| Van der Moolen Holding N.V. – Notes to the Consolidated Financial Statements (in € millions, except per share data) |
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Subordinated notes: The subordinated notes bear market rates of interest, and their carrying amounts are reasonable estimates of their fair value.
22. Derivatives and Risk Management
The Company enters into interest rate and foreign exchange derivative contracts in connection with its balance sheet management activities, which involve the management of interest rate and foreign exchange rate risk, and trading activities. These derivative contracts involve, to varying degrees, credit risk and market risk. Market risk is the risk that a change in the level of one or more market factors, such as interest rates, indices, volatilities, correlations, or other factors will result in losses for a specified position or portfolio. Credit risk represents the loss that the Company would incur if a counterparty fails to perform its contractual obligation to the Company. In managing derivative credit risk, both the current exposure, which is the replacement cost of contracts on the measurement date, as well as an estimate of the potential change in value of contracts over their remaining lives are considered. Where possible, to minimize credit risk, the Company enters into legally enforceable netting arrangements, which reduce risk by permitting the settlement and netting of transactions with the same counterparty upon occurrence of certain events. All option trading is conducted on recognized exchanges. With respect to the Company’s option trading activities, the Company’s clearing brokers, through industry clearing organizations, act as the counterparty and therefore bear the risk of delivery to and from counterparties. Derivative contracts are reported on a net-by-counterparty basis on the Company’s Consolidated Statements of Financial Condition where it is determined a legal right of setoff exists under an enforceable netting agreement.The majority of the Company’s derivatives are entered into for trading purposes and the accounting treatment was not materially affected by the adoption of SFAS 133 as of January 1, 2001.
Derivatives designated as hedges for accounting purposes must be considered to be highly effective at reducing the risk associated with the exposure being hedged. Each derivative must be designated as a hedge, with documentation of the risk management objective and strategy for the hedge, including identification of the hedging instrument, the hedged item and the risk exposure, and how effectiveness is to be assessed both prospectively and retrospectively.
The Company’s qualifying fair value hedges relate to interest rate swaps used to modify exposure to interest rate risk by converting fixed rate debt into a floating rate. All changes in the fair value of the derivative and changes in the fair value of the hedged item have been included in earnings consistent with the classification of the hedged transaction, in Interest expense, net. These interest rate swaps were terminated in June 2005. The fair value of interest rate swaps designated as qualifying fair value hedges, determined in accordance with the Company’s netting policy, was € nil at December 31, 2005 (December 31, 2004: € 0.6 million; December 31, 2003: € 0.4 million negative).
(a) Market risk arising from trading activities
Market risk is the risk that price changes could affect the value of the equity, option or bond positions that arise from normal trading activity. Market risk increases when markets move sharply and volatility increases. The management of market risk is primarily based at each of the Company’s operating units, with central oversight, analysis and formation of risk policy based at the Company’s headquarters. Except for VDM Specialists, the central risk control department establishes, in consultation with the Executive Board and the management of the operating units, specific maximum risk levels to which the operating units must adhere, monitors compliance with those limits and reports the risk profile of the Company directly to the Executive Board on a daily basis. With respect to VDM Specialists, the first line of responsibility for risk management is with staff that is present on the floor of the New York Stock Exchange throughout trading hours.
(b) Currency risk
The Company is affected by a number of currency risks:
- the risks of currency gains or losses on monetary assets and liabilities denominated in currencies other than the functional currency of the entity concerned;
- the effect of exchange rate fluctuations on the translation of the income statements and balance sheets of entities for the purpose of presenting consolidated financial statements in euros; and
- the risk arising from trading positions denominated in any currency other than the functional currency of the trading unit holding those trading positions.
The Company’s policy is to:
- mitigate, where economically appropriate, the effect of currency fluctuations that will result in volatility in the Company’s Statement of Income, as reported under International Financial Reporting Standards; and
- hedge cash in- and outflows in various currencies to mitigate their possible translation effect on the Company’s liquidity position. Changes in valuation that result from translation into the Company’s presentation currency will, in principle, not be hedged.
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In addition to these considerations, a number of the Company’s operating units run currency exposure risks in the normal course of their trading activities. These exposures are hedged when incurred, amongst others by using foreign currency derivative contracts that are accounted for as derivatives used for trading purposes.
(c) Interest rate risk
The Company uses external debt instruments for financing its operations, including the capital and liquidity requirements of exchanges. The Company's interest risk policy is designed to match the financing instruments used to the risk profile of the underlying assets. Adjustment of this risk profile can be accomplished by the use of interest rate swaps. Until June 2005, VDM Specialists used interest rate swaps to swap the fixed interest rate exposure on its subordinated borrowings into floating rate exposure. As a result of developments in US dollar interest rates, these swaps were terminated in June 2005.
(d) Credit risk
Credit risk that could result from counterparties defaulting is limited for the Company’s operations that operate on regulated exchanges, since the settlement risk is essentially transferred to recognized clearing organizations. Excess cash and cash equivalents are invested in short-term money market instruments. The Company minimizes the related credit risk by following strict policies governing its choice of counterparties.
(e) Liquidity risk
Liquidity risk relates to the Company’s capacity to finance security positions and liquidity requirements of exchanges and clearing utilities. The Company’s financial resources, relative to its capital employed, and the liquid nature of most of the instruments traded, limit this risk. In addition, the Company maintains a credit facility with a commercial bank. The Company budgets cash flows on a rolling twelve-month basis. Cash flow and available cash positions are monitored daily, and when appropriate, these budgets are adjusted accordingly.
(f) Compliance, Legal and Operational risks
The Company and its subsidiaries, and the business segments in which they are active, operate under significant regulatory and legal obligations in both the United States and Europe, imposed by (local) governments and securities regulators. The legal and regulatory obligations under which the Company’s subsidiaries operate relate, among other things, to their financial reporting, their trading activities, capital requirements and the supervision of their employees. Failure to fulfill legal or regulatory obligations can lead to fines, censure or disqualification of management and/or staff and other measures that could have negative consequences for the Company’s activities and financial performance. Certain violations could result in them losing their trading permissions. If that were to occur, the Company would lose its ability to carry out a portion of its existing activities, which could have a material effect on the Company’s financial position, net profit and cash flows.
See Note 23 for an overview of pending regulatory and litigation matters.
23. Commitments and Contingent Liabilities
Regulatory Proceedings and Litigation
VDM Specialists USA, LLC
Specialist Trading Investigations
On March 30, 2004, we announced a settlement with the New York Stock Exchange and the SEC with respect to charges resulting from an investigation of trading practices at several specialist firms, including VDM Specialists. The settlement, which was agreed on the basis of no admission or denial, was entered into in connection with alleged violations of Section 11(b) of the Exchange Act, and rules promulgated under the Exchange Act concerning New York Stock Exchange specialist trading, including the requirement that a specialist maintain a fair and orderly market, and violations of Section 15(b)(4)(E) of the Exchange Act, including failure to supervise with respect to certain transactions in which one or more of our employees allegedly violated Section 10(b) of the Exchange Act including Rule 10b-5. Pursuant to the settlement, and without admitting or denying any wrongdoing, we announced that VDM Specialists would pay a total of $57.7 million in restitution to customers and civil penalties for certain trades that occurred during the five year period from 1999 to 2003. Of the total agreed restitution and civil penalties, $34.9 million represented restitution and $22.8 million represented civil penalties. The full amount of the restitution payment was paid within ten days of the date of settlement. We agreed with the SEC to pay the $22.8 million in civil penalties on an installment basis, with the first installment of $10.8 million made within ten days of the date of settlement and $2.0 million paid every three months thereafter until all penalties have been paid in full. The remainder of the installments of $6.0 million, due at December 31, 2004, was paid in 2005. On March 30, 2004, four of the other largest New York Stock Exchange specialist firms also settled the investigation concerning their specialist trading activities during the 1999 to 2003 period. The SEC, the New York Stock Exchange and the Department of Justice continue to investigate the conduct of certain present and former employees of VDM Specialists.
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On April 12, 2005, seven former employees of VDM Specialists were indicted for securities fraud and conspiracy to commit securities fraud. Also on April 12, 2005, the SEC commenced civil proceedings against these seven former employees of VDM Specialists, as well as another employee of VDM Specialists who was not indicted. The NYSE has also brought charges against these former employees of VDM Specialists. Van der Moolen Holding N.V. and VDM Specialists are cooperating fully with the New York Stock Exchange and the SEC, as and when requested, in connection with these investigations. Of the seven indicted former VDM employees, two pleaded guilty to securities fraud on May 12, 2006, the trial of the two others began in U.S. district court in New York on June 14, 2006, and trials of the remaining three may take place one after another following the conclusion of the first trial. It is not possible to anticipate at this time whether or not such future trials will occur, the length of any such trial, or the outcomes of such trials.
In April 2006, VDM Specialists entered into fee agreements with five of the aforementioned seven indicted former employees thereby setting a maximum on the amounts of the company’s indemnification of legal fees and expenses for these five individuals pursuant to Section 5.5 of the company’s Operating Agreement. See under "Legal Fees" for further comments.
In re New York Stock Exchange Specialists Securities Litigation
In the fourth quarter of 2003, four putative class actions were filed with the U.S. District Court for the Southern District of New York against VDM Specialists and other New York Stock Exchange specialist firms. On March 11, 2004, a similar suit, which was brought by an individual plaintiff who was not purporting to represent a class, was filed in the U.S. District Court for the Southern District of New York. One of the class actions and the individual suit also name the New York Stock Exchange and Van der Moolen Holding N.V. as defendants. Each of these five actions was filed on behalf of plaintiffs who allege that the defendants violated U.S. federal securities law by conducting improper trading activity to the detriment of pending customer orders. The actions were filed on the grounds of the alleged trading violations that were the subject of the New York Stock Exchange and SEC investigation mentioned above. The actions seek unspecified restitution and damages. On May 27, 2004, the U.S. District Court for the Southern District of New York entered an order consolidating the four class actions and the individual action, appointing lead plaintiffs, and directing that a consolidated amended complaint be filed within 45 days. The co-lead plaintiff filed an amended consolidated complaint on September 16, 2004 (In re NYSE Specialists Securities Litigation, No. 03-8264 (S.D.N.Y.)).
On November 16, 2004, Van der Moolen Holding N.V., VDM Specialists, and the other New York Stock Exchange specialist firms moved to dismiss the amended consolidated complaint. On December 15, 2005, the court granted in part and denied in part the motion to dismiss, thereby allowing plaintiffs’ claims to go forward against Van der Moolen Holding N.V., VDM Specialists, and the other specialist firms. Van der Moolen Holding N.V. and VDM Specialists answered the complaint on February 23, 2006.
No class has yet been certified. Documents requests have been served on Van der Moolen Holding N.V., VDM Specialists and other defendants, and discovery commenced in June 2006. We believe that Van der Moolen Holding N.V. and VDM Specialists have substantial defenses to this litigation.There can be no assurance, however, as to the outcome or timing of the resolution of these proceedings and actions. The range of reasonably possible losses, which cannot be reliably estimated by us, could include determinations and judgments against us or settlements that could require substantial payments by us, all of which could have a material adverse effect on our financial condition, results of operations and cash flows.
In re Van der Moolen Holding N.V. Securities Litigation
On October 20, 2003, a plaintiff, who purported to represent holders of our ADRs, filed a class action on their behalf in the U.S. District Court for the Southern District of New York against Van der Moolen Holding N.V. and the members of our executive board during the relevant period. The plaintiff alleged that defendants violated U.S. federal securities law by failing to disclose the alleged trading activity at issue in the NYSE Specialists litigation and the New York Stock Exchange and SEC investigations into NYSE specialist trading activity. On April 14, 2004, the Court entered an order designating co-lead plaintiffs. On July 9, 2004, co-lead plaintiffs filed an amended complaint seeking unspecified damages. On September 14, 2004, co-lead plaintiffs filed a Second Amended and Consolidated Class Action Complaint (In re Van der Moolen Holding N.V. Securities Litigation, No. 03-8284 (S.D.N.Y.)), also naming VDM Specialists as a defendant. On November 22, 2004, Van der Moolen Holding N.V., VDM Specialists and the individual defendants moved to dismiss the complaint. On December 15, 2005, the Court granted in part and denied in part defendants’ motion to dismiss. Van der Moolen Holding N.V., VDM Specialists and the individual defendants answered the complaint on February 17, 2006.
No class has yet been certified. Discovery commenced in May 2006. We believe that defendants have substantial defenses to this litigation. There can be no assurance, however, as to the outcome or timing of the resolution of these proceedings and actions. The range of reasonably possible losses, which cannot be reliably estimated by us, could include determinations and judgments against us or settlements that could require substantial payments by us, all of which could have a material adverse effect on our financial condition, results of operations and cash flows.
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Other
On February 22, 2005, the New York Stock Exchange advised VDM Specialists that it is conducting an investigation into the possibility that (i) employees of VDM Specialists submitted or caused to be submitted, misleading or inaccurate floor official approvals during the period from September 2002 through August 2003, and (ii) VDM Specialists and/or certain supervisory employees may have failed to discharge their responsibility in supervising the firm’s floor employees. The outcome or a range of outcomes of this investigation cannot be predicted at this time.
Legal Fees
In 2005, VDM Specialists incurred € 5.7 million in legal fees in relation to regulatory proceedings and litigation that is included in General and administrative expenses in the Consolidated Statement of Income (2004: € 4.0 million; 2003: € 1.3 million). Pursuant to Section 5.5 of its operating agreement with minority members, VDM Specialists is required to advance funds for actual litigation expenses incurred by various present and former members and employees in connection with litigation and regulatory inquiries. All such advances have been included in the aforementioned amount and are recognized as expenses in the Consolidated Statement of Income. In 2005, an amount of approximately € 4.6 million was recognized in respect of such advances (2004: € 0.7 million; 2003: nil). Reference is made to Note 11 for details of a provision of € 1.9 million established at December 31, 2005. There can be no assurance that further legal fees over and above this provision will not arise, and such expenses could be material.
Stock Lending
In late 2004, the New York Stock Exchange requested documents and interviews with certain employees of VDM Specialists’ stock lending department. On January 14, 2005, VDM Specialists terminated two senior members of its stock lending department for violations of the firm’s policies and their terms of employment. On February 11, 2005, we disclosed that the New York Stock Exchange was conducting an inquiry into broker-dealer stock lending practices, focusing on transactions involving finders, including transactions carried out by VDM Specialists’ stock lending department. Also on February 11, 2005, based on the existence of this New York Stock Exchange inquiry and the results of VDM Specialists’ own internal inquiry, Van der Moolen Holding N.V. announced that VDM Specialists was closing its stock lending business. At the time when VDM Specialists closed its stock lending business, New York Stock Exchange rules did not expressly bar the payment of reasonable fees to legitimate finders of securities in connection with a member firm’s stock lending activity, although certain broker-dealers had adopted policies prohibiting such payments.
On May 26, 2005, the SEC issued a subpoena duces tecum requesting the production of certain documents concerning VDM Specialists’ stock loan business, which VDM Specialists answered.
While we cannot predict with certainty the outcome of the inquiry of the New York Stock Exchange, which will be subject to the approval of the New York Stock Exchange's board, we are actively engaged in discussions with the staff of the New York Stock Exchange. The range of further possible losses cannot be reliably estimated at this time.
The Audit Committee has reviewed the findings of the internal inquiries described above, and in the light of these findings and the steps taken by management is satisfied that appropriate remedial action has been taken. The stock lending activities of VDM Specialists contributed less than €0.1 million to 2005 net income (2004: €0.6 million; 2003: €0.6 million).
U.S. Option Business
Cohen, Duffy, McGowan, LLC has been informed by the American Stock Exchange's Market Regulation Department that the Exchange's Enforcement Division has initiated an investigation that may result in disciplinary actions. The investigation is focused on charges of possible violations of American Stock Exchange Rule 156(b) and Article V, Section 4(h), combined with possible violations of the exchange's limit order display rule during the period between June 3, 2002 and May 30, 2003. Further, on February 25, 2004, the American Stock Exchange Enforcement Division started an investigation in relation to alleged violations of the firm quote rule (American Stock Exchange Rule 958A).
Further, the Department of Market Regulation of the Chicago Board Options Exchange requested written information from Van der Moolen Options USA, LLC relating to compliance with the Chicago Board Options Exchange's firm quote rule. On January 28, 2004, the SEC requested data from all U.S. option exchanges, including all those on which our option units acted as specialists or in a similar capacity, regarding the functioning and trading practices of specialists on those exchanges. It is possible that these requests have been lodged in advance of additional investigations into trading practices by the Chicago Board Options Exchange or the SEC.
On May 11, 2004, the SEC requested financial information and information in respect of the compliance procedures of Cohen, Duffy, McGowan, LLC. Cohen, Duffy, McGowan, LLC was closed in December 2003 and we disposed of Van der Moolen Options USA, LLC in December 2004.
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Last Atlantis Capital et al. vs Chicago Board Options Exchange et al.
On January 20, 2004, five entities who allege that they are purchasers and sellers of options commenced an action in the U.S. District Court for the Northern District of Illinois against four national securities exchanges (the American Stock Exchange, the Chicago Board Options Exchange, the Philadelphia Stock Exchange and the Pacific Stock Exchange) and 35 securities dealers who made markets in options, including Cohen, Duffy, McGowan, LLC and Van der Moolen Options USA, LLC, as well as Van der Moolen Holding N.V. Plaintiffs allege that our subsidiaries conspired with other defendants by allegedly failing to execute orders, cancelling orders and refusing to cancel orders for the purchase and sale of options. Plaintiffs allege violations of federal antitrust laws (Sections 1 of the Sherman Act and 4 and 16 of the Clayton Act), and securities laws (Section 10(b) of the Exchange Act and rule 10b-5 thereunder), breach of contract, common law fraud, breach of fiduciary duty, violations of an Illinois consumer fraud and deceptive business practices statute and tortuous interference with business. Injunctive relief and damages (including punitive damages) in an unspecified amount are sought. Cohen, Duffy, McGowan, LLC, Van der Moolen Options USA, LLC and Van der Moolen Holding N.V. were never served with process in this action, and although named in the caption of the Complaint, there are no specific allegations in the complaint against either Van der Moolen Holding N.V. or Van der Moolen Options USA, LLC. Motions to dismiss were filed with the court on June 14, 2004. On March 30, 2005 the court granted the motion to dismiss. On May 9, 2005, the court denied the plaintiffs' motion for reconsideration except with respect to the federal securities count as to which the court gave plaintiffs leave to replead with particularity. No amended complaint has been served on either Cohen, Duffy, McGowan, LLC or Van der Moolen Options USA, LLC or on Van der Moolen Holding N.V. On January 28, 2005, counsel for plaintiffs in this action filed a virtually identical complaint with the U.S. District Court for the Southern District of Illinois. The new complaint has not been served on either Cohen, Duffy, McGowan, LLC, Van der Moolen Options USA, LLC, or on Van der Moolen Holding N.V. On November 7, 2005, counsel for plaintiffs in this action filed a virtually identical complaint with the U.S. District Court for the Northern District of Illinois, which consolidated the original Last Atlantis complaint and the complaints filed by plaintiffs Bryan Rule and River North Investors LLC into one consolidated complaint. The consolidated complaint has not been served on any of Cohen, Duffy, McGowan, LLC, Van der Moolen Options USA, LLC or on Van der Moolen Holding N.V. A joint motion to dismiss the consolidated complaint by all of the named market maker defendants was filed with the court on January 6, 2006. That joint motion attacks the factual and legal sufficiency of the consolidated complaint. Van der Moolen Options USA, LLC and Van der Moolen Holding N.V. separately filed a supplemental motion to dismiss the consolidated complaint as to them for two additional reasons, including the failure of the plaintiffs to serve them and the failure of the plaintiffs to include any allegations specific to them. Both motions remain pending before the court.
On February 11, 2005, the Chicago Board Options Exchange sent a notice informing Van der Moolen Options USA, LLC that it had initiated an inquiry to determine whether Van der Moolen Options USA, LLC, in its capacity as Designated Primary Market-Maker on the Chicago Board Options Exchange or through its designee members, interpositioned or traded ahead its principal account ahead of orders Van der Moolen Options USA, LLC represented as agent during the period from at least January 1999 through December 2004 in violation of Chicago Board Options Exchange or SEC rules. The outcome of this investigation cannot be predicted at this time.
Also, on December 21, 2004, the Philadelphia Stock Exchange advised Van der Moolen Options USA, LLC that it is conducting an investigation and fact-finding effort related to the order handling and trading activity by Van der Moolen Options USA, LLC for the period of February 2003 through September 2004, regarding compliance with Philadelphia Stock Exchange Rule 1082.
The outcomes or range of losses arising from these investigations in respect of our U.S. Option business cannot be reliably estimated at this time.
With respect to the regulatory investigations and civil litigations described above, there can be no assurance as to the outcome or timing of the resolution of these matters. The range of possible resolutions could include determinations and judgments against us or settlements that could require substantial payments by us that could have a material adverse effect on our financial condition, results of operations and cash flows.
Credit facilities
On December 31, 2005, the Group had committed credit facilities in the amount of € 15 million that mature in December 2006. At December 31, 2005, no amounts were drawn under these facilities. In 2005, the Company paid € 0.2 million (2004: € 0.1 million; 2003: € 0.2 million) in relation to commitment fees on credit facilities.
Other commitments and contingencies
Van der Moolen Holding N.V. has issued guarantees to third parties for a total amount of € 2.3 million (2004: € 3.4 million). These guarantees were issued in relation to loans granted to LOC, LLC, an entity owned by (former) partners and an employee of VDM Specialists, in order to enable them to acquire seats on the New York Stock Exchange. This guarantee was cancelled upon the full repayment of the loan in May 2006.
Van der Moolen Holding N.V. has issued a guarantee to third parties for a total amount of € 1.0 million in relation to a credit facility of
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| Van der Moolen Holding N.V. – Notes to the Consolidated Financial Statements (in ��� millions, except per share data) |
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Stichting Van der Moolen Holding. No amounts were drawn under this facility on December 31, 2005 (2004: nil).
Van der Moolen Holding N.V. is liable for debts arising from the legal activities of its 100%-owned direct and indirect subsidiaries, with the exception of the companies established outside the Netherlands.
VDM Specialists has issued so-called 325(e) guarantees to the New York Stock Exchange in the total amount of € 4.4 million (2004: € 4.3 million).
In the ordinary course of its business, the Company indemnifies certain service providers, such as clearing and custody agents, trustees and administrators against specified potential losses in connection with their acting as an agent of, or providing services to, the Company or its affiliates. In addition, the Company is a member of payment, clearing and settlement networks as well as securities exchanges that may require the Company to meet the obligations of such networks and exchanges in the event of member defaults. The Company is unable to develop an estimate of the maximum payout under these guarantees and indemnifications. However, management believes that it is unlikely the Company will have to make material payments under these arrangements, and no liabilities related to these guarantees and indemnifications have been recognized in the Consolidated Statement of Financial Condition as of December 31, 2005.
The Company and its subsidiaries have obligations under operating leases with initial non-cancelable terms in excess of one year. Minimum rental commitments under non-cancelable leases for 2006 and the succeeding four years and thereafter are as follows:
| Year | | (in € millions) |
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| 2006 | | € | 1.3 | |
| 2007 | | | 0.9 | |
| 2008 | | | 0.9 | |
| 2009 | | | 0.9 | |
| 2010 (final expiry date September 30, 2010) | | | 0.6 | |
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| Total minimum lease payments | | € | 4.6 | |
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Certain leases contain renewal options and escalation clauses. Rental expense for the year ended December 31, 2005 from continuing operations amounted to € 1.3 million (2004: € 1.3 million; 2003: € 1.2 million).
24. Net Capital Requirements
VDM Specialists is subject to the SEC Uniform Net Capital Rule (SEC Rule 15c3-1), which specifies minimum net capital requirements. At December 31, 2005, VDM Specialists’ net capital, as defined in SEC Rule 15c3-1, was € 213.1 million, which was € 212.9 million in excess of its net capital requirement.
The Company is also subject to capital requirements with respect to its subsidiaries in the Netherlands. The net capital requirements at December 31, 2005 for Van der Moolen Effecten Specialist and Van der Moolen Obligaties are € 0.73 million and € 0.73 million, respectively. For each of these companies, the net capital at December 31, 2005 exceeds requirements.
Van der Moolen Equities Limited has a net capital requirement at December 31, 2005 of € 0.73 million. The net capital at December 31, 2005 exceeds the requirement.
The Company’s German subsidiary, Van der Moolen Trading has a net capital requirement at December 31, 2005 of € 6.8 million. Van der Moolen Trading’s net capital at December 31, 2005 exceeds the requirement.
25. Net Liquid Asset Requirements
VDM Specialists is subject to New York Stock Exchange Rule 104.22, which specify minimum net liquid asset requirements. As of December 31, 2005, VDM Specialists’ minimum net liquid asset requirement was € 205.4 million and its actual net liquid assets were € 221.2 million. In order to meet its net liquid asset requirement, VDM Specialists holds substantial cash balances which are included in Cash and cash equivalents in the Consolidated Statement of Financial Condition.
26. Subsequent Events
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a) Business combinations
On January 2, 2006, the Company acquired 100% of the share capital of Curvalue Beheer BV and its subsidiaries (together “Curvalue”). Curvalue is one of the leading independent trading and broker/dealer houses in Europe. The company focuses mainly on the European derivative exchanges as a specialist. In 2005, Curvalue launched the internet broker ‘OnlineTrader’ which provides professional clients with direct access to the world’s markets for futures and options. The primary reasons for the acquisition of Curvalue are stated below:
- Realisation of Van der Moolen’s European growth strategy
- Curvalue significantly strengthens VDM’s European operations
- Combination will implement Curvalue’s proven business model in screen based trading on the United States’ electronic derivativesmarkets
- The combination of both companies aligns with recent developments of exchanges towards more electronic-based trading
The results of Curvalue will be included in the Consolidated Statement of Income as from January 2, 2006.
The consideration for this acquisition is comprised of an initial cash payment of € 5.0 million and 3,803,509 common shares in Van der Moolen Holding N.V. ('VDM shares') issued on the date of acquisition ('closing'), being January 2, 2006. In addition, there will be an earn-out consisting of two payments: a maximum amount of € 10.4 million in cash and a maximum number of 1,920,964 VDM shares due approximately five months and one year after closing of the transaction; and a maximum amount of € 10.4 million in cash and a maximum number of 1,920,964 VDM shares due approximately seventeen months and two years after closing of the transaction. The amount of the earn-out payments is dependent upon the profitability of Curvalue in 2005 and 2006 relative to pre-established profit targets.
The cost of the acquisition is comprised of the fair value of the VDM shares issued on January 2, 2006 at a share price determined by the average quoted price of VDM shares in the period two days before and after the measurement date of October 12, 2005, the initial cash payment of € 5.0 million, the estimated cash earn-out payment in respect of the year 2005 and the estimated number of issuable shares arising from the 2005 earn-out (based on the average quoted price of VDM shares in the period two days before and after the measurement date of December 31, 2005) and costs directly attributable to the business combination. A subsequent adjustment to the cost of the acquisition, and goodwill recognized with respect to this acquisition, will be made for the earn-out arrangement in relation to the performance of Curvalue in the year ending December 31, 2006, when the contingency has been resolved.
The VDM shares issued and issuable with respect to this transaction have selling restrictions of between two to four years.
The VDM shares issuable in respect of the earn-out arrangement will have a dilutive impact on earnings per share as from January 2, 2006. The VDM shares issued on January 2, 2006 are eligible for dividends as declared by the Annual General Meeting of shareholders on April 5, 2006 (see below).
The Company is currently finalizing the purchase price allocation of the Curvalue business combination under U.S. GAAP. Consequently, at this stage further details of the financial consequences of the business combination cannot be provided.
(b) NYSE memberships
As of December 31, 2005, the Company owned 6 NYSE memberships (excluding the three memberships owned by LOC, LLC, a company consolidated under FIN 46(R), see Note 2) out of a total of 1366 NYSE memberships, representing a 0.4% ownership interest in the NYSE. The Company has accounted for its investment in these memberships under the adjusted cost method since its inception; see Note 2. On April 20, 2005, the NYSE and Archipelago Holdings, Inc. entered into a definitive merger agreement, as amended and restated on July 20, 2005 (as so amended, the “NYSE Merger Agreement”), pursuant to which Archipelago and NYSE agreed to combine their businesses and become wholly-owned subsidiaries of NYSE Group, Inc. (“NYSE Group”), a newly-created, for-profit and publicly-traded holding company (collectively, the “NYSE Merger”).
On March 7, 2006, the NYSE Merger was consummated, and each NYSE member became entitled to receive in exchange for each NYSE membership $ 300,000 in cash, plus 80,177 shares of NYSE Group common stock. In addition, immediately prior to the consummation of the NYSE Merger, the NYSE announced a “permitted dividend” to be paid to each NYSE membership in the amount of approximately $ 70,570, which was equivalent to the membership’s pro rata portion of the NYSE’s “excess cash,” as defined in the NYSE Merger Agreement. The Company received the permitted dividend with respect to each of its 6 NYSE memberships on March 14, 2006 and the merger consideration on March 28, 2006.
As a result of the NYSE Merger, the Company’s 6 NYSE memberships were converted into the right to receive an aggregate of $ 1.8 million in cash (not including the permitted dividend) and 481,062 shares of NYSE Group common stock. The $ 1.8 million cash portion of the
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| Van der Moolen Holding N.V. – Notes to the Consolidated Financial Statements (in € millions, except per share data) |
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merger consideration will be treated as receipt of monetary consideration for which a realized gain will be recognized in the first quarter of 2006. After the consummation of the NYSE Merger, the Company will account for its investment in the NYSE Group common stock as owned restricted stock, carried at the estimated fair value of such restricted shares pursuant to theAmerican Institute of Certified Public Accountants Audit and Accounting Guide—Brokers and Dealers in Securities, with fair value changes recognized through the Statement of Income. The shares of NYSE Group common stock to be received in the NYSE Merger are subject to a three-year restriction on transfer. The restriction will be removed in equal one-third installments on each of March 7, 2007, 2008 and 2009, unless the restrictions are removed earlier by the NYSE Group in its sole discretion. The fair value of the stock received will be adjusted for a discount from the published market value of the NYSE Group common stock, as a result of these transfer restrictions. Subsequent to the merger, we have joined the so-called secondary offering of NYSE Group shares and in early May 2006, 159,897 shares, out of the 481,062 set out above, were successfully offered in this process. The 159,897 shares were sold for a consideration of $ 61.50, each, which amount excludes the deduction for offering costs.
Prior to the closing of the NYSE Merger, the Company participated in a “Dutch” auction in early January 2006 for trading licenses which will replace the prior trading rights provided by the ownership or lease of an NYSE membership. The Company successfully bid for 59 trading licenses at an annual price of $ 49,290 each, the minimum bid accepted by the NYSE. The licenses became active for trading on the NYSE on March 8, 2006.
(c) Dividend distribution on common shares
At the Annual General Meeting of shareholders on April 5, 2006, shareholders approved the declaration of a € 0.13 cash dividend or its approximate equivalent in shares. On April 21, 2006, 437,158 common shares of Van der Moolen Holding N.V. were issued in respect of the optional stock dividend. The cash outflow related to the dividend was € 2.3 million.
(d) New financing structure for the cumulative financing preferred shares
With retrospective application as from January 1, 2006, the dividend for the financing preferred shares B was reset for the next seven years. The preferred financing dividend is fixed as per closing of the new term sheet at 475 basis points above seven year Dutch government bonds, being 8.45% per annum; and the rate was previously 5.52% per annum.
Further, changes in the Company's Articles of Association were approved by the Annual General Meeting of Shareholders on April 5, 2006, amongst others to provide discretionary authority for the executive board, after the approval of the supervisory board, to make a reservation to the dividend reserve of the respective financing preferred shares, or to make a dividend payment. This means that with effect from January 1, 2006, the payment of dividends on cumulative financing preferred shares is at the discretion of the Company, and there is no obligation for the Company to make such dividend payments.
(e) Regulatory proceedings and Litigation
For an overview of recent developments in regulatory proceedings and litigation reference is made to Note 23 “Commitments and Contingent Liabilities - Regulatory proceedings and litigation.”
27. Parent Only Financial Statements
This note presents Schedule I information for the parent company only, using the equity method of accounting for consolidated subsidiaries. Parent only financial information is required if the restricted net assets (as defined in Rule 4-08(e) of Regulation S-X) of consolidated subsidiaries exceed 25% of total consolidated net assets. The restricted net assets of VDM Specialists exceed this percentage as a result of the net liquid asset requirement described in Note 25. The restricted net assets of VDM Specialists amount to € 205.4 million at December 31, 2005, being 55.6% of consolidated net assets. There is no further specific restriction on the capacity of VDM Specialists to make profit distributions. The distribution of dividends by Van der Moolen Holding N.V., the parent company, out of retained earnings is restricted by Dutch Law. At December 31, 2005, freely distributable retained earnings amounted to € 74.5 million, including unappropriated result for the year 2005 of € 11.3 million.
Unless otherwise described in this note, reference should be made to the Notes to the Consolidated Financial Statements for details of the accounting principles adopted in these Parent Only Financial Statements.
Van der Moolen Holding N.V. Parent Only Statements of Financial Condition (in € millions, except per share data)
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| ASSETS | | | | | | | | |
| Cash and cash equivalents | | € | 45.9 | | | € | 12.3 | |
| Receivable from Group companies | | | 0.7 | | | | 3.7 | |
| Loans receivable from Group companies | | | 54.2 | | | | - | |
| Loans receivable | | | 5.0 | | | | - | |
F-43
| Van der Moolen Holding N.V. – Notes to the Consolidated Financial Statements (in € millions, except per share data) |
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| Property and equipment, net | | | 0.7 | | | | 0.8 | |
| Other intangible assets | | | 0.2 | | | | - | |
| Investments in subsidiaries using the equity method | | | 355.4 | | | | 373.5 | |
| Other assets | | | 11.8 | | | | 9.7 | |
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| Total assets | | € | 473.9 | | | € | 400.0 | |
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| LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | | | |
| Liabilities: | | | | | | | | |
| Short–term borrowings | | € | 94.4 | | | € | 45.4 | |
| Payable to Group companies | | | 1.4 | | | | 11.2 | |
| Current income tax liabilities | | | 1.7 | | | | 0.2 | |
| Accounts payable, accrued expenses, and other liabilities | | | 6.3 | | | | 4.8 | |
| Deferred tax liabilities, net | | | 0.6 | | | | 2.4 | |
| Notes payable | | | 1.7 | | | | 2.0 | |
| Subordinated borrowings: | | | | | | | | |
| Subordinated notes | | | - | | | | 3.6 | |
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| Total liabilities | | € | 106.1 | | | € | 69.6 | |
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| Shareholders’ equity: | | | | | | | | |
| Financing Preferred A shares, € 0.60 par value, authorized 1,200,000 shares, issued | | | | | | | | |
| and outstanding 251,000 shares | | | 0.1 | | | | 0.1 | |
| Financing Preferred B shares, € 0.60 par value, authorized 1,200,000 shares, issued | | | 0.3 | | | | 0.3 | |
| and outstanding 391,304 shares | | | | | | | | |
| Common shares, € 0.08 par value, authorized 54,000,000 shares, issued and | | | 3.1 | | | | 3.1 | |
| outstanding 39,445,477 and 38,419,282 shares, respectively | | | | | | | | |
| Treasury stock, 102,182 common shares | | | (2.4 | ) | | | (2.4 | ) |
| Additional paid-in capital | | | 282.6 | | | | 277.6 | |
| Retained earnings | | | 160.1 | | | | 174.3 | |
| Accumulated other comprehensive income | | | (76.0 | ) | | | (122.6 | ) |
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| Total shareholders’ equity | | € | 367.8 | | | € | 330.4 | |
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| Total liabilities and shareholders’ equity | | € | 473.9 | | | € | 400.0 | |
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The maturities of short-term borrowings, payable to Group companies and notes payable is as follows:
| | | | | Payable to | | | | |
| | | Short-term | | Group | | | | |
| (in € millions) | | borrowings | | companies | | Notes Payable | | Total |
| 2006 | | 94.4 | | 1.4 | | 0.3 | | 96.1 |
| 2007 | | - | | - | | 0.3 | | 0.3 |
| 2008 | | - | | - | | 0.3 | | 0.3 |
| 2009 | | - | | - | | 0.3 | | 0.3 |
| 2010 | | - | | - | | 0.5 | | 0.5 |
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| Total | | 94.4 | | 1.4 | | 1.7 | | 97.5 |
Short-term borrowings consist of bank overdrafts. For these balances a cash pooling arrangement exists that includes bank deposits and cash at bank of Van der Moolen Holding N.V. and its subsidiaries of in total € 104.3 million.
See Note 23 for disclosure of the parent company’s commitments and contingent liabilities.
Cash dividends paid to the parent by consolidated subsidiaries were € 52.0 million, € 61.3 million and € 108.1 million during the years ended December 31, 2005, 2004 and 2003, respectively.
Van der Moolen Holding N.V. Parent Only Statements of Income (in € millions)
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| | | Year Ended December 31, |
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| | | | 2005 | | | | 2004 | | | | 2003 | |
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| Revenues | | € | - | | | € | - | | | € | - | |
F-44
| Van der Moolen Holding N.V. – Notes to the Consolidated Financial Statements (in € millions, except per share data) |
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| Expenses: | | | | | | | | | | | | |
| Employee compensation and benefits | | | 2.7 | | | | 2.3 | | | | 5.3 | |
| Information and communication | | | - | | | | 0.3 | | | | 0.4 | |
| General and administrative expenses | | | 5.1 | | | | 2.0 | | | | 0.4 | |
| Depreciation and amortization | | | 0.4 | | | | 0.4 | | | | 0.5 | |
| Recharged expenses | | | (2.0 | ) | | | (2.6 | ) | | | - | |
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| Total expenses | | € | 6.2 | | | € | 2.4 | | | € | 6.6 | |
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| Loss from operations | | € | (6.2 | ) | | € | (2.4 | ) | | € | (6.6 | ) |
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| Gain on disposal of long-term investments and associates | | | - | | | | - | | | | 0.9 | |
| Interest expense, net | | | (1.3 | ) | | | (2.2 | ) | | | (2.7 | ) |
| Other income/ (expense) | | | 8.8 | | | | (4.1 | ) | | | 5.6 | |
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| Income/(loss) from continuing operations before income taxes | | € | 1.3 | | | € | (8.7 | ) | | € | (2.8 | ) |
| Provision for income taxes | | | 2.6 | | | | 6.9 | | | | 1.3 | |
| Loss from Group companies after income taxes using the equity method | | | (7.0 | ) | | | (7.2 | ) | | | (57.1 | ) |
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| Net loss | | € | (3.1 | ) | | € | (9.0 | ) | | € | (58.6 | ) |
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| Financing preferred shares dividends | | | (2.9 | ) | | | (2.9 | ) | | | - | |
| Net loss attributable to common shareholders | | € | (6.0 | ) | | € | (11.9 | ) | | € | (58.6 | ) |
F-45
| Van der Moolen Holding N.V. – Notes to the Consolidated Financial Statements (in € millions, except per share data) |
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Van der Moolen Holding N.V. Parent Only Statements of Cash Flow (in € millions)
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| | | Year Ended December 31, |
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| Cash flows from operating activities: | | | | | | | | | | | | |
| Net loss | | € | (3.1 | ) | | € | (9.0 | ) | | € | (58.6 | ) |
| Adjustments of non-cash items to reconcile net (loss) income to net | | | | | | | | | | | | |
| cash used in operating activities: | | | | | | | | | | | | |
| Loss from Group companies using the equity method | | | 7.0 | | | | 7.2 | | | | 57.1 | |
| Depreciation and amortization | | | 0.4 | | | | 0.4 | | | | 0.5 | |
| Release of provision on loan receivable | | | - | | | | (2.4 | ) | | | - | |
| Deferred tax (benefit) expense, net and non-cash tax effects | | | (2.1 | ) | | | (4.5 | ) | | | - | |
| Compensation expense related to stock-based compensation | | | 0.1 | | | | 0.3 | | | | 3.2 | |
| Pensions and other long-term benefit plans | | | (0.6 | ) | | | (0.3 | ) | | | (0.1 | ) |
| Distributions as included in Other income | | | (1.1 | ) | | | - | | | | - | |
| Gain on disposal of long-term investments and associates | | | - | | | | - | | | | (0.9 | ) |
| Foreign currency result, net | | | (7.6 | ) | | | 4.0 | | | | - | |
| Change in assets and liabilities net of effects from purchase or sale of | | | | | | | | | | | | |
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| Receivable from Group companies | | | 3.0 | | | | 0.5 | | | | (1.0 | ) |
| Other assets | | | (0.4 | ) | | | 6.4 | | | | (6.0 | ) |
| Payable to Group companies | | | (0.3 | ) | | | 9.7 | | | | (15.5 | ) |
| Accounts payable, accrued expenses and other liabilities | | | 1.5 | | | | (2.2 | ) | | | 1.1 | |
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| Net cash (used in) provided by operating activities | | € | (3.2 | ) | | € | 10.1 | | | € | (20.2 | ) |
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| Cash flows from investing activities: | | | | | | | | | | | | |
| Purchase of property and equipment, net | | | (0.2 | ) | | | (0.2 | ) | | | (0.2 | ) |
| Purchase of intangible assets | | | (0.2 | ) | | | - | | | | - | |
| Investments in Group companies | | | - | | | | (17.9 | ) | | | (16.8 | ) |
| Dividends received from Group companies | | | 52.0 | | | | 61.3 | | | | 108.1 | |
| Capital repayment by Group companies | | | 1.1 | | | | - | | | | - | |
| Distributions by and disposals of investments, net | | | 1.1 | | | | - | | | | 2.9 | |
| Loans granted to Group companies | | | (51.3 | ) | | | - | | | | - | |
| Loans granted | | | (5.0 | ) | | | - | | | | - | |
| Repayment on loans receivable | | | - | | | | 14.3 | | | | - | |
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| Net cash provided by (used in) investing activities | | € | (2.5 | ) | | € | 57.5 | | | € | 94.0 | |
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| Cash flows from financing activities: | | | | | | | | | | | | |
| Net increase/(decrease) in short-term borrowings | | | 48.0 | | | | (53.9 | ) | | | (35.4 | ) |
| Payments of notes payable, net | | | (0.3 | ) | | | (4.9 | ) | | | (0.4 | ) |
| Payments of subordinated notes | | | (3.6 | ) | | | (3.2 | ) | | | (3.2 | ) |
| Sale/ (purchase) of treasury shares | | | - | | | | 5.6 | | | | (8.1 | ) |
| Dividend paid | | | (6.1 | ) | | | (2.9 | ) | | | (30.2 | ) |
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| Net cash provided by (used in) financing activities | | € | 38.0 | | | € | (59.3 | ) | | € | (77.3 | ) |
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| Effects of exchange rate differences | | | 1.3 | | | | 0.8 | | | | (0.1 | ) |
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| Net change in cash and cash equivalents | | € | 33.6 | | | € | 9.1 | | | € | (3.6 | ) |
| Cash and cash equivalents at beginning of the year | | | 12.3 | | | | 3.2 | | | | 6.8 | |
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| Cash and cash equivalents at end of the year | | € | 45.9 | | | € | 12.3 | | | | 3.2 | |
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| Supplemental information: | | | | | | | | | | | | |
| Cash paid for | | | | | | | | | | | | |
| Interest | | € | 1.7 | | | € | 2.6 | | | € | 2.9 | |
| Income taxes | | € | 0.5 | | | € | - | | | € | - | |
F-46
