, 1993, the N.J. District Court granted plaintiffs'
motion for class certification in Easton I. The parties have agreed to
certification of a class in Easton II for purchases of certain fixed-rate
MBLI-backed bonds during the class period.
Maxwell Related Litigation
Certain of the Company's subsidiaries are defendants in several lawsuits
arising out of transactions entered into with the late Robert Maxwell or
entities controlled by Maxwell interests. These actions are described below.
Berlitz International Inc. v. Macmillan Inc. et al. This interpleader action
was commenced in Supreme Court, New York County (the "Court") on or about
January 2, 1992, by Berlitz International Inc. ("Berlitz") against Macmillan
Inc. ("Macmillan"), Lehman Brothers Holdings PLC ("PLC"), Lehman Brothers
International Limited (now known as Lehman Brothers International (Europe),
("LBIE") and seven other named defendants. The interpleader complaint seeks a
declaration of the rightful ownership of approximately 10.6 million shares of
Berlitz common stock, including 1.9 million shares then registered in PLC's
name, alleging that Macmillan claimed to be the beneficial owner of all 10.6
million shares, while the defendants did or might claim ownership to some or all
of the shares. As a result of its bankruptcy filing, MacMillan sought to remove
this case to the Bankruptcy Court for the Southern District of New York. On the
motion of LBIE and PLC, the case was remanded back to the Court. Following the
remand, the parties entered into a stipulation pursuant to which all proceedings
have been stayed pending the outcome of the appeal in Macmillan v. Bishopsgate
Investment Trust et al., referred to below.
13
Macmillan, Inc. v. Bishopsgate Investment Trust, Shearson Lehman Brothers
Holdings PLC et al. This action was commenced by issuance of a writ in the High
Court of Justice in London, England on or about December 9, 1991. In this
action, Macmillan sought relief virtually identical to that sought in the
Berlitz action, described above. Specifically, Macmillan sought a declaration
that it is the legal and beneficial owner of the disputed 10.6 million shares of
Berlitz common stock, including the 1.9 million shares then held by PLC. After a
trial, on December 10, 1993, the High Court of Justice handed down a judgment
finding for the Company on all aspect of its defense and dismissing MacMillan's
claims. On November 2, 1995, the Court of Appeal issued a preliminary judgment
dismissing MacMillan s appeal. MacMillan has sought leave to appeal to the House
of Lords.
MCC Proceeds Inc. v. Lehman Brothers International (Europe) This action was
commenced by issuance of a writ in the High Court of Justice in London, England
on July 14, 1995. In this action, MCC Proceeds Inc., as successor to Macmillan,
Inc., seeks relief identical to that sought in the Berlitz action described
above, but based on a legal theory which was initially pleaded but ultimately
abandoned by the plaintiff in Berlitz. The High Court granted LBIE's has issued
an application to dismiss the proceeding and assessed costs against MCC
Proceeds.
Lehman Brothers Commercial Corporation and Lehman Brothers Special Financing
Inc. v. China International United Petroleum and Chemical Co., Ltd.
On November 15, 1994, two Lehman Brothers subsidiaries, Lehman Brothers
Commercial Corporation ("LBCC") and Lehman Brothers Special Financing Inc.
("LBSF"), commenced an action against China International United Petroleum and
Chemicals Company ("Unipec") in the United States District Court for the
Southern District of New York alleging breach of contract. The litigation arose
from the refusal by Unipec to honor its obligations with respect to certain
foreign exchange and swap transactions. LBCC and LBSF seek to recover
approximately $44 million from Unipec. Unipec asserted fifteen counterclaims
against Lehman entities based on violations of federal securities and
commodities laws and rules and theories of fraud, breach of fiduciary duty,
conversion and business torts. Unipec seeks $8 million in compensatory damages,
as well as punitive damages. The Court granted the motion of the Lehman
counterclaim defendants in part, and dismissed the counterclaims based on
business tort theories. Discovery is progressing.
Lehman Brothers Commercial Corporation and Lehman Brothers Special Financing
Inc. v. Minmetals International Non-Ferrous Metals Trading Company
On November 15, 1994, LBCC and LBSF commenced an action against Minmetals
International Non-Ferrous Metals Trading Company ("Minmetals") and China
National Metals and Minerals Import and Export Company ("CNM") in the United
States District Court for the Southern District of New York alleging breach of
contract against Minmetals and breach of guarantee against CNM. The litigation
arose from the refusal by Minmetals and CNM to honor their obligations with
respect to certain foreign exchange and swap transactions. LBCC and LBSF seek to
recover approximately $53.5 million from Minmetals and/or CNM. On June 26, 1995,
the court granted CNM's motion to dismiss the claims against it, but also
granted LBCC and LBSF leave to replead. Minmetals filed fourteen counterclaims
against Lehman entities based on violations of federal securities and
commodities laws and rules, and theories of fraud, breach of fiduciary duty and
conversion. The court denied a motion by the Lehman counterclaim defendants to
dismiss the six fraud-based counterclaims. On February 7, 1996, LBCC and LBSF
sought leave to file an amended complaint naming CNM as an additional defendant.
Discovery is progressing.
14
Sinochem(USA) Inc. v. Lehman Brothers Inc. et al.
On January 4, 1996, a complaint was filed in the United States District
Court for the Southern District of New York by Sinochem (USA) Inc. ("Sinochem")
against Lehman Brothers Inc., Lehman Special Financing and Sheng Yan, a former
Lehman salesperson. The complaint alleges that Sinochem has been exposed to
losses of approximately $20 million by entering into unsuitable investments,
namely interest rate swaps and repurchase transactions, with the defendants. The
complaint, which includes claims based on fraud, breach of fiduciary duty,
breach of contract and alleged violations of federal securities and commodities
laws and rules, seeks return of the capital Sinochem invested, a declaration
that the transactions are void, and punitive damages. The defendants intend to
file an answer denying the material allegations of the complaint and to assert
counterclaims against Sinochem and its parent corporation, China National
Chemicals Import & Export Corporation ("Sinochem Beijing"), to recover all
amounts due and owing from Sinochem and Sinochem Beijing.
Actions Relating to National Association of Securities Dealers Automated
Quotations System ("NASDAQ") Market Maker Antitrust and Securities Litigation.
Beginning in May, 1994, several class actions were filed in various state
and federal courts against various broker-dealers making markets in NASDAQ
securities. With respect to a number of those actions LBI was either
specifically named as a defendant or was not specifically named as a defendant
but could be deemed to be a member of the defendant class as defined in the
complaints. Plaintiffs in these cases have alleged violations of the antitrust
laws, securities laws and have pled a variety of other statutory and common law
claims. All of these actions are based on the theory that because odd-eighth
quotes occur less often than quarter quotes, NASDAQ market makers must be
colluding wrongfully to maintain a wider spread.
By Order filed October 14, 1994, the Judicial Panel on Multidistrict
Litigation consolidated these actions in the Southern District of New York and
ordered that all related actions be transferred and coordinated for all pretrial
purposes. The case is captioned In Re NASDAQ Market-Makers Antitrust Litigation,
MDL No. 1023.
On December 16, 1994, plaintiffs served a consolidated Amended Complaint
naming 33 defendants including LBI. Plaintiffs claim violations of the federal
antitrust laws including Section 1 of the Sherman Antitrust Act. Plaintiffs seek
unspecified compensatory damages trebled in accordance with the antitrust laws,
costs including attorneys' fees as well as injunctive relief. The court
dismissed the action with leave to replead, stating that the complaint failed to
identify the securities involved with sufficient specificity. The plaintiffs
replied and the defendants answered the amended complaint on November 17, 1995.
Discovery has commenced.
Leetate Smith, et al. v. Merrill Lynch, et al.
On February 28, 1995 a First Amended Consolidated Class Action Complaint for
Violations of the Federal Securities Laws and the California Corporations Code
(the "Complaint") was filed in the United States District Court for the Central
District of California amending a previously filed complaint and adding, among
other defendants, LBI. The Complaint is purportedly brought on behalf of
purchasers of bonds, notes and other securities during the period July 1, 1992
through December 6, 1994 (the "Class Period") that were issued by Orange County
or by other public entities which had funds invested in Orange County's
Investment Pool (collectively the "County"). Also named as defendants are eight
other broker-dealers who are, like LBI, alleged to have acted as underwriters of
the County's debt securities and the five financial advisors who allegedly
advised the County during the Class Period. The Complaint alleges violations of
Section 10b of the Exchange Act of 1934 and various sections of the California
Corporations Code based on alleged misstatements and omissions in the
15
Official Statements of the debt offerings by the County primarily relating to
the County's creditworthiness and ability to repay the debts. The Complaint
seeks (i) to certify the action as a class action; (ii) unspecified damages plus
interest; and (iii) attorneys fees.
Sonnenfeld v. The City and County of Denver, Colorado, et al.
On August 4, 1995, a Consolidated Amended Class Action Complaint (the
"Complaint") was filed in the United States District Court for the District of
Colorado, consolidating and amending previously filed complaints and adding,
among other defendants, LBI. The Complaint is purportedly brought on behalf of
all persons, other than defendants, who purchased Denver Airport System Revenue
Bonds during the period February 27, 1992 through May 3, 1994 that were issued
by the City and County of Denver (the "Bonds") and who were damaged by their
investments. Also named as defendants are seven other broker-dealers who acted
as underwriters or financial advisors in connection with the issuances of the
Bonds and the City and County of Denver. The Complaint alleges violations of
Section 10b of the Exchange Act of 1934 and the Colorado Securities Act and
common law fraud based on alleged misstatements and omissions in the Official
Statements for the Bonds primarily relating to status of the design and
construction of the new Denver International Airport (the "Airport"), the amount
of revenues it would likely generate and the risks posed to the timely opening
of the Airport by the installation of an automated baggage system. The Complaint
seeks (i) to certify the action as a class action; (ii) unspecified damages; and
(iii) costs and attorneys fees.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Pursuant to General Instruction J of Form 10-K, the information required by
Item 4 is omitted.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
All of the outstanding common stock of the Company is owned by Holdings.
ITEM 6. SELECTED FINANCIAL DATA
Pursuant to General Instruction J of Form 10-K, the information required by
Item 6 is omitted.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Set forth on the following pages is Management's Discussion and Analysis of
Financial Condition and Results of Operations for the twelve months ended
November 30, 1995, the eleven months ended November 30, 1994 and the twelve
months ended December 31, 1993.
BUSINESS ENVIRONMENT
The principal business activities of Lehman Brothers Inc., a registered
broker-dealer ("LBI") and subsidiaries (collectively, the "Company" or "Lehman
Brothers") are investment banking and securities trading and sales, which by
their nature are subject to volatility, primarily due to changes in interest and
foreign exchange rates, global economic and political trends and industry
competition. As a result, revenues and earnings may vary significantly from
quarter to quarter and from year to year. LBI is a wholly owned subsidiary of
Holdings.
The adverse market conditions that prevailed during the last three quarters
of 1994, characterized by rising interest rates and depressed underwriting
volumes, continued throughout most of the first quarter of 1995.
16
In the second quarter of 1995, market conditions showed signs of improvement
as expectations for lower U.S. interest rates prompted strong rallies in the
stock and bond markets. Although customer volumes increased in both the debt and
equity markets, market conditions continued to be volatile during this period.
In general, investors remained conservative and defensive due to uncertainties
surrounding the direction of U.S. interest rates and the value of the dollar.
Over the same period, derivative transaction volumes showed improvement as
customers and clients were looking for protection in a declining interest rate
and volatile currency environment.
The positive momentum established during the second quarter of 1995
continued into the third quarter of 1995. In early July 1995, the U.S. Federal
Reserve Bank reduced the federal funds rate by one-quarter of a percentage
point. Investors reacted favorably to this long-awaited rate cut, leading to a
rally in the bond market. However, by the middle of July 1995, positive economic
data caused renewed investor concerns regarding inflation, the growth rate of
the economy and the future direction of interest rates. Towards the end of the
third quarter, the market tone turned decidedly more positive as investors
concluded that interest rate increases would be unnecessary. In addition, the
dollar continued to strengthen against key currencies such as the yen and the
Deutsche mark, providing further support for a more stable interest rate
environment.
The fixed income and equity markets rallied as a result of these factors.
Improved market conditions allowed for a continuing increase in debt and equity
origination activity. Driving the robust equity markets were strong individual
company and industry fundamentals, near record levels of merger and acquisition
activity and substantial cash inflows into mutual funds.
The market rally, which began in September, accelerated through the months
of October and November. The more favorable view on interest rates provided
strong support for the U.S. equity market as the major equity indices hit
all-time highs. Business fundamentals have remained reasonably positive in the
U.S. bond market, as lower levels of inflation and the possibility of a deficit
reduction agreement by the U.S. Government have raised the potential for further
interest rate reductions by the U.S. Federal Reserve Bank. These conditions have
been positive for debt and equity origination activity and secondary trading
volumes for the industry as a whole. Internationally, lower growth rates in the
major European countries have prompted interest rate reductions from a number of
central banks and strong rallies in their respective bond and stock markets.
Higher relative returns in the U.S. markets vis-a-vis foreign markets have
bolstered international interest in U.S. securities and provided support for the
U.S. dollar. This positive market environment has continued into 1996.
HOLDINGS' SPIN-OFF FROM AMERICAN EXPRESS
On May 31, 1994, American Express effected a special dividend to its common
shareholders of record on May 20, 1994, of approximately 98.2 million shares of
Holdings' common stock. (See Note 6 to the Consolidated Financial Statements.)
As part of the spin-off, Holdings' equity capital was increased and
restructured, with Holdings receiving a net increase of $1.25 billion of equity,
primarily from American Express. As a result of the Distribution, Holdings
became a widely held public corporation with its common stock traded on the New
York Stock Exchange.
CHANGE IN YEAR-END
Effective with the Distribution, the Company and Holdings changed their
year-end from December 31 to November 30, in order to shift certain year-end
administrative activities to a time period that conflicts less with the business
needs of the Company's institutional customers. As a result of the change in the
Company's year-end, it reported its 1994 financial statements on the basis of an
eleven month transition period ended November 30, 1994. Due to the eleven month
reporting period for 1994, the Company's 1994 results of operations are not
directly comparable with the Company's results for 1995 or 1993.
17
BUSINESSES SOLD
The Company completed the sale of three businesses during 1993: The Boston
Company, Shearson, and SLHMC which were completed on May 21, July 31, and August
31, 1993, respectively. (See Note 18 to the Consolidated Financial Statements.)
The Company's operating results reflect The Boston Company as a discontinued
operation, while the operating results of Shearson and SLHMC are included in the
Company's results from continuing operations for all periods prior to their sale
in 1993. Because of the significant sale transactions completed during 1993, the
Company's historical financial statements are not fully comparable for all
periods presented.
RESULTS OF OPERATIONS
SUMMARY. The Company reported net income of $69 million for 1995, including
a $26 million ($43 million pretax) charge for occupancy-related real estate
expenses and severance. Excluding the restructuring charge, net income was $95
million for 1995. The Company's 1995 results reflect improved performance in
corporate finance advisory activity and in fixed income and equity origination
as well as higher levels of customer activity in a number of businesses. The
Company benefited from the continuing increase in merger and acquisition
activity throughout the year and from a stronger market climate beginning in the
second quarter of 1995. Realization of benefits from the continued investments
in selective investment banking, research and sales resources, combined with
reductions in the Company's non-interest expenses (excluding special charges),
also had a positive effect on 1995 results. For 1994, the Company reported a net
loss of $29 million, including a $13 million ($23 million pretax) charge for the
cumulative effect of a change in accounting for postemployment benefits, a $15
million ($27 million pretax) severance charge recorded in the first quarter of
1994 related to the Company's ongoing review of its personnel needs ("Severance
Charge") and $50 million preferred dividend of subsidiary. Excluding these
charges, net income from continuing operations before preferred dividend of
subsidiary was $49 million in 1994. The 1994 results reflect the difficult
market environment for many of the Company's principal businesses. The Company
reported a net loss of $259 million for 1993 which included a loss of $646
million for businesses sold, net income of $198 million for the Company's
continuing businesses and a net gain of $189 million from discontinued
operations. A detailed breakout of the 1993 results into these three categories
is included on page 25. The primary discussion and comparison of operating
results for 1993 includes only the continuing Lehman Businesses, with a separate
section for Businesses Sold/Discontinued Operations listed subsequently on pages
25-26.
NET REVENUES. Net revenues were $2,078 million for 1995, $1,969 million for
1994 and $2,674 million for 1993. Revenues in 1995 were positively affected by
increased underwriting volumes and customer flow activity due to strong rallies
in the stock and bond markets during the last three quarters of the year. The
Company's revenues increased during each quarter of 1995. Although 1994 revenues
on an annualized basis were comparable to 1995 levels, the Company's 1994
revenues declined from a first quarter peak as increasing interest rates and
volatile equity markets served to depress underwriting volumes and to reduce
customer flow activity. Revenues in 1993 were affected by the positive economic
environment, which resulted in a record year for the U.S. securities industry,
as historically low interest rates, higher volumes of new stock and bond issues
and the continued restructuring of corporate balance sheets produced strong
results.
Since 1990, Lehman Brothers has focused on a "client/customer-driven"
strategy. Under this strategy, Lehman Brothers concentrates on serving the needs
of major issuing and advisory clients and investing customers worldwide to build
an increasing "flow" of business that leverages the Company's research,
underwriting and distribution capabilities. Customer flow continues to be the
primary source of the Company's net revenues. In addition to its customer flow
activities, the Company also takes proprietary positions based upon expected
movements in interest rate, foreign exchange, equity and commodity markets in
both the short- and long-term. The Company's success in this area is dependent
upon its ability to anticipate economic and market trends and to develop trading
strategies that
18
capitalize on these anticipated changes. Consistent with the Company's
client/customer-driven strategy, the Company estimates that proprietary trading
activities accounted for approximately 9% of net revenues in 1995. Proprietary
trading is not anticipated to grow significantly.
As part of its market-making activities, the Company maintains inventory
positions of varying amounts across a broad range of financial instruments which
are marked-to-market on a daily basis and along with the Company's proprietary
trading positions, give rise to principal transactions revenues. The Company
utilizes various hedging strategies to minimize its exposure to significant
movements in interest and foreign exchange rates and the equity markets. Net
revenues from the Company's market making and trading activities in fixed income
and equity products are recognized as either principal transactions or net
interest revenues depending upon the method of financing and/or hedging related
to specific inventory positions. The Company evaluates its trading strategies on
an overall profitability basis which includes both principal transaction
revenues and net interest. Therefore, changes in net interest should not be
viewed in isolation but should be viewed in conjunction with revenues from
principal transactions. Net interest and dividend revenues in 1995 decreased
over the prior year due to decreased net interest spreads in certain of the
Company's fixed income and equity financing portfolios. Additionally, net
interest and dividend revenues in 1995 were adversely affected by increased
financing costs due to the net reduction in the Company's equity capital base,
primarily as a result of dividends and capital distributions to Holdings. The
Company's net interest and dividend revenues in 1994 were adversely affected by
reduced spreads on fixed income products and increased funding costs to the
Company as compared to the prior year as a result of the higher interest rate
environment in 1994.
The following table of net revenues by business unit and the accompanying
discussion have been prepared in order to present the Company's net revenues in
a format which reflects the manner in which the Company manages its businesses.
For internal management purposes, the Company has been segregated into five
major business units: Fixed Income, Equity, Corporate Finance Advisory, Merchant
Banking and Asset Management. Each business unit represents a grouping of
financial activities and products with similar characteristics. These business
activities result in revenues that are recognized in multiple revenue categories
contained in the Company's Consolidated Statement of Operations. Net revenues by
business unit contain certain internal allocations, including funding costs,
which are centrally managed.
19
TWELVE MONTHS ENDED NOVEMBER 30, 1995
PRINCIPAL
TRANSACTIONS AND INVESTMENT
NET INTEREST COMMISSIONS BANKING OTHER TOTAL
---------------- ----------- ---------- ----- ------
Fixed Income............................ $ 970 $ 84 $160 $10 $1,224
Equity.................................. 98 287 198 1 584
Corporate Finance Advisory.............. 186 186
Merchant Banking........................ (36) 77 9 50
Asset Management........................ (2) 24 12 34
------- ----- ----- ----- ------
$1,030 $ 395 $621 $32 $2,078
------- ----- ----- ----- ------
ELEVEN MONTHS ENDED NOVEMBER 30, 1994
PRINCIPAL
TRANSACTIONS AND INVESTMENT
NET INTEREST COMMISSIONS BANKING OTHER TOTAL
---------------- ----------- ---------- ----- ------
Fixed Income............................ $ 933 $ 101 $ 80 $37 $1,151
Equity.................................. 196 263 154 7 620
Corporate Finance Advisory.............. 153 153
Merchant Banking........................ (8) 12 4
Asset Management........................ 1 27 13 41
------- ----- ----- ----- ------
$1,122 $ 391 $399 $57 $1,969
------- ----- ----- ----- ------
TWELVE MONTHS ENDED DECEMBER 31, 1993
PRINCIPAL
TRANSACTIONS AND INVESTMENT
NET INTEREST COMMISSIONS BANKING OTHER TOTAL
---------------- ----------- ---------- ----- ------
Fixed Income............................ $1,216 $ 114 $172 $12 $1,514
Equity.................................. 346 292 336 12 986
Corporate Finance Advisory.............. 101 101
Merchant Banking........................ (12) 15 3
Asset Management........................ 8 31 31 70
------- ----- ----- ----- ------
$1,558 $ 437 $624 $55 $2,674
------- ----- ----- ----- ------
For 1995, net revenues were positively impacted by significantly improved
underwriting levels in fixed income and equity products, and strengthened
customer activity throughout the year. Net revenues by business unit for 1994
were down in each major category except corporate finance advisory and merchant
banking in comparison to the business unit revenues recorded in 1993, reflecting
the particularly robust conditions in the capital markets for the entire 1993
year. In 1995, fixed income revenues of $1,224 million reflected a higher
contribution from investment banking, as the mix and after-market performance of
the Company's underwriting improved from 1994 levels. Equity revenues of $584
million in 1995 also reflected the stronger underwriting market environment.
Corporate finance advisory revenues of $186 million in 1995 reflected the
Company's increased participation in strategic mergers and acquisitions and
advisory activities throughout the year. Merchant banking revenues of $50
million in 1995 reflected the merger of certain subsidiaries of Holdings with
merchant banking activities into the Company in the fourth quarter of 1994.
20
The following discussion provides an analysis of the Company's net revenues
based upon the various business units which generated these revenues.
FIXED INCOME
The Company's fixed income revenues reflect customer flow activities (both
institutional and high net-worth retail), secondary trading, debt underwriting,
syndicate and financing activities related to fixed income products. Fixed
income products include government securities, mortgage- and asset-backed
securities, money market products, dollar and non-dollar corporate debt
securities, emerging market securities, municipal securities, financing (global
access to debt financing sources including repurchase and reverse repurchase
agreements), foreign exchange, commodities and fixed income derivative products.
Lehman Brothers is one of the leading 37 primary dealers in U.S. government
securities. The Company is also a dominant market-maker for a broad range of
other fixed income products.
Fixed income revenues were $1,224 million for 1995, $1,151 million for 1994
and $1,514 million for 1993. Reduced interest rates and a strengthening U.S.
dollar contributed to a favorable market environment in 1995, particularly
during the second half of the Company's year. The improved market environment
contributed to a stronger debt syndicate calendar and increased customer flow
activities for many of the Company's fixed income products, including high grade
corporates, municipals and foreign exchange. The most significant component of
the increases in fixed income revenues was investment banking due to a
strengthening in origination volumes and an improved mix of underwriting
revenues compared to the depressed 1994 levels. Holdings and its subsidiaries
ranked #2 in lead-managed fixed income offerings worldwide in 1995 with
underwritings of $77 billion, based on Securities Data Company information.
Commission revenues which primarily relate to the Company's foreign exchange and
commodities trading in listed products decreased in 1995 from 1994 levels. Fixed
income derivative revenues were down in 1995 compared to 1994 due to a decrease
in new customer activity early in the year. Toward the end of 1995, derivative
activities increased with related revenues in the fourth quarter up
substantially compared to the same quarter in 1994; much of the increase was
attributable to a broadening of the Company's international customer and client
business. This reflects the results of a concerted effort to continue to
globalize the Company's efforts in these areas. Financing revenues were down in
1995 compared to 1994 due to decreased net interest spreads in certain of the
matched book portfolios.
Rising interest rates and inflationary concerns in 1994 had a negative
effect on customer activity resulting in reduced profitability for most of the
fixed income businesses as compared to 1993.
EQUITY
The Company's equity revenues reflect customer flow activities (both
institutional and high-net-worth retail), secondary trading, equity
underwriting, equity finance and arbitrage activities.
Equity revenues were $584 million for 1995, $620 million for 1994 and $986
million for 1993. The favorable syndicate calendar in 1995 contributed to
increased customer flow in the Company's secondary trading activities.
Commission revenues were up as trading volumes on domestic exchanges increased.
These increases were more than offset by reduced trading revenues in certain
products in 1995. Holdings and its subsidiaries ranked third in total NYSE
listed trading volume throughout all of 1995.
The decrease in equity revenues in 1994 from 1993 reflected the difficult
business environment in 1994. The 1994 decline was broad based across most
equity-related products.
21
CORPORATE FINANCE ADVISORY
Corporate finance advisory net revenues, classified in the Consolidated
Statement of Operations as a component of investment banking revenues, result
primarily from fees earned by the Company in its role as strategic advisor to
its clients. This role primarily consists of advising clients on mergers and
acquisitions, divestitures, leveraged buyouts, financial restructurings, and a
variety of cross border transactions. The net revenues for corporate finance
advisory increased in 1995 to $186 million from $153 million and $101 million in
1994 and 1993, respectively. The increased revenues reflected a strong mergers
and acquisitions environment throughout 1995 as companies concentrated on cost
cutting and creating greater economies of scale via acquisitions, asset sales,
and corporate restructurings on a global basis. During 1995, Holdings and its
subsidiaries acted as advisor for 141 completed transactions valued at
approximately $67 billion, based on Securities Data Company information.
Corporate finance advisory exhibited renewed strength in 1994 versus 1993 as
both the fees earned by the Company and the number of completed transactions
increased from 1993 levels.
MERCHANT BANKING
Merchant banking net revenues primarily represent the net realized gains and
net unrealized changes resulting from the Company's participation in certain
investment partnerships, such amounts are classified in the Consolidated
Statement of Operations as a component of investment banking revenues. Merchant
banking net revenues also reflect the related net interest expense used to
finance capital contributions to the partnerships. Merchant banking revenues
were $50 million, $4 million and $3 million for 1995, 1994 and 1993,
respectively.
The Company, through a subsidiary, is the general partner for four merchant
banking partnerships, including three institutional funds and one employee
investment vehicle. Current merchant banking investments held by the
partnerships include both publicly traded and privately held companies
diversified on a geographic and industry basis. For 1995, merchant banking
revenues resulting from the participation in these partnerships increased to $77
million from $12 million for 1994, reflecting the merger of certain subsidiaries
of Holdings with merchant banking activities into the Company in the fourth
quarter of 1994. For 1994, merchant banking revenues decreased slightly to $12
million from $15 million for 1993. Net revenues of the merchant banking business
include an allocation of net interest expense related to the Company's
investment in the partnerships. The method used to allocate interest expense was
revised in 1995 from prior periods to better reflect the costs of capital
utilized.
ASSET MANAGEMENT
Revenues from asset management activities were $34 million for 1995, $41
million for 1994 and $70 million for 1993. These revenues primarily consist of
fees from the management of various funds, commissions from the sale of funds to
customers and fees from the management of certain accounts for institutions and
high-net-worth individuals. The decline in revenues from 1994 to 1995 resulted
from the realignment of product offerings to be consistent with the change in
the Company's focus towards high-net-worth and institutional clients. The
decrease in revenues from 1993 to 1994 relates to the loss of certain
commissions and other revenues related to funds and customers transferred to
Smith Barney in conjunction with the sale of the retail division.
NON-INTEREST EXPENSES. Non-interest expenses were $2,000 million for 1995,
$1,968 million for 1994 and $2,282 million for 1993. Compensation and benefits
expense was $1,055 million for 1995, $1,004 million for 1994 and $1,400 million
for 1993. Compensation and benefits expense does not include any portion of
management fees, which are separately categorized on the Company's Consolidated
Statement of Operations, related to employee services provided by Holdings.
Non-interest expenses in 1995 included a restructuring charge of $43 million.
Non-interest expenses in 1994 included a $27 million severance charge. Included
within non-interest expenses in 1993 was a charge of $21
22
million related to certain non-core partnership syndication activities in which
the Company is no longer actively engaged.
The restructuring charge in 1995 included a $26 million occupancy related
real estate charge and a $17 million severance charge. The real estate component
of the charge resulted from a complete review of the Company's real estate
requirements at current headcount levels and the elimination of excess real
estate, primarily in New York, London and Tokyo. This charge includes costs to
write-down the carrying value of leasehold improvements, as well as projected
shortfalls of sublease rentals versus expected operating costs related to the
Company's excess capacity. The excess real estate capacity resulted from
headcount reductions associated with the Company's cost reduction efforts. The
severance component of the charge relates to payments made to terminated
personnel arising from a formalized fourth quarter business unit productivity
review. The Company expects to realize approximately $11 million of reduced
occupancy and depreciation expenses on an annualized basis as a result of these
actions.
Excluding these special charges, non-interest expenses were $1,957 million
for 1995, $1,941 million for 1994 and $2,261 million for 1993.
COST REDUCTION EFFORT. At year-end 1994, Holdings announced a cost reduction
program to reduce expenses by $300 million on an annualized basis (pretax)
compared to Holdings' third quarter 1994 expense run rate. The Company's expense
base was permanently lowered as a result of Holdings' cost reduction efforts.
However, the Company's cost structure differs from Holdings in that nonpersonnel
related expenses are not readily determinable from the Company's consolidated
statement of operations, since a portion of the Company's management fee expense
is comprised of charges related to employee services provided by Holdings and
its subsidiaries. In addition, the Company's management fees are subject to
fluctuation due to changes in the nature and levels of intercompany services
provided. Listed below is a summary of Holdings' cost reduction efforts which
were targeted into three areas: personnel cost savings of $100 million,
nonpersonnel cost savings of $150 million and interest and tax expense savings
of $50 million.
Through November 1995, Holdings achieved its cost reduction goals in all the
identified cost categories. In fact, through the fourth quarter of 1995,
Holdings reduced total expenses by approximately $326 million on an annualized
basis compared to the third quarter of 1994. These costs savings achieved do not
include the $11 million of future cost savings attributable to the Company's
real estate related restructuring charge previously discussed.
With respect to Holdings' personnel related cost reduction goals, Holdings
reduced headcount to 7,771 at November 30, 1995 from 8,512 at November 30, 1994
and 17% from a peak of 9,400 in early 1994. As a result of these reductions,
Holdings reduced its operating compensation and benefits ratio to 50.7% in the
fourth quarter of 1995 from the third quarter 1994 benchmark of 53.9%,
translating into annualized cost savings of approximately $100 million.
Nonpersonnel cost reductions were achieved as a result of a systematic and
comprehensive global review of all major expense categories. As a result,
Holdings' nonpersonnel expenses decreased to $254 million in the fourth quarter
of 1995 from the third quarter 1994 benchmark of $298 million, resulting in
reduced quarterly expenses of $44 million or annualized savings of approximately
$177 million.
Holdings achieved its $50 million cost reduction goal related to interest
and taxes through equal reductions in each category. The interest expense
savings were accomplished as a result of Holdings' efforts to improve its
collateral utilization and long-term debt hedging strategies. Holdings achieved
tax savings of approximately $25 million as a result of the implementation of
additional tax planning strategies.
23
As a result of these efforts, Holdings' expense base has been permanently
lowered. Holdings plans to continue its focus on nonpersonnel costs, with the
goal of achieving further cost savings in excess of $50 million by the end of
1996.
INCOME TAXES
Through affirmative actions the Company continues to aggressively pursue
maintaining a low effective tax rate. The actions taken in 1995 include the
restructuring of certain legal entities and a general review of overall
operations to assure the Company is operating in the most tax efficient manner.
The Company anticipates ongoing benefits related to the actions taken.
The Company had an income tax provision of $9 million for 1995 compared to
an income tax benefit of $33 million for 1994, and an income tax provision of
$126 million for 1993. The 1995 provision reflects the Company's continued focus
on generating income subject to preferential tax treatment as well as creating
organizational structures that optimize tax results. The 1994 benefit reflects
an increase in benefits attributable to income subject to preferential tax
treatment as compared to that of 1993. The 1993 income tax provision consisted
of a provision of $133 million for continuing businesses and a tax benefit of $7
million related to non-core business reserves. During the third quarter of 1993,
the statutory U.S. federal income tax rate was increased to 35% from 34%,
effective January 1, 1993. The Company's 1993 tax provision includes a one-time
benefit of approximately $8 million from the impact of the federal rate change
on the Company's net deferred tax assets.
The Company's net deferred tax assets increased $25 million to $39 million
at November 30, 1995 from $14 million at November 30, 1994. The net increase is
primarily attributable to the reversal of certain temporary differences. It is
anticipated that the deferred tax assets will be realized through future
earnings. The Company had a net deferred tax asset of $14 million at November
30, 1994 as compared to a net deferred tax liability of $36 million at December
31, 1993. The increase in net deferred tax assets is primarily attributable to
the reversal of certain temporary differences.
As of November 30, 1995, the Company had approximately $25 million of tax
net operating losses available to offset future taxable income.
1993 RESULTS
Because of the significant sale transactions completed during 1993, the
Company's 1993 financial statements are not fully comparable with 1995 and 1994.
In order to facilitate an understanding of the Company's 1993 results, the
following table segregates the Company's results between the results of the
Lehman Businesses (the results of the businesses that now comprise Lehman
Brothers), Businesses Sold (the results of Shearson and SLHMC through their
respective sale dates; the loss on the sale of Shearson; and the reserves for
non-core businesses) and Discontinued Operations (the results of The Boston
Company accounted for as a discontinued operation).
24
TWELVE MONTHS ENDED
DECEMBER 31, 1993
------------------------------------------------------
LEHMAN BUSINESSES DISCONTINUED
BUSINESSES SOLD OPERATIONS HISTORICAL
---------- ---------- ------------ ----------
(IN MILLIONS)
Revenues:
Principal transactions............................. $1,132 $ 323
Investment banking................................. 624 170
Commissions........................................ 437 828
Interest and dividends............................. 4,868 161
Other.............................................. 55 412
---------- ---------- ------------ ----------
Total revenues................................... 7,116 1,894
Interest expense................................... 4,442 143
---------- ---------- ------------ ----------
Net revenues..................................... 2,674 1,751 $ 4,425
---------- ---------- ------------ ----------
Non-interest expenses:
Compensation and benefits........................ 1,400 1,164
Other expenses................................... 861 470
Loss on sale of Shearson......................... 535
Reserves and other charges....................... 21 120
---------- ---------- ------------ ----------
Total non-interest expenses...................... 2,282 2,289 4,571
---------- ---------- ------------ ----------
Income (loss) from continuing operations before
taxes and preferred dividend of subsidiary....... 392 (538) (146)
Provision for income taxes......................... 126 108 234
---------- ---------- ------------ ----------
Income (loss) from continuing operations before
preferred dividend of subsidiary................... 266 (646) (380)
---------- ---------- ------------ ----------
Income from discontinued operations, net of
taxes.............................................. 189 189
---------- ---------- ------------ ----------
Net income (loss) before preferred dividend of
subsidiary......................................... 266 (646) 189 (191)
---------- ---------- ------------ ----------
Preferred dividend of subsidiary................... $ (68) $ (68)
---------- ---------- ------------ ----------
Net income (loss)................................ $ 198 $ (646) $ 189 $ (259)
---------- ---------- ------------ ----------
The discussion of the 1993 results for the Lehman Businesses has been
included in the previous sections discussing revenues, non-interest expenses and
taxes. The following section includes a discussion of the Businesses
Sold/Discontinued Operations.
BUSINESSES SOLD/DISCONTINUED OPERATIONS
This discussion is provided to analyze the results of the Businesses Sold.
All 1993 amounts for the Businesses Sold include results through their dates of
sale.
The Businesses Sold recorded a net loss of $646 million for 1993. The 1993
results include a loss on the sale of Shearson of $630 million and a $79 million
charge recorded in the first quarter as a reserve for non-core businesses in
anticipation of the sale of SLHMC. The loss on the sale of Shearson included a
reduction in goodwill of $750 million and transaction-related costs such as
relocation, systems and operations modifications and severance. Excluding the
$630 million aftertax loss on the sale, Shearson's net income was $63 million in
1993. Excluding the $79 million aftertax charge discussed above, SLHMC
operations were break-even in 1993.
Net revenues related to the Businesses Sold were $1,751 million for 1993.
Excluding the loss on the sale of Shearson and the reserve for non-core
businesses related to SLHMC, non-interest expenses of
25
the Businesses Sold were $1,634 million for 1993. Compensation and benefits
expense were $1,164 million for 1993.
The 1993 tax provision of $108 million for the Businesses Sold included (i)
expenses of $54 million related to the operating results of Shearson: (ii) an
expense of $95 million from the sale of Shearson and (iii) a tax benefit of $41
million related to the $120 million reserve for non-core businesses recorded in
anticipation of the sale of SLHMC. The provision related to the sale of Shearson
primarily resulted from the write-off of $750 million of goodwill which was not
deductible for tax purposes.
The Company reported net income of $189 million from discontinued operations
of The Boston Company, including an aftertax gain of $165 million on the sale
and aftertax earnings of $24 million. (See Note 18 for further discussion of the
Businesses Sold and the Discontinued Operations.)
LIQUIDITY AND CAPITAL RESOURCES
The Company's total assets increased to $82.6 billion at November 30, 1995
from $79.1 billion at November 30, 1994. The increase in total assets is
primarily the result of the change in the Company's clearing arrangements,
partially offset by decreases in other areas. At the close of business on
February 17, 1995, the Company became self-clearing for equities, municipal
securities and corporate debt instruments. As a result of this arrangement,
assets increased at that time by approximately $11 billion which were
predominantly funded with offsetting liabilities. The Company's Consolidated
Statement of Financial Condition now includes accounts previously cleared,
settled and carried by Smith Barney Inc. Principal areas impacted include the
Company's stock borrow and lending activities and high-net-worth customer
business. The Company has entered into an agreement for a term of five years
with the Bear Stearns Securities Corp ("BSSC") pursuant to which BSSC has agreed
to process the transactions previously cleared by Smith Barney Inc.
The Company's balance sheet is highly liquid and consists primarily of cash
and cash equivalents, securities and other financial instruments owned which are
marked-to-market daily and collateralized short-term financing agreements which
arise primarily from the Company's customer flow securities transactions. As the
Company's primary activities are based on customer flow, the assets experience a
rapid turnover rate. In addition, the highly liquid nature of these assets
provides the Company with flexibility in financing and managing its business. At
November 30, 1995, short-term assets, those which can be converted to cash in
less than one year, represented approximately 99% of the Company's total balance
sheet.
FUNDING AND CAPITAL POLICIES
Holdings' Global Asset and Liability Committee ("ALCO"), which includes
senior officers from key areas of the Company, are responsible for establishing
and managing the funding and liquidity policies of the Company. This includes
recomendations for balance sheet size as well as the allocation of balance sheet
to product areas as determined by internal profitability models and return on
equity targets.
The primary goal of the Company's funding principles as set by ALCO are to
provide sufficient liquidity and availability of funding sources throughout all
market environments. These funding principles are:
(i) To maintain an appropriate overall capital structure to support the
business activities in which the Company is engaged.
The Company manages Total Capital, defined as long-term debt, both
senior notes and subordinated indebtedness, plus stockholder's equity, on a
business and product level. The determination of the amount of capital
assigned to each business and product is a function of asset quality,
26
risk, liquidity and regulatory capital requirements. Periodically, the
Company reallocates capital to its businesses based upon their ability to
obtain targeted returns, perceived opportunities in the marketplace and the
Company's long-term strategy.
(ii) To maximize the portion of the Company's balance sheet that is
funded through collateralized borrowing sources and conversely minimize the
use of commercial paper and short-term debt.
Collateralized borrowing sources include securities and other financial
instruments sold but not yet purchased, as well as collateralized short-term
financings, defined as securities sold under agreements to repurchase
("repos") and securities loaned.
Because of their secured nature, repos and other types of collateralized
borrowing sources are less credit-sensitive and have historically been a
more stable financing source under adverse market conditions. Also,
collateralized borrowing sources generally provide the Company with access
to lower cost funding. The Company has been able to exceed its goal of
maintaining repo funding lines significantly in excess of actual
utilization.
(iii) To minimize refunding risk by funding the Company's assets with
liabilities which have maturities similar to the anticipated holding period
of the assets.
The Company continually reviews its mix of long- and short-term
borrowings as it relates to maturity matching and the availability of
secured and unsecured financing. In general, long-term assets are financed
with fixed rate long-term debt and stockholder's equity and inventories and
all other short-term assets are financed with a combination of short-term
funding and floating rate long-term debt and stockholder's equity.
(iv) To diversify and expand the Company's borrowing sources to maximize
liquidity and reduce concentration risk. The Company seeks financing from a
global investor base with the goal of broadening the availability of its
funding sources and maintaining funding availability well in excess of
actual utilization. The Company also utilizes a broad range of debt
instruments, which it issues in varying maturities and currencies.
The Company accesses both commercial paper and other short-term debt
instruments, including master notes and bank borrowings under uncommitted
lines of credit. To reduce liquidity risk, the Company carefully manages its
maturities to avoid large refinancings on any one given day. In addition,
the Company limits its exposure to any single investor to avoid
concentration risk.
(v) To maintain sufficient liquidity in a period of financial stress.
Financial stress is defined as any event which severely constrains the
Company's access to unsecured funding sources.
The Company's liquidity contingency plans are continually reviewed and
updated as the Company's asset/liability mix and liquidity requirements
change. The Company's liquidity contingency plan is based on an estimate of
its ability to meet its funding requirements through a combination of
collateralized short-term financings and short-term secured debt, as well as
Total Capital.
To achieve this objective, the Company's liquidity policies include
maintaining sufficient excess unencumbered securities to use as collateral,
if necessary, to obtain secured financing to meet maturities of short-term
unsecured liabilities as well as current maturities of long-term debt. Also,
the Company maintains a sufficient amount of Total Capital to enable the
Company to fund those assets which are less liquid. Lastly, the Company
periodically tests its secured and unsecured credit facilities to insure
availability and operational readiness. The Company believes that these
policies position the Company to meet its liquidity requirements in all
periods including those of financial stress.
27
SHORT-TERM FUNDING
To implement the policies as noted above, each business is required to fund
its products primarily through global collateralized financings. There are two
principal business areas which are responsible for these efforts, Lehman
Brothers' Fixed Income Financing ("Financing") and Equity Finance. Financing
works in conjunction with the institutional fixed income sales and trading
professionals to provide financing to customers and the firm through the
repurchase markets. Equity Finance provides a similar function in the equity
markets typically through securities loaned/securities borrowed transactions. An
ability to leverage their global market expertise and the Company's distribution
capabilities are a key to successful financing efforts. The amount of the
Company's collateralized borrowing activities will vary reflecting changes in
the mix and overall levels of securities and other financial instruments owned
and global market conditions. However, at all times, the majority of the
Company's assets are funded with collateralized borrowing sources. The Company's
Treasury area works closely with Financing and Equity Finance to develop funding
plans to support the business areas, as well as to execute daily funding
activities. On a daily basis, Treasury is responsible for meeting any funding
needs not met through Financing and Equity Finance. Funding through treasury is
managed globally with regional centers which have access to the capital markets
though the issuance of commercial paper as well as bank lines of credit and
other short- and long-term debt instruments.
At November 30, 1995 and 1994, $56 billion and $54 billion respectively, of
the Company's total balance sheet was financed using collateralized borrowing
sources. The remainder of the financing for the balance sheet is comprised of
short-term debt, payables and Total Capital.
In conjunction with the increase in collateralized short-term financings, as
well as the increase in the Company's Total Capital, as discussed below, the
Company's use of short-term debt decreased to $1.0 billion at November 30, 1995
from $2.3 billion at November 30, 1994. On November 30, 1995 and 1994, there was
no commercial paper outstanding.
The Company's uncommitted lines of credit provide an additional source of
secured and unsecured short-term financings. At November 30, 1995, the Company
had $5.1 billion of uncommitted lines of credit compared to $5.3 billion at
November 30, 1994. Uncommitted lines consist of facilities that the Company has
been advised are available but for which no contractual lending obligations
exists.
TOTAL CAPITAL
Long-term assets are financed with Total Capital. The Company maintains
Total Capital in excess of its long-term assets to provide additional liquidity,
which the Company uses to meet its short-term funding requirements and to reduce
its reliance on commercial paper and short-term debt.
At November 30, 1995 the Company had $5.5 billion of Total Capital compared
to $6.0 billion at November 30, 1994. During 1995, the Company issued $250
million in long-term debt, compared to $1.6 billion for 1994. At November 30,
1995 the Company had long-term debt outstanding of $3.5 billion with an average
life of 3.1 years, compared with $3.4 billion with an average life of 3.5 years
at November 30, 1994. For debt with a maturity of greater than one year, the
average life was 3.5 years at November 30, 1995 compared to 3.7 years at
November 30, 1994.
At November 30, 1995 the Company had approximately $1.0 billion of debt
securities available for issuance under various shelf registrations.
The Company's stockholder's equity decreased to $2.0 billion at November 30,
1995 from $2.6 billion at November 30, 1994 primarily due to the payment of $635
million to Holdings by the Company, $559 million as a return of capital and $76
million as dividends, partially offset by net income of $69 million. These
distributions were made to Holdings in order to more efficiently utilize the
capital of the consolidated group and did not decrease the level of LBI's net
capital compared to 1994, as
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defined by the Net Capital Rules used by its regulators. As a regulated company,
LBI is required to maintain a sufficient amount of capital as dictated by the
Net Capital Rules. These rules require specific amounts of capital to be
maintained by LBI depending on the composition of its assets and the related
risk factors.
At November 30, 1995 LBI's net capital, as defined by regulatory
authorities, aggregated $1,402 million and was $1,301 million in excess of the
minimum regulatory requirements. This is a slight increase from the net capital
of $1,338 million at November 30, 1994, which was $1,281 million in excess of
the minimum regulatory requirements.
The Company is subject to certain rules and regulations which limit the
amount of capital which can be withdrawn from regulated entities. As of November
30, 1995, the Company is in compliance with all such regulatory capital
requirements.
In 1996, the Company expects to maintain Total Capital at levels consistent
with the amount outstanding at November 30, 1995.
DEPENDENCE ON CREDIT RATINGS
The Company, like other companies in the securities industry, relies on
external sources to finance a significant portion of its day-to-day operations.
Access to global capital markets for short-term financing, such as commercial
paper and short-term debt, senior notes and subordinated indebtedness are
dependent on t