WADDELL & REED FINANCIAL INC - FORM 10-Q

WADDELL & REED FINANCIAL INC - FORM 10-Q - July 29, 2016

Attached files

Attached files

file	filename
EX-32.2 - EX-32.2 - WADDELL & REED FINANCIAL INC	wdr-20160630ex3223a3198.htm
EX-32.1 - EX-32.1 - WADDELL & REED FINANCIAL INC	wdr-20160630ex32117a6e2.htm
EX-31.2 - EX-31.2 - WADDELL & REED FINANCIAL INC	wdr-20160630ex312bfffe6.htm
EX-31.1 - EX-31.1 - WADDELL & REED FINANCIAL INC	wdr-20160630ex3118c0f91.htm

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2016

☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 001-13913

WADDELL & REED FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

Delaware		51-0261715
(State or other jurisdiction		(I.R.S. Employer
of incorporation or organization)		Identification No.)

6300 Lamar Avenue

Overland Park, Kansas 66202

(Address, including zip code, of Registrant’s principal executive offices)

(913) 236-2000

(Registrant’s telephone number, including area code)

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 ☒ No ☐.

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).

Large accelerated filer ☒		Accelerated filer ☐

Non-accelerated filer ☐		Smaller reporting company ☐
(Do not check if a smaller reporting company)

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

Shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date:


Class		Outstanding as of July 15, 2016
Class A common stock, $.01 par value		82,840,733

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WADDELL & REED FINANCIAL, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

Quarter Ended June 30, 2016

			Page No.

Part I.	Financial Information

Item 1.		Financial Statements (unaudited)

		Consolidated Balance Sheets at June 30, 2016 and December 31, 2015	3

		Consolidated Statements of Income for the three and six months ended June 30, 2016 and June 30, 2015	4

		Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2016 and June 30, 2015	5

		Consolidated Statement of Stockholders’ Equity for the six months ended June 30, 2016	6

		Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and June 30, 2015	7

		Notes to the Unaudited Consolidated Financial Statements	8

Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations	21

Item 3.		Quantitative and Qualitative Disclosures About Market Risk	37

Item 4.		Controls and Procedures	37

Part II.	Other Information

Item 1.		Legal Proceedings	38

Item 1A.		Risk Factors	38

Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds	39

Item 6.		Exhibits	40

		Signatures	41

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands)


	June 30,
	2016		December 31,
	(Unaudited)		2015
Assets:
Cash and cash equivalents	$	467,458	558,495
Cash and cash equivalents - restricted		33,200	66,880
Investment securities		361,615	291,743
Receivables:
Funds and separate accounts		26,090	34,399
Customers and other		166,656	220,660
Income taxes receivable		4,701	10,594
Prepaid expenses and other current assets		24,042	34,800
Total current assets		1,083,762	1,217,571

Property and equipment, net		105,871	105,434
Deferred sales commissions, net		6,783	24,262
Goodwill and identifiable intangible assets		158,318	158,118
Deferred income taxes		31,319	32,692
Other non-current assets		20,185	17,074
Total assets	$	1,406,238	1,555,151

Liabilities:
Accounts payable	$	25,397	32,858
Payable to investment companies for securities		48,838	113,648
Payable to third party brokers		34,458	49,848
Payable to customers		84,635	120,420
Accrued compensation		75,861	69,335
Other current liabilities		63,093	57,104
Total current liabilities		332,282	443,213

Long-term debt		189,519	189,432
Accrued pension and postretirement costs		29,408	48,810
Other non-current liabilities		26,605	27,241
Total liabilities		577,814	708,696

Commitments and contingencies

Redeemable noncontrolling interests		10,865	—

Stockholders’ equity:
Preferred stock—$1.00 par value: 5,000 shares authorized; none issued		—	—
Class A Common stock—$0.01 par value: 250,000 shares authorized; 99,701 shares issued; 82,870 shares outstanding (82,850 at December 31, 2015)		997	997
Additional paid-in capital		279,206	331,611
Retained earnings		1,135,646	1,141,608
Cost of 16,831 common shares in treasury (16,851 at December 31, 2015)		(540,782)	(566,256)
Accumulated other comprehensive loss		(57,508)	(61,505)
Total stockholders’ equity		817,559	846,455

Total liabilities, redeemable noncontrolling interests and stockholders’ equity	$	1,406,238	1,555,151

See accompanying notes to the unaudited consolidated financial statements.

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WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Income

(Unaudited, in thousands, except for per share data)


	For the three months ended June 30,				For the six months ended June 30,
	2016		2015		2016		2015

Revenues:
Investment management fees	$	140,880		185,914		285,658		368,019
Underwriting and distribution fees		146,312		171,508		292,970		338,486
Shareholder service fees		32,016		36,568		64,396		72,943
Total		319,208		393,990		643,024		779,448

Operating expenses:
Underwriting and distribution		181,245		195,762		355,081		391,182
Compensation and related costs (including share-based compensation of $12,625, $11,333, $26,147 and $23,806, respectively)		58,341		52,829		111,281		106,324
General and administrative		19,276		27,897		38,428		53,575
Subadvisory fees		2,325		2,394		4,418		4,781
Depreciation		4,260		4,064		8,622		8,098
Total		265,447		282,946		517,830		563,960

Operating income		53,761		111,044		125,194		215,488
Investment and other income (loss)		687		9		(9,531)		3,981
Interest expense		(2,776)		(2,765)		(5,544)		(5,531)

Income before provision for income taxes		51,672		108,288		110,119		213,938
Provision for income taxes		18,101		40,843		39,079		79,380
Net income		33,571		67,445		71,040		134,558
Net income (loss) attributable to redeemable noncontrolling interests		(124)		—		377		—
Net income attributable to Waddell & Reed Financial, Inc	$	33,695		67,445		70,663		134,558

Net income per share attributable to Waddell and Reed Financial, Inc. common shareholders, basic and diluted:	$	0.41		0.80		0.86		1.61

Weighted average shares outstanding, basic and diluted:		82,947		84,079		82,526		83,831

See accompanying notes to the unaudited consolidated financial statements.

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WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Unaudited, in thousands)


	For the three months ended June 30,				For the six months ended June 30,
	2016		2015		2016		2015

Net income	$	33,571		67,445		71,040		134,558

Other comprehensive income:

Unrealized appreciation (depreciation) of available for sale investment securities during the period, net of income tax expense (benefit) of $0, $(8), $0, and $5, respectively		1,884		(4,974)		1,960		(3,164)

Pension and postretirement benefits, net of income tax expense of $566, $397, $1,185 and $951, respectively		960		933		2,037		1,876

Comprehensive income		36,415		63,404		75,037		133,270
Comprehensive income (loss) attributable to redeemable noncontrolling interests		(124)		—		377		—
Comprehensive income attributable to Waddell & Reed Financial, Inc.	$	36,539		63,404		74,660		133,270

See accompanying notes to the unaudited consolidated financial statements.

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WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statement of Stockholders’ Equity and redeemable noncontrolling interests

For the Six Months Ended June 30, 2016

(Unaudited, in thousands)


									Redeemable
							Accumulated Other	Total	Non
	Common Stock			Additional	Retained	Treasury	Comprehensive	Stockholders’	Controlling
	Shares	Amount		Paid-in Capital	Earnings	Stock	Income (Loss)	Equity	interest
Balance at December 31, 2015	99,701		997	331,611	1,141,608	(566,256)	(61,505)	846,455	—
Adoption of consolidation guidance on January 1, 2016 - redeemable noncontrolling interests in sponsored funds	—		—	—	—	—	—	—	14,330
Net income	—		—	—	70,663	—	—	70,663	377
Net redemption of redeemable noncontrolling interests in sponsored funds	—		—	—	—	—	—	—	(3,842)
Recognition of equity compensation	—		—	26,147	—	—	—	26,147	—
Net issuance/forfeiture of nonvested shares	—		—	(72,935)	—	72,935	—	—	—
Dividends accrued, $0.92 per share	—		—	—	(76,625)	—	—	(76,625)	—
Tax impact of share-based payment arrangements	—		—	(5,617)	—	—	—	(5,617)	—
Repurchase of common stock	—		—	—	—	(47,461)	—	(47,461)	—
Other comprehensive income	—		—	—	—	—	3,997	3,997	—
Balance at June 30, 2016	99,701	$	997	279,206	1,135,646	(540,782)	(57,508)	817,559	10,865

See accompanying notes to the unaudited consolidated financial statements.

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WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited, in thousands)


	For the six months ended June 30,
	2016		2015

Cash flows from operating activities:
Net income	$	71,040		134,558
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		8,627		8,100
Amortization of deferred sales commissions		19,661		24,270
Share-based compensation		26,147		23,806
Excess tax benefits from share-based payment arrangements		(1,423)		(4,814)
Investments gain, net		(8,560)		(2,804)
Net purchases and sales or maturities of trading securities		(24,996)		56
Deferred income taxes		187		(2,130)
Net change in trading securities held by consolidated sponsored funds		(45,455)		—
Other		328		81
Changes in assets and liabilities:
Cash and cash equivalents - restricted		33,680		16,660
Customer and other receivables		54,004		65,293
Payable to investment companies for securities and payable to customers		(100,595)		(83,835)
Receivables from funds and separate accounts		8,309		5,288
Other assets		6,560		(7,887)
Deferred sales commissions		(2,182)		(6,752)
Accounts payable and payable to third party brokers		(22,852)		(15,814)
Other liabilities		(4,034)		1,768

Net cash provided by operating activities	$	18,446		155,844

Cash flows from investing activities:
Purchases of available for sale and equity method securities		(104)		(25,891)
Proceeds from sales and maturities of available for sale and equity method securities		17,986		29,778
Additions to property and equipment		(9,265)		(14,078)
Net cash of sponsored funds on consolidation		6,887		—
Other		(196)		—

Net cash provided by (used in) investing activities	$	15,308		(10,191)

Cash flows from financing activities:
Dividends paid		(76,616)		(72,219)
Repurchase of common stock		(47,461)		(30,004)
Net subscriptions from (redemptions and distributions to) redeemable noncontrolling interests in sponsored funds		(2,224)		—
Excess tax benefits from share-based payment arrangements		1,423		4,814
Other		87		—

Net cash used in financing activities	$	(124,791)		(97,409)
Net increase (decrease) in cash and cash equivalents		(91,037)		48,244
Cash and cash equivalents at beginning of period		558,495		566,621
Cash and cash equivalents at end of period	$	467,458		614,865

See accompanying notes to the unaudited consolidated financial statements.

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WADDELL & REED FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.Description of Business and Significant Accounting Policies

Waddell & Reed Financial, Inc. and Subsidiaries

Waddell & Reed Financial, Inc. and subsidiaries (hereinafter referred to as the “Company,” “we,” “our” and “us”) derive revenues from investment management and advisory services, investment product underwriting and distribution, and/or shareholder services administration provided to the Waddell & Reed Advisors group of mutual funds (the “Advisors Funds”), Ivy Funds (the “Ivy Funds”), Ivy Funds Variable Insurance Portfolios (the “Ivy Funds VIP”) and InvestEd Portfolios (“InvestEd”) (collectively, the Advisors Funds, Ivy Funds, Ivy Funds VIP and InvestEd are referred to as the “Funds”), the Ivy Global Investors Fund SICAV (the “SICAV”) and its sub-funds (the “IGI Funds”), and institutional and separately managed accounts. The Funds and the institutional and separately managed accounts operate under various rules and regulations set forth by the United States Securities and Exchange Commission (the “SEC”). The IGI Funds are regulated by Luxembourg’s Commission de Surveillance du Secteur Financier as an undertaking for collective investment in transferable securities (“UCITS”). Services to the Funds are provided under investment management agreements, underwriting agreements, and shareholder servicing and accounting service agreements that set forth the fees to be charged for these services. Services to the IGI Funds are provided under investment management and distribution agreements. The majority of these agreements are subject to annual review and approval by each Fund’s board of trustees. Our revenues are largely dependent on the total value and composition of assets under management. Accordingly, fluctuations in financial markets and composition of assets under management can significantly impact our revenues and results of operations.

Basis of Presentation

We have prepared the accompanying unaudited consolidated financial statements pursuant to the rules and regulations of the SEC. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations, although we believe that the disclosures are adequate to enable a reasonable understanding of the information presented. The information in this Quarterly Report on Form 10-Q should be read in conjunction with Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2015 (the “2015 Form 10-K”). Certain amounts in the prior years’ financial statements have been reclassified for consistent presentation.

The accompanying unaudited consolidated financial statements are prepared consistent with the accounting policies described in Note 1 to the consolidated financial statements included in our 2015 Form 10-K except as noted below. In our opinion, the accompanying unaudited consolidated financial statements reflect all adjustments (consisting of only a normal and recurring nature) necessary to present fairly our financial position at June 30, 2016, the results of operations and cash flows for the six months ended June 30, 2016 and 2015 in conformity with accounting principles generally accepted in the United States.

Investments Securities and Investments in Sponsored Funds

Sponsored funds, which include the Funds, the IGI Funds and privately offered funds structured in the form of limited liability companies, are investments we have made for general corporate investment purposes and to provide seed capital for new investment products. The Company’s initial investment in a new investment product typically represents 100% ownership in that product. Sponsored funds are initially consolidated and are accounted for as trading securities. The Company has classified its investments in certain sponsored funds as either equity method investments (when the Company owns between 20% and 50% of the fund) or as available for sale investments (when the Company owns less than 20% of the fund) as described in Note 4. Investments held by our broker-dealer entities or certain investments that are anticipated to be purchased and sold on a more frequent basis are classified as trading.

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2.Cash and Cash Equivalents

Cash and cash equivalents include cash on hand and short-term investments. We consider all highly liquid investments with maturities upon acquisition of 90 days or less to be cash equivalents. Cash and cash equivalents - restricted represents cash held for the benefit of customers segregated in compliance with federal and other regulations.

3.New Accounting Guidance

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers,” which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This standard also specifies the accounting for certain costs to obtain or fulfill a contract with a customer. This ASU will supersede much of the existing revenue recognition guidance in accounting principles generally accepted in the United States and is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period; early application is permitted for the first interim period within annual reporting periods beginning after December 15, 2016. ASU 2014-09 permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating which transition method to apply and the estimated impact the adoption of this ASU will have on our consolidated financial statements and related disclosures.

In January 2016, the FASB issued ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities,” which provides updated guidance on the recognition, measurement, presentation and disclosure of certain financial assets and financial liabilities. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is evaluating the estimated impact the adoption of this ASU will have on our consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU 2016-02, “Leases,” which increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This ASU will be presented using a modified retrospective approach, which includes a number of optional practical expedients that entities may elect to apply. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early application permitted. The Company is evaluating the estimated impact the adoption of this ASU will have on our consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU 2016-07,“Simplifying the Transition to the Equity Method of Accounting.” The amendments in this ASU eliminate the requirement that when an investment qualifies for the use of equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively as if the equity method had been in effect during all previous periods that the investment had been held. ASU 2016-07 also requires that an entity that has an available for sale equity security that becomes qualified for the equity method recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. ASU 2016-07 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The Company is evaluating the estimated impact the adoption of this ASU will have on our consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting,” which recognizes all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement, with classifying excess tax benefits along with other income tax cash flows as an operating activity; allows an entity to either estimate the number of awards that are expected to vest or account for forfeitures when they occur; and permits withholding up to the maximum statutory tax rates in the applicable jurisdictions. ASU 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods, with early adoption permitted. The Company is evaluating the estimated impact the adoption of this ASU will have on our consolidated financial statements and related disclosures.

In June 2016, the FASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments.” The ASU changes the impairment model for most financial assets, and will require the use of an “expected loss” model for instruments measured at amortized cost. Under this model, entities will be required to estimate the lifetime expected credit loss on such instruments and record an allowance to offset the amortized cost basis of the financial asset, resulting

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in a net presentation of the amount expected to be collected on the financial asset. ASU 2016-13 is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2019. The Company is evaluating the estimated impact the adoption of this ASU will have on our consolidated financial statements and related disclosures.

4.Investment Securities

Investment securities at June 30, 2016 and December 31, 2015 are as follows:


	June 30,		December 31,
	2016		2015
(in thousands)
Available for sale securities:
Sponsored funds	$	84,947	40,552
Sponsored privately offered funds		868	825
Total available for sale securities		85,815	41,377
Trading securities:
Mortgage-backed securities		16	20
Corporate bond		3	5
Common stock		97	87
Consolidated sponsored funds		111,803	—
Sponsored funds		29,924	29,701
Total trading securities		141,843	29,813
Equity method securities:
Sponsored funds		130,898	217,380
Sponsored privately offered funds		3,059	3,173
Total equity method securities		133,957	220,553
Total securities	$	361,615	291,743

The following is a summary of the gross unrealized gains (losses) related to securities classified as available for sale at June 30, 2016:


	Amortized		Unrealized	Unrealized
	cost		gains	losses	Fair value
	(in thousands)
Available for sale securities:
Sponsored funds	$	89,278	1,928	(6,259)	84,947
Sponsored privately offered funds		500	368	—	868
	$	89,778	2,296	(6,259)	85,815

The following is a summary of the gross unrealized gains (losses) related to securities classified as available for sale at December 31, 2015:


	Amortized		Unrealized	Unrealized
	cost		gains	losses	Fair value
	(in thousands)
Available for sale securities:
Sponsored funds	$	46,800	434	(6,682)	40,552
Sponsored privately offered funds		500	325	—	825
	$	47,300	759	(6,682)	41,377

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A summary of available for sale sponsored funds with fair values below carrying values at June 30, 2016 and December 31, 2015 is as follows:


	Less than 12 months			12 months or longer		Total
			Unrealized		Unrealized		Unrealized
June 30, 2016	Fair value		losses	Fair value	losses	Fair value	losses
	(in thousands)
Sponsored funds	$	2,258	(44)	33,859	(6,037)	36,117	(6,081)
Sponsored privately offered funds		7,001	(178)	—	—	7,001	(178)
	$	9,259	(222)	33,859	(6,037)	43,118	(6,259)

Less than 12 months

12 months or longer

Total

Unrealized

December 31, 2015

Fair value

losses

Fair value

losses

Fair value

losses

(in thousands)

Sponsored privately offered funds

The Company holds interests in privately offered funds structured in the form of limited liability companies. The members of these entities have the substantive ability to remove the Company as managing member or dissolve the entity upon a simple majority vote. These entities do not meet the criteria of a variable interest entity and are considered to be voting interest entities.

Consolidated sponsored funds

The following table details the balances related to consolidated sponsored funds at June 30, 2016, as well as the Company’s net interest in these funds:


	June 30, 2016
	(in thousands)

Cash	$	7,801
Investments		111,803
Other assets		2,014
Other liabilities		(955)
Redeemable noncontrolling interests		(10,865)
Net interest in consolidated sponsored funds	$	109,798

During the six months ended June 30, 2016, we consolidated Ivy Funds and IGI Funds in which we provided initial seed capital at the time of the funds formation. When we no longer have a controlling financial interest in a sponsored fund, it is deconsolidated from our financial statements. We deconsolidated $44.2 million of these investments from our consolidated balance sheet during the first quarter of 2016. There was no impact to the consolidated statement of income as a result of this deconsolidation.

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Accounting standards establish a framework for measuring fair value and a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of the asset. Inputs may be observable or unobservable and refer broadly to the assumptions that market participants would use in pricing the asset. An individual investment’s fair value measurement is assigned a level based upon the observability of the inputs that are significant to the overall valuation. The three-level hierarchy of inputs is summarized as follows:

Level 1 – Investments are valued using quoted prices in active markets for identical securities.

Level 2 – Investments are valued using other significant observable inputs, including quoted prices in active markets for similar securities.

Level 3 – Investments are valued using significant unobservable inputs, including the Company’s own assumptions in determining the fair value of investments.

Assets classified as Level 2 can have a variety of observable inputs. These observable inputs are collected and utilized, primarily by an independent pricing service, in different evaluated pricing approaches depending upon the specific asset to determine a value. The fair value of municipal bonds is measured based on pricing models that take into account, among other factors, information received from market makers and broker-dealers, current trades, bid-wants lists, offerings, market movements, the callability of the bond, state of issuance and benchmark yield curves. The fair value of corporate bonds is measured using various techniques, which consider recently executed trades in securities of the issuer or comparable issuers, market price quotations (where observable), bond spreads and fundamental data relating to the issuer.

Securities’ values classified as Level 3 are primarily determined through the use of a single quote (or multiple quotes) from dealers in the securities using proprietary valuation models. These quotes involve significant unobservable inputs, and thus, the related securities are classified as Level 3 securities.

The following tables summarize our investment securities as of June 30, 2016 and December 31, 2015 that are recognized in our consolidated balance sheets using fair value measurements based on the differing levels of inputs.


June 30, 2016	Level 1		Level 2	Level 3	Total
	(in thousands)
Available for sale securities:
Sponsored funds	$	84,947	—	—	84,947
Sponsored privately offered funds measured at net asset value (2)		—	—	—	868
Trading securities:
Mortgage-backed securities		—	16	—	16
Corporate bonds		—	3	—	3
Common stock		97	—	—	97
Consolidated sponsored funds (2)		—	—	—	111,803
Sponsored funds		29,924	—	—	29,924
Equity method securities: (1)
Sponsored funds		130,898	—	—	130,898
Sponsored privately offered funds measured at net asset value (2)		—	—	—	3,059
Total	$	245,866	19	—	361,615

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December 31, 2015	Level 1		Level 2	Level 3	Total
	(in thousands)
Available for sale securities:
Sponsored funds	$	40,552	—	—	40,552
Sponsored privately offered funds measured at net asset value (2)		—	—	—	825
Trading securities:
Mortgage-backed securities		—	20	—	20
Corporate bonds		—	5	—	5
Common stock		87	—	—	87
Sponsored funds		29,701	—	—	29,701
Equity method securities: (1)
Sponsored funds		217,380	—	—	217,380
Sponsored privately offered funds measured at net asset value (2)		—	—	—	3,173
Total	$	287,720	25	—	291,743

(1)

Substantially all of the Company’s equity method investments are investment companies that record their underlying investments at fair value. Fair value is measured using the Company’s share of the investee’s underlying net income or loss, which is predominantly representative of fair value adjustments in the investments held by the investee.

(2)

Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets.

5.Derivative Financial Instruments

In January 2016, the Company implemented an economic hedge program that uses total return swap contracts to hedge market risk with its investments in certain sponsored funds. As of June 30, 2016, we had 91% of our investments in sponsored funds, excluding our available for sale portfolio, hedged, 82% of which were hedged with total return swap contracts. Certain of the consolidated sponsored funds may utilize derivative financial instruments within their portfolios in pursuit of their stated investment objectives. We do not hedge for speculative purposes.

As of June 30, 2016, excluding derivative financial instruments held in certain consolidated sponsored funds, the Company was party to three total return swap contracts with a combined notional value of $200.7 million. These derivative instruments are not designated as hedges for accounting purposes. Changes in fair value of the total return swap contracts are recognized in investment and other income (loss), net on the Company’s consolidated statement of income.

The Company posted $8.2 million in cash collateral with the counterparties of the total return swap contracts as of June 30, 2016. The cash collateral is included in customers and other receivables on the Company’s consolidated balance sheet. The company does not record its fair value in derivative transactions against the posted collateral.

The following table presents the fair value of the derivative financial instruments, excluding derivative financial instruments held in certain consolidated sponsored funds as of June 30, 2016:

June 30, 2016

Balance sheet

Fair value

(in thousands)

Total return swap contracts

Other current liabilities