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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

x	Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2011

 

¨	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from            to            

333-108818

(Commission file no.)

 

 

SUMMIT FINANCIAL SERVICES GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

FLORIDA		05-0577932
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
595 SOUTH FEDERAL HIGHWAY, SUITE 500 BOCA RATON, FLORIDA		33432
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (561) 338-2800

 

 

Securities registered under Section 12(b) of the Act:

NONE

Securities registered under Section 12(g) of the Act:

COMMON STOCK, $0.0001 PAR VALUE

(Title of class)

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.    Yes  ¨    No  x

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant Item 405 of Regulation S-K 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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One)

 

Large accelerated filer		¨		Accelerated filer		¨
Non-accelerated filer		¨  (Do not check if a smaller reporting company)		Smaller reporting company		x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of June 30, 2011, the aggregate market value of the common stock held by non-affiliates was approximately $10.5 million based upon the price at which stock was sold at such date.

As of March 14, 2012, there were 26,534,059 shares of the registrant’s common stock outstanding.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

Certain of the exhibits to this Annual Report on Form 10-K have been incorporated by reference to the Registrant’s Registration Statement on Form S-4, dated September 15, 2004, and to various periodic reports (Forms 10-KSB, 10-QSB, and 8-K), publicly filed by the Registrant; and the Registrant’s Proxy Statement, filed on November 24, 2006.

 

 

 

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TABLE OF CONTENTS

 

PART I					4
Item 1.		Business			4
Item 2.		Properties			11
Item 3.		Legal Proceedings			12
Item 4.		Mine Safety Disclosures			13
PART II					13
Item 5.		Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			13
Item 6.		Selected Financial Data			13
Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operation			13
Item 7A.		Quantitative and Qualitative Disclosures About Market Risk			27
Item 8.		Financial Statements and Supplementary Data			27
Item 9.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			27
Item 9A.		Controls and Procedures			27
Item 9B.		Other Information			28
PART III					28
Item 10.		Directors, Executive Officers and Corporate Governance			28
Item 11.		Executive Compensation			30
Item 12.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			35
Item 13.		Certain Relationships and Related Transactions, and Director Independence			36
Item 14.		Principal Accounting Fees and Services			36
PART IV
Item 15.		Exhibits and Financial Statement Schedules			37

Introductory Comment

Throughout this Annual Report on Form 10-K, the terms “we,” “us,” “our,” “Summit” and the “Company” refer to Summit Financial Services Group, Inc., a Florida corporation, and, unless the context indicates otherwise, include our subsidiaries.

 

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Forward Looking Statements

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. When used in this Annual Report, the words “may,” “will,” “expect,” “anticipate,” “continue,” “estimate,” “project” or “intend” and similar expressions identify forward-looking statements regarding events, conditions and financial trends in connection with our future plan of operations, business strategy, operating results and financial position. Discussions containing such forward-looking statements may be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operation.” Shareholders and prospective investors are cautioned that any forward-looking statements are not guarantees of future performance. Such forward-looking statements by their nature involve substantial risks and uncertainties, certain of which are beyond our control, and actual results for future periods could differ materially from those discussed in this Annual Report on Form 10-K, depending on a variety of important factors, including: any adverse effect on the stock market and investor confidence in general, as a result of the economic recession, the sustainability and magnitude of the economic recovery, high unemployment and/or global events, including economic instability among members of the European Union (including Greece), continued unrest in the Middle East, and the increase in oil prices; the success or failure of our management’s efforts to implement our business strategy, including the net addition of financial advisors; the level of acquisition opportunities available to us and our ability to price and negotiate such transactions on a favorable basis; declining and/or volatile interest rates; our ability to properly manage growth and successfully integrate acquired companies and operations; our ability to compete with major established companies; our ability to attract and retain qualified personnel in a highly competitive environment; our ability to comply in a cost effective manner with increased regulation, and other risks which are described in our filings with the Securities and Exchange Commission (the “SEC”).

 

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PART I

 

Item 1.

Business.

Introduction

Summit Financial Services Group, Inc. (“SFSG” or the “Company”) is a Florida-based financial services holding company that provides, through its Summit Brokerage Services, Inc. (“Summit Brokerage” or “SBS”) operating subsidiary, a broad range of securities brokerage and investment services to primarily individual investors. Summit Brokerage also sells insurance products, predominantly variable and fixed annuities and life insurance, under licenses held by its SBS Insurance Agency of Florida, Inc. (“SBSIA”) subsidiary (or by SBSIA’s subsidiary entities). Summit Brokerage also provides, through its Securities and Exchange Commission (“SEC”) registered investment advisor subsidiary, Summit Financial Group, Inc. (“SFG”), asset management and investment advisory services. SFG was incorporated under the laws of the State of Florida in 2003.

Summit Brokerage is registered as a broker-dealer with the SEC, is a member of the Financial Industry Regulatory Authority (“FINRA”), the Municipal Securities Rule Making Board (“MSRB”), the National Futures Association (“NFA”) and the Securities Investor Protection Corporation (“SIPC”), and is licensed to conduct its brokerage activities in all 50 states, plus the District of Columbia. SFG, our investment advisory firm, is registered or eligible to conduct business as an investment advisor in 38 states and the District of Columbia. SBSIA, our subsidiary insurance agency, directly or through its subsidiary entities, is licensed to sell insurance, or is not required to be so licensed, in all jurisdictions where the Company conducts its brokerage activities.

As of February 2012, we had approximately 290 producing financial advisors operating from approximately 200 offices located throughout the country, with approximately 51% of those offices located in the south, 17% located in the Midwest, 15% located in the north and 17% located in the west. Our financial advisors service retail, and to a much lesser extent, institutional clients. The number of financial advisors in each affiliate office typically ranges from one to five, although the number of financial advisors in certain offices may exceed this amount. With the exception of our Boca Raton, Florida branch (the “Boca Branch”), all of our branch offices and satellite locations are owned and operated by independent owners, who we refer to as affiliates. Such affiliates are required to maintain all appropriate licenses and are responsible for all of their respective office overhead and expenses. In many instances, these affiliates may have several financial advisors operating from their branch offices. Historically, many of our affiliates have also provided financial planning services to their clients, wherein the financial advisor evaluates a client’s financial needs and objectives, develops a detailed plan, and then implements the plan with the client’s approval. When the implementation of such objectives involves the purchase or sale of securities (including the placement of assets within a managed account) such transactions are effected through Summit Brokerage, for which we earn either a commission or a fee.

We do not hold any funds or securities of our clients, but instead utilize, on a fully disclosed basis, the services of First Clearing, LLC (an affiliate of Wells Fargo & Company) and Pershing LLC (an affiliate of BNY Mellon) as our clearing brokers (the “Clearing Brokers”). Our clearing arrangements provide us with back office support, transaction processing services on all principal national and international securities exchanges, and access to many other financial services and products. These arrangements allow us to offer a range of products and services that are generally offered only by firms that are larger and have more capital than Summit Brokerage. At December 31, 2011 and December 31, 2010, our Clearing Brokers held approximately 43,000 active client accounts, respectively. In addition to accounts held by our Clearing Brokers, our clients also have assets that are held directly by the various mutual funds, insurance companies, partnership sponsors and investment advisors with whom they have invested and for which Summit Brokerage serves as the broker-dealer of record.

Our revenues consist primarily of commissions and fee income earned from securities transactions and related activities, such as fees for managing a client’s assets (asset managed accounts). The following table reflects the various sources of revenue and the percentage of total revenues for each of the last two fiscal years:

 

		2011								2010
Insurance related products		$	22,730,678				33	%		$	20,631,883				32	%
Investment advisory fees			13,068,786				19				10,931,690				17
Equities			10,305,219				15				12,547,801				19
Mutual funds			10,628,791				16				8,802,474				14
Other commission revenue			6,617,827				10				7,007,556				11
Interest and dividends			1,117,219				2				1,420,504				2
Other revenue			3,647,486				5				3,559,045				5
Total		$	68,116,006				100	%		$	64,900,953				100	%

 

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By their nature, our business activities are highly competitive and are subject to, among other things, general market conditions, including investor confidence and the volatility of the trading markets (and its related impact on the attractiveness of various forms of investment products), as well as the overall net gain or loss of a significant number of financial advisors. Consequently, our revenues and net income or loss are subject to substantial positive and negative fluctuations due to a variety of factors that cannot be predicted with great certainty and may result in revenues and net income or loss in any particular period that may not be representative of future results, and may vary significantly from period to period. Furthermore, our mix of business in any particular period will be impacted by several factors, including the attractiveness of any particular type of investment when compared with other types of investments, and the types of investments sold by newly added financial advisors to our Company, many of whom specialize in the sale of specific types of investment products.

In 2011 and 2010, we reported gross revenues and net income of $68.1 million and $1.47 million and $64.9 million and $1.30 million, respectively. During 2011, our revenues and earnings grew as a result of the ability to successfully recruit financial advisors during 2011 and the latter part of 2010, as well as due to an increase in the average production of those financial advisors that had been with us for at least 18 months prior to the end of 2011. Prospectively, we continue to believe that events that trigger the loss of investor confidence, including economic problems and uncertainty within the European Union, the geopolitical uncertainty of the Middle East, and concerns of a faltering domestic economy, will negatively impact our results of operations. Declining margins on an industry-wide basis may also lead to a reduction in our earnings. We may also be unable to sustain the same level of growth in financial advisors as we experienced in prior years, especially if the factors that permitted such growth are in any way diminished.

Broker-dealers, and their affiliated registered representatives, operate in a highly regulated industry. For 2012 and beyond, we expect our operating results to be impacted by the continued increase in the rules and regulations that govern how we and our advisors are required to conduct business. Many of these new rules, which were designed in response to the factors leading up to the market turmoil of 2008, as well as the Madoff scandal and other instances of corporate fraud, will require Summit Brokerage to devote considerable resources to their implementation, and subsequent monitoring. Significant new rules and regulations are likely to arise as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was enacted in July 2010. Provisions of the Dodd-Frank Act that may impact our business include, but are not limited to: the potential implementation of a more stringent fiduciary standard for broker-dealers and enhanced regulatory oversight of incentive compensation. Compliance with these provisions, as well as other regulatory initiatives, has resulted in, and is likely to continue to result in, increased costs. Moreover, to the extent the Dodd-Frank Act impacts the operations, financial condition, liquidity and capital requirements of financial institutions with which we do business, those institutions may seek to pass on increased costs, reduce their capacity to transact, or otherwise present inefficiencies in their interactions with us. The ultimate impact that the Dodd-Frank Act will have on us, the financial industry and the economy cannot be known until all such applicable regulations called for under the Dodd-Frank Act have been finalized and implemented. In addition, several of these rules, as well as other regulatory initiatives, may ultimately have the effect of reducing certain types of compensation received by Summit Brokerage, such as the SEC’s consideration of a rule that would limit the amount of 12b-1 fees that could be paid to a broker-dealer. See Regulation.

For 2012, we expect to continue to focus our business plan on increasing our network of affiliated financial advisors, primarily through recruiting efforts. Although we will continue to attempt to recruit those financial advisors who serve as financial planners (who sell primarily annuities, insurance, mutual funds and fee-based products), we also intend to pursue the addition of financial advisors who focus on the sale of different types of products and securities, namely investment advisory services and equity and fixed income products. Because of the numerous factors influencing a financial advisor’s decision to affiliate with us, there can be no assurance that we will be successful in our recruiting efforts. We may also pursue mergers with, or the acquisition of the assets of, other brokerage firms. Our ability to realize growth through acquisitions, however, will depend on the availability of suitable broker-dealer candidates and our ability to successfully negotiate favorable terms (from both sellers as well as financing sources, if necessary), and there can be no assurance that we will be able to consummate any such acquisitions. Further, there are costs associated with the integration of new businesses and personnel, which may be more than we anticipate at that time. Thus, there is no assurance that we will be able to successfully execute such growth strategy.

As we continue to grow, we may also incur increases in expenses related to, among other things, commission expense (for financial advisors receiving accelerated payouts), marketing and recruiting, personnel, office space, compliance, and the amortization of forgivable loans provided to newly recruited financial advisors. There can also be no assurance that any increase in the Company’s overall gross margin from revenue growth will be sufficient to offset any increased expenses, or that the Company’s current gross margin (as both a percentage of total revenues as well as in absolute dollars) will not otherwise be adversely effected by factors beyond the control of the Company. For example, recent legislation, as well as initiatives undertaken by the regulatory agencies charged with overseeing the financial services industry, will have the effect of not only reducing sources of revenue to the Company, but also increasing the cost of compliance. Furthermore, the Company has determined that its long-term growth strategy can best be maximized through the reinvestment of a portion of its earnings into the development of its infrastructure and its recruiting and business development efforts, including through the payment of upfront amounts to financial advisors. As a result, the Company’s future earnings may be negatively impacted should our future revenue growth be less than anticipated.

 

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Based on our anticipated level of operating activities, we believe that our operations and current capital resources will be sufficient to fund our working capital needs through 2012. The Company may, however, seek additional capital within the next 12 months should it elect to expand upon its current strategy of incorporating the use of both forgivable and non-forgivable loans to induce newly recruited financial advisors to affiliate with the Company. In addition, we anticipate that, depending on the size and terms of any transaction, our strategy of growth through acquisitions may necessitate additional debt and/or equity financing, although there can be no assurances that this will happen. Our failure to obtain sufficient financing for either of these purposes could have a materially adverse effect on our ability to execute our growth strategy to the extent desired.

Affiliate Program

Our primary method of operation is through an affiliate program, which allows financial advisors to operate as independent contractors. As of December 31, 2011, all but 12 of our financial advisors were affiliates (or financial advisors operating from an affiliate’s branch office). A financial advisor who becomes a Summit Brokerage affiliate establishes his/her own office and is solely responsible for the payment of all expenses associated with the operation of the branch office (including clearing and execution, rent, utilities, furniture, equipment, stock quotations, and general office supplies), although all of that branch’s revenues from securities brokerage transactions accrue to Summit Brokerage. In many instances, these affiliates may have several financial advisors operating from their branch offices. Because our affiliates bear the responsibility for these expenses, we pay to them a significant percentage, typically 80% to 90%, of the commissions they and any other financial advisors operating from their branch generate. This compares with a payout rate of approximately 25% to 50% to financial advisors working in a traditional brokerage setting where the brokerage firm bears substantially all of the costs of maintaining its sales forces, including the costs of providing clearing and execution, employee benefits, office space, sales assistants, telephone service, and supplies. The affiliate program permits the Company to expand its base of revenue and its network for the retail distribution of securities without the capital expenditures that would be required to open Company-owned offices and the additional administrative and other costs of hiring financial advisors as in-house employees.

Historically, Summit Brokerage has recruited affiliates that have offices comprised of between one and three financial advisors. Prospectively, we expect to continue to recruit smaller offices, although we may also target larger offices comprised of many financial advisors. Because of the size of these offices, we may be required to pay a greater percentage of the office’s commissions than we would pay to a smaller office. As a result, if we are successful, we may experience a potential decline in our gross margin percentage.

Affiliates must possess a sufficient level of commission brokerage business and experience to enable the individual to independently support his/her own office. Financial professionals, such as insurance agents, financial planners, and accountants, who already provide financial services to their clients, typically possess the requisite licenses and experience to affiliate with Summit Brokerage. Affiliation enables these professionals to offer financial products and services to their clients through Summit Brokerage and earn commissions and fees for these transactions and services. Affiliates are given discretion to structure their own practices and to specialize in different areas of the securities business, subject to Summit Brokerage’s supervisory procedures as well as compliance with applicable regulatory requirements.

We provide full support services to each of our affiliates, including: access to stock and options execution and over-the-counter stock trading, fixed income products (such as government, municipal and corporate bonds), insurance (annuities and life insurance), mutual funds, unit trusts and investment advisory programs. We also provide, or make available through the Clearing Brokers, research, compliance, supervision, accounting and other related services.

Each affiliate is required to obtain and maintain in good standing each license required by the SEC and FINRA to conduct the type of securities business in which the affiliate engages, and to register in the various states in which he/she has clients. Summit Brokerage is ultimately responsible for supervising all of its financial advisors, whether affiliates or in-house financial advisors. We can incur substantial liability from improper actions of any of our financial advisors. We maintain a professional liability “errors and omissions” insurance policy which generally provides a limited degree of coverage for certain actions taken and/or omissions made by our financial advisors, employees and other agents in connection with the purchase and sale of securities and the rendering of financial advice. In addition, we maintain a fidelity bond that provides for the reimbursement of amounts lost through certain dishonest acts by our financial advisors or employees. There can be no assurance, however, that we will be able to obtain errors and omissions insurance or a fidelity bond in the future, or that if it can be obtained, that the price for such insurance will be reasonable, or that even if such insurance is in force that it will cover any and all claims made or, if such claims are covered, that the amount of any liability will not exceed the maximum coverage provided by such insurance, in which case we will be required to pay any uncovered portion.

 

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Commission Revenues

A significant portion of our revenues is derived from commissions from the sale of annuities, in which case the commission is paid by the insurance company. We also derive a significant portion of our revenues from commissions generated by our brokerage activities, including the purchase or sale of equities and fixed income products for our clients, the majority of which are executed on an agency basis. For such transactions, we are paid a commission by our client for processing that client’s buy or sell order. We also generate commissions from the sale of mutual fund shares and other investment products. The percentage of revenue that we derive from the sale of each type of investment product may change as investors’ preferences change. Our mix of business may also change depending on the types of financial advisors we recruit and the types of investment products on which they focus. In addition to commissions, we also generate fees, primarily paid to us in connection with the management of a client’s account through SFG. We do not currently make markets in any securities, although we act as a principal for the trading of fixed income securities.

We record commissions earned from transactions in securities, annuities and insurance as “commission revenue,” when transactions occur. We also record as “commission revenue” the fees we are paid to manage our clients’ accounts, at the time we receive such fees.

We then pay out a percentage of this amount, which we record as “commission expense,” to the financial advisor who produced the commission or fee, in accordance with the agreement each financial advisor enters into with us. In general, these agreements provide for either a fixed or tiered payout percentage based on total gross production.

Insurance Related Products. Our financial advisors offer variable and fixed annuities and life insurance products to their clients through SBSIA, which has executed agency agreements with various national insurance companies and insurance marketing organizations. As an agent for any particular insurance company, we receive commissions equal to some percentage, typically between 5% and 7%, of the amount invested in an annuity, or, in the case of life insurance, some percentage of the premium. In 2011 and 2010, the Company earned gross commissions of approximately $22.7 million and $20.6 million, respectively, from the sale of insurance and annuity products, representing approximately 34% and 33%, respectively, of our total revenue.

Equities. We charge commissions to our clients in accordance with our established commission schedule. In certain instances, varying discounts from the schedule are given, generally based upon the client’s level of business, the trade size and other relevant factors. For 2011 and 2010, we earned gross commissions of approximately $10.3 million and $12.5 million, respectively, on equity transactions, representing approximately 16% and 20%, respectively, of our total revenue.

Mutual Funds. We have agreements with numerous mutual fund management companies under which we sell shares in a variety of mutual funds. Mutual fund commissions are derived from standard dealers’ discounts that are a small percentage of the purchase price of the shares depending upon the terms of the dealer agreement and the size of the transaction. In addition, most funds permit the Company to receive additional periodic fees based upon the client’s investment maintained in particular funds. For 2011 and 2010, we earned gross commissions of approximately $10.6 million and $8.8 million, respectively, from mutual fund transactions, representing approximately 16% and 14%, respectively, of our total revenue.

Investment Advisory Fees. Through our investment advisor, SFG, we provide investment advisory services to clients, including through the use of independent, third-party sponsored advisory programs. SFG is registered or eligible to conduct business as an investment advisor in 38 states and the District of Columbia. Clients who utilize our investment advisory services pay an annual fee, payable quarterly, which typically equals some percentage multiplied by the value of the assets, as of the beginning of the quarter, which they have placed with us to manage (or, in certain cases, which have been placed with an outside third-party money manager). In general, a client will pay from 1.0% to 3.0%, on an annual basis, of the amount of assets placed under management as a management fee. The actual fee charged to a particular client is based on, among other things, the value of the assets under management and the particular management fee program in which that investor is participating. To the extent the value of the assets under management for any individual investor changes between one quarter and the next, the fees that we are paid by that investor may also change. Periods during which the market value of securities are declining will generally result in a decrease in the investment advisory fees that we receive that are based on the asset values of client portfolios, while periods during which the market value of securities are increasing will generally result in an increase in the investment advisory fees that we receive that are based on the asset values of client portfolios. Because clients with managed accounts are paying this fee, they are generally not charged a per-transaction commission or other fees each time a transaction is effected in their accounts. In addition, we provide financial planning services for clients, which fees are included as investment advisory fees. In 2011 and 2010, we earned investment advisory fees of approximately $13.1 million and $10.9 million, respectively, representing approximately 20% and 18%, respectively, of our total revenue.

 

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Other Commission Revenue. Included under Other Commission Revenues are commissions generated in connection with the sale of products not included elsewhere, such as fixed income securities, options and alternative investments. For 2011 and 2010, respectively, we earned gross commissions of approximately $6.6 million and $7.0 million from such transactions, representing approximately 10% and 11%, respectively, of our total revenue.

Interest and Dividends

Under its agreements with its Clearing Brokers, Summit Brokerage receives a portion of the interest income earned from, and interest expense charged to, its clients. As interest rates and yields have declined, so has the amount that Summit Brokerage receives. For 2011, the percentage paid to Summit by one of its Clearing Brokers was reduced from prior year levels. That same Clearing Broker has informed Summit that beginning in the second quarter of 2012, further reductions will take place. Unless Summit Brokerage is able to offset these decreases with proportionate increases in the balances upon which such amounts are earned, our earnings will be negatively impacted, as was the case in 2011. Furthermore, additional reductions into 2012 and beyond will continue to adversely affect our operating results. A significant reduction in such overall compensation may have a material adverse impact on the Company’s operating results. In 2011 and 2010, we earned approximately $1.10 million and $1.40 million, respectively, of such compensation, which amounts are included in the accompanying Consolidated Statements of Income as interest and dividend revenue.

Other Revenue

Other Revenue represents fees generated by the Company primarily from providing services and administration and from acting as a principal in certain types of fixed income transactions. For 2011 and 2010, respectively, we generated approximately $3.65 million and $3.56 million from such transactions, representing approximately 5% of our total revenue.

Clearing Brokers

We do not hold any funds or securities of our securities brokerage clients. Rather, we use the services of our Clearing Brokers on a fully disclosed basis. Our Clearing Brokers process securities transactions and maintain client accounts on a fee basis. The services provided include, among other things, billing, credit review and control (including for margin accounts), receipt, and custody and delivery of securities. The Clearing Brokers also lend funds to our clients through the use of margin credit. These loans are made to clients on a collateralized basis, with the Clearing Brokers maintaining collateral in the form of saleable securities, cash or cash equivalents. However, if the Company’s clients do not pay or deliver securities for a trade or if they do not properly maintain their credit balances on “margin” accounts, and there is a loss for which we cannot collect from our client, we are generally liable for such losses. The Company currently uses First Clearing, LLC (an affiliate of Wells Fargo & Company) and Pershing LLC (an affiliate of BNY Mellon) as its Clearing Brokers.

Client accounts are protected through the SIPC for up to $500,000 per account, of which coverage for cash balances is limited to $250,000. Additional protection may be available through private insurance carriers. Pursuant to the terms of our agreement with the Clearing Brokers, Summit Brokerage has agreed to indemnify and hold the Clearing Brokers harmless from certain liabilities and claims, including claims arising from transactions of our clients. We believe that, in general, the Clearing Brokers are able to provide Summit Brokerage and its clients with services at a total cost which is less than it would cost us to process such transactions on our own.

 

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In the event a Clearing Broker were to cease doing business with us, our ability to execute transactions on behalf of, and provide a full range of services to, our clients would be negatively impacted, which could, in turn, have a material adverse affect on both our revenues and our earnings.

Seasonality and Cyclical Factors

Our revenues are affected only slightly by the traditional U.S. vacation and holiday seasons. Our revenues may be more adversely affected by cyclical factors, such as financial market downturns, as well as problems or recessions in the U.S. or global economies. These downturns may cause investor concern, which has historically resulted in fewer transactions and less investing through broker-dealers such as Summit Brokerage, thereby reducing our revenues and potential profits. Such conditions might also expose us to the risk of being unable to raise additional capital, if needed, to offset related significant reductions in earnings.

Competition

We encounter intense competition in all aspects of our business. In general, we compete directly with other providers of financial services focused on meeting the needs of individual investors. Some of the strongest competition comes from companies that have greater marketing, financial and technical resources than ours. These competitors can offer a wider range of services and financial products than we can. Some of our competitors also have greater name recognition and more extensive client bases. Firms such as Merrill Lynch & Co., Inc. (a wholly-owned subsidiary of Bank of America Corporation), Morgan Stanley Smith Barney LLC (part of Citigroup Global Markets, Inc.), the Charles Schwab Corporation and Edward D. Jones & Co., L.P., have collectively garnered a significant percentage of the overall retail financial services industry. Furthermore, we compete with numerous regional and local securities firms, as well as with firms that provide online trading and discount brokerage services, such as E*TRADE Financial Corp., TD Ameritrade Holding Corporation, Charles Schwab & Co. and Fidelity Brokerage Services LLC. Additionally, increasing competition continues from other sources, such as commercial banks, insurance companies, and accounting and consulting firms that have entered the securities industry. We believe that the principal factors affecting competition in the securities industry are the quality and ability of professional personnel, the relative prices of services and products offered, and the reputation of the firm.

In addition to competing for clients, we compete with other financial services providers to attract and retain experienced and productive investment professionals, especially those firms offering independent affiliate programs, such as Raymond James Financial, Inc. and LPL Financial Services. Historically, Summit Brokerage has relied on the use of both in-house, as well as outside recruiters, together with advertising campaigns designed to attract financial advisors. In January 2011, Summit Brokerage retained the services of Don Shula, the former coach of the Miami Dolphins and a National Football League Hall of Fame Inductee, as its corporate spokesperson for the recruiting of financial advisors. Under certain circumstances, Summit Brokerage may provide, in the form of either forgivable or non-forgivable loans, amounts to newly recruited financial advisors as an incentive for becoming affiliated with the firm. Alternatively, Summit Brokerage may offer newly recruited advisors a higher payout than they would otherwise receive for a limited period of time (e.g., 12 months). Summit Brokerage may also agree to reimburse financial advisors for certain costs incurred by them in connection with their transition to the firm. Forgivable loans are typically amortized over a period of not more than 48 months, while non-forgivable loans are repaid by the financial advisor through the withholding of a certain percentage of the financial advisor’s monthly gross production until the note has been repaid in full. All loans typically require the personal guarantee of the financial advisor. In many instances the amount of loans made available by Summit Brokerage may be less than the amount of loans made available by our competitors, many of whom have greater financial resources than the Company.

We have also not undertaken any significant marketing efforts designed to attract retail clients. Instead, we rely on each financial advisor to attract his/her own clientele, which typically occurs through referrals from other clients. Additionally, many of our financial advisors hold seminars to educate potential clients about various investment opportunities.

Employees

As of March 15, 2012, we employed approximately 70 full-time people, including six executives, 48 others in general staff positions and 16 in sales and sales-related positions (including 11 producing financial advisors). As of March 15, 2012, there were approximately 350 registered representatives licensed with Summit Brokerage, the majority of which are producing financial advisors engaged by us as independent contractors, although approximately 40 are engaged as full-time employees (including approximately 25 in an operational capacity). None of our employees are represented by a labor union or are subject to a collective bargaining agreement. We believe that our relations with our employees are good.

 

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Regulation

The securities industry in the United States is subject to extensive regulation under various federal and state laws and regulations. While the SEC administers federal securities laws, much of the regulation for those operating within the securities industry comes from various self-regulatory organizations such as FINRA.

Additionally, securities firms are also subject to regulation by the state securities departments of the various jurisdictions in which they operate or in which their clients reside. In general, regulatory authorities promulgate regulations and provide oversight in the areas of sales practices, trade practices among broker-dealers, capital requirements, record keeping, and the conduct of employees and affiliates of member organizations.

The SEC, the self-regulatory organizations, including FINRA, and state regulatory agencies also have the authority to conduct administrative proceedings which can result in the censure, fine, suspension or expulsion of a broker-dealer and an investment advisor, and their registered representatives, employees or officers. Also, new legislation, such as the Dodd-Frank Act (which was enacted in response to, among other things, the factors leading up to the market turmoil of 2008), changes in the rules and regulations promulgated by the SEC or self-regulatory organizations, and changes in the interpretation or enforcement of existing laws and rules often directly affect the operation and profitability of broker-dealers and investment advisors. Provisions of the Dodd-Frank Act that may impact our business include, but are not limited to: the potential implementation of a more stringent fiduciary standard for broker-dealers and enhanced regulatory oversight of incentive compensation. Compliance with these provisions has resulted in, and is likely to continue to result in, increased costs. Moreover, to the extent the Dodd-Frank Act impacts the operations, financial condition, liquidity and capital requirements of financial institutions with which we do business, those institutions may seek to pass on increased costs, reduce their capacity to transact, or otherwise present inefficiencies in their interactions with us. The ultimate impact that the Dodd-Frank Act will have on us, the financial industry and the economy cannot be known until all such applicable regulations called for under the Dodd-Frank Act have been finalized and implemented. The stated purpose of much of the regulation of broker-dealers and investment advisors is the protection of clients and the securities markets, rather than the protection of creditors and shareholders of broker-dealers and investment advisors.

As in the past, many of the changes to the rules and regulations that govern the financial services industry will be driven by the concerns among regulators, legislators and the public about the fairness of the dealings and the openness of the disclosures, of those who provide financial services, including broker-dealers.

Current and pending regulatory initiatives which may or will have an impact on the manner in which Summit Brokerage conducts its business include, but are not limited to, the following:

 

•

The requirement that registered representatives operate under a fiduciary standard, as opposed to a suitability standard under which they currently operate. Under a fiduciary standard, registered representatives will not only be required to make certain that all investments are reasonably suited based on such factors as the client’s risk tolerance, financial position and investment objectives, but also put the clients’ interests ahead of their own;

 

•

Changes to ERISA Section 408(b)(2), requiring, in general, the expanded disclosure of the services being provided by, the status of (e.g., fiduciary versus non-fiduciary), and the compensation being earned by, the provider of such services to pension funds;

 

•

Expanded requirements related to the monitoring of internet-based communications, including through social networking sites;

 

•

The proposed reduction of 12b-1 fees paid by mutual funds;

 

•

The inability to collect commissions and 12b-1 fees on qualified retirement accounts (including IRAs); and

 

•

A rule requiring broker-dealers to more closely supervise the strategies and recommendations (including hold recommendations) of its financial advisors.

As part of the regulatory process, broker-dealers and investment advisors are subject to routine examinations, the purpose of which is to determine their compliance with rules and regulations promulgated by the examining regulatory authority. It is not uncommon for the regulators to assert, upon completion of an examination, that the broker-dealer or investment advisor being examined has violated certain of these rules and regulations. Depending on the nature and extent of the violations, the broker-dealer or investment advisor may be required to pay a fine and/or be subject to other forms of disciplinary action. In the past, Summit Brokerage has been required to pay a fine for certain violations, and no assurance can be given that the firm will not be subject to future fines or other forms of disciplinary action. In those instances where Summit Brokerage is informed of a potential violation by an examining regulatory authority, it endeavors to correct such violations as soon as is practicable.

 

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The SEC, FINRA and the NFA have stringent rules and regulations with respect to the maintenance of specific levels of net capital by regulated entities. In general, a broker-dealer is required to maintain at least a minimum part of its assets in a relatively liquid form.

The net capital rules also require that Summit Brokerage notify its regulators when net capital falls below certain predefined criteria. These rules also dictate the ratio of debt to equity in the regulatory capital composition of a broker-dealer, and constrain the ability of a broker-dealer to expand its business under certain circumstances. If a broker-dealer fails to maintain the required net capital, it may be subject to suspension or revocation of registration by the applicable regulatory agency, and suspension or expulsion by these regulators ultimately could lead to the broker-dealer’s liquidation. Additionally, the net capital rule and certain FINRA rules impose requirements that may have the effect of prohibiting a broker-dealer from distributing or withdrawing capital, and that require prior notice to the SEC and FINRA for certain capital withdrawals.

Summit Brokerage is also subject to rules and regulations related to the prevention and detection of money laundering. The USA PATRIOT Act of 2001 (the “PATRIOT Act”) contains anti-money laundering and financial transparency laws and mandates the implementation of various regulations applicable to broker-dealers and other financial services companies. Financial institutions subject to the PATRIOT Act generally must have anti-money laundering procedures in place, implement specialized employee training programs, designate an anti-money laundering compliance officer and are audited periodically by an independent party to test the effectiveness of compliance. We have established policies, procedures and systems designed to comply with these regulations.

In addition to the aforementioned, regulatory activity in the areas of privacy and data protection continues to grow worldwide and is generally being driven by the growth of technology and related concerns about the rapid and widespread dissemination and use of information. We must comply with these information-related regulations, including, but not limited to, the 1999 Gramm-Leach-Bliley Act, SEC Regulation S-P, the Fair Credit Reporting Act of 1970, as amended, and the 2003 Fair and Accurate Credit Transactions Act, to the extent they are applicable to us.

Furthermore, several members of Congress have recently considered enacting legislation that would change the eligibility requirements for determining one’s status as an independent contractor. Any change to such requirements that would have the effect of precluding Summit Brokerage from continuing to treat financial advisors operating from their offices as independent contractors could have an adverse effect on the Company.

There can be no assurance that the findings of any regulatory agencies will not result in subjecting Summit Brokerage and its principals and financial advisors to some form of disciplinary action, including fines. In addition, regulators may put restrictions on Summit Brokerage’s ability to grow. Furthermore, any contemplated merger by or with Summit Brokerage will require the approval of regulatory authorities, which approval may not be granted. Accordingly, even if Summit Brokerage is able to negotiate a transaction with a merger candidate, we may not be able to consummate such transaction, thereby inhibiting our ability to fully execute our growth strategy. In addition, no assurance can be given as to our ability to comply with any increased regulation in a cost effective manner.

 

Item 2.

Properties

In December 2009, the Company entered into two separate lease agreements for office space in Boca Raton, Florida to replace four lease agreements that expired on January 31, 2010. The first lease (“Lease Agreement”) is for 13,554 square feet of office space to house the corporate headquarters for the Company’s operations. The term of the Lease Agreement is from February 1, 2010 through August 31, 2017, with the Company having the option to extend the Lease Agreement for two five-year renewal terms. Initial base rent is approximately $23,719 per month, subject to certain fixed increases over the course of the term, as set forth in the Lease Agreement. The second lease (“Second Lease Agreement”) is for 4,264 square feet of office space to house certain financial advisors. The Second Lease Agreement, which was originally effective as of August 1, 2010, was amended on January 14, 2010 to provide for occupancy effective as of March 1, 2010. The term of the Second Lease Agreement is from March 1, 2010 through August 31, 2013, with the Company having the option to extend the Second Lease Agreement for one four-year renewal term and, subsequently, two five-year renewal terms. Initial base rent is approximately $7,462 per month, subject to certain fixed increases over the course of the term, as set forth in the Second Lease Agreement.

 

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Total rent expense, including month-to-month leases for the years ended December 31, 2011 and 2010, was approximately $630,000 and $689,000, respectively.

Summit Brokerage also leases certain equipment under operating leases, which provide for minimum monthly payments of approximately $1,500 through December 2015.

 

Item 3.

Legal Proceedings

The Company is presently and regularly involved in legal proceedings in the ordinary course of our business, including lawsuits, arbitration claims, regulatory and/or governmental subpoenas, investigations and actions, and other claims. Many of our legal proceedings are initiated by our advisors’ clients and involve the purchase or sale of investment securities. Management cannot presently predict the outcome of these matters, although management believes that the ultimate resolution of these matters will not have a material adverse affect on our financial position.

Many aspects of the securities brokerage business involve substantial risks of liability. In recent years, litigation involving the securities brokerage industry has continued to increase, including class action and other lawsuits that generally seek substantial damages, including, in some cases, punitive damages. Furthermore, given the significant decline in the major market indices beginning in 2008, and the generally poor performance of investments that have historically been considered safe and conservative, no assurance can be given that Summit Brokerage may not be subjected to a potentially significant increase in the number of proceedings to which it may be named as a party. Summit Brokerage currently maintains errors and omissions insurance, the proceeds of which may help to reduce the amount we may otherwise be required to pay with respect to certain types of claims. There can be no assurance, however, that Summit Brokerage will be able to obtain errors and omissions insurance in the future, or that if it can be obtained, that the price for such insurance will be reasonable, or that even if such insurance is in force that it will cover any and all claims made or, if such claims are covered, that the amount of any award will not exceed the maximum coverage provided by such insurance, in which case we will be required to pay any uncovered portion. Further, management evaluates whether or not to establish reserves for pending litigation. There is no assurance that, absent sufficient insurance coverage, the reserves will be adequate to cover any awards against Summit Brokerage. While it is not possible to determine with certainty the outcome of these matters of which we are currently aware, we are of the opinion the eventual resolution of such proceedings will not have a material adverse effect on our financial position or operating results. Any such litigation brought in the future could have a material adverse effect on our business, financial condition and operating results.

In March 2011, the Company became aware that a financial advisor operating from one of its branch offices may have misappropriated funds. In connection therewith, the Company undertook an investigation, including notifying FINRA. The Company also notified, or attempted to notify, clients of the advisor. The Company also notified its fidelity bond carrier. During 2011, the Company settled with two of the four identified parties representing approximately 95% of the total known loss. The Company was subsequently reimbursed by its fidelity bond carrier. While it is not possible to determine with certainty the outcome of this matter, and in particular whether additional claims may be forthcoming, based on the information currently available to the Company, management is of the opinion the resolution of this matter will not have a material adverse effect on our financial position or operating results

Summit Brokerage is a registered broker-dealer and as such is subject to the continual scrutiny of those who regulate its industry, including FINRA, the SEC, and the various securities commissions of the states and jurisdictions in which we operate and/or have clients. As part of the regulatory process, Summit Brokerage is subject to routine examinations, the purpose of which is to determine its compliance with rules and regulations promulgated by the examining regulatory authority. It is not uncommon for the regulators to assert, upon completion of an examination, that Summit Brokerage has violated certain of these rules and regulations. Where possible, Summit Brokerage endeavors to correct such asserted violations. In certain circumstances, and depending on the nature and extent of the violations, Summit Brokerage may be subject to disciplinary action, including fines. In addition, other aspects of our business, including our investment advisory activities and the sale of insurance products, are subject to regulatory authority, and no assurance can be given that we will not be subject to any form of action, including fines and/or penalties.

From time to time, we may also be engaged in various legal proceedings not related to securities. We currently maintain various types of insurance, including directors’ and officers’ liability insurance, as well as employment practices liability insurance, the proceeds of which may help to reduce the amount we may otherwise be required to pay with respect to certain types of claims. However, there can be no assurance that we will be able to obtain such insurance in the future. If it can be obtained, the price for such insurance may be unreasonable. Even if such insurance is in force, the amount of any award may exceed the maximum coverage provided by such insurance, in which case we will be required to pay any uncovered portion.

 

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Item 4.

Mine Safety Disclosures

Not applicable.

PART II

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our common stock is traded in the over-the-counter market and is currently quoted on the electronic bulletin board under the symbol “SFNS.OB”. The following table represents the range of the high and the low closing prices, as reported by NASDAQ Trading and Market Services, for each fiscal quarter for the last two fiscal years ended December 31, 2011. These quotations represent prices between dealers, may not include retail mark-ups, markdowns or commissions, and may not necessarily represent actual transactions.

 

		Low				High
Fiscal Quarter Ended
March 31, 2011		$	0.75			$	0.85
June 30, 2011		$	0.67			$	0.75
September 30, 2011		$	0.60			$	0.80
December 31, 2011		$	0.62			$	0.79
March 31, 2010		$	0.38			$	0.52
June 30, 2010		$	0.49			$	0.90
September 30, 2010		$	0.80			$	1.02
December 31, 2010		$	0.70			$	0.94

On March 16, 2012, the closing price of our common stock was $0.75 and we had approximately 150 holders of record.

Dividends and Dividend Policy

We have not paid any cash dividends on our common stock during the last two fiscal years and we do not anticipate paying any cash dividends on our common stock in the foreseeable future. We currently intend to retain any future earnings for reinvestment in our business. Any future determination to pay cash dividends will be at the discretion of our Board of Directors and will be dependent on our financial condition, results of operations, capital requirements and other relevant factors. With respect to our Series A Preferred Stock, we paid or accrued a total of $15,000 in dividends during each of 2011 and 2010, and had accrued dividends of $29,376 as of December 31, 2011 and $26,376 as of December 31, 2010.

 

Item 6.

Selected Financial Data

Not Applicable

 

Item 7.

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

Critical Accounting Policies

General. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Actual results could differ from those estimates.

 

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Clearing Arrangements. Summit Brokerage does not carry accounts for clients or perform custodial functions related to clients’ securities. Summit Brokerage introduces certain of its client transactions to its Clearing Brokers, which maintain the clients’ accounts and clears such transactions. These activities may expose us to significant risk in the event that clients do not fulfill their obligations with the Clearing Brokers since Summit Brokerage has agreed to indemnify the Clearing Brokers for any resulting losses. Any such client-related losses are typically charged to the client’s financial advisor, as a result of such financial advisor agreeing to indemnify Summit Brokerage against such losses. In the event the financial advisor is unable to fulfill their indemnification obligation, Summit Brokerage will bear the loss. Losses related to these types of activity have historically not been material.

Customer Claims, Litigation and Regulatory Matters. In the normal course of business as a broker-dealer, investment advisor, and insurance agent, we are subject to client-related complaints relating to the manner in which client accounts are handled by our financial advisors. When the complaint relates to the sale of securities, both Summit Brokerage and the client are typically obligated to seek resolution through arbitration. When the complaint is not client-related, or does not relate to the sale of securities, such matters will be resolved pursuant to the terms of the governing agreement or contract or, if no such agreement or contract exists, through an otherwise appropriate forum. The Company maintains various types of insurance to reduce exposure relating to possible claims, including errors and omissions insurance, directors’ and officers’ liability insurance and employment practices liability insurance. Due to the uncertain nature of litigation in general, we are unable to estimate a range of possible loss related to arbitration or litigation filed against us, but based on our historical experience and consultation with counsel, we typically reserve an amount we believe will be sufficient to cover any damages assessed against us. However, it is possible that the actual amounts required to be paid by us will exceed the reserved amount. If we misjudged the amount of damages that may be assessed against us from pending or threatened claims, or if we are unable to adequately estimate the amount of damages that will be assessed against us from claims that arise in the future and our reserves are inadequate, our income would be reduced. Furthermore, our ability to reasonably estimate the amount of damages that may be assessed may be hampered by the introduction of all lay-person arbitration panels. Industry studies have shown that such panels tend to award larger amounts to clients than those panels upon which at least one industry-associated person sits. Such costs may have a material adverse effect on our future financial position, results of operations or liquidity.

Valuation of Deferred Tax Assets. We account for income taxes in accordance with U.S. generally accepted accounting principles, which requires the recognition of tax benefits or expense on the timing differences between the tax basis and book basis of assets and liabilities. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those timing differences are expected to be recovered or settled. Deferred tax assets as of December 31, 2011, which consisted principally of unrecognized stock-based compensation, the amortization of client list and goodwill and the net effect of timing differences, amounted to approximately $1.36 million. We have determined that a valuation allowance at December 31, 2011 was necessary to fully offset such deferred tax asset based on the likelihood of future realization.

Expense Recognition of Employee Stock Options and Warrants. We account for all option and warrant issuances (including those issued to both employees and non-employees of Summit Brokerage) using a fair market value method. In connection therewith, we record, upon the issuance of each option and warrant, unearned stock-based compensation in an amount equal to the number of shares covered by the option or warrant multiplied by the fair value per option or warrant. The amount recorded as unearned stock-based compensation is then amortized over the vesting period of the option or warrant. Consequently, the total expense recognized in the current period represents the amortized portion, if any, of the fair value of all outstanding options and warrants (net of recaptures, if any).

See the notes to our Consolidated Financial Statements included elsewhere in this Annual Report for additional information concerning our accounting policies.

The following discussion and analysis of our financial condition and results of its operation for the fiscal years ended December 31, 2011 and December 31, 2010 should be read in conjunction with our Consolidated Financial Statements included elsewhere in this Annual Report.

When used in the following discussions, the words “believes,” “anticipates,” “intends,” “expects,” and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause results to differ materially from those anticipated or projected, including, but not limited to, those set forth in “Factors That May Affect Future Results and Market Price of Our Stock” set forth below.

Certain amounts from the prior periods have been reclassified to conform to the current year’s presentation.

 

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Overview

Summit Financial Services Group, Inc., through its primary operating subsidiary, Summit Brokerage Services, Inc., provides full-service securities brokerage through a network of approximately 290 producing financial advisors serving retail and, to a much lesser extent, institutional client accounts. With the exception of our Boca Branch, which we acquired from Wachovia Securities Financial Network in January 2003, our approximately 200 other branch offices are owned and operated by independent owners who maintain appropriate licenses and are responsible for all office overhead and expenses. This arrangement allows us to operate with a reduced amount of fixed costs and lowers the risk of operational losses for non-production. Because these independent operators, many of whom are financial planners, are required to pay their own expenses, we generally pay them a much greater percentage of the commissions and fee income they generate, typically 80%-90%.

Summit Brokerage is registered as a broker-dealer with the SEC, is a member of FINRA, the MSRB, the NFA and SIPC, and is licensed to conduct its brokerage activities in all 50 states, plus the District of Columbia. SFG, our investment advisory firm, is registered or eligible to conduct business as an investment advisor in 38 states and the District of Columbia. SBSIA, our subsidiary insurance agency, directly or through its subsidiary entities, is licensed to sell insurance, or is not required to be so licensed, in all jurisdictions where the Company conducts its brokerage activities.

Our financial advisors offer a broad range of investment products and services. These products and services allow us to generate both commissions (from the purchase and sale of securities and other investment transactions) and fee income (for providing investment advisory services, namely managing a client’s account). The investment products and services offered include mutual funds, annuities, insurance, individual stocks and bonds, and managed money accounts. The following table reflects the various sources of revenue and the percentage of total revenues for each of the last two fiscal years:

 

		2011								2010
Insurance related products		$	22,730,678				33	%		$	20,631,883				32	%
Investment advisory fees			13,068,786				19				10,931,690				17
Equities			10,305,219				15				12,547,801				19
Mutual funds			10,628,791				16				8,802,474				14
Other commission revenue			6,617,827				10				7,007,556				11
Interest and dividends			1,117,219				2				1,420,504				2
Other			3,647,486				5				3,559,045				5
Total		$	68,116,006				100	%		$	64,900,953				100	%

Summit Brokerage is a fully-disclosed broker-dealer, and therefore relies on its Clearing Brokers to provide the back office support and transaction processing services necessary to effect transactions on all principal national and international securities exchanges. Additionally, because the Clearing Brokers provide us with access to many other financial products and services that we would not otherwise be able to offer, we are able to provide our clients with products and services comparable to much larger brokerage firms. In exchange for providing these services, the Clearing Brokers typically charge us a fee every time they effect a transaction on behalf of the firm or its clients.

In 2011 and 2010, we reported gross revenues and net income of $68.1 million and $1.47 million and $64.9 million and $1.30 million, respectively. During 2011, our revenues and earnings grew as a result of the ability to successfully recruit financial advisors during 2011 and the latter part of 2010, as well as due to an increase in the average production of those financial advisors that had been with us for at least 18 months prior to the end of 2011. Prospectively, we continue to believe that events that trigger the loss of investor confidence, including as a result of economic problems and uncertainty within the European Union, the geopolitical uncertainty of the Middle East, and concerns of a faltering domestic economy, will negatively impact our results of operations. We may also be unable to sustain the same level of growth in financial advisors as we experienced in prior years, especially if the factors that permitted such growth are in any way diminished.

 

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In addition to the factors described above, our operating results in 2012 and beyond may be negatively impacted by several other factors, including, but not limited to, increased costs required to become compliant with the extensive regulatory reforms recently enacted (as well as proposed reforms), the potential loss of revenue sources related to such regulatory reforms, Summit Brokerage’s decision to focus on expanding its marketing and recruiting efforts, and an overall reduction of margins on an industry-wide basis.

Although we expect our results, in general, to be impacted by macroscopic forces, such as the state of the economy, as well as overall market conditions and investor confidence, we may experience fluctuations in our revenue that do not follow such trends, or mirror trends experienced by the financial services industry as a whole. This is because, given our size, we may add, or lose, financial advisors who generate a significant amount of commissions from the sale of a particular type of investment product. As we grow larger, we anticipate that the ability of any branch office to impact the overall revenue mix will be diminished. However, due to our size, it is possible that the addition or loss of financial advisors (and their clients), who focus on certain products over other products, will be a factor in causing fluctuations in our revenue and/or revenue mix from period to period, which may not be representative of results in other periods or reflective of general market conditions or economic trends.

Our business plan is focused primarily on increasing our network of affiliated financial advisors, which permits us to expand our base of revenue and our network for the retail brokerage of securities without the capital expenditures that would be required to open Company-owned offices and the additional administrative and other costs of hiring financial advisors as in-house employees. As was the case with the Boca Branch, however, we may evaluate potential acquisitions, including those that would result in acquired financial advisors becoming employees of Summit Brokerage. Historically, Summit Brokerage has recruited offices comprised of between one and three financial advisors. Prospectively, we expect to continue to recruit smaller offices, although we may target larger offices comprised of many financial advisors. Because of the size of these larger offices, we may be required to pay a greater percentage of the offices’ commissions than we would pay to a smaller office. As a result, if we are successful, of which no assurance can be given, we may experience a potential decline in our gross margin percentage.

By their nature, our business activities are highly competitive and are subject to, among other things, general market conditions, including the volatility of the trading markets and the attractiveness of various forms of investment products. Consequently, our revenues and net income are subject to substantial positive and negative fluctuations due to a variety of factors that cannot be predicted with great certainty and may result in revenues and net income (or losses) in any particular period that may not be representative of future results and may vary significantly from period to period. Furthermore, we have determined that our long-term growth strategy can best be maximized through the reinvestment of a portion of our earnings into the development of our infrastructure and recruiting and business development efforts, including through the payment of upfront amounts to advisors. As a result, our future earnings may be significantly less than in prior years.

Results of Operation

The following discussion relates to the results of operations for the fiscal year ended December 31, 2011 (“2011”), compared to the results of operations for the fiscal year ended December 31, 2010 (“2010”). All amounts are rounded. Certain amounts from 2010 have been reclassified to conform to the current year presentation. These reclassifications had no impact on the reported net income for 2010.

Comparison of Fiscal Years Ended December 31, 2011 and December 31, 2010

Revenue:

Commission revenue of $63.35 million for 2011 represents an increase of $3.43 million, or 6%, over the $59.92 million of commission revenue reported for 2010. During 2011, our revenues and earnings grew as a result of the ability to successfully recruit financial advisors during 2011 and the latter part of 2010, as well as due to an increase in the average production of those financial advisors that had been with us for at least 18 months prior to the end of 2011.

In any period, our mix of business will be impacted by several factors, including, among other things, investor confidence, as reflected by the movements of the equities markets, and the attractiveness of non-equity-related investment products, such as fixed income securities. Additionally, during any period, we may add, or lose, a significant number of financial advisors who focus only on the sale of a particular type or types of investment product(s) (e.g., insurance, equities, fixed income, etc.).

Interest and dividend income decreased by $0.3 million, or 21%, from $1.42 million in 2010 to $1.12 million in 2011. Interest and dividend income is comprised primarily of that portion of the interest income earned from, and the interest expense charged to, clients of Summit Brokerage that are received from our Clearing Brokers. For 2011, the percentage paid to Summit by one of its Clearing Brokers was reduced from prior year levels. That same Clearing Broker has informed Summit that beginning in the second quarter of 2012, further reductions will take place. Unless Summit Brokerage is able to offset these decreases with proportionate increases in the balances upon which such amounts are earned, our earnings will be negatively impacted, as was the case in 2011. Furthermore, additional reductions into 2012 and beyond will continue to adversely affect our operating results. A significant reduction in such overall compensation may have a material adverse impact on the Company’s operating results.

 

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Other revenue increased by approximately $90,000, or 3%, from $3.56 million in the 2010 to $3.65 million in 2011. Other revenue represents fees generated by the Company primarily from providing services and administration and acting as a principal in certain fixed income transactions.

Expenses:

Commissions and clearing costs increased to $54.05 million in 2011, representing an increase of $2.08 million, or 4%, over the $51.97 million reported in 2010. In general, commissions and clearing costs are directly related to commission revenue, and will typically increase or decrease proportionately as commission revenue rises or falls. Commissions and clearing costs, as a percentage of commission revenue, decreased in 2011 to 85.3% from 86.7% in 2010. Prospectively, we would expect this percentage to increase as we recruit more independent financial advisors. Because our independent financial advisors are responsible for the payment of all costs associated with operating their offices, we must pay them a higher percentage of the commissions they generate (typically 80% to 90%), than we pay to those financial advisors working from the Boca Branch, where Summit pays the costs associated with operating the Boca Branch. In addition to the commission expense we pay to our financial advisors, we also include certain costs that are either billed, or credited, to Summit Brokerage other than those related to clearance and execution.

Employee compensation and benefits increased to $6.24 million in 2011, which represents an increase of $170,000, or 3%, over the $6.07 million reported for 2010. This increase is due primarily to an increase in salaries, which increase was partially offset by a decrease in the costs associated with issuing common stock and equivalents to our employees. For 2011 and 2010, a total of $577,000 and $675,000, respectively, was expensed (net of recaptured amortization), all of which related to the amortization of unearned stock-based compensation for employees.

Occupancy and equipment costs decreased to $733,000 in 2011, which represents a decrease of $63,000, or 8%, from the $796,000 reported for 2010. This decrease was due primarily to the elimination during 2011 of duplicative rent expense that the Company was paying for a short period of time during early 2010 on both its old and new headquarters locations.

Communications costs increased by $58,000, or 12%, to $526,000 during 2011 from $468,000 during 2010. This increase in costs was due primarily to enhancements to the Company’s technology infrastructure, including its website.

Depreciation and amortization expense remained relatively constant between the 2011 and 2010.

Other operating expenses include the general and administrative costs incurred by us, to the extent such costs are not included elsewhere. Other operating expenses increased by $270,000, or 8%, to approximately $3.57 million during 2011 from $3.31 million for 2010. During 2011, certain costs that we pay to acquire and retain financial advisors increased by 17%, or $.25 million, to $1.72 million over the $1.47 million incurred in 2010. These increases were partially offset by the decrease in professional fees of 28%, or $132,000, from $469,000 in 2010 to $337,000 in 2011. Insurance costs also decreased, by $20,000, or 3%, from $602,000 in 2010 to $582,000 in 2011. We also include within other operating expenses the costs related to the issuance of common stock and equivalents to our independent financial advisors. For 2011 and 2010, a total of approximately $133,000 and $156,000, respectively, was expensed (net of recaptured amortization) for such issuances, all of which related to the amortization of unearned stock-based compensation.

Net Income:

For 2011, we reported net income of $1.46 million, or $0.05 per basic and diluted share. For 2010, we reported net income of $1.30 million, or $0.05 per basic share and $0.04 per diluted share. Our performance in 2011 was positively impacted by an increase in commission revenues, as well as a decrease in the percentage of those commission revenues that we pay to our advisors.

 

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Liquidity and Capital Resources

Net cash provided by operating activities totaled approximately $1.71 million in 2011, compared to $3.36 million during 2010. During 2011, net cash provided by operating activities approximated net income. For 2010, however, net cash provided by operating activities significantly exceeded net income as a result of the net changes in certain balance sheet accounts, as well as certain non-cash items, such as stock-based compensation expense. Cash and cash equivalents increased during 2011 by approximately $1.35 million to approximately $10.79 million.

During 2011, we purchased approximately $192,000 of property and equipment, compared to approximately $503,000 purchased during 2010. The decrease between 2011 and 2010 was due to the Company having completed its move to its new corporate headquarters during 2010. For 2012, the Company does not anticipate incurring significant capital expenditures for furniture, equipment and leasehold improvements.

Financing activities resulted in a net use of cash of approximately $170,000 during 2011. During 2010, financing activities provided net cash of $281,000. The primary reason for the decrease in cash provided by financing activities was the purchase, during 2011, of our common stock from a shareholder for approximately $412,000. During 2011, options were exercised for aggregate consideration of approximately $257,000, which proceeds were partially offset by the payment and accrual of $15,000 in Preferred Stock dividends. This compares with aggregate proceeds from the exercise of options and warrants of $297,000 during 2010, which was partially offset by the payment and accrual of $15,000 in Preferred Stock dividends.

In the normal course of business, we evaluate acquisitions of businesses that complement our business. In connection with any acquisitions, we may issue additional securities, which could result in dilution for existing shareholders.

Inflation. Inflation has not been a major factor in our business since inception. There can be no assurances that this will continue.

Significant Business Relationships

Since 1994, we have had a clearing agreement with First Clearing Corporation, an affiliate of Wells Fargo & Company, to execute securities orders and maintain accounts for clients on behalf of Summit Brokerage and its clients. On March 19, 2008, we entered into a clearing agreement with Pershing LCC (a division of the BNY Mellon) to provide clearing services in addition to First Clearing Corporation. In the event a Clearing Broker were to cease doing business with us, our ability to execute transactions on behalf of, and provide a full range of services to, our clients could be negatively impacted, which could, in turn, have a material adverse effect on both our revenues and earnings.

Factors That May Affect Future Results and Market Price of Our Stock

We operate in a rapidly changing environment that involves numerous risks, some of which are beyond our control. The following discussion highlights some of these risks.

There can be no assurance that we will continue to operate profitably in the future. Although the Company has reported an after-tax profit in every year but one since 2004, we cannot assure you that we will continue to sustain profitability, or that, even if we generate net income, that our cash flow from operations will be sufficient to allow us to fully execute our strategy for the reasons further described in this Annual Report on Form 10-K.

Our business could be harmed by market volatility, declining investor confidence, declines in general economic conditions and other securities industry risks. As a provider of financial products and services, we are affected by economic and political conditions over which we have no control. These conditions may directly and indirectly impact a number of factors that may be detrimental to our operating results, including reduced investor confidence, a slowdown in economic activity, declining or volatility in interest rates, and changes in volume and price levels of the securities markets. These types of conditions have historically resulted in a reduction in the value and attractiveness of certain types of investments, which will negatively impact our operating results. In periods during major stock market declines, many firms in the securities industry suffer financial losses, and the level of individual investor confidence (and trading activity) decreases after these events. When investor confidence and trading volume is low, our profitability is adversely affected because a portion of our costs do not vary with revenue. For these reasons, severe market fluctuations can have a material adverse effect on our business, financial condition and operating results. Some of our competitors with more diversified business lines and/or greater financial resources might withstand a downturn in the securities industry better than we could.

 

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In addition, declines in the market value of securities generally result in a decline in revenues from fees based on the asset values of client portfolios, and in the failure of Summit Brokerage’s clients to fulfill their credit and settlement obligations. Summit Brokerage permits its clients to purchase securities on margin. During periods of steep declines in securities prices, the value of the collateral securing client accounts margin purchases may drop below the amount of the purchaser’s indebtedness. If the clients are unable to provide additional collateral for these loans, Summit Brokerage may lose money on these margin transactions because it is required to indemnify its Clearing Brokers. This may cause Summit Brokerage to incur additional expenses defending or pursuing claims or litigation related to counterparty or client defaults. Furthermore, a tightening of credit, or a change in the requirements related to the use and maintenance of margin accounts, could result in a reduction in the number of brokerage transactions executed by Summit Brokerage clients. The resulting lack of available credit, including as a result of a lack of confidence in the financial markets, could have a material adverse effect on Summit Brokerage’s financial condition and results of operations, as well as its access to capital.

We receive additional compensation from certain product vendors (e.g., insurance companies and mutual funds), which amounts are used to offset the costs associated with, among other things, our sponsored meetings of our financial advisors. For 2012, we expect many of such vendors to reduce or eliminate such additional compensation. Depending on the amount of such reduction or elimination of such payments, our operating results would be negatively impacted.

In addition to the factors described above, our operating results in 2012 and beyond may be negatively impacted by several other factors, including, but not limited to, increased costs required to become compliant with the extensive regulatory reforms recently enacted (as well as proposed reforms), the potential loss of revenue sources related to such regulatory reforms, Summit Brokerage’s decision to focus on expanding its marketing and recruiting efforts, and an overall reduction of margins on an industry-wide basis.

We believe that the factors that have affected both the economy, in general, and the financial markets, in particular, during 2010 and 2011 may continue for the foreseeable future, and that the Company’s operating results may be negatively impacted as a result thereof.

Our earnings can be negatively impacted by declining interest rates and yields. Under its agreements with its Clearing Brokers, Summit Brokerage receives a portion of the interest income earned from, and interest expense charged to, its clients. As interest rates and yields have declined, so has the amount that Summit Brokerage receives. For 2011, the percentage paid to Summit by one of its Clearing Brokers was reduced from prior year levels. That same Clearing Broker has informed Summit that beginning in the second quarter of 2012, further reductions will take place. Unless Summit Brokerage is able to offset these decreases with proportionate increases in the balances upon which such amounts are earned, our earnings will be negatively impacted, as was the case in 2011. Furthermore, additional reductions into 2012 and beyond will continue to adversely affect our operating results. A significant reduction in such overall compensation may have a material adverse impact on the Company’s operating results.

We operate in a highly regulated industry and compliance failures could adversely affect our business. The securities industry in the jurisdictions in which we operate is subject to extensive regulation covering all aspects of the securities business. The SEC, the self-regulatory organizations, including FINRA, and state regulatory agencies also have the authority to conduct administrative proceedings which can result in the censure, fine, suspension or expulsion of a broker-dealer and an investment advisor, and their registered representatives, employees or officers. Additionally, certain regulatory agencies have the ability to limit our growth by restricting the number of offices, or financial advisors, that we can add, as well as require that Summit Brokerage maintain a certain amount of regulatory capital. Furthermore, new legislation, such as the Dodd-Frank Act, changes in the rules and regulations promulgated by the SEC or self-regulatory organizations, and changes in the interpretation or enforcement of existing laws and rules often directly affect the operation and profitability of broker-dealers and investment advisors. Provisions of the Dodd-Frank Act that may impact our business include, but are not limited to: the potential implementation of a more stringent fiduciary standard for broker-dealers and enhanced regulatory oversight of incentive compensation. Compliance with these provisions has resulted in, and is likely to continue to result in, increased costs. Moreover, to the extent the Dodd-Frank Act impacts the operations, financial condition, liquidity and capital requirements of financial institutions with which we do business, those institutions may seek to pass on increased costs, reduce their capacity to transact, or otherwise present inefficiencies in their interactions with us. The ultimate impact that the Dodd-Frank Act will have on us, the financial industry and the economy cannot be known until all such applicable regulations called for under the Dodd-Frank Act have been finalized and implemented. The stated purpose of much of the regulation of broker-dealers and investment advisors is the protection of clients and the securities markets, rather than the protection of creditors and shareholders of broker-dealers and investment advisors. As part of the regulatory process, broker-dealers and investment advisors are subject to routine examinations, the purpose of which is to determine their compliance with rules and regulations promulgated by the examining regulatory authority. It is not uncommon for the regulators to assert, upon completion of an examination, that the broker-dealer or investment advisor being examined has violated certain of these rules and regulations. Depending on the nature and extent of the violations, the broker-dealer or investment advisor may be required to pay a fine and/or be subject to other forms of disciplinary action. In the past, Summit Brokerage has been required to pay a fine for certain violations, and no assurance can be given that the firm will not be subject to future fines or other forms of disciplinary action. For 2012 and beyond, we believe that the various regulatory agencies will seek to assess increasing fines and penalties by seeking to identify more instances of non-compliance, lowering the threshold of materiality upon which the decision to assess a fine or penalty is made (versus another form of disciplinary action), and increasing the amount of the fine (for a particular violation) over what was assessed in prior years. In those instances where Summit Brokerage is informed of a potential violation by an examining regulatory authority, it endeavors to correct such violations as soon as is practicable.

 

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Our ability to comply with all applicable laws and rules, as well as unpredictable changes in their content, and in the regulatory interpretation and enforcement of them, is largely dependent on our establishment and maintenance of compliance and reporting systems, our ability to attract and retain qualified compliance and other personnel, and the maintenance of sufficient regulatory capital. We could be subject to disciplinary or other regulatory or legal actions in the future due to noncompliance. In addition, it is possible that any past noncompliance could subject us to future civil lawsuits, the outcome of which could have a material adverse effect on our financial condition and operating results.

In connection with past examinations, Summit Brokerage has been notified by FINRA of, and endeavored to correct, certain alleged violations. There can be no assurance that the findings of any regulatory agencies will not result in subjecting Summit Brokerage (and possibly certain of our principals and/or financial advisors) to some form of disciplinary action, including fines. In addition, regulators may put restrictions on Summit Brokerage’s ability to add new financial advisors and / or branch offices. Furthermore, any contemplated merger by or with Summit Brokerage will require the approval of regulatory authorities, which approval may not be granted. Accordingly, even if Summit Brokerage is able to negotiate a transaction with a merger candidate, we may not be able to consummate such transaction, thereby inhibiting our ability to fully execute our growth strategy.

There is considerable fluctuation during any year and from year-to-year in the volume of transactions we must process. We record transactions and post our books on a daily basis. Compliance and operations personnel monitor operations to determine compliance with applicable laws, rules and regulations. Failure to keep current and accurate books and records can render us liable to disciplinary action by governmental and self-regulatory authorities, as well as to claims by our clients. A significant increase in the number of transactions that we process may increase the likelihood of such failures if we are not able to maintain an adequate supervisory infrastructure.

As a broker-dealer, we are limited in the manner in which we can receive compensation for the services we provide. Currently, Summit Brokerage receives 12b-1 fees, or trail commissions, related to the sale of mutual fund shares. The SEC is currently reviewing its policies with respect to such payments. In the event the SEC was to limit the ability of Summit Brokerage to receive such fees, our revenues and earnings would be negatively impacted. Additionally, the Department of Labor, which promulgates rules related to retirement plans, is considering eliminating commissions and 12b-1 fees on qualified retirement accounts, including IRAs.

Summit Brokerage is also subject to rules and regulations related to the prevention and detection of money laundering. The USA PATRIOT Act of 2001 (the “PATRIOT Act”) contains anti-money laundering and financial transparency laws and mandates the implementation of various regulations applicable to broker-dealers and other financial services companies. Financial institutions subject to the PATRIOT Act generally must have anti-money laundering procedures in place, implement specialized employee training programs, designate an anti-money laundering compliance officer and are audited periodically by an independent party to test the effectiveness of compliance. We have established policies, procedures and systems designed to comply with these regulations. Failure to comply with these rules could subject Summit Brokerage to disciplinary sanctions or other penalties.

As a result of the growth of the Internet as a means of conducting business, regulatory activity in the areas of privacy and data protection continues to increase worldwide among concerns about the rapid and widespread dissemination and use of information. We must comply with these information-related regulations, including, but not limited to, the 1999 Gramm-Leach-Bliley Act, SEC Regulation S-P, the Fair Credit Reporting Act of 1970, as amended, and the 2003 Fair and Accurate Credit Transactions Act, to the extent they are applicable to us. Additionally, the regulatory agencies have adopted stringent standards related to a broker-dealer’s requirement to identify, review and monitor its advisors use of the internet, including related to emails, websites and social networking. Violations of existing laws and regulations, including related to the safeguarding of private information, could subject us to fines and penalties, as well as to civil action by affected parties.

 

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In addition, the growth of the Internet as a means of conducting business has raised many legal issues regarding, among other things, the circumstances in which jurisdictions have the right to regulate internet services that may be available from service providers. In many cases, there are ambiguous, inconsistent or no laws, regulations, judicial decisions or governmental interpretations that clearly resolve these issues. This uncertainty may adversely affect our ability to use the internet to expand, and creates the risk that we could be subject to disciplinary sanctions or other penalties for failure to comply with applicable laws or regulations.

Furthermore, several members of Congress have recently considered enacting legislation that would change the eligibility requirements for determining one’s status as an independent contractor. Any change to such requirements that would have the effect of precluding Summit Brokerage from continuing to treat its affiliates and the financial advisors operating from their offices as independent contractors could have an adverse effect on the Company.

There can be no assurance that the findings of any regulatory agencies with respect to the aforedescribed matters will not result in subjecting Summit Brokerage and its principals and financial advisors to some form of disciplinary action, including fines. In addition, no assurance can be given as to our ability to comply with any increased regulation in a cost effective manner.

We face substantial competition that could reduce our market share and harm our financial performance. All aspects of our business are highly competitive. We compete directly with national and regional full-service broker-dealers and, to a lesser extent, with discount brokers, investment advisors and certain commercial banks. 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. As a result of this and other factors, the gross margins of those companies operating within our industry, including Summit Brokerage, have faced significant downward pressure.

These mergers and acquisitions have increased competition from these firms, many of which have significantly greater equity capital and financial and other resources than we do. With respect to retail brokerage activities, certain regional firms with which we compete have operated in certain markets longer than we have and have established long-standing client relationships. In addition, we expect competition to continue from commercial banks that have expanded into the brokerage business. We also compete with others in the financial services industry in recruiting financial advisors and new employees, as well as retaining current personnel (including senior members of management), and we could be adversely affected in the event we were to lose financial advisors who either individually or in the aggregate account(s) for a significant percentage of our revenues. Furthermore, a trend in the independent brokerage industry is to provide upfront amounts (in the form of either forgivable or non-forgivable loans) to newly recruited financial advisors as an incentive to become affiliated with a broker-dealer. Alternatively, Summit Brokerage may offer newly recruited advisors a higher payout than they would otherwise receive for a limited period of time (e.g., 12 months). Although Summit Brokerage typically offers such incentives, its ability to fully execute its growth strategy could be adversely impacted should those firms against whom we compete offer financial incentives: (i) beyond what we are able to offer based on our financial resources, or (ii) that, in general, do not make economic sense based on our current cost and operating structure, or in the event any such incentives are limited in the future by regulatory action. Furthermore, the provision of upfront amounts, including higher payouts, may have an adverse effect on our operating results and our working capital. In addition to providing upfront amounts, many of our competitors offer commission payout rates in excess of the rates Summit Brokerage currently offers. As a result, we may not be able to attract and/or retain those financial advisors interested in receiving a greater percentage of the commissions and fees they generate. Should we elect to increase our payout rates to our financial advisors, our operating margins could be negatively impacted. Furthermore, should we elect to increase the amount of upfront money that we pay, our results could be negatively impacted if the advisors receiving such upfront money leave and Summit is unable to collect any unamortized balance, or such advisors remain with Summit but generate significantly less production than the production upon which the upfront payment was based. An increase in upfront amounts will also potentially negatively impact our results because the Company will be required to recognize greater amortization expense.

We expect to continue to face increasing competition from companies offering electronic brokerage services. These competitors may have lower costs or provide alternative services, and may offer certain clients more attractive pricing or other terms, than we offer.

We may be unable to hire, integrate or retain qualified personnel. Most aspects of our business are dependent on highly skilled individuals. We devote considerable resources to recruiting, training and compensating these individuals. In addition, one component of our growth strategy is to increase market penetration by recruiting experienced financial advisors. We cannot assure that we will be successful in our recruiting efforts. Furthermore, our business could be adversely affected if we were to lose financial advisors who account for a significant percentage of our revenues.

 

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In connection with our recruiting efforts, we rely significantly on the extensive relationships developed by senior management, resulting from their years of involvement in the financial services industry. We also rely on referrals, the use of both in-house and outside recruiters and targeted advertising. We cannot assure that these recruiting efforts will be successful or, if successful, that they will enhance our business, results of operations, or financial condition. We also cannot assure that profit generated by recruited financial advisors will exceed the costs incurred to recruit such financial advisors, including, but not limited to, recruiter salaries, overrides (to both in-house, as well as outside recruiters), marketing and advertising costs, and upfront amounts paid to financial advisors.

Competition for key personnel is intense. We cannot assure that losses of key personnel due to such competition, or for other reasons, will not occur in the future. The loss of any key employee, particularly Marshall T. Leeds, could have a material adverse effect on our operating results. We currently maintain key man life insurance on Mr. Leeds in the amount of $3,000,000, although there can be no assurance that we will be able to renew this policy on terms that are acceptable.

Other than Mr. Leeds, we do not have employment agreements with any other members of senior management. We attempt to retain employees with incentive-based compensation, including stock options conditioned on continued employment. These incentives, however, may be insufficient in light of the increasing competition for experienced professionals in the securities industry, particularly if our stock price were to decline, or fail to appreciate sufficiently. If that happened, our benefit plan might no longer be perceived as a competitive incentive for our key employees to stay with us.

The Company has agreed to reimburse Mr. Leeds for the tax liability incurred by him in connection with the disposition of certain common stock equivalents issued to him by the Company. In the event this obligation was triggered by an acquisition of the Company, the amount that would otherwise be available to the Company’s shareholders would be reduced. See “Employment Agreements.”

We need to comply with stringent capital requirements. Many of the regulatory agencies, securities exchanges and other industry self-regulatory organizations that regulate us have stringent rules with respect to the maintenance of specific levels of net capital by securities broker-dealers and/or investment advisors. Net capital is the net worth of a broker-dealer, less deductions for certain types of assets. If Summit Brokerage fails to maintain the required net capital, it may be subject to suspension or revocation of its licenses, which could ultimately lead to Summit Brokerage and/or the Company being liquidated. Additionally, the net capital rule and certain FINRA rules impose requirements that may have the effect of prohibiting a broker-dealer from distributing or withdrawing capital, and that require prior notice to the SEC and FINRA for certain capital withdrawals. If such net capital rules are changed or expanded, or if there is an unusually large charge or charges against our net capital (including as a result of Summit Brokerage’s obligation to indemnify our Clearing Brokers or as a result of a judgment levied against the Firm), we might be required to limit or discontinue those portions of our business that require us to maintain certain net capital levels. A large operating loss or charge(s) against net capital could adversely affect our ability to expand or even maintain our present levels of business. Currently, Summit Brokerage is required to maintain net capital equal to the greater of: (i) $250,000 or (ii) 6.67% of aggregate indebtedness. As of December 31, 2011, Summit Brokerage had net capital of approximately $3.7 million and excess net capital of approximately $3.4 million, as computed under SEC Rule 15c3-1. Historically, amounts of capital in excess of what the Company’s board of directors have deemed necessary to support Summit Brokerage’s operations have been upstreamed to the Company, thereby reducing the amount of net capital in Summit Brokerage. The Company intends to continue this policy in the future.

The Company’s operating results and financial position are directly related to the activities of its principal operating subsidiary. The Company serves as a holding company for Summit Brokerage, its principal operating subsidiary. Any factors that may negatively affect Summit Brokerage’s financial results or ability to execute its business strategy, including as a result of any regulatory restrictions, will have an adverse effect on the Company and its prospects.

Our strategy of reinvesting our profits may adversely impact future earnings. The Company has determined that its long-term growth strategy can best be maximized through the reinvestment of a portion of its earnings into the development of its infrastructure and its recruiting and business development efforts, including through the payment of upfront amounts to financial advisors, and the issuance of stock options to financial advisors. Additionally, should we elect to increase the amount of upfront money that we pay, our results could be negatively impacted if the advisors receiving such upfront money leave and Summit is unable to collect any unamortized balance, or such advisors remain with Summit but generate significantly less production than the production upon which the upfront payment was based. An increase in upfront amounts will also potentially negatively impact our results because the Company will be required to recognize greater amortization expense. As a result, the Company’s future earnings may be negatively impacted.

 

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Our growth has placed significant demands on our management and other resources and is likely to continue. To manage the currently anticipated growth of our business, we will need to attract, hire and retain highly skilled and motivated officers, employees and financial advisors. In particular, we expect that a need for increased staffing will continue for service personnel to support any expansion of our branch offices. We will also need to continue improving our existing systems, and/or implement new systems, for transaction processing, operational, compliance and financial management and training, and integrating and managing our growing employee and affiliate base. We cannot assure you that we will be able to attract the employees and consultants or conduct the improvements necessary to manage this growth effectively or that we will be able to achieve the rate of growth we have experienced in the past.

Furthermore, if we elect to continue a strategy that incorporates the use of both forgivable and non-forgivable loans to induce newly recruited financial advisors to affiliate with the Company, we may use a significant portion of our working capital. Additionally, there can be no assurance that the financial advisors receiving such loans will not terminate their affiliation with the Company prior to either repaying the note or, in the case of forgivable loans, prior to the amortization of their notes. Our financial position and operating results could be materially adversely affected if we are unable to collect the unpaid/unamortized portion of the notes. Our financial position and operating results could also be materially adversely affected if, after having joined the Company, the gross production of the financial advisors receiving such loans is significantly below the gross production upon which the amount of the loan (typically some percentage of the registered representative’s gross production prior to joining the Company) was based. In addition, to the extent we need additional working capital to fund any of such loans, we may seek additional financing sources, including the procurement of capital through a debt and/or equity offering, the success of which no assurance can be given.

We may not be able to grow as planned. As part of our long-term growth strategy, we recruit individual financial advisors (or groups of financial advisors) and we evaluate the acquisition of other firms or assets that could complement or expand our business in attractive service markets or that could broaden our client relationships. We cannot assure you that we will be successful in our recruiting efforts or that we will be able to identify suitable acquisition candidates available on terms that are acceptable to us, or that we will be able to consummate any acquisition (see additional risk factors set forth in this Annual Report on Form 10-K). Additionally, our ability to grow may be limited by applicable regulation. Furthermore, even if our recruiting efforts are successful, our revenues, and therefore our profitability, may be affected by a number of factors beyond our control, including a decline in investor confidence.

Future acquisitions may increase our leverage or cause dilution of existing shareholders’ interests. We anticipate that our growth strategy, which includes recruiting financial advisors and/or the acquisition of assets of other firms, may necessitate additional debt and/or equity financing, although there can be no assurance that this will happen. Our failure to obtain sufficient financing could limit our ability to grow. In addition, issuing securities, including stock options, in connection with acquisitions, or the hiring or retention of financial advisors and other personnel may have a dilutive effect on the equity interests of our shareholders.

We may have difficulty integrating businesses and/or generating acceptable returns from future acquisitions. Even if we are able to identify acquisition candidates and complete the acquisitions on terms favorable to us, we cannot assure that we will be able to successfully integrate any acquired business into our operations. The success of any completed acquisition will depend in large measure on our ability to integrate the operations of the acquired business with our operations and otherwise to maintain and improve the results of operations of the acquired business. Acquisitions involve a number of special risks and present financial, managerial and operational challenges, some of which include:

 

•

diversion of management’s attention;

 

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unanticipated events or circumstances;

 

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existence of unknown liabilities;

 

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potential disputes with sellers; and

 

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•

adverse effects on our reported earnings per share in the event acquired intangible net assets, if any, become impaired.

An acquisition increases the risk that any business may lose key advisors, clients or employees of the acquired business. An acquired business could under-perform relative to our expectations and we may not realize the value we expect from the acquisition. Adverse market conditions or poor investment or other performance by an acquired company may adversely affect revenue. We could also experience financial or other setbacks if an acquired company has problems of which we are not aware. Although we conduct due diligence reviews of potential acquisition candidates, we may not identify all material liabilities or risks related to acquisition candidates. Some or all of these risks could have a material adverse effect on our business, financial condition and results of operations. Further, future acquisitions may further increase our leverage or, if we issue equity securities to pay for the acquisitions, our shareholders could suffer dilution of their interests.

Our exposure to possible litigation could adversely affect our business. From time to time, we are engaged in various legal and regulatory proceedings arising in the normal course of business. Many aspects of the securities brokerage business involve substantial risks of liability. In recent years, there has been an increasing incidence of litigation involving the securities brokerage industry, including class action and other lawsuits that generally seek substantial damages, including, in some cases, punitive damages. We currently maintain errors and omissions insurance, the proceeds of which may help to reduce the amount we may otherwise be required to pay with respect to certain types of claims. However, there can be no assurance that we will be able to obtain errors and omissions insurance in the future. If it can be obtained, the price for such insurance may be unreasonable. Even if such insurance is in force, the coverage for any particular claim (if covered at all) will be limited, and the amount of any liability may exceed the maximum coverage provided by such insurance, in which case we will be required to pay any uncovered portion. Consequently, any such litigation brought in the future could have a material adverse effect on our business, financial condition and operating results. During 2010 and 2011, several brokerage firms were forced to cease operations as a result of disputes with their errors and omissions insurance carriers regarding the extent of available coverage. For 2012 and beyond, we expect that the cost of errors and omissions insurance will increase significantly.

With respect to litigation to which the Company is currently a party to, it is not possible to determine with certainty the outcome of such proceedings, although we believe that the eventual resolution of such proceedings will not have a material adverse effect on our financial position or operating results. Furthermore, given the significant decline in the major market indices that began in the second half of 2008 and the resulting reduction in the value of investments (including those investments that historically have been considered safe and conservative), no assurance can be given that the Company may not be subjected to a potentially significant increase in the number of proceedings to which it may be named as a party. In addition, our business may be negatively impacted if any of our financial advisors engage in dishonest activities. In March 2011, the Company became aware that a financial advisor operating from one of its branch offices may have misappropriated funds. In connection therewith, the Company undertook an investigation, including notifying FINRA. The Company also notified, or attempted to notify, clients of the advisor. The Company also notified its fidelity bond carrier. During 2011, the Company settled with two of the four identified parties representing approximately 95% of the total known loss. The Company was subsequently reimbursed by its fidelity bond carrier. It currently is not possible to determine with certainty the outcome of this matter, and in particular whether additional claims may be forthcoming. Such future claims, although currently unknown, may potentially have a material adverse effect on our financial position or operating results should they arise and are not covered by, or exceed the coverage available through, our fidelity bond.

From time to time, we may also be engaged in various legal proceedings not related to securities. We currently maintain various types of insurance, including directors’ and officers’ liability insurance, as well as employment practices liability insurance, the proceeds of which may help to reduce the amount we may otherwise be required to pay with respect to certain types of claims. However, there can be no assurance that we will be able to obtain such insurance in the future. If it can be obtained, the price for such insurance may be unreasonable. Even if such insurance is in force, the amount of any award may exceed the maximum coverage provided by such insurance, in which case we will be required to pay any uncovered portion.

 

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Our business relies heavily on computers and other electronic systems and capacity constraints and failures of these systems could harm our business. As our business expands, we face risks relating to the need to expand and upgrade our transaction processing and monitoring systems, network infrastructure and other aspects of our technology. While many of our systems are designed to accommodate additional growth without redesign or replacement, we may nevertheless need to make significant investments in additional hardware and software to accommodate growth. We cannot assure you that we will be able to predict accurately the timing or rate of such growth, or expand and upgrade our systems and infrastructure on a timely basis, or that such upgrades will ultimately serve the purposes for which they were intended. Additionally, our business may be negatively impacted by acts of cyberterrorism. Problems may arise in the operation of the Company’s technology platform that are out of the Company’s control, including, for example, unexpected interruptions caused by system failures, the inability or failure of the Company and /or its Clearing Brokers to maintain the connectivity required for the Company to timely process transactions, concerns (actual or potential) about the security of data gathering and retrieval, interruptions of operations due to hackers, computer viruses or other malicious activity, including the unauthorized release of private information. Any of these problems could adversely affect the Company’s business.

We may not be able to completely protect ourselves from various forms of business interruption. Although we maintain business interruption insurance, the net proceeds from such insurance may not be sufficient to cover lost revenues and earnings. Additionally, in the future, it may not be possible to obtain business interruption insurance on terms that management deems acceptable, especially if such interruption relates to acts of terror, including acts of cyberterrorism, or natural disasters, such as hurricanes.

We rely on third-party vendors to provide services that are an integral part of our business. As a fully disclosed broker-dealer, we rely on our Clearing Brokers to provide a number of operations and support functions that we cannot provide internally. If our relationship with one or both of our Clearing Brokers were to be terminated or become impaired, our business could be materially adversely impacted unless we were able to utilize the services of another clearing firm. Even if we were to develop such other relationships, our business could be adversely impacted if we were unable to obtain terms as favorable as those currently in place. In the event a Clearing Broker were to cease doing business with us, our ability to execute transactions on behalf of, and provide a full range of services to, our clients could be negatively impacted, which could, in turn, have a material adverse effect on both our revenues and our earnings.

Our risk management policies and procedures may leave us exposed to unidentified risks or an unanticipated level of risk. The policies and procedures we employ to identify, monitor and manage risks may not be fully effective. Some methods of risk management are based on the use of observed historical market behavior. As a result, these methods may not accurately predict future risk exposures, which could be significantly greater than what the historical measures indicate (especially during periods of market volatility and waning investor confidence). Other risk management methods depend on evaluation of information regarding markets, clients or other matters that are publicly available or otherwise accessible by us. This information may not be accurate, complete, up-to-date or properly evaluated. Management of operational, legal and regulatory risks requires, among other things, policies and procedures to properly record and verify a large number of transactions and events. We cannot assure that our policies and procedures will effectively and accurately record and verify this information.

We seek to monitor and control our risk exposure through a variety of separate but complementary financial, credit, operational and legal reporting systems. We believe that we are able to evaluate and manage the market, credit and other risks to which we are exposed. Nonetheless, our ability to manage risk exposure can never be completely or accurately predicted or fully assured. For example, unexpectedly large or rapid movements or disruptions in one or more markets or other unforeseen developments, including dishonest activity by a financial advisor or the management of a company in which Summit Brokerage’s clients held a large position, can have a material adverse effect on our results of operations and financial condition. The consequences of these developments can include losses due to increases in our credit risk to clients, as well as to third parties, and increases in general systemic risk.

Credit risk exposes us to losses caused by financial or other problems experienced by third parties. We are exposed to the risk that third parties which owe us money, securities or other assets will not fulfill their obligations. These parties include, but are not limited to, clients, clearing firms and other financial intermediaries. These parties may default on their obligations owed to us due to bankruptcy, lack of liquidity, operational failure or other reasons. Significant failures by third parties to perform their obligations owed to us could adversely affect our operating results and working capital.

 

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We have to indemnify our Clearing Brokers. Included in the Company’s clearing agreements with our Clearing Brokers is an indemnification clause. This clause relates to instances where the Company’s clients fail to settle security transactions. In the event this occurs, the Company has agreed to indemnify the Clearing Brokers to the extent of the net loss on the unsettled trade. As is customary in the industry, each of the Company’s Clearing Brokers has required that the Company put up a deposit, although there can be no assurance that the amount of any indemnified loss(es) will not exceed the amount of the deposit. Furthermore, in periods of extreme market volatility, it is possible that the Company may experience an increase in the number of unsettled trades.

We depend on our headquarters and operations center for continued operation of our business. A disaster directly affecting our headquarters and operations center, as well as that of one or both of our Clearing Brokers, may have a material adverse impact on our ability to continue to operate our business without interruption. Although we have disaster recovery programs in place, there can be no assurance that these will be sufficient to mitigate the harm that may result from such a disaster. In addition, insurance and other safeguards might only partially reimburse us for our losses. Furthermore, we rely on third parties to perform certain back office and trade execution functions on our behalf. In the event these third parties are unable to provide these services, including, as a result of a natural disaster or such other event which results in an interruption of their business activities, our operations could be materially negatively impacted.

We may have to indemnify our directors and officers for certain actions. Our Amended and Restated Articles of Incorporation, as amended, require us to indemnify (to the fullest extent permitted under Florida law) each of our directors and officers against liabilities imposed upon them (including reasonable amounts paid in settlement) and expenses incurred by them in connection with any claim made against them or any action, lawsuit or proceeding to which they may be a party by reason of their being or having been directors or officers of our Company. The foregoing provisions may reduce the likelihood of derivative litigation against directors and may discourage or deter shareholders or management from suing directors for breaches of their fiduciary duties, including the duty of care, even though such an action, if successful, might otherwise benefit our shareholders and us. We maintain directors’ and officers’ liability insurance coverage. There can be no assurance that such insurance will be available in the future, or that if available, it will be available on terms that are acceptable to us. Furthermore, there can be no assurance that any action will be covered by insurance, or if covered, that the insurance coverage provided will be sufficient to cover the amount of any judgment awarded against an officer or director (either individually or in the aggregate). Consequently, if such judgment exceeds the coverage under the policy, we may be forced to pay such difference.

Our common stock is subject to price volatility. The price of our common stock is volatile. Because of the limited trading market for our stock, investors interested in buying or selling our stock may experience significant price fluctuations, especially if such investors are looking to acquire or sell a large number of shares. For example, if an investor is interesting in selling a large number of our shares, the market price of our common stock could decline significantly. Furthermore, the price of our stock may be volatile because of possible fluctuations in our operating results and performance. Additionally, price volatility may also result from the general favor (or disfavor) among investors for our Company, or financial services firms in general, as a result of the economy, the attractiveness of the financial markets, or any number of other factors. A significant decline in the market price of our common stock could result in litigation that could subsequently result in increased costs and a diversion of management’s attention and resources from operations.

Additional capital may dilute current shareholders. In order to provide capital for the operation of the business, we may enter into additional financing arrangements. These arrangements may involve the issuance of new shares of common stock, preferred stock that is convertible into common stock, debt securities, and debt securities that are convertible into common stock, or warrants for the purchase of common stock. Any of these items could result in a material increase in the number of shares of common stock outstanding, which could, in turn, result in a dilution of the equity ownership interests of existing shareholders. In addition, these new securities could contain provisions, such as priorities on distributions and voting rights, which could affect the value of our existing common stock. Furthermore, issuances of options or warrants, including issuances of stock options to our financial advisors and employees, may also significantly dilute our current shareholders.

There may not be a liquid market for the common stock. Our common stock is currently traded on the OTC Electronic Bulletin Board. This market generally has less liquidity than the NASDAQ SmallCap Market, and certain institutional investors are precluded from buying stock in this market. There can be no assurance that our investors will be able to sell their shares of common stock at prices and at times that are desirable, if at all. In addition, no assurance can be given that the Company will continue to be a reporting public company in the future, or that our common stock will continue to be traded publicly on the bulletin board or on any other inter-dealer quotation system or exchange. Additionally, there is a wide range of valuations at which independent brokerage firms trade, making it difficult for investors to determine a value for the Company based on the value of comparable companies.

 

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Our common stock is subject to the penny stock rules; as a result, our market liquidity could be adversely affected. The SEC’s regulations define a “penny stock” to be an equity security that has a market price of less than $5.00 per share, subject to certain exceptions. These rules impose additional sales practice requirements on broker-dealers that sell low-priced securities to persons other than established clients and institutional accredited investors and require the delivery of a disclosure schedule explaining the nature and risks of the penny stock market. As a result, the ability or willingness of broker-dealers to sell or make a market in our common stock might be adversely affected.

No dividends are anticipated. We intend to retain any future earnings to fund the operation and expansion of our business. We do not anticipate paying cash dividends on our shares of common stock in the foreseeable future.

Our preferred stock may cause further dilution. Our Amended and Restated Articles of Incorporation, as amended, authorizes the issuance of up to 5,000,000 shares of undesignated preferred stock, with such rights and preferences as may be determined from time to time by our Board of Directors without further shareholder approval. The Company designated 150,000 shares, and issued to investors 125,000 shares, of such preferred stock as its Series A Preferred Stock. Consequently, we have 4,850,000 shares of authorized shares of preferred stock that may be sold in the future and that can, at the discretion of our Board of Directors, be designated as other series of preferred stock, with dividend and liquidation preferences that are senior, and not available to, the holders of our common stock. In the event that we issue additional preferred stock, the holders of such stock, as well as the Series A Preferred Stock, shall be entitled to receive dividends and distributions prior to their receipt by the holders of our common stock. Thus, holders of common stock could realize less than the amount of dividends and/or distributions to which they may otherwise be entitled.

We may propose a reverse-split of our common stock. We may, at some time in the future, propose a reverse-split of our common stock. There can be no assurance that, in the event of a reverse-split, the stock will not otherwise decline in value.

 

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

 

Item 8.

Financial Statements and Supplementary Data

The financial statements required by this Item are set forth on pages F-1 through F-14 and are incorporated herein by this reference. The financial statements are the financial statements of Summit Financial Services Group, Inc. and its subsidiaries on a consolidated basis.

 

Item 9.

Changes In and Disagreements With Accountants on Accounting and Financial Disclosure

Not applicable.

 

Item 9A.

Controls and Procedures

(a) Disclosure Controls and Procedures

Disclosure controls and procedures are the controls and other procedures that are designed to provide reasonable assurance that information required to be disclosed by the issuer in the reports that it files or submits under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including the principal executive and principal financial officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

We have carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act as of December 31, 2011(the end of the fiscal year covered by this Annual Report).

Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of the end of the fiscal year covered by this Annual Report on Form 10-K.

 

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(b) Management’s Evaluation of Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. This system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Consolidated Financial Statements for external purposes, in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and disposition of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of Consolidated Financial Statements, in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the Consolidated Financial Statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. The scope of management’s assessment of the effectiveness of internal control over financial reporting includes all of our Company’s subsidiaries.

Our management performed an assessment as of December 31, 2011 of the effectiveness of our internal controls over financial reporting based upon the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and concluded that our internal control over financial reporting was effective as of December 31, 2011.

(c) Change in Internal Control over Financial Reporting

There were no significant changes to our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our last fourth fiscal quarter that could materially affect, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Item 9B.

Other Information

Not applicable

PART III

 

Item 10.

Directors, Executive Officers and Corporate Governance

The executive officers and directors of the Company are as follows:

 

Name		Age				Title
Marshall T. Leeds			56			Chairman of the Board, Chief Executive Officer and President
Steven C. Jacobs			51			Executive Vice President, Chief Financial Officer, Secretary and Director
Sanford B. Cohen			54			Director
Paul D. DeStefanis			51			Director
William L. Harvey			56			Director

Executive Officers and Directors

The biographies of our executive officers and directors are set forth below, including the experiences, qualifications, attributes or skills that have caused the Company to currently determine that each such person should serve as director of the Company.

 

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Marshall T. Leeds, Chairman of the Board, Chief Executive Officer and President. Mr. Leeds was elected our President, and re-elected our Chairman and Chief Executive Officer, on February 26, 2004. He holds the same offices and board membership with Summit Brokerage. Mr. Leeds acquired a controlling interest in Summit Brokerage on May 22, 2002, whereupon he became our Chairman and Chief Executive Officer. From March 22, 2002 to May 22, 2002, Mr. Leeds was engaged as our Director of Recruiting. Between October 2001 and March 2002, Mr. Leeds was a private investor. Prior thereto, Mr. Leeds served, between January 2001 and September 2001, as Chairman and Chief Executive Officer of First Union Securities Financial Network, Inc. Prior to joining First Union, Mr. Leeds served, between December 1983 and December 2000, as Chairman, President and Chief Executive Officer of JWGenesis Financial Corp. and its predecessor. JWGenesis Financial Corp. was acquired by First Union Securities Financial Network, Inc. on January 1, 2001. Mr. Leeds is a past Chairman of the Regional Investment Bankers Association, Inc. and also serves on the Independent Contractor Firm Committee of the Securities Industry Association. Mr. Leeds has extensive experience in the securities industry in the operation and management of independent brokerage firms, in the recruitment of financial advisors and in strategic planning.

Steven C. Jacobs, Executive Vice President, Chief Financial Officer, Secretary, and a Director. Mr. Jacobs has been a director of the Company since February 26, 2004 and a director of Summit Brokerage since May 22, 2002. He became our Executive Vice President in February 2003, and assumed the additional duties of our Chief Financial Officer and Secretary in May 2003. He is also a director of and holds the same offices with Summit Brokerage. Prior to joining Summit Brokerage, Mr. Jacobs served, between October 2000 and January 2003, as the Managing Partner of Tucker Ridge Financial Partners, LLC, a private investment banking and financial advisory firm serving emerging growth and middle market companies. For the ten-year period prior to founding Tucker Ridge in October 2000, Mr. Jacobs held several senior executive investment banking positions, including having served, between January 2000 and September 2000, as Managing Director for Union Atlantic, LLC and prior thereto, between March 1998 and December 1999, as Managing Director of Pinnacle Partners, LLC, a private investment banking and financial advisory firm that was acquired by Union Atlantic in December 1999. Immediately following his graduation from the University of Florida in 1982 with a Bachelors in Accounting, Mr. Jacobs held audit, tax and consulting positions with Deloitte & Touche, and subsequent thereto served as Manager of Tax and Special Projects for Microtel, Inc. Mr. Jacobs also served as Chief Financial Officer for Corporate Securities Group, Inc., an NASD member broker-dealer. Mr. Jacobs has extensive experience in the securities industry, including related to accounting and finance, operations, corporate finance and strategic planning.

Sanford B. Cohen, Director. Mr. Cohen has been a director of the Company and of Summit Brokerage since February 2004 and a director of Summit Brokerage since May 22, 2002. Mr. Cohen also serves as a member of our compensation committee. In 1985, Mr. Cohen founded Prescott Valley Broadcasting Co., Inc., owner of KPPV-FM and KQNA-AM radio stations in Prescott Valley, Arizona, and has been its President since its inception. From 1982 to 1984, Mr. Cohen was Vice President of National Phonecasting Co., a joint venture with Gannett Broadcasting Corp., a private company engaged in telephone broadcasting of financial information. Mr. Cohen received his B.A. degree in Economics in 1979 from Michigan State University. Mr. Cohen has extensive executive experience with strong skills in strategic planning.

Paul D. DeStefanis, Director. Mr. DeStefanis became a director of the Company and Summit Brokerage in February 2004. Mr. DeStefanis also serves as a member of our compensation and audit committees. He has over twenty years of financial and accounting experience. Mr. DeStefanis is currently a principal of Advanced Business Valuations, a business valuation and litigation support services firm he founded in 1990. Mr. DeStefanis also sits on the board of directors of Emax, Inc. (d/b/a databazaar.com), an online retailer of imaging and information supplies. Between 1994–1996, Mr. DeStefanis served, on a part-time basis, as Chief Financial Officer and Treasurer of The Commonwealth Group, a merchant banking and corporate consulting firm. Prior thereto, between 1990 and 1994, Mr. DeStefanis served as Senior Vice President, Treasurer and Chief Financial Officer for Jillian’s Entertainment Corp., a diversified publicly-held entertainment company. Between 1982 and 1990, Mr. DeStefanis held various positions with Deloitte & Touche. Mr. DeStefanis graduated from the University of Florida in 1982 with a Bachelors in Accounting. In addition to being a Certified Public Accountant, he is an Accredited Business Valuator (AICPA designation), an Accredited Senior Appraiser (American Society of Appraisers designation) and a Certified Valuation Analyst (NACVA designation). Mr. DeStefanis is also a past member of the NACVA’S Education Board. Mr. DeStefanis has strong skills in corporate finance and accounting, business valuations, and strategic planning.

 

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William L. Harvey, Director. Mr. Harvey became a director of the Company and Summit Brokerage in February 2004. Mr. Harvey also serves as a member of our audit committee. Mr. Harvey has over thirty years of financial and accounting experience, and has, since August 2008, served as Chief Financial Officer of Interval Leisure Group, Inc. (“ILG”) and as Executive Vice President since June 2009. Prior to joining ILG in June 2008, Mr. Harvey served as the Chief Financial Officer for TrialGraphix, Inc., a Miami-based litigation support firm from August 2006 through November 2007. Between June 2003 and July 2006, Mr. Harvey served as a Vice President at LNR Property Corporation, a Miami-based diversified real estate and finance company, managing various financial and accounting units. From September 1992 through February 2003, Mr. Harvey served as the Executive Vice President and Chief Financial Officer of Pan Am International Flight Academy, Inc., a private provider of flight training services. Mr. Harvey is a CPA who began his professional career at Deloitte & Touche and was a partner in their Miami office prior to September 1992 where he served as a member of the firm’s National Office SEC Services Department for two years. Mr. Harvey graduated from Florida State University in 1977 with a BS in Accounting. Mr. Harvey has extensive experience in corporate finance and accounting and strong skills in real estate and strategic planning.

Section 16(a) Beneficial Ownership Reporting Compliance

Based solely upon a review of Forms 3, 4 and 5 that were furnished to us, all such reports were timely filed.

Code of Ethics

We have adopted a code of ethics for our Chief Executive Officer, and for our senior financial officers, including our Chief Financial Officer and Principal Accounting Officer. Our code of ethics is included as an exhibit to this Annual Report on Form 10-K.

Audit Committee

The members of our audit committee are currently Paul D. DeStefanis and William L. Harvey. Messrs. DeStefanis and Harvey are considered “independent” as that term is defined in NASDAQ Rule 4200(a)(15). Further, the Board of Directors has determined that the audit committee has at least one financial expert, who is William L. Harvey.

 

Item 11.

Executive Compensation

The following table sets forth all compensation awarded to, earned by, or paid by the Company during the fiscal years ended December 31, 2011, and 2010 to our Chief Executive Officer and any executive officer who received compensation in excess of $100,000 for the last completed fiscal year (each a “Named Executive Officer”).

SUMMARY COMPENSATION TABLE

 

Name and Principal Position (a)		Year (b)				Salary ($) (c)				Bonus ($) (d)				Stock Awards ($) (e)				Option Awards ($) (f)				Non-equity Incentive Plan Compensation ($) (g)				Non-qualified Deferred Compensation Earnings ($) (h)				All Other Compensation ($) (i)				Total ($) (j)
Marshall T. Leeds,			2011			$	303,889			$	—			$	—			$	543,150	(1)		$	400,000	(2)		$	—			$	24,190	(3)		$	1,271,229
Chairman of the Board, Chief Executive Officer and President			2010			$	289,406			$	—			$	549,096	(4)		$	262,778	(5)		$	408,164	(6)		$	—			$	23,509	(3)		$	1,532,953
Steven C. Jacobs,			2011			$	210,905			$	56,194	(7)		$	—			$	37,967			$	—			$	—			$	20,761	(8)		$	325,827
Executive Vice President, Chief Financial Officer, Secretary and Director			2010			$	188,451			$	45,000	(7)		$	—			$	39,046			$	—			$	—			$	20,319	(8)		$	292,816

 

(1)	Includes $505,183 attributable to the value of options issued in connection with the employment agreement Mr. Leeds entered into in July 2011. See “Employment Agreements.”

(2)	Represents that amount of non-discretionary bonus accrued in 2011 but not paid until 2012.

(3)	Includes an automobile allowance, employee benefits in the form of health and other insurance, and club dues.

(4)	Represents the value of deferred stock shares awarded in January 2010. See “Employment Agreements.”

(5)	Includes $223,732 attributable to the value of options cancelled and replaced in January 2010. See “Employment Agreements.”

(6)	Includes $389,558 of non-discretionary bonus amounts accrued in 2010, a portion of which was also paid in 2010.

(7)	Represents a discretionary bonus

(8)	Includes an automobile allowance and employee benefits in the form of health and other insurance.

 

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Outstanding Equity Awards at Fiscal Year End

The following table sets forth certain information concerning unexercised options; stock that has not vested and equity incentive plan awards for each Named Executive Officer outstanding as of December 31, 2011.

 

		Option Awards														Stock Awards
Name (a)		Number of Securities Underlying Unexercised Options (#) Exercisable (b)				Number of Securities Underlying Unexercised Options (#) Unexercisable (c)				Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options (#) (d)		Option Exercise Price ($) (e)				Option Expiration Date (f)				Number of Shares or Units of Stock That Have  Not Vested (#) (g)				Market Value of Shares or Units of Stock That Have Not Vested ($) (h)				Equity Incentive Plan Awards: Number of Unearned Shares, Units  or Other Rights That Have Not Vested (#) (i)				Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights That Have Not Vested ($) (j)
Marshall T. Leeds			2,800,000				—	(9)				$	0.50				12/31/2019				2,800,000
			40,000				—	(1)				$	0.40				12/31/2014
			40,000				—	(2)				$	0.28				12/31/2015
			40,000				—	(3)				$	0.35				12/31/2013
			705,252				—	(4)				$	0.32				1/1/2017
			705,252				—	(4)				$	0.35				1/1/2017
			40,000				—	(5)				$	0.70				12/31/2014
			30,000				10,000	(6)				$	0.50				12/31/2015
			40,000				40,000	(7)				$	0.52				12/31/2016
			21,250				63,750	(8)				$	0.80				12/31/2017
			1,304,583				—	(11)				$	0.75
			—				90,000	(10)				$	0.85				12/31/2018
			5,766,337				203,750														2,800,000				—				—				—
Steven C. Jacobs			20,000				—	(1)				$	0.50				3/22/2012
			25,000				—	(1)				$	0.50				8/2/2012
			600,000				—	(1)				$	0.45				8/7/2013
			5,000				—	(1)				$	0.50				12/22/2013
			40,000				—	(1)				$	0.40				12/31/2013
			44,000				—	(1)				$	0.40				6/1/2014
			6,500				—	(1)				$	0.40				12/31/2014
			40,000				—	(1)				$	0.40				12/31/2014
			40,000				—	(2)				$	0.28				12/31/2015
			10,000				—	(2)				$	0.28				12/31/2015
			40,000				—	(3)				$	0.35				12/31/2013
			250,000				—	(3)				$	0.32				12/31/2013
			250,000				—	(3)				$	0.35				12/31/2013
			40,000				—	(5)				$	0.70				12/31/2014
			30,000				10,000	(6)				$	0.50				12/31/2015
			40,000				40,000	(7)				$	0.52				12/31/2016
			21,250				63,750	(8)				$	0.80				12/31/2017
							90,000	(10)				$	0.85				12/31/2018
			1,501,750				203,750														—				—				—				—

 

(1)	Options were fully vested as of December 31, 2005.

(2)	Options vest 25% on 12/31/06, 12/31/07, 12/31/08 and 12/31/09.

(3)	Options vest 25% on 12/31/07, 12/31/08, 12/31/09 and 12/31/10.

(4)	Options vest 33.3% on 1/1/08, 1/1/09 and 1/1/10.

(5)	Options vest 25% on 12/31/08, 12/31/09, 12/31/10 and 12/31/11.

(6)	Options vest 25% on 12/31/09, 12/31/10, 12/31/11 and 12/31/12.

(7)	Options vest 25% on 12/31/10, 12/31/11, 12/31/12 and 12/31/13.

(8)	Options vest 25% on 12/31/11, 12/31/12, 12/31/13 and 12/31/14.

(9)

On January 14, 2010, the Company cancelled options to acquire 5,600,000 shares in consideration, in part, for the issuance of immediately exercisable options to acquire 2,800,000 shares of common stock at an exercise price of $.50, together with 2,800,000 shares of deferred stock, under our 2006 Incentive Compensation Plan. See “Employment Agreements.”

(10)	Options vest 25% on 12/31/12,12/31/13, 12/31/14 and 12/31/15

(11)

On July 6, 2011, the Company and Mr. Leeds entered into a new employment agreement providing for the issuance to Mr. Leeds of an option to acquire up to 1,304,583 shares of common stock at an exercise price of $0.75 per share. The options vest 20% on 12/31/12, 12/31/13, 12/31/14, 12/31/15 and 12/31/16.

 

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Director Compensation

The following table sets forth certain information concerning compensation paid to our outside directors during the year ended December 31, 2011:

 

Name (a)		Fees Earned or Paid in Cash ($) (b)				Stock Awards ($) (c)				Option Awards ($) (d)				Non-equity Incentive Plan Compensation ($) (e)				Non-qualified Deferred Compensation Earnings ($) (f)				All Other Compensation ($) (g)				Total ($) (h)
William L. Harvey		$	12,400							$	44,107	(1)														$	56,507
Paul D. DeStefanis			2,400								39,464	(2)															41,864
Sanford B. Cohen			2,400								39,464	(3)															41,864
		$	17,200			$	—			$	123,035			$	—			$	—			$	—			$	140,235

 

(1)	As of December 31, 2011, Mr. Harvey beneficially owned options covering 585,000 shares of the Company’s common stock, all of which had vested. Mr. Harvey was also granted an option, on January 3, 2012, for an additional 95,000 shares, which options vested immediately upon issuance.

(2)	As of December 31, 2011, Mr. DeStefanis beneficially owned options covering 520,000 shares of the Company’s common stock, all of which had vested. Mr. DeStefanis was also granted an option, on January 3, 2012, for an additional 85,000 shares, which options vested immediately upon issuance.

(3)	As of December 31, 2011, Mr. Cohen beneficially owned options covering 560,000 shares of the Company’s common stock, all of which had vested. Mr. Cohen was also granted an option, on January 3, 2012, for an additional 85,000 shares, which options vested immediately upon issuance.

In serving on our Board, non-employee directors receive compensation of $350 for each meeting attended, as well as the grant of stock options from time to time at the discretion of our Board. Non-employee directors are also reimbursed for their reasonable expenses incurred in attending Board or Committee meetings. Additional fees and options may be granted for chairing special committees, such as the audit committee. In connection with their service to the Company in 2011, each non-employee director received an option for 85,000 shares of common stock at an exercise price equal to the price of our common stock at date of grant. The Chairman of the audit committee receives options for an additional 10,000 shares on the same terms and conditions as the other option awards described herein provided to all outside directors. Beginning in 2010, all non-employee directors also receive additional compensation of $1,000 per year in addition to the per-meeting amounts described herein.

Equity Compensation Plan Information

The following table summarizes share information about our equity compensation plans, including the 2000 Incentive Compensation Plan, the 2006 Incentive Compensation Plan, and non-plan equity compensation agreements as of December 31, 2011.

 

Plan Category		Number of Securities to  be Issued Upon Exercise of Outstanding Options, Warrants and Rights (a)				Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights (b)				Number of  Securities Remaining Available For Future Issuance Under Equity Compensation Plans (excluding  securities reflected in column (a) (c)
Equity Compensation Plans Approved By Shareholders			20,877,638	(1)		$	0.50				2,962,519	(2)
Equity Compensation Plans Not Approved by Shareholders			400,000	(3)		$	0.45				-0-
Total			21,277,638			$	0.50				2,962,519	(2)

 

(1)

Includes 1,840,154 shares subject to outstanding options under the 2000 Incentive Compensation Plan, 15,678,484 shares subject to outstanding options under the 2006 Incentive Compensation Plan, 2,800,000 shares of deferred stock issued under the 2006 Incentive Compensation Plan as part of a transaction in which the Company cancelled certain non-plan options for 5,600,000 shares in consideration, in part, for the issuance of immediately exercisable options to acquire 2,800,000 shares of common stock at an exercise price of $.50, together with 2,800,000 shares of deferred stock. Also includes warrants entitling the holders thereof to acquire up to 559,000 shares of common stock. See “Employment Agreements.”

(2)	Represents shares available for award grants under the 2006 Incentive Compensation Plan as of December 31, 2010.

(3)	Includes 400,000 shares subject to non-plan option agreements outstanding as of December 31, 2011. See “Equity Compensation Plans Not Approved by Shareholders—Options”

 

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Equity Compensation Plans Not Approved by Shareholders—Options. The equity compensation plans not approved by shareholders consist of 400,000 shares of the Company’s common stock issuable upon exercise of options granted between 2000 and 2003 at an exercise price of $0.45 per share, all of which were vested as of December 31, 2006. The options have a ten-year term. The optionee may pay the exercise price with respect to their options either in cash, by check, with already owned shares of common stock of the Company that have been held by the optionee for at least six (6) months (or such other shares as will not cause the Company to recognize for financial accounting purposes a charge for compensation expense), or such other manner as provided in the agreements or as may otherwise be determined by the Company. The option agreements provide for appropriate adjustment of the number of shares subject to the options and the exercise price of the options in the event of any increase or decrease in the number of issued and outstanding shares of the Company’s capital stock resulting from a stock dividend, a recapitalization or other capital adjustment of the Company. The Company has discretion to make appropriate anti-dilution adjustments to outstanding options in the event of a merger, consolidation or other reorganization of the Company, or a sale or other disposition of substantially all of the Company’s assets. The options are not assignable or transferable, other than by will or by the laws of descent and distribution. During the lifetime of the optionee, an option is exercisable only by the optionee. In general, the vested portion of an option must be exercised within 90 days from disassociation with the Company.

Employment Agreements

Effective January 1, 2007, the Company entered into an employment agreement with Mr. Leeds for his continued service as Chairman of the Board, Chief Executive Officer, and President. Under the terms of such agreement, Mr. Leeds receives a base annual salary of $250,000 (subject to yearly increases of 5%), together with a non-discretionary bonus equal to 10% of the Company’s Earnings (as such term is defined under the employment agreement), subject to a yearly limitation of $200,000 in 2007, $300,000 in 2008 and $400,000 thereafter. Mr. Leeds is also entitled to receive a percentage of the commissions, if any, that he generates. Mr. Leeds also received an option to acquire up to 2.5% of the Company’s issued and outstanding shares of common stock at an exercise price of $.32 and an option to acquire up to 2.5% of the Company’s issued and outstanding shares of common stock at an exercise price of $.35. Based on the number of shares outstanding as of January 1, 2007, Mr. Leeds was issued an option to acquire up to 705,252 shares at an exercise price of $.32 and an option to acquire up to 705,252 shares at an exercise price of $.35.

In connection with the signing of employment agreements (initially on May 22, 2002 and a new agreement on January 1, 2007, and the related issuance of options covering 7,000,000 shares and 1,410,504 shares (the “Leeds’ Options”), respectively, the Company has agreed to pay the amount of income tax liability incurred by Mr. Leeds upon exercise of the Leeds’ Options or any portion thereof that is directly related to such exercise; provided, however, that the Company’s obligation to pay such tax shall not exceed the amount of the tax benefit the Company receives as a direct result of Mr. Leeds’ exercise of the Leeds’ Options or any portion thereof. Coverage of such tax by the Company shall be made in the form of a bonus to Mr. Leeds, which will also be subject to the same tax coverage by the Company, up to a maximum amount of the Company’s tax benefit derived from such bonus.

On January 14, 2010, options entitling Mr. Leeds to acquire up to 5,600,000 shares of our common stock at an exercise price of $.25 per share were cancelled (the “Cancelled Options”), in consideration, in part, for the issuance of options to acquire 2,800,000 shares of our common stock (the “New Options”), together with 2,800,000 shares of deferred stock (“Deferred Stock”). The Cancelled Options were initially issued to Mr. Leeds in connection with his employment with us. The New Options and the Deferred Stock were issued subject to shareholder approval of certain amendments to our 2006 Incentive Compensation Plan to, among other things, increase the number of shares of Common Stock available for issuance. Such approval was obtained from the shareholders as part of the annual shareholder meeting held on October 6, 2010. The New Options were issued with an exercise price of $.50 per share (an amount in excess of the closing price of our common stock on the date of grant), and were immediately exercisable upon shareholder approval of the amendments to the 2006 Incentive Compensation Plan (the “Plan Amendments”). The New Options will expire, if not sooner exercised, on December 31, 2019. The Deferred Stock represents a contingent right to receive an equal number of shares of common stock, which will vest ratably over a period of seven years, and will be delivered to Mr. Leeds upon the earlier to occur of: (i) December 31, 2019; (ii) change in control of the issuer; or (iii) under certain circumstances, the termination of Mr. Leeds employment with us. Both the New Options and Deferred Stock provide for the payment by the Company of the income tax liability incurred by Mr. Leeds upon any exercise of the New Options or delivery of the Deferred Shares that is directly related to such exercise or delivery; provided, however, that the Company’s obligation to pay such tax shall not exceed the amount of the tax benefit the Company receives as a direct result of such exercise or delivery, including any portion thereof. Any such payments the Company is obligated to make to Mr. Leeds shall be in the form of a bonus, which will also be subject to the same tax coverage by the Company, up to a maximum amount of the Company’s tax benefit derived from such bonus.

 

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On July 6, 2011, we entered in to a new employment agreement (the “Agreement”), with Marshall T. Leeds, our Chairman of the Board, Chief Executive Officer, and President. The Agreement supersedes our prior employment agreement with Mr. Leeds, and will become effective on January 1, 2012, upon the expiration of the term of the current employment agreement with Mr. Leeds (with the exception of certain specified provisions in the Agreement which became effective on July 6, 2011). The Agreement will expire on December 31, 2016, with successive one-year automatic renewal terms, unless earlier terminated in accordance with the Agreement.

In accordance with the terms of the Agreement, Mr. Leeds will receive, beginning on January 1, 2012, a base annual salary of $500,000 (subject to yearly increases equal to the greater of 3% or the yearly increase in the Consumer Price Index, but in no case more than 5%), together with a non-discretionary bonus equal to 10% of the Company’s Earnings (as such term is defined in the Agreement), and which bonus is subject to a yearly limitation of $500,000 in 2012, $600,000 in 2013, $700,000 in 2014, $800,000 in 2015 and $900,000 thereafter. Mr. Leeds also was issued on July 6, 2011, seven year options to acquire up to an aggregate 1,304,583 shares of the Company’s Common Stock at an exercise price of $.75, which options will vest in equal annual installments over a five-year period of time, commencing December 31, 2012.

Among other things, the Agreement also provides that Mr. Leeds would receive a one-time payment, ranging from 100% to 200% of his then-in-effect base salary, in the event certain conditions are met with respect to a change of control, as defined in the Agreement. Mr. Leeds would also be entitled under the Agreement to certain compensation in the event Mr. Leeds’ employment is terminated without cause or for good reason, as defined in the Agreement.

2006 Incentive Compensation Plan

On December 13, 2006, the Company’s shareholders approved the 2006 Incentive Compensation Plan (the “2006 Plan”), as the successor to the 2000 Incentive Compensation Plan. The terms of the 2006 Plan provide for grants of stock options (incentive and non-statutory), stock appreciation rights (SARs), and restricted stock to eligible persons capable of contributing to the Company’s performance. The total number of shares of common stock that may be subject to the granting of awards under the 2006 Plan at any time during the term of the 2006 Plan was increased from 12,000,000 to 22,000,000 during 2010. The 2006 Plan imposes individual limitations on the amount of certain awards, in part, to comply with Section 162(m) of the Internal Revenue Code of 1986, as amended. Under these limitations, during any fiscal year the number of options, SARs, restricted shares of common stock, deferred shares of common stock, shares as a bonus or in lieu of other Company obligations, and other stock-based awards granted to any one participant may not exceed 2,000,000 shares for each type of such award, subject to adjustment in certain circumstances. The maximum amount that may be paid out as an annual incentive award or other cash award in any fiscal year to any one participant is $2,000,000, and the maximum amount that may be earned as a performance award or other cash award in respect of a performance period by any one participant is $5,000,000. The Board of Directors or Committee administering the 2006 Plan is authorized to adjust the limitations described above and is authorized to adjust outstanding awards (including adjustments to exercise prices of options and other affected terms of awards) in the event that a dividend or other distribution (whether in cash, shares of common stock or other property), recapitalization, forward or reverse split, reorganization, merger, consolidation, spin-off, combination, repurchase, share exchange or other similar corporate transaction or event affects the common stock so that an adjustment is appropriate in order to prevent dilution or enlargement of the rights of participants. The Board of Directors or Committee is also authorized to adjust performance conditions and other terms of awards in response to these kinds of events or in response to changes in applicable laws, regulations or accounting principles. As of December 31, 2011, the Company had issued, or committed to issue, options and deferred stock shares entitling the holders thereof to acquire up to 19.04 million shares under the 2006 Plan, leaving a total of 2.96 million shares available for future grants. See “Employment Agreements.”

2000 Incentive Compensation Plan

Our 2000 Incentive Compensation Plan (the “Plan”), which was superceded by our 2006 Plan, was approved by our Board of Directors and shareholders in 2000. Our Plan is currently administered by the Company’s Board of Directors. The Plan provided for the grant of options (incentive and non-statutory), stock appreciation rights and restricted stock to officers, directors, employees and independent contractors capable of contributing to the Company’s performance. As of December 31, 2011, the Company had issued options entitling the holders thereof to acquire up to 1.84 million shares under the Plan. The exercise prices of the options range from $0.28 per share to $1.00 per share, with all options having vesting in their entirety as of December 31, 2011.

 

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Options Granted Outside of Our 2000 Incentive Compensation Plan and 2006 Incentive Compensation Plan

As of December 31, 2011, we had options outstanding allowing the holders thereof to purchase an aggregate of approximately 400,000 shares of common stock with an exercise price of $0.45. During 2010, options (which were initially issued outside of our Plan) to acquire up to 5,600,000 shares of common stock at an exercise price of $.25 per share were cancelled in consideration, in part, for the issuance of options to acquire 2,800,000 shares of common stock at a price of $0.50 per share (expiring on December 31, 2019), together with 2,800,000 shares of deferred stock under our 2006 Plan. See “Employment Agreements.”

All other non-plan options have a term of ten years from the date of grant, unless otherwise terminated in accordance with their terms. In general, options granted outside the plans must be exercised within 90 days of an employee’s disassociation from the Company. All outstanding options granted outside of our plans were exercisable as of December 31, 2011.

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Security Ownership of Certain Beneficial Owners

The following table sets forth certain information as of March 15, 2012 with respect to the beneficial ownership of common stock by: (i) each Named Executive Officer; (ii) each director; (iii) each shareholder known by us to be the beneficial owner of more than 5% of the Company’s common stock; and (iv) all executive officers and directors as a group.

 

Title of Class		Name and Address of Beneficial Owner(1)		Amount and Nature of Benefit Ownership				Percent of Class (2)
Common Stock		Marshall T. Leeds			11,741,754	(3)			36.9	%
Common Stock		Steven C. Jacobs			1,941,750	(4)			6.8	%
Common Stock		Sanford B. Cohen			645,000	(5)			2.4	%
Common Stock		Paul D. DeStefanis			805,000	(6)			3.0	%
Common Stock		William L. Harvey			680,000	(7)			2.5	%
Common Stock		Antares Capital Fund III Limited Partnership(8)			4,000,000				15.1	%
Common Stock		The Equity Group Inc. Profit Sharing Plan & Trust(9)			1,600,000				6.0	%
Common Stock		All executive officers and directors as a group (5 persons)			15,813,504	(10)			44.3	%

 

(1)	Unless otherwise noted, the address of each person or entity listed is Summit Financial Services Group, Inc., 595 South Federal Highway, Suite 500, Boca Raton, Florida 33432.

(2)

Based on 26,534,059 shares outstanding on March 15, 2012, and additional shares deemed to be outstanding as to a particular person, in accordance with the following applicable rules of the SEC. Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. Shares of common stock subject to options, warrants or convertible securities that are exercisable or convertible within 60 days of the date of March 15, 2012, are deemed outstanding for computing the percentage of the person holding such options, warrants or convertible securities, but are not deemed outstanding for computing the percentage of any other person. Except as indicated by footnote and subject to community property laws, where applicable, the persons named in the table have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them.

(3)	Includes: (a) 6,480,000 shares of common stock, (b) 800,000 vested deferred stock shares, and (c) 4,461,754 shares issuable pursuant to stock options exercisable within the next 60 days.

(4)	Includes 1,501,750 shares issuable pursuant to stock options exercisable within the next 60 days and 440,000 shares issuable pursuant to currently exercisable warrants.

(5)	Includes 645,000 shares issuable pursuant to stock options exercisable within the next 60 days.

(6)

Includes 605,000 shares issuable pursuant to stock options exercisable within the next 60 days. Also includes 200,000 shares of common stock owned of record by Mr. DeStefanis and his spouse as tenants by the entireties, and with respect to such shares, Mr. DeStefanis and his wife share voting and investment power.

(7)	Includes 680,000 shares issuable pursuant to stock options exercisable within the next 60 days.

(8)

Address: 9999 N.E. 2 Avenue, Suite 306, Miami Shores, Florida 33138. Antares Capital Fund III Limited Partnership (“ACF”) is a Delaware limited partnership whose general partner is Antares Capital Partners III, L.L.C. (“ACP”), a Florida limited liability company. As the general partner, ACP has sole voting authority over ACF’s investments. The managing partners of ACP are Jonathan I. Kislak and Randall Poliner.

 

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(9)

Address: 800 Third Avenue, 36th Floor, New York, NY 10022. The co-trustees of the Equity Group Inc. Profit Sharing Plan & Trust are Robert Goldstein and Loren Mortman, either of whom has voting authority over the Trust’s investments. Also, Ms. Mortman and her spouse jointly own 200,000 shares of common stock.

(10)	Includes 9,133,504 shares issuable pursuant to stock options and warrants which are exercisable within the next 60 days, as well as vested deferred stock shares.

Voting Agreements and Agreements Related to Corporate Governance.

When Antares Capital Fund III Limited Partnership purchased 4,000,000 shares common stock of Summit Brokerage on April 11, 2003, it entered into a Stock Purchase Agreement with Summit Brokerage and a Co-Sale and Voting Rights Agreement with Marshall T. Leeds. Under those agreements, Antares has certain rights relating to corporate governance matters for so long as Antares owns 2,000,000 of the original 4,000,000 shares it purchased. Such rights include:

 

•

the right to appoint or nominate for election a director, which director would also serve on the compensation and audit committees; and further, Mr. Leeds agreed to vote his shares in favor of such appointment or election;

 

•

the right to have a representative present at meetings of the Board and its committees, which right includes the same access to the Company’s records as a Board member would have;

 

•

majority approval by the independent directors of certain stock purchases, if any, under $0.25 per share by Mr. Leeds, and if so approved, Antares has the right to participate with Mr. Leeds on a pro-rata basis;

 

•

the right to participate on a pro-rata basis in any sale of the Company’s stock by Mr. Leeds on the same terms and conditions as any such proposed sale.

Although Antares has a right to designate a nominee to our Board of Directors, it has not done so and has not indicated to us when or if it will do so.

 

Item 13.

Certain Relationships and Related Transactions, and Director Independence.

There were no related-party transactions during the years ended December 31, 2011 or December 31, 2010.

 

Item 14.

Principal Accountant Fees and Services.

Audit Fees

Moore Stephens Lovelace, P.A., our principal accountants, billed us an aggregate of $85,900 and $83,000 for each of the fiscal years ended December 31, 2011 and 2010, respectively, for fees and expenses for professional services rendered in connection with the audits of our financial statements for those fiscal years, reviews of the financial statements included in our quarterly reports on Form 10-Q and/or Form 10Q-SB during such fiscal years, and services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements during such fiscal years.

Audit Related Fees

Our principal accountants billed us $1,920 and $2,923 for audit-related fees in each of the fiscal years ended December 31, 2011 and 2010 for assurance and related services that are reasonably related to the performance of our audit or review of our financial statements. Fees included attendance at our annual shareholder meeting and miscellaneous consultations during the course of the year.

Tax Fees

Our principal accountants billed us $8,700 and $11,742 for fees and expenses for services performed relating to tax compliance, tax advice or tax planning in each of the fiscal years ended December 31, 2011 and 2010.

All Other Fees

Our principal accountants billed us $650 and $1,700 for all other fees in the fiscal years ended December 31, 2011 and 2010 for products and services other than those products and services described above.

Audit Committee Pre-Approval Process, Policies and Procedures

Our principal auditors were authorized to perform audit services for the fiscal year ended 2011 by our Board of Directors and the Company’s Chief Executive Officer and Chief Financial Officer. Moore Stephens Lovelace, P.A. was appointed by our audit committee as our independent auditors for purposes of auditing and reviewing our financial statements for 2011. Our principal auditors informed our audit committee of the scope and nature of each service to be provided. During the year ended December 31, 2011, all services and fees rendered by Moore Stephens Lovelace, P.A. were approved by our audit committee in advance of providing such services.

 

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Item 15.

Exhibits and Financial Statement Schedules

A. Exhibits

Set forth below is a list of the exhibits to this Annual Report on Form 10-K.

 

Number		Name
3.1		Amended and Restated Articles of Incorporation (1)
3.2		Amendment to Amended and Restated Articles of Incorporation (9)
3.3		Bylaws (1)
10.1		2000 Incentive Compensation Plan, as amended (6)
10.2		2000 Incentive Compensation Plan, as amended on June 22, 2005 (7)
10.4		Stock Option Agreement between Summit Brokerage Services, Inc. and Marshall T. Leeds dated March 22, 2002 (2)
10.9		Form of Registration Rights Agreement between Summit Brokerage Services, Inc. and certain investors (3)
10.10		Form of Warrants dated effective March 19, 2003 (4)
10.11		Warrant Agreement between Summit Brokerage Services, Inc. and Steven C. Jacobs effective March 19, 2003 (6)
10.12		Warrant Agreement between Summit Brokerage Services, Inc. and Steven C. Jacobs effective April 11, 2003 (6)
10.13		Stock Purchase Agreement between Summit Brokerage Services, Inc. and Antares Capital Fund III Limited Partnership, dated April 11, 2003 (5)
10.14		Supplemental Letter between Summit Brokerage Services, Inc., Antares Capital Fund III Limited Partnership, and Marshall T. Leeds, dated April 11, 2003 (5)
10.15		Registration Rights Agreement between Summit Brokerage Services, Inc. and Antares Capital Fund III Limited Partnership, dated April 11, 2003 (5)
10.16		Co-Sale and Voting Rights Agreement between Marshall T. Leeds and Antares Capital Fund III Limited Partnership, dated April 11, 2003 (5)
10.17		Lease Agreement between Summit Brokerage Services, Inc. and 980 Associates dated June 25, 2003 and commencing February 1, 2004 for Suite #310 of 980 N. Federal Highway, Boca Raton, Florida (8)
10.18		Lease Agreement between Summit Brokerage Services, Inc. and 980 Associates dated June 25, 2003 and commencing February 1, 2004 for Suite #311 of 980 N. Federal Highway, Boca Raton, Florida (8)
10.19		Lease Agreement between Summit Financial Services Group, Inc. and 980 Associates dated March 22, 2005 and commencing February 1, 2005 for Suites #110 and #233 of 980 N. Federal Highway, Boca Raton, Florida (8)
10.20		Addendum to the Lease Agreement between Summit Financial Services Group, Inc. and 980 Associates dated March 22, 2005 and commencing February 1, 2005 for Suites #110 and #233 of 980 N. Federal Highway, Boca Raton, Florida (8)
10.21		Lease Agreement between Summit Brokerage Services, Inc. and GLL BVK Properties, L.P. dated December 8, 2009 and commencing February 1, 2010 for Suites 500 and 240 of 595 S. Federal Highway, Boca Raton, Florida (12)
10.22		Employment Agreement between the Company and Marshall T. Leeds, dated January 1, 2007 (10)
10.23		2006 Incentive Compensation Plan (9)
10.24		Fully Disclosed Clearing Agreement of First Clearing, LLC, dated October 26, 2007 (11)
10.25		Fully Disclosed Clearing Agreement of Pershing, LLC, dated March 19, 2008 (11)
14.1		Code of Ethics for the CEO and Senior Financial Officers (11)
21.1		Subsidiaries of the Registrant*
23.1		Consent of Independent Registered Public Accounting Firm*
31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
32.1		Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
32.2		Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
101.INS		XBRL Instance Document*
101.SCH		XBRL Schema Document*
101.CAL		XBRL Calculation Linkbase Document*
101.DEF		XBRL Definition Linkbase Document*
101.LAB		XBRL Label Linkbase Document*
101.PRE		XBRL Presentation Linkbase Document*

 

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*	Filed herewith

(1)	Incorporated by reference to the Registrant’s Registration Statement on Form S-4 (Amendment No. 2), filed on February 12, 2004, File No. 333-108818.

(2)	Incorporated by reference to the Form 10-QSB for the fiscal quarter ended March 31, 2002 of Summit Brokerage Services, Inc., filed May 24, 2002, file no. 0-29337.

(3)	Incorporated by reference to the Form 10-KSB for the fiscal year ended December 31, 2002, of Summit Brokerage Services, Inc., filed March 31, 2003, file no. 0-29337.

(4)	Incorporated by reference to the Form 10-QSB for the fiscal quarter ended September 30, 2003, of Summit Brokerage Services, Inc., filed November 14, 2003, file no. 0-29337.

(5)	Incorporated by reference to the Form 8-K filed on April 21, 2003 by Summit Brokerage Services, Inc., file no. 0-29337.

(6)	Incorporated by reference to the Registrant’s Form 10-KSB for the fiscal year ended December 31, 2003, filed March 30, 2004, file no. 0-29337.

(7)	Incorporated by reference to the Registrant’s Form 10-QSB for the quarter ended June 30, 2005, filed on August 15, 2005, file no. 0-29337.

(8)	Incorporated by reference to the Registrant’s Form 10-KSB for the fiscal year ended December 31, 2005 filed March 31, 2006, file no. 0-29337.

(9)	Incorporated by reference to the Registrant’s Form 14A as filed on November 24, 2006, file no. 0-29337.

(10)	Incorporated by reference to the Form 8-K filed on January 4, 2007 by Summit Financial Services Group, Inc., file no. 0-29337.

(11)	Incorporated by reference to the Registrant’s Form 10-KSB for the fiscal year ended December 31, 2007, filed March 31, 2008, file no. 0-29337.

(12)	Incorporated by reference to Registrant’s Form 8-K filed on December 10, 2009 by Summit Financial Services Group, Inc.

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, Summit Financial Services Group, Inc. caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

SUMMIT FINANCIAL SERVICES GROUP, INC.

/S/    MARSHALL T. LEEDS

Marshall T. Leeds

Chairman of the Board and Chief Executive Officer (principal executive officer)

Date: March 30, 2012

/S/    STEVEN C. JACOBS

Steven C. Jacobs

Executive Vice President and Chief Financial Officer (principal financial officer)

Date: March 30, 2012

Pursuant to the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of Summit Financial Services Group, Inc. and in the capacities and on the dates indicated.

 

Signature		Title		Date
/S/    MARSHALL T. LEEDS          Marshall T. Leeds		Chairman of the Board and Chief Executive Officer (principal executive officer)		March 30, 2012
/S/    STEVEN C. JACOBS         Steven C. Jacobs		Executive Vice President, Chief Financial Officer, and Secretary (principal financial officer)		March 30, 2012
/S/    PAUL D. DESTEFANIS         Paul D. DeStefanis		Director		March 30, 2012
/S/    WILLIAM L. HARVEY         William L. Harvey		Director		March 30, 2012
/S/    SANFORD B. COHEN         Sanford B. Cohen		Director		March 30, 2012

 

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SUMMIT FINANCIAL SERVICES GROUP, INC.

AND SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

Years Ended December 31, 2011 and 2010

CONTENTS

 

		Page Number
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM			F-2
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Financial Condition			F-3
Consolidated Statements of Income			F-4
Consolidated Statements of Changes in Stockholders’ Equity			F-5
Consolidated Statements of Cash Flows			F-6
Notes to Consolidated Financial Statements			F-7

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

Summit Financial Services Group, Inc. and Subsidiaries

We have audited the accompanying consolidated statements of financial condition of Summit Financial Services Group, Inc. and Subsidiaries as of December 31, 2011 and 2010, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for the years ended December 31, 2011 and 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Summit Financial Services Group, Inc. and Subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for the years ended December 31, 2011 and 2010 in conformity with accounting principles generally accepted in the United States of America.

 

/s/ Moore Stephens Lovelace, P.A.

Certified Public Accountants

Orlando, Florida

March 30, 2012

 

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SUMMIT FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Financial Condition

December 31, 2011 and 2010

 

		2011				2010
ASSETS
Cash and cash equivalents		$	10,786,669			$	9,439,672
Deposits held at clearing brokers			128,779				128,736
Commissions receivable, net			1,865,118				1,272,677
Notes receivable, net			388,841				432,782
Other receivables			445,676				323,514
Securities owned, at fair value			8,587				16,605
Prepaid expenses and other assets			791,401				666,059
Property and equipment, net			546,821				538,217
Goodwill			500,714				500,714
Total assets		$	15,462,606			$	13,318,976
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Accounts payable and accrued expenses		$	2,150,638			$	1,572,213
Accrued commissions expense			2,475,754				2,915,607
Total liabilities			4,626,392				4,487,820
Commitments and contingencies
Stockholders’ equity
Preferred stock, undesignated; par value $0.0001 per share; authorized 4,850,000 shares; none issued and outstanding			—				—
Preferred stock, Series A, 12% cumulative convertible; par value $0.0001 per share; authorized 150,000 shares; 125,000 issued and outstanding (liquidation preference of $125,000)			13				13
Common stock, par value $0.0001 per share; authorized 100,000,000 shares; 26,548,971 issued and 26,534,059 outstanding at December 31, 2011; 26,821,597 issued and 26,806,685 outstanding at December 31, 2010			2,656				2,683
Additional paid-in capital			13,122,572				12,342,284
Unearned stock-based compensation			(1,942,657	)			(1,717,512	)
Treasury stock, 14,912 shares, at cost			(10,884	)			(10,884	)
Accumulated deficit			(335,486	)			(1,785,428	)
Total stockholders’ equity			10,836,214				8,831,156
Total liabilities and stockholders’ equity		$	15,462,606			$	13,318,976

The accompanying notes are an integral part of the consolidated financial statements.

 

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SUMMIT FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Income

For The Years Ended December 31, 2011 and 2010

 

		2011				2010
Revenues
Commissions		$	63,351,301			$	59,921,404
Interest and dividends			1,117,219				1,420,504
Other Revenue			3,647,486				3,559,045
			68,116,006				64,900,953
Expenses
Commissions and clearing costs			54,051,751				51,974,671
Employee compensation and benefits			6,235,162				6,071,268
Occupancy and equipment			733,428				796,213
Communications			526,857				467,956
Depreciation and amortization			183,482				180,654
Other operating expenses			3,573,384				3,305,410
			65,304,064				62,796,172
Income before income taxes			2,811,942				2,104,781
Provision for income taxes			1,347,000				809,248
Net income		$	1,464,942			$	1,295,533
Basic income per common share		$	0.05			$	0.05
Diluted income per common share		$	0.05			$	0.04
Weighted average common shares outstanding:
Basic			26,526,635				25,946,078
Diluted			30,960,959				30,195,439

The accompanying notes are an integral part of the consolidated financial statements.

 

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SUMMIT FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Stockholders’ Equity

For The Years Ended December 31, 2011 and 2010

 

		Preferred Stock Series A								Common Stock
		Number of Shares Outstanding				Par Value				Number of Shares Outstanding				Par Value				Additional Paid-In Capital				Unearned Stock-based Compensation				Treasury Stock				Accumulated Deficit				Total Stockholders’ Equity
Balances, December 31, 2009			125,000			$	13				25,720,288			$	2,573			$	10,612,693			$	(1,114,477	)		$	(10,884	)		$	(3,065,961	)		$	6,423,957
Preferred stock dividend																															(15,000	)			(15,000	)
Issuance of options			—				—				—				—				1,529,246				(1,529,246	)			—				—				—
Amortization of unearned stock compensation (net of cancellations)			—				—				—				—				(95,263	)			926,211				—				—				830,948
Exercise of options and warrants			—				—				1,086,397				110				295,608				—				—				—				295,718
Net income																															1,295,533				1,295,533
Balances, December 31, 2010			125,000				13				26,806,685				2,683				12,342,284				(1,717,512	)			(10,884	)			(1,785,428	)			8,831,156
Preferred stock dividend																															(15,000	)			(15,000	)
Issuance of options and warrants			—				—				—				—				1,072,401				(1,072,401	)			—				—				—
Amortization of unearned stock compensation (net of cancellations)			—				—				—				—				(136,834	)			847,256				—				—				710,422
Repurchase of common stock											(829,751	)			(83	)			(411,792	)															(411,875	)
Exercise of options			—				—				557,125				56				256,513				—				—				—				256,569
Net income																															1,464,942				1,464,942
Balances, December 31, 2011			125,000			$	13				26,534,059			$	2,656			$	13,122,572			$	(1,942,657	)		$	(10,884	)		$	(335,486	)		$	10,836,214

The accompanying notes are an integral part of the consolidated financial statements.

 

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SUMMIT FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For The Years Ended December 31, 2011 and 2010

 

		2011				2010
Cash flows from operating activities
Net income		$	1,464,942			$	1,295,533
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization			183,482				180,654
Stock-based compensation			710,422				830,948
Amortization of advisor notes			207,217				394,161
Changes in:
Deposits held at clearing brokers			(44	)			(40	)
Commissions receivable			(592,440	)			29,343
Notes receivable			(163,276	)			(31	)
Other receivables			(122,162	)			(160,857	)
Prepaid expenses and other current assets			(125,342	)			41,681
Securities owned			8,018				(7,224	)
Accounts payable and accrued expenses			578,425				265,615
Accrued commissions expense			(439,854	)			489,869
Net cash provided by operating activities			1,709,388				3,359,652
Cash flows from investing activities
Purchase of property and equipment			(192,085	)			(502,619	)
Cash flows from financing activities
Dividends paid – preferred stock			(15,000	)			(15,000	)
Repurchase of common stock			(411,875	)			—
Proceeds from exercise of stock options			256,569				295,718
Net cash (used in) provided by financing activities			(170,306	)			280,718
Net increase in cash and cash equivalents			1,346,997				3,137,751
Cash and cash equivalents at beginning of year			9,439,672				6,301,921
Cash and cash equivalents at end of year		$	10,786,669			$	9,439,672

The accompanying notes are an integral part of the consolidated financial statements.

 

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SUMMIT FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

NOTE 1—NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BUSINESS—Summit Financial Services Group, Inc. (“SFSG”) is a holding company whose principal operating subsidiary is Summit Brokerage Services, Inc. (“SBS”). Through its network of approximately 200 independent branch offices, as well as its one company-owned office, SBS provides a wide range of financial products and services to clients across the country. SBS is registered as a broker-dealer with the Securities and Exchange Commission, and is a member of the Financial Industry Regulatory Authority (“FINRA”), the Securities Investor Protection Corporation, the Municipal Securities Rulemaking Board and the National Futures Association.

CONSOLIDATION POLICY—The accompanying consolidated financial statements include the accounts of SFSG and its subsidiaries (collectively, the “Company”). SFSG’s primary subsidiary is SBS and its wholly owned subsidiaries Summit Financial Group, Inc. (a registered investment advisor), SBS Insurance Agency of Florida, Inc. (an insurance business) and its wholly owned subsidiaries, and Summit Holding Group, Inc. (a holding company). All significant intercompany transactions and balances have been eliminated in consolidation.

CASH AND CASH EQUIVALENTS—The Company considers all highly liquid debt instruments purchased with original maturities of three months or less to be cash equivalents.

DEPOSITS HELD AT CLEARING BROKERS—The Company has interest-bearing deposits with its clearing brokers. The clearing brokers require deposits of all introducing brokers for whom they transact business.

COMMISSIONS RECEIVABLE, NET—The Company does not provide an allowance for commissions and other amounts due from its clearing brokers since, in the opinion of management, such amounts are fully collectible. For commissions due from parties other than the clearing brokers, the Company reduces the gross receivable based on the length of time it has been outstanding. As of December 31, 2011 and December 31, 2010, the allowance amount was not significant.

NOTES RECEIVABLE, NET—Notes receivable, net are comprised of amounts due from the Company’s financial advisors in the form of both non-forgivable and forgivable loans. Non-forgivable loans are typically repaid by the financial advisor from the amounts they would otherwise be due as a result of their gross production, while the forgivable loans are amortized, typically over a period of four years. Any amortized amounts are included in commissions and clearing costs in the Consolidated Statements of Income. The Company’s policy is to establish an allowance against the net amount of the notes. Furthermore, management periodically reviews the loans to determine whether additional allowances should be recorded or whether any amounts should be written off. As of December 31, 2011 and 2010, the Company had established allowances totaling approximately $75,000 and $23,000, respectively. In the event a financial advisor’s affiliation terminates prior to either the repayment of the loan or its complete amortization, the financial advisor is required to repay such balance to the Company.

OTHER RECEIVABLES, NET—Other receivables, net consist primarily of amounts due from employees and financial advisors of approximately $102,000 and $154,000 and other receivables of approximately $343,000 and $170,000 at December 31, 2011 and 2010, respectively.

SECURITIES OWNED, AT FAIR VALUE—Securities owned are classified as trading securities and are thus marked to market and stated at estimated fair value, as determined by management, using the quoted closing or latest bid prices. The resulting differences between cost and estimated fair value are included in the Consolidated Statements of Income. Substantially all securities owned at December 31, 2011 are categorized as Level 1 investments within the fair value hierarchy.

PROPERTY AND EQUIPMENT, NET—Property and equipment is recorded at cost. Depreciation, for financial reporting purposes, is primarily based on the straight-line method over the estimated useful lives of the related assets, generally 3 to 7 years. Leasehold improvements are amortized over the estimated remaining term of the related leases, or the useful life of the improvement, if shorter.

 

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COMMISSION REVENUE AND EXPENSE—Commission revenue and the corresponding expense are recorded on a trade-date basis. The Company receives commissions and fee income on securities transactions sold by its financial advisors. The Company receives the gross amount of commissions due from the transactions and remits a percentage of that amount to the financial advisors based on a formal commission payout schedule maintained with each financial advisor and/or branch licensee. The following table reflects the various sources of commission revenue for the years ended December 31, 2011 and 2010:

 

		2011				2010
Insurance related products		$	22,730,678			$	20,631,883
Investment advisory fees			13,068,786				10,931,690
Mutual funds			10,628,791				8,802,474
Equities			10,305,219				12,547,801
Other commission revenue			6,617,827				7,007,556
Total		$	63,351,301			$	59,921,404

ADMINISTRATION AND SERVICE FEES—Administration and service fees are recorded as services are provided or underlying transactions are executed.

INCOME TAXES—Income taxes are provided for the tax effects of transactions reported in the consolidated financial statements and consist primarily of taxes currently due plus deferred taxes.

Deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax may also be recognized for operating losses and tax credits that are available to offset future taxable income (See Note 10).

STOCK OPTIONS—The Company accounts for stock-based compensation using the fair market value method. Most often, options are granted for the provision of future services, such as continued employment or, in the case of independent financial advisors, their affiliation with the Company. Consequently, the options typically provide for vesting over a period of years, with a certain percentage of the options vesting each year upon the anniversary date of the grant if the grantee is then still affiliated with the Company. In certain instances, unearned stock compensation is recorded for options issued to either employees or non-employees for services to be rendered in the future. Any unearned stock compensation is generally amortized over the period the underlying options are earned, which is typically the vesting period. The fair value of each option grant is estimated at the date of grant using the Black-Scholes option pricing model. The Black-Scholes model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. The amortization of earned stock expense related to issuances to employees is included in the Consolidated Statements of Income under the caption “Employee Compensation and Benefits”, while the amortization of earned stock expense related to issuances to non-employees is included under the caption “Other Operating Expenses” (See Note 8).

INCOME PER SHARE—Basic income per share for the years ended December 31, 2011 and 2010 has been computed by dividing net income (less preferred dividends of $15,000 in each of 2011 and 2010) by the weighted average number of common shares outstanding. For the years ended December 31, 2011 and 2010, the following table reflects the effect of dilutive options and warrants and convertible preferred stock on basic and diluted earnings per share (“EPS”).

 

		2011												2010
		Income (Numerator)				Shares (Denominator)				Per Share Amount				Income (Numerator)				Shares (Denominator)				Per Share Amount
Basic EPS
Net income		$	1,464,942											$	1,295,533
Less: preferred stock dividends			(15,000	)											(15,000	)
Income available to common shareholders			1,449,942				26,526,635			$	0.05				1,280,533				25,946,078			$	0.05
Effect of dilutive securities			—				4,434,324								—				4,249,361
Diluted EPS
Income available to common shareholders plus assumed conversions		$	1,449,942				30,960,959			$	0.05			$	1,280,533				30,195,439			$	0.04

 

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The number of potentially anti-dilutive securities (options, warrants, convertible preferred stock) that were excluded from the fully diluted calculation for the years ended December 31, 2011 and 2010, totaled 7,895,609 and 7,364,426, respectively.

ESTIMATES—The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates by management include the determination of the amounts to accrue with respect to certain litigation, the ultimate outcome of which is not determinable until such litigation has been settled, the valuation of intangible assets, the allowances for notes receivable from financial advisors, and stock-based compensation. Actual results could differ from those estimates.

RECLASSIFICATIONS—The Company has reclassified certain administrative and service fees that were previously offset against related expenses as reflected in the following table. Previously reported amounts have also been reclassified to conform to the current year presentation. The reclassifications had no impact on previously reported net income.

 

		2010
		As Originally Presented				Reclassifcation				As Reclassified
Other Revenue		$	1,119,188			$	2,439,857			$	3,559,045
Commissions and clearing costs			51,223,614				751,057				51,974,671
Communications			283,447				184,509				467,956
Other operating expenses			1,801,119				1,504,291				3,305,410
		$	53,308,180			$	2,439,857			$	55,748,037
Net Effect on Income before income taxes							—

NOTE 2—PROPERTY AND EQUIPMENT

Property and equipment consisted of the following at December 31, 2011 and 2010 (See Note 9):

 

		2011				2010
Computer systems and software		$	354,970			$	370,794
Equipment and furniture			341,006				314,093
Leasehold improvements			167,558				164,658
Total			863,534				849,545
Less: accumulated depreciation and amortization			(316,713	)			(311,328	)
Total property and equipment, net		$	546,821			$	538,217

NOTE 3—ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses consisted of the following at December 31, 2011 and 2010:

 

		2011				2010
Accounts payable		$	274,675			$	268,053
Accrued expenses and other accrued liabilities			1,359,216				1,106,620
Accrued wages and other			516,747				197,540
		$	2,150,638			$	1,572,213

 

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NOTE 4—GOODWILL

Goodwill, resulting from the 2003 acquisition of a branch office, is reviewed for impairment at least annually, with the Company recording adjustments, if any, that are deemed appropriate. No such impairment expense was recorded in 2011 or 2010.

NOTE 5—COMMON STOCK

In December 2006, the Company established the 2006 Incentive Compensation Plan (“the 2006 Plan”) as the successor to the 2000 Incentive Compensation Plan (the “2000 Plan”) established in July 2000 (collectively, “the Plans”). The terms of the Plans provide for grants of stock options (incentive and non-statutory), stock appreciation rights and restricted stock to employees and consultants of the Company capable of contributing to the Company’s performance (See Note 8).

NOTE 6—PREFERRED STOCK

On March 27, 2002 the Company amended its Articles of Incorporation to designate 150,000 shares as Series A Convertible Preferred Stock from its 5,000,000 authorized shares of undesignated preferred stock, par value $0.0001 per share. During the year ended December 31, 2001, the Company issued 125,000 shares of 12%, cumulative Series A Convertible Preferred Stock (the “Series A Preferred Stock”) for $125,000. The number of shares of common stock which may be issued in respect of the shares of Series A Preferred Stock shall be determined by dividing (i) a numerator equal to the number of shares of Series A Preferred Stock being converted multiplied by 115% of the subscription price of $1.00 per Series A Preferred share, (ii) a denominator representing the per share price that is the lower of the closing price and the average closing sale price for the 20 trading days immediately preceding the Series A conversion date; provided, however, in no event shall the denominator be less than the subscription price. The estimated number of shares that would have been issued if the Series A Preferred Stock were converted as of December 31, 2011 and 2010 was 143,750. All such Series A Preferred Stock is non-voting stock. The holders of Series A Preferred Stock shall be entitled to receive, out of funds legally available for that purpose, cash dividends at the rate of $0.12 per annum, subject to voluntary conversion. Such dividends shall accrue and be cumulative from the issue date. Dividends shall be payable in arrears, when and as declared by the Board of Directors, on March 31, June 30, September 30 and December 31 of each year; provided, however, the first dividend payment date shall not occur before the last calendar day of the first full fiscal quarter following the issue date. During each of 2011 and 2010, the Company paid or accrued a total of $15,000 in dividends and reflected, as of December 31, 2011 and 2010, accrued dividends of $29,376 and $26,376, respectively. As of December 31, 2011 and 2010, undeclared dividends in arrears approximated $35,000 and $32,000, respectively. In the event of any liquidation, dissolution or winding up of the Company’s affairs for a price per share which is less than the subscription price set forth herein, holders of the preferred shares will be entitled to a liquidation preference of $1.00 per preferred share, plus the dividends set forth above, prior to any distribution to the holders of common stock in full and complete liquidation of the interest of the holders of Series A Preferred Stock. In the event that the Company does not have sufficient funds to pay the full liquidation preference payable to the holders of preferred shares, and any other shares issued on a parity with the preferred shares (“Parity Shares”), the existing funds will be allocated among the holders of all such preferred shares and Parity Shares pro rata in proportion to the full amounts to which they would respectively be entitled. At any time, the Company may, unless otherwise prevented by law, redeem from the holder thereof, the holder’s preferred shares at the subscription price ($1.00 per share), together with any accrued but unpaid dividends thereon to and including the date of redemption, in whole or, from time to time, in part. Any partial redemption shall be allocated among the holders of preferred shares pro rata or by lot, as determined by the Company.

NOTE 7-—OTHER REVENUE AND OTHER OPERATING EXPENSES

Other Revenue and Other Operating Expenses are summarized as follows:

 

Other Revenue		2011				2010
Administration and Service Fees		$	2,507,461			$	2,475,751
Fixed Income Trading Revenue			461,148				446,064
Other			678,878				637,230
		$	3,647,486			$	3,559,045
Other Operating Expenses
Advisor Acquisition and Retention Costs		$	1,715,965			$	1,464,407
Insurance Costs			582,100				602,329
Professional fees and related			336,859				468,965
Other expenses			938,460				769,709
		$	3,573,384			$	3,305,410

NOTE 8—STOCK OPTIONS AND WARRANTS

The Company accounts for all option issuances (including those issued by the Company to both employees and non-employees of SBS) using the fair market value method. In connection therewith, the Company records, upon the issuance of each option, unearned stock-based compensation in an amount equal to the number of shares covered by the option multiplied by the estimated fair value per option. The amount recorded as unearned stock-based compensation is then amortized over the vesting period of the option. Consequently, the total expense recognized in the current period represents the amortized portion, if any, of the fair value of all outstanding options.

 

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On December 13, 2006, the Company’s shareholders approved the 2006 Incentive Compensation Plan (the “2006 Plan”), as the successor to the 2000 Incentive Compensation Plan. The terms of the 2006 Plan provide for grants of stock options (incentive and non-statutory), stock appreciation rights (SARs), and restricted stock to eligible persons capable of contributing to the Company’s performance. The total number of shares of common stock that may be subject to the granting of awards under the 2006 Plan at any time during the term of the 2006 Plan was increased from 12,000,000 to 22,000,000 during 2010.

The following table summarizes information about stock option activity during 2010 and 2011:

 

		Number of Options				Weighted Average Exercise Price
Outstanding at December 31, 2009			18,873,428			$	0.42
Granted			1,965,595			$	0.74
Cancelled options			(5,600,000	)		$	0.25
Issued upon cancellation of previously granted options			2,800,000			$	0.50
Forfeited or expired			(651,808	)		$	0.65
Exercised			(886,397	)		$	0.27
Outstanding at December 31, 2010			16,500,818			$	0.53
Granted			2,713,307			$	0.82
Forfeited or expired			(738,361	)		$	0.62
Exercised			(557,125	)		$	0.46
Outstanding at December 31, 2011			17,918,639			$	0.58

The following schedule reflects the number of shares covered by, and the fair market value of, stock option and warrant activity during 2011 and 2010 related to both employees and non-employees. Included within the activity for 2010 is a transaction in which options to acquire up to 5,600,000 shares of common stock at an exercise price of $0.25 per share were cancelled, in consideration, in part, for the issuance of new options to acquire 2,800,000 shares of common stock at an exercise price of $0.50, together with 2,800,000 shares of deferred stock. The fair market value of the replacement options and deferred stock was $223,732 and $549,096.

 

		2011				2010
Shares
Option grants – employees			2,326,715				1,117,444
Option grants – non-employees			386,592				848,151
Warrant grants – non-employees			50,000				—
Grants of replacement options – employees			—				2,800,000
Forfeited, expired or exercised – employees			332,048				369,191
Forfeited, expired or exercised – non-employees			963,438				282,617
Fair Market Value
Options issued – employees		$	924,520			$	451,782
Options issued – non-employees		$	127,288			$	304,636
Warrants issued – non-employees		$	20,593			$	—
Earned Stock Expense
Earned stock expense, net – employees		$	576,949			$	674,883
Earned stock expense, net – non-employees		$	133,473			$	156,065

During 2011, options to acquire 557,125 shares of common stock with a weighted average exercise price of $0.46 were exercised, resulting in proceeds of approximately $257,000. The approximate weighted average intrinsic value per share—that is, the difference between the market price of the common stock at the time of exercise and the exercise price—was $0.29. During 2010, options to acquire 886,397 shares of common stock with a weighted average exercise price of $0.27 were exercised, resulting in proceeds of approximately $236,000. The approximate weighted average intrinsic value per share was $0.57.

 

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As of December 31, 2011, there were currently exercisable options outstanding allowing the holders thereof to purchase approximately 13.48 million shares of common stock at a weighted average exercise price of approximately $0.52 per share with a weighted average remaining contractual term of approximately 3.9 years (compared with a weighted average remaining contractual term of approximately 4.2 years for all outstanding options). The exercise prices for outstanding, as well as currently exercisable, options range from $0.28 to $1.00. As of December 31, 2011, the Company had issued, or committed to issue, options and deferred stock shares entitling the holders thereof to acquire up to 19.04 million shares under the 2006 Plan, leaving a total of 2.96 million shares available for future grants.

As of December 31, 2011 and 2010, there was approximately $1.94 million and $1.72 million, respectively, of total unrecognized stock-based compensation cost, which cost is expected to be recognized over a weighted average period of 2.5 years and 3.5 years, respectively.

The weighted average fair value of options granted for 2011 and 2010 was $0.39 and $0.32 per option, respectively.

As of December 31, 2011, the aggregate intrinsic value of vested and exercisable options was approximately $3.5 million, based on approximately 13.48 million vested options outstanding, a weighted average exercise price of $0.52 and a year-end closing price for the Company’s common stock of $.78 per share.

During 2003, the Company issued warrants entitling the holders thereof to acquire up to 1,478,000 shares of common stock at a price of $.30 per share. These warrants were exercisable for a period of five years and had expiration dates ranging from March 18, 2008 to April 11, 2008. During 2006, the Company agreed to extend the term of warrants covering 838,000 shares of common stock by two years, with expiration dates now ranging from March 18, 2010 to April 11, 2010. During 2009, holders of warrants underlying 509,000 shares of common stock cancelled and replaced their warrants in exchange for new warrants with an exercise price of $.50 per share, immediate vesting and a five-year term. During 2010, a holder of warrants underlying 200,000 shares of common stock exercised such warrant, resulting in proceeds of $60,000 to the Company. The intrinsic value per share was $0.21. No warrants were exercised during 2011. During 2011, the Company issued a warrant entitling the holder thereof to acquire up to 50,000 shares of the Company’s common stock at an exercise price of $0.85. As of December 31, 2011 and 2010, there were outstanding warrants allowing the holders thereof to purchase 559,000 and 509,000 shares of common stock, respectively. The exercise prices for outstanding, as well as currently exercisable, warrants range from $0.50 to $0.85.

As a result of the exercises of both options and warrants during 2011, the Company recognized a tax benefit of approximately $77,000, which represents the total intrinsic value of all option and warrant exercises of approximately $160,000 multiplied by the Company’s effective tax rate of approximately 48%. As a result of the exercises of both options and warrants during 2010, the Company recognized a tax benefit of approximately $200,000, which represents the total intrinsic value of all option and warrant exercises of approximately $543,000 multiplied by the Company’s effective tax rate (See Note 10).

For purposes of valuing options and warrants, the Company uses the Black-Scholes option pricing model. For the years ended December 31, 2011 and 2010, the following assumptions have been utilized:

 

		2011		2010
Expected life (in years)		5 – 7		2.2 – 10.0
Risk-free interest rate		0.83% - 2.74%		0.94% - 3.76%
Volatility		55% - 56%		55% - 66%
Dividend yield		0.0%		0.0%

 

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NOTE 9—COMMITMENTS AND CONTINGENCIES

Operating Leases

In December 2009, the Company entered into two separate lease agreements for office space in Boca Raton, Florida. The first lease (the “Lease Agreement”) is for 13,554 square feet of office space to house the corporate headquarters for the Company’s operations. The Lease Agreement took effect as of February 1, 2010 and replaced the Company’s then existing lease, which expired in January 2010. The term of the Lease Agreement is from February 1, 2010 through August 31, 2017, with the Company having the option to extend the Lease Agreement for two five-year renewal terms. Initial base rent is approximately $23,719 per month, subject to certain fixed increases over the course of the term, as set forth in the Lease Agreement. The second lease (the “Second Lease Agreement”) is for 4,264 square feet of office space to house certain financial advisors. The Second Lease Agreement, which was originally effective as of August 1, 2010, was amended on January 14, 2010 to provide for occupancy effective as of March 1, 2010. The term of the Second Lease Agreement is from March 1, 2010 through August 31, 2013, with the Company having the option to extend the Second Lease Agreement for one four-year renewal term and, subsequently, two five-year renewal terms. Initial base rent is approximately $7,462 per month, subject to certain fixed increases over the course of the term, as set forth in the Second Lease Agreement.

Total rent expense, including month-to-month leases for the year ended December 31, 2011 and 2010, was approximately $630,000 and $689,000, respectively.

Summit Brokerage also leases certain equipment under operating leases, which provide for minimum monthly payments of approximately $1,500 through December 2015.

The approximate minimum annual, non-cancelable rent payments due under all Company operating leases (based only on the base rent, without regard to the Company’s share of common areas and other expenses) are as follows:

 

Year		Amount
2012		$	404,000
2013			322,000
2014			314,000
2015			324,000
2016			333,000
Thereafter			227,000
		$	1,924,000

Legal Proceedings

The Company is a party to legal proceedings relating to various claims and lawsuits arising in the normal course of business. Management has provided an accrual for estimated probable losses that could result from these matters. Management believes that the range of potential net losses resulting from these proceedings in excess of the accrued amount, if any, will not be material to the Company’s financial position or results of operations.

The Company is a registered broker-dealer and as such is subject to the continual scrutiny of those who regulate its industry, including FINRA, the United States Securities and Exchange Commission, and the various securities commissions of the states and jurisdictions in which it operates. As part of the regulatory process, the Company is subject to routine examinations, the purpose of which is to determine the Company’s compliance with rules and regulations promulgated by the examining regulatory authority. It is not uncommon for the regulators to assert, upon completion of an examination, that the Company has violated certain of these rules and regulations. Where possible, the Company endeavors to correct such asserted violations. In certain circumstances, and depending on the nature and extent of the violations, the Company may be subject to disciplinary action, including fines.

Retirement Plan

The Company has a retirement plan, which management believes qualifies as a deferred compensation plan (the “Plan”), under Section 401(k) of the Internal Revenue Code. All employees who are at least 21 years old are eligible to participate in the Plan on the first day of the month following their six-month anniversary of service. During the years ended December 31, 2011 and 2010, the Company matched 100% of the eligible participant’s contribution up to 3% of the participant’s qualifying wages and then 50% of the next 2% of participant’s contribution. Company matching contributions charged to employee compensation and benefits for the years ended December 31, 2011 and 2010 approximated $138,000 and $146,000, respectively.

 

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Natural Disasters

The Company’s operations are located in an area that has been, and will potentially be, affected by tropical storms. In prior years, some portions of the Company’s operations have been impacted by such storms. Although the Company maintains business interruption insurance, and has filed claims related to storms in prior years, there can be no assurance that, in the future, the amount of such proceeds will be sufficient to offset any losses incurred. The Company does not reserve any amounts for such contingency.

Clearing Firms

Included in the Company’s clearing agreements with its clearing brokers is an indemnification clause. This clause relates to instances where the Company’s clients fail to settle security transactions. In the event this occurs, the Company has indemnified the clearing brokers to the extent of the net loss on the unsettled trade. At December 31, 2011, management of the Company had not been notified by the clearing brokers, nor were they otherwise aware, of any potential losses relating to this indemnification.

Other

In connection with the execution of employment agreements with, and the related issuance of stock options and deferred shares to, the Company’s Chief Executive Officer, the Company has agreed to pay the income tax liability incurred by the Chief Executive Officer upon the exercise of such stock options or the delivery of such deferred shares. The Company’s obligation to pay such tax, however, shall not exceed the amount of the tax benefit the Company receives as a direct result of the Chief Executive Officer’s exercise of the stock options or any portion thereof, or the delivery of the deferred shares or any portion thereof. No options were exercised by, nor were any deferred shares delivered to, the Chief Executive Officer during either 2011 or 2010.

In March 2011, the Company became aware that a financial advisor operating from one of its branch offices may have misappropriated funds. In connection therewith, the Company undertook an investigation, including notifying FINRA. The Company also notified, or attempted to notify, clients of the advisor. The Company also notified its fidelity bond carrier. During 2011, the Company settled with two of the four identified parties representing approximately 95% of the total known loss. The Company was subsequently reimbursed by its fidelity bond carrier. While it is not possible to determine with certainty the outcome of this matter, and in particular whether additional claims may be forthcoming, based on the information currently available to the Company, management is of the opinion the resolution of this matter will not have a material adverse effect on our financial position or operating results. No accrual or provision has been made in the accompanying financial statements related to this matter.

NOTE 10—INCOME TAXES

The Company recognizes deferred tax assets and liabilities based on temporary differences between the financial reporting bases and the tax bases of assets and liabilities. As of December 31, 2011 and 2010, the Company recognized a deferred tax asset, prior to the valuation allowance of approximately $1,359,000 and $1,185,000, respectively, the significant components of which are as follows:

 

		2011				2010
Deferred tax assets
Amortization of stock-based compensation		$	900,000			$	751,000
Difference between book and tax depreciation			185,000				157,000
Amortization of client list and goodwill			125,000				135,000
Allowances and other items			149,000				142,000
Net deferred tax asset before valuation allowance		$	1,359,000			$	1,185,000

A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of December 31, 2011 and 2010, the Company has established a valuation allowance equal to the amount of the net deferred tax asset. The valuation allowance increased by approximately $174,000 and decreased by approximately $268,000 during the years ended December 31, 2011 and 2010, respectively.

 

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The Company’s effective tax rate differs from the statutory federal income tax rate due to the following at December 31, 2011 and 2010:

 

		2011				2010
Tax at statutory rate			34	%			34	%
Increase (decrease) resulting from:
Effect of state income tax			3	%			3	%
Effect of non-deductible expenses (primarily stock-based compensation)			7	%			13	%
Effect of accelerated depreciation of property and equipment			1	%			(6	)%
Effect of other items			3	%			(6	)%
Effective tax rate			48	%			38	%

The federal and state income tax provision is approximately as follows for the years ended December 31, 2011 and 2010:

 

		2011				2010
Current
Federal		$	1,150,000			$	691,000
State			197,000				118,000
			1,347,000				809,000
Deferred
Federal			—				—
State			—				—
			—				—
Total provision for income taxes		$	1,347,000			$	809,000

The entire federal and state income tax provision for the year ended December 31, 2011 is considered current after giving effect to the increase in the deferred tax asset valuation allowance. As of December 31, 2011, with few exceptions, the consolidated income tax returns filed by SFSG are no longer subject to income tax examinations by the U.S Federal taxing authorities for any years prior to 2008.

NOTE 11—CONCENTRATIONS OF CREDIT RISK AND FAIR VALUE OF FINANCIAL INSTRUMENTS

CONCENTRATIONS—Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of temporary cash investments, deposits, commissions receivable, notes and other receivables. The Company places its temporary cash investments with financial institutions, which balances may exceed federally-insured limits.

During the years ended December 31, 2011 and 2010, transactions representing approximately 36% and 42%, respectively, of the Company’s total commission revenues were processed through one of the Company’s clearing brokers. At December 31, 2011 and 2010, commissions receivable from this clearing broker represented approximately 11% and 15%, respectively, of total commissions receivable. During 2011, approximately 52% of the Company’s total commission revenues were processed through both of its clearing brokers.

FAIR VALUE—All financial instruments are carried at amounts that approximate fair value because of the short maturity of these instruments.

 

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NOTE 12—NET CAPITAL REQUIREMENT

SBS is a “Fully Disclosed Broker-Dealer.” SBS does not carry client accounts and does not accept client funds or securities. Instead, it has entered into a “clearing agreement” with its clearing brokers and has fully disclosed all of its client accounts to these brokers.

SBS is subject to the Securities and Exchange Commission’s Uniform Net Capital Rule (SEC Rule 15c3-1), which requires the maintenance of minimum net capital. Under the Rule, the SBS is required to maintain minimum net capital equal to the greater of: (i) $250,000, or (ii) 6.67% of aggregate indebtedness. The Rule also requires that SBS’s ratio of aggregate indebtedness to net capital not exceed 15 to 1, as computed under SEC Rule 15c-3-1.

At December 31, 2011 and 2010, SBS had net capital of approximately $3.7 million and $3.4 million, respectively, and the Company’s aggregate indebtedness to net capital ratio was 1.26 to 1 and 1.34 to 1, respectively, as computed under SEC Rule 15c-3-1.

 

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EXHIBIT INDEX

 

Number		Name
21.1		Subsidiaries of the Registrant
23.1		Consent of Independent Registered Public Accounting Firm
31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS		XBRL Instance Document
101.SCH		XBRL Schema Document
101.CAL		XBRL Calculation Linkbase Document
101.DEF		XBRL Definition Linkbase Document
101.LAB		XBRL Label Linkbase Document
101.PRE		XBRL Presentation Linkbase Document