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EX-32.1 - SECTION 1350 CERTIFICATION - PIPER JAFFRAY COMPANIESpjc2017ex321.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - PIPER JAFFRAY COMPANIESpjc2017ex312.htm
EX-31.1 - CERTIFICATION OF CHAIRMAN AND CHIEF EXECUTIVE OFFICER - PIPER JAFFRAY COMPANIESpjc2017ex311.htm
EX-10.2 - SECOND AMENDMENT TO SECURITIES PURCHASE AGREEMENT - PIPER JAFFRAY COMPANIESpjc2017ex102.htm
EX-10.1 - FOURTH AMENDMENT TO AMENDED AND RESTATED LOAN AGREEMENT - PIPER JAFFRAY COMPANIESpjc2017ex101.htm
 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
þ

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2017
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to                     

Commission File No. 001-31720
PIPER JAFFRAY COMPANIES
(Exact Name of Registrant as specified in its Charter)
DELAWARE
 
30-0168701
(State or Other Jurisdiction of Incorporation or Organization)
 
(IRS Employer Identification No.)
800 Nicollet Mall, Suite 1000
Minneapolis, Minnesota
 
55402
(Address of Principal Executive Offices)
 
(Zip Code)
 
(612) 303-6000
 
(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  þ 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  þ No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
þ
 
Accelerated filer
¨
Non-accelerated filer
¨
(Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
 
Emerging growth company
¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ¨

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

As of May 3, 2017, the registrant had 15,052,049 shares of Common Stock outstanding.

 




Piper Jaffray Companies
Index to Quarterly Report on Form 10-Q

PART I. FINANCIAL INFORMATION
 
 
 
 
ITEM 1.
 
 
 
 
 
 
 
 
 
 
 
ITEM 2.
 
ITEM 3.
 
ITEM 4.
 
 
 
 
 
PART II. OTHER INFORMATION
 
 
 
 
ITEM 1.
 
ITEM 1A.
 
ITEM 2.
 
ITEM 6.
 
 
 





PART I.    FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS.
Piper Jaffray Companies
Consolidated Statements of Financial Condition
 
March 31,
 
December 31,
 
2017
 
2016
(Amounts in thousands, except share data)
(Unaudited)
 
 
Assets
 
 
 
Cash and cash equivalents
$
18,879

 
$
41,359

Cash and cash equivalents segregated for regulatory purposes
53,022

 
29,015

Receivables:
 
 
 
Customers
23,488

 
31,917

Brokers, dealers and clearing organizations
194,286

 
212,730

Securities purchased under agreements to resell
227,011

 
159,697

 
 
 
 
Financial instruments and other inventory positions owned
567,210

 
464,610

Financial instruments and other inventory positions owned and pledged as collateral
451,083

 
594,361

Total financial instruments and other inventory positions owned
1,018,293

 
1,058,971

 
 
 
 
Fixed assets (net of accumulated depreciation and amortization of $57,859 and $58,308, respectively)
25,402

 
25,343

Goodwill
196,218

 
196,218

Intangible assets (net of accumulated amortization of $73,839 and $70,017, respectively)
33,412

 
37,234

Investments
159,675

 
168,057

Other assets
163,471

 
164,962

Total assets
$
2,113,157

 
$
2,125,503

 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
Short-term financing
$
297,146

 
$
418,832

Senior notes
175,000

 
175,000

Payables:
 
 
 
Customers
41,594

 
29,352

Brokers, dealers and clearing organizations
204,063

 
40,842

Securities sold under agreements to repurchase
10,457

 
15,046

Financial instruments and other inventory positions sold, but not yet purchased
404,539

 
299,357

Accrued compensation
117,821

 
288,255

Other liabilities and accrued expenses
40,581

 
42,553

Total liabilities
1,291,201

 
1,309,237

 
 
 
 
Shareholders’ equity:
 
 
 
Common stock, $0.01 par value:
 
 
 
Shares authorized: 100,000,000 at March 31, 2017 and December 31, 2016;
 
 
 
Shares issued: 19,509,951 at March 31, 2017 and 19,535,307 at December 31, 2016;
 
 
 
Shares outstanding: 12,784,865 at March 31, 2017 and 12,391,970 at December 31, 2016
195

 
195

Additional paid-in capital
784,739

 
788,927

Retained earnings
272,706

 
257,188

Less common stock held in treasury, at cost: 6,725,086 at March 31, 2017 and 7,143,337 shares at December 31, 2016
(277,099
)
 
(284,461
)
Accumulated other comprehensive loss
(2,376
)
 
(2,599
)
Total common shareholders’ equity
778,165

 
759,250

 
 
 
 
Noncontrolling interests
43,791

 
57,016

Total shareholders’ equity
821,956

 
816,266

 
 
 
 
Total liabilities and shareholders’ equity
$
2,113,157

 
$
2,125,503

See Notes to the Consolidated Financial Statements

3

Piper Jaffray Companies
Consolidated Statements of Operations
(Unaudited)

 
Three Months Ended
 
March 31,
(Amounts in thousands, except per share data)
2017
 
2016
Revenues:
 
 
 
Investment banking
$
132,250

 
$
103,938

Institutional brokerage
39,136

 
32,049

Asset management
16,007

 
13,848

Interest
7,719

 
8,829

Investment income
10,375

 
937

 
 
 
 
Total revenues
205,487

 
159,601

 
 
 
 
Interest expense
4,958

 
6,045

 
 
 
 
Net revenues
200,529

 
153,556

 
 
 
 
Non-interest expenses:
 
 
 
Compensation and benefits
134,378

 
104,436

Outside services
10,328

 
8,451

Occupancy and equipment
8,462

 
7,718

Communications
7,616

 
7,330

Marketing and business development
7,547

 
7,004

Trade execution and clearance
1,811

 
1,762

Restructuring and integration costs

 
6,773

Intangible asset amortization expense
3,822

 
3,296

Back office conversion costs
866

 

Other operating expenses
2,890

 
3,344

 
 
 
 
Total non-interest expenses
177,720

 
150,114

 
 
 
 
Income before income tax expense/(benefit)
22,809

 
3,442

 
 
 
 
Income tax expense/(benefit)
(395
)
 
256

 
 
 
 
Net income
23,204

 
3,186

 
 
 
 
Net income applicable to noncontrolling interests
2,929

 
749

 
 
 
 
Net income applicable to Piper Jaffray Companies
$
20,275

 
$
2,437

 
 
 
 
Net income applicable to Piper Jaffray Companies’ common shareholders
$
16,828

 
$
2,124

 
 
 
 
Earnings per common share
 
 
 
Basic
$
1.33

 
$
0.16

Diluted
$
1.31

 
$
0.16

 
 
 
 
Dividends declared per common share
$
0.31

 
$

 
 
 
 
Weighted average number of common shares outstanding
 
 
 
Basic
12,594

 
13,160

Diluted
12,922

 
13,172


See Notes to the Consolidated Financial Statements

4

Piper Jaffray Companies
Consolidated Statements of Comprehensive Income
(Unaudited)

 
Three Months Ended
 
March 31,
(Amounts in thousands)
2017
 
2016
Net income
$
23,204

 
$
3,186

 
 
 
 
Other comprehensive income/(loss), net of tax:
 
 
 
Foreign currency translation adjustment
223

 
(403
)
 
 
 
 
Comprehensive income
23,427

 
2,783

 
 
 
 
Comprehensive income applicable to noncontrolling interests
2,929

 
749

 
 
 
 
Comprehensive income applicable to Piper Jaffray Companies
$
20,498

 
$
2,034


See Notes to the Consolidated Financial Statements


5

Piper Jaffray Companies
Consolidated Statements of Cash Flows
(Unaudited)

 
Three Months Ended
 
March 31,
(Dollars in thousands)
2017
 
2016
 
 
 
 
Operating Activities:
 
 
 
Net income
$
23,204

 
$
3,186

Adjustments to reconcile net income to net cash provided by/(used in) operating activities:
 
 
 
Depreciation and amortization of fixed assets
1,703

 
1,458

Deferred income taxes
13,916

 
6,436

Stock-based and deferred compensation
4,676

 
10,064

Amortization of intangible assets
3,822

 
3,296

Amortization of forgivable loans
1,820

 
2,051

Decrease/(increase) in operating assets:
 
 
 
Cash and cash equivalents segregated for regulatory purposes
(24,007
)
 
33,980

Receivables:
 
 
 
Customers
8,428

 
12,748

Brokers, dealers and clearing organizations
18,444

 
(36,899
)
Securities purchased under agreements to resell
(71,423
)
 
17,899

Net financial instruments and other inventory positions owned
145,860

 
(85,486
)
Investments
8,382

 
(12,878
)
Other assets
(14,170
)
 
(12,732
)
Increase/(decrease) in operating liabilities:
 
 
 
Payables:
 
 
 
Customers
12,242

 
7,277

Brokers, dealers and clearing organizations
163,221

 
122,800

Securities sold under agreements to repurchase
(480
)
 
2,809

Accrued compensation
(153,843
)
 
(133,238
)
Other liabilities and accrued expenses
(1,993
)
 
(17,075
)
 
 
 
 
Net cash provided by/(used in) operating activities
139,802

 
(74,304
)
 
 
 
 
Investing Activities:
 
 
 
Business acquisitions, net of cash acquired

 
(70,230
)
Purchases of fixed assets, net
(1,756
)
 
(1,331
)
 
 
 
 
Net cash used in investing activities
(1,756
)
 
(71,561
)
 
 
 
 
Continued on next page

6

Piper Jaffray Companies
Consolidated Statements of Cash Flows – Continued
(Unaudited)

 
Three Months Ended
 
March 31,
(Dollars in thousands)
2017
 
2016
 
 
 
 
Financing Activities:
 
 
 
Increase/(decrease) in short-term financing
$
(121,686
)
 
$
12,853

Increase in securities sold under agreements to repurchase

 
5,416

Payment of cash dividend
(4,746
)
 

Increase/(decrease) in noncontrolling interests
(16,154
)
 
7,262

Repurchase of common stock
(19,788
)
 
(19,445
)
Reduced tax benefit from stock-based compensation

 
(895
)
Proceeds from stock option exercises
1,703

 

 
 
 
 
Net cash provided by/(used in) financing activities
(160,671
)
 
5,191

 
 
 
 
Currency adjustment:
 
 
 
Effect of exchange rate changes on cash
145

 
(96
)
 
 
 
 
Net decrease in cash and cash equivalents
(22,480
)
 
(140,770
)
 
 
 
 
Cash and cash equivalents at beginning of period
41,359

 
189,910

 
 
 
 
Cash and cash equivalents at end of period
$
18,879

 
$
49,140

 
 
 
 
Supplemental disclosure of cash flow information –
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
4,464

 
$
6,067

Income taxes
$
7,710

 
$
19,827

 
 
 
 
Non-cash investing activities –
 
 
 
Issuance of common stock related to the acquisition of Simmons & Company International:
 
 
 
25,525 shares for the three months ended March 31, 2016
$

 
$
1,074

 
 
 
 
Non-cash financing activities –
 
 
 
Issuance of restricted common stock for annual equity award:
 
 
 
198,981 shares and 843,889 shares for the three months ended March 31, 2017 and 2016, respectively
$
16,187

 
$
35,089


See Notes to the Consolidated Financial Statements


7

Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)


Index
Note 1
 
Note 2
 
Note 3
 
Note 4
 
Note 5
 
Note 6
 
Note 7
 
Note 8
 
Note 9
 
Note 10
 
Note 11
 
Note 12
 
Note 13
 
Note 14
 
Note 15
 
Note 16
 
Note 17
 
Note 18
 
Note 19
 
Note 20
 


8

Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Note 1 Organization and Basis of Presentation

Organization

Piper Jaffray Companies is the parent company of Piper Jaffray & Co. ("Piper Jaffray"), a securities broker dealer and investment banking firm; Piper Jaffray Ltd., a firm providing securities brokerage and mergers and acquisitions services in Europe headquartered in London, England; Simmons & Company International Limited ("SCIL"), a firm providing mergers and acquisitions services to the energy industry headquartered in Aberdeen, Scotland; Advisory Research, Inc. ("ARI"), which provides asset management services to separately managed accounts, closed-end and open-end funds and partnerships; Piper Jaffray Investment Group Inc., which consists of entities providing alternative asset management services; Piper Jaffray Financial Products Inc. and Piper Jaffray Financial Products II Inc., entities that facilitate derivative transactions; and other immaterial subsidiaries. Piper Jaffray Companies and its subsidiaries (collectively, the "Company") operate in two reporting segments: Capital Markets and Asset Management. A summary of the activities of each of the Company’s business segments is as follows:

Capital Markets

The Capital Markets segment provides investment banking services and institutional sales, trading and research services. Investment banking services include management of and participation in underwritings, financial advisory services and public finance activities. Revenues are generated through the receipt of advisory and financing fees. Institutional sales, trading and research services focus on the trading of equity and fixed income products with institutions, government and non-profit entities. Revenues are generated through commissions and sales credits earned on equity and fixed income institutional sales activities, net interest revenues on trading securities held in inventory, and profits and losses from trading these securities. Also, the Company generates revenue through strategic trading and investing activities, which focus on investments in municipal bonds, U.S. government agency securities, and merchant banking activities involving equity or debt investments in late stage private companies. The Company has created alternative asset management funds in merchant banking, energy and senior living in order to invest firm capital and to manage capital from outside investors. The Company receives management and performance fees for managing these funds.

Asset Management

The Asset Management segment provides traditional asset management services with product offerings in equity securities and master limited partnerships to institutions and individuals. Revenues are generated in the form of management and performance fees. Revenues are also generated through investments in the partnerships and funds that the Company manages.

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP") for interim financial information and the rules and regulations of the Securities and Exchange Commission ("SEC"). Pursuant to this guidance, certain information and disclosures have been omitted that are included within complete annual financial statements. Except as disclosed herein, there have been no material changes in the information reported in the financial statements and related disclosures in the Company's Annual Report on Form 10-K for the year ended December 31, 2016.

The consolidated financial statements include the accounts of Piper Jaffray Companies, its wholly owned subsidiaries, and all other entities in which the Company has a controlling financial interest. Noncontrolling interests represent equity interests in consolidated entities that are not attributable, either directly or indirectly, to Piper Jaffray Companies. Noncontrolling interests include the minority equity holders’ proportionate share of the equity in the Company's alternative asset management funds. All material intercompany balances have been eliminated.

Management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although these estimates and assumptions are based on the best information available, actual results could differ from those estimates.


9

Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Note 2 Accounting Policies and Pronouncements

Summary of Significant Accounting Policies

Refer to the Company's Annual Report on Form 10-K for the year ended December 31, 2016 for a full description of the Company's significant accounting policies. Changes to the Company's significant accounting policies are described below.

Stock-Based Compensation

Financial Accounting Standards Board ("FASB") Accounting Standards Codification Topic 718, "Compensation — Stock Compensation," ("ASC 718") requires all stock-based compensation to be expensed on the consolidated statements of operations based on the grant date fair value of the award. Compensation expense related to stock-based awards that do not require future service are recognized in the year in which the awards were deemed to be earned. Stock-based awards that require future service are amortized over the relevant service period. Forfeitures of awards with service conditions are accounted for when they occur. See Note 16 for additional information on the Company's accounting for stock-based compensation.

Adoption of New Accounting Standards

Stock-Based Compensation

In March 2016, the FASB issued Accounting Standard Update ("ASU") No. 2016-09, "Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting" ("ASU 2016-09"). ASU 2016-09 made targeted amendments to the accounting for share-based payments to employees. It became effective for the Company as of January 1, 2017. There was no impact to the Company’s retained earnings upon adoption of ASU 2016-09.

Under ASU 2016-09, the Company recognizes the income tax effects of stock awards in the income statement when the awards vest or are settled. In the first quarter of 2017, this accounting change resulted in the recording of a $7.0 million tax benefit for stock awards vesting during the period. Prior to the adoption of this ASU, this amount would have been recorded directly to additional paid-in capital. In addition, the Company has elected to account for forfeitures of awards with service conditions as they occur. This will result in dividends originally charged against retained earnings for forfeited, unvested stock-based payment awards to be reclassified to compensation expense in the period in which the forfeiture occurs. Furthermore, tax impacts from the vesting of stock-based compensation are presented as an operating activity on the consolidated statements of cash flows on a prospective basis.

Future Adoption of New Applicable Accounting Standards

Revenue Recognition

In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)," ("ASU 2014-09") which supersedes current revenue recognition guidance, including most industry-specific guidance. ASU 2014-09 requires a company to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods and services, and also requires additional disclosures regarding the nature, amount, timing and uncertainty of revenue that is recognized. The FASB has subsequently issued various ASUs which amend specific areas of guidance in ASU 2014-09. The Company’s implementation efforts include the identification of revenue within the scope of the guidance, and the potential impact on its consolidated results of operations and disclosures. The current broker dealer industry treatment of netting deal expenses with investment banking revenues, the timing of performance fee recognition related to consolidated alternative asset management entities, and fees received for equity research may be impacted by the new guidance. The Company is also evaluating whether certain asset management contract costs can be capitalized on the consolidated statements of financial position. The Company will adopt this guidance effective as of January 1, 2018. The two permitted transition methods under ASU 2014-09 are the full retrospective method, in which case the standard would be applied to each prior reporting period presented, or the modified retrospective method, under which the cumulative effect of applying the standard would be recognized at the date of initial application. The Company is in the process of determining its method of adoption, which depends, in part, upon the completion of further analysis.


10

Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Recognition and Measurement of Financial Assets and Financial Liabilities

In January 2016, the FASB issued ASU No. 2016-01, "Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities" ("ASU 2016-01"). The amendments in ASU 2016-01 address certain aspects of the recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 is effective for annual and interim periods beginning after December 15, 2017. Except for the early application guidance outlined in ASU 2016-01, early adoption is not permitted. The adoption of ASU 2016-01 is not expected to have a material impact on the Company's results of operations or financial position, but may impact the Company's disclosures.

Leases

In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)" ("ASU 2016-02"). ASU 2016-02 requires lessees to recognize a right-of-use asset and lease liability on the consolidated statements of financial position and disclose key information about leasing arrangements. The recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee have not significantly changed from current U.S. GAAP. ASU 2016-02 is effective for annual and interim periods beginning after December 15, 2018. As of December 31, 2016, the Company had approximately 65 operating leases for office space with aggregate minimum lease commitments of $78.4 million. The Company is evaluating other service contracts which may include embedded leases. Upon adoption of ASU 2016-02, the Company does not expect material changes to the recognition of rent expense in its consolidated statements of operations. The impact of the new guidance on Piper Jaffray’s net capital is expected to be minimal.

Financial Instruments Credit Losses

In June 2016, the FASB issued ASU No. 2016-13, "Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" ("ASU 2016-13"). The new guidance requires an entity to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts as opposed to delaying recognition until the loss was probable of occurring. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019. Early adoption is permitted for annual and interim periods beginning after December 15, 2018. The Company does not expect the adoption of ASU 2016-13 to have a material impact on its consolidated financial statements.

Statement of Cash Flows

In August 2016, the FASB issued ASU No. 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments" ("ASU 2016-15"). ASU 2016-15 clarifies how entities should classify certain cash receipts and cash payments on the statement of cash flows. The amendments in ASU 2016-15 are effective for annual and interim periods beginning after December 31, 2017 and should be applied retrospectively. Early adoption is permitted. The Company expects that only a limited number of amendments will impact the presentation of its consolidated statements of cash flows.

In November 2016, the FASB issued ASU No. 2016-18, "Statement of Cash Flows (Topic 230): Restricted Cash" ("ASU 2016-18"). Under ASU 2016-18, restricted cash will be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts shown on the consolidated statements of cash flows. ASU 2016-18 is effective for annual and interim periods beginning after December 15, 2017 and should be applied retrospectively. Early adoption is permitted.

Goodwill Impairment

In January 2017, the FASB issued ASU No. 2017-04, "Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment" ("ASU 2017-04"). ASU 2017-04 eliminates the requirement to calculate the implied fair value of goodwill (i.e., perform a hypothetical purchase price allocation) to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value. ASU 2017-04 is effective for the Company’s annual and any interim goodwill impairment tests in fiscal years beginning after December 15, 2019 and should be applied prospectively. Early adoption is permitted for interim and annual goodwill impairment testing dates after January 1, 2017.


11

Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Note 3 Acquisition of Simmons & Company International

On February 26, 2016, the Company completed the acquisition of Simmons & Company International ("Simmons"), an employee-owned investment bank and broker dealer focused on the energy industry. The economic value of the acquisition was approximately $140.0 million.

The Company acquired net assets with a fair value of $119.3 million. As part of the purchase price, the Company issued 1,149,340 restricted shares valued at $48.2 million as equity consideration on the acquisition date. Employees must fulfill service requirements in exchange for the rights to the shares. Compensation expense will be amortized on a straight-line basis over the requisite service period of one or three years (a weighted average service period of 2.7 years). The fair value of the restricted stock was determined using the market price of the Company's common stock on the date of the acquisition.

The Company also entered into acquisition-related compensation arrangements with certain employees of $20.6 million which consisted of cash ($9.0 million) and restricted stock ($11.6 million) for retention purposes. Compensation expense related to these arrangements will be amortized on a straight-line basis over the requisite service period of three years. Additional cash compensation may be available to certain investment banking employees subject to exceeding an investment banking revenue threshold during the three year post-acquisition period to the extent they are employed by the Company at the time of payment. Amounts estimated to be payable related to this performance award plan will be recorded as compensation expense on the consolidated statements of operations over the requisite performance period of three years. As of March 31, 2017, the Company had accrued $5.6 million related to this performance award plan.

The acquisition was accounted for pursuant to FASB Accounting Standards Codification Topic 805, "Business Combinations." Accordingly, the purchase price was allocated to the acquired assets and liabilities assumed based on their estimated fair values as of the acquisition date. The excess of the purchase price over the net assets acquired was allocated between goodwill and intangible assets within the Capital Markets segment. The Company recorded $60.7 million of goodwill on its consolidated statements of financial condition, of which $59.4 million is expected to be deductible for income tax purposes. In management's opinion, the goodwill represents the reputation and operating expertise of Simmons.

Identifiable intangible assets purchased by the Company consisted of customer relationships and the Simmons trade name with acquisition-date fair values of $17.5 million and $9.1 million, respectively. Transaction costs of $0.5 million were incurred for the three months ended March 31, 2016, and are included in restructuring and integration costs on the consolidated statements of operations.

Simmons’ results of operations have been included in the Company's consolidated financial statements prospectively beginning on the date of acquisition. The acquisition has been fully integrated with the Company's existing operations. Accordingly, post-acquisition revenues and net income are not discernible. The following unaudited pro forma financial data assumes the acquisition had occurred on January 1, 2015, the beginning of the prior annual period in which the acquisition occurred. Pro forma results have been prepared by adjusting the Company's historical results to include Simmons' results of operations adjusted for the following changes: amortization expense was adjusted to account for the acquisition-date fair value of intangible assets; compensation and benefits expenses were adjusted to reflect such expenses based on the Company’s compensation arrangements and the restricted stock issued as equity consideration; and the income tax effect of applying the Company's statutory tax rates to Simmons’ results of operations. The Company's unaudited pro forma information presented does not necessarily reflect the results of operations that would have resulted had the acquisition been completed at the beginning of the applicable period presented, does not contemplate anticipated operational efficiencies of the combined entities, nor does it indicate the results of operations in future periods.
 
 
Three Months Ended
(Dollars in thousands)
 
March 31, 2016
Net revenues
 
$
161,353

Net loss applicable to Piper Jaffray Companies
 
(656
)



12

Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Note 4 Financial Instruments and Other Inventory Positions Owned and Financial Instruments and Other Inventory Positions Sold, but Not Yet Purchased

 
March 31,
 
December 31,
(Dollars in thousands)
2017
 
2016
Financial instruments and other inventory positions owned:
 
 
 
Corporate securities:
 
 
 
Equity securities
$
45,160

 
$
6,363

Convertible securities
53,781

 
103,486

Fixed income securities
36,882

 
21,018

Municipal securities:
 
 
 
Taxable securities
66,284

 
63,090

Tax-exempt securities
380,799

 
559,329

Short-term securities
62,163

 
35,175

Mortgage-backed securities
5,492

 
5,638

U.S. government agency securities
342,669

 
205,685

U.S. government securities
521

 
29,970

Derivative contracts
24,542

 
29,217

Total financial instruments and other inventory positions owned
1,018,293

 
1,058,971

 
 
 
 
Less noncontrolling interests (1)

 
(57,700
)
 
$
1,018,293

 
$
1,001,271

 
 
 
 
Financial instruments and other inventory positions sold, but not yet purchased:
 
 
 
Corporate securities:
 
 
 
Equity securities
$
81,707

 
$
89,453

Fixed income securities
22,508

 
17,324

U.S. government agency securities
21,790

 
6,723

U.S. government securities
273,030

 
180,650

Derivative contracts
5,504

 
5,207

Total financial instruments and other inventory positions sold, but not yet purchased
404,539

 
299,357

 
 
 
 
Less noncontrolling interests (2)

 
(631
)
 
$
404,539

 
$
298,726

(1)
Noncontrolling interests attributable to third party ownership in a consolidated municipal bond fund consist of $1.3 million of taxable municipal securities, $55.2 million of tax-exempt municipal securities, and $1.2 million of derivative contracts as of December 31, 2016
(2)
Noncontrolling interests attributable to third party ownership in a consolidated municipal bond fund consist of U.S. government securities as of December 31, 2016.

At March 31, 2017 and December 31, 2016, financial instruments and other inventory positions owned in the amount of $451.1 million and $594.4 million, respectively, had been pledged as collateral for short-term financings and repurchase agreements.

Financial instruments and other inventory positions sold, but not yet purchased represent obligations of the Company to deliver the specified security at the contracted price, thereby creating a liability to purchase the security in the market at prevailing prices. The Company is obligated to acquire the securities sold short at prevailing market prices, which may exceed the amount reflected on the consolidated statements of financial condition. The Company economically hedges changes in the market value of its financial instruments and other inventory positions owned using inventory positions sold, but not yet purchased, interest rate derivatives, credit default swap index contracts, U.S. treasury bond futures and exchange traded options.


13

Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Derivative Contract Financial Instruments

The Company uses interest rate swaps, interest rate locks, credit default swap index contracts, U.S. treasury bond futures and equity option contracts as a means to manage risk in certain inventory positions. The Company also enters into interest rate swaps to facilitate customer transactions. The following describes the Company’s derivatives by the type of transaction or security the instruments are economically hedging.

Customer matched-book derivatives: The Company enters into interest rate derivative contracts in a principal capacity as a dealer to satisfy the financial needs of its customers. The Company simultaneously enters into an interest rate derivative contract with a third party for the same notional amount to hedge the interest rate and credit risk of the initial client interest rate derivative contract. In certain limited instances, the Company has only hedged interest rate risk with a third party, and retains uncollateralized credit risk as described below. The instruments use interest rates based upon either the London Interbank Offer Rate ("LIBOR") index or the Securities Industry and Financial Markets Association ("SIFMA") index.

Trading securities derivatives: The Company enters into interest rate derivative contracts and uses U.S. treasury bond futures to hedge interest rate and market value risks associated with its fixed income securities. These instruments use interest rates based upon either the Municipal Market Data ("MMD") index, LIBOR or the SIFMA index. The Company also enters into credit default swap index contracts to hedge credit risk associated with its taxable fixed income securities and option contracts to hedge market value risk associated with its convertible securities.

Derivatives are reported on a net basis by counterparty (i.e., the net payable or receivable for derivative assets and liabilities for a given counterparty) when a legal right of offset exists and on a net basis by cross product when applicable provisions are stated in master netting agreements. Cash collateral received or paid is netted on a counterparty basis, provided a legal right of offset exists. The total absolute notional contract amount, representing the absolute value of the sum of gross long and short derivative contracts, provides an indication of the volume of the Company's derivative activity and does not represent gains and losses. The following table presents the gross fair market value and the total absolute notional contract amount of the Company's outstanding derivative instruments, prior to counterparty netting, by asset or liability position:
 
 
March 31, 2017
 
December 31, 2016
(Dollars in thousands)
 
Derivative
 
Derivative
 
Notional
 
Derivative
 
Derivative
 
Notional
Derivative Category
 
Assets (1)
 
Liabilities (2)
 
Amount
 
Assets (1)
 
Liabilities (2)
 
Amount
Interest rate
 
 
 
 
 
 
 
 
 
 
 
 
Customer matched-book
 
$
276,781

 
$
261,052

 
$
3,314,630

 
$
288,955

 
$
272,819

 
$
3,330,207

Trading securities
 
1,633

 
4,011

 
402,650

 
13,952

 
1,707

 
423,550

Credit default swap index
 
 
 
 
 
 
 
 
 
 
 
 
Trading securities
 

 

 

 

 
127

 
7,470

 
 
$
278,414

 
$
265,063

 
$
3,717,280

 
$
302,907

 
$
274,653

 
$
3,761,227

(1)
Derivative assets are included within financial instruments and other inventory positions owned on the consolidated statements of financial condition.
(2)
Derivative liabilities are included within financial instruments and other inventory positions sold, but not yet purchased on the consolidated statements of financial condition.

The Company’s derivative contracts do not qualify for hedge accounting, therefore, unrealized gains and losses are recorded on the consolidated statements of operations. The gains and losses on the related economically hedged inventory positions are not disclosed below as they are not in qualifying hedging relationships. The following table presents the Company’s unrealized gains/(losses) on derivative instruments:
 
 
 
 
Three Months Ended
(Dollars in thousands)
 
 
 
March 31,
Derivative Category               
 
Operations Category
 
2017
 
2016
Interest rate derivative contract
 
Investment banking
 
$
(292
)
 
$
(1,172
)
Interest rate derivative contract
 
Institutional brokerage
 
(14,738
)
 
1,744

Credit default swap index contract
 
Institutional brokerage
 
255

 
389

Futures and equity option derivative contracts
 
Institutional brokerage
 

 
29

 
 
 
 
$
(14,775
)
 
$
990


14

Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Credit risk associated with the Company’s derivatives is the risk that a derivative counterparty will not perform in accordance with the terms of the applicable derivative contract. Credit exposure associated with the Company’s derivatives is driven by uncollateralized market movements in the fair value of the contracts with counterparties and is monitored regularly by the Company’s financial risk committee. The Company considers counterparty credit risk in determining derivative contract fair value. The majority of the Company’s derivative contracts are substantially collateralized by its counterparties, who are major financial institutions. The Company has a limited number of counterparties who are not required to post collateral. Based on market movements, the uncollateralized amounts representing the fair value of the derivative contract can become material, exposing the Company to the credit risk of these counterparties. As of March 31, 2017, the Company had $22.1 million of uncollateralized credit exposure with these counterparties (notional contract amount of $183.1 million), including $15.1 million of uncollateralized credit exposure with one counterparty.

Note 5 Fair Value of Financial Instruments

Based on the nature of the Company’s business and its role as a "dealer" in the securities industry or as a manager of alternative asset management funds, the fair values of its financial instruments are determined internally. The Company’s processes are designed to ensure that the fair values used for financial reporting are based on observable inputs wherever possible. In the event that observable inputs are not available, unobservable inputs are developed based on an evaluation of all relevant empirical market data, including prices evidenced by market transactions, interest rates, credit spreads, volatilities and correlations and other security-specific information. Valuation adjustments related to illiquidity or counterparty credit risk are also considered. In estimating fair value, the Company may utilize information provided by third party pricing vendors to corroborate internally-developed fair value estimates.

The Company employs specific control processes to determine the reasonableness of the fair value of its financial instruments. The Company’s processes are designed to ensure that the internally-estimated fair values are accurately recorded and that the data inputs and the valuation techniques used are appropriate, consistently applied, and that the assumptions are reasonable and consistent with the objective of determining fair value. Individuals outside of the trading departments perform independent pricing verification reviews as of each reporting date. The Company has established parameters which set forth when the fair value of securities are independently verified. The selection parameters are generally based upon the type of security, the level of estimation risk of a security, the materiality of the security to the Company’s financial statements, changes in fair value from period to period, and other specific facts and circumstances of the Company’s securities portfolio. In evaluating the initial internally-estimated fair values made by the Company’s traders, the nature and complexity of securities involved (e.g., term, coupon, collateral, and other key drivers of value), level of market activity for securities, and availability of market data are considered. The independent price verification procedures include, but are not limited to, analysis of trade data (both internal and external where available), corroboration to the valuation of positions with similar characteristics, risks and components, or comparison to an alternative pricing source, such as a discounted cash flow model. The Company’s valuation committee, comprised of members of senior management and risk management, provides oversight and overall responsibility for the internal control processes and procedures related to fair value measurements.

The following is a description of the valuation techniques used to measure fair value.

Cash Equivalents

Cash equivalents include highly liquid investments with original maturities of 90 days or less. Actively traded money market funds are measured at their net asset value and classified as Level I.

Financial Instruments and Other Inventory Positions Owned

The Company records financial instruments and other inventory positions owned and financial instruments and other inventory positions sold, but not yet purchased at fair value on the consolidated statements of financial condition with unrealized gains and losses reflected on the consolidated statements of operations.


15

Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Equity securities – Exchange traded equity securities are valued based on quoted prices from the exchange for identical assets or liabilities as of the period-end date. To the extent these securities are actively traded and valuation adjustments are not applied, they are categorized as Level I. Non-exchange traded equity securities (principally hybrid preferred securities) are measured primarily using broker quotations, prices observed for recently executed market transactions and internally-developed fair value estimates based on observable inputs and are categorized within Level II of the fair value hierarchy.

Convertible securities – Convertible securities are valued based on observable trades, when available. Accordingly, these convertible securities are categorized as Level II.

Corporate fixed income securities – Fixed income securities include corporate bonds which are valued based on recently executed market transactions of comparable size, internally-developed fair value estimates based on observable inputs, or broker quotations. Accordingly, these corporate bonds are categorized as Level II.

Taxable municipal securities – Taxable municipal securities are valued using recently executed observable trades or market price quotations and therefore are generally categorized as Level II. Certain illiquid taxable municipal securities are valued using market data for comparable securities (maturity and sector) and management judgment to infer an appropriate current yield or other model-based valuation techniques deemed appropriate by management based on the specific nature of the individual security and are therefore categorized as Level III.

Tax-exempt municipal securities – Tax-exempt municipal securities are valued using recently executed observable trades or market price quotations and therefore are generally categorized as Level II. Certain illiquid tax-exempt municipal securities are valued using market data for comparable securities (maturity and sector) and management judgment to infer an appropriate current yield or other model-based valuation techniques deemed appropriate by management based on the specific nature of the individual security and are therefore categorized as Level III.

Short-term municipal securities – Short-term municipal securities include auction rate securities, variable rate demand notes, and other short-term municipal securities. Variable rate demand notes and other short-term municipal securities are valued using recently executed observable trades or market price quotations and therefore are generally categorized as Level II. Auction rate securities with limited liquidity are categorized as Level III and are valued using discounted cash flow models with unobservable inputs such as the Company’s expected recovery rate on the securities.

Mortgage-backed securities – Mortgage-backed securities are valued using observable trades, when available. Certain mortgage-backed securities are valued using models where inputs to the model are directly observable in the market, or can be derived principally from or corroborated by observable market data. These mortgage-backed securities are categorized as Level II. Other mortgage-backed securities, which are principally collateralized by residential mortgages, have experienced low volumes of executed transactions resulting in less observable transaction data. Certain mortgage-backed securities collateralized by residential mortgages are valued using cash flow models that utilize unobservable inputs including credit default rates, prepayment rates, loss severity and valuation yields. As judgment is used to determine the range of these inputs, these mortgage-backed securities are categorized as Level III.

U.S. government agency securities – U.S. government agency securities include agency debt bonds and mortgage bonds. Agency debt bonds are valued by using either direct price quotes or price quotes for comparable bond securities and are categorized as Level II. Mortgage bonds include bonds secured by mortgages, mortgage pass-through securities, agency collateralized mortgage-obligation ("CMO") securities and agency interest-only securities. Mortgage pass-through securities, CMO securities and interest-only securities are valued using recently executed observable trades or other observable inputs, such as prepayment speeds and therefore are generally categorized as Level II. Mortgage bonds are valued using observable market inputs, such as market yields ranging from 187-573 basis points ("bps") on spreads over U.S. treasury securities, or models based upon prepayment expectations ranging from 0%-21% conditional prepayment rate ("CPR"). These securities are categorized as Level II.

U.S. government securities – U.S. government securities include highly liquid U.S. treasury securities which are generally valued using quoted market prices and therefore categorized as Level I. The Company does not transact in securities of countries other than the U.S. government.


16

Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Derivatives – Derivative contracts include interest rate swaps, interest rate locks, credit default swap index contracts, U.S. treasury bond futures and equity option contracts. These instruments derive their value from underlying assets, reference rates, indices or a combination of these factors. The Company's equity option derivative contracts are valued based on quoted prices from the exchange for identical assets or liabilities as of the period-end date. To the extent these contracts are actively traded and valuation adjustments are not applied, they are categorized as Level I. The Company’s credit default swap index contracts are valued using market price quotations and are classified as Level II. The majority of the Company’s interest rate derivative contracts, including both interest rate swaps and interest rate locks, are valued using market standard pricing models based on the net present value of estimated future cash flows. The valuation models used do not involve material subjectivity as the methodologies do not entail significant judgment and the pricing inputs are market observable, including contractual terms, yield curves and measures of volatility. These instruments are classified as Level II within the fair value hierarchy. Certain interest rate locks transact in less active markets and were valued using valuation models that included the previously mentioned observable inputs and certain unobservable inputs that required significant judgment, such as the premium over the MMD curve. These instruments are classified as Level III.

Investments

The Company’s investments valued at fair value include equity investments in private companies and partnerships, investments in registered mutual funds, warrants of public and private companies and private company debt. Investments in registered mutual funds are valued based on quoted prices on active markets and classified as Level I. Company-owned warrants, which have a cashless exercise option, are valued based upon the Black-Scholes option-pricing model and certain unobservable inputs. The Company applies a liquidity discount to the value of its warrants in public and private companies. For warrants in private companies, valuation adjustments, based upon management’s judgment, are made to account for differences between the measured security and the stock volatility factors of comparable companies. Company-owned warrants are reported as Level III assets. Investments in private companies are valued based on an assessment of each underlying security, considering rounds of financing, third party transactions and market-based information, including comparable company transactions, trading multiples (e.g., multiples of revenue and earnings before interest, taxes, depreciation and amortization ("EBITDA")) and changes in market outlook, among other factors. These securities are generally categorized as Level III.

Fair Value Option – The fair value option permits the irrevocable fair value option election on an instrument-by-instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument. The fair value option was elected for certain merchant banking and other investments at inception to reflect economic events in earnings on a timely basis. Merchant banking and other equity investments of $13.1 million and $19.7 million, included within investments on the consolidated statements of financial condition, are accounted for at fair value and are classified as Level III assets at March 31, 2017 and December 31, 2016, respectively. The realized and unrealized net gains from fair value changes included in earnings as a result of electing to apply the fair value option to certain financial assets were $0.5 million and $0.3 million for the three months ended March 31, 2017 and 2016, respectively.


17

Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

The following table summarizes quantitative information about the significant unobservable inputs used in the fair value measurement of the Company’s Level III financial instruments as of March 31, 2017:
 
Valuation
 
 
 
 
 
Weighted
 
Technique
 
Unobservable Input
 
Range      
 
Average
Assets:
 
 
 
 
 
 
 
Financial instruments and other inventory positions owned:
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
Tax-exempt securities
Discounted cash flow
 
Expected recovery rate (% of par) (2)
 
5 - 60%
 
19.4%
Short-term securities
Discounted cash flow
 
Expected recovery rate (% of par) (2)
 
66 - 94%
 
91.0%
Mortgage-backed securities:
 
 
 
 
 
 
 
Collateralized by residential mortgages
Discounted cash flow
 
Credit default rates (3)
 
0 - 6%
 
0.9%
 
 
 
Prepayment rates (4)
 
1 - 35%
 
17.4%
 
 
 
Loss severity (3)
 
0 - 100%
 
21.6%
 
 
 
Valuation yields (3)
 
0 - 7%
 
4.8%
Derivative contracts:
 
 
 
 
 
 
 
Interest rate locks
Discounted cash flow
 
Premium over the MMD curve (1)
 
2 - 5 bps
 
3.4 bps
Investments at fair value:
 
 
 
 
 
 
 
Equity securities in private companies
Market approach
 
Revenue multiple (2)
 
2 - 5 times
 
4.1 times
 
 
 
EBITDA multiple (2)
 
10 - 15 times
 
12.2 times
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Financial instruments and other inventory positions sold, but not yet purchased:
 
 
 
 
 
 
 
Derivative contracts:
 
 
 
 
 
 
 
Interest rate locks
Discounted cash flow
 
Premium over the MMD curve (1)
 
1 - 49 bps
 
13.3 bps
Sensitivity of the fair value to changes in unobservable inputs:
(1)
Significant increase/(decrease) in the unobservable input in isolation would result in a significantly lower/(higher) fair value measurement.
(2)
Significant increase/(decrease) in the unobservable input in isolation would result in a significantly higher/(lower) fair value measurement.
(3)
Significant changes in any of these inputs in isolation could result in a significantly different fair value. Generally, a change in the assumption used for credit default rates is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally inverse change in the assumption for valuation yields.
(4)
The potential impact of changes in prepayment rates on fair value is dependent on other security-specific factors, such as the par value and structure. Changes in the prepayment rates may result in directionally similar or directionally inverse changes in fair value depending on whether the security trades at a premium or discount to the par value.

18

Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

The following table summarizes the valuation of the Company’s financial instruments by pricing observability levels defined in FASB Accounting Standards Codification Topic 820, "Fair Value Measurement" ("ASC 820") as of March 31, 2017:
 
 
 
 
 
 
 
Counterparty
 
 
 
 
 
 
 
 
 
and Cash
 
 
 
 
 
 
 
 
 
Collateral
 
 
(Dollars in thousands)
Level I
 
Level II
 
Level III
 
Netting (1)
 
Total
Assets:
 
 
 
 
 
 
 
 
 
Financial instruments and other inventory positions owned:
 
 
 
 
 
 
 
 
 
Corporate securities:
 
 
 
 
 
 
 
 
 
Equity securities
$
524

 
$
44,636

 
$

 
$

 
$
45,160

Convertible securities

 
53,781

 

 

 
53,781

Fixed income securities

 
36,882

 

 

 
36,882

Municipal securities:
 
 
 
 
 
 
 
 
 
Taxable securities

 
66,284

 

 

 
66,284

Tax-exempt securities

 
379,682

 
1,117

 

 
380,799

Short-term securities

 
61,419

 
744

 

 
62,163

Mortgage-backed securities

 

 
5,492

 

 
5,492

U.S. government agency securities

 
342,669

 

 

 
342,669

U.S. government securities
521

 

 

 

 
521

Derivative contracts

 
276,781

 
1,633

 
(253,872
)
 
24,542

Total financial instruments and other inventory positions owned
1,045

 
1,262,134

 
8,986

 
(253,872
)
 
1,018,293

 
 
 
 
 
 
 
 
 
 
Cash equivalents
1,058

 

 

 

 
1,058

 
 
 
 
 
 
 
 
 
 
Investments at fair value
37,087

 

 
110,693

(2)

 
147,780

Total assets
$
39,190

 
$
1,262,134

 
$
119,679

 
$
(253,872
)
 
$
1,167,131

 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Financial instruments and other inventory positions sold, but not yet purchased:
 
 
 
 
 
 
 
 
 
Corporate securities:
 
 
 
 
 
 
 
 
 
Equity securities
$
80,795

 
$
912

 
$

 
$

 
$
81,707

Fixed income securities

 
22,508

 

 

 
22,508

U.S. government agency securities

 
21,790

 

 

 
21,790

U.S. government securities
273,030

 

 

 

 
273,030

Derivative contracts

 
261,157

 
3,906

 
(259,559
)
 
5,504

Total financial instruments and other inventory positions sold, but not yet purchased
$
353,825

 
$
306,367

 
$
3,906

 
$
(259,559
)
 
$
404,539

(1)
Represents cash collateral and the impact of netting on a counterparty basis. The Company had no securities posted as collateral to its counterparties.
(2)
Noncontrolling interests of $40.2 million are attributable to third party ownership in consolidated merchant banking and senior living funds.


19

Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

The following table summarizes the valuation of the Company’s financial instruments by pricing observability levels defined in ASC 820 as of December 31, 2016:
 
 
 
 
 
 
 
Counterparty
 
 
 
 
 
 
 
 
 
and Cash
 
 
 
 
 
 
 
 
 
Collateral
 
 
(Dollars in thousands)
Level I
 
Level II
 
Level III
 
Netting (1)
 
Total
Assets:
 
 
 
 
 
 
 
 
 
Financial instruments and other inventory positions owned:
 
 
 
 
 
 
 
 
 
Corporate securities:
 
 
 
 
 
 
 
 
 
Equity securities
$
82

 
$
6,281

 
$

 
$

 
$
6,363

Convertible securities

 
103,486

 

 

 
103,486

Fixed income securities

 
21,018

 

 

 
21,018

Municipal securities:
 
 
 
 
 
 
 
 
 
Taxable securities

 
60,404

 
2,686

 

 
63,090

Tax-exempt securities

 
558,252

 
1,077

 

 
559,329

Short-term securities

 
34,431

 
744

 

 
35,175

Mortgage-backed securities

 
273

 
5,365

 

 
5,638

U.S. government agency securities

 
205,685

 

 

 
205,685

U.S. government securities
29,970

 

 

 

 
29,970

Derivative contracts

 
288,955

 
13,952

 
(273,690
)
 
29,217

Total financial instruments and other inventory positions owned
30,052

 
1,278,785

 
23,824

 
(273,690
)
 
1,058,971

 
 
 
 
 
 
 
 
 
 
Cash equivalents
768

 

 

 

 
768

 
 
 
 
 
 
 
 
 
 
Investments at fair value
32,783

 

 
123,319

(2)

 
156,102

Total assets
$
63,603

 
$
1,278,785

 
$
147,143

 
$
(273,690
)
 
$
1,215,841

 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Financial instruments and other inventory positions sold, but not yet purchased:
 
 
 
 
 
 
 
 
 
Corporate securities:
 
 
 
 
 
 
 
 
 
Equity securities
$
89,453

 
$

 
$

 
$

 
$
89,453

Fixed income securities

 
17,324

 

 

 
17,324

U.S. government agency securities

 
6,723

 

 

 
6,723

U.S. government securities
180,650

 

 

 

 
180,650

Derivative contracts

 
273,166

 
1,487

 
(269,446
)
 
5,207

Total financial instruments and other inventory positions sold, but not yet purchased
$
270,103

 
$
297,213

 
$
1,487

 
$
(269,446
)
 
$
299,357

(1)
Represents cash collateral and the impact of netting on a counterparty basis. The Company had no securities posted as collateral to its counterparties.
(2)
Noncontrolling interests of $45.1 million are attributable to third party ownership in consolidated merchant banking and senior living funds.

The Company’s Level III assets were $119.7 million and $147.1 million, or 10.3 percent and 12.1 percent of financial instruments measured at fair value at March 31, 2017 and December 31, 2016, respectively. The value of transfers between levels are recognized at the beginning of the reporting period. There were no significant transfers between Level I, Level II or Level III for the three months ended March 31, 2017.
 

20

Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

The following tables summarize the changes in fair value associated with Level III financial instruments held at the beginning or end of the periods presented:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gains/
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(losses) for assets/
 
Balance at
 
 
 
 
 
 
 
 
 
Realized
 
Unrealized
 
Balance at
 
liabilities held at
 
December 31,
 
 
 
 
 
Transfers
 
Transfers
 
gains/
 
gains/
 
March 31,
 
March 31,
(Dollars in thousands)
2016
 
Purchases
 
Sales
 
in
 
out
 
(losses) (1)
 
(losses) (1)
 
2017
 
2017 (1)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial instruments and other inventory positions owned:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable securities
$
2,686

 
$

 
$
(2,703
)
 
$

 
$

 
$
716

 
$
(699
)
 
$

 
$

Tax-exempt securities
1,077

 

 

 

 

 

 
40

 
1,117

 
40

Short-term securities
744

 

 

 

 

 

 

 
744

 

Mortgage-backed securities
5,365

 
996

 
(790
)
 

 

 
314

 
(393
)
 
5,492

 
(71
)
Derivative contracts
13,952

 
240

 
(10,885
)
 

 

 
10,645

 
(12,319
)
 
1,633

 
(347
)
Total financial instruments and other inventory positions owned
23,824

 
1,236

 
(14,378
)
 

 

 
11,675

 
(13,371
)
 
8,986

 
(378
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investments at fair value
123,319

 
6,587

 
(24,469
)
 

 

 
8,656

 
(3,400
)
 
110,693

 
6,493

Total assets
$
147,143

 
$
7,823

 
$
(38,847
)
 
$

 
$

 
$
20,331

 
$
(16,771
)
 
$
119,679

 
$
6,115

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial instruments and other inventory positions sold, but not yet purchased:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative contracts
$
1,487

 
$
(719
)
 
$

 
$

 
$

 
$
719

 
$
2,419

 
$
3,906

 
$
3,061

Total financial instruments and other inventory positions sold, but not yet purchased
$
1,487

 
$
(719
)
 
$

 
$

 
$

 
$
719

 
$
2,419

 
$
3,906

 
$
3,061

(1)
Realized and unrealized gains/(losses) related to financial instruments, with the exception of customer matched-book derivatives, are reported in institutional brokerage on the consolidated statements of operations. Realized and unrealized gains/(losses) related to customer matched-book derivatives are reported in investment banking. Realized and unrealized gains/(losses) related to investments are reported in investment banking revenues or investment income on the consolidated statements of operations.

21

Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gains/
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(losses) for assets/
 
Balance at
 
 
 
 
 
 
 
 
 
Realized
 
Unrealized
 
Balance at
 
liabilities held at
 
December 31,
 
 
 
 
 
Transfers
 
Transfers
 
gains/
 
gains/
 
March 31,
 
March 31,
(Dollars in thousands)
2015
 
Purchases
 
Sales
 
in
 
out
 
(losses) (1)
 
(losses) (1)
 
2016
 
2016 (1)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial instruments and other inventory positions owned:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable securities
$
5,816

 
$

 
$
(611
)
 
$

 
$
(5,216
)
 
$
11

 
$

 
$

 
$

Tax-exempt securities
1,177

 

 

 

 

 

 

 
1,177

 

Short-term securities
720

 

 

 

 

 

 
28

 
748

 
28

Mortgage-backed securities
121,124

 
26,519

 
(27,213
)
 

 

 
1,067

 
(3,606
)
 
117,891

 
(730
)
Derivative contracts

 

 

 

 

 

 
5

 
5

 
5

Total financial instruments and other inventory positions owned
128,837

 
26,519

 
(27,824
)
 

 
(5,216
)
 
1,078

 
(3,573
)
 
119,821

 
(697
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investments at fair value
109,444

 
14,131

 

 

 
(9,088
)
 

 
2,354

 
116,841

 
2,354

Total assets
$
238,281

 
$
40,650

 
$
(27,824
)
 
$

 
$
(14,304
)
 
$
1,078

 
$
(1,219
)
 
$
236,662

 
$
1,657

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial instruments and other inventory positions sold, but not yet purchased:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative contracts
$
7,148

 
$

 
$
(9,882
)
 
$

 
$

 
$
9,882

 
$
(1,740
)
 
$
5,408

 
$
4,534

Total financial instruments and other inventory positions sold, but not yet purchased
$
7,148

 
$

 
$
(9,882
)
 
$

 
$

 
$
9,882

 
$
(1,740
)
 
$
5,408

 
$
4,534

(1)
Realized and unrealized gains/(losses) related to financial instruments, with the exception of customer matched-book derivatives, are reported in institutional brokerage on the consolidated statements of operations. Realized and unrealized gains/(losses) related to customer matched-book derivatives are reported in investment banking. Realized and unrealized gains/(losses) related to investments are reported in investment banking revenues or investment income on the consolidated statements of operations.

The carrying values of the Company’s cash, securities either purchased or sold under agreements to resell, receivables and payables either from or to customers and brokers, dealers and clearing organizations and short-term financings approximate fair value due to their liquid or short-term nature.


22

Piper Jaffray Companies
Notes to the Consolidated Financial Statements
(Unaudited)

Note 6 Variable Interest Entities ("VIEs")

The Company has investments in and/or acts as the managing partner of various partnerships, limited liability companies, and registered mutual funds. These entities were established for the purpose of investing in securities of public or private companies, or municipal debt obligations, or providing financing to senior living facilities, and were initially financed through the capital commitments or seed investments of the members.

VIEs are entities in which equity investors lack the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities. The determination as to whether an entity is a VIE is based on the structure and nature of each entity. The Company also considers other characteristics such as the power through voting rights or similar rights to direct the activities of an entity that most significantly impact the entity’s economic performance and how the entity is financed.

The Company is required to consolidate all VIEs for which it is considered to be the primary beneficiary. The determination as to whether the Company is considered to be the primary beneficiary is based on whether the Company has both the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE.

Consolidated VIEs

The Company’s consolidated VIEs at March 31, 2017 include certain alternative asset management funds in which the Company has an investment and, as the managing partner, is deemed to have both the power to direct the most significant activities of the funds and the right to receive benefits (or the obligation to absorb losses) that could potentially be significant to these funds.

The following table presents information about the carrying value of the assets and liabilities of the VIEs which are consolidated by the Company and included on the consolidated statements of financial condition at March 31, 2017. The assets can only be used to settle the liabilities of the respective VIE, and the creditors of the VIEs do not have recourse to the general credit of the Company. The assets and liabilities are presented prior to consolidation, and thus a portion of these assets and liabilities are eliminated in consolidation.

 
 
Alternative Asset
(Dollars in thousands)
 
Management Funds
Assets:
 
 
Receivables from brokers, dealers and clearing organizations
 
$
59,509

Financial instruments and other inventory positions owned and pledged as collateral
 
194,621

Investments
 
94,082

Other assets
 
6,584

Total assets
 
$
354,796

 
 
 
Liabilities:
 
 
Short-term financing