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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(MARK ONE)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED NOVEMBER 30, 1995
/ / Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 [No Fee Required]
Commission File Number 1-6817
Lehman Brothers Inc.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 13-2518466
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3 WORLD FINANCIAL CENTER 10285
NEW YORK, NEW YORK (Zip Code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 526-7000
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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10 3/4% Senior Subordinated Notes Due 1996 New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NONE
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes _X_ No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Sec.229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. _X_
As the registrant is a wholly-owned subsidiary of Lehman Brothers Holdings
Inc., none of the registrant's outstanding voting stock is held by
non-affiliates of the registrant. As of the date hereof, 1,006 shares of the
registrant's Common Stock. $.10 per share, were issued and outstanding.
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION J(1)(A)
AND (B) OF FORM 10-K AND THEREFORE IS FILING THIS FORM WITH A PORTION OF THE
REDUCED DISCLOSURE CONTEMPLATED THEREBY.
DOCUMENTS INCORPORATED BY REFERENCE:
None.
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PART I
ITEM 1. BUSINESS
GENERAL DEVELOPMENT OF BUSINESS
As used herein, "LBI" or the "Registrant" means Lehman Brothers Inc., a
Delaware corporation, incorporated on January 21, 1965. LBI and its subsidiaries
are collectively referred to as the "Company" or "Lehman Brothers". LBI is a
wholly owned subsidiary of Lehman Brothers Holdings Inc., a Delaware
corporation, which (together with its subsidiaries, where appropriate) is
referred to herein as "Holdings".
The Company is one of the leading global investment banks serving
institutional, corporate, government and high-net-worth individual clients and
customers. Its executive offices are located at 3 World Financial Center, New
York, New York 10285 and its telephone number is (212) 526-7000.
LEHMAN BROTHERS
Lehman Brothers is one of the leading global investment banks serving
institutional, corporate, government and high-net-worth individual clients and
customers. The Company's worldwide headquarters in New York are complemented by
offices in additional locations in the United States, Europe, the Middle East,
Latin and South America and the Asia Pacific region. Lehman Brothers also
operates a commodities trading and sales operation in London. Holdings provides
investment banking and capital markets services in Europe and Asia. The Company
is engaged primarily in providing financial services. Other businesses in which
the Company is engaged represent less than 10 percent of consolidated assets,
revenues or pre-tax income.
The Company's business includes capital raising for clients through
securities underwriting and direct placements; corporate finance and strategic
advisory services; merchant banking; securities sales and trading; asset
management; research; and the trading of foreign exchange, derivative products
and certain commodities. The Company acts as a market-maker in all major equity
and fixed income products in both the domestic and certain international
markets. Lehman Brothers is a member of all principal securities and commodities
exchanges in the United States, as well as the National Association of
Securities Dealers, Inc. ("NASD"). Holdings holds memberships or associate
memberships on several principal international securities and commodities
exchanges, including the London, Tokyo, Hong Kong, Frankfurt and Milan stock
exchanges.
Since 1990, Lehman Brothers has focused on a "client/customer-driven"
strategy. Under this strategy, Lehman Brothers concentrates on serving the needs
of major issuing and advisory clients and investing customers worldwide to build
an increasing "flow" of business that leverages the Company's research,
underwriting and distribution capabilities. Customer flow continues to be the
primary source of the Company's net revenues. Developing lead relationships with
issuing clients and investing customers is a central premise of the Company's
client/customer-driven strategy. Based on management's belief that each client
and customer directs a majority of its financial transactions to a limited
number of investment banks, Lehman Brothers' investment banking and
institutional and private client sales professionals focus on a targeted group
of clients and customers worldwide to identify and develop lead relationships.
The Company believes that such relationships position Lehman Brothers to receive
a substantial portion of its clients' and customers' financial business and
lessen the volatility of revenues generally associated with the financial
services industry.
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LEHMAN BUSINESSES
INVESTMENT BANKING
Lehman Brothers is a leading underwriter of equity and fixed income
securities in the public and private markets. The Company is also a prominent
advisor for corporations and governments around the world.
Investment Banking professionals are responsible for developing and
maintaining relationships with issuing clients, gaining a thorough understanding
of their specific needs and bringing together the full resources of Lehman
Brothers and Holdings to accomplish their financial objectives. Investment
Banking is organized into industry, product and geographic coverage groups,
enabling individual bankers to develop specific expertise in particular
industries and markets. Industry coverage groups include Consumer Products,
Financial Services, Financial Sponsors, Health Care, Industrials, Merchandising,
Natural Resources, Real Estate and Mortgage Finance, Technology, Media and
Telecommunications, Transportation and Utilities. Where appropriate, specialized
groups such as Equity Capital Markets, Debt Capital Markets, Mergers and
Acquisitions, Private Placements, Leveraged Finance, Derivatives, Liability
Management and Project Finance are integrated into the client coverage teams.
Lehman Brothers has a long history of providing strategic advisory services
to corporate, institutional and government clients around the world on a wide
range of financial matters, including mergers and acquisitions, divestitures,
leveraged transactions, takeover defenses, spin-offs, corporate reorganizations
and recapitalizations, tender and exchange offers, privatizations, opinion
letters and valuations. The Company's Mergers and Acquisitions group works
closely with product, industry and geographic coverage bankers around the world.
Merchant Banking. Through its Merchant Banking group, the Company and its
affiliates make equity and certain other investments in merger, acquisition,
restructuring and leveraged capital transactions, including leveraged buyouts,
either independently or in partnership with the Company's clients. Current
merchant banking investments held by the Company include both publicly traded
and privately held companies diversified on a geographic and industry basis.
Since 1989, the Company and its affiliates' principal method of making
merchant banking investments has been through a series of partnerships (the
"1989 Partnerships"), for which the Company and its affiliates act as general
partner, and in some cases as a limited partner. During the remaining life of
the 1989 Partnerships, the Company's merchant banking activities, with respect
to investments made by the 1989 Partnerships, will be directed toward selling or
otherwise monetizing such investments.
FIXED INCOME
Lehman Brothers actively participates in all key fixed income product areas.
The Company combines professionals from the sales, trading, financing,
derivatives and research areas of Fixed Income, together with investment
bankers, into teams to serve the financial needs of the Company's clients and
customers. The Company is a leading underwriter of new issues, and also makes
markets in these and other fixed income securities. The Company's global
presence facilitates client and customer transactions and provides liquidity in
marketable fixed and floating rate debt securities.
Fixed Income products consist of government, sovereign and supranational
agency obligations; money market products; corporate debt securities; mortgage
and asset-backed securities; emerging market securities; municipal and
tax-exempt securities; derivative products and research. In addition, the
Company's financing unit provides global access to cost efficient debt financing
sources, including repurchase agreements, for the Company and its clients and
customers.
Government and Agency Obligations. Lehman Brothers is one of the leaders
among the 37 primary dealers in U.S. Government securities, as designated by the
Federal Reserve Bank of New
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York, participating in the underwriting and market-making of U.S. Treasury
bills, notes and bonds, and securities of federal agencies.
Money Market Products. Lehman Brothers holds dominant market positions in
the origination and distribution of medium-term notes and commercial paper. The
Company and its affiliates have received global medium-term note mandates for
1,125 programs with a borrowing capacity of $1.6 trillion. The Company and its
affiliates are appointed dealers for approximately 750 commercial paper programs
on behalf of companies and government agencies worldwide. The Company is also a
major participant in the preferred stock market.
Corporate Debt Securities. Lehman Brothers engages in the underwriting and
market making of fixed and floating rate investment grade debt. The Company also
underwrites and makes markets in non-investment grade debt securities and bank
loans.
High Yield Securities and Bank Loans. In 1995, the Company expanded its high
yield debt business from both a strategic and an operational perspective. The
Company now provides a "one-stop" leveraged finance solution for corporate and
financial acquirers and high yield issuers.
Mortgage and Asset-Backed Securities. The Company is a leading underwriter
of and market maker in mortgage and asset-backed securities.
Emerging Market Securities. The Company is active in the trading,
structuring and underwriting of Latin American, Eastern European, and Asian
dollar and local currency instruments.
Municipal and Tax-Exempt Securities. Lehman Brothers is a major dealer in
municipal and tax-exempt securities, including general obligation and revenue
bonds, notes issued by states, counties, cities, and state and local
governmental agencies, municipal leases, tax-exempt commercial paper and put
bonds. Lehman Brothers is also a leader in the structuring, underwriting and
sale of tax-exempt and taxable securities and derivative products for city,
state, not-for-profit and other public sector clients.
Derivative Products. The Company offers a broad range of derivative product
services. Derivatives professionals are integrated into all of the Company's
major fixed income product areas to develop optimal issuance structures and
investment products for the Company's clients.
Lehman Brothers Financial Products Inc. ("LBFP"), the Company's triple-A
rated derivatives subsidiary, commenced trading with counterparties in July
1994. It exceeded expectations in 1995 in terms of notional volumes and number
of counterparties. This entity also received rating agency approval to double
the amount of products eligible for inclusion in the subsidiary.
Financing. The Company's Financing unit engages in three primary functions:
managing the Company's matched book activities, supplying secured financing to
customers, and providing funding for the Company's inventory positions. Matched
book funding involves lending cash on a short-term basis to institutional
customers collateralized by marketable securities, typically government or
government agency securities. The Company enters into these agreements in
various currencies and seeks to generate profits from the difference between
interest earned and interest paid. The Financing unit works with the Company's
institutional sales force to identify customers that have cash to invest and/or
securities to pledge to meet the financing and investment objectives of the
Company and its customers. Financing also coordinates with the Company's
treasury area to provide collateralized financing for a large portion of the
Company's securities and other financial instruments owned.
Fixed Income Research. Fixed Income research at Lehman Brothers encompasses
the full range of research disciplines: quantitative, economic, strategic,
credit, portfolio and market-specific analysis. Fixed Income research is
integrated with and supports the Company's investment banking, sales and trading
activities. An important objective of Fixed Income research is to have in place
high quality research analysts covering industry, geographic and economic
sectors that support the activities of the Company's clients and customers. The
Company and its affiliates' 200 specialists are based in New York, Toronto,
London, Tokyo and Hong Kong. Their expertise includes U.S., European and Asian
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government and agency securities, derivatives, sovereign issues, corporate
securities, high yield, asset-and mortgage-backed securities, commercial real
estate, emerging market debt and municipal securities.
Foreign Exchange. Through its foreign exchange operations, Lehman Brothers
seeks to provide its clients and customers with superior trading execution,
price protection and hedging strategies to manage volatility. The Company and
its affiliates, through operations in New York, London, Hong Kong, Singapore,
and Tokyo engage in trading activities in all major currencies and maintain a
24-hour foreign exchange market-making capability for clients and customers
worldwide. In addition to the Company's traditional client/customer-driven
foreign exchange activities, Lehman Brothers also trades foreign exchange for
its own account.
Commodities and Futures. Lehman Brothers engages in commodities and futures
trading through its market-making activities in metals as well as its activities
in exchange futures execution for its institutional and private clients. The
Company and its affiliates provide their clients with global market-making and
execution through its commodities and futures operations in New York, London,
Frankfurt, Singapore, Hong Kong and Tokyo.
EQUITIES
Lehman Brothers combines professionals from the sales, trading, financing,
derivatives and research areas of Equities, together with investment bankers,
into teams to serve the financial needs of the Company's equity clients and
customers. The Company's equity expertise and the integrated nature of the
Company's global operations enable Lehman Brothers to structure and execute
global equity transactions for clients worldwide. The Company is a leading
underwriter of initial public and secondary offerings of equity and
equity-related securities. Lehman Brothers also makes markets in these and other
securities, and executes block trades on behalf of clients and customers. The
Company also actively participates in assisting governments around the world in
raising equity capital as part of their privatization programs.
The Equities product group is responsible for the Company's equity
operations and all dollar and non-dollar equity and equity-related products
worldwide. These products include listed and over-the-counter ("OTC")
securities, American Depositary Receipts, convertibles, options, warrants and
derivatives.
Derivative Products. Lehman Brothers, in conjunction with affiliates, offers
equity derivative capabilities across a wide spectrum of products and
currencies, including domestic and international program trading, listed options
and futures, structured derivatives and convertible products.
Equity Research. The Equity Research department is integrated with and
supports the Company's investment banking, sales and trading activities. An
important objective of Equities research is to have in place high quality
research analysts covering industry and geographic sectors that support the
activities of the Company's clients and customers. The Equity Research
department is comprised of 250 professionals covering 26 industry sectors and
over 1,100 companies worldwide from locations in New York, London, Hong Kong and
Tokyo.
Equity Finance. Lehman Brothers operates a comprehensive Equity Financing
and Prime Broker business to provide liquidity to its clients and customers.
Margin lending for the purchase of equities and equity derivatives, securities
lending and short sale facilitation are among the main functions of the Equity
Financing group. The Prime Broker business engages in full operations, clearing
and processing services for that unit's customers.
ASSET MANAGEMENT
The Company's asset management activities provide investment management
services to institutional investors, individuals and small to mid-sized
institutions. At November 30, 1995, the Company
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and its affiliates had over $10 billion in assets under management. The Company
and its affiliates plan to focus on sponsoring and distributing more
sophisticated strategic funds attractive to high-net-worth individuals and
institutions. The Asset Management division also has developed individually
customized investment services through the Company's Private Client Services
group.
INSTITUTIONAL SALES
Institutional Sales serves the investing and liquidity needs of major
institutional investors worldwide and provides the distribution mechanism for
new issues and secondary market securities. Lehman Brothers maintains a network
of over 500 sales professionals in major locations around the world.
Institutional Sales focuses on the large institutional investors that constitute
the major share of global buying power in the financial markets. Lehman
Brothers' goal is to be considered one of the top three investment banks by such
institutional investors. By serving the needs of these customers, the Company
also gains insight into investor sentiment worldwide regarding new issues and
secondary products and markets, which in turn benefits the Company's issuing
clients.
Institutional Sales is organized into four distinct sales forces,
specialized by the following product types: Equities, Fixed Income, Foreign
Exchange/Commodities and Asset Management. Institutional Sales professionals
work together to coordinate coverage of major institutional investors through
customer teams. Depending on the size and investment objectives of the
institutional investor, a customer team can be comprised of from two to five
sales professionals, each specializing in a specific product. This approach
positions Lehman Brothers to understand and to deliver the full resources of the
Company to its customer base.
PRIVATE CLIENT SERVICES
The Company's Private Client Services Group serves the investment needs of
private investors with substantial assets as well as small and mid-sized
institutions. The group has a global presence with investment representatives
located in seven offices in North America and additional offices in major
financial centers in South America, Europe, the Middle East and Asia. The
Company's investment representatives provide investing customers with direct
access to Lehman Brothers' equity and fixed income product and research,
including capabilities in new issue and secondary product, foreign exchange and
derivatives. The Private Client Services group also enables the Company's
issuing clients to access a diverse, high-net-worth investor base throughout the
world. The group employs portfolio strategists within their organization to
optimize asset allocation requirements and to manage the specific asset classes
of their private clients.
OTHER BUSINESS ACTIVITIES
While Lehman Brothers concentrates on its client/customer-driven strategy,
the Company also participates in business opportunities such as arbitrage and
proprietary trading that leverage the Company's expertise, infrastructure and
resources. These businesses may generate substantial revenues but generally
entail a higher degree of risk as the Company trades for its own account.
Arbitrage. Lehman Brothers engages in a variety of arbitrage activities. In
traditional or "riskless" arbitrage, the Company seeks to benefit from temporary
price discrepancies that occur when a security is traded in two or more markets,
or when a convertible or derivative security is trading at a price disparate
from its underlying security. The Company's "risk" arbitrage activities involve
the purchase of securities at discounts from the expected values that would be
realized if certain proposed or anticipated corporate transactions (such as
mergers, acquisitions, recapitalizations, exchange offers, reorganizations,
bankruptcies, liquidations or spin-offs) were to occur. To the extent that these
anticipated transactions do not materialize in a manner consistent with the
Company's expectations, the Company is subject to the risk that the value of
these investments will decline. Lehman Brothers' arbitrage activities benefit
from the Company's presence in the global capital markets, access to
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advanced information technology, in-depth market research, proprietary risk
management tools and general experience in assessing rapidly changing market
conditions.
Proprietary Trading. Lehman Brothers engages in the trading of various
securities, derivatives, currencies and commodities for its own account. The
Company's proprietary trading activities bring together various research and
trading disciplines allowing it to take market positions, which at times may be
significant, consistent with the Company's expectations of future events (such
as movements in the level of interest rates, changes in the shape of yield
curves and changes in the value of currencies). The Company is subject to the
risk that actual market events will be different from the Company's
expectations, which may result in significant losses associated with such
proprietary positions. The Company's proprietary trading activities are
generally carried out in consultation with personnel from the relevant major
product area (e.g., mortgages, derivatives and foreign exchange).
TRADING SERVICES AND CORPORATE
The Company's Trading Services and Corporate divisions provide support to
its businesses through the processing of certain securities and commodities
transactions; receipt, identification and delivery of funds and securities;
safeguarding of customers' securities; and compliance with regulatory and legal
requirements. In addition, this staff is responsible for technology
infrastructure and systems development, treasury operations, financial control
and analysis, tax planning and compliance, internal audit, expense management,
career development and recruiting and other support functions.
In 1995, the Company made broad enhancements to its technology environment,
including the implementation of improved funding, credit, market risk and sales
support systems. The Company also made significant investments in its employees
through management training and career development initiatives and an expanded
recruitment program for analysts and associates.
On October 12, 1994, the Company and Bear Stearns Securities Corp. ("BSSC")
entered into an agreement pursuant to which BSSC agreed to process the
transactions previously cleared by Smith Barney (the "BSSC Agreement"). As a
result, the Company is now self-clearing, and the accounts previously carried by
Smith Barney are carried on the Company's books. The BSSC Agreement took effect
on February 17, 1995 and will run for a term of five years.
ONGOING COST REDUCTION EFFORT
Throughout 1995, Holdings and the Company took actions to reduce costs based
on Holdings' cost reduction efforts announced at year-end 1994. Throughout 1995,
Holdings achieved its cost reduction goals in personnel costs, non-personnel
costs and interest and tax expense. As a result of these efforts, the Company's
expense base has been permanently lowered. With respect to personnel costs, the
Company's total number of employees was reduced from approximately 6,950 at
fiscal year-end 1994 to approximately 6,200 at fiscal year-end 1995.
Non-personnel cost reductions were achieved as a result of a systematic and
comprehensive global review of all major expense categories.
RISK MANAGEMENT
As a leading global investment company, risk is an inherent part of all of
Lehman Brothers' businesses and activities. The extent to which Lehman Brothers
properly and effectively identifies, assesses, monitors and manages each of the
various types of risks involved in its trading, brokerage and investment banking
activities is critical to the success and profitability of the Company. The
principal types of risk involved in Lehman Brothers' activities are market
risks, credit or counterparty risks and transaction risks. Lehman Brothers has
developed a control infrastructure to monitor and manage each type of risk on a
global basis throughout the Company.
In its trading, market-making and underwriting activities, Lehman Brothers
is subject to risks relating to fluctuations in market prices and liquidity of
specific securities, instruments and derivative
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products, as well as volatility in market conditions in general. The markets for
these securities and products are affected by many factors, including the
financial performance and prospects of specific companies and industries,
domestic and international economic conditions (including inflation, interest
and currency exchange rates and volatility), the availability of capital and
credit, political events (including proposed and enacted legislation) and the
perceptions of participants in these markets.
Lehman Brothers' exposure to credit risks in its trading activities arise
from the possibility that a counterparty to a transaction could fail to perform
under its contractual commitment, resulting in Lehman Brothers incurring losses
in liquidating or covering its position in the open market.
In connection with its investment banking and product origination
activities, Lehman Brothers is exposed to risks relating to the merits of
proposed transactions. These risks involve not only the market and credit risks
associated with underwriting securities and developing derivative products, but
also potential liabilities under applicable securities and other laws which may
result from Lehman Brothers' role in the transaction.
The Company aims to reduce risk through the diversification of its products,
counterparties and activities in geographic regions. The Company accomplishes
this objective through allocating the usage of capital to each of its
businesses, establishing trading limits for individual products and traders, and
the approval of credit limits for individual counterparties including regional
concentrations. In addition, the Company is committed to employing qualified
personnel with expertise in each of its various businesses who are responsible
for the establishment of risk management policies and the continued review and
evaluation of these policies in light of changes in market conditions,
counterparty credit status, and the long- and short-term goals of the Company.
Senior management plays a critical role in the ongoing evaluation of risks,
including credit, market, operational and liquidity risks and makes necessary
changes in risk management policies in light of these factors.
The Company's risk management strategy is based on a multi-tier approach to
risk which includes many independent groups (i.e., risk management, finance,
legal, front office senior management, credit) being included in the risk
monitoring process. The Company's risk management department independently
reviews the Company's trading portfolios on a daily basis from a market risk
perspective which includes value at risk and other quantitative and qualitative
risk measurements and analyses. The risk management department has full time
professionals dedicated to each of the trading and geographic areas. The
Company's trade analysis department performs independent verification of the
prices of trading positions, regularly monitors the aging of inventory, and
performs daily review and analysis of the Company's profitability, by business
unit. The corporate credit department has the responsibility for establishing
and monitoring counterparty limits, structuring and approving specific
transactions, and establishing collateral requirements or other credit
enhancement features (such as financial covenants, guarantees or letters of
credit), when deemed necessary, to secure the Company's position. The Company's
Commitment Committee has the responsibility for reviewing and approving proposed
transactions involving the underwriting or placement of securities by Lehman
Brothers, while the Investment Committee performs a similar function in
reviewing and approving proposed transactions related to investments of capital
in connection with the Company's investment banking and merchant banking
activities. Additionally, the Company employs an internal audit department that
reports directly to the Company's Audit Committee and the Board of Directors.
This group performs periodic reviews to evaluate compliance with established
control processes. These reviews include performing tests on the accuracy of
inventory prices, compliance with established credit and trading limits, and
compliance with securities and other laws. The Company's control structure and
various control mechanisms are also subject to periodic reviews as a result of
examinations by the Company's external auditors as well as various regulatory
authorities.
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The Company seeks to ensure that it achieves adequate returns from each of
its business units commensurate with the risks assumed. To achieve this
objective, the Company periodically re-allocates capital to each of its
businesses based upon their ability to obtain returns consistent with
established guidelines as well as perceived opportunities in the marketplace and
the Company's long-term strategy.
NON-CORE ASSETS
Prior to 1990, the Company participated in a number of activities that are
not central to its current business as an institutional investment banking firm.
As a result of these activities, the Company carries on its balance sheet a
number of relatively illiquid assets (the "Non-Core Assets"), including a number
of individual real estate assets, limited partnership interests and a number of
smaller investments. Subsequent to their purchase, the values of certain of
these Non-Core Assets declined below the recorded values on the Company's
balance sheet, which necessitated the write-down of the carrying values of these
assets and corresponding charges to the Company's income statement. Certain of
these activities have resulted in various legal proceedings.
Since 1990, management has devoted substantial resources to reducing the
Company's Non-Core Assets. Between December 31, 1990 and November 30, 1995, the
Company's Non-Core Assets decreased from $1.1 billion in 1990 to approximately
$60 million in 1995. The value of the Company's Non-Core Assets includes
carrying value plus contingent exposures net of reserves. Management's intention
with regard to these Non-Core Assets is the prudent liquidation of these
investments as and when possible.
COMPETITION
All aspects of the Company's business are highly competitive. The Company
competes in domestic and international markets directly with numerous other
brokers and dealers in securities and commodities, investment banking firms,
investment advisors and certain commercial banks and, indirectly for investment
funds, with insurance companies and others.
The financial services industry has become considerably more concentrated as
numerous securities firms have either ceased operations or have been acquired by
or merged into other firms. In addition, several small and specialized
securities firms have been successful in raising significant amounts of capital
for their merger and acquisition activities and merchant banking investment
vehicles and for their own accounts. These developments have increased
competition from firms, many of whom have significantly greater equity capital
than the Company.
REGULATION
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. LBI and certain other subsidiaries
of Holdings are registered as broker-dealers and investment advisers with the
Commission and as such are subject to regulation by the Commission and by
self-regulatory organizations, principally the NASD and national securities
exchanges such as the NYSE, which has been designated by the Commission as LBI's
primary regulator, and the Municipal Securities Rulemaking Board. Securities
firms are also subject to regulation by state securities administrators in those
states in which they conduct business. LBI is a registered broker-dealer in all
50 states, the District of Columbia and the Commonwealth of Puerto Rico. The
Commission, self-regulatory organizations and state securities commissions may
conduct administrative proceedings, which may result in censure, fine, the
issuance of cease-and-desist orders or suspension or expulsion of a
broker-dealer or an investment adviser, its officers or employees.
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LBI is registered with the CFTC as a futures commission merchant and is
subject to regulation as such by the CFTC and various domestic boards of trade
and other commodity exchanges. The Company's U.S. commodity futures and options
business is also regulated by the National Futures Association, a not-for-profit
membership corporation which has been designated as a registered futures
association by the CFTC.
Holdings and the Company do business in the international fixed income,
equity and commodity markets and undertakes investment banking activities
through Holdings' subsidiaries. The U.K. Financial Services Act of 1986 (the
"Financial Services Act") governs all aspects of the United Kingdom investment
business, including regulatory capital, sales and trading practices, use and
safekeeping of customer funds and securities, record keeping, margin practices
and procedures, registration standards for individuals, periodic reporting and
settlement procedures. Pursuant to the Financial Services Act, Holdings and the
Company are subject to regulations administered by The Securities and Futures
Authority Limited, a self regulatory organization of financial services
companies (which regulates their equity, fixed income, commodities and
investment banking activities) and the Bank of England (which regulates their
wholesale money market, bullion and foreign exchange businesses).
The Company believes that it is in material compliance with regulations
described herein.
The Company anticipates regulation of the securities and commodities
industries to increase at all levels and for compliance therewith to become more
difficult. Monetary penalties and restrictions on business activities by
regulators resulting from compliance deficiencies are also expected to become
more severe.
CAPITAL REQUIREMENTS
As a registered broker-dealer, LBI is subject to the Commission's Rule
15c3-1 (the "Net Capital Rule") promulgated under the Securities Exchange Act of
1934, as amended (the "Exchange Act"). The Net Capital Rule requires LBI to
maintain net capital of not less than the greater of 2% of aggregate debit items
arising from customer transactions, as defined, or 4% of funds required to be
segregated for customers' regulated commodity accounts, as defined.
Compliance with the Net Capital Rule could limit those operations of LBI
that require the intensive use of capital, such as underwriting and trading
activities and the financing of customer account balances, and also could
restrict the ability of Holdings to withdraw capital from LBI, which in turn
could limit the ability of Holdings to pay dividends, repay debt and redeem or
purchase shares of its outstanding capital stock. See Footnote 8 of Notes to
Consolidated Financial Statements.
EMPLOYEES
As of November 30, 1995 the Company employed approximately 6,200 persons.
The Company considers its relationship with its employees to be good.
ITEM 2. PROPERTIES
The Company's headquarters occupy approximately 1,147,000 square feet of
space at 3 World Financial Center in New York, New York, which is owned by the
Company as tenants-in-common with American Express and various other American
Express subsidiaries.
Holdings entered into a lease for approximately 392,000 square feet for
offices located at 101 Hudson Street in Jersey City, New Jersey (the "Operations
Center"). The Operations Center is used by
9
systems, operations, and certain administrative personnel and contains certain
back-up trading systems. The lease term is approximately 16 years and commenced
in August 1994.
Most of the Company's other offices are located in leased premises, the
leases for which expire at various dates through the year 2007. During 1995, the
Company conducted a global review of its real estate requirements, and took an
occupancy-related real estate charge. See Note 17 to Consolidated Financial
Statements. The Company intends to sublet certain of these leased premises.
Facilities owned or occupied by the Company and its subsidiaries are believed to
be adequate for the purposes for which they are currently used and are well
maintained.
ITEM 3--LEGAL PROCEEDINGS
The Company is involved in a number of judicial, regulatory and arbitration
proceedings concerning matters arising in connection with the conduct of its
business. Such proceedings include actions brought against the Company and
others with respect to transactions in which the Company acted as an underwriter
or financial advisor, actions arising out of the Company's activities as a
broker or dealer in securities and commodities and actions brought on behalf of
various classes of claimants against many securities and commodities firms of
which the Company is one.
Although there can be no assurance as to the ultimate outcome, the Company
has denied, or believes it has a meritorious defense and will deny, liability in
all significant cases pending against it including the matters described below,
and intends to defend vigorously each such case. Although there can be no
assurance as to the ultimate outcome, based on information currently available
and established reserves, the Company believes that the eventual outcome of the
actions against it, including the matters described below, will not, in the
aggregate, have a material adverse effect on the consolidated financial
condition of the Company.
Bamaodah v. E.F. Hutton & Company Inc.
In April 1986, Ahmed and Saleh Bamaodah commenced an action against E.F.
Hutton & Company Inc., ("EFH") to recover all losses the Bamaodahs had incurred
since May 1981 in the trading of commodity futures contracts in a
nondiscretionary EFH trading account. The Dubai Civil Court ruled that the
trading of commodity futures contracts constituted illegal gambling under
Islamic law and that therefore the brokerage contract was void. In January 1987,
a judgment was rendered against EFH in the amount of $48,656,000. On January 5,
1991, the Dubai Court of Appeals affirmed the judgment. On March 22, 1992, the
Court of Cassation, Dubai's highest court, revoked and quashed the decision of
the Court of Appeals and ordered that the case be remanded to the Court of
Appeals for a further review. On April 26, 1994, the Dubai Court of Appeals
again affirmed the judgment of the Dubai Civil Court. The Company appealed the
judgment to the Court of Cassation, which reversed the Court of Appeals on
November 27, 1994 and ordered that a new expert be appointed to review the case.
A new expert has been appointed, with instructions to report back to the Court
of Cassation.
Actions Relating To First Capital Holdings Inc.
Derivative Actions. On or about March 29, 1991, two identical purported
shareholder derivative actions were filed, entitled Mentch v. Weingarten, et al.
and Isaacs v. Weingarten, et al. The complaints in these two actions, pending in
the Superior Court of the State of California, County of Los Angeles, are filed
allegedly on behalf of and naming as a nominal defendant First Capital Holdings
Inc. ("FCH"). Other defendants include Holdings, two former officers and
directors of FCH, Robert Weingarten and Gerry Ginsberg, the four outside
directors of FCH, Peter Cohen, Richard DeScherer, William L. Mack and Jerome H.
Miller (collectively, the "Outside Directors"), and Michael Milken. The
complaints alleged generally breaches of fiduciary duty, gross corporate
mismanagement and waste
10
of assets in connection with FCH's purchase of non-rated bonds underwritten by
Drexel Burnham Lambert Inc. and sought damages for losses suffered by FCH,
punitive damages and attorneys' fees. On January 30, 1996, these two actions
were dismissed.
Concurrent with the bankruptcy filing of FCH and the conservatorship and
receivership of its two life insurance subsidiaries, First Capital Life
Insurance Company ("First Capital Life") and Fidelity Bankers Life Insurance
Company ("Fidelity Bankers Life") (First Capital Life and Fidelity Bankers Life
collectively, the "Insurance Subsidiaries"), a number of additional actions were
instituted, naming one or more of Holdings, Lehman Brothers and American Express
as defendants (individually or collectively, as the case may be, the "American
Express Defendants").
Under the terms of an agreement between American Express and Holdings,
Holdings has agreed to indemnify American Express for liabilities which it may
incur in connection with any action (including any derivative action) relating
to FCH. In connection therewith, Holdings' indemnification obligation extends to
the below described actions.
FCH Shareholder and Agent Actions. Three actions were commenced in the
United States District Courts for the Southern District of New York and the
Central District of California allegedly as class actions on behalf of the
purchasers of FCH securities during certain specified periods, commencing no
earlier than May 4, 1988 and ending no later than May 31, 1991 (the "Shareholder
Class"). The complaints are captioned Larkin, et al. v. First Capital Holdings
Corp., et al., amended on May 15, 1991 to add American Express as a defendant,
Zachary v. American Express Company, et al., filed on May 20, 1991, and Morse v.
Weingarten, et al., filed on June 13, 1991 (the "Shareholder Class Actions").
The complaints raised claims under the federal securities laws and alleged that
the defendants concealed adverse material information regarding the finances,
financial condition and future prospects of FCH and made material misstatements
regarding these matters.
On July 1, 1991 an action was filed in the United States District Court for
the Southern District of Ohio entitled Benndorf v. American Express Company, et
al. The action was brought purportedly on behalf of three classes. The first
class is similar to the Shareholder Class; the second consisted of managing
general agents and general agents who marketed various First Capital Life
products from April 2, 1990 to the present and to whom it is alleged
misrepresentations were made concerning FCH (the "Agent Class"); and the third
class consists of Agents who purchased common stock of FCH through the First
Capital Life Non Qualified Stock Purchase Plan ("FSPP") and who have an interest
in the Stock Purchase Account under the FSPP (the "FSPP Class"). The complaint
raised claims similar to those asserted in the other Shareholder Class Actions,
along with additional claims relating to the FSPP Class and the Agent Class
alleging damages in marketing the products. In addition, on August 15, 1991,
Kruthoffer v. American Express Company, et al. was filed in the United States
District Court for the Eastern District of Kentucky, whose complaint was nearly
identical to the Benndorf complaint (collectively the "Agent Class Actions").
On November 14, 1991, the Judicial Panel on Multidistrict Litigation issued
an order transferring and coordinating for all pretrial purposes all related
actions concerning the sale of FCH securities, including the Shareholder Class
Action and Agent Class Actions, and any future filed "tag-along" actions, to
Judge John G. Davies of the United States District Court for the Central
District of California (the "California District Court"). The cases are
captioned In Re: First Capital Holdings Corporation Financial Products
Securities Litigation. MDL Docket No.-901 (the "MDL Action").
On January 18, 1993, an amended consolidated complaint (the "Third
Complaint") was filed on behalf of the Shareholder Class and the Agent Class.
The Third Complaint names as defendants American Express, Holdings, Lehman
Brothers, Weingarten and his wife, Palomba Weingarten, Ginsberg, Philip A.
Fitzpatrick (FCH's Chief Financial Officer), the Outside Directors and former
FCH outside directors Jeffrey B. Lane and Robert Druskin (the "Former Outside
Directors"), Fred
11
Buck (President of First Capital Life) and Peat Marwick. The complaint raises
claims under the federal securities law and the common law of fraud and
negligence. On March 10, 1993, the American Express defendants answered the
Third Amended Complaint, denying its material allegations.
On March 11, 1993, the California District Court entered an order granting
class certification to the Shareholder Class. The class consists of all persons,
except defendants, who purchased FCH common stock, preferred stock and
debentures during the period May 4, 1988 to and including May 10, 1991. It also
issued an order denying class certification to the Agent Class. The FSPP Class
action had been previously dropped by the plaintiffs.
The American Express Shareholder Action. On or about May 20, 1991, a
purported class action was filed on behalf of all shareholders of American
Express who purchased American Express common shares during the period beginning
August 16, 1990 to and including May 10, 1991. The case is captioned Steiner v.
American Express Company, et al. and was commenced in the United States District
Court for the Eastern District of New York. The defendants are Holdings,
American Express, James D. Robinson, III, Howard L. Clark, Jr., Harvey Golub and
Aldo Papone. The complaint alleges generally that the defendants failed to
disclose material information in their possession with respect to FCH which
artificially inflated the price of the common shares of American Express from
August 16, 1990 to and including May 10, 1991 and that such nondisclosure
allegedly caused damages to the purported shareholder class. The action has been
transferred to California and is now part of the MDL Action. The defendants have
answered the complaint, denying its material allegations.
American Express Derivative Action. On June 6, 1991, a purported shareholder
derivative action was filed in the United States District Court for the Eastern
District of New York, entitled Rosenberg v. Robinson, et al., against all of the
then-current directors of American Express. In January 1992, this action was
transferred by stipulation to be part of the MDL action. The complaint alleged
that the Board of Directors of American Express should have required Holdings to
divest its investment in FCH and to write down such investment sooner. In
addition, the complaint alleged that the failure to act constituted a waste of
corporate assets and caused damage to American Express' reputation. The
complaint sought a judgment declaring that the directors named as defendants
breached their fiduciary duties and duties of loyalty and requiring the
defendants to pay money damages to American Express, and remit their
compensation for the period in which the duties were breached, to pay attorneys'
fees and costs and other relief. The parties to the American Express Shareholder
Action and the American Express Derivative Action have entered into a settlement
agreement, subject to approval by the Court.
The Virginia Commissioner of Insurance Action. On December 9. 1992, a
complaint was filed in federal court in the Eastern District of Virginia by
Steven Foster, the Virginia Commissioner of Insurance as Deputy Receiver of
Fidelity Bankers Life. The Complaint names Holdings and Weingarten, Ginsberg and
Leonard Gubar, a former director of FCH and Fidelity Bankers Life, as
defendants. The action was subsequently transferred to California to be part of
the MDL Action. The Complaint alleges that Holdings acquiesced in and approved
the continued mismanagement of Fidelity Bankers Life and that it participated in
directing the investment of Fidelity Bankers Life assets. The complaint asserts
claims under the federal securities laws and asserts common law claims including
fraud, negligence and breach of fiduciary duty and alleges violations of the
Virginia Securities laws by Holdings. It allegedly seeks no less than $220
million in damages to Fidelity Bankers Life and its present and former
policyholders and creditors and punitive damages. Holdings has answered the
complaint, denying its material allegations.
Easton & Co. v. Mutual Benefit Life Insurance Co., et al.; Easton & Co. v.
Lehman Brothers Inc.
Lehman Brothers has been named as a defendant in two consolidated class
action complaints pending in the United States District Court for the District
of New Jersey (the "N.J. District Court").
12
Easton & Co. v. Mutual Benefit Life Insurance Co., et al. ("Easton I"), and
Easton & Co. v. Lehman Brothers Inc. ("Easton II"). The plaintiff in both of
these actions is Easton & Co., which is a broker-dealer located in Fort Lee, New
Jersey. Both of these actions allege federal securities law claims and pendent
common law claims in connection with the sale of certain municipal bonds as to
which Mutual Benefit Life Insurance Company ("MBLI") has guaranteed the payment
of principal and interest. MBLI is an insurance company which was placed in
rehabilitation proceedings under the supervision of the New Jersey Insurance
Department on or about July 16, 1991. In the Matter of the Rehabilitation of
Mutual Benefit Life Insurance Company, (Sup. Ct. N.J. Mercer County.)
Easton I was commenced on or about September 17, 1991. In addition to Lehman
Brothers, the defendants named in this complaint are MBLI, Henry E. Kates
(MBLI's former Chief Executive Officer) and Ernst & Young (MBLI's accountants).
The litigation is purportedly brought on behalf of a class consisting of all
persons and entities who purchased DeKalb, Georgia Housing Authority Multi-
Family Housing Revenue Refunding Bonds (North Hill Ltd. Project), Series 1991,
due November 30, 1994 (the "DeKalb Bonds") during the period from May 3, 1991
(when the DeKalb bonds were issued) through July 16, 1991. Lehman Brothers acted
as underwriter for this bond issue, which was in the aggregate principal amount
of $18.7 million. The complaint alleges that Lehman Brothers violated Section
10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, and seeks
damages in an unspecified amount or rescission. The complaint also alleges a
common law negligent misrepresentation claim against Lehman Brothers and the
other defendants.
Easton II was commenced on or about May 18, 1992, and names Lehman Brothers
as the only defendant. Plaintiff purports to bring this second lawsuit on behalf
of a class composed of all persons who purchased "MBLI-backed Bonds" from Lehman
Brothers during the period April 19, 1991 through July 16, 1991. The complaint
alleges that Lehman Brothers violated Section 10(b) and Rule 10b-5, and seeks
monetary damages in an unspecified amount, or rescission pursuant to Section
29(b) of the Exchange Act. The complaint also contains a common law claim of
alleged breach of duty and negligence.
On or about February 9, 1993, the N.J. District Court granted plaintiffs'
motion for class certification in Easton I. The parties have agreed to
certification of a class in Easton II for purchases of certain fixed-rate
MBLI-backed bonds during the class period.
Maxwell Related Litigation
Certain of the Company's subsidiaries are defendants in several lawsuits
arising out of transactions entered into with the late Robert Maxwell or
entities controlled by Maxwell interests. These actions are described below.
Berlitz International Inc. v. Macmillan Inc. et al. This interpleader action
was commenced in Supreme Court, New York County (the "Court") on or about
January 2, 1992, by Berlitz International Inc. ("Berlitz") against Macmillan
Inc. ("Macmillan"), Lehman Brothers Holdings PLC ("PLC"), Lehman Brothers
International Limited (now known as Lehman Brothers International (Europe),
("LBIE") and seven other named defendants. The interpleader complaint seeks a
declaration of the rightful ownership of approximately 10.6 million shares of
Berlitz common stock, including 1.9 million shares then registered in PLC's
name, alleging that Macmillan claimed to be the beneficial owner of all 10.6
million shares, while the defendants did or might claim ownership to some or all
of the shares. As a result of its bankruptcy filing, MacMillan sought to remove
this case to the Bankruptcy Court for the Southern District of New York. On the
motion of LBIE and PLC, the case was remanded back to the Court. Following the
remand, the parties entered into a stipulation pursuant to which all proceedings
have been stayed pending the outcome of the appeal in Macmillan v. Bishopsgate
Investment Trust et al., referred to below.
13
Macmillan, Inc. v. Bishopsgate Investment Trust, Shearson Lehman Brothers
Holdings PLC et al. This action was commenced by issuance of a writ in the High
Court of Justice in London, England on or about December 9, 1991. In this
action, Macmillan sought relief virtually identical to that sought in the
Berlitz action, described above. Specifically, Macmillan sought a declaration
that it is the legal and beneficial owner of the disputed 10.6 million shares of
Berlitz common stock, including the 1.9 million shares then held by PLC. After a
trial, on December 10, 1993, the High Court of Justice handed down a judgment
finding for the Company on all aspect of its defense and dismissing MacMillan's
claims. On November 2, 1995, the Court of Appeal issued a preliminary judgment
dismissing MacMillan s appeal. MacMillan has sought leave to appeal to the House
of Lords.
MCC Proceeds Inc. v. Lehman Brothers International (Europe) This action was
commenced by issuance of a writ in the High Court of Justice in London, England
on July 14, 1995. In this action, MCC Proceeds Inc., as successor to Macmillan,
Inc., seeks relief identical to that sought in the Berlitz action described
above, but based on a legal theory which was initially pleaded but ultimately
abandoned by the plaintiff in Berlitz. The High Court granted LBIE's has issued
an application to dismiss the proceeding and assessed costs against MCC
Proceeds.
Lehman Brothers Commercial Corporation and Lehman Brothers Special Financing
Inc. v. China International United Petroleum and Chemical Co., Ltd.
On November 15, 1994, two Lehman Brothers subsidiaries, Lehman Brothers
Commercial Corporation ("LBCC") and Lehman Brothers Special Financing Inc.
("LBSF"), commenced an action against China International United Petroleum and
Chemicals Company ("Unipec") in the United States District Court for the
Southern District of New York alleging breach of contract. The litigation arose
from the refusal by Unipec to honor its obligations with respect to certain
foreign exchange and swap transactions. LBCC and LBSF seek to recover
approximately $44 million from Unipec. Unipec asserted fifteen counterclaims
against Lehman entities based on violations of federal securities and
commodities laws and rules and theories of fraud, breach of fiduciary duty,
conversion and business torts. Unipec seeks $8 million in compensatory damages,
as well as punitive damages. The Court granted the motion of the Lehman
counterclaim defendants in part, and dismissed the counterclaims based on
business tort theories. Discovery is progressing.
Lehman Brothers Commercial Corporation and Lehman Brothers Special Financing
Inc. v. Minmetals International Non-Ferrous Metals Trading Company
On November 15, 1994, LBCC and LBSF commenced an action against Minmetals
International Non-Ferrous Metals Trading Company ("Minmetals") and China
National Metals and Minerals Import and Export Company ("CNM") in the United
States District Court for the Southern District of New York alleging breach of
contract against Minmetals and breach of guarantee against CNM. The litigation
arose from the refusal by Minmetals and CNM to honor their obligations with
respect to certain foreign exchange and swap transactions. LBCC and LBSF seek to
recover approximately $53.5 million from Minmetals and/or CNM. On June 26, 1995,
the court granted CNM's motion to dismiss the claims against it, but also
granted LBCC and LBSF leave to replead. Minmetals filed fourteen counterclaims
against Lehman entities based on violations of federal securities and
commodities laws and rules, and theories of fraud, breach of fiduciary duty and
conversion. The court denied a motion by the Lehman counterclaim defendants to
dismiss the six fraud-based counterclaims. On February 7, 1996, LBCC and LBSF
sought leave to file an amended complaint naming CNM as an additional defendant.
Discovery is progressing.
14
Sinochem(USA) Inc. v. Lehman Brothers Inc. et al.
On January 4, 1996, a complaint was filed in the United States District
Court for the Southern District of New York by Sinochem (USA) Inc. ("Sinochem")
against Lehman Brothers Inc., Lehman Special Financing and Sheng Yan, a former
Lehman salesperson. The complaint alleges that Sinochem has been exposed to
losses of approximately $20 million by entering into unsuitable investments,
namely interest rate swaps and repurchase transactions, with the defendants. The
complaint, which includes claims based on fraud, breach of fiduciary duty,
breach of contract and alleged violations of federal securities and commodities
laws and rules, seeks return of the capital Sinochem invested, a declaration
that the transactions are void, and punitive damages. The defendants intend to
file an answer denying the material allegations of the complaint and to assert
counterclaims against Sinochem and its parent corporation, China National
Chemicals Import & Export Corporation ("Sinochem Beijing"), to recover all
amounts due and owing from Sinochem and Sinochem Beijing.
Actions Relating to National Association of Securities Dealers Automated
Quotations System ("NASDAQ") Market Maker Antitrust and Securities Litigation.
Beginning in May, 1994, several class actions were filed in various state
and federal courts against various broker-dealers making markets in NASDAQ
securities. With respect to a number of those actions LBI was either
specifically named as a defendant or was not specifically named as a defendant
but could be deemed to be a member of the defendant class as defined in the
complaints. Plaintiffs in these cases have alleged violations of the antitrust
laws, securities laws and have pled a variety of other statutory and common law
claims. All of these actions are based on the theory that because odd-eighth
quotes occur less often than quarter quotes, NASDAQ market makers must be
colluding wrongfully to maintain a wider spread.
By Order filed October 14, 1994, the Judicial Panel on Multidistrict
Litigation consolidated these actions in the Southern District of New York and
ordered that all related actions be transferred and coordinated for all pretrial
purposes. The case is captioned In Re NASDAQ Market-Makers Antitrust Litigation,
MDL No. 1023.
On December 16, 1994, plaintiffs served a consolidated Amended Complaint
naming 33 defendants including LBI. Plaintiffs claim violations of the federal
antitrust laws including Section 1 of the Sherman Antitrust Act. Plaintiffs seek
unspecified compensatory damages trebled in accordance with the antitrust laws,
costs including attorneys' fees as well as injunctive relief. The court
dismissed the action with leave to replead, stating that the complaint failed to
identify the securities involved with sufficient specificity. The plaintiffs
replied and the defendants answered the amended complaint on November 17, 1995.
Discovery has commenced.
Leetate Smith, et al. v. Merrill Lynch, et al.
On February 28, 1995 a First Amended Consolidated Class Action Complaint for
Violations of the Federal Securities Laws and the California Corporations Code
(the "Complaint") was filed in the United States District Court for the Central
District of California amending a previously filed complaint and adding, among
other defendants, LBI. The Complaint is purportedly brought on behalf of
purchasers of bonds, notes and other securities during the period July 1, 1992
through December 6, 1994 (the "Class Period") that were issued by Orange County
or by other public entities which had funds invested in Orange County's
Investment Pool (collectively the "County"). Also named as defendants are eight
other broker-dealers who are, like LBI, alleged to have acted as underwriters of
the County's debt securities and the five financial advisors who allegedly
advised the County during the Class Period. The Complaint alleges violations of
Section 10b of the Exchange Act of 1934 and various sections of the California
Corporations Code based on alleged misstatements and omissions in the
15
Official Statements of the debt offerings by the County primarily relating to
the County's creditworthiness and ability to repay the debts. The Complaint
seeks (i) to certify the action as a class action; (ii) unspecified damages plus
interest; and (iii) attorneys fees.
Sonnenfeld v. The City and County of Denver, Colorado, et al.
On August 4, 1995, a Consolidated Amended Class Action Complaint (the
"Complaint") was filed in the United States District Court for the District of
Colorado, consolidating and amending previously filed complaints and adding,
among other defendants, LBI. The Complaint is purportedly brought on behalf of
all persons, other than defendants, who purchased Denver Airport System Revenue
Bonds during the period February 27, 1992 through May 3, 1994 that were issued
by the City and County of Denver (the "Bonds") and who were damaged by their
investments. Also named as defendants are seven other broker-dealers who acted
as underwriters or financial advisors in connection with the issuances of the
Bonds and the City and County of Denver. The Complaint alleges violations of
Section 10b of the Exchange Act of 1934 and the Colorado Securities Act and
common law fraud based on alleged misstatements and omissions in the Official
Statements for the Bonds primarily relating to status of the design and
construction of the new Denver International Airport (the "Airport"), the amount
of revenues it would likely generate and the risks posed to the timely opening
of the Airport by the installation of an automated baggage system. The Complaint
seeks (i) to certify the action as a class action; (ii) unspecified damages; and
(iii) costs and attorneys fees.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Pursuant to General Instruction J of Form 10-K, the information required by
Item 4 is omitted.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
All of the outstanding common stock of the Company is owned by Holdings.
ITEM 6. SELECTED FINANCIAL DATA
Pursuant to General Instruction J of Form 10-K, the information required by
Item 6 is omitted.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Set forth on the following pages is Management's Discussion and Analysis of
Financial Condition and Results of Operations for the twelve months ended
November 30, 1995, the eleven months ended November 30, 1994 and the twelve
months ended December 31, 1993.
BUSINESS ENVIRONMENT
The principal business activities of Lehman Brothers Inc., a registered
broker-dealer ("LBI") and subsidiaries (collectively, the "Company" or "Lehman
Brothers") are investment banking and securities trading and sales, which by
their nature are subject to volatility, primarily due to changes in interest and
foreign exchange rates, global economic and political trends and industry
competition. As a result, revenues and earnings may vary significantly from
quarter to quarter and from year to year. LBI is a wholly owned subsidiary of
Holdings.
The adverse market conditions that prevailed during the last three quarters
of 1994, characterized by rising interest rates and depressed underwriting
volumes, continued throughout most of the first quarter of 1995.
16
In the second quarter of 1995, market conditions showed signs of improvement
as expectations for lower U.S. interest rates prompted strong rallies in the
stock and bond markets. Although customer volumes increased in both the debt and
equity markets, market conditions continued to be volatile during this period.
In general, investors remained conservative and defensive due to uncertainties
surrounding the direction of U.S. interest rates and the value of the dollar.
Over the same period, derivative transaction volumes showed improvement as
customers and clients were looking for protection in a declining interest rate
and volatile currency environment.
The positive momentum established during the second quarter of 1995
continued into the third quarter of 1995. In early July 1995, the U.S. Federal
Reserve Bank reduced the federal funds rate by one-quarter of a percentage
point. Investors reacted favorably to this long-awaited rate cut, leading to a
rally in the bond market. However, by the middle of July 1995, positive economic
data caused renewed investor concerns regarding inflation, the growth rate of
the economy and the future direction of interest rates. Towards the end of the
third quarter, the market tone turned decidedly more positive as investors
concluded that interest rate increases would be unnecessary. In addition, the
dollar continued to strengthen against key currencies such as the yen and the
Deutsche mark, providing further support for a more stable interest rate
environment.
The fixed income and equity markets rallied as a result of these factors.
Improved market conditions allowed for a continuing increase in debt and equity
origination activity. Driving the robust equity markets were strong individual
company and industry fundamentals, near record levels of merger and acquisition
activity and substantial cash inflows into mutual funds.
The market rally, which began in September, accelerated through the months
of October and November. The more favorable view on interest rates provided
strong support for the U.S. equity market as the major equity indices hit
all-time highs. Business fundamentals have remained reasonably positive in the
U.S. bond market, as lower levels of inflation and the possibility of a deficit
reduction agreement by the U.S. Government have raised the potential for further
interest rate reductions by the U.S. Federal Reserve Bank. These conditions have
been positive for debt and equity origination activity and secondary trading
volumes for the industry as a whole. Internationally, lower growth rates in the
major European countries have prompted interest rate reductions from a number of
central banks and strong rallies in their respective bond and stock markets.
Higher relative returns in the U.S. markets vis-a-vis foreign markets have
bolstered international interest in U.S. securities and provided support for the
U.S. dollar. This positive market environment has continued into 1996.
HOLDINGS' SPIN-OFF FROM AMERICAN EXPRESS
On May 31, 1994, American Express effected a special dividend to its common
shareholders of record on May 20, 1994, of approximately 98.2 million shares of
Holdings' common stock. (See Note 6 to the Consolidated Financial Statements.)
As part of the spin-off, Holdings' equity capital was increased and
restructured, with Holdings receiving a net increase of $1.25 billion of equity,
primarily from American Express. As a result of the Distribution, Holdings
became a widely held public corporation with its common stock traded on the New
York Stock Exchange.
CHANGE IN YEAR-END
Effective with the Distribution, the Company and Holdings changed their
year-end from December 31 to November 30, in order to shift certain year-end
administrative activities to a time period that conflicts less with the business
needs of the Company's institutional customers. As a result of the change in the
Company's year-end, it reported its 1994 financial statements on the basis of an
eleven month transition period ended November 30, 1994. Due to the eleven month
reporting period for 1994, the Company's 1994 results of operations are not
directly comparable with the Company's results for 1995 or 1993.
17
BUSINESSES SOLD
The Company completed the sale of three businesses during 1993: The Boston
Company, Shearson, and SLHMC which were completed on May 21, July 31, and August
31, 1993, respectively. (See Note 18 to the Consolidated Financial Statements.)
The Company's operating results reflect The Boston Company as a discontinued
operation, while the operating results of Shearson and SLHMC are included in the
Company's results from continuing operations for all periods prior to their sale
in 1993. Because of the significant sale transactions completed during 1993, the
Company's historical financial statements are not fully comparable for all
periods presented.
RESULTS OF OPERATIONS
SUMMARY. The Company reported net income of $69 million for 1995, including
a $26 million ($43 million pretax) charge for occupancy-related real estate
expenses and severance. Excluding the restructuring charge, net income was $95
million for 1995. The Company's 1995 results reflect improved performance in
corporate finance advisory activity and in fixed income and equity origination
as well as higher levels of customer activity in a number of businesses. The
Company benefited from the continuing increase in merger and acquisition
activity throughout the year and from a stronger market climate beginning in the
second quarter of 1995. Realization of benefits from the continued investments
in selective investment banking, research and sales resources, combined with
reductions in the Company's non-interest expenses (excluding special charges),
also had a positive effect on 1995 results. For 1994, the Company reported a net
loss of $29 million, including a $13 million ($23 million pretax) charge for the
cumulative effect of a change in accounting for postemployment benefits, a $15
million ($27 million pretax) severance charge recorded in the first quarter of
1994 related to the Company's ongoing review of its personnel needs ("Severance
Charge") and $50 million preferred dividend of subsidiary. Excluding these
charges, net income from continuing operations before preferred dividend of
subsidiary was $49 million in 1994. The 1994 results reflect the difficult
market environment for many of the Company's principal businesses. The Company
reported a net loss of $259 million for 1993 which included a loss of $646
million for businesses sold, net income of $198 million for the Company's
continuing businesses and a net gain of $189 million from discontinued
operations. A detailed breakout of the 1993 results into these three categories
is included on page 25. The primary discussion and comparison of operating
results for 1993 includes only the continuing Lehman Businesses, with a separate
section for Businesses Sold/Discontinued Operations listed subsequently on pages
25-26.
NET REVENUES. Net revenues were $2,078 million for 1995, $1,969 million for
1994 and $2,674 million for 1993. Revenues in 1995 were positively affected by
increased underwriting volumes and customer flow activity due to strong rallies
in the stock and bond markets during the last three quarters of the year. The
Company's revenues increased during each quarter of 1995. Although 1994 revenues
on an annualized basis were comparable to 1995 levels, the Company's 1994
revenues declined from a first quarter peak as increasing interest rates and
volatile equity markets served to depress underwriting volumes and to reduce
customer flow activity. Revenues in 1993 were affected by the positive economic
environment, which resulted in a record year for the U.S. securities industry,
as historically low interest rates, higher volumes of new stock and bond issues
and the continued restructuring of corporate balance sheets produced strong
results.
Since 1990, Lehman Brothers has focused on a "client/customer-driven"
strategy. Under this strategy, Lehman Brothers concentrates on serving the needs
of major issuing and advisory clients and investing customers worldwide to build
an increasing "flow" of business that leverages the Company's research,
underwriting and distribution capabilities. Customer flow continues to be the
primary source of the Company's net revenues. In addition to its customer flow
activities, the Company also takes proprietary positions based upon expected
movements in interest rate, foreign exchange, equity and commodity markets in
both the short- and long-term. The Company's success in this area is dependent
upon its ability to anticipate economic and market trends and to develop trading
strategies that
18
capitalize on these anticipated changes. Consistent with the Company's
client/customer-driven strategy, the Company estimates that proprietary trading
activities accounted for approximately 9% of net revenues in 1995. Proprietary
trading is not anticipated to grow significantly.
As part of its market-making activities, the Company maintains inventory
positions of varying amounts across a broad range of financial instruments which
are marked-to-market on a daily basis and along with the Company's proprietary
trading positions, give rise to principal transactions revenues. The Company
utilizes various hedging strategies to minimize its exposure to significant
movements in interest and foreign exchange rates and the equity markets. Net
revenues from the Company's market making and trading activities in fixed income
and equity products are recognized as either principal transactions or net
interest revenues depending upon the method of financing and/or hedging related
to specific inventory positions. The Company evaluates its trading strategies on
an overall profitability basis which includes both principal transaction
revenues and net interest. Therefore, changes in net interest should not be
viewed in isolation but should be viewed in conjunction with revenues from
principal transactions. Net interest and dividend revenues in 1995 decreased
over the prior year due to decreased net interest spreads in certain of the
Company's fixed income and equity financing portfolios. Additionally, net
interest and dividend revenues in 1995 were adversely affected by increased
financing costs due to the net reduction in the Company's equity capital base,
primarily as a result of dividends and capital distributions to Holdings. The
Company's net interest and dividend revenues in 1994 were adversely affected by
reduced spreads on fixed income products and increased funding costs to the
Company as compared to the prior year as a result of the higher interest rate
environment in 1994.
The following table of net revenues by business unit and the accompanying
discussion have been prepared in order to present the Company's net revenues in
a format which reflects the manner in which the Company manages its businesses.
For internal management purposes, the Company has been segregated into five
major business units: Fixed Income, Equity, Corporate Finance Advisory, Merchant
Banking and Asset Management. Each business unit represents a grouping of
financial activities and products with similar characteristics. These business
activities result in revenues that are recognized in multiple revenue categories
contained in the Company's Consolidated Statement of Operations. Net revenues by
business unit contain certain internal allocations, including funding costs,
which are centrally managed.
19
TWELVE MONTHS ENDED NOVEMBER 30, 1995
PRINCIPAL
TRANSACTIONS AND INVESTMENT
NET INTEREST COMMISSIONS BANKING OTHER TOTAL
---------------- ----------- ---------- ----- ------
Fixed Income............................ $ 970 $ 84 $160 $10 $1,224
Equity.................................. 98 287 198 1 584
Corporate Finance Advisory.............. 186 186
Merchant Banking........................ (36) 77 9 50
Asset Management........................ (2) 24 12 34
------- ----- ----- ----- ------
$1,030 $ 395 $621 $32 $2,078
------- ----- ----- ----- ------
ELEVEN MONTHS ENDED NOVEMBER 30, 1994
PRINCIPAL
TRANSACTIONS AND INVESTMENT
NET INTEREST COMMISSIONS BANKING OTHER TOTAL
---------------- ----------- ---------- ----- ------
Fixed Income............................ $ 933 $ 101 $ 80 $37 $1,151
Equity.................................. 196 263 154 7 620
Corporate Finance Advisory.............. 153 153
Merchant Banking........................ (8) 12 4
Asset Management........................ 1 27 13 41
------- ----- ----- ----- ------
$1,122 $ 391 $399 $57 $1,969
------- ----- ----- ----- ------
TWELVE MONTHS ENDED DECEMBER 31, 1993
PRINCIPAL
TRANSACTIONS AND INVESTMENT
NET INTEREST COMMISSIONS BANKING OTHER TOTAL
---------------- ----------- ---------- ----- ------
Fixed Income............................ $1,216 $ 114 $172 $12 $1,514
Equity.................................. 346 292 336 12 986
Corporate Finance Advisory.............. 101 101
Merchant Banking........................ (12) 15 3
Asset Management........................ 8 31 31 70
------- ----- ----- ----- ------
$1,558 $ 437 $624 $55 $2,674
------- ----- ----- ----- ------
For 1995, net revenues were positively impacted by significantly improved
underwriting levels in fixed income and equity products, and strengthened
customer activity throughout the year. Net revenues by business unit for 1994
were down in each major category except corporate finance advisory and merchant
banking in comparison to the business unit revenues recorded in 1993, reflecting
the particularly robust conditions in the capital markets for the entire 1993
year. In 1995, fixed income revenues of $1,224 million reflected a higher
contribution from investment banking, as the mix and after-market performance of
the Company's underwriting improved from 1994 levels. Equity revenues of $584
million in 1995 also reflected the stronger underwriting market environment.
Corporate finance advisory revenues of $186 million in 1995 reflected the
Company's increased participation in strategic mergers and acquisitions and
advisory activities throughout the year. Merchant banking revenues of $50
million in 1995 reflected the merger of certain subsidiaries of Holdings with
merchant banking activities into the Company in the fourth quarter of 1994.
20
The following discussion provides an analysis of the Company's net revenues
based upon the various business units which generated these revenues.
FIXED INCOME
The Company's fixed income revenues reflect customer flow activities (both
institutional and high net-worth retail), secondary trading, debt underwriting,
syndicate and financing activities related to fixed income products. Fixed
income products include government securities, mortgage- and asset-backed
securities, money market products, dollar and non-dollar corporate debt
securities, emerging market securities, municipal securities, financing (global
access to debt financing sources including repurchase and reverse repurchase
agreements), foreign exchange, commodities and fixed income derivative products.
Lehman Brothers is one of the leading 37 primary dealers in U.S. government
securities. The Company is also a dominant market-maker for a broad range of
other fixed income products.
Fixed income revenues were $1,224 million for 1995, $1,151 million for 1994
and $1,514 million for 1993. Reduced interest rates and a strengthening U.S.
dollar contributed to a favorable market environment in 1995, particularly
during the second half of the Company's year. The improved market environment
contributed to a stronger debt syndicate calendar and increased customer flow
activities for many of the Company's fixed income products, including high grade
corporates, municipals and foreign exchange. The most significant component of
the increases in fixed income revenues was investment banking due to a
strengthening in origination volumes and an improved mix of underwriting
revenues compared to the depressed 1994 levels. Holdings and its subsidiaries
ranked #2 in lead-managed fixed income offerings worldwide in 1995 with
underwritings of $77 billion, based on Securities Data Company information.
Commission revenues which primarily relate to the Company's foreign exchange and
commodities trading in listed products decreased in 1995 from 1994 levels. Fixed
income derivative revenues were down in 1995 compared to 1994 due to a decrease
in new customer activity early in the year. Toward the end of 1995, derivative
activities increased with related revenues in the fourth quarter up
substantially compared to the same quarter in 1994; much of the increase was
attributable to a broadening of the Company's international customer and client
business. This reflects the results of a concerted effort to continue to
globalize the Company's efforts in these areas. Financing revenues were down in
1995 compared to 1994 due to decreased net interest spreads in certain of the
matched book portfolios.
Rising interest rates and inflationary concerns in 1994 had a negative
effect on customer activity resulting in reduced profitability for most of the
fixed income businesses as compared to 1993.
EQUITY
The Company's equity revenues reflect customer flow activities (both
institutional and high-net-worth retail), secondary trading, equity
underwriting, equity finance and arbitrage activities.
Equity revenues were $584 million for 1995, $620 million for 1994 and $986
million for 1993. The favorable syndicate calendar in 1995 contributed to
increased customer flow in the Company's secondary trading activities.
Commission revenues were up as trading volumes on domestic exchanges increased.
These increases were more than offset by reduced trading revenues in certain
products in 1995. Holdings and its subsidiaries ranked third in total NYSE
listed trading volume throughout all of 1995.
The decrease in equity revenues in 1994 from 1993 reflected the difficult
business environment in 1994. The 1994 decline was broad based across most
equity-related products.
21
CORPORATE FINANCE ADVISORY
Corporate finance advisory net revenues, classified in the Consolidated
Statement of Operations as a component of investment banking revenues, result
primarily from fees earned by the Company in its role as strategic advisor to
its clients. This role primarily consists of advising clients on mergers and
acquisitions, divestitures, leveraged buyouts, financial restructurings, and a
variety of cross border transactions. The net revenues for corporate finance
advisory increased in 1995 to $186 million from $153 million and $101 million in
1994 and 1993, respectively. The increased revenues reflected a strong mergers
and acquisitions environment throughout 1995 as companies concentrated on cost
cutting and creating greater economies of scale via acquisitions, asset sales,
and corporate restructurings on a global basis. During 1995, Holdings and its
subsidiaries acted as advisor for 141 completed transactions valued at
approximately $67 billion, based on Securities Data Company information.
Corporate finance advisory exhibited renewed strength in 1994 versus 1993 as
both the fees earned by the Company and the number of completed transactions
increased from 1993 levels.
MERCHANT BANKING
Merchant banking net revenues primarily represent the net realized gains and
net unrealized changes resulting from the Company's participation in certain
investment partnerships, such amounts are classified in the Consolidated
Statement of Operations as a component of investment banking revenues. Merchant
banking net revenues also reflect the related net interest expense used to
finance capital contributions to the partnerships. Merchant banking revenues
were $50 million, $4 million and $3 million for 1995, 1994 and 1993,
respectively.
The Company, through a subsidiary, is the general partner for four merchant
banking partnerships, including three institutional funds and one employee
investment vehicle. Current merchant banking investments held by the
partnerships include both publicly traded and privately held companies
diversified on a geographic and industry basis. For 1995, merchant banking
revenues resulting from the participation in these partnerships increased to $77
million from $12 million for 1994, reflecting the merger of certain subsidiaries
of Holdings with merchant banking activities into the Company in the fourth
quarter of 1994. For 1994, merchant banking revenues decreased slightly to $12
million from $15 million for 1993. Net revenues of the merchant banking business
include an allocation of net interest expense related to the Company's
investment in the partnerships. The method used to allocate interest expense was
revised in 1995 from prior periods to better reflect the costs of capital
utilized.
ASSET MANAGEMENT
Revenues from asset management activities were $34 million for 1995, $41
million for 1994 and $70 million for 1993. These revenues primarily consist of
fees from the management of various funds, commissions from the sale of funds to
customers and fees from the management of certain accounts for institutions and
high-net-worth individuals. The decline in revenues from 1994 to 1995 resulted
from the realignment of product offerings to be consistent with the change in
the Company's focus towards high-net-worth and institutional clients. The
decrease in revenues from 1993 to 1994 relates to the loss of certain
commissions and other revenues related to funds and customers transferred to
Smith Barney in conjunction with the sale of the retail division.
NON-INTEREST EXPENSES. Non-interest expenses were $2,000 million for 1995,
$1,968 million for 1994 and $2,282 million for 1993. Compensation and benefits
expense was $1,055 million for 1995, $1,004 million for 1994 and $1,400 million
for 1993. Compensation and benefits expense does not include any portion of
management fees, which are separately categorized on the Company's Consolidated
Statement of Operations, related to employee services provided by Holdings.
Non-interest expenses in 1995 included a restructuring charge of $43 million.
Non-interest expenses in 1994 included a $27 million severance charge. Included
within non-interest expenses in 1993 was a charge of $21
22
million related to certain non-core partnership syndication activities in which
the Company is no longer actively engaged.
The restructuring charge in 1995 included a $26 million occupancy related
real estate charge and a $17 million severance charge. The real estate component
of the charge resulted from a complete review of the Company's real estate
requirements at current headcount levels and the elimination of excess real
estate, primarily in New York, London and Tokyo. This charge includes costs to
write-down the carrying value of leasehold improvements, as well as projected
shortfalls of sublease rentals versus expected operating costs related to the
Company's excess capacity. The excess real estate capacity resulted from
headcount reductions associated with the Company's cost reduction efforts. The
severance component of the charge relates to payments made to terminated
personnel arising from a formalized fourth quarter business unit productivity
review. The Company expects to realize approximately $11 million of reduced
occupancy and depreciation expenses on an annualized basis as a result of these
actions.
Excluding these special charges, non-interest expenses were $1,957 million
for 1995, $1,941 million for 1994 and $2,261 million for 1993.
COST REDUCTION EFFORT. At year-end 1994, Holdings announced a cost reduction
program to reduce expenses by $300 million on an annualized basis (pretax)
compared to Holdings' third quarter 1994 expense run rate. The Company's expense
base was permanently lowered as a result of Holdings' cost reduction efforts.
However, the Company's cost structure differs from Holdings in that nonpersonnel
related expenses are not readily determinable from the Company's consolidated
statement of operations, since a portion of the Company's management fee expense
is comprised of charges related to employee services provided by Holdings and
its subsidiaries. In addition, the Company's management fees are subject to
fluctuation due to changes in the nature and levels of intercompany services
provided. Listed below is a summary of Holdings' cost reduction efforts which
were targeted into three areas: personnel cost savings of $100 million,
nonpersonnel cost savings of $150 million and interest and tax expense savings
of $50 million.
Through November 1995, Holdings achieved its cost reduction goals in all the
identified cost categories. In fact, through the fourth quarter of 1995,
Holdings reduced total expenses by approximately $326 million on an annualized
basis compared to the third quarter of 1994. These costs savings achieved do not
include the $11 million of future cost savings attributable to the Company's
real estate related restructuring charge previously discussed.
With respect to Holdings' personnel related cost reduction goals, Holdings
reduced headcount to 7,771 at November 30, 1995 from 8,512 at November 30, 1994
and 17% from a peak of 9,400 in early 1994. As a result of these reductions,
Holdings reduced its operating compensation and benefits ratio to 50.7% in the
fourth quarter of 1995 from the third quarter 1994 benchmark of 53.9%,
translating into annualized cost savings of approximately $100 million.
Nonpersonnel cost reductions were achieved as a result of a systematic and
comprehensive global review of all major expense categories. As a result,
Holdings' nonpersonnel expenses decreased to $254 million in the fourth quarter
of 1995 from the third quarter 1994 benchmark of $298 million, resulting in
reduced quarterly expenses of $44 million or annualized savings of approximately
$177 million.
Holdings achieved its $50 million cost reduction goal related to interest
and taxes through equal reductions in each category. The interest expense
savings were accomplished as a result of Holdings' efforts to improve its
collateral utilization and long-term debt hedging strategies. Holdings achieved
tax savings of approximately $25 million as a result of the implementation of
additional tax planning strategies.
23
As a result of these efforts, Holdings' expense base has been permanently
lowered. Holdings plans to continue its focus on nonpersonnel costs, with the
goal of achieving further cost savings in excess of $50 million by the end of
1996.
INCOME TAXES
Through affirmative actions the Company continues to aggressively pursue
maintaining a low effective tax rate. The actions taken in 1995 include the
restructuring of certain legal entities and a general review of overall
operations to assure the Company is operating in the most tax efficient manner.
The Company anticipates ongoing benefits related to the actions taken.
The Company had an income tax provision of $9 million for 1995 compared to
an income tax benefit of $33 million for 1994, and an income tax provision of
$126 million for 1993. The 1995 provision reflects the Company's continued focus
on generating income subject to preferential tax treatment as well as creating
organizational structures that optimize tax results. The 1994 benefit reflects
an increase in benefits attributable to income subject to preferential tax
treatment as compared to that of 1993. The 1993 income tax provision consisted
of a provision of $133 million for continuing businesses and a tax benefit of $7
million related to non-core business reserves. During the third quarter of 1993,
the statutory U.S. federal income tax rate was increased to 35% from 34%,
effective January 1, 1993. The Company's 1993 tax provision includes a one-time
benefit of approximately $8 million from the impact of the federal rate change
on the Company's net deferred tax assets.
The Company's net deferred tax assets increased $25 million to $39 million
at November 30, 1995 from $14 million at November 30, 1994. The net increase is
primarily attributable to the reversal of certain temporary differences. It is
anticipated that the deferred tax assets will be realized through future
earnings. The Company had a net deferred tax asset of $14 million at November
30, 1994 as compared to a net deferred tax liability of $36 million at December
31, 1993. The increase in net deferred tax assets is primarily attributable to
the reversal of certain temporary differences.
As of November 30, 1995, the Company had approximately $25 million of tax
net operating losses available to offset future taxable income.
1993 RESULTS
Because of the significant sale transactions completed during 1993, the
Company's 1993 financial statements are not fully comparable with 1995 and 1994.
In order to facilitate an understanding of the Company's 1993 results, the
following table segregates the Company's results between the results of the
Lehman Businesses (the results of the businesses that now comprise Lehman
Brothers), Businesses Sold (the results of Shearson and SLHMC through their
respective sale dates; the loss on the sale of Shearson; and the reserves for
non-core businesses) and Discontinued Operations (the results of The Boston
Company accounted for as a discontinued operation).
24
TWELVE MONTHS ENDED
DECEMBER 31, 1993
------------------------------------------------------
LEHMAN BUSINESSES DISCONTINUED
BUSINESSES SOLD OPERATIONS HISTORICAL
---------- ---------- ------------ ----------
(IN MILLIONS)
Revenues:
Principal transactions............................. $1,132 $ 323
Investment banking................................. 624 170
Commissions........................................ 437 828
Interest and dividends............................. 4,868 161
Other.............................................. 55 412
---------- ---------- ------------ ----------
Total revenues................................... 7,116 1,894
Interest expense................................... 4,442 143
---------- ---------- ------------ ----------
Net revenues..................................... 2,674 1,751 $ 4,425
---------- ---------- ------------ ----------
Non-interest expenses:
Compensation and benefits........................ 1,400 1,164
Other expenses................................... 861 470
Loss on sale of Shearson......................... 535
Reserves and other charges....................... 21 120
---------- ---------- ------------ ----------
Total non-interest expenses...................... 2,282 2,289 4,571
---------- ---------- ------------ ----------
Income (loss) from continuing operations before
taxes and preferred dividend of subsidiary....... 392 (538) (146)
Provision for income taxes......................... 126 108 234
---------- ---------- ------------ ----------
Income (loss) from continuing operations before
preferred dividend of subsidiary................... 266 (646) (380)
---------- ---------- ------------ ----------
Income from discontinued operations, net of
taxes.............................................. 189 189
---------- ---------- ------------ ----------
Net income (loss) before preferred dividend of
subsidiary......................................... 266 (646) 189 (191)
---------- ---------- ------------ ----------
Preferred dividend of subsidiary................... $ (68) $ (68)
---------- ---------- ------------ ----------
Net income (loss)................................ $ 198 $ (646) $ 189 $ (259)
---------- ---------- ------------ ----------
The discussion of the 1993 results for the Lehman Businesses has been
included in the previous sections discussing revenues, non-interest expenses and
taxes. The following section includes a discussion of the Businesses
Sold/Discontinued Operations.
BUSINESSES SOLD/DISCONTINUED OPERATIONS
This discussion is provided to analyze the results of the Businesses Sold.
All 1993 amounts for the Businesses Sold include results through their dates of
sale.
The Businesses Sold recorded a net loss of $646 million for 1993. The 1993
results include a loss on the sale of Shearson of $630 million and a $79 million
charge recorded in the first quarter as a reserve for non-core businesses in
anticipation of the sale of SLHMC. The loss on the sale of Shearson included a
reduction in goodwill of $750 million and transaction-related costs such as
relocation, systems and operations modifications and severance. Excluding the
$630 million aftertax loss on the sale, Shearson's net income was $63 million in
1993. Excluding the $79 million aftertax charge discussed above, SLHMC
operations were break-even in 1993.
Net revenues related to the Businesses Sold were $1,751 million for 1993.
Excluding the loss on the sale of Shearson and the reserve for non-core
businesses related to SLHMC, non-interest expenses of
25
the Businesses Sold were $1,634 million for 1993. Compensation and benefits
expense were $1,164 million for 1993.
The 1993 tax provision of $108 million for the Businesses Sold included (i)
expenses of $54 million related to the operating results of Shearson: (ii) an
expense of $95 million from the sale of Shearson and (iii) a tax benefit of $41
million related to the $120 million reserve for non-core businesses recorded in
anticipation of the sale of SLHMC. The provision related to the sale of Shearson
primarily resulted from the write-off of $750 million of goodwill which was not
deductible for tax purposes.
The Company reported net income of $189 million from discontinued operations
of The Boston Company, including an aftertax gain of $165 million on the sale
and aftertax earnings of $24 million. (See Note 18 for further discussion of the
Businesses Sold and the Discontinued Operations.)
LIQUIDITY AND CAPITAL RESOURCES
The Company's total assets increased to $82.6 billion at November 30, 1995
from $79.1 billion at November 30, 1994. The increase in total assets is
primarily the result of the change in the Company's clearing arrangements,
partially offset by decreases in other areas. At the close of business on
February 17, 1995, the Company became self-clearing for equities, municipal
securities and corporate debt instruments. As a result of this arrangement,
assets increased at that time by approximately $11 billion which were
predominantly funded with offsetting liabilities. The Company's Consolidated
Statement of Financial Condition now includes accounts previously cleared,
settled and carried by Smith Barney Inc. Principal areas impacted include the
Company's stock borrow and lending activities and high-net-worth customer
business. The Company has entered into an agreement for a term of five years
with the Bear Stearns Securities Corp ("BSSC") pursuant to which BSSC has agreed
to process the transactions previously cleared by Smith Barney Inc.
The Company's balance sheet is highly liquid and consists primarily of cash
and cash equivalents, securities and other financial instruments owned which are
marked-to-market daily and collateralized short-term financing agreements which
arise primarily from the Company's customer flow securities transactions. As the
Company's primary activities are based on customer flow, the assets experience a
rapid turnover rate. In addition, the highly liquid nature of these assets
provides the Company with flexibility in financing and managing its business. At
November 30, 1995, short-term assets, those which can be converted to cash in
less than one year, represented approximately 99% of the Company's total balance
sheet.
FUNDING AND CAPITAL POLICIES
Holdings' Global Asset and Liability Committee ("ALCO"), which includes
senior officers from key areas of the Company, are responsible for establishing
and managing the funding and liquidity policies of the Company. This includes
recomendations for balance sheet size as well as the allocation of balance sheet
to product areas as determined by internal profitability models and return on
equity targets.
The primary goal of the Company's funding principles as set by ALCO are to
provide sufficient liquidity and availability of funding sources throughout all
market environments. These funding principles are:
(i) To maintain an appropriate overall capital structure to support the
business activities in which the Company is engaged.
The Company manages Total Capital, defined as long-term debt, both
senior notes and subordinated indebtedness, plus stockholder's equity, on a
business and product level. The determination of the amount of capital
assigned to each business and product is a function of asset quality,
26
risk, liquidity and regulatory capital requirements. Periodically, the
Company reallocates capital to its businesses based upon their ability to
obtain targeted returns, perceived opportunities in the marketplace and the
Company's long-term strategy.
(ii) To maximize the portion of the Company's balance sheet that is
funded through collateralized borrowing sources and conversely minimize the
use of commercial paper and short-term debt.
Collateralized borrowing sources include securities and other financial
instruments sold but not yet purchased, as well as collateralized short-term
financings, defined as securities sold under agreements to repurchase
("repos") and securities loaned.
Because of their secured nature, repos and other types of collateralized
borrowing sources are less credit-sensitive and have historically been a
more stable financing source under adverse market conditions. Also,
collateralized borrowing sources generally provide the Company with access
to lower cost funding. The Company has been able to exceed its goal of
maintaining repo funding lines significantly in excess of actual
utilization.
(iii) To minimize refunding risk by funding the Company's assets with
liabilities which have maturities similar to the anticipated holding period
of the assets.
The Company continually reviews its mix of long- and short-term
borrowings as it relates to maturity matching and the availability of
secured and unsecured financing. In general, long-term assets are financed
with fixed rate long-term debt and stockholder's equity and inventories and
all other short-term assets are financed with a combination of short-term
funding and floating rate long-term debt and stockholder's equity.
(iv) To diversify and expand the Company's borrowing sources to maximize
liquidity and reduce concentration risk. The Company seeks financing from a
global investor base with the goal of broadening the availability of its
funding sources and maintaining funding availability well in excess of
actual utilization. The Company also utilizes a broad range of debt
instruments, which it issues in varying maturities and currencies.
The Company accesses both commercial paper and other short-term debt
instruments, including master notes and bank borrowings under uncommitted
lines of credit. To reduce liquidity risk, the Company carefully manages its
maturities to avoid large refinancings on any one given day. In addition,
the Company limits its exposure to any single investor to avoid
concentration risk.
(v) To maintain sufficient liquidity in a period of financial stress.
Financial stress is defined as any event which severely constrains the
Company's access to unsecured funding sources.
The Company's liquidity contingency plans are continually reviewed and
updated as the Company's asset/liability mix and liquidity requirements
change. The Company's liquidity contingency plan is based on an estimate of
its ability to meet its funding requirements through a combination of
collateralized short-term financings and short-term secured debt, as well as
Total Capital.
To achieve this objective, the Company's liquidity policies include
maintaining sufficient excess unencumbered securities to use as collateral,
if necessary, to obtain secured financing to meet maturities of short-term
unsecured liabilities as well as current maturities of long-term debt. Also,
the Company maintains a sufficient amount of Total Capital to enable the
Company to fund those assets which are less liquid. Lastly, the Company
periodically tests its secured and unsecured credit facilities to insure
availability and operational readiness. The Company believes that these
policies position the Company to meet its liquidity requirements in all
periods including those of financial stress.
27
SHORT-TERM FUNDING
To implement the policies as noted above, each business is required to fund
its products primarily through global collateralized financings. There are two
principal business areas which are responsible for these efforts, Lehman
Brothers' Fixed Income Financing ("Financing") and Equity Finance. Financing
works in conjunction with the institutional fixed income sales and trading
professionals to provide financing to customers and the firm through the
repurchase markets. Equity Finance provides a similar function in the equity
markets typically through securities loaned/securities borrowed transactions. An
ability to leverage their global market expertise and the Company's distribution
capabilities are a key to successful financing efforts. The amount of the
Company's collateralized borrowing activities will vary reflecting changes in
the mix and overall levels of securities and other financial instruments owned
and global market conditions. However, at all times, the majority of the
Company's assets are funded with collateralized borrowing sources. The Company's
Treasury area works closely with Financing and Equity Finance to develop funding
plans to support the business areas, as well as to execute daily funding
activities. On a daily basis, Treasury is responsible for meeting any funding
needs not met through Financing and Equity Finance. Funding through treasury is
managed globally with regional centers which have access to the capital markets
though the issuance of commercial paper as well as bank lines of credit and
other short- and long-term debt instruments.
At November 30, 1995 and 1994, $56 billion and $54 billion respectively, of
the Company's total balance sheet was financed using collateralized borrowing
sources. The remainder of the financing for the balance sheet is comprised of
short-term debt, payables and Total Capital.
In conjunction with the increase in collateralized short-term financings, as
well as the increase in the Company's Total Capital, as discussed below, the
Company's use of short-term debt decreased to $1.0 billion at November 30, 1995
from $2.3 billion at November 30, 1994. On November 30, 1995 and 1994, there was
no commercial paper outstanding.
The Company's uncommitted lines of credit provide an additional source of
secured and unsecured short-term financings. At November 30, 1995, the Company
had $5.1 billion of uncommitted lines of credit compared to $5.3 billion at
November 30, 1994. Uncommitted lines consist of facilities that the Company has
been advised are available but for which no contractual lending obligations
exists.
TOTAL CAPITAL
Long-term assets are financed with Total Capital. The Company maintains
Total Capital in excess of its long-term assets to provide additional liquidity,
which the Company uses to meet its short-term funding requirements and to reduce
its reliance on commercial paper and short-term debt.
At November 30, 1995 the Company had $5.5 billion of Total Capital compared
to $6.0 billion at November 30, 1994. During 1995, the Company issued $250
million in long-term debt, compared to $1.6 billion for 1994. At November 30,
1995 the Company had long-term debt outstanding of $3.5 billion with an average
life of 3.1 years, compared with $3.4 billion with an average life of 3.5 years
at November 30, 1994. For debt with a maturity of greater than one year, the
average life was 3.5 years at November 30, 1995 compared to 3.7 years at
November 30, 1994.
At November 30, 1995 the Company had approximately $1.0 billion of debt
securities available for issuance under various shelf registrations.
The Company's stockholder's equity decreased to $2.0 billion at November 30,
1995 from $2.6 billion at November 30, 1994 primarily due to the payment of $635
million to Holdings by the Company, $559 million as a return of capital and $76
million as dividends, partially offset by net income of $69 million. These
distributions were made to Holdings in order to more efficiently utilize the
capital of the consolidated group and did not decrease the level of LBI's net
capital compared to 1994, as
28
defined by the Net Capital Rules used by its regulators. As a regulated company,
LBI is required to maintain a sufficient amount of capital as dictated by the
Net Capital Rules. These rules require specific amounts of capital to be
maintained by LBI depending on the composition of its assets and the related
risk factors.
At November 30, 1995 LBI's net capital, as defined by regulatory
authorities, aggregated $1,402 million and was $1,301 million in excess of the
minimum regulatory requirements. This is a slight increase from the net capital
of $1,338 million at November 30, 1994, which was $1,281 million in excess of
the minimum regulatory requirements.
The Company is subject to certain rules and regulations which limit the
amount of capital which can be withdrawn from regulated entities. As of November
30, 1995, the Company is in compliance with all such regulatory capital
requirements.
In 1996, the Company expects to maintain Total Capital at levels consistent
with the amount outstanding at November 30, 1995.
DEPENDENCE ON CREDIT RATINGS
The Company, like other companies in the securities industry, relies on
external sources to finance a significant portion of its day-to-day operations.
Access to global capital markets for short-term financing, such as commercial
paper and short-term debt, senior notes and subordinated indebtedness are
dependent on the Company's short- and long-term debt ratings. The current short-
and long-term senior and subordinated ratings of the Company are as follows:
LBI
-------------------------
SHORT-TERM LONG-TERM**
---------- -----------
Duff & Phelps Credit Rating Co. ..................... D-1 A/A-
Fitch Investors Service Inc. ........................ F-1 A/A-
IBCA................................................. A1 A/A-
Moody's.............................................. P2 A3*/Baa1
S&P ***.............................................. A-1 A+*/A
Thomson BankWatch.................................... TBW-1 A/A-
- ------------
* Provisional ratings on shelf registration
** Senior/subordinated
*** Long-term ratings outlook revised to negative on September 21, 1994
On March 21, 1995 Moody's Investors Service Inc. ("Moody's") lowered the
short-term and long-term subordinated ratings of the Company. However, the
long-term senior ratings remained unchanged.
29
END USER ACTIVITIES
To achieve certain asset and liability management objectives as set forth by
ALCO, the Company utilizes a variety of derivative products as an end user to
modify the interest rate characteristics of its long-term debt portfolio and to
reduce borrowing costs (see Note 5 to the Consolidated Financial Statements).
In addition, the Company also enters into interest rate swap agreements as
an end user to modify its interest rate exposure associated with its secured
financing activities, including securities purchased under agreements to resell,
securities borrowed, securities sold under agreements to repurchase and
securities loaned (see Note 13 to the Consolidated Financial Statements).
CASH FLOWS. Cash and cash equivalents decreased $74 million in 1995 to $287
million, as the net cash used in financing and investing activities exceeded the
net cash provided by operating activities. Net cash provided by operating
activities of $2,037 million included income from continuing operations adjusted
for non-cash items of approximately $219 million for 1995. Net cash used in
financing and investing activities was $2,090 million and $21 million,
respectively.
Cash and cash equivalents increased $45 million in 1994 to $361 million, as
the net cash provided by financing activities exceeded the net cash used in
operating and investing activities. Net cash used in operating activities of
$2,422 million included income from continuing operations adjusted for non-cash
items of approximately $159 million for 1994. Net cash provided by financing
activities was $2,518 million and net cash used in investing activities was $51
million.
Cash and cash equivalents increased $21 million in 1993 to $316 million, as
the net cash provided by operating and investing activities exceeded the net
cash used in financing activities. In addition, cash and cash equivalents for
discontinued operations increased $42 million in 1993. Net cash provided by
operating activities of $1,312 million included the loss from continuing
operations adjusted for non-cash items of approximately $464 million for 1993.
Net cash used in financing activities was $3,784 million in 1993. Net cash
provided by investing activities of $2,535 million in 1993 included cash
proceeds from the sales of The Boston Company, Shearson and SLHMC of $2,570
million.
INCENTIVE PLANS. In 1994, to broaden and increase the level of employee
ownership in Holdings, the Compensation and Benefits Committee (the
"Compensation Committee") approved the 1994 Management Ownership Plan (the "1994
Plan") pursuant to which it has awarded in 1995 and 1994 approximately 8.0
million and 5.2 million Restricted Stock Units ("RSUs"), respectively, to
employees as a portion of total compensation in lieu of cash, subject to vesting
and transfer restrictions. Included in the 1995 awards are Performance Stock
Units ("PSUs") granted by the Compensation Committee to members of the Corporate
Management Committee as part of a three year long-term incentive award. The
number of PSUs which may be earned, if any, is dependent upon the achievement of
certain performance levels within a two-year period. At the end of the
performance period, any PSUs earned will convert one-for-one to RSUs which then
vest at the end of the third year. Holdings will meet the share requirements for
the 1994 Plan and other common stock based compensation and benefit plans by
either repurchasing shares in the open market or issuing additional common stock
or a combination of both.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS AND DERIVATIVES
OVERVIEW
Derivatives are financial instruments, which include swaps, options, futures
and forwards whose value is based upon an underlying asset (e.g., treasury
bond), index (e.g., S&P 500) or reference rate (e.g., LIBOR). A derivative
contract may be traded on an exchange or negotiated in the over-the-counter
markets. Exchange-traded derivatives are standardized and include futures and
certain option contracts listed on an exchange. Over-the-counter ("OTC")
derivative contracts are individually negotiated between contracting parties and
include forwards, swaps and certain options, including caps,
30
collars and floors. The use of derivative financial instruments has expanded
significantly over the past decade. One reason for this expansion is that
derivatives provide a cost effective alternative for managing market risk. In
this regard, derivative contracts provide a reduced funding alternative for
managing market risk since derivatives are based upon notional values, which are
generally not exchanged, but rather are used merely as a basis for exchanging
cash flows during the duration of the contract. Derivatives are also utilized
extensively as highly effective tools that enable users to adjust risk profiles,
such as interest rate, currency, or other market risks, or to take proprietary
trading positions, since OTC derivative instruments can be tailored to meet
individual client needs. Additionally, derivatives provide users with access to
market risk management tools which are often times unavailable in traditional
cash instruments.
Derivatives are subject to various risks similar to non-derivative financial
instruments including market, credit and operational risk. The risks of
derivatives should not be viewed in isolation but rather should be considered on
an aggregate basis along with the Company's other trading-related activities. A
brief description of these risks is included below.
MARKET RISK. Market risk is the potential for a financial loss due to
changes in the value of derivative financial instruments due to market changes.
Market risk includes interest rate risk, foreign exchange risk, equity price
risk and commodity price risk. Market risk is affected by both the absolute
levels and volatility of interest and foreign exchange rates and equity and
commodity prices. Market risk is also directly impacted by the size,
diversification and duration of positions held, and the liquidity in the markets
in which the related underlying assets are traded.
CREDIT RISK. Credit risk is the possibility that a loss may occur from the
failure of a counterparty to perform according to the terms of a contract.
Credit risk is a significant factor in the evaluation of OTC derivatives. Credit
risk considerations for OTC derivative instruments include assessing the credit
quality of the counterparty, length of time to the maturity of the derivative
contract, collateral arrangements and the existence of a master netting
agreement. At any point in time, the credit risk for OTC derivative contracts is
limited to the net unrealized gain for each counterparty for which a master
netting agreement exists, net of collateral received. Exchange clearing houses
require margin to be posted on exchange-traded contracts on the origination of
the contract and for any changes in the market value of open contracts on a
daily basis (certain foreign exchanges extend settlement to three days). Due to
the daily settlement of variation margin, credit risk related to exchange-traded
contracts is limited to unsettled variation and original margin outstanding.
OPERATIONAL RISK. Operational risk is the possibility of a deficiency in
systems for executing derivative transactions. Such risks include the potential
for liabilities resulting from one's role in the execution of a derivative
transaction in which there was a breakdown in information transfer or settlement
systems.
In addition to these risks, counterparties to derivative financial
instruments may also be exposed to legal risks related to its derivative
activities including the possibility that a transaction may be unenforceable
under applicable law. The Company may be exposed to the risk that a derivative
transaction may not be enforceable against the counterparty. The Company
mitigates this risk through a process of carefully reviewing derivative
transactions with the counterparties to ensure that they fully understand the
economic and legal consequences of entering into a derivative products
transaction. In addition, the Company performs its own legal due diligence to
ensure that the counterparty has the legal capacity to enter into the derivative
product transaction and that the transaction is appropriately documented.
As derivative products have continued to expand in volume, so has market
participation and competition. As a result, additional liquidity has been added
into the markets for conventional derivative products, such as interest rate
swaps. Competition has also contributed to the development of more complex
products structured for specific clients. It is this rapid growth and complexity
of certain derivative products which has led to the perception, by some, that
derivative products are unduly risky
31
to users and the financial markets. In order to remove the public perception
that derivatives may be unduly risky and to ensure ongoing liquidity of
derivatives in the marketplace, the Company supports the efforts of the
regulators in striving for enhanced risk management disclosures which consider
the effects of both derivative products and cash instruments. In addition, the
Company supports the activities of regulators which are designed to ensure that
users of derivatives are fully aware of the nature of risks inherent within
derivative transactions. As evidence of this support, the Company, through its
participation as a member of the Derivatives Policy Group, provided leadership
in the development of a framework for voluntary industry self regulation of
derivatives. The Company has also been actively involved with the various
regulatory and accounting authorities in the development of additional enhanced
reporting requirements related to derivatives. The Company strongly believes
that derivatives provide significant value to the financial markets and is
committed to providing its clients with innovative products to meet their
financial needs.
LEHMAN BROTHERS' USE OF DERIVATIVE INSTRUMENTS
In the normal course of business, the Company enters into derivative
transactions both in a trading capacity and as an end user. As an end user, the
Company utilizes derivative products to adjust the interest rate nature of its
funding sources from fixed to floating interest rates and vice versa, and to
change the index upon which floating interest rates are based (i.e., Prime to
LIBOR) (collectively, "End User Derivative Activities"). For a further
discussion of the Company's End User Derivative Activities, see Note 13 to the
Consolidated Financial Statements.
The Company utilizes derivative products in a trading capacity both as a
dealer to satisfy the financial needs of its clients and in each of its trading
businesses (collectively, "Trading Related Derivative Activities"). The
Company's use of derivative products in its trading businesses is combined with
cash instruments to fully execute various trading strategies.
As a dealer, the Company conducts its activities in fixed income derivative
products through its special purpose subsidiary, Lehman Brothers Special
Financing Inc., and a separately capitalized triple-A rated subsidiary, Lehman
Brothers Financial Products Inc. As a dealer of interest rate swap products, the
Company enters into derivative transactions to satisfy the financial needs of
its clients who wish to modify the nature of their interest rate risk based upon
existing positions or speculate on the direction or volatility of interest
rates. These fixed income derivative products include swaps (interest and
currency), interest rate option contracts (caps, collars and floors), swap
options and similar instruments. In addition, the Company also takes proprietary
positions to profit from market movements based upon the Company's expectations
regarding the level and volatility of interest rates. The counterparties to the
Company's fixed income derivative products business are primarily other swap
dealers, commercial banks, insurance companies, corporations and other financial
institutions.
In addition to these businesses, the Company also enters into derivative
transactions in its role as a global investment bank. The Company is a
market-maker in a number of foreign currencies. As a market-maker, the Company
actively trades currencies in the OTC spot, forward and futures markets and also
takes positions in the currency markets in which the Company seeks to profit
from pricing inconsistencies in the spot, forward and futures currency markets.
The Company also makes a market in foreign currency options and offers clients
currency swaps as a means to hedge or speculate in the currency markets on a
longer-term basis. The significant majority of the Company's foreign exchange
transactions are conducted in major foreign currencies, including: Canadian
dollar, Deutsche mark, French franc, British pound sterling, Swiss franc and the
Japanese yen. The Company also transacts in a broad range of other foreign
currencies, including the currencies of emerging market countries. The
counterparties to the Company's OTC foreign exchange transactions primarily
include central banks, commercial banks, other investment banks, brokers and
dealers and other corporations.
As a global investment bank the Company also actively trades in the global
commodity markets. The Company is a market-maker in physical metals (base and
precious) and is active in trading a
32
variety of derivatives related to these commodities, such as futures, forwards
and exchange and OTC options. The counterparties to the Company's commodity
derivative transactions primarily include precious metal producers, consumers
and refiners, central banks and shipping companies.
The Company manages the risks associated with derivatives on an aggregate
basis along with the risks associated with its proprietary trading and
market-making activities in cash instruments as part of its firmwide risk
management policies. For a further discussion of the Company's risk management
policies, refer to Management's Discussion and Analysis page 36.
The Company's Trading-Related Derivative Activities have increased during
the current year to a notional value of $1,139 billion at November 30, 1995 from
$1,028 billion at November 30, 1994, primarily as a result of growth in the
Company's activities as a dealer in fixed income derivative products. Notional
values are not recorded on the balance sheet and are not indicative of potential
risk, but rather they provide a measure of the Company's involvement with such
instruments.
As a result of the Company's Trading-Related Derivative activities, the
Company is subject to credit risk. With respect to OTC derivative contracts, the
Company's credit exposure is directly with its counterparties and extends
through the duration of the derivative contracts. The Company views its net
credit exposure to be $3,030 million at November 30, 1995, representing the fair
value of the Company's OTC contracts in an unrealized gain position, after
consideration of collateral. Collateral held related to OTC contracts generally
includes cash and U.S. government and federal agency securities. At November 30,
1995 approximately 87% of the Company's net credit risk exposure related to OTC
contracts was with counterparties rated single-A or better.
Additionally, the Company is exposed to credit risk related to its
exchange-traded derivative contracts. Exchange-traded derivative contracts
include futures contracts and certain options. Futures contracts and options on
futures are transacted on the respective exchange. The exchange clearing house
is a counterparty to the futures contracts and options. As a clearing member
firm, the Company is required by the exchange clearing house to deposit cash or
other securities as collateral for its obligation upon the origination of the
contract and for any daily changes in the market value of open futures
contracts. Unlike OTC derivatives which involve numerous counterparties, the
number of counterparties from exchange-traded derivatives include only those
exchange clearing houses of which the Company is a clearing member firm or
utilizes other member firms as agents. Substantially all of the Company's
exchange-traded derivatives are transacted on exchanges of which the Company
and/or its affiliates are clearing member firms. To protect against the
potential for a default, all exchange clearing houses impose net capital
requirements for their membership. Therefore, the potential for losses from
exchange-traded products is limited. As of November 30, 1995 the Company had
approximately $144 million on deposit with futures exchanges consisting of cash
and securities (customer and proprietary), and had posted approximately $242
million of letters of credit. Included within this amount was $94 million and
$50 million of cash and securities related to domestic and foreign futures
exchanges, respectively, and $152 million and $90 million of letters of credit
with domestic exchanges and the London Clearing House, respectively. In
addition, the Company had approximately $665 million of cash and securities
(customer and proprietary) on deposit with affiliates, acting as the Company's
clearing broker related to futures contracts. These deposits primarily relate to
futures contracts on foreign exchanges.
See Note 13 to the Consolidated Financial Statements for a further
discussion of the Company's Trading-Related Derivative Activities.
SPECIFIC BUSINESS ACTIVITIES AND TRANSACTIONS
The following sections include information on specific business activities
of the Company which affect overall liquidity and capital resources:
33
HIGH YIELD SECURITIES. The Company underwrites, trades, invests and makes
markets in high yield corporate debt securities. The Company also syndicates,
trades and invests in loans to below investment grade companies. For purposes of
this discussion, high yield debt securities are defined as securities or loans
to companies rated as BB+ or lower, or equivalent ratings by recognized credit
rating agencies, as well as non-rated securities or loans which, in the opinion
of management, are non-investment grade. Non-investment grade securities
generally involve greater risks than investment grade securities due to the
issuer's creditworthiness and the liquidity of the market for such securities.
In addition, these issuers have higher levels of indebtedness, resulting in an
increased sensitivity to adverse economic conditions. The Company recognizes
these risks and aims to reduce market and credit risk through the
diversification of its products and counterparties. High yield debt securities
are carried at market value and unrealized gains or losses for these securities
are reflected in the Company's consolidated statement of operations. The
Company's portfolio of such securities at November 30, 1995 and 1994 included
long positions with an aggregate market value of approximately $940 million and
$624 million, respectively, and short positions with an aggregate market value
of approximately $72 million and $71 million, respectively. The portfolio may,
from time to time, contain concentrated holdings of selected issues. The
Company's largest high yield position was $47 million at November 30, 1995 and
$89 million at November 30, 1994.
WESTINGHOUSE. In May 1993, the Company and Westinghouse Electric Corporation
("Westinghouse") entered into a partnership to facilitate the disposition of
Westinghouse's commercial real estate portfolio, valued at approximately $1.1
billion, to be accomplished substantially through securitizations, asset sales
and mortgage remittances. The Company's original investment in the partnership
was approximately $136 million. The Company also advanced approximately $750
million of financing to the partnership in 1993, which has subsequently been
repaid in its entirety from proceeds related to the disposition of the real
estate assets. In August 1995, the Company agreed to purchase the partnership
interests owned by Westinghouse. The Company also entered into an agreement to
sell a portion of its partnership interest to an affiliate of Lennar Inc., a
third party mortgage servicer, so that the Company and Lennar Inc. would own 75%
and 25%, respectively, of the partnership. The Company's net investment in the
partnership at November 30, 1995 is $142 million. As a result of its increased
ownership percentage, the Company's consolidated financial statements at
November 30, 1995 include the accounts of the partnership. The Partnership
expects to substantially liquidate the remaining real estate assets by the end
of 1996.
MERCHANT BANKING PARTNERSHIPS. At November 30, 1995 the Company's investment
in merchant banking partnerships, for which the Company acts as a general
partner, was $80 million. At November 30, 1995 the Company had no remaining
commitments to make investments through these partnerships. The Company's policy
is to carry its interests in merchant banking partnerships at fair value based
upon the Company's assessment of the underlying investments. The Company's
merchant banking investments, made primarily through a series of partnerships
are consistent with the terms of those partnerships and are expected to be sold
or otherwise monetized during the remaining term of the partnerships.
NON-CORE ACTIVITIES AND INVESTMENTS. In March 1990, the Company discontinued
the origination of partnerships (the assets of which are primarily real estate)
and investments in real estate. Currently, Holdings and the Company act as
general partner for approximately $4 billion of partnership investment capital
and manage the remaining real estate investment portfolio. At November 30, 1995
the Company had $32 million of investments in these real estate activities, as
well as $28 million of commitments and contingent liabilities under guarantees
and credit enhancements, both net of applicable reserves. In certain
circumstances, the Company provides financial and other support and assistance
to such investments to maintain investment values. There is no contractual
requirement that the Company continue to provide this support.
34
Non-core activities and investments have declined 42% since November 30,
1994. Management's intention with regard to non-core assets is the prudent
liquidation of these investments as and when possible.
NEW ACCOUNTING PRONOUNCEMENTS
In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). SFAS No. 123
establishes financial accounting and reporting standards for stock-based
employee compensation plans. The financial accounting standards of SFAS No. 123
permit companies to either continue accounting for stock-based compensation
under existing rules or adopt SFAS No. 123 and begin reflecting the fair value
of stock options and other forms of stock-based compensation in the results of
operations as additional expense. The disclosure requirements of SFAS No. 123
require companies which elect not to record the fair value in the statement of
operations to provide pro forma disclosures of net income and earnings per share
in the notes to the consolidated financial statements as if the fair value of
stock-based compensation had been recorded. The disclosure requirements of SFAS
No. 123 are effective for financial statements for fiscal years beginning after
December 15, 1995. Holdings will provide the pro forma disclosures beginning
with its 1996 Annual Report and will continue accounting for such plans under
the existing accounting rules.
During the first quarter of 1994, the Company adopted Financial Accounting
Standards Board Interpretation No. 39, "Offsetting of Amounts Related to Certain
Contracts" ("FIN No. 39"). FIN No. 39 restricts the historical industry practice
of offsetting certain receivables and payables. In January 1995, the Financial
Accounting Standards Board issued Interpretation No. 41, "Offsetting of Amounts
Related to Certain Repurchase and Reverse Repurchase Agreements" ("FIN No. 41").
FIN No. 41 is a modification to FIN No. 39, to permit certain limited exceptions
to the criteria established under FIN No. 39 for offsetting certain repurchase
and reverse repurchase agreements with the same counterparty. The Company has
adopted this modification, effective January 1995, which partially mitigates the
increase in the Company's gross assets and liabilities resulting from the
implementation of FIN No. 39.
Effective January 1, 1994, the Company adopted SFAS No. 112, "Employers'
Accounting for Postemployment Benefits." SFAS No. 112 requires the accrual of
obligations associated with services rendered to date for employee benefits
accumulated or vested for which payment is probable and can be reasonably
estimated. These benefits principally include the continuation of salary, health
care and life insurance costs for employees on service disability leaves. The
Company previously expensed the cost of these benefits as they were incurred.
The cumulative effect of adopting SFAS No. 112 reduced net income for the first
quarter of 1994 by $13 million aftertax ($23 million pretax). Excluding the
cumulative effect of this accounting change, the effect of this change on the
1994 results of operations was not material.
EFFECTS OF INFLATION
Because the Company's assets are, to a large extent, liquid in nature, they
are not significantly affected by inflation. However, the rate of inflation
affects the Company's expenses, such as employee compensation, office space
leasing costs and communications charges, which may not be readily recoverable
in the price of services offered by the Company. To the extent inflation results
in rising interest rates and has other adverse effects upon the securities
markets, it may adversely affect the Company's financial position and results of
operations in certain businesses.
35
RISK MANAGEMENT
Risk management is an integral part of the Company's business. The Company
has established extensive policies and procedures to identify, monitor, assess
and manage risk effectively. For a discussion of these policies and procedures,
see "Business--Risk Management."
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary financial information required by
this Item and included in this Report are listed in the Index to Financial
Statements and Schedules appearing on page F-1 and are incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Pursuant to General Instruction J of Form 10-K, the information required by
Item 10 is omitted.
ITEM 11. EXECUTIVE COMPENSATION
Pursuant to General Instruction J of Form 10-K, the information required by
Item 11 is omitted.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Pursuant to General Instruction J of Form 10-K, the information required by
Item 12 is omitted.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Pursuant to General Instruction J of Form 10-K, the information required by
Item 13 is omitted.
PART IV
ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements:
See Index to Financial Statements and Schedules appearing on page F-1.
2. Financial Statement Schedules:
Schedules are omitted since they are not required or are not applicable.
36
3. Exhibits
EXHIBIT
NO.
- -------
3.1 Restated Certificate of Incorporation of the Registrant dated September 3, 1981
(incorporated by reference to Exhibit 3.1 of the Registrant's Annual Report on Form
10-K for the year ended December 31, 1987).
3.2 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant
dated May 11, 1984 (incorporated by reference to Exhibit 3.2 of the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1988).
3.3 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant,
dated March 6, 1985 (incorporated by reference to Exhibit 3.3 of the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1985).
3.4 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant,
dated August 31, 1987 (incorporated by reference to Exhibit 3.4 of the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1987).
3.5 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant,
dated January 28, 1988 (incorporated by reference to Exhibit 3.5 of the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1987).
3.6 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant,
dated July 19, 1990. (Incorporated by reference to Exhibit 3.6 of the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1990).
3.7 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant,
dated August 2, 1993 (incorporated by reference to Exhibit 3 of the Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1993).
3.8 By-Laws of the Registrant, amended as of July 1, 1991 (incorporated by reference to
Exhibit 3.7 of the Registrant Annual Report on Form 10-K for the year ended December
31, 1992).
4.1 The instruments defining the rights of holders of the long-term debt securities of
the Registrant and its subsidiaries are omitted pursuant to section (b)(4)(iii)(A)
of Item 601 of Regulation S-K. The Registrant hereby agrees to furnish copies of
these instruments to the Securities and Exchange Commission upon request.
10.1 Lease and Land Disposition Agreement, dated as of September 14, 1984, between
Shearson Lehman Construction Inc. and The City of New York (incorporated by
reference to Exhibit 10.16 of the Registrant's Registration Statement on Form S-1
(reg. No. 33-12976)).
10.2 Agreement of Tenants-In-Common by and among American Express Company, American
Express Bank Ltd, American Express Travel Related Services Company, Inc., Shearson
Lehman Brothers Inc., Shearson Lehman Government Securities, Inc. and Shearson
Lehman Commercial Paper Incorporated (incorporated by reference to Exhibit 10.1 of
Lehman Brothers Holdings Inc.'s Transition Report on Form 10-K for the eleven months
ended November 30, 1994.)
12. Computation in support of ratio of earnings to fixed charges.*
21. Pursuant to General Instruction J of Form 10-K, the list of the Registrant's
Subsidiaries is omitted.
23. Consent of Ernst & Young LLP.*
24. Powers of Attorney.*
27. Financial Data Schedule.*
(b) Reports on Form 8-K.
None.
- ------------
* Filed herewith.
37
SIGNATURES
Pursuant to the Requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report to be
signed on its behalf by the undersigned, thereunto duly authorized.
LEHMAN BROTHERS INC.
(Registrant)
February 28, 1996
By: /s/ Karen M. Muller
..................................
Title: Managing Director
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.
NAME TITLE DATE
- ----------------------------------- ----------------------------------- ------------------
* Chief Executive Officer and February 28, 1996
................................... Chairman of the Board of
Richard S. Fuld, Jr. Directors (principal executive
officer)
* Chief Operating Officer, February 28, 1996
................................... President and Director
T. Christopher Pettit
*
................................... Chief Financial Officer February 28, 1996
Robert Matza (principal financial officer)
* Controller February 28, 1996
................................... (principal accounting officer)
David Goldfarb
* Director February 28, 1996
...................................
Roger S. Berlind
* Director February 28, 1996
...................................
Philip Caldwell
* Director February 28, 1996
...................................
Howard L. Clark, Jr.
* Director February 28, 1996
...................................
Frederick Frank
*
................................... Director February 28, 1996
Sherman J. Lewis, Jr.
*
................................... Director February 28, 1996
Malcolm Wilson
* By: /s/ Karen M. Muller
...................................
Karen M. Muller
(Attorney-in-fact)
February 28, 1996
38
LEHMAN BROTHERS INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
FINANCIAL STATEMENTS PAGE
- -------------------------------------------------------------------------------------- ----
Report of Independent Auditors........................................................ F-2
Consolidated Statement of Operations for the Twelve Months Ended November 30, 1995, for
the Eleven Months Ended November 30, 1994 and the twelve months ended December 31,
1993.................................................................................. F-3
Consolidated Statement of Financial Condition at November 30, 1995, and November 30,
1994.................................................................................. F-4
Consolidated Statement of Changes in Stockholders' Equity for the Twelve Months Ended
November 30, 1995, for the eleven months ended November 30, 1994 and the twelve
months ended December 31, 1993........................................................ F-6
Consolidated Statement of Cash Flows for the Twelve Months Ended November 30, 1995,
for the eleven months ended November 30, 1994 and the twelve months ended December
31, 1993.............................................................................. F-7
Notes to Consolidated Financial Statements............................................ F-9
F-1
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholder of
Lehman Brothers Inc.
We have audited the accompanying consolidated statement of financial condition
of Lehman Brothers Inc. and Subsidiaries (the "Company") as of November 30, 1995
and 1994, and the related consolidated statements of operations, changes in
stockholder's equity, and cash flows for the year ended November 30, 1995, for
the eleven month period ended November 30, 1994 and for the year ended December
31, 1993. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Lehman Brothers
Inc. and Subsidiaries at November 30, 1995 and 1994, and the consolidated
results of its operations and its cash flows for the year ended November 30,
1995, for the eleven month period ended November 30, 1994 and for the year ended
December 31, 1993 in conformity with generally accepted accounting principles.
As discussed in Note 9 to the consolidated financial statements, in 1994 the
Company changed its method of accounting for postemployment benefits.
ERNST & YOUNG LLP
New York, New York
January 10, 1996
F-2
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
TWELVE MONTHS ELEVEN MONTHS TWELVE MONTHS
ENDED ENDED ENDED
NOVEMBER 30 NOVEMBER 30 DECEMBER 31
1995 1994 1993
------------- ------------- -------------
(IN MILLIONS)
REVENUES
Principal transactions............................. $ 695 $ 732 $ 1,455
Investment banking................................. 621 399 794
Commissions........................................ 395 391 1,265
Interest and dividends............................. 10,289 6,235 5,029
Other.............................................. 32 57 467
------------- ----- -------------
Total revenues................................... 12,032 7,814 9,010
Interest expense................................... 9,954 5,845 4,585
------------- ----- -------------
Net revenues..................................... 2,078 1,969 4,425
------------- ----- -------------
NON-INTEREST EXPENSES
Compensation and benefits.......................... 1,055 1,004 2,564
Brokerage, commissions and clearance fees.......... 192 190 189
Communications..................................... 120 135 271
Occupancy and equipment............................ 85 82 189
Business development............................... 80 86 131
Professional services.............................. 79 103 153
Depreciation and amortization...................... 63 89 135
Management fees.................................... 145 102
Other.............................................. 138 150 263
Restructuring charge............................... 43
Severance charge................................... 27
Loss on sale of Shearson........................... 535
Reserves for non-core businesses................... 141
------------- ----- -------------
Total non-interest expenses...................... 2,000 1,968 4,571
------------- ----- -------------
Income (loss) from continuing operations before
taxes, cumulative effect of change in accounting
principle and preferred dividend of subsidiary..... 78 1 (146)
Provision for (benefit from) income taxes............ 9 (33) 234
------------- ----- -------------
Income (loss) from continuing operations before
cumulative effect of change in accounting principle
and preferred dividend of subsidiary................. 69 34 (380)
------------- ----- -------------
Income from discontinued operations, net of taxes:
Income from operations............................. 24
Gain on disposal................................... 165
------------- ----- -------------
Net income from discontinued operations.............. 189
------------- ----- -------------
Income (loss) before cumulative effect of change in
accounting principle and preferred dividend of
subsidiary........................................... 69 34 (191)
------------- ----- -------------
Cumulative effect of change in accounting principle,
net of taxes....................................... (13)
Preferred dividend of subsidiary..................... (50) (68)
------------- ----- -------------
Net income (loss).................................... $ 69 $ (29) $ (259)
------------- ----- -------------
------------- ----- -------------
See Notes to Consolidated Financial Statements.
F-3
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
NOVEMBER 30
------------------
1995 1994
------- -------
(IN MILLIONS)
ASSETS
Cash and cash equivalents................................................ $ 287 $ 361
Cash and securities segregated and on deposit for regulatory and other
purposes................................................................. 785 1,263
Securities and other financial instruments owned:
Governments and agencies............................................... 14,038 16,941
Corporate obligations and other contractual commitments................ 8,115 7,094
Mortgages and mortgage-backed.......................................... 3,182 2,444
Certificates of deposit and other money market instruments............. 2,958 1,239
Corporate stocks and options........................................... 2,856 1,411
------- -------
31,149 29,129
------- -------
Collateralized short-term agreements:
Securities purchased under agreements to resell........................ 25,982 29,392
Securities borrowed.................................................... 16,562 9,210
Receivables:
Brokers, dealers and clearing organizations............................ 2,719 3,868
Customers.............................................................. 2,219 1,406
Others................................................................. 2,175 3,694
Property, equipment and leasehold improvements (net of accumulated
depreciation and amortization of $455 in 1995 and $424 in 1994).......... 333 409
Deferred expenses and other assets....................................... 219 221
Excess of cost over fair value of net assets acquired (net of accumulated
amortization of $86 in 1995 and $79 in 1994)............................. 174 181
------- -------
Total assets..................................................... $82,604 $79,134
------- -------
------- -------
See Notes to Consolidated Financial Statements.
F-4
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION--(CONTINUED)
NOVEMBER 30
------------------
1995 1994
------- -------
(IN MILLIONS,
EXCEPT SHARE DATA)
LIABILITIES AND STOCKHOLDER'S EQUITY
Short-term debt.......................................................... $ 1,008 $ 2,272
Securities and other financial instruments sold but not yet purchased:
Government and agencies................................................ 6,477 5,184
Corporate obligations and other contractual commitments................ 3,403 2,842
Corporate stocks and options........................................... 1,195 1,352
------- -------
11,075 9,378
------- -------
Collateralized short-term financings:
Securities sold under agreements to repurchase......................... 41,900 44,174
Securities loaned...................................................... 2,649 315
Advances from Holdings and other affiliates.............................. 8,418 8,807
Payables:
Brokers, dealers and clearing organizations............................ 4,467 2,730
Customers.............................................................. 5,733 2,059
Accrued liabilities and other payables................................... 1,829 3,416
Long-term debt:
Senior notes........................................................... 420 511
Subordinated indebtedness.............................................. 3,077 2,885
------- -------
Total liabilities................................................ 80,576 76,547
------- -------
Commitments and contingencies
STOCKHOLDER'S EQUITY
Preferred stock, $.10 par value; 10,000 shares authorized; none
outstanding
Common stock, $.10 par value; 10,000 shares authorized; 1,006 shares
issued and outstanding in 1995 and 1994
Additional paid-in capital............................................. 2,353 2,905
Foreign currency translation adjustment................................ 3 3
Accumulated deficit.................................................... (328) (321)
------- -------
Total stockholder's equity....................................... 2,028 2,587
------- -------
Total liabilities and stockholder's equity....................... $82,604 $79,134
------- -------
------- -------
See Notes to Consolidated Financial Statements.
F-5
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDER'S EQUITY
TWELVE MONTHS ELEVEN MONTHS TWELVE MONTHS
ENDED ENDED ENDED
NOVEMBER 30 NOVEMBER 30 DECEMBER 31
1995 1994 1993
------------- ------------- -------------
(IN MILLIONS)
ADDITIONAL PAID-IN CAPITAL
Beginning balance.................................. $ 2,905 $ 2,738 $ 2,588
Merger of subsidiaries............................. 467
Capital contributions.............................. 7 20
Capital distributions.............................. (559) (300) (300)
Issuance of common stock........................... 430
------------- ------------- -------------
Ending balance....................................... 2,353 2,905 2,738
------------- ------------- -------------
FOREIGN CURRENCY TRANSLATION ADJUSTMENT
Beginning balance.................................. 3 2 2
Translation adjustment............................. 1
------------- ------------- -------------
Ending balance....................................... 3 3 2
------------- ------------- -------------
RETAINED EARNINGS (ACCUMULATED DEFICIT)
Beginning balance.................................. (321) (56) 203
Net income (loss).................................. 69 (29) (259)
Dividends.......................................... (76) (236)
------------- ------------- -------------
Ending balance....................................... (328) (321) (56)
------------- ------------- -------------
NET UNREALIZED SECURITIES LOSSES
Beginning balance.................................. (13)
Change in unrealized securities losses, net........ 13
------------- ------------- -------------
Ending balance.......................................
------------- ------------- -------------
TOTAL STOCKHOLDER'S EQUITY........................... $ 2,028 $ 2,587 $ 2,684
------------- ------------- -------------
------------- ------------- -------------
See Notes to Consolidated Financial Statements.
F-6
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
TWELVE MONTHS ELEVEN MONTHS TWELVE MONTHS
ENDED ENDED ENDED
NOVEMBER 30 NOVEMBER 30 DECEMBER 31
1995 1994 1993
------------- ------------- -------------
(IN MILLIONS)
CASH FLOWS FROM OPERATING ACTIVITIES
Income (loss) from continuing operations before
cumulative effect of change in accounting principle
and preferred dividend of subsidiary................. $ 69 $ 34 $ (380)
Adjustments to reconcile income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization...................... 63 89 135
Restructuring charge............................... 26
Provisions for losses and other reserves........... 37 32 75
Loss on sale of Shearson........................... 535
Non-core business reserves......................... 141
Deferred tax provision (benefit)................... 5 (13) (106)
Other adjustments.................................. 19 17 64
Net change in:
Cash and securities segregated..................... 478 (396) 308
Receivables from brokers, dealers and clearing
organizations........................................ 1,149 234 (677)
Receivables from customers......................... (813) (15) 508
Securities purchased under agreements to resell.... 3,410 (6,217) 6,191
Securities borrowed................................ (7,352) (4,934) 3,217
Loans originated or purchased for resale........... (62)
Securities and other financial instruments owned... (2,020) (8,572) 899
Payables to brokers, dealers and clearing
organizations........................................ 1,737 709 579
Payables to customers.............................. 3,564 (263) (984)
Accrued liabilities and other payables............. (1,636) 802 408
Securities sold under agreements to repurchase..... (2,274) 13,376 (2,945)
Securities loaned.................................. 2,334 (457) (1,728)
Securities and other financial instruments sold but
not yet purchased................................ 1,697 4,155 (4,578)
Other operating assets and liabilities, net........ 1,544 (1,003) (716)
------------- ------------- -------------
2,037 (2,422) 884
------------- ------------- -------------
Net cash flows provided by operating activities of
discontinued operations.............................. 428
------------- ------------- -------------
NET CASH PROVIDED BY (USED IN) OPERATING
ACTIVITIES........................................... $ 2,037 $(2,422) $ 1,312
------------- ------------- -------------
See Notes to Consolidated Financial Statements.
F-7
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS--(CONTINUED)
TWELVE MONTHS ELEVEN MONTHS TWELVE MONTHS
ENDED ENDED ENDED
NOVEMBER 30 NOVEMBER 30 DECEMBER 31
1995 1994 1993
------------- ------------- -------------
(IN MILLIONS)
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments of senior notes................... $ (98) $ (155) $ (636)
Proceeds from issuance of subordinated
indebtedness......................................... 250 1,560 722
Principal payments of subordinated indebtedness...... (64) (1,733) (702)
Proceeds from (payments for) commercial paper and
short-term debt...................................... (1,161) (362) (3,557)
Increase (decrease) in advances from Holdings and
other affiliates................................... (389) 3,744 540
Capital contributions................................ 7 20
Proceeds from the issuance of common stock........... 430
Dividends and capital distributions paid............. (635) (536) (300)
Net cash flows used in financing activities of
discontinued operations.............................. (301)
------------- ------------- -------------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES........................................... (2,090) 2,518 (3,784)
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, equipment and leasehold
improvements......................................... (21) (51) (101)
Proceeds from the sale of:
The Boston Company................................. 1,300
Shearson........................................... 1,200
SLHMC.............................................. 70
Other................................................ 151
Net cash flows used in investing activities of
discontinued operations.............................. (85)
------------- ------------- -------------
NET CASH (USED IN) PROVIDED BY INVESTING
ACTIVITIES........................................... (21) (51) 2,535
------------- ------------- -------------
Net change in cash and cash equivalents of
discontinued operations............................ 42
------------- ------------- -------------
Net change in cash and cash equivalents............ (74) 45 21
------------- ------------- -------------
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD....... 361 316 295
------------- ------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD....... $ 287 $ 361 $ 316
------------- ------------- -------------
------------- ------------- -------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (IN MILLIONS)
(INCLUDING THE BOSTON COMPANY)
Interest paid totaled $9,985 in 1995, $5,818 in 1994 and $4,796 in 1993.
Income taxes paid totaled $194 in 1995, $33 in 1994 and $265 in 1993.
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITY
During 1993, the Company completed the sale of The Boston Company, Shearson
and SLHMC. The cash proceeds related to these sales have been separately
reported in the above statement. Excluded from the statement are the individual
Statement of Financial Condition changes related to the net assets sold as well
as the non-cash proceeds received related to these sales. See Note 18.
See Notes to Consolidated Financial Statements.
F-8
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Lehman
Brothers Inc., a registered broker-dealer ("LBI") and subsidiaries (LBI together
with its subsidiaries, the "Company"). LBI is a wholly owned subsidiary of
Lehman Brothers Holdings Inc. ("Holdings"). LBI is one of the leading global
investment banks serving institutional, corporate, government and high-net-worth
individual clients and customers. The Company's worldwide headquarters in New
York are complemented by offices in additional locations in North America,
Europe, the Middle East, Latin and South America and the Asia Pacific region.
Holdings provides investment banking and capital markets services in Europe and
Asia. The Company is engaged primarily in providing financial services. The
Company also operates a commodities trading and sales operation in London. All
material intercompany accounts and transactions have been eliminated in
consolidation. Prior to May 31, 1994, the American Express Company ("American
Express") owned 100% of Holdings' common stock (the "Common Stock"), which
represented approximately 93% of Holdings' voting stock. Effective May 31, 1994,
Holdings became a widely held public company with its Common Stock traded on the
New York Stock Exchange. (See Note 6.)
The Consolidated Statement of Operations includes the results of operations
of Shearson and SLHMC which were sold on July 31, 1993 and August 31, 1993,
respectively. (See Note 18 for definitions and additional information concerning
these sales.)
The Company uses the trade date basis of accounting for recording principal
transactions.
Certain prior period amounts reflect reclassifications to conform to the
current period's presentation.
DISCONTINUED OPERATIONS
As described in Note 18, the Company completed the sale of The Boston
Company, Inc. ("The Boston Company"), on May 21, 1993. The accompanying
consolidated financial statements and notes to consolidated financial statements
reflect The Boston Company as a discontinued operation.
TRANSLATION OF FOREIGN CURRENCIES
Assets and liabilities of foreign subsidiaries having non-U.S. dollar
functional currencies are translated at exchange rates at the statement of
financial condition date. Revenues and expenses are translated at average
exchange rates during the period. The gains or losses resulting from translating
foreign currency financial statements into U.S. dollars, net of hedging gains or
losses and related tax effects, are included in a separate component of
stockholder's equity, the foreign currency translation adjustment. Gains or
losses resulting from foreign currency transactions are included in the
Consolidated Statement of Operations.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Management believes that the estimates utilized in preparing
its financial statements are reasonable and prudent. Actual results could differ
from these estimates.
SECURITIES AND OTHER FINANCIAL INSTRUMENTS
Securities and other financial instruments owned and securities and other
financial instruments sold but not yet purchased are valued at market or fair
value, as appropriate, with unrealized gains and
F-9
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
losses reflected in principal transactions in the Consolidated Statement of
Operations. Market value is generally based on listed market prices. If listed
market prices are not available, fair value is determined based on other
relevant factors, including broker or dealer price quotations, and valuation
pricing models which take into account time value and volatility factors
underlying the financial instruments.
DERIVATIVE FINANCIAL INSTRUMENTS
Derivatives include futures, forwards, swaps and options and other similar
instruments. Derivative transactions entered into for market-making or
proprietary position taking or used as hedges of other trading instruments are
recorded at market or fair value with realized and unrealized gains and losses
reflected in principal transactions in the Consolidated Statement of Operations.
The market or fair value associated with derivatives utilized for trading
purposes is recorded on a net by counterparty basis where a legal right of
set-off exists in the Consolidated Statement of Financial Condition. Unrealized
gains and losses related to swaps and option contracts are recorded as
securities and other financial instruments owned and securities and other
financial instruments sold but not yet purchased, as applicable. Unrealized
gains and losses related to securities and foreign exchange forwards and
commodity contracts are recorded as receivables and payables with brokers,
dealers and clearing organizations and customers, as applicable.
In addition to trading and market-making activities, the Company enters into
various derivative products as an end user to modify the interest rate exposure
of certain assets and liabilities. In this regard, the Company utilizes interest
rate swaps, caps, collars and floors to manage the interest rate exposure
associated with its long-term debt obligations and secured financing activities,
including securities purchased under agreements to resell, securities borrowed,
securities sold under agreements to repurchase and securities loaned. In
addition to modifying the interest rate exposure of existing assets and
liabilities, the Company utilizes derivative instruments as an end user to
modify the interest rate characteristics of certain anticipated transactions
related to its secured financing activities, where there is a high degree of
certainty that the Company will enter into such contracts. Derivatives which
have been designated and are effective in modifying the interest rate
characteristics of existing assets and liabilities or anticipated transactions
are accounted for on an accrual basis.
The Company monitors the effectiveness of its end user hedging activities by
periodically comparing the change in the value of the hedge instrument to the
underlying item being hedged and re-assessing the likelihood of the occurrence
of anticipated transactions. In the event that the Company determines that a
hedge is no longer effective, such as upon extinguishment of the underlying
asset or liability or a change in circumstances whereby there is not a high
degree of certainty that the anticipated transaction will occur, the derivative
transaction is accounted for at fair value, with changes in the fair value of
the derivative contract being recognized in the Consolidated Statement of
Operations. In the event that a derivative designated as a hedge is terminated
early, any realized gain or loss on termination would be deferred and amortized
over the original period of the hedge.
REPURCHASE AND RESALE AGREEMENTS
Securities purchased under agreements to resell and securities sold under
agreements to repurchase, which are treated as financing transactions for
financial reporting purposes, are collateralized primarily by government and
government agency securities and are carried net by counterparty, when
permitted, at the amounts at which the securities will be subsequently resold or
repurchased plus accrued interest. It is the policy of the Company to take
possession of securities purchased under agreements to resell. The Company
monitors the market value of the underlying positions on a daily basis as
compared to the related receivable or payable balances, including accrued
interest. The Company requires counterparties to deposit additional collateral
or return collateral pledged as necessary, to ensure that the market value of
the underlying collateral remains sufficient. Securities and
F-10
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
other financial instruments owned which are sold under repurchase agreements are
carried at market value with changes in market value reflected in the
Consolidated Statement of Operations.
Securities purchased under agreements to resell and Securities sold under
agreements to repurchase for which the resale/repurchase date corresponds to the
maturity date of the underlying securities are accounted for as purchases and
sales, respectively. At November 30, 1995, such resale and repurchase agreements
which have not yet matured aggregated $6.7 billion and $3.1 billion,
respectively.
SECURITIES BORROWED AND LOANED
Securities borrowed and securities loaned are carried at the amount of cash
collateral advanced or received plus accrued interest. It is the Company's
policy to value the securities borrowed and loaned on a daily basis and to
obtain additional cash as necessary to ensure such transactions are adequately
collateralized.
INCOME TAXES
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes."
The Company recognizes the current and deferred tax consequences of all
transactions that have been recognized in the financial statements using the
provisions of the enacted tax laws. In this regard, deferred tax assets are
recognized for temporary differences that will result in deductible amounts in
future years and for tax loss carryforwards, if in the opinion of management, it
is more likely than not that the deferred tax asset will be realized. SFAS 109
requires companies to set up a valuation allowance for that component of net
deferred tax assets which does not meet the "more likely than not" criterion for
realization.
FIXED ASSETS AND INTANGIBLES
Property, equipment, and leasehold improvements are recorded at historical
cost, net of accumulated depreciation and amortization. Depreciation is
recognized on a straight-line basis over the estimated useful lives of the
related assets. Leasehold improvements are amortized over the lesser of their
economic useful lives or the terms of the underlying leases. The Company
capitalizes interest costs during construction and amortizes the interest costs
based on the useful lives of the assets.
Excess of cost over fair value of net assets acquired (goodwill) is
amortized using the straight-line method over a period of 35 years. Goodwill is
also reduced upon the recognition of certain acquired net operating loss
carryforward benefits.
STATEMENT OF CASH FLOWS
The Company defines cash equivalents as highly liquid investments with
original maturities of three months or less, other than those held for sale in
the ordinary course of business.
NOTE 2. CHANGE OF YEAR-END
During 1994, the Company changed its year-end from December 31 to November
30. Such a change to a non-calendar cycle shifts certain year-end administrative
activities to a time period that conflicts less with the business needs of the
Company's institutional customers.
F-11
NOTE 2. CHANGE OF YEAR-END--(CONTINUED)
The following is selected financial data for the eleven month transition
period ending November 30, 1994 and the comparable prior year period.
ELEVEN MONTHS ENDED
--------------------------
NOVEMBER 30 NOVEMBER 30
1994 1993
----------- -----------
(IN MILLIONS)
(UNAUDITED)
Total revenues...................................................... $ 7,814 $ 8,412
Interest expense.................................................... 5,845 4,213
----------- -----------
Net revenues........................................................ 1,969 4,199
Non-interest expenses............................................... 1,968 4,362
----------- -----------
Income (loss) from continuing operations before taxes, cumulative
effect of change in accounting principle and preferred dividend of
subsidiary.......................................................... 1 (163)
Provision for (benefit from) income taxes........................... (33) 234
----------- -----------
Income (loss) from continuing operations before cumulative effect of
change in accounting principle and preferred dividend of
subsidiary.......................................................... 34 (397)
----------- -----------
Income from discontinued operations, net of taxes:
Income from operations............................................ 24
Gain on disposal.................................................. 165
----------- -----------
Net income from discontinued operations............................. 189
----------- -----------
Income (loss) before cumulative effect of change in accounting
principle and preferred dividend of subsidiary.................... 34 (208)
Cumulative effect of change in accounting principle, net of taxes... (13)
Preferred dividend of subsidiary.................................... (50) (62)
----------- -----------
Net loss............................................................ $ (29) $ (270)
----------- -----------
The selected financial data for 1993 includes the results of operations of
Shearson and SLHMC, which were sold on July 31, 1993 and August 31, 1993,
respectively. The Company completed the sale of The Boston Company on May 21,
1993. The above selected financial data for 1993 reflects The Boston Company as
a discontinued operation. (See Note 18 for definitions and additional
information concerning these sales.)
NOTE 3. CASH AND SECURITIES SEGREGATED AND ON DEPOSIT FOR REGULATORY AND OTHER
PURPOSES
In addition to amounts presented in the accompanying Consolidated Statement
of Financial Condition as cash and securities segregated and on deposit for
regulatory and other purposes, securities with a market value of approximately
$320 million and $941 million at November 30, 1995 and 1994, respectively,
primarily collateralizing securities purchased under agreements to resell, have
been segregated in a special reserve bank account for the exclusive benefit of
customers pursuant to the Reserve Formula requirements of the Securities and
Exchange Commission ("SEC") Rule 15c3-3.
NOTE 4. SHORT-TERM FINANCINGS
The Company obtains short-term financing on both a secured and unsecured
basis. The secured financing is obtained through the use of repurchase
agreements and securities loaned agreements, which are primarily collateralized
by government, agency and equity securities. The unsecured financing is
generally obtained through short-term debt and the issuance of commercial paper.
F-12
NOTE 4. SHORT-TERM FINANCINGS--(CONTINUED)
The Company's short-term debt is comprised of the following:
NOVEMBER 30 NOVEMBER 30
1995 1994
----------- -----------
(IN MILLIONS)
Short-term debt
Payables to banks................................................. $ 566 $ 1,053
Master notes...................................................... 381 999
Bank loans........................................................ 61 220
----------- -----------
$ 1,008 $ 2,272
----------- -----------
The Company's weighted average interest rates were as follows:
NOVEMBER 30 NOVEMBER 30
1995 1994
----------- -----------
Short-term debt..................................................... 5.7% 5.9%
Securities sold under agreements to repurchase...................... 5.7% 5.2%
NOTE 5. LONG-TERM DEBT
U.S. DOLLAR NON-U.S. DOLLAR
----------------- -----------------
FIXED FLOATING FIXED FLOATING NOVEMBER 30 NOVEMBER 30
RATE RATE RATE RATE 1995 1994
------ -------- ------ -------- ----------- -----------
(IN MILLIONS)
Senior Notes
Maturing in Fiscal 1995.................. $ 114
Maturing in Fiscal 1996.................. $ 212 $ 10 $ 222 185
Maturing in Fiscal 1997.................. 1 1 18
Maturing in Fiscal 1998.................. 1 1 10
Maturing in Fiscal 1999.................. 21 21 21
Maturing in Fiscal 2000.................. 24 24 24
December 1, 2000 and thereafter.......... 151 151 139
------ -------- ------ -------- ----------- -----------
Senior Notes........................... 410 10 420 511
------ -------- ------ -------- ----------- -----------
Subordinated Indebtedness
Maturing in Fiscal 1995.................. 64
Maturing in Fiscal 1996.................. 97 161 258 260
Maturing in Fiscal 1997.................. 741 741 1,561
Maturing in Fiscal 1998.................. 350 820 1,170 350
Maturing in Fiscal 1999.................. 179 179 179
Maturing in Fiscal 2000.................. 192 192 192
December 1, 2000 and thereafter.......... 415 122 537 279
------ -------- ------ -------- ----------- -----------
Subordinated Indebtedness.............. 1,974 1,103 3,077 2,885
------ -------- ------ -------- ----------- -----------
Long-Term Debt........................... $2,384 $ 1,103 $ 10 $ 3,497 $ 3,396
------ -------- ------ -------- ----------- -----------
Of the Company's subordinated debt outstanding as of November 30, 1995, $200
million is repayable prior to maturity at the option of the holder, at par
value. These obligations are reflected in the above table as maturing at their
put date, of fiscal 1997, rather than at their contractual maturity of fiscal
2003.
F-13
NOTE 5. LONG-TERM DEBT--(CONTINUED)
The Company's interest in 3 World Financial Center is financed with U.S.
dollar fixed rate senior notes totaling $308 million as of November 30, 1995.
These notes are unconditionally guaranteed by American Express with a portion of
these notes being collateralized by certain mortgage obligations.
As of November 30, 1995, the Company had $1.0 billion available for the
issuance of debt securities under various shelf registrations.
Of the fixed rate senior notes maturing in fiscal 1996, $102 million are an
obligation of a subsidiary of LBI and are guaranteed by Holdings.
END USER DERIVATIVE ACTIVITIES
The Company utilizes interest rate swaps as an end user to modify the
interest rate characteristics of its long-term debt portfolio. The Company
actively manages the interest rate exposure on its long-term debt portfolio to
more closely match the terms of its debt to the assets being funded and to
minimize interest rate risk. In certain instances, two or more derivative
contracts may be utilized by the Company to manage the interest rate nature of
an individual long-term debt issuance. In these cases, the notional value of the
derivative contracts may exceed the carrying value of the related long-term debt
issuance.
At November 30, 1995, the notional values of the Company's interest rate
swaps related to its long-term debt obligations were approximately $2.7 billion.
In terms of notional amounts outstanding, these derivative products mature as
follows:
TOTAL
-------------
(IN MILLIONS)
Maturing in Fiscal 1996.......................................................... $ 198
Maturing in Fiscal 1997.......................................................... 1,451
Maturing in Fiscal 1998.......................................................... 350
Maturing in Fiscal 1999.......................................................... 179
Maturing in Fiscal 2000.......................................................... 192
December 1, 2000 and thereafter.................................................. 344
-------------
Total............................................................................ $ 2,714
-------------
-------------
Weighted average rate at November 30, 1995
Receive rate..................................................................... 6.68%
Pay rate......................................................................... 6.04%
During 1995, the Company terminated certain swaps which were utilized to
modify the interest rate characteristics of the Company's long-term debt
issuances. At November 30, 1995, the Company had deferred gains of approximately
$7 million related to such terminated contracts which will be amortized to
reduce interest expense through fiscal 1997.
On an overall basis, the Company's long-term debt related end user
derivative activities resulted in reduced interest expense of approximately $29
million, $40 million and $54 million in 1995, 1994 and 1993, respectively. In
addition, the Company's end user derivative activities resulted in the following
F-14
NOTE 5. LONG-TERM DEBT--(CONTINUED)
changes to the Company's mix of fixed and floating rate debt and effective
weighted average rates of interest.
NOVEMBER 30, 1995
---------------------------------------------------------------
LONG-TERM DEBT WEIGHTED AVERAGE
---------------------------- -------------------------------
BEFORE AFTER EFFECTIVE RATE
END USER END USER CONTRACTUAL AFTER END USER
ACTIVITIES ACTIVITIES INTEREST RATE ACTIVITIES
------------ ------------ ------------- --------------
(DOLLARS IN MILLIONS)
USD Obligations
Fixed Rate................................ $2,384 $ 580 8.60% 7.51%
Floating Rate............................. 1,103 2,907 7.31% 7.55%
Non-USD Obligations......................... 10 10 0.94% 0.94%
------------ ------------ --- ---
Total....................................... $3,497 $3,497 8.17% 7.52%
------------ ------------ --- ---
NOVEMBER 30, 1994
---------------------------------------------------------------
LONG-TERM DEBT WEIGHTED AVERAGE
---------------------------- -------------------------------
BEFORE AFTER EFFECTIVE RATE
END USER END USER CONTRACTUAL AFTER END USER
ACTIVITIES ACTIVITIES INTEREST RATE ACTIVITIES
------------ ------------ ------------- --------------
(DOLLARS IN MILLIONS)
USD Obligations
Fixed Rate................................ $2,365 $ 803 8.78% 8.72%
Floating Rate............................. 1,014 2,576 6.64% 6.60%
Non-USD Obligations......................... 17 17 2.96% 2.96%
------------ ------------ --- ---
Total....................................... $3,396 $3,396 8.11% 7.08%
------------ ------------ --- ---
NOTE 6. HOLDINGS--EQUITY INVESTMENTS AND DISTRIBUTION OF COMMON STOCK
On May 31, 1994 all of the shares of common stock of Holdings were
distributed (the "Distribution") to American Express common shareholders of
record on May 20, 1994, as a result of a special dividend declared on April 29,
1994 by the Board of Directors of American Express. Prior to the Distribution,
an additional equity investment of approximately $1.25 billion was made in
Holdings, most significantly by American Express.
NOTE 7. INCENTIVE PLANS
1994 REPLACEMENT PLAN
The Lehman Brothers Holdings Inc. 1994 Management Replacement Plan (the
"Replacement Plan") allowed the Compensation and Benefits Committee (the
"Compensation Committee") to grant stock options and restricted stock awards to
eligible employees. The primary purpose of the Replacement Plan was to provide
awards similar to the American Express common shares granted to Company
employees which were canceled as of the date of the Distribution. No further
awards will be granted under this plan.
EMPLOYEE STOCK PURCHASE PLAN
The Employee Stock Purchase Plan (the "ESPP") allows employees to purchase
Common Stock at a 15% discount from market value, with a maximum of $15,000
($25,000 effective on January 1, 1996) in annual aggregate purchases by any one
individual. The number of shares of Common Stock authorized for purchase by
eligible employees is 6,000,000. As of November 30, 1995 and 1994,
F-15
NOTE 7. INCENTIVE PLANS--(CONTINUED)
663,349 shares and 130,827 shares, respectively, of Common Stock were purchased
by eligible employees through the ESPP. The shares were purchased in the open
market and thus did not increase Holdings' total shares outstanding.
1994 MANAGEMENT OWNERSHIP PLAN
The Lehman Brothers Holdings Inc. 1994 Management Ownership Plan (the "1994
Plan") provides for the Compensation Committee to grant stock options, stock
appreciation rights ("SARs"), restricted stock units ("RSUs"), restricted stock,
performance shares and performance stock units ("PSUs") for a period of up to
ten years to eligible employees. A total of 16,650,000 shares of Common Stock
may be subject to awards under the 1994 Plan, including 150,000 shares available
as RSUs which may be issued to non-employee Directors. In addition, the 1994
Plan provides that non-employee Directors of Holdings will receive on an annual
basis RSUs representing $30,000 of Common Stock, which vest ratably over a
three-year period. Vesting provisions for stock options and SARs are at the
discretion of the Compensation Committee, but in no case may the term of the
award exceed ten years. No individual may receive options or SARs over the life
of the 1994 Plan, attributable to more than 1,650,000 shares of Common Stock.
Stock options may be awarded as either incentive stock options or non-qualified
stock options. The exercise price for any stock option shall not be less than
the market price of Common Stock on the day of grant.
Under the 1994 Plan, eligible employees received RSUs in 1995 and 1994 as a
portion of their total compensation in lieu of cash. There was no further cost
to employees and senior officers associated with the RSU awards. In addition,
the Compensation Committee may, from time to time, award RSUs to certain senior
officers of Holdings and its subsidiaries (the "Firm"). The Firm records
compensation expense for RSUs based on the market value of Common Stock and the
applicable vesting provisions. All of the RSUs awarded to employees vest 80% one
year from the date of the grant with the remaining 20% vesting five years from
the date of grant. Each RSU outstanding on the respective dates for which 100%
vesting occurs will be exchanged for a share of Common Stock. Holdings pays a
dividend equivalent on each RSU outstanding based on dividends paid on the
Common Stock.
On October 25, 1995, Holdings granted 1,125,000 options to members of the
Corporate Management Committee ("CMC") at the market price of the Common Stock
on that date ($20.875) (the "1995 Options"). The 1995 Options become exercisable
in four and one half years; exercisability is accelerated ratably in one-third
increments at such time as the closing price of Holdings' Common Stock meets, or
exceeds, $26.00, $28.00 and $30.00 for 30 consecutive trading days. If a minimum
target price is not reached and maintained for the specified period on or before
April 24, 2000, the award recipients may then exercise all of their options
beginning April 25, 2000. Other than the 1995 Options, all options awarded under
the 1994 Plan become exercisable in one-third increments ratably in the three
years following grant date. No compensation expense has been recognized for
Holdings' stock options as all have been issued at the market price of the
Common Stock on the date of the respective grant.
The Compensation Committee also awarded PSUs to members of the CMC during
1995 as part of a three-year long term incentive award. The number of PSUs which
may be earned, if any, is dependent upon achievement of certain performance
levels within a two-year period. At the end of the performance period, any PSUs
earned will convert one-for-one to RSUs which then vest at the end of the third
year. The compensation cost for the estimated number of RSUs that may eventually
become payable in satisfaction of PSUs is accrued over the three-year
performance and vesting period and added to common stock issuable.
F-16
NOTE 7. INCENTIVE PLANS--(CONTINUED)
EMPLOYEE INCENTIVE PLAN
During 1995, the Board of Directors of Holdings adopted the Employee
Incentive Plan ("EIP"), which has provisions similar to the 1994 Plan, and under
which up to 5 million shares may be awarded to eligible employees. During 1995,
approximately 2 million RSUs were awarded to new hires as part of the Company's
recruitment efforts. In addition, Holdings granted PSUs and 1.4 million options
to certain senior officers which have provisions similar to the PSUs and 1995
Options granted under the 1994 Plan. Holdings will fund these awards over time
with purchases of Common Stock in the open market and thus will not increase
total shares outstanding.
The following is a summary of stock awards issued and outstanding under
Holdings' stock based compensation plans:
RESTRICTED STOCK
REPLACEMENT
PLAN
-----------
Balance, January 1, 1994
Granted in connection with the spin-off....................................... 115,283
Exchanged for stock without restrictions...................................... (47,179)
Canceled...................................................................... (6,026)
-----------
Balance, November 30, 1994...................................................... 62,078
-----------
Exchanged for stock without restrictions...................................... (5,690)
Canceled...................................................................... (11,560)
-----------
Balance, November 30, 1995...................................................... 44,828
-----------
RESTRICTED STOCK UNITS
1994 PLAN EIP TOTAL
---------- --------- ----------
Balance, January 1, 1994
Granted............................................... 5,279,321 5,279,321
Canceled.............................................. (674,216) (674,216)
---------- --------- ----------
Balance, November 30, 1994.............................. 4,605,105 4,605,105
---------- --------- ----------
Granted............................................... 8,021,784 2,039,220 10,061,004
Canceled.............................................. (586,092) (586,092)
---------- --------- ----------
Balance, November 30, 1995.............................. 12,040,797 2,039,220 14,080,017
---------- --------- ----------
Of the RSUs issued and outstanding at November 30, 1995, approximately 4.2
million RSUs vested on July 1, 1995, approximately 5.6 million RSUs will vest on
July 1, 1996, and the remaining will vest July 1, 1997 to July 1, 2000.
F-17
NOTE 7. INCENTIVE PLANS--(CONTINUED)
STOCK OPTIONS
REPLACEMENT EXERCISE EXPIRATION
1994 PLAN PLAN EIP TOTAL PRICE DATES
--------- ----------- --------- --------- -------- ----------
Balance, January 1, 1994
Granted............... 1,960,720 1,849,769 3,810,489 $ 18.00 2/95-5/04
Canceled.............. (60,000) (60,000) $ 18.00
--------- ----------- --------- --------- -------- ----------
Balance, November 30,
1994.................... 1,960,720 1,789,769 3,750,489 $ 18.00 2/95-5/04
--------- ----------- --------- --------- -------- ----------
Granted............... 1,125,000 1,400,000 2,525,000 $ 20.875 10/00
Exercised............. (68,996) (68,996) $ 18.00
Canceled.............. (7,040) (291,588) (298,628) $ 18.00
--------- ----------- --------- --------- -------- ----------
Balance, November 30,
1995.................... 3,078,680 1,429,185 1,400,000 5,907,865 $ 18.00 -
$ 20.875 5/96-5/04
--------- ----------- --------- --------- -------- ----------
At November 30, 1995, approximately 2.1 million options are currently
exercisable at a price of $18.00.
As of December 31, 1995, the Compensation Committee awarded RSUs to members
of the CMC under the 1994 Plan based on performance goals satisfied for the
period from January 1, 1995 through December 31, 1995. An annual RSU award also
was made to employees in the Company's high-net-worth sales force. Approximately
500,000 RSUs, not included in the preceding RSU summary, were added to common
stock issuable at November 30, 1995 for these awards.
F-18
NOTE 8. CAPITAL REQUIREMENTS
As a registered broker-dealer, LBI is subject to SEC Rule 15c3-1, the Net
Capital Rule, which requires LBI to maintain net capital of not less than the
greater of 2% of aggregate debit items arising from customer transactions, as
defined, or 4% of funds required to be segregated for customers' regulated
commodity accounts, as defined. At November 30, 1995, LBI's regulatory net
capital, as defined, of $1,402 million exceeded the minimum requirement by
$1,301 million. On August 31, 1995, Lehman Government Securities Inc., a wholly
owned subsidiary of LBI and a registered broker-dealer, was merged into LBI.
Repayment of subordinated indebtedness and certain advances and dividend
payments by LBI are restricted by the regulations of the SEC and other
regulatory agencies. In addition, certain instruments governing the indebtedness
of LBI contractually limit its ability to pay dividends. At November 30, 1995,
$1,414 million of net assets of the Company were restricted as to the payment of
dividends.
NOTE 9. CHANGES IN ACCOUNTING PRINCIPLES
ACCOUNTING FOR POSTEMPLOYMENT BENEFITS
Effective January 1, 1994, the Company adopted SFAS No. 112, "Employers'
Accounting for Postemployment Benefits." SFAS No. 112 requires the accrual of
obligations associated with services rendered to date for employee benefits
accumulated or vested for which payment is probable and can be reasonably
estimated. These benefits principally include the continuation of salary, health
care and life insurance costs for employees on service disability leaves. The
Company previously expensed the cost of these benefits as they were incurred.
The cumulative effect of adopting SFAS No. 112 reduced net income for the
first quarter of 1994 by $13 million aftertax ($23 million pretax). The effect
of this accounting change on the 1994 results of operations was not material,
excluding the cumulative effect.
OFFSETTING OF CERTAIN RECEIVABLES AND PAYABLES
During the first quarter of 1994, the Company adopted the Financial
Accounting Standards Board Interpretation No. 39, "Offsetting of Amounts Related
to Certain Contracts" ("FIN No. 39"). FIN No. 39 restricts the historical
industry practice of offsetting certain receivables and payables. In January
1995, the Financial Accounting Standards Board issued Interpretation No. 41,
"Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase
Agreements" ("FIN No. 41"). FIN No. 41 is a modification to FIN No. 39 to permit
certain limited exceptions to the criteria established under FIN No. 39 for
offsetting certain repurchase and reverse repurchase agreements with the same
counterparty. The Company has adopted this modification, effective January 1995,
which partially mitigates the increase in the Company's gross assets and
liabilities resulting from the implementation of FIN No. 39.
NOTE 10. PENSION PLANS
The Company participates in several noncontributory defined benefit pension
plans sponsored by Holdings. The cost of pension benefits for eligible
employees, measured by length of service, compensation and other factors, is
currently being funded through trusts established under the plans. Funding of
retirement costs for the applicable plans complies with the minimum funding
requirements specified by the Employee Retirement Income Security Act of 1974,
as amended.
F-19
NOTE 10. PENSION PLANS--(CONTINUED)
Total (income) expense related to pension benefits for 1995, 1994 and 1993
consisted of the following components:
TWELVE MONTHS ELEVEN MONTHS TWELVE MONTHS
ENDED ENDED ENDED
NOVEMBER 30 NOVEMBER 30 DECEMBER 31
1995 1994 1993
------------- ------------- -------------
(IN MILLIONS)
Service cost--benefits earned during the period...... $ 5 $ 8 $ 24
Interest cost on projected benefit obligation........ 26 23 36
Actual return on plan assets......................... (72) 2 (59)
Net amortization and deferral........................ 37 (30) 15
----- ----- -----
Total (income) expense............................... $ (4) $ 3 $ 16
----- ----- -----
Plan assets within the trusts consist principally of equities and bonds. The
actual returns on plan assets for 1995 and 1993 reflect a favorable market
environment in those years. In addition, Company contributions increased assets
under investment in 1995. Adverse market conditions in 1994 were the principal
reason for the lower return earned in that year.
The following table sets forth the funded status of Holdings' domestic
defined benefit plans:
NOVEMBER 30 NOVEMBER 30
1995 1994
----------- -----------
(IN MILLIONS)
Actuarial present value of benefit obligations
Vested benefit obligation........................ $(375) $(289)
----------- -----------
Accumulated benefit obligation................... $(378) $(296)
----------- -----------
Projected benefit obligation....................... $(387) $(312)
Plan assets at fair value.......................... 481 380
----------- -----------
Plan assets in excess of projected benefit
obligation......................................... 94 68
Unrecognized net loss.............................. 95 74
Unrecognized prior service cost.................... (4) (4)
Unrecognized net asset............................. (2) (3)
----------- -----------
Prepaid pension asset recognized in Holdings'
Consolidated Statement of Financial Condition...... $ 183 $ 135
----------- -----------
The weighted average assumed discount rate used in determining the actuarial
present value of the projected benefit obligation for the plans was 7.25% and
8.5% in 1995 and 1994, respectively. The weighted average rate of increase in
future compensation levels used was 5.0% and 5.5% in 1995 and 1994,
respectively. The weighted average expected long-term rate of return on assets
was 9.75% in 1995, 1994 and 1993.
During 1993, the Company incurred a settlement and curtailment with respect
to its domestic pension plan in relation to the Primerica Transaction. The net
gain of approximately $26 million pretax was included in the loss on the sale of
Shearson. (See Note 18 for definitions and additional information concerning
this sale.)
NOTE 11. POSTRETIREMENT BENEFITS
The Company participates in several defined benefit health care plans
sponsored by Holdings that provide health care, life insurance and other
postretirement benefits to substantially all eligible retired employees. The
health care plans include participant contributions, deductibles, co-insurance
provisions
F-20
NOTE 11. POSTRETIREMENT BENEFITS--(CONTINUED)
and service-related eligibility requirements. The Company funds the cost of
these benefits as they are incurred.
Net periodic postretirement benefits cost for 1995, 1994, and 1993 consisted
of the following components:
TWELVE MONTHS ELEVEN MONTHS TWELVE MONTHS
ENDED ENDED ENDED
NOVEMBER 30 NOVEMBER 30 DECEMBER 31
1995 1994 1993
------------- ------------- -------------
(IN MILLIONS)
Service cost......................................... $ 1 $ 1 $ 2
Interest cost........................................ 4 5 8
Amortization of unrecognized prior service cost...... (1) (1)
--- --- ---
Net periodic postretirement benefits cost............ $ 4 $ 5 $10
--- --- ---
During 1993, the Company incurred a curtailment with respect to its
postretirement plan, in relation to the Primerica Transaction. The net gain of
approximately $56 million pretax was included in the loss on the sale of
Shearson. (See Note 18 for definitions and additional information concerning
this sale.)
The following table sets forth the amount recognized in the Consolidated
Statement of Financial Condition for the Company's postretirement benefit
obligation (other than pension plans):
NOVEMBER 30 NOVEMBER 30
1995 1994
----------- -----------
(IN MILLIONS)
Accumulated postretirement benefit obligation
Retirees.......................................................... $42 $45
Fully eligible active plan participants........................... 4 5
Other active plan participants.................................... 6 6
--- ---
52 56
--- ---
Unrecognized net gain............................................... 17 12
Unrecognized prior service cost..................................... 8 9
--- ---
Accrued postretirement benefits cost................................ $77 $77
--- ---
The discount rate used in determining the accumulated postretirement benefit
obligation was 7.25% and 8.5% in 1995 and 1994, respectively.
The annual assumed health care cost trend rate is 11% for the year ended
November 30, 1996 and is assumed to decrease at the rate of 1% per year to 6% in
the year ended November 30, 2001 and remain at that level thereafter. An
increase in the assumed health care cost trend rate by one percentage point in
each period would increase the accumulated postretirement benefit obligation as
of November 30, 1995 by approximately $1 million.
NOTE 12. INCOME TAXES
For tax filings subsequent to the spin-off from American Express, commencing
with the period June 1, 1994 to December 31, 1994, the Company will file a
consolidated U.S. federal income tax return with Holdings reflecting the income
of Holdings and its subsidiaries. For the period prior to the spin-off, the
income of Holdings was included in the American Express consolidated U.S.
federal income tax return, as it had been since August of 1990. The income tax
provision for the Company is computed in accordance with the income tax
allocation agreement among Holdings and its subsidiaries.
F-21
NOTE 12. INCOME TAXES--(CONTINUED)
With respect to the period in which the Company was included in the American
Express consolidated U.S. federal income tax return, intercompany taxes are
remitted to, or from, American Express when they are otherwise due to or from
the relevant taxing authority. The balances due to Holdings at November 30, 1995
and November 30, 1994 were $9 million and $226 million, respectively.
The provision for (benefit from) income taxes from continuing operations
consists of the following:
TWELVE MONTHS ELEVEN MONTHS TWELVE MONTHS
ENDED ENDED ENDED
NOVEMBER 30 NOVEMBER 30 DECEMBER 31
1995 1994 1993
------------- ------------- -------------
(IN MILLIONS)
Current
Federal............................................... $15 $ (1) $ 218
State................................................. (15) (21) 115
Foreign............................................... 4 2 7
--- --- -----
4 (20) 340
--- --- -----
Deferred
Federal............................................... (11) (16) (75)
State................................................. 16 3 (31)
--- --- -----
$ 9 $ (33) $ 234
--- --- -----
During the third quarter of 1993, the statutory U.S. federal income tax rate
was increased to 35% from 34%, effective January 1, 1993. The Company's 1993 tax
provision includes a one-time benefit of approximately $8 million from the
impact of the rate change on the Company's net deferred tax assets as of January
1, 1993.
Income from continuing operations before taxes included $24 million, $79
million and $41 million that is subject to income taxes of foreign jurisdictions
for 1995, 1994 and 1993, respectively.
The income tax provision (benefit) differs from that computed by using the
statutory federal income tax rate for the reasons shown below:
TWELVE MONTHS ELEVEN MONTHS TWELVE MONTHS
ENDED ENDED ENDED
NOVEMBER 30 NOVEMBER 30 DECEMBER 31
1995 1994 1993
------------- ------------- -------------
(IN MILLIONS)
Federal income taxes at statutory rate.................. $ 27 $ 1 $ (51)
State and local taxes................................... 1 (12) 54
Tax-exempt interest and dividends....................... (17) (21) (24)
Goodwill reduction related to the sale of Shearson...... 263
Amortization of goodwill................................ 2 3 9
U.S. federal rate change................................ (8)
Other................................................... (4) (4) (9)
--- --- -----
$ 9 $ (33) $ 234
--- --- -----
Deferred income tax assets and liabilities result from the recognition of
temporary differences. Temporary differences are differences between the tax
bases of assets and liabilities and their reported amounts in the consolidated
financial statements that will result in differences between income for tax
purposes and income for consolidated financial statement purposes in future
years.
F-22
NOTE 12. INCOME TAXES--(CONTINUED)
At November 30, 1995 and 1994, the Company's net deferred tax assets from
continuing operations consisted of the following:
NOVEMBER 30 NOVEMBER 30
1995 1994
----------- -----------
(IN MILLIONS)
Deferred tax assets................................ $67 $ 115
Less: Valuation allowance.......................... 26 97
--- -----
Deferred tax assets net of valuation allowance..... 41 18
Deferred tax liabilities........................... (2) (4)
--- -----
Net deferred tax assets from continuing
operations......................................... $39 $ 14
--- -----
The net deferred tax assets increased by $25 million to $39 million at
November 30, 1995. The net increase is primarily attributable to the reversal of
certain temporary differences. At November 30, 1995 and 1994 the deferred tax
assets and liabilities consist primarily of reserves not yet deducted for tax
purposes of $30 million and $99 million, respectively, and unrealized gains
related to trading and investment activities of $33 million and $11 million,
respectively. In addition, in accordance with the tax sharing agreement with
Holdings, the Company was reimbursed for $238 million and $345 million of net
deferred tax assets as of November 30, 1995 and November 30, 1994, respectively.
The net deferred tax assets are included in deferred expenses and other
assets in the accompanying Consolidated Statement of Financial Condition. At
November 30, 1995, the valuation allowance recorded against deferred tax assets
from continuing operations was $26 million as compared to $97 million at
November 30, 1994, of which approximately $2 million and $59 million,
respectively, will reduce goodwill if future circumstances permit recognition.
The decrease in the valuation allowance primarily relates to the write-off of
certain net operating losses ("NOLs") that no longer meet the asset recognition
criteria under SFAS 109. The decrease had no impact on the Company's profit and
loss since it was associated with a corresponding decrease in gross assets.
For tax return purposes, the Company has approximately $25 million of NOL
carryforwards, substantially all of which are attributable to the 1988
acquisition of E.F. Hutton Group Inc. (now known as LB I Group Inc.)
Substantially, all of the NOLs are scheduled to expire in the years 1999 through
2009.
NOTE 13. DERIVATIVE FINANCIAL INSTRUMENTS
Derivatives are financial instruments whose value is based upon an
underlying asset (e.g., treasury bond), index (e.g., S&P 500) or reference rate
(e.g., LIBOR). Over-the-counter ("OTC") derivative products are privately
negotiated contractual agreements that can be tailored to meet individual client
needs and include forwards, swaps and certain options including caps, collars
and floors. Exchange-traded derivative products are standardized contracts
transacted through regulated exchanges and include futures and certain option
contracts listed on an exchange.
In the normal course of business, the Company enters into derivative
transactions both in a trading capacity and as an end user. Acting in a trading
capacity, the Company enters into derivative transactions to satisfy the needs
of its clients and to manage the Company's own exposure to market and credit
risks resulting from its trading activities in cash instruments (collectively,
"Trading-Related Derivative Activities"). As an end user, the Company primarily
enters into interest rate swap and option contracts to adjust the interest rate
nature of its funding sources from fixed to floating rates and vice versa, and
to change the index upon which floating interest rates are based (i.e., Prime to
LIBOR) (collectively, "End User Derivative Activities").
F-23
NOTE 13. DERIVATIVE FINANCIAL INSTRUMENTS--(CONTINUED)
There is an extensive volume of derivative products available in the
marketplace which can vary from a simple forward foreign exchange contract to a
complex derivative instrument with multiple risk characteristics involving the
aggregation of the risk characteristics of a number of derivative product types
including swap products, options, futures and forwards. Listed below are
examples of various derivative products types along with a brief discussion of
the performance mechanics of certain specific derivative instruments.
SWAP PRODUCTS
Interest rate swap products include interest rate and currency swaps,
leveraged swaps, swap options, and other interest rate option products including
caps, collars, and floors. An interest rate swap is a negotiated OTC contract in
which two parties agree to exchange periodic interest payments for a defined
period, calculated based upon a predetermined notional amount. Interest payments
are usually exchanged on a net basis throughout the duration of the swap
contract. A currency swap is an OTC agreement to exchange a fixed amount of one
currency for a specified amount of a second currency at the outset and
completion of the swap term. Leveraged swaps involve the multiplication of the
interest rate factor upon which the interest payment streams are based (i.e.,
Party A pays 3 times six month LIBOR). Caps are contractual commitments that
require the writer to pay the purchaser the amount by which an interest
reference rate exceeds a defined contractual rate, if any, at specified times
during the contract. Conversely, a floor is a contractual commitment that
requires the writer to pay the amount by which a defined contractual rate
exceeds an interest reference rate at specified times over the life of the
contract, if any.
Equity swaps are contractual agreements whereby one party agrees to receive
the appreciation (or depreciation) value over a strike price on an equity
investment in return for paying another rate, which is usually based upon equity
index movements or interest rates. Commodity swaps are contractual commitments
to exchange the fixed price of a commodity for a floating price (which is
usually the prevailing spot price) throughout the swap term.
OPTIONS
Option contracts provide the option purchaser (holder) with the right but
not the obligation to buy or sell a financial instrument, commodity or currency
at a predetermined exercise price (strike price) during a defined period
(American Option) or at a specified date (European Option). The option purchaser
pays a premium to the option seller (writer) for the right to exercise the
option. The option seller is obligated to buy (call) or sell (put) the item
underlying the contract at a set price, if the option purchaser chooses to
exercise. Option contracts also exist for various indices and are similar to
options on a security or other instrument except that, rather than settling
physical with delivery of the underlying instrument, they are cash settled. As a
purchaser of an option contract, the Company is subject to credit risk but is
not subject to market risk, since the counterparty is obligated to make payments
under the terms of the option contract if the Company exercises the option. As
the writer of an option contract, the Company is not subject to credit risk but
is subject to market risk, since the Company is obligated to make payments under
the terms of the option contract if exercised.
Option contracts may be exchange-traded or OTC. Exchange-traded options are
the obligations of the exchange and generally have standardized terms and
performance mechanics. In contrast, all of the terms of an OTC option including
the method of settlement, term, strike price, premium, and security are
determined by negotiation of the parties.
FUTURES AND FORWARDS
Futures contracts are exchange-traded contractual commitments to either
receive (purchase) or deliver (sell) a standard amount or value of a financial
instrument or commodity at a specified future
F-24
NOTE 13. DERIVATIVE FINANCIAL INSTRUMENTS--(CONTINUED)
date and price. Maintaining a futures contract requires the Company to deposit
with the exchange, as security for its obligation (original margin), an amount
of cash or other specified asset. Additionally, futures exchanges generally
require the daily cash settlement of unrealized gains/losses on open contracts
with the futures exchange. Therefore, futures contracts provide a reduced
funding alternative to purchasing the underlying cash position in the
marketplace. Futures contracts may be settled by physical delivery of the
underlying asset or cash settlement (for index futures) on the settlement date
or by entering into an offsetting futures contract with the futures exchange
prior to the settlement date.
Forwards are OTC contractual commitments to purchase or sell a specified
amount of a financial instrument, foreign currency or commodity at a future date
at a predetermined price. TBA's are forward contracts which give the
purchaser/seller an obligation to obtain/deliver mortgage securities in the
future. Therefore, TBA's subject the holder to both interest rate risk and
principal prepayment risk.
TRADING-RELATED DERIVATIVE ACTIVITIES
Derivatives are subject to various risks similar to other financial
instruments including market, credit and operational risk. In addition, the
Company may also be exposed to legal risks related to its derivative activities
including the possibility that a transaction may be unenforceable under
applicable law. The risks of derivatives should not be viewed in isolation, but
rather should be considered on an aggregate basis along with the Company's other
trading-related activities. The Company manages the risks associated with
derivatives on an aggregate basis along with the risks associated with its
proprietary trading and market-making activities in cash instruments as part of
its firmwide risk management policies.
Derivatives are generally based upon notional values. Notional values are
not recorded on-balance-sheet, but rather are utilized solely as a basis for
determining future cash flows to be exchanged. Therefore, notional amounts
provide a measure of the Company's involvement with such instruments, but are
not indicative of potential risk.
The following table reflects the notional/contract value of the Company's
Trading-Related Derivative Activities.
TRADING-RELATED DERIVATIVE FINANCIAL INSTRUMENTS
NOTIONAL/CONTRACT VALUE
-------------------------- 1995 WEIGHTED
NOVEMBER 30 NOVEMBER 30 AVERAGE MATURITY
1995 1994 IN YEARS
----------- ----------- ----------------
(IN MILLIONS)
OVER-THE-COUNTER:
Swap products..................................... $ 552,877 $ 431,607 3.87
Options purchased................................. 5,092 6,031 0.16
Options written................................... 6,900 2,089 0.16
Forwards.......................................... 371,383 301,115 0.20
----------- ----------- ---
936,252 740,842 2.36
----------- ----------- ---
EXCHANGE-TRADED:
Futures........................................... 156,529 245,706 0.74
Options purchased................................. 25,392 17,248 0.17
Options written................................... 20,558 23,969 0.56
----------- ----------- ---
202,479 286,923 0.65
----------- ----------- ---
$ 1,138,731 $ 1,027,765 2.06
----------- ----------- ---
F-25
NOTE 13. DERIVATIVE FINANCIAL INSTRUMENTS--(CONTINUED)
Approximately $326 billion and $269 billion of these contracts relate to
foreign exchange transactions at November 30, 1995 and 1994, respectively.
Approximately $636 billion of the notional/contract value of the Company's
Trading-Related Derivative Activities mature within the year ended November 30,
1996, of which approximately 43% have maturities of less than one month.
The Company records its Trading-Related Derivative Activities on a
mark-to-market basis with realized and unrealized gains (losses) recognized
currently in principal transactions. The Company currently records unrealized
gains and losses on derivative contracts on a net basis in the Consolidated
Statement of Financial Condition for those transactions with counterparties
executed under a legally enforceable master netting agreement. While the Company
may utilize derivative products in all its businesses, the Company views its
derivative product revenues as the revenues earned from the Company's fixed
income derivative product business, foreign exchange derivatives and metals.
Principal transactions revenues related to the fixed income derivative product
business were $219 million for 1995, $354 million for 1994 and $230 million for
1993. Principal transactions revenues related to foreign exchange derivatives
and metals were $42 million for 1995, $54 million for 1994 and $88 million for
1993.
Listed in the following table is the fair value of the Company's
Trading-Related Derivative Activities as of November 30, 1995 and 1994 as well
as the average fair value of these instruments. Average fair values of these
instruments were calculated based upon month-end statement of financial
condition values,which the Company believes does not vary significantly from the
average fair value calculated on a more frequent basis. Variances between
average fair values and period-end values are due to changes in the volume of
activities in these instruments and changes in the valuation of these
instruments due to changes in market and credit conditions.
FAIR VALUE OF TRADING-RELATED DERIVATIVE FINANCIAL INSTRUMENTS
FAIR VALUE AVERAGE FAIR VALUES
------------------------------------------- -------------------------------------------
NOVEMBER 30, 1995 NOVEMBER 30, 1994 TWELVE MONTHS 1995 ELEVEN MONTHS 1994
-------------------- -------------------- -------------------- --------------------
ASSETS LIABILITIES ASSETS LIABILITIES ASSETS LIABILITIES ASSETS LIABILITIES
------ ----------- ------ ----------- ------ ----------- ------ -----------
(IN MILLIONS)
Swap products............................ $2,672 $ 2,247 $3,739 $ 2,072 $2,692 $ 2,060 $2,981 $ 1,596
Options purchased........................ 116 79 110 89
Options written.......................... 83 75 86 54
Forwards................................. 1,005 1,271 925 817 1,287 1,329 864 886
Futures(1)............................... 41 64 14 11 39 44 9 15
Commodities.............................. 39 51 289 2 67 60 289 2
------ ----- ------ ----- ------ ----- ------ -----
$3,873 $ 3,716 $5,046 $ 2,977 $4,195 $ 3,579 $4,232 $ 2,553
------ ----- ------ ----- ------ ----- ------ -----
- ------------
(1) Fair values of futures contracts represent the unsettled net receivable or
payable amount due to/from various future exchanges on open futures
contracts.
Assets included in the table above represent the Company's unrealized gains,
net of unrealized losses for situations in which the Company has a master
netting agreement. Similarly, liabilities represent net amounts owed to
counterparties. Therefore, the fair value of assets related to derivative
contracts at November 30, 1995 represents the Company's net receivable for
derivative financial instruments before consideration of collateral. Included
within this amount was $3,794 million and $79 million, respectively, related to
OTC and exchange-traded contracts.
The primary difference in risks related to OTC and exchange-traded contracts
is credit risk. OTC contracts contain credit risk for unrealized gains from
various counterparties, net of collateral. Exchange-traded contracts are
transacted directly on the respective exchanges. The exchange clearing house
requires its counterparties to post margin upon the origination of the contract
and for any changes in the market value of the contract on a daily basis
(certain foreign exchanges extend settlement to three days).
F-26
NOTE 13. DERIVATIVE FINANCIAL INSTRUMENTS--(CONTINUED)
With respect to OTC instruments, the Company views its net credit exposure
to be $3,030 million at November 30, 1995, representing the fair value of the
Company's OTC contracts in an unrealized gain position, after consideration of
collateral of $764 million.
Counterparties to the Company's OTC derivative products are primarily
financial intermediaries (U.S. and foreign banks), securities firms,
corporations, governments and their agencies, finance companies, insurance
companies, investment companies, pension funds and consumers and producers of
metals products. Collateral held related to OTC contracts generally includes
cash and U.S. government and federal agency securities. Presented below is an
analysis of the Company's net credit exposure for OTC contracts based upon
internal designations of counterparty credit quality.
1995
COUNTERPARTY S&P/MOODY'S NET CREDIT
RISK RATING EQUIVALENT EXPOSURE
- ------------- ---------------------- ----------
1 AAA/Aaa 22%
2 AA-/Aa3 or higher 25%
3 A-/A3 or higher 40%
4 BBB-/Baa3 or higher 9%
5 BB-/Ba3 or higher 3%
6 B+/B1 or lower 1%
These designations are based on actual ratings made by external rating
agencies or by equivalent ratings established and utilized by the Company's
Corporate Credit Department.
With respect to exchange-traded derivative instruments, the fair value of
assets reflects the unsettled variation margin due from futures exchanges as
well as the fair value of exchange-listed purchased options. Foreign futures
exchanges, consistent with their domestic counterparts, require cash or other
securities to be deposited with the exchange as collateral for open contracts.
END USER DERIVATIVE ACTIVITIES
The Company utilizes interest rate swaps as an end user to modify the
interest rate characteristics of its long-term debt portfolio. The Company
actively manages the interest rate exposure on its long-term debt portfolio to
more closely match the terms of its debt portfolio to the assets being funded
and to minimize interest rate risk. At November 30, 1995 and November 30, 1994
the notional value of the Company's interest rate swaps related to its long-term
debt obligations were approximately $2.7 billion and $3.8 billion, respectively.
(For a further discussion of the Company's long-term debt related end user
activities see Note 5.)
The Company also enters into interest rate swap agreements as an end user to
modify its interest rate exposure associated with its secured financing
activities, including securities purchased under agreements to resell,
securities borrowed, securities sold under agreements to repurchase and
securities loaned. At November 30, 1995 and 1994, the Company had $87 billion
and $83 billion, respectively, of such secured financing activities. As with the
Company's long-term debt, its secured financing activities expose the Company to
interest rate risk. The Company, as an end user, manages the interest rate risk
related to these activities by entering into derivative financial instruments,
including interest rate swaps and purchased options. The Company designates
certain specific derivative transactions against specific assets and liabilities
with matching maturities. In addition, the Company manages the interest rate
risk of anticipated secured financing transactions with derivative products.
These derivative products are designated against the existing secured financing
transactions for their applicable maturity. The remaining term of these
transactions are designated against the anticipated secured financing
transactions which will replace the existing secured financing transactions at
their maturity. The Company continuously monitors the level of secured financing
transactions to ensure that there is a high degree of
F-27
NOTE 13. DERIVATIVE FINANCIAL INSTRUMENTS--(CONTINUED)
certainty that the Company will enter into the anticipated secured financing
transactions at a level in excess of the designated derivative product
transactions. At November 30, 1995 and November 30, 1994, the Company, as an end
user, utilized derivative financial instruments with an aggregate notional
amount of $21.5 billion and $32.3 billion, respectively, to modify the interest
rate characteristics of its secured financing activities. The total notional
value of these agreements had a weighted average maturity of 1.1 years and 1.2
years as of November 30, 1995 and November 30, 1994, respectively.
During 1995, the Company terminated certain swaps designated as hedges of
the Company's secured financing activities. At November 30, 1995, a loss of
approximately $16 million from these terminated contracts was deferred and will
be amortized to interest expense in 1996. On an overall basis, the Company's
secured financing end user activities increased net interest income by
approximately $39 million and $6 million for 1995 and 1994, respectively.
NOTE 14. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107 "Disclosures about Fair Value of Financial Instruments"
requires the disclosure of the fair value of on- and off-balance sheet financial
instruments, both assets and liabilities, for which it is practicable to
estimate fair value. Fair value is the amount at which a financial instrument
could be exchanged in a current transaction between willing parties, other than
in a forced sale or liquidation. The fair values of financial instruments are
estimates based upon market conditions and perceived risks as of the statement
of financial condition date and require varying degrees of management judgment.
Quoted market prices, when available, are used as the measure of fair value. In
cases where quoted market prices are not available, fair values are based on
quotations of similarly traded instruments and pricing models. Pricing models
which consider time value, volatility factors, the current market and
contractual prices of the underlying financial instrument are used to value
derivatives and other contractual agreements. The disclosure requirements of
SFAS No. 107 exclude certain financial instruments such as employee benefit
obligations and all non-financial instruments such as fixed assets and goodwill.
All of the Company's financial instruments are carried at fair value or
contractual values which approximate fair value, with the exception of long-term
debt, certain secured financing activities and the related financial instruments
utilized by the Company as an end user to manage the interest rate risk of these
portfolios. Assets and liabilities which are carried at fair value include
securities and other financial instruments owned and securities and other
financial instruments sold but not yet purchased. Assets and liabilities, which
are recorded at contractual amounts that approximate market or fair value,
include cash and cash equivalents, cash and securities segregated and on deposit
for regulatory and other purposes, receivables, certain other assets and
deferred expenses, commercial paper and short-term debt, and payables.
The Company's long-term debt is recorded at contractual or historical
amounts that do not necessarily approximate market or fair value. For fair value
purposes, the carrying value of variable rate long-term debt that reprices
within one year and fixed rate long-term debt which matures in less than six
months is considered to approximate fair value. For the remaining long-term debt
portfolio, fair value is estimated using either quoted market prices or
discounted cash flow analyses based on the Company's current borrowing rates for
similar types of borrowing arrangements. The Company utilizes derivative
financial instruments as an end user to convert the interest rate basis for its
long-term debt from fixed or floating to another basis. The unrecognized net
gains/(losses) related to these end user activities reflect the estimated
amounts the Company would receive/pay if the agreements were
F-28
NOTE 14. FAIR VALUE OF FINANCIAL INSTRUMENTS--(CONTINUED)
terminated based on market rates at November 30, 1995 and 1994, respectively.
The following is a summary of the fair value of the Company's long-term debt and
related end user activities:
NOVEMBER 30
----------------
1995 1994
------ ------
(IN MILLIONS)
Carrying value of long-term debt........................................... $3,497 $3,396
Fair value of long-term debt............................................... 3,647 3,393
------ ------
Unrecognized net gain (loss) on long-term debt............................. $ (150) $ 3
------ ------
Unrecognized net gain (loss) on long-term debt end user activities......... $ 56 $ (24)
------ ------
The Company carries its secured financing activities, including securities
purchased under agreements to resell, securities borrowed, securities sold under
agreements to repurchase and securities loaned, at their original contract
amount plus accrued interest, which for the majority of such financing
activities is an approximation of fair value. At November 30, 1995 and 1994, the
Company had $87 billion and $83 billion, respectively, of such secured financing
activities. As with the Company's long-term debt, its secured financing
activities expose the Company to interest rate risk.
At November 30, 1995 and 1994, the Company, as an end user, utilized
derivative financial instruments with an aggregate notional amount of $21.5
billion and $32.3 billion, respectively, to modify the interest rate
characteristics of its secured financing activities. The unrecognized net losses
related to these derivative financial instruments of $36 million and $110
million at November 30, 1995 and 1994, respectively, were offset by unrecognized
net gains arising from the Company's secured financing activities.
NOTE 15. OTHER COMMITMENTS AND CONTINGENCIES
As of November 30, 1995 and 1994, the Company was contingently liable for
$721 million and $675 million, respectively, of letters of credit, primarily
used to provide collateral for securities and commodities borrowed and to
satisfy margin deposits at option and commodity exchanges, and other guarantees.
The Company has commitments under certain secured lending arrangements of
approximately $1.6 billion at November 30, 1995. These commitments require
borrowers to provide acceptable collateral, as defined in the agreements, when
amounts are drawn under the lending facilities. Advances under the above lending
arrangements are typically at variable interest rates and generally provide for
over-collateralization based upon the borrowers' creditworthiness.
As of November 30, 1995 and 1994, the Company had pledged or otherwise
transferred securities, primarily fixed income, having a market value of $23.2
billion and $15.2 billion, respectively, as collateral for securities borrowed
or otherwise received having a market value of $23.1 billion and $15.1 billion,
respectively.
Securities and other financial instruments sold but not yet purchased
represent obligations of the Company to purchase the securities at prevailing
market prices. Therefore, the future satisfaction of such obligations may be for
an amount greater or less than the amount recorded. The ultimate gain or loss is
dependent upon the price at which the underlying financial instrument is
purchased to settle its obligation under the sale commitment.
In addition, the Company's customer activities may expose it to
off-balance-sheet credit and market risk. These risks may arise in the normal
course of business as a result of executing, financing and settling various
customer security and commodity transactions. Off-balance-sheet risk arises from
the potential that customers or counterparties fail to satisfy their obligations
and that the collateral
F-29
NOTE 15. OTHER COMMITMENTS AND CONTINGENCIES--(CONTINUED)
obtained is insufficient. In such instances, the Company may be required to
purchase or sell financial instruments at unfavorable market prices. The Company
seeks to control these risks by obtaining margin balances and other collateral
in accordance with regulatory and internal guidelines.
Subsidiaries of the Company, as general partner, are contingently liable for
the obligations of certain public and private limited partnerships organized as
pooled investment funds or engaged primarily in real estate activities. In the
opinion of the Company, contingent liabilities, if any, for the obligations of
such partnerships will not in the aggregate have a material adverse effect on
the Company's consolidated financial position or results of operations.
In the normal course of its business, the Company has been named a defendant
in a number of lawsuits and other legal proceedings. After considering all
relevant facts, available insurance coverage and the advice of outside counsel,
in the opinion of the Company such litigation will not, in the aggregate, have a
material adverse effect on the Company's consolidated financial position or
results of operations.
CONCENTRATIONS OF CREDIT RISK
As a major international securities firm, the Company is actively involved
in securities underwriting, brokerage, distribution and trading. These and other
related services are provided on a worldwide basis to a large and diversified
group of clients and customers, including multinational corporations,
governments, emerging growth companies, financial institutions and individual
investors.
A substantial portion of the Company's securities and commodities
transactions is collateralized and is executed with, and on behalf of,
commercial banks and other institutional investors, including other brokers and
dealers. The Company's exposure to credit risk associated with the
non-performance of these customers and counterparties in fulfilling their
contractual obligations pursuant to securities transactions can be directly
impacted by volatile or illiquid trading markets, which may impair the ability
of customers and counterparties to satisfy their obligations to the Company.
Securities and other financial instruments owned by the Company include U.S.
government and agency securities, and securities issued by non-U.S. governments
which, in the aggregate, represented 17% of the Company's total assets at
November 30, 1995. In addition, substantially all of the collateral held by the
Company for resale agreements or securities borrowed, which together represented
52% of total assets at November 30, 1995, consisted of securities issued by the
U.S. government, federal agencies or non-U.S. governments. In addition to these
specific exposures, the Company's most significant concentration is financial
institutions, which include other brokers and dealers, commercial banks and
institutional clients. This concentration arises in the normal course of the
Company's business.
LEASE COMMITMENTS
The Company leases office space and equipment throughout the world and has
entered into a ground lease with the Battery Park City Authority covering its
headquarters at 3 World Financial Center which extends through 2069. Total rent
expense for 1995, 1994 and 1993 was $31 million, $34 million and $85 million,
respectively. Certain leases on office space contain escalation clauses
providing for additional rentals based upon maintenance, utility and tax
increases.
F-30
NOTE 15. OTHER COMMITMENTS AND CONTINGENCIES--(CONTINUED)
Minimum future rental commitments under noncancellable operating leases (net
of subleases of $589 million) are as follows:
AMOUNT
-------------
(IN MILLIONS)
Fiscal 1996..................................................... $ 34
Fiscal 1997..................................................... 24
Fiscal 1998..................................................... 18
Fiscal 1999..................................................... 17
Fiscal 2000..................................................... 12
December 1, 2000 and thereafter................................. 206
-----
$ 311
-----
The minimum future rental commitments shown above include lease obligations
related to facilities which the Company intends to vacate and sublease in future
periods, before consideration of the Company's fourth quarter restructuring
charge. (See Note 17.)
NOTE 16. RELATED PARTY TRANSACTIONS
In the normal course of business, the Company engages in various securities
trading, investment banking and financing activities with Holdings and many of
its subsidiaries (the "Related Parties"). Various charges, such as compensation,
occupancy, administration and computer processing are allocated between the
Related Parties, based upon specific identification and allocation methods.
In addition, Holdings and subsidiaries of Holdings raise money through
short- and long-term funding in the capital markets, which is used to fund the
operations of certain of the Company's wholly owned subsidiaries. Advances from
Holdings and other affiliates were $8,418 million and $8,807 million at November
30, 1995 and 1994, respectively.
In connection therewith, advances from Holdings aggregating approximately
$7.4 billion and $7.1 billion at November 30, 1995 and 1994, respectively, are
generally payable on demand. The average interest rate charged on these advances
is primarily based on Holdings' average daily cost of funds, which was 6.5% for
the twelve months ended November 30, 1995 and 4.8% for the eleven months ended
November 30, 1994. In addition, the Company had borrowings from subsidiaries of
Holdings comprised of approximately $821 million in subordinated indebtedness.
Interest charges incurred during the twelve months ended November 30, 1995, the
eleven months ended November 30, 1994 and the twelve months ended December 31,
1993 from Holdings, including interest charges on subordinated and senior debt
issued to Holdings, amounted to $483 million, $277 million and $227 million,
respectively. In addition, the Company has advances from other subsidiaries of
Holdings aggregating approximately $1.0 billion and $1.7 billion, at November
30, 1995 and 1994, respectively, with various repayment terms. The Company had
notes and other receivables due from Holdings and subsidiaries of Holdings
aggregating approximately $2.1 billion and $3.4 billion at November 30, 1995 and
1994, respectively, with various repayment terms.
During the third quarter of 1994, Holdings acquired additional space in the
World Financial Center and also began occupying its leased facility at 101
Hudson Street in Jersey City, New Jersey. In addition, certain employees of the
Company who perform administrative and corporate functions were transferred to
Holdings. Accordingly, Holdings has allocated the cost of these new facilities
and services provided by employees transferred to its appropriate subsidiaries.
These charges, which are classified in the Consolidated Statement of Operations
as Management fees, are primarily comprised of compensation, occupancy and
computer processing. The result of these allocations was to reduce expenses
incurred directly by the Company in previous periods with an offsetting increase
in Management fees.
F-31
NOTE 16. RELATED PARTY TRANSACTIONS--(CONTINUED)
The Company believes that amounts arising through related party
transactions, including those allocated expenses referred to above, are
reasonable and approximate the amounts that would have been recorded if the
Company operated as an unaffiliated entity.
LBI Group ("Group"), a wholly owned subsidiary of the Company had
outstanding 1,000 shares of its 9% Cumulative Preferred Stock, Series A (the
"Preferred Stock"), which it issued for an aggregate purchase price of
$750,000,000 to LB Funding Corp. ("Funding"), a wholly owned subsidiary of
Holdings for $1,000 in cash and a promissory note of $749,999,000 bearing
interest at a rate equal to the holder's cost of funds (the "Note"). In the
fourth quarter of 1994, the Preferred Stock and Note were canceled. Interest
income for the eleven months ended November 30, 1994 and the twelve months ended
December 31, 1993 includes $25 million and $28 million, respectively, from the
Note. The dividend requirement on the Preferred Stock, as reflected on the
Company's Consolidated Statement of Operations was $50 million for the eleven
months ended November 30, 1994 and $68 million for the twelve months ended
December 31, 1993.
Effective June 10, 1994, Lehman Special Securities Inc., a wholly owned
subsidiary of Holdings, was merged into a subsidiary of the Company resulting in
an increase in stockholder's equity of approximately $149 million. In addition,
in the fourth quarter of 1994, Funding and certain other wholly owned
subsidiaries of Holdings were merged into the Company. As a result,
Stockholder's equity increased by $318 million. The effect of these mergers on
the results of operations to this and prior periods was not material.
During 1995, the Company paid $635 million to Holdings, $559 million as a
return of capital and $76 million as dividends. During 1994, the Company paid
$536 million to Holdings, $300 million as a return of capital and $236 million
as dividends.
In 1993, the Company issued three shares of its common stock to Holdings for
$430 million.
NOTE 17. OTHER CHARGES
RESTRUCTURING CHARGE
During the fourth quarter of 1995, the Company recorded a charge of $43
million pretax ($26 million aftertax) for occupancy-related real estate and
severance expenses. The occupancy-related real estate expense component of the
charge, $26 million pretax ($16 million aftertax), resulted from a complete
global review of the Company's real estate requirements at current headcount
levels and the elimination of excess real estate, primarily in its New York,
London and Tokyo locations. The charge includes the cost to write-down the
carrying value of leasehold improvements as well as the difference between
expected operating costs and projected sublease recoveries. In addition, the
restructuring charge includes a $17 million pretax ($10 million aftertax)
component related to severance payments made during the fourth quarter. The
severance component of the charge relates to payments made to terminated
personnel arising from a fourth quarter formalized business unit productivity
review.
REDUCTION IN PERSONNEL
During the first quarter of 1994, the Company conducted a review of
personnel needs, which resulted in the termination of certain personnel. The
Company recorded a severance charge of $27 million pretax ($15 million aftertax)
in the first quarter of 1994.
RESERVES FOR NON-CORE BUSINESSES
During the first quarter of 1993, the Company provided $141 million pretax
($93 million aftertax) of non-core business reserves. Of this amount, $21
million pretax ($14 million aftertax) related to
F-32
NOTE 17. OTHER CHARGES--(CONTINUED)
certain non-core partnership syndication activities in which the Company is no
longer actively engaged. The remaining $120 million pretax ($79 million
aftertax) related to reserves recorded in anticipation of the sale of SLHMC.
Such sale was completed during the third quarter of 1993.
NOTE 18. SALE OF BUSINESS UNITS
SHEARSON
On July 31, 1993, pursuant to an asset purchase agreement (the "Primerica
Agreement"), the Company completed the sale (the "Primerica Transaction") of
LBI's domestic retail brokerage business (except for such business conducted
under the Lehman Brothers' name) and substantially all of its asset management
business (collectively, "Shearson") to Primerica Corporation (now known as The
Travelers Inc., "Travelers") and its subsidiary, Smith Barney, Harris Upham &
Co. Incorporated ("Smith Barney"). Also included in the Primerica Transaction
were the operations and data processing functions that supported these
businesses, as well as certain of the assets and liabilities related to these
operations.
LBI received approximately $1.2 billion in cash and a $586 million
interest-bearing note from Smith Barney which was repaid in January 1994 (the
"Smith Barney Note"). As further consideration for the sale of Shearson, LBI
received 2,500,000 shares of 5.50% Convertible Preferred Stock, Series B, of
Travelers and a warrant to purchase 3,749,466 shares of common stock of
Travelers at an exercise price of $39 per share. In August 1993, American
Express purchased such preferred stock and warrant from LBI for aggregate
consideration of $150 million.
The Company recognized a 1993 first quarter loss related to the Primerica
Transaction of approximately $630 million aftertax ($535 million pretax), which
included a reduction in goodwill of $750 million and transaction-related costs
such as relocation, systems and operations modifications and severance.
Presented below is the results of operations and the loss on the sale of
Shearson:
YEAR ENDED
DECEMBER 31
1993
-----------
(IN
MILLIONS)
Revenues....................................................... $ 1,825
Expenses....................................................... 1,708
Loss on sale of Shearson....................................... 535
-----------
Income (loss) before taxes..................................... (418)
Provision for income taxes..................................... 149
-----------
Net income (loss).............................................. $ (567)
-----------
Shearson operating results reflect allocated interest expense of $72 million
for the year ended December 31, 1993.
THE BOSTON COMPANY
On May 21, 1993, pursuant to a stock purchase agreement (the "Mellon
Agreement") between LBI and Mellon Bank Corporation ("Mellon Bank"), LBI sold to
Mellon Bank (the "Mellon Transaction") The Boston Company. Under the terms of
the Mellon Agreement, LBI received approximately $1.3 billion in cash, 2,500,000
shares of Mellon Bank common stock and ten-year warrants to purchase an
additional 3,000,000 shares of Mellon Bank's common stock at an exercise price
of $50 per share. In June 1993, such shares and warrants were sold by LBI to
American Express for an aggregate purchase
F-33
NOTE 18. SALE OF BUSINESS UNITS--(CONTINUED)
price of $169 million. After accounting for transaction costs and certain
adjustments, the Company recognized a 1993 first quarter aftertax gain of $165
million for the Mellon Transaction.
As a result of the Mellon Transaction, the Company treated The Boston
Company as a discontinued operation. Accordingly, the Company's financial
statements segregate the operating results of The Boston Company.
Presented below is the results of operations and the gain on disposal of The
Boston Company included in income from discontinued operations:
YEAR ENDED
DECEMBER 31
1993
-----------
(IN
MILLIONS)
Discontinued Operations
Revenues..................................................... $ 201
Expenses..................................................... 159
-----
Income before taxes............................................ 42
Provision for income taxes..................................... 18
-----
Income from operations......................................... 24
Gain on disposal, net of taxes of $37.......................... 165
-----
Income from discontinued operations, net of taxes.............. $ 189
-----
SHEARSON LEHMAN HUTTON MORTGAGE CORPORATION
LBI completed the sale of its wholly owned subsidiary, Shearson Lehman
Hutton Mortgage Corporation ("SLHMC") to GE Capital Corporation on August 31,
1993. The sales price, net of proceeds used to retire debt of SLHMC, was
approximately $70 million. During the first quarter of 1993, the Company
provided $120 million of pretax reserves in anticipation of the sale of SLHMC,
which reserves are included in the $141 million of pretax reserves for non-core
businesses on the Consolidated Statement of Operations. After accounting for
these reserves, the sale did not have a material effect on the Company's results
of operations.
NOTE 19. QUARTERLY INFORMATION (UNAUDITED)
The following information represents the Company's unaudited quarterly
results of operations for 1995 and 1994. Certain amounts reflect
reclassifications to conform to the current period's presentation.
F-34
NOTE 19. QUARTERLY INFORMATION (UNAUDITED)--(CONTINUED)
These quarterly results reflect all normal recurring adjustments which are, in
the opinion of management, necessary for a fair presentation of the results.
Revenues and earnings of the Company can vary significantly from quarter to
quarter due to the nature of the Company's business activities.
1995 1994
------------------------------------ -------------------------------------
NOV. 30 AUG. 31 MAY 31 FEB. 28 NOV. 30 AUG. 31 JUNE 30 MAR. 31
------- ------- ------ ------- ------- ------- ------- -------
(IN MILLIONS)
Total revenues............................... $ 3,175 $ 3,086 $2,991 $ 2,780 $ 2,460 $ 2,198 $ 1,958 $1,927
Interest expense............................. 2,596 2,525 2,504 2,329 1,956 1,695 1,475 1,254
------- ------- ------ ------- ------- ------- ------- -------
Net revenues................................. 579 561 487 451 504 503 483 673
Non-interest expenses
Compensation and benefits................... 302 306 267 180 251 265 256 336
Other expenses.............................. 207 194 232 269 255 268 256 245
Loss on sale of Shearson
Reserves and other charges.................. 43 27
------- ------- ------ ------- ------- ------- ------- -------
Total non-interest expenses.................. 552 500 499 449 506 533 512 608
------- ------- ------ ------- ------- ------- ------- -------
Income (loss) before taxes, cumulative effect
of change in accounting principle and
preferred dividend of subsidiary............. 27 61 (12) 2 (2) (30) (29) 65
Provision for (benefit from) income taxes.... 2 22 (12) (3) (9) (28) (22) 24
------- ------- ------ ------- ------- ------- ------- -------
Income (loss) before cumulative effect of
change in accounting principle and preferred
dividend of subsidiary....................... 25 39 0 5 7 (2) (7) 41
Cumulative effect of change in accounting
principle, net of taxes..................... (13 )
Preferred dividend of subsidiary............. (5) (17) (17) (17 )
------- ------- ------ ------- ------- ------- ------- -------
Net income (loss)............................ $ 25 $ 39 $ 0 $ 5 $ 2 $ (19) $ (24) $ 11
------- ------- ------ ------- ------- ------- ------- -------
------- ------- ------ ------- ------- ------- ------- -------
In conjunction with the decision to change its year-end, the Company
reported its third quarter 1994 results on the basis of its new fiscal year for
the three months ended August 31, 1994. As such, the results for the month of
June 1994 have been reflected in both the second and third quarters of 1994.
Thus, the four quarters of 1994 are not additive.
Net income for the first quarter of 1994 includes a $13 million aftertax
charge for the cumulative effect of a change in accounting for postemployment
benefits as a result of the adoption of SFAS No. 112.
F-35
EXHIBIT INDEX
EXHIBIT
NO.
- -------
3.1 Restated Certificate of Incorporation of the Registrant dated September 3, 1981
(incorporated by reference to Exhibit 3.1 of the Registrant's Annual Report on Form
10-K for the year ended December 31, 1987).
3.2 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant
dated May 11, 1984 (incorporated by reference to Exhibit 3.2 of the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1988).
3.3 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant,
dated March 6, 1985 (incorporated by reference to Exhibit 3.3 of the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1985).
3.4 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant,
dated August 31, 1987 (incorporated by reference to Exhibit 3.4 of the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1987).
3.5 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant,
dated January 28, 1988 (incorporated by reference to Exhibit 3.5 of the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1987).
3.6 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant,
dated July 19, 1990. (Incorporated by reference to Exhibit 3.6 of the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1990).
3.7 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant,
dated August 2, 1993 (incorporated by reference to Exhibit 3 of the Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1993).
3.8 By-Laws of the Registrant, amended as of July 1, 1991 (incorporated by reference to
Exhibit 3.7 of the Registrant Annual Report on Form 10-K for the year ended December
31, 1992).
4.1 The instruments defining the rights of holders of the long-term debt securities of
the Registrant and its subsidiaries are omitted pursuant to section (b)(4)(iii)(A)
of Item 601 of Regulation S-K. The Registrant hereby agrees to furnish copies of
these instruments to the Securities and Exchange Commission upon request.
10.1 Lease and Land Disposition Agreement, dated as of September 14, 1984, between
Shearson Lehman Construction Inc. and The City of New York (incorporated by
reference to Exhibit 10.16 of the Registrant's Registration Statement on Form S-1
(reg. No. 33-12976)).
10.2 Agreement of Tenants-In-Common by and among American Express Company, American
Express Bank Ltd, American Express Travel Related Services Company, Inc., Shearson
Lehman Brothers Inc., Shearson Lehman Government Securities, Inc. and Shearson
Lehman Commercial Paper Incorporated (incorporated by reference to Exhibit 10.1 of
Lehman Brothers Holdings Inc.'s Transition Report on Form 10-K for the eleven months
ended November 30, 1994.)
12. Computation in support of ratio of earnings to fixed charges.*
21. Pursuant to General Instruction J of Form 10-K, the list of the Registrant's
Subsidiaries is omitted.
23. Consent of Ernst & Young LLP.*
24. Powers of Attorney.*
27. Financial Data Schedule.*
(b) Reports on Form 8-K.
None.