FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(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, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 001-13731
FRIEDMAN, BILLINGS, RAMSEY GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
VIRGINIA 54-1837743
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1001 NINETEENTH STREET NORTH
ARLINGTON, VA 22209
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(703) 312-9500
(REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF SECURITIES EXCHANGES ON WHICH REGISTERED
CLASS A COMMON STOCK, PAR VALUE $0.01 NEW YORK STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NONE
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 ____
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Aggregate market value of the voting stock held by non-affiliates of the
Registrant: $59,691,184 as of March 15, 1999.
Indicate the number of shares outstanding of each of the registrant's classes
of common stock, as of the latest practicable date:
12,584,694 shares of Class A Common Stock as of March 15, 1999 and
36,305,929 shares of Class B Common Stock as of March 15, 1999.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Registrant's Annual Report to Shareholders for the year ended
December 31, 1998, are incorporated by reference in Part II, Items 6 and 7; and
Part IV, Item 14.
Portions of the Registrant's definitive Proxy Statement to be filed with
the Securities and Exchange Commission no later than 120 days after the
Registrant's fiscal year ended December 31, 1998 and to be delivered to
stockholders in connection with the 1999 Annual meeting of Stockholders in Part
III, Items 10 (as related to Directors), 11, 12 and 13.
Indicate by check mark if disclosure of delinquent filers pursuant to 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]
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PART I
Certain statements set forth in Friedman, Billings, Ramsey Group, Inc.'s
Annual Report on Form 10-K for the year ended December 31, 1998 constitute
forward looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and are subject to the safe harbor created by such
section. Certain factors that could cause results to differ materially from
those described in the forward looking statements are enumerated in Item 1.
"Business--Factors Affecting the Company's Business, Operating Results and
Financial Condition" and elsewhere as appropriate. This Annual Report on
Form 10-K (including those items incorporated by reference), including the
Consolidated Financial Statements and the notes thereto, should be read in its
entirety for a complete understanding.
ITEM 1. BUSINESS
GENERAL
Friedman, Billings, Ramsey Group, Inc., a Virginia corporation, is the non-
operating holding company of two subsidiary non-operating holding companies:
(i)Friedman, Billings, Ramsey Capital Markets, Inc., which owns subsidiaries
engaged in brokerage, investment banking and corporate finance activities,
including its primary operating subsidiary, Friedman, Billings, Ramsey & Co.,
Inc. ("FBRC") and (ii) FBR Capital Management, Inc. (formerly Friedman,
Billings, Ramsey Asset Management, Inc.), which owns subsidiaries engaged in
asset management, investment fund and venture capital and private equity
activities. The terms "FBR" and the "Company", as used herein, refer to
Friedman, Billings, Ramsey Group, Inc. and its predecessors and its consolidated
subsidiaries, unless the context requires otherwise.
The Company is a full service investment banking and asset management firm.
FBR's strategy since inception has been to target specific industry sectors
where it believes it can develop a unique research perspective. The Company then
uses this research perspective together with its capital markets expertise to
provide value for its clients.
The Company believes the success of its strategy is demonstrated by its
increasing market presence, the performance over time of its asset management
products and the increased number of industries on which it has focused its
research, investment banking and sales and trading professionals.
The Company believes that the increases in recent years, in the depth and
complexity of the capital markets and in the number of non-traditional issuers
coupled with significant inflows of cash into mutual funds and other managed
funds, has led to greater demand by both issuers and investors for the type of
focused advisory, capital markets, and capital management products and services
that FBR offers.
The Company seeks to identify rapidly changing industries and those that are
not fully understood or appropriately valued by the market. Once an industry is
identified, the Company develops a thorough understanding of the fundamentals
and opportunities of that industry. The Company employs a team approach in which
professionals from various groups within the Company have the opportunity to
contribute to and communicate the Company's expertise in an industry. For each
industry on which the Company is focused, the Company, through its various
subsidiaries, offers significant underwriting capabilities, brokerage services
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and advisory services in mergers, acquisitions and strategic partnerships, as
well as asset management services, including separate accounts, proprietary
investment partnerships, public mutual funds, private equity and venture capital
and mezzanine finance.
The Company believes its strategy and culture provide a foundation for success
in a changing marketplace. Since commencing its investment banking activities in
1992, FBRC has completed approximately $17.0 billion in capital raising
transactions and approximately $6.5 billion in merger and acquisition and other
advisory transactions which span a wide range of geographic regions and security
types and a growing variety of industry sectors.
The Company has also applied its research focus and team-based approach to its
asset management activities. At December 31, 1996, 1997 and 1998 assets under
management were $216.2 ,$641.6 and $688.8 million, respectively. At December 31,
1998, 72 percent or $496.3 million of these assets were assets which allow FBR
to earn performance related incentive income above a base management fee.
The Company's revenues for the years ended December 31, 1996, 1997 and 1998
were $109.9, $256.1 and $122.9 respectively. The 52% decline in revenue from
1997 to 1998 was largely attributable to a decline in underwriting activity in
the second half of 1998 and to market making losses related to the securities of
companies in which FBR acted as underwriter.
CULTURE AND STRATEGY
FBR began as a secondary research and trading firm, dependent on its ability
to identify undervalued investment opportunities. FBR has a culture where ideas
are developed as a team and communicated as a team to its clients. Although the
Company has grown from 17 to 358 people at December 31, 1998, it has sought to
maintain a culture of teamwork and broad-based knowledge of investment theses.
The Company seeks to continue to emphasize its culture while executing the five
core business strategies described below.
Identify Rapidly-evolving or Undervalued Industries. FBR continually searches
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for industries and sectors where it can produce innovative market insights
through its integrated research-focused approach and provide value for its
investment banking, institutional brokerage and asset management clients.
Build on In-depth, Focused Industry Coverage. FBR believes that industry
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specialization is critical to meeting the requirements of its clients for
sophisticated and non-traditional investment advice. The Company organizes its
research, investment banking and asset management activities along industry
specializations,continually re-examining its industry categories, and monitoring
them to ensure coverage of emerging opportunities. The Company's strategy is to
focus on selected segments within a limited number of undervalued, high
potential industries and to offer FBR's full range of research, investment
banking, sales and trading and asset management services within those
industries.
Build and Maintain Lasting Relationships. FBR has built a core base of
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institutional brokerage and investment banking clients. FBR believes that it has
generated client loyalty and goodwill by virtue of its diligent service. FBR
values these relationships and regards them as an essential part of the
foundation for many of its businesses. FBR continues to establish, and intends
to build, similar new relationships in the future.
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Bring Under-valued Companies to Sophisticated Investors. FBR seeks to identify
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opportunities where sophisticated capital and undervalued companies intersect.
FBR believes that its fundamental understanding and commitment to undervalued,
high-potential industries has enabled the Company to build significant
credibility in the issuer and investor communities.
Offer Expanded Range of Services to Clients. FBR's strategy is to capture a
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greater share of the revenue opportunities available from FBR investment
banking, asset management and brokerage clients. For issuers, FBR has expanded
from its core equity capital raising and research capabilities to provide high
yield debt, financial advisory (including merger and acquisition, stock
buybacks, and dividend analysis), venture capital, private equity, mezzanine
financing, and corporate and high net worth services. For investors, FBR has
expanded from its core sales and trading capabilities to provide asset
management, venture capital and private equity services. In addition, FBR
continues to expand the number of industries on which its research is focused
and now offers investors direct access to its research product via the internet.
STRATEGIC BUSINESS RELATIONSHIP WITH PNC BANK CORP.
PNC Bank Corp. ("PNC") owns just under 5% of the outstanding shares of FBR
common stock. FBR and PNC have established a strategic business relationship
with respect to selected capital markets and related activities. FBR and PNC
work together on an arms-length basis to refer potential business to each other.
PNC is an investor in certain of FBR's private equity, venture and proprietary
investment partnerships.
PNC, a registered bank holding company, is one of the largest diversified
financial services companies in the United States with consolidated assets at
December 31, 1998 of $77.2 billion. PNC offers a variety of financial products
and services in its primary geographic locations in Pennsylvania, New Jersey,
Delaware, Ohio and Kentucky and nationally through retail distribution networks
and alternative delivery channels.
INVESTMENT BANKING
FBRC's underwriting and corporate finance activities consist of a broad range
of services, including public and private offerings of a wide variety of
securities and financial advisory services in merger and acquisition, mutual to
stock conversions, strategic partnering transactions and other advisory
assignments.
Capital Raising Activities
FBRC's capital raising activities have encompassed a wide range of securities,
structures and amounts. FBRC is a leading underwriter of securities in its areas
of focus, and FBRC is dedicated to the successful completion and aftermarket
performance of each underwriting transaction it executes. FBRC's investment
banking, research, and sales professionals employ an integrated methodology,
each benefiting from and building on the others' capabilities to execute
successfully underwriting assignments.
The successful execution of an underwritten transaction is predominantly
determined by the lead manager. As a result, FBRC has sought to enhance the
quality and reputation of its investment banking services delivered to its
corporate clients by acting as sole or lead manager of an offering. FBRC
recognizes, however, that as it expands the number of industries on which it
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focuses and as competition increases for underwriting activity it may
increasingly act as a co-manager or syndicate member on underwritten
transactions will increase.
FBRC bases its decision to underwrite an offering of a company's securities on
due diligence, company fundamentals, management's track record, historical
financial results and financial projections. FBRC chooses to underwrite clients
that it believes will be able to execute long-term strategies that will deliver
significant returns to investors. As a result, FBRC's investment banking focus
is nationwide.
FBRC's strategy is to maintain long-term relationships with its corporate
clients by serving their capital needs beyond their initial access to capital
markets. FBRC also seeks to increase its base of publicly held clients by
serving as a lead or co-manager or syndicate member in follow-on offerings for
companies which FBRC believes have attractive investment characteristics,
whether or not FBRC participated as a lead or co-manager in the IPOs for such
companies.
Beginning in 1996, in connection with certain capital raising transactions,
FBRC has received and seeks to receive warrants for stock of its capital raising
clients. The Company carries the warrants at a nominal value in its financial
statements. The Company has decided that as part of the retention element of its
employee compensation programs, that certain non-executive officer employees
will receive up to 40% of the these warrants.
Mergers and Acquisitions Advisory Services
FBRC's mergers and acquisitions group uses the firm's research capability,
business valuation skills and secondary market experience to evaluate merger and
acquisition candidates and opportunities for its clients. FBRC believes that its
research capacity and capital raising activities have created a network of
relationships that enable it to identify and engineer mutually beneficial
combinations between companies. As a financial advisor, FBRC relies upon its
experience gained through in-depth and daily involvement in the capital markets.
Financial advisory services have included advice on mergers and on acquisitions
(including ongoing review of merger and acquisition opportunities), market
comparable performance analysis, advice on dividend policy, and evaluation of
stock repurchase programs. In 1998, FBRC provided merger and acquisition and
other advisory services in transactions valued at $3.7 billion in the aggregate.
RESEARCH SERVICES
FBR's creation in 1989 as a research and trading firm laid the foundation
for FBR's commitment to research and its focus on the role research services
play in the investment banking and institutional brokerage process. FBRC's
research analysts operate under two guiding principles: (i) to identify
undervalued investment opportunities in the capital markets and (ii) to
communicate effectively the fundamentals of these investment opportunities to
Company professionals and potential investors. To achieve these objectives,
FBRC believes that industry specialization is necessary, and, as a result, FBRC
organizes its research staff along industry lines. Each industry team works
together to identify and evaluate industry trends and developments. Within
industry groups, analysts are further subdivided into specific areas of focus so
that they can maintain and apply specific industry knowledge to each investment
opportunity they address. To achieve this level of specialization, FBRC seeks to
recruit or train analysts with significant industry and technical expertise, in
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addition to securities industry expertise. In this manner, FBRC believes that
its analysts can assess the capital markets to identify attractive investment
opportunities within their strategic niches, can assist investment banking
personnel in valuing companies accessing the capital markets for the first time,
and in evaluating merger and acquisition and other strategic transactions and
can effectively monitor and communicate developments relating to the scope of
their research to the institutional sales force and institutional investors.
FBRC has focused its research efforts in some of the fastest growing and most
rapidly changing sectors of the United States and world economies. These sectors
include banks, thrifts, real estate investment trusts, specialty finance
companies, homebuilding, Internet, healthcare, automotive retailing, information
technology, electronic commerce, telecommunications, gaming, industry
consolidators, health care information technology, insurance and energy. FBR
believes these industry sectors will have great demand for the products and
services it offers in the future and provide ample diversification for its
business.
After initiating coverage on a company, FBRC's analysts seek to maintain a
long-term relationship with that company and a long-term commitment to ensuring
that new developments are effectively communicated to FBRC's sales force and
institutional investors. FBRC produces full-length research reports, notes or
earnings estimates on more than 460 issuers. In addition, FBRC analysts
distribute written updates on these issuers both internally and to FBRC clients
through the use of daily morning meeting notes, real-time electronic mail and
other forms of immediate communication. FBRC's clients can also receive analyst
comments through the Friedman, Billings, Ramsey web site (www.fbr.com). FBRC
also makes its research available through electronic media, including Multex and
First Call.
SALES AND TRADING
FBRC and its United Kingdom affiliate, Friedman, Billings, Ramsey
International Ltd., focus on institutional sales to and trading services for
equity and high-yield investors in the United States, Europe and elsewhere. The
Company executes securities transactions for institutional investors such as
banks, mutual funds, insurance companies, hedge funds, money managers and
pension and profit-sharing plans. Institutional investors normally purchase and
sell securities in large quantities, which requires special marketing and
trading expertise.
FBR's sales professionals provide services to a nationwide institutional
client base as well as to institutional clients in Europe and elsewhere. Sales
professionals work closely with FBRC's research analysts to provide the most up-
to-date information to the Company's institutional clients. Starting in late
1998, FBRC reorganized its sales professionals into teams focused on particular
industry sectors in order to facilitate the communication of in-depth
information to FBR's clients. Each team maintains regular contact with FBR's
research staff and with the specialized portfolio managers and buy-side analysts
of each institutional client.
FBRC's trading professionals facilitate trading in equity and high-yield
securities. FBRC is involved in market-making in Nasdaq and other OTC
securities, trading listed securities and servicing the trading desks of major
institutions in the United States and Europe. FBRC's trading professionals have
direct access to the major stock exchanges, including the New York Stock
Exchange and the American Stock Exchange, Inc. as a result of FBRC's
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relationship with its clearing broker. At year-end 1998, FBR made a market in
more than 400 securities.
PRIVATE CLIENT GROUP
Since its inception in 1989, FBR has provided services to corporate executives
and small institutions, as well as to other sophisticated high net worth
clients. In late 1997, the Company formed the Private Client Group ("PCG") to
focus on the growth of this business for FBR's growing corporate client base.
Given FBR's strong investment banking relationships with both public and private
companies, the Company believes that there are natural synergies between its PCG
and the executives of these companies.
The PCG seeks to offer creative money management solutions and investment
ideas suited to high net worth individuals. Using a consultative approach, PCG
professionals research, interpret, evaluate and select sophisticated investment
strategies. PCG specializes in hedging and preserving significant equity
positions as well as offering traditional brokerage services.
Additionally, PCG professionals are knowledgeable in various aspects of the
sale of restricted and control stocks as well as the financing of employee stock
options. Individuals who own restricted or control stock receive PCG assistance
with the complex regulations and paperwork required to sell such securities. For
individuals unable to sell positions, PCG offers a number of strategies for
preserving value in such assets, as well as the ability to borrow funds at
favorable rates to provide liquidity.
SYNDICATE
FBRC's Syndicate Department coordinates FBRC's participation as an underwriter
in corporate securities distributions. In an underwriting transaction, FBRC acts
as sole or lead manager, co-manager, or member of an underwriting syndicate
managed by other investment banks. In transactions in which FBRC is the sole or
lead manager, the Syndicate Department coordinates the marketing and book-
building process, and participates in discussions with the issuer leading to the
pricing of the offered securities on behalf of the underwriting group. In
transactions in which FBRC is a co-manager or syndicate member, the Syndicate
Department coordinates FBRC's activities with the lead underwriter.
ASSET MANAGEMENT
The Company seeks to leverage the expertise of its research professionals and
portfolio managers to develop and implement investment strategies on behalf of
institutional and high net worth individual investors. At December 31, 1998, the
Company had assets under management of more than $689 million. Following is a
description of the Company's primary asset management products.
Proprietary Investment Partnerships
At December 31, 1998, the Company's proprietary investment partnerships had
$189.6 million under management. In addition to base fees, these partnerships
provide for incentive income, if certain benchmarks are met. The largest of
these partnerships uses investment strategies primarily involving publicly-
traded financial services companies' equity and fixed income securities. In
1998, the Company added an arbitrage fund to the partnerships it manages.
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Private Equity and Venture Capital
At December 31, 1998, the Company's private equity and venture capital funds
had approximately $156.2 million in assets under management, a 162 percent
increase over December 31, 1997. In addition to base fees, these funds provide
for incentive income, if certain benchmarks are met. FBR Private Equity Fund,
L.P. was formed in June 1996 to make private investments, primarily in small
financial services firms. FBR Technology Venture Partners, L.P., a venture
capital fund dedicated to technology investments in software, communication, and
Internet companies, was formed in August 1997.
Mutual Funds
The FBR Family of Funds, an open-end management type investment company
registered under the Investment Company Act of 1940, began business in 1997 and
currently is comprised of four no-load funds: the FBR Financial Services Fund,
the FBR Small Cap Financial Services Fund, the FBR Small Cap Growth/Value Fund
and the FBR Realty Growth Fund, added in 1998. At December 31, 1998, total
assets included in The FBR Family of Funds were $118.6 million.
FBR Investment Services, Inc.("FBRIS") is the distributor of The FBR Family of
Funds. FBRIS is registered as a broker-dealer with the SEC and is a member of
the NASD. FBRIS operates from the Company's headquarters building and uses its
own existing client base, as well as the contacts of FBR's other groups, to
market the FBR Family of Funds.
FBR Asset Investment Corp.
FBR Asset Investment Corp. (FBR-Asset) is a real estate investment trust
managed by the Company and is 16% owned by the Company. FBR-Asset invests in
real-estate related assets, including mortgage loans and mortgage-backed
securities, as well as securities of companies engaged in real estate-related
activities. At December 31, 1998, FBR-Asset had total assets of $295.9 million,
shareholders' equity of $150.9 million and book value of $17.66 per share. The
Company receives dividend income on its investment in FBR-Asset, as well as base
management fees and, is entitled to receive performance based incentive income
if certain performance benchmarks are met.
ACCOUNTING, ADMINISTRATION AND OPERATIONS
The Company's accounting, administration and operations personnel are
responsible for financial controls, internal and external financial reporting,
office and personnel services, the Company's management information and
telecommunications systems, and the processing of the Company's securities
transactions. With the exception of payroll processing, which is performed by an
outside service bureau, and customer account processing, which is performed by
the Company's clearing broker, most data processing functions are performed by
the Company's management information systems department. The Company believes
that future growth will require implementation of new and enhanced
communications and information systems and training of its personnel to operate
such systems as well as the hiring of additional personnel.
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COMPETITION
The Company is engaged in the highly competitive securities brokerage and
financial services businesses. The Company competes directly with large Wall
Street securities firms, securities subsidiaries of major commercial bank
holding companies, U.S. subsidiaries of large foreign institutions, major
regional firms and smaller niche players, and those offering competitive
services via the Internet. To an increasing degree, the Company also competes
for various segments of the financial services business with other institutions,
such as commercial banks, savings institutions, mutual fund companies, life
insurance companies and financial planning firms.
In addition to competing for investment clients, companies in the securities
industry compete to attract and retain experienced and productive investment
professionals. See "Factors Affecting the Company's Business, Operations and
Financial Condition - Competition for Retaining and Recruiting Personnel."
Many competitors have greater personnel and financial resources than the
Company. Larger competitors are able to advertise their products and services on
a national or regional basis and may have a greater number and variety of
distribution outlets for their products, including retail distribution. Discount
and Internet brokerage firms market their services through aggressive pricing
and promotional efforts. In addition, some competitors have much more extensive
investment banking activities than the Company and therefore may possess a
relative advantage with regard to access to deal flow and capital.
Recent rapid advancements in computing and communications technology, in
particularly the Internet, are substantially changing the means by which
financial services are delivered. These changes are providing consumers with
more direct access to a wide variety of financial and investment services,
including market information and on-line trading and account information.
Advancements in technology also create demand for more sophisticated levels of
client services. The Company is committed to utilizing technological
advancements to provide a high level of client service to its target market of
institutional and high net worth clients. Provision of these services may entail
considerable cost without an offsetting source of revenue.
EMPLOYEES
At December 31, 1998, the Company had a total of 358 full-time employees, of
whom 60 were engaged in research, 93 in investment banking, 103 in sales,
trading and syndicate, 33 in venture capital, private equity and asset
management activities and 69 in accounting, administration and operations. Of
these employees, 266 were classified as professionals and 92 were in support
positions. The Company also had 22 interns. None of the Company's employees are
subject to a collective bargaining agreement. The Company believes that its
relations with its employees are excellent.
RISK MANAGEMENT
The Company has established various policies and procedures for the management
of its exposure to operating, principal and credit risk. There can be no
assurance that the Company's risk management procedures and internal controls
will prevent or reduce any such risks. Operating risk arises out of the daily
conduct of the Company's business and relates to the possibility that one or
more of the Company's personnel could cause the Company to engage in imprudent
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business activities. Principal risk relates to the fact that the Company holds
securities that are subject to changes in value, and such changes could result
in the Company incurring material losses. Credit risk occurs because the Company
extends credit through its clearing broker to various of its customers in the
form of margin and other types of loan activities that are normal industry
practices.
Operating risk is monitored by managers of the Company's business groups, and
by the directors of each of the Company's operating subsidiaries. These
directors review the overall business activities of each of the Company's
subsidiaries, and issue directions to address issues which, in the judgment of
the directors, could result in a material loss to the Company.
Principal risk is managed primarily by conducting real-time monitoring of the
amount and types of securities held from time to time by the Company and by
limiting the exposure to any one investment or type of investment. The most
common categories of securities owned are those related to the daily trading
activities of the Company's brokerage operations and those which arise out of
the Company's underwriting, asset management and mezzanine financing activities
and other securities held for investment and available for sale. The Company
attempts to limit its exposure to market risk on securities held as a result of
its daily trading activities by limiting its inventory of trading securities to
the amount needed to provide the appropriate level of liquidity in the
securities for which it is a market maker.
Credit risk is monitored both by the Company's own operations personnel and by
the Company's clearing broker. Margin calls are issued if the value of
collateral declines below established margin requirements, and margin
maintenance requirements are increased in the event that the concentration in a
client's account exceeds certain levels.
REGULATION
In the United States, a number of federal regulatory agencies are charged with
safeguarding the integrity of the securities and other financial markets and
with protecting the interests of customers participating in those markets. The
Securities and Exchange Commission ("SEC") is the federal agency that is
primarily responsible for the regulation of broker-dealers and investment
advisers doing business in the United States, and the Federal Reserve Board
promulgates regulations applicable to securities credit (margin) transactions
involving broker-dealers and certain other institutions in the United States.
Much of the regulation of broker-dealers has been delegated to self-regulatory
organizations ("SROs"), principally the NASD (and its subsidiaries NASD
Regulation, Inc. and the Nasdaq Stock Market ("Nasdaq")), and the national
securities exchanges. These organizations(which are subject to approval by the
SEC) that govern the industry, monitor daily activity and conduct periodic
examinations of member broker-dealers. While FBRC and the Company's other
broker-dealer subsidiaries are not members of the New York Stock Exchange
("NYSE"), the Company's business is impacted by the exchange's rules and the
Company's Class A common stock is listed for trading on the NYSE.
Securities firms are also subject to regulation by state securities
commissions in the states in which they are required to be registered. FBRC is
registered as a broker-dealer with the SEC and in 49 states, Puerto Rico and the
District of Columbia, and is a member of, and subject to regulation by the NASD
and the Municipal Securities Rulemaking Board. FBRIS is registered as a broker-
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dealer with the SEC in all 50 states, Puerto Rico and the District of Columbia;
it is a member of the NASD.
As a result of federal and state registration and SRO memberships, FBRC and
FBRIS are subject to overlapping schemes of regulation which cover all aspects
of their securities business. Such regulations cover matters including capital
requirements, uses and safe-keeping of clients' funds, conduct of directors,
officers and employees, record-keeping and reporting requirements, supervisory
and organizational procedures intended to assure compliance with securities laws
and to prevent improper trading on material nonpublic information, employee-
related matters, including qualification and licensing of supervisory and sales
personnel, limitations on extensions of credit in securities transactions,
clearance and settlement procedures, requirements for the registration,
underwriting, sale and distribution of securities, and rules of the SROs
designed to promote high standards of commercial honor and just and equitable
principles of trade. A particular focus of the applicable regulations concerns
the relationship between broker-dealers and their customers. As a result, many
aspects of the broker-dealer customer relationship are subject to regulation
including, in some instances, "suitability" determinations as to certain
customer transactions, limitations on the amounts that may be charged to
customers, timing of proprietary trading in relation to customers' trades and
disclosures to customers.
FBRC and FBRIS are also subject to "Risk Assessment Rules" imposed by the SEC
which require, among other things, that certain broker-dealers maintain and
preserve certain information, describe risk management policies and procedures
and report on the financial condition of certain affiliates whose financial and
securities activities are reasonably likely to have a material impact on the
financial and operational condition of the broker-dealers. Certain "Material
Associated Persons" (as defined in the Risk Assessment Rules) of the broker-
dealers and the activities conducted by such Material Associated Persons may
also be subject to regulation by the SEC. In addition, the possibility exists
that, on the basis of the information it obtains under the Risk Assessment
Rules, the SEC could seek authority over the Company's unregulated subsidiaries
either directly or through its existing authority over the Company's regulated
subsidiaries.
Three of the Company's asset management subsidiaries are registered as
investment advisers with the SEC. As investment advisers registered with the
SEC, they are subject to the requirements of the Investment Advisers Act of 1940
and the SEC's regulations thereunder. Such requirements relate to, among other
things,limitations on the ability of investment advisers to charge performance-
based or non-refundable fees to clients, record-keeping and reporting
requirements, disclosure requirements, limitations on principal transactions
between an adviser or its affiliates and advisory clients, as well as general
anti-fraud prohibitions. They may also be subject to certain state securities
laws and regulations. The state securities law requirements applicable to
registered investment advisers are in certain cases more comprehensive than
those imposed under the federal securities laws. In addition, FBR Fund Advisers,
Inc. and the mutual funds it manages are subject to the requirements of the
Investment Company Act of 1940 and the SEC's regulations thereunder.
In the event of non-compliance by the Company or one of its subsidiaries with
an applicable regulation, governmental regulators and the one or more of the
SROs may institute administrative or judicial proceedings that may result in
censure, fine, civil penalties (including treble damages in the case of insider
trading violations), the issuance of cease-and-desist orders, the deregistration
12
or suspension of the non-compliant broker-dealer or investment adviser, the
suspension or disqualification of officers or employees or other adverse
consequences. The imposition of any such penalties or orders on the Company or
its personnel could have a material adverse effect on the Company's operating
results and financial condition.
The Company's business is also subject to regulation by various foreign
governments and regulatory bodies. FBRC is registered with and subject to
regulation by the Ontario Securities Commission in Canada. FBR International,
Ltd. ("FBRIL"), FBR's United Kingdom brokerage subsidiary, is subject to
regulation by the Securities and Futures Authority in the United Kingdom ("SFA")
pursuant to the United Kingdom Financial Services Act of 1986. Foreign
regulation may govern all aspects of the investment business, including
regulatory capital, sales and trading practices, use and safekeeping of customer
funds and securities, record-keeping, margin practices and procedures,
registration standards for individuals, periodic reporting and settlement
procedures.
In connection with much of the Company's asset management activities, the
Company and the private investment vehicles that it manages are relying on
exemptions from registration under the Investment Company Act of 1940, and under
certain state securities laws and the laws of various foreign countries. Failure
to comply with the initial and continuing requirements of any such exemptions
could have a material adverse effect on the manner in which the Company and
these vehicles carry on their activities.
Additional legislation and regulations, including those relating to the
activities of broker-dealers and investment advisers, changes in rules
promulgated by the SEC or other United States or foreign governmental regulatory
authorities and SROs or changes in the interpretation or enforcement of existing
laws and rules may adversely affect the manner of operation and profitability of
the Company. The Company's businesses may be materially affected not only by
regulations applicable to it as a financial market intermediary, but also by
regulations of general application. For example, the volume of FBR's
underwriting, merger and acquisition, securities trading and asset management
activities in any year could be affected by, among other things, existing and
proposed tax legislation, antitrust policy and other governmental regulations
and policies (including the interest rate policies of the Federal Reserve Board)
and changes in interpretation or enforcement of existing laws and rules that
affect the business and financial communities.
NET CAPITAL REQUIREMENTS
As broker-dealers registered with the SEC and as member firms of the NASD,FBRC
and FBRIS are subject to the net capital requirements of the SEC and the NASD.
FBRIL is subject to the capital regulations of the SFA. These capital
requirements specify minimum levels of capital, computed in accordance with
regulatory requirements, that each firm is required to maintain and also limit
the amount of leverage that each firm is able to obtain in its respective
business.
"Net capital" is essentially defined as net worth (assets minus liabilities,
as determined under generally accepted accounting principles), plus qualifying
subordinated borrowings, less the value of all of a broker-dealer's assets that
are not readily convertible into cash (such as furniture, prepaid expenses and
unsecured receivables), and further reduced by certain percentages (commonly
called "haircuts") of the market value of a broker-dealer's positions in
13
securities and other financial instruments. The amount of net capital in excess
of regulatory minimum is referred to as "excess net capital."
The SEC's capital rules also (i) require that broker-dealers notify it, in
writing, two business days prior to making withdrawals or other distributions of
equity capital or lending money to certain related persons if those withdrawals
would exceed, in any 30-day period, 30% of the broker-dealer's excess net
capital, and that they provide such notice within two business days after any
such withdrawal or loan that would exceed, in any 30-day period, 20% of the
broker-dealer's excess net capital, (ii) prohibit a broker-dealer from
withdrawing or otherwise distributing equity capital or making related party
loans if after such distribution or loan, the broker-dealer would have net
capital of less than $300,000 or if the aggregate indebtedness of the broker-
dealer's consolidated entities would exceed 1,000% of the broker-dealer's net
capital and in certain other circumstances, and (iii) provide that the SEC may,
by order, prohibit withdrawals of capital from a broker-dealer for a period of
up to 20 business days, if the withdrawals would exceed, in any 30-day period,
30% of the broker-dealer's excess net capital and if the SEC believes such
withdrawals would be detrimental to the financial integrity of the firm or would
unduly jeopardize the broker-dealer's ability to pay its customer claims or
other liabilities.
Compliance with regulatory net capital requirements could limit those
operations that require the intensive use of capital, such as underwriting and
trading activities, and also could restrict the Company's ability to withdraw
capital from its affiliated broker-dealers, which in turn could limit its
ability to pay dividends, repay debt and redeem or repurchase shares of its
outstanding capital stock.
The Company believes that at all times FBRC and FBRIS have been in compliance
in all material respects with the applicable minimum net capital rules of the
SEC and the NASD and that FBR International has been in compliance in all
material respects with the applicable minimum net capital rules of the SFA. As
of December 31, 1998, FBRC was required to maintain minimum net capital, in
accordance with SEC rules, of approximately $1.0 million and had total net
capital of approximately $37.0 million, or approximately $36.0 million of excess
net capital. As of December 31, 1998, FBRIS was required to maintain minimum net
capital, in accordance with SEC rules, of $50,000 and had total net capital of
approximately $359,000, or approximately $309,000 of excess net capital. FBRIL
was required to maintain minimum net capital under SFA rules of the equivalent
of $847,000 and had total net capital of approximately $1 million, or
approximately $174,000 in excess of the minimum amount required.
A failure of a broker-dealer to maintain its minimum required net capital
would require it to cease executing customer transactions until it came back
into compliance, and could cause it to lose its NASD membership, its
registration with the SEC or require its liquidation. Further, the decline in a
broker-dealer's net capital below certain "early warning levels," even though
above minimum net capital requirements, could cause material adverse
consequences to the broker-dealer and to the Company.
FACTORS AFFECTING THE COMPANY'S BUSINESS, OPERATING RESULTS AND FINANCIAL
CONDITION
The statements in this Form 10-K that relate to future plans, events or
performance are forward looking statements that involve risks and uncertainties.
The Company cautions the reader that actual results may differ materially due to
14
a variety of important factors, including, among others, those discussed below
and in "Competition" above. These factors could have a material adverse affect
on the Company's business, operating results and financial condition.
The securities business is, by its nature, subject to numerous and substantial
risks, particularly in volatile or illiquid markets, and in markets influenced
by sustained periods of low or negative economic growth, including the risk of
losses resulting from the underwriting or ownership of securities, trading,
principal activities, counterparty failure to meet commitments, customer default
and fraud, customer complaints, employee errors, misconduct and fraud (including
unauthorized transactions by traders), failures in connection with the
processing of securities transactions, litigation and arbitration, the risks of
reduced revenues in periods of reduced demand for public offerings or reduced
activity in the secondary markets and the risk of reduced spreads on the trading
of securities.
Reduced Revenues during Periods of Declining Prices or Reduced Demand for
Public Offerings or Reduced Activity in the Secondary Markets in Sectors on
which the Company Focuses
The Company's revenues are likely to be lower during periods of declining
prices or inactivity in the market for securities of companies in the sectors on
which the Company is focused. The Company's business is particularly dependent
on the market for equity offerings by, and secondary trading in, companies in
the financial services, technology and real estate industries. These markets
have historically experienced significant volatility not only in the number and
size of equity offerings, but also in the after-market trading volume and prices
of newly issued securities. For example, during the second half of 1998, the
market for equity offerings deteriorated and the market prices of many of the
securities which FBR had underwritten and made a market in were subject to
considerable volatility and declines in price. These factors led to a
significant reduction in underwriting revenues and to significant market making
losses for the Company.
Historically, growth in the Company's revenues arose in large part from a
significantly increased number and size of underwritten transactions by
companies in the Company's targeted industries and by the related increase in
aftermarket trading for such companies. Underwriting activities in the Company's
targeted industries can decline for a number of reasons. For example, as noted
above, underwriting activity generally (and particularly in the Company's areas
of focus) was adversely affected in the second half of 1998 due to, among other
things, concerns about the effect of the global economy on United States
markets. Underwriting activity may also decrease due to increased competition
for underwriting business or due to periods of market uncertainty occasioned by
concerns over inflation, rising interest rates and related issues. Underwriting
and brokerage activity can also be materially adversely affected for a company
or industry segment by disappointments in quarterly performance relative to
analysts' expectations or by changes in long-term prospects.
Reduced Revenues Due to Economic, Political and Market Conditions
Reductions in public offering, merger and acquisition and securities trading
activities, due to any one or more changes in economic, political or market
conditions could cause the Company's revenues from investment banking, trading
and sales activities to decline materially. The amount and profitability of
these activities are affected by many national and international factors,
including economic, political and market conditions; level and volatility of
15
interest rates; legislative and regulatory changes; currency values; inflation;
flows of funds into and out of mutual and pension funds; and availability of
short-term and long-term funding and capital. For example, in 1998, concerns
about the economies of Russia and some Asian countries adversely affected
underwriting and securities trading activity in the United States.
Reduced Revenues Due to Declining Market Volume, Price or Liquidity
As occurred in 1998, the Company's revenues may decrease in the event of a
decline in market volume, prices or liquidity. Declines in the volume of
securities transactions and in market liquidity generally result in lower
revenues from trading activities and commissions. Lower price levels of
securities may also result in a reduced volume of underwriting transactions, and
could cause a reduction in revenue from corporate finance fees, as well as
losses from declines in the market value of securities held in trading,
investment and underwriting positions, reduced asset management fees and
withdrawals of funds under management. Sudden sharp declines in market values of
securities can result in illiquid markets and the failure of issuers and
counterparties to perform their obligations, as well as increases in claims and
litigation, including arbitration claims from customers. In such markets, the
Company has incurred, and may incur in the future, reduced revenues or losses in
its principal trading and market-making activities.
Possibility of Losses Associated with Underwriting Activities
Participation in underwritings involves both economic and regulatory risks. An
underwriter may incur losses if it is unable to resell the securities it is
committed to purchase or if it is forced to liquidate its commitment at less
than the agreed purchase price. In addition, the trend, for competitive and
other reasons, toward larger commitments on the part of lead underwriters means
that, from time to time, an underwriter (including a co-manager) may retain
significant position concentrations in individual securities. Increased
competition has eroded and is expected to continue to erode underwriting
spreads. Another result of increased competition is that revenues from
individual underwriting transactions have been increasingly allocated among a
greater number of co-managers, which has resulted in reduced revenues for
certain transactions. For example, in 1998, FBRC saw the average revenue per
transaction decrease by approximately 50%. FBRC's underwriting business is very
competitive and is expected to remain so in the near future.
Net Capital Requirements
Underwriting commitments require a charge against net capital and,
accordingly, the Company's ability to make underwriting commitments may be
limited by the requirement that it must at all times have sufficient capital to
meet the applicable net capital regulations. See "Net Capital Requirements"
above.
Focus on Relatively Few Industries
As a result of its dependence on revenues related to securities issued by
companies in specific industry sectors, any downturn in the market for the
securities of companies in these industries, or factors affecting such
companies, could adversely affect the Company's operating results and financial
condition. In 1998, the specialty finance companies, equity REITs and mortgage
REITS on which the Company focused experienced a significant downturn which in
turn adversely affected the Company. Securities offerings can vary significantly
16
from industry to industry due to economic, legislative, regulatory and political
factors. Underwriting activities in a particular industry can decline for a
number of reasons. For example, underwriting activities in the financial
services industry decreased significantly starting in the third quarter of
calendar 1998 and, to date, have not recovered. Underwriting and brokerage
activity can also be materially adversely affected for a company or industry
segment by disappointments in quarterly performance relative to analysts'
expectations, or by changes in long-term prospects for particular companies,
industries or industry segments.
The financial services, technology, REIT and consolidation sectors, and to a
lesser extent the insurance and energy sectors, account for the majority of the
Company's investment banking, asset management and research activities, exposing
the Company to potential downturns in these industries. The Company also derives
a significant portion of its revenues from institutional brokerage transactions
related to the securities of companies in these sectors. In the past, revenues
from such institutional brokerage transactions have declined when underwriting
activities in these industry sectors declined, the volume of trading on Nasdaq
or the NYSE declined, or when industry sectors or individual companies reported
results below investors' expectations.
Significant Fluctuations in Quarterly Operating Results
The Company's revenues and operating results may fluctuate from quarter to
quarter and from year to year due to a combination of factors, including the
number of underwriting and merger and acquisition transactions completed by the
Company's clients, access to public markets for companies in which the Company
has invested as a principal, the valuations of the Company's principal
investments and the investments of funds managed by the Company, the level of
institutional and retail brokerage transactions, the timing of recording of
asset management fees and special allocations of income, variations in
expenditures for personnel, litigation expenses, and expenses of establishing
new business units. The Company's revenues from underwriting transactions are
recorded only when the underwriting is completed. Revenues from merger and
acquisition transactions are recorded only when the services have been rendered
and the client is contractually obligated to pay; generally, most of the fee is
earned only after the transaction closes. Accordingly, the timing of the
Company's recognition of revenue from a significant transaction may be delayed
and can materially affect the Company's quarterly operating results. The
Company's cost structure currently is oriented to meet a level of demand for
underwriting and corporate finance transactions experienced prior to the second
half of 1998. As a result, despite the variability of professional incentive
compensation, the Company could experience losses if demand for these
transactions returns to the levels that the Company experienced in the second
half of 1998. Due to the foregoing and other factors, there can be no assurance
that the Company will be able to sustain profitability on a quarterly or annual
basis. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Competition for Retaining and Recruiting Personnel
The Company's business is dependent on the highly skilled, and often highly
specialized, individuals it employs. Retention of research, investment banking,
sales and trading, asset management, venture capital, mezzanine lending, and
management and administrative professionals is particularly important to the
Company's prospects. The Company's strategy is to establish relationships with
the Company's prospective corporate clients in advance of any transaction, and
17
to maintain such relationships over the long term by providing advisory services
to corporate clients in equity, debt and merger and acquisition transactions.
Such relationships depend in part upon the individual employees who represent
the Company in its dealings with such clients. In addition, research
professionals contribute significantly to the Company's ability to secure a role
in managing public offerings and in executing trades in the secondary market.
From time to time, other companies in the securities industry have experienced
losses of professionals in all areas of the securities business. The level of
competition for key personnel has increased recently, particularly due to the
market entry efforts of certain non-brokerage U.S. and foreign financial
services companies, commercial banks and other investment banks targeting or
increasing their efforts in some of the same industries that the Company serves.
While the Company has historically experienced little turnover in professional
employees, there can be no assurance that losses of key personnel due to such
competition or otherwise will not occur in the future. The loss of
professionals, particularly a senior professional with a broad range of contacts
in an industry, could materially and adversely affect the Company's operating
results.
Although the Company made certain targeted personnel reductions in 1998, the
Company experienced overall growth in the number of its personnel in 1998 (and
expects to experience continued growth) in specific areas of its business which
it has targeted for growth. Competition for employees with the qualifications
desired by the Company is intense, especially with respect to research, asset
management and investment banking professionals with expertise in industries in
which underwriting or advisory activity is robust. Competition for the
recruiting and retention of employees has recently increased elements of the
Company's compensation costs, and the Company expects that continuing
competition may cause its compensation costs to continue to increase. There can
be no assurance that the Company will be able to recruit a sufficient number of
new employees with the desired qualifications in a timely manner. The failure to
recruit new employees could have a material adverse effect on the Company's
future operating results.
While the Company generally does not have employment agreements with its
employees, it attempts to retain its employees with incentives, such as bonus
plans, the grant of warrants to purchase the stock of companies that the Company
has received for investment banking services and the grant of options to
employees to buy Company stock that vests over a number of years of employment.
The Company regularly reviews its compensation policies, including stock
incentives, however, these policies may be insufficient in light of the
increasing competition for experienced professionals in the securities industry,
particularly if the value of the Company's stock declines or fails to appreciate
sufficiently to be a competitive source of a portion of professional
compensation. See "Business--Employees" and "Management."
Prior to becoming a public company, the Company had issued Common Stock to
certain employees subject to an agreement among the Company's shareholders,
which required shareholders leaving the Company's employ to sell their Common
Stock back to the Company at book value. In connection with the FBR IPO, the
shareholders agreement was terminated. Consequently, employee shareholders are
no longer required to sell at book value their Common Stock to the Company upon
leaving employment at the Company and will be able to sell their Common Stock in
the public market. This change could result in a higher level of attrition of
senior employees than the Company had historically experienced.
Significant Competition from Larger Securities Firms
18
The Company is engaged in the highly competitive securities brokerage and
financial services businesses. It competes directly with large Wall Street
securities firms, securities subsidiaries of major commercial bank holding
companies, U.S. subsidiaries of large foreign institutions, major regional firms
and smaller "niche" players. The Company's industry focus also subjects it to
direct competition from a number of specialty securities firms and smaller
investment banking boutiques that specialize in providing services to those
industry sectors.
Competition from commercial banks has increased because of recent acquisitions
of securities firms by commercial banks, as well as internal expansion by
commercial banks into the securities business. In addition, the Company expects
competition from domestic and international banks to increase as a result of
recent and anticipated legislative and regulatory initiatives in the United
States to remove or relieve certain restrictions on commercial banks. Such
competition could adversely affect the Company's operating results, as well as
its ability to attract and retain highly skilled individuals.
Many other companies have greater personnel and financial resources than the
Company. Larger competitors are able to advertise their products and services on
a national or regional basis and may have a greater number and variety of
distribution outlets for their products, including retail distribution. Discount
brokerage firms market their services through aggressive pricing and promotional
efforts. In addition, some competitors have a much longer history of investment
banking activities than the Company and, therefore, may possess a relative
advantage with regard to access to deal flow and capital.
Recent rapid advancements in computing and communications technology, in
particular delivery of sales and trading services via the Internet, are
substantially changing the means by which financial services are delivered.
These changes are providing consumers with more direct access to a wide variety
of financial and investment services including market information and on-line
trading and account information. Advancements in technology also create demand
for more sophisticated levels of client services. Provision of these services
may entail considerable cost without an offsetting source of revenue. See
"Business--Competition."
Regulation
The securities business is subject to extensive regulation under federal and
state laws in the United States, and also is subject to regulation in the
foreign countries in which FBR conducts its activities. One of the most
important regulations with which the Company's broker-dealer subsidiaries must
continually comply is the Securities and Exchange Commission (the "SEC") Rule
15c3-1 (the "Net Capital Rule"), and a similar rule of the United Kingdom's
Securities and Futures Authority with respect to FBR International, which
require the broker-dealer subsidiaries of the Company to maintain a minimum
amount of net capital, as defined under such regulations.
Compliance with many of the regulations applicable to the Company involves a
number of risks, particularly in areas where applicable regulations may be
subject to interpretation. In the event of non-compliance with an applicable
regulation, governmental regulators and the NASD may institute administrative or
judicial proceedings that may result in censure, fine, civil penalties
(including treble damages in the case of insider trading violations), issuance
of cease-and-desist orders, deregistration or suspension of the non-compliant
19
broker-dealer or investment adviser, suspension or disqualification of the
broker-dealer's officers or employees or other adverse consequences. The
imposition of any such penalties or orders on the Company could have a material
adverse effect on the Company's operating results and financial condition.
The regulatory environment in which the Company operates is subject to change.
The Company may be adversely affected as a result of new or revised legislation
or regulations imposed by the SEC, other United States or foreign governmental
regulatory authorities or the NASD. The Company also may be adversely affected
by changes in the interpretation or enforcement of existing laws and rules by
these governmental authorities and the NASD.
Additional regulation, changes in existing laws and rules, or changes in
interpretations or enforcement of existing laws and rules often affect directly
the method of operation and profitability of securities firms. The Company
cannot predict what effect any such changes might have. Furthermore, the
Company's businesses may be materially affected not only by regulations
applicable to it as a financial market intermediary, but also by regulations of
general application. For example, the volume of the Company's underwriting,
merger and acquisition and principal investment businesses in a given time
period could be affected by, among other things, existing and proposed tax
legislation, antitrust policy and other governmental regulations and policies
(including the interest rate policies of the Board of Governors of the Federal
Reserve System (the "Federal Reserve Board")) and changes in interpretation or
enforcement of existing laws and rules that affect the business and financial
communities. The level of business and financing activity in each of the
industries on which the Company focuses can be affected not only by such
legislation or regulations of general applicability, but also by industry-
specific legislation or regulations. See "Business--Regulation."
Potential Conflicts of Interest
Executive officers, directors and employees of the Company from time to time
invest, or receive a profit interest, in investments in private or public
companies or investment funds in which the Company, or an affiliate of the
Company, is an investor or for which the Company carries out investment banking
assignments, on which it publishes research or in whose securities it acts as a
market maker. In addition, the Company has in the past organized and may in the
future organize businesses, such as its private investment vehicles, in which
employees of the Company may acquire minority interests. There are risks that,
as a result of such investment or profit interest, a director, officer or
employee may take actions that would conflict with the best interests of the
Company. In addition, certain members of senior management of the Company are
actively involved in managing investment funds operated by the Company which
could create a conflict of interest to the extent these officers are aware of
inside information concerning potential investment targets from their other
activities with the Company or to the extent these officials wish to invest in
companies for which FBR is underwriting securities. The Company has in place
compliance procedures and practices designed to ensure that such inside
information is not used for making investment decisions on behalf of the funds
and to monitor funds invested in the Company's investment banking clients. No
assurance can be provided that these procedures and practices will be effective.
In addition, this conflict and these procedures and practices may limit the
freedom of such officials to make potentially profitable investments on behalf
of those funds. See "Business--Asset Management".
Possibility of Losses Associated with Principal and Trading Activities
20
The Company's securities trading and market-making activities are primarily
conducted by the Company as principal and subject the Company's capital to
significant risks, including market, credit, leverage, counterparty and
liquidity risks. These activities often involve the purchase, sale or short sale
of securities as principal in markets that may be characterized by relative
illiquidity or that may be particularly susceptible to rapid fluctuations in
liquidity and price. The Company from time to time has large position
concentrations in securities of, or commitments to, a single issuer, or issuers
engaged in a specific industry, particularly as a result of the Company's
underwriting activities. The Company tends to concentrate its trading and
investment positions in a more limited number of industry sectors and companies
than some other broker-dealers, which might result in higher trading and
investment losses than would occur if the Company's positions and activities
were less concentrated. For example, in 1998, the Company experienced
significant marketmaking losses due to the downturn in the two of the industries
on which it focuses - specialty finance industry and REITs. See "Business--Risk
Management."
Litigation and Potential Securities Laws Liability
Many aspects of the Company's business involve substantial risks of liability.
An underwriter is exposed to substantial liability under federal and state
securities laws, other federal and state laws and court decisions, including
decisions with respect to underwriters' liability and limitations on
indemnification of underwriters by issuers. For example, a firm that acts as an
underwriter may be held liable for material misstatements or omissions of fact
in a prospectus used in connection with the securities being offered or for
statements made by its securities analysts or other personnel. In recent years
there has been an increasing incidence of litigation involving the securities
industry, including class actions that seek substantial damages. The Company is
also subject to the risk of litigation from its other business activities,
including its activities as a broker-dealer. As the Company intends actively to
defend any such litigation, significant legal expenses could be incurred. An
adverse resolution of any future lawsuits against the Company could have a
material adverse effect on the Company's operating results and financial
condition. See "Item 3.--Legal Proceedings."
Dependence on Cash Inflows to Mutual Funds
A slowdown or reversal of cash inflows to mutual funds and other pooled
investment vehicles could lead to lower underwriting and brokerage revenues for
the Company since mutual funds purchase a significant portion of the securities
offered in public offerings and traded in the secondary markets. The recent
demand for new equity offerings has been driven in part by institutional
investors, particularly large mutual funds, seeking to invest cash received from
the public. The public may withdraw additional cash from mutual funds as a
result of a decline in the market generally or as a result of a decline in
mutual fund net asset values. To the extent that a decline in cash inflows into
mutual funds or a decline in net asset values of these funds reduces demand by
fund managers for initial public or secondary offerings, the Company's business
and results of operations could be materially adversely affected. Moreover, a
slowdown in investment activity by mutual funds may have an adverse effect on
the securities markets generally.
Management of Growth
21
Over the past several years, the Company has experienced significant growth in
its business activities and the number of its employees. This growth has
required and will continue to require increased investment in management
personnel, financial and management systems and controls and facilities, which
could cause the Company's operating margins to decline from historical levels,
especially in the absence of revenue growth. In addition, as is common in the
securities industry, the Company is and will continue to be highly dependent on
the effective and reliable operation of its communications and information
systems. The Company believes that its current and anticipated future growth
will require implementation of new and enhanced communications and information
systems and training of its personnel to operate such systems. In addition, the
scope of procedures for assuring compliance with applicable laws and regulations
and NASD rules has changed as the size and complexity of the Company's business
has changed. As the Company has grown and continues to grow, the Company has
implemented and continues to implement additional formal compliance procedures
to reflect such growth. Any difficulty or significant delay in the
implementation or operation of existing or new systems, compliance procedures or
the training of personnel could adversely affect the Company's ability to manage
growth. See Item 7. "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Accounting, Administration and Operations"
above.
Dependence on Systems and Third Parties
The Company's business is highly dependent on communications and information
systems, including certain systems provided by its clearing broker. Any failure
or interruption of the Company's systems, systems of the Company's clearing
broker or third party trading systems, could cause delays or other problems in
the Company's securities trading activities, which could have a material adverse
effect on the Company's operating results. Such failures and interruptions may
result from the inability of certain computing systems (including those of the
Company, its clearing broker, Nasdaq and other third party vendors) to recognize
the year 2000. There can be no assurance that the year 2000 issue can be
resolved prior to the upcoming change in the century. Although the Company may
incur substantial costs, particularly costs resulting from charges by its third
party service providers, in correcting year 2000 issues. See Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Matters Related to the Company's Information Systems". In addition,
the Company's principal disaster recovery system is provided by its clearing
broker. There can be no assurance that the Company or its clearing broker will
not suffer any systems failure or interruption, including one caused by an
earthquake, fire, other natural disaster, power or telecommunications failure,
act of God, act of war or otherwise, or that the Company's or its clearing
broker's back-up procedures and capabilities in the event of any such failure or
interruption will be adequate. See "Business--Accounting, Administration and
Operations."
Dependence upon Availability of Capital and Funding
The Company's business is dependent upon the availability of adequate funding
and regulatory capital under applicable regulatory requirements. Historically,
the Company has satisfied these needs from equity contributions, internally
generated funds and loans from third parties. The Company's IPO in December 1997
alleviated in part the Company's funding and capital needs, however, there can
be no assurance that any, or sufficient, funding or regulatory capital will
continue to be available to the Company in the future on terms that are
22
acceptable to it. See "Business--Regulation," and Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Overview," "-- Liquidity and Capital Resources."
Control of the Company; Anti-Takeover Effects of Certain Charter Provisions
The Company's Articles of Incorporation and Bylaws, as well as Virginia
corporate law, contain certain provisions that could have the effect of making
it more difficult for a third party to acquire, or of discouraging a third party
from attempting to acquire, control of the Company. These provisions could limit
the price that certain investors might be willing to pay in the future for
shares of Class A Common Stock. Certain of these provisions allow the Company to
issue, without shareholder approval, preferred stock having rights senior to
those of Common Stock. Other provisions impose various procedural and other
requirements that could make it more difficult for shareholders to affect
certain corporate actions.
ITEM 2. PROPERTIES
The Company leases four floors of its headquarters building totaling
approximately 69,000 square feet. The Company also leases approximately 8,000
square feet for its offices in Irvine, California, London, England and Boston,
Massachusetts. The Company believes that its present facilities, together with
its current options to extend lease terms and occupy additional space, are
adequate for its current and presently projected needs.
ITEM 3. LEGAL PROCEEDINGS
The Company is not currently a defendant or plaintiff in any material lawsuits
or arbitrations. The Company is a defendant in a small number of civil lawsuits
relating to its various businesses. There can be no assurances that these
matters will not have a material adverse effect on the results of operations of
the Company in a future period, depending in part on the results for such
period. However, based on management's review of these matters with counsel,
management believes that any result of these actions against the Company will
not have a material adverse effect on either the consolidated financial
condition of the Company or on the results of operations of the Company.
Many aspects of the Company's business involve substantial risks of liability,
litigation and arbitration. As both an underwriter and as a broker-dealer, the
Company is exposed to potential liability under federal and state securities
laws, other federal and state laws and court decisions, including decisions with
respect to underwriters' liability and limitations on indemnification of
underwriters by issuers, as well as with respect to the handling of customer
accounts. For example, a firm that acts as an underwriter may be held liable for
material misstatements or omissions of fact in a prospectus used in connection
with the securities being offered or for statements made by its securities
analysts or other personnel.
If plaintiffs in any future suits against the Company were to prosecute their
claims successfully, or if the Company were to settle such suits by making
significant payments to the plaintiffs, the Company's operating results and
financial condition could be materially and adversely affected. The Company
carries very limited insurance that may cover only a portion of any such
payments.
23
In recent years, there has been an increasing incidence of litigation
involving the securities industry, including class actions that seek substantial
damages and frequently name as defendants underwriters of a public offering and
investment banks that provide advisory services in merger and acquisition
transactions. The eventual impact of the recently passed Federal Private
Securities Litigation Reform Act of 1995 on securities class action litigation
is not yet known.
In addition to these financial costs and risks, the defense of litigation or
arbitration may divert the efforts and attention of the Company's management and
staff, and the Company may incur significant legal expenses in defending such
litigation or arbitration. This may be the case even with respect to claims and
litigation that management believes to be frivolous, and the Company intends to
defend vigorously any frivolous claims against it. The amount of time that
management and other employees may be required to devote in connection with the
defense of litigation could be substantial and might materially divert their
attention from other responsibilities within the Company.
The Company also may become a defendant in civil actions and arbitrations
arising out of its other activities as a broker-dealer, as an investment
adviser, as an employer and as a result of other business activities. There can
be no assurance that substantial payments in connection with the resolution of
disputed claims will not occur in the future.
In addition, the Company's charter documents allow indemnification of the
Company's officers, directors and agents to the maximum extent permitted under
Virginia law. The Company intends to enter into indemnification agreements with
these persons. The Company has been and in the future may be the subject of
indemnification assertions under these charter documents or agreements by
officers, directors or agents of the Company who are or may become defendants in
litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company and their ages as of December 31, 1998
are as follows:
NAME AGE POSITIONS
Emanuel J. Friedman..... 52 Chairman and Chief Executive Officer; Director
Eric F. Billings........ 46 Vice Chairman and Chief Operating Officer;
Director
W. Russell Ramsey....... 39 President and Secretary; Director
Eric Y. Generous........ 38 Executive Vice President and Chief Financial
Officer
Nicholas J. Nichols..... 58 Executive Vice President and Director of
Compliance
Robert S. Smith......... 39 Executive Vice President and General Counsel
Kurt R. Harrington...... 46 Treasurer and Chief Accounting Officer
Emanuel J. Friedman
24
Mr. Friedman is Chairman and Chief Executive Officer of FBR. He has
continuously served as Chairman and Chief Executive Officer since co-founding
the Company in 1989. He serves as a director of FBR-Asset. He manages FBR
Ashton, Limited Partnership and FBR Private Equity Fund, L.P. Mr. Friedman
founded the Friedman, Billings & Ramsey Charitable Foundation, Inc., a
charitable foundation, in 1993 and currently serves as a director. Mr. Friedman
entered the securities industry in 1973 when he joined Legg Mason Wood Walker &
Co., Inc., and from 1985 until 1989 he was Senior Vice President in the
institutional sales group at Johnston, Lemon & Co., Incorporated, a Washington,
D.C. brokerage firm.
Eric F. Billings
Mr. Billings is Vice Chairman and Chief Operating Officer of FBR. He has
continuously served as Vice Chairman and Chief Operating Officer since co-
founding the Company in 1989. He serves as Chief Executive Officer and as a
director of FBR-Asset. He also manages FBR Weston, Limited Partnership. Mr.
Billings entered the securities industry in 1982 when he joined Legg Mason Wood
Walker & Co., Inc., and from 1984 until 1989 served as Senior Vice President in
the institutional sales group at Johnston, Lemon & Co., Incorporated, a
Washington, D.C. brokerage firm.
W. Russell Ramsey
Mr. Ramsey is President and Secretary of FBR. He has continuously served as
President since co-founding the Company in 1989. Prior to co-founding FBR, Mr.
Ramsey served as Vice President in the institutional sales group at Johnston,
Lemon & Co., Incorporated, a Washington, D.C. brokerage firm. Mr. Ramsey serves
as a director of Building One Services Corporation, a publicly-held company
engaged in the consolidation of the building management industry.
Eric Y. Generous
Mr. Generous is Chief Financial Officer and Executive Vice President of FBR.
He has continuously served as an officer since joining the Company at its
inception in 1989. Mr. Generous entered the securities industry in 1983 when
he joined Legg Mason Wood Walker & Co., Inc., and from 1984 until 1989 served
in the institutional sales group at Johnston, Lemon & Co., Incorporated, a
Washington, D.C. brokerage firm.
Nicholas J. Nichols
Mr. Nichols joined the Company at its inception in 1989 and has been
Director of Compliance throughout that period. Mr. Nichols entered the
securities industry in 1968 when he joined Mason & Co., Inc. (currently Legg
Mason Wood Walker & Co., Inc.). Mr. Nichols established Legg Mason Wood Walker
& Co., Inc.'s institutional trading desk, and became a corporate officer and
shareholder prior to leaving the firm in 1979. For the next seven years, Mr.
Nichols monitored and evaluated congressional and regulatory securities
activities as the Director of Legislative Affairs, American Institute of CPAs.
Mr. Nichols joined the institutional sales group at Johnston, Lemon & Co.,
Incorporated as a Senior Vice President in 1986.
Robert S. Smith
Mr. Smith joined the Company as its General Counsel in January 1997. Prior
to joining the Company, Mr. Smith was a partner of McGuire, Woods, Battle &
Boothe, LLP, where he had been in practice since 1986, and represented the
25
Company from its inception in 1989. Mr. Smith formerly practiced as a lawyer
in the United Kingdom from 1982-1985.
Kurt R. Harrington
Mr. Harrington joined the Company in March 1997, as Vice President,
Finance/Treasurer. From September 1996 to March 1997, Mr. Harrington was a
consultant to the venture capital industry. For the five years prior thereto,
Mr. Harrington was Chief Financial Officer of Jupiter National, Inc., a
publicly-traded venture capital company, and in this capacity served as a
director of a number of companies, including Viasoft, Inc., a publicly-held
software company from January 1994 to October 1995. Mr. Harrington is a
Certified Public Accountant.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The principal market for trading the Company's common stock is the New York
Stock Exchange. Set forth below are the high and low sale prices of the
Company's common stock for each quarter for the year ended December 31, 1998 and
for the quarter ended December 31, 1997.
HIGH LOW
-------- --------
1998
- ----
Fourth Quarter 7 3/4 3 3/4
Third Quarter 16 5/16 5
Second Quarter 21 13 3/4
First Quarter 17 13/16 14
1997
- ----
Fourth Quarter* 21 3/4 17 15/16
_______________________________________________
*The effective date of the Company's initial public offering was December 22,
1997
According to the records of the Company's transfer agent, the Company had
approximately 74 shareholders of record as of December 31, 1998. Because many
shares are held by brokers and other institutions on behalf of shareholders, the
Company is unable to estimate the total number of beneficial shareholders
represented by these record holders.
The Company's policy is to reinvest earnings in the Company in order to fund
future growth. The Company, therefore, has not paid and does not plan to declare
dividends on its common stock, at this time. The Company repurchased 1,036,092
shares of its common stock in 1998 and issued 126,055 shares pursuant to its
Employee Stock Purchase Plan.
ITEM 6. SELECTED FINANCIAL DATA
26
"Selected Consolidated Financial Information" for the years 1994 through 1998,
on page 19 of the Company's Annual Report to Shareholders for the year ended
December 31, 1998, filed as Exhibit 13.01 to this Form 10-K, is incorporated by
reference into this report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" on pages 20 through 29 of the Company's Annual Report to
shareholders for the year ended December 31, 1998, filed as Exhibit 13.01 to
this Form 10-K, is incorporated by reference into this report.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by Item 8 is set forth in Item 14 of this report.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information regarding directors required by this Item 10 is incorporated
by reference to the Company's definitive Proxy Statement for its annual meeting
of shareholders to be held on May 20, 1999 under the headings "Proposal No. 1--
Election of Directors" and "Section 16 (a) Beneficial Ownership Reporting
Compliance." Information regarding executive officers found under the Heading
"Executive Officers of the Registrant" in Part I hereof is also incorporated by
reference into this Item 10.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is incorporated by reference to the
Company's definitive Proxy Statement for its annual meeting of shareholders to
be held on May 20, 1999 under the heading "Executive Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item 12 is incorporated by reference to the
Company's definitive Proxy Statement for its annual meeting of shareholders to
be held on May 20, 1999 under the heading "Security Ownership of Certain
Beneficial Owners and Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item 13 is incorporated by reference to the
Company's definitive Proxy Statement for its annual meeting of shareholders to
be held on May 20, 1999 under the heading "Certain Relationships and Related
Transactions."
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements. The following consolidated financial statements of
27
the Company included in the Company's Annual Report to Shareholders for
the year ended December 31, 1998, filed as Exhibit 13.01 to this Form 10-
K, are incorporated by reference into this Item 14:
Consolidated Balance Sheets - Years ended 1998 and 1997 (page 30)
Consolidated Statements of Operations - Years ended 1998, 1997 and
1996 (page 31)
Consolidated Statements of Changes in Shareholders' Equity - Years
ended 1998, 1997 and 1996 (page 32)
Consolidated Statements of Cash Flows - Years ended 1998, 1997 and
1996 (page 33)
Notes to Consolidated Financial Statements (pages 34 through 43)
Report of Independent Public Accountants (page 44)
2. All schedules are omitted because they are not required or because the
information is shown in the financial statements or notes thereto.
3. Exhibits identified in parenthesis below are on file with the SEC as
part of the Company's Registration Statement on Form S-1, as amended,
No. 333-39107, and are incorporated herein by reference.
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT TITLE
- -------- -------------
3.01 -- Registrant's Articles of Incorporation. (Exhibit 3.01)
3.02 -- Registrant's Bylaws. (Exhibit 3.03)
4.01 -- Form of Specimen Certificate for Registrant's Class A Common
Stock. (Exhibit 4.01)
10.01 -- Revolving Subordinated Loan Agreement, between Custodial Trust
Company and Friedman, Billings, Ramsey & Co., dated August 4,
1998.
10.02 -- The 1997 Employee Stock Purchase Plan. (Exhibit 10.05)
10.03 -- The 1997 Stock and Annual Incentive Plan. (Exhibit 10.06)
10.04 -- The Non-Employee Director Stock Compensation Plan. (Exhibit
10.07)
10.05 -- The Key Employee Incentive Plan. (Exhibit 10.08)
13.01 -- Annual Report to Shareholders for the Year ended December 31,
1998
21.01 -- List of Subsidiaries of the Registrant.
23.01 -- Consent of Independent Public Accountants
27.01 -- Financial Data Schedule.
99.01 -- Memorandum of Understanding between the Company and PNC Bank
Corp., dated as of October 28, 1997. (Exhibit 99.01)
28
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Friedman, Billings, Ramsey Group, Inc.
March , 1999 By: /s/ W. Russell Ramsey
- ----------------- --------------------------------------------
W. Russell Ramsey
Date President and Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
March , 1999 By: /s/ Emanuel J. Friedman
- ------------------ ----------------------------------------------
Emanuel J. Friedman, Chairman of the Board of
Date Directors, Chief Executive Officer (Principal
Executive Officer)
March , 1999 By: /s/ Eric F. Billings
- ------------------ ----------------------------------------------
Eric F. Billings, Vice Chairman of the Board of
Date Directors and Chief Operating Officer
March , 1999 By: /s/ W. Russell Ramsey
- ------------------ ----------------------------------------------
Date W. Russell Ramsey, President, Secretary and
Director
March , 1999 By: /s/ Eric Y. Generous
- ------------------ ----------------------------------------------
Date Eric Y. Generous, Chief Financial Officer
(Principal Financial Officer)
March , 1999 By: /s/ Kurt R. Harrington
- ------------------ ----------------------------------------------
Date Kurt R. Harrington, Treasurer (Principal
Accounting Officer)
March , 1999 By: /s/ Wallace L. Timmeny
- ------------------ ----------------------------------------------
Date Wallace L. Timmeny, Director
March , 1999 By: /s/ Mark R. Warner
- ------------------ ----------------------------------------------
Date Mark R. Warner, Director
29