2010 ANNUAL REPORT Interactive Brokers The Professionals Gateway to the Worlds Markets |
The momentum of our brokerage business is unsurpassed Average equity per account in thousands Commissions & Execution Fees in millions Daily average revenue trades in thousands Customer Equity in billions Brokerage pretax profit margin Customer accounts in thousands |
1 Daily average revenue trades (DARTs) are based on customer orders Billion equity capital Customer accounts Total customer DARTs1 Brokerage pretax profit margin S&P rating for IB LLC Interactive Brokers is the electronic brokerage of choice for successful traders and investors who demand superior technology and access to the worlds markets at exceptionally low cost. |
Interactive Brokers Industry IB Advantage US Stocks per 100 shares US Options per contract $0.27 $0.87 $0.66 $-0.03 $0.30 $0.21 US Execution Price European Stocks per 100 shares Whats driving IBs explosive growth? IB SmartRoutingSM achieves the industrys best execution - Based upon independent measurements by The Transaction Auditing Group, a third party provider of transaction analysis, IBs price executions are significantly better than the industry. IBs market maker designed platform and sophisticated analytical tools earned IB a 4.5 star rating by Barrons magazine in Best for Frequent Traders category3. IBs commissions and margin rates are among the lowest in the industry. IB has received four stars or higher in Barrons annual survey of online brokers for six straight years1. Net Dollar Price Improvement vs. National Best Bid/Offer2 Significantly better than the industry as a whole during the second half 2010. Source: The Transaction Auditing Group, Inc. (TAG), a third-party provider of transaction analysis. Member - NYSE, FINRA, SIPC Supporting documentation for any claims and statistical information will be provided upon request. [1] Low Cost Rated by Barrons 6 Years Straight - Low cost broker 2005 through 2010 according to Barrons online broker review. 2005 - 5 Stars, 2006 - 5 Stars, 2007 - 4.8 Stars, 2008 - 4.5 Stars, 2009 - 4.5 Stars, 2010 - 4.2 stars, according to Barrons How Barrons Ranks 22 Leading Online Brokers - March 15, 2010, ranked Interactive Brokers with a 4.2 star rating for cost. Barrons is a registered trademark of Dow Jones & Company, Inc. Criteria included Trade Experience, Trading Technology, Usability, Range of Offerings, Research Amenities, Portfolio Analysis & Report, Customer Service & Education, and Costs. low cost broker 6 straight years Superior Trading Technology |
Broad global access IBs customers enjoy access to over 90 exchanges and market centers in 19 countries and trade multiple asset classes denominated in 15 different currencies, on one screen, from a single account. IBs automated real-time margin system continuously enforces limits so customers can monitor their margin cushion and their trading risk at any moment of the day. The IB Risk Navigator tool provides sophisticated portfolio risk management that unifies exposure across multitple asses classes around the globe and is free to all customers. IBs Education Center provides information about IB products and services in many different ways, from self-paced interactive tours and live webinars to detailed, step-by-step instructions. Member - NYSE, FINRA, SIPC Supporting documentation for any claims and statistical information will be provided upon request. [1] Low Cost Rated by Barrons 6 Years Straight - Low cost broker 2005 through 2010 according to Barrons online broker review. 2005 - 5 Stars, 2006 - 5 Stars, 2007 - 4.8 Stars, 2008 - 4.5 Stars, 2009 - 4.5 Stars, 2010 - 4.2 stars, according to Barrons How Barrons Ranks 22 Leading Online Brokers - March 15, 2010, ranked Interactive Brokers with a 4.2 star rating for cost. Barrons is a registered trademark of Dow Jones & Company, Inc. Criteria included Trade Experience, Trading Technology, Usability, Range of Offerings, Research Amenities, Portfolio Analysis & Report, Customer Service & Education, and Costs. |
Dear Fellow Shareholders: Trends emerging in 2009 in the markets, the brokerage industry and our company extended and strengthened into 2010. The Federal Reserve continued providing cheap money to pay for our boom-time sins, creating an economic climate favorable enough for many financial companies to replace assets gone sour with new earnings and for consumers and businesses to renew their technology purchases. Markets continued their upward march driven by rising corporate earnings and fears of the coming of a great inflationary cycle. Volatilities came down further with the spectacular exception of the May 6th flash crash, which exposed serious structural deficiencies in our markets. In the course of the year we had several opportunities to meet with regulators and explain our concerns. As of this writing, we believe that several of these concerns, namely, revised circuit breakers, naked access to trading venues, audit trails and, possibly, market maker incentives will be addressed by regulators in the course of this year. The climate in 2010 was not hospitable to our market making business, which continues to deteriorate into the coming year. Low market volatility, a high ratio of implied to actual volatilities, shrinking bid / offer spreads, remarkably accurate foresight by some option traders and fierce competition from high frequency traders are all factors that are ever more difficult for us to overcome. Our poor prospects in the market making business prompted us to reduce the excess capital employed there by paying a dividend of approximately $1 billion in December 2010. Should the inhospitable environment persist through the current year, we are likely to continue on the same course. In stark contrast, our brokerage business is growing by leaps and bounds. It is extremely satisfying to see that the reaction in the marketplace justifies our simple, age-old business model: Identify your target customer and provide them with more value than any of your competitors do, by a large magnitude. By relying on our superior technology, we were able to do this and still achieve a high pretax profit margin of 50% in 2010 for our brokerage segment. The interest rates we charge on margin loans are a simple, illustrative example. The lowest rates we have seen published recently by competitors are at about 4 percent, which would allow us to compete successfully at 3 percent. But instead, we charge from 1.67 percent to as low as 0.67 percent. Why? Because at these rates, many of our customers can achieve satisfactory results, whereas at higher rates they could not. The same logic applies to our low commission rates, our meticulous preoccupation with getting the best execution prices and stock loan rates, and our ever-broadening product base, risk analytics and trade allocation software. We are determined to keep our growth rates at the current levels. This requires an ever-rising investment in expanding the intelligence and versatility of our platform, which we intend to pursue. We hope you agree with our strategy. Thomas Peterffy Chairman, Chief Executive Officer and President |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the year ended December 31, 2010
Commission File Number: 001-33440
INTERACTIVE BROKERS GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization) |
30-0390693 (I.R.S. Employer Identification No.) |
One Pickwick Plaza
Greenwich, Connecticut 06830
(Address of principal executive office)
(203) 618-5800
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of the each exchange on which registered | |
---|---|---|
Common Stock, par value $.01 per share | The NASDAQ Stock Market LLC (NASDAQ Global Select Market) |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the securities act. Yes ý No o.
Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or 15(d) of the act. Yes o No ý.
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 ý No o.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
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 ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ý | Accelerated filer o | Non-accelerated filer o (Do not check if smaller reporting company) |
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý.
The aggregate market value of the voting and non-voting common equity stock held by non-affiliates of the registrant was approximately $700,900,000 computed by reference to the $16.60 closing sale price of the common stock on the NASDAQ Global Select Market, on June 30, 2010, the last business day of the registrant's most recently completed second fiscal quarter.
As of February 28, 2011, there were 42,231,551 shares of the issuer's Class A common stock, par value $0.01 per share, outstanding and 100 shares of the issuer's Class B common stock, par value $0.01 per share, outstanding.
Documents Incorporated by Reference: Portions of Registrant's definitive proxy statement for its 2011 annual meeting of shareholders are incorporated by reference in Part III of this Form 10-K.
ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2010
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Business |
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Risk Factors |
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Unresolved Staff Comments |
32 |
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Properties |
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Legal Proceedings and Regulatory Matters |
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Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
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Selected Financial Data |
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Management's Discussion and Analysis of Financial Condition and Results of Operations |
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Quantitative and Qualitative Disclosures about Market Risk |
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Financial Statements and Supplementary Data |
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Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
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Controls and Procedures |
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Other Information |
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Directors, Executive Officers and Corporate Governance |
120 |
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Executive Compensation |
120 |
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Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
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Transactions with Related Persons, Promoters and Certain Control Persons |
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Principal Accountant Fees and Services |
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Exhibits and Financial Statement Schedules |
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Index to Financial Statements and Financial Statement Schedule |
F-1 |
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i
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
We have included or incorporated by reference in this Annual Report on Form 10-K, and from time to time our management may make statements that may constitute "forward-looking statements" within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical facts, but instead represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside our control. These statements include statements other than historical information or statements of current condition and may relate to our future plans and objectives and results, among other things, and may also include our belief regarding the effect of various legal proceedings, as set forth under "Legal Proceedings" in Part I, Item 3 of this Annual Report on Form 10-K, as well as statements about the objectives and effectiveness of our liquidity policies, statements about trends in or growth opportunities for our businesses, in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of this Annual Report on Form 10-K. By identifying these statements for you in this manner, we are alerting you to the possibility that our actual results may differ, possibly materially, from the anticipated results indicated in these forward-looking statements. Important factors that could cause actual results to differ from those in the forward-looking statements include, among others, those discussed below and under "Risk Factors" in Part I, Item 1A of this Annual Report on Form 10-K and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of this Annual Report on Form 10-K.
Factors that could cause actual results to differ materially from any future results, expressed or implied, in these forward-looking statements include, but are not limited to, the following:
We undertake no obligation to publicly update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this Annual Report on Form 10-K.
1
Overview
Interactive Brokers Group, Inc. ("IBG, Inc." or the "Company") is an automated global electronic market maker and broker specializing in routing orders and executing and processing trades in securities, futures, foreign exchange instruments, bonds and mutual funds on more than 90 electronic exchanges and trading venues around the world. In the U.S., our business is conducted from our headquarters in Greenwich, Connecticut, Chicago, Illinois and Jersey City, New Jersey. Abroad, we conduct business through offices located in Canada, England, Switzerland, Hong Kong, India, Australia and Japan. At December 31, 2010 we had 857 employees worldwide.
IBG, Inc. is a holding company and our primary assets are our ownership of approximately 10.8% of the membership interests of IBG LLC, the current holding company for our businesses. We are the sole managing member of IBG LLC. On May 3, 2007, IBG, Inc. priced its initial public offering (the "IPO") of shares of common stock. In connection with the IPO, IBG, Inc. purchased 10.0% of the membership interests in IBG LLC and began to consolidate IBG LLC's financial results into its financial statements. When we use the terms "we," "us," and "our," we mean IBG LLC and its subsidiaries for periods prior to the IPO, and IBG, Inc. and its subsidiaries (including IBG LLC) for periods from and after the IPO. Unless otherwise indicated, the term "common stock" refers to the Class A common stock of IBG, Inc.
We are a successor to the market making business founded by our Chairman and Chief Executive Officer, Thomas Peterffy, on the floor of the American Stock Exchange in 1977. Since our inception, we have focused on developing proprietary software to automate broker-dealer functions. During that time, we have been a pioneer in developing and applying technology as a financial intermediary to increase liquidity and transparency in the capital markets in which we operate. The advent of electronic exchanges in the last 20 years has provided us with the opportunity to integrate our software with an increasing number of exchanges and trading venues into one automatically functioning, computerized platform that requires minimal human intervention. Three decades of developing our automated market making platform and our automation of many middle and back office functions has allowed us to become one of the lowest cost providers of broker-dealer services and significantly increase the volume of trades we handle.
Our activities are divided into two principal business segments: (1) market making and (2) electronic brokerage:
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products or exchanges where they may not have up-to-date technology, to offer their customers a complete global range of services and products.
Our electronic market making and brokerage businesses are complementary. Both benefit from our combined scale and volume, as well as from our proprietary technology. Our brokerage customers benefit from the technology and market structure expertise developed in our market making business. The expense of developing and maintaining our unique technology, clearing, settlement, banking and regulatory structure required by any specific exchange or market center is shared by both of our businesses. This, in turn, enables us to provide lower transaction costs to our customers than our competitors, whether they use our services as a market maker, broker or both. In addition, we believe we gain a competitive advantage by applying the software features we have developed for a specific product or market to newly-introduced products and markets over others who may have less automated facilities in one or both of our businesses or who operate only in a subset of the exchanges and market centers on which we operate. Our trading system contains unique architectural aspects that, together with our massive trading volume in markets worldwide, may impose a significant barrier to entry for firms wishing to compete in our specific businesses and permit us to compete favorably against our competitors.
Our Internet address is www.interactivebrokers.com and the investor relations section of our web site is located at www.interactivebrokers.com/ir. We make available free of charge, on or through the investor relations section of our web site, this Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, related Interactive Data exhibits, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as well as proxy statements, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission ("SEC"). Also posted on our web site are our Bylaws, our Amended and Restated Certificate of Incorporation, charters for the Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee of our board of directors, our Accounting Matters Complaint Policy, our Whistle Blower Hotline, our Corporate Governance Guidelines and our Code of Business Conduct and Ethics governing our directors, officers and employees. Within the time periods required by SEC and the NASDAQ Stock Market ("NASDAQ"), we will post on our web site any amendment to the Code of Business Conduct and Ethics and any waiver applicable to any executive officer, director or senior financial officer. In addition, our web site includes information concerning purchases and sales of our equity securities by our executive officers and directors, as well as disclosure relating to certain non-GAAP financial measures (as defined in Regulation G) promulgated under the Securities Act of 1933, as amended (the "Securities Act") and the Securities Exchange Act of 1934, as amended (the "Exchange Act") that we may make public orally, telephonically, by webcast, by broadcast or by similar means from time to time.
Our Investor Relations Department can be contacted at Interactive Brokers Group, Inc., Eight Greenwich Office Park, Greenwich, Connecticut 06831, Attn: Investor Relations, telephone: 203-618-4070, e-mail: investor-relations@interactivebrokers.com.
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Segment Operating Results
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Year Ended December 31, | ||||||||||
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2010 | 2009 | 2008 | ||||||||
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(in millions) |
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Market Making |
Net revenues | $ | 379.2 | $ | 626.4 | $ | 1,343.5 | |||||
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Non-interest expenses | 289.7 | 295.6 | 315.9 | ||||||||
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Income before income taxes | $ | 89.5 | $ | 330.8 | $ | 1,027.6 | |||||
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Pre-tax profit margin | 24 | % | 53 | % | 76 | % | |||||
Electronic Brokerage |
Net revenues |
$ |
547.3 |
$ |
474.4 |
$ |
505.8 |
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Non-interest expenses | 272.5 | 243.2 | 281.8 | ||||||||
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Income before income taxes | $ | 274.8 | $ | 231.2 | $ | 224.0 | |||||
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Pre-tax profit margin | 50 | % | 49 | % | 44 | % | |||||
Corporate |
Net revenues |
$ |
(4.4 |
) |
$ |
(0.5 |
) |
$ |
1.1 |
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Non-interest expenses | 19.1 | 17.0 | 2.7 | ||||||||
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Income before income taxes | $ | (23.5 | ) | $ | (17.5 | ) | $ | (1.6 | ) | ||
Total |
Net revenues |
$ |
922.1 |
$ |
1,100.3 |
$ |
1,850.4 |
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Non-interest expenses | 581.3 | 555.8 | 600.4 | ||||||||
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Income before income taxes | $ | 340.8 | $ | 544.5 | $ | 1,250.0 | |||||
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Pre-tax profit margin | 37 | % | 49 | % | 68 | % |
Financial information concerning our business segments for each of 2010, 2009, and 2008 is set forth in "Management's Discussion and Analysis of Financial Condition and Results of Operations," and the consolidated financial statements and the notes thereto, which are in Part II, Items 7 and 8 of this Annual Report on Form 10-K.
Market MakingTimber Hill
Market making represented 41% of 2010 net revenues. We conduct our market making business through our Timber Hill ("TH") subsidiaries. As one of the largest market makers on many of the world's leading electronic exchanges, we provide liquidity by offering competitively tight bid/offer spreads over a broad base of over 620,000 tradable, exchange-listed products, including equity derivative products, equity index derivative products, equity securities and futures. As principal, we commit our own capital and derive revenues or incur losses from the difference between the price paid when securities are bought and the price received when those securities are sold. Historically, our profits have been principally a function of transaction volume and price volatility of electronic exchange-traded products rather than the direction of price movements. Other factors, including the ratio of actual to implied volatility and shifts in foreign currency exchange rates, can also have a meaningful impact on our results, as described further in "Business Environment" in Part II, Item 7 of this Annual Report on Form 10-K.
Our strategy is to calculate quotes at which supply and demand for a particular security are likely to be in balance a few seconds ahead of the market and execute small trades at tiny but favorable differentials. Because we provide continuous bid and offer quotations and we are continuously both buying and selling quoted securities, we may have either a long or a short position in a particular product at a given point in time. As a matter of practice, we will generally not take portfolio positions in either the broad market or the financial instruments of specific issuers in anticipation that prices will either rise or fall. Our entire portfolio is evaluated each second and continuously rebalanced
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throughout the trading day, thus minimizing the risk of our portfolio at all times. This real-time rebalancing of our portfolio, together with our real-time proprietary risk management system, enables us to curtail risk and to be profitable in both up-market and down-market scenarios. Our quotes are based on our proprietary model rather than customer order flow, and we believe that this approach provides us with a competitive advantage.
We are a market leader in exchange-traded equity options and equity-index options and futures. Together with our electronic brokerage customers, in 2010 we accounted for approximately 10.1% of exchange-listed equity options traded worldwide and approximately 10.2% of exchange-listed equity options volume traded on those markets in which we actively trade, according to data received from exchanges worldwide. Our ability to make markets in such a large number of exchanges and market centers simultaneously around the world is one of our core strengths and has contributed to the large volumes in our market making business. We engage in market making operations in North and South America, Europe and in the Asia/Pacific regions as described below.
North and South American Market Making Activities. Our U.S. market making activities are conducted through Timber Hill LLC ("TH LLC"), a SEC-registered securities broker-dealer that conducts market making in equity derivative products, equity index derivative products and equity securities. Since its inception in 1982, TH LLC has grown to become one of the largest of the listed options market makers in the United States. As of December 31, 2010, TH LLC held specialist, primary market maker or lead market maker designations in options on approximately 1,300 underlying securities listed in the United States. TH LLC is a member of the, Boston Options Exchange, BATS exchange, Chicago Board Options Exchange, Chicago Mercantile Exchange, Chicago Board of Trade, International Securities Exchange, NYSE AMEX Options Exchange, NYSE Arca, OneChicago and NASDAQ OMX PHLX. TH LLC also conducts market making activities in Mexico at the MEXDER and the Mexican Stock Exchange and in Brazil at the São Paulo Stock Exchange and the Brazilian Mercantile and Futures Exchange. We conduct market making activities in Canada through our Canadian subsidiary, Timber Hill Canada Company ("THC") at the Toronto Stock Exchange and Montreal Exchange. In addition, we participate in stock trading at the notable Electronic Communications Networks ("ECNs") in both the U.S. and Canada.
European, Asian, and Australian Market Making Activities. Our European, Asian, and Australian market making subsidiaries, primarily Timber Hill Europe AG ("THE"), conduct operations in 23 countries, comprising the major securities markets in these regions.
We began our market making operations in Europe in 1990. In Germany and Switzerland, we have been among the largest equity options market makers in terms of volume on Eurex, one of the world's largest futures and options exchanges, which is jointly operated by Deutsche Börse AG and SIX Swiss Exchange. We have also been active in trading German stocks and warrants as a member of XETRA, the German electronic stock trading system, and the Frankfurt and Stuttgart stock exchanges; and in Swiss stocks and warrants as a member of the SIX Swiss Exchange. Our other European operations are conducted on the London Stock Exchange; the Irish Stock Exchange; the Copenhagen Stock Exchange; the Helsinki Stock Exchange; the Euronext exchanges in Amsterdam, Paris, Brussels, Lisbon and London; NASDAQ OMX Nordic in Sweden, Finland and Denmark; the Swedish Stock Exchange; the MEFF and Bolsa de Valencia in Spain; the IDEM and Borsa Valori de Milano in Milan; and the ÖTOB in Vienna.
Since 1995, we have conducted market making operations in Hong Kong. Our Hong Kong subsidiary, Timber Hill Securities Hong Kong Ltd ("THSHK"), is a member of the cash and derivatives markets of the Hong Kong Exchanges. Since 1997, we have conducted operations in Australia. Our Australian subsidiary, Timber Hill Australia Pty Ltd ("THA"), is a member of the Australian Stock Exchange, and routes orders for its trading on the Sydney Futures Exchange through its affiliate, Interactive Brokers LLC. We commenced trading in Japan during 2002, Korea and Singapore during
5
2004 and Taiwan in 2007. In 2008, we began our market making operation in India through our subsidiary, Interactive Brokers (India) Private Limited ("IBI"), which is a member of the National Stock Exchange of India and the Bombay Stock Exchange.
Most of the above trading activities take place on exchanges and all securities and commodities that we trade are cleared by exchange owned or authorized clearing houses.
Electronic BrokerageInteractive Brokers
Electronic brokerage represented 59% of 2010 net revenues. We conduct our electronic brokerage business through our Interactive Brokers ("IB") subsidiaries. As an electronic broker, we execute, clear and settle trades globally for both institutional and individual customers. Capitalizing on the technology originally developed for our market making business, IB's systems provide our customers with the capability to monitor multiple markets around the world simultaneously and to execute trades electronically in these markets at a low cost in multiple products and currencies from a single trading account.
Since launching this business in 1993, we have grown to approximately 158,000 institutional and individual brokerage customers. We provide our customers with what we believe to be one of the most effective and efficient electronic brokerage platforms in the industry. The following are key highlights of our electronic brokerage business:
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and trade efficiently. Our system is configured to remember the user's preferences and is specifically designed for multi-screen systems. When away from their main workstations, customers are able to access their accounts through our IB WebTraderSM or MobileTrader interfaces.
IB provides its customers with high-speed trade execution at low commission rates, in large part because it utilizes the backbone technology developed for Timber Hill's market making operations. As a result of our advanced electronic brokerage platform, IB attracts sophisticated and active investors. No single customer represents more than 2% of our commissions and execution fees.
Technology
Our proprietary technology is the key to our success. We built our business on the belief that a fully computerized market making system that could integrate pricing and risk exposure information quickly and continuously would enable us to make markets profitably in many different financial instruments simultaneously. We believe that integrating our system with electronic exchanges and market centers results in transparency, liquidity and efficiencies of scale. Together with the IB SmartRoutingSM system and our low commissions, this reduces overall transaction costs to our customers and, in turn, increases our transaction volume and profits. Over the past 33 years, we have developed an integrated trading system and communications network and have positioned our company as an efficient conduit for the global flow of risk capital across asset and product classes on electronic exchanges around the world, permitting us to have one of the lowest cost structures in the industry. We believe that developing, maintaining and continuing to enhance our proprietary technology provides us and our customers with the competitive advantage of being able to adapt quickly to the changing environment of our industry and to take advantage of opportunities presented by new exchanges, products or regulatory changes before our competitors.
The quotes that we provide as market makers are driven by proprietary mathematical models that assimilate market data and re-evaluate our outstanding quotes each second. Because our technology infrastructure enables us to process large volumes of pricing and risk exposure information rapidly, we are able to make markets profitably in securities with relatively low spreads between bid and offer
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prices. As market makers, we must ensure that our interfaces connect effectively and efficiently with each exchange and market center where we make markets and that they are in complete conformity with all the applicable rules of each local venue. Utilizing up-to-date computer and telecommunications systems, we transmit continually updated pricing information directly to exchange computer devices and receive trade and quote information for immediate processing by our systems. As a result, we are able to maintain more effective control over our exposure to price and volatility movements on a real-time basis than many of our competitors. This is important, not only because our system must process, clear and settle several hundred thousand market maker trades per day with a minimal number of errors, but also because the system monitors and manages the risk on the entire portfolio, which generally consists of more than ten million open contracts distributed among more than 100,000 different products. Using our system, which we believe affords an optimal interplay of decentralized trading activity and centralized risk management, we quote markets in over 620,000 securities and futures products traded around the world.
In our electronic brokerage business, our proprietary technology infrastructure enables us to provide our customers with the ability to effect trades at among the lowest execution and commission costs in the industry. Additionally, our customers benefit from real-time systems optimization for our market making business. Customer trades are both automatically captured and reported in real time in our system. Our customers trade on more than 90 exchanges and market centers in 19 countries around the world. All of these exchanges are partially or fully electronic, meaning that a customer can buy or sell a product traded on that exchange via an electronic link from his or her computer terminal through our system to the exchange. We offer our products and services through a global communications network that is designed to provide secure, reliable and timely access to the most current market information. We provide our customers with a variety of means to connect to our brokerage systems, including dedicated point-to-point data lines, virtual private networks and the Internet.
Specifically, our customers receive worldwide electronic access connectivity through our Trader Workstation (our real-time Java-based trading platform), our proprietary Application Program Interface ("API"), and/or industry standard Financial Information Exchange ("FIX") connectivity. Customers who want a professional quality trading application with a sophisticated user interface utilize our Trader Workstation. Customers interested in developing program trading applications in MS-Excel, Java, Visual Basic or C++ utilize our API. Large institutions with FIX infrastructure prefer to use our FIX solution for seamless integration of their existing order gathering and reporting applications.
While many brokerages, including online brokerages, rely on manual procedures to execute many day-to-day functions, IB employs proprietary technology to automate, or otherwise facilitate, many of the following functions:
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Research and Development
One of our core strengths is our expertise in the rapid development and deployment of automated technology for the financial markets. Our core software technology is developed internally, and we do not generally rely on outside vendors for software development or maintenance. To achieve optimal performance from our systems, we are continuously rewriting and upgrading our software. Use of the best available technology not only improves our performance but also helps us attract and retain talented developers. Our software development costs are low because the employees who oversee the development of the software are the same employees who design the application and evaluate its performance. This also enables us to add features and further refine our software rapidly.
Our internally-developed, fully integrated trading and risk management systems are unique and transact across all product classes on more than 90 markets and 18 currencies around the world. These systems have the flexibility to assimilate new exchanges and new product classes without compromising transaction speed or fault tolerance. Fault tolerance, or the ability to maintain system performance despite exchange malfunctions or hardware failures, is crucial to successful market making and ensuring best executions for brokerage customers. Our systems are designed to detect exchange malfunctions and quickly take corrective actions by re-routing pending orders.
Our company is technology-focused, and our management team is hands-on and technology-savvy. Most members of the management team write detailed program specifications for new applications. The development queue is prioritized and highly disciplined. Progress on programming initiatives is generally tracked on a weekly basis by a steering committee consisting of senior executives. This enables us to prioritize key initiatives and achieve rapid results. All new business starts as a software development project. We generally do not engage in any business that we cannot automate and incorporate into our platform prior to entering into the business.
The rapid software development and deployment cycle is achieved by our ability to leverage a highly integrated, object oriented development environment. The software code is modular, with each object providing a specific function and being reusable in multiple applications. New software releases are tracked and tested with proprietary automated testing tools. We are not hindered by disparate and often limiting legacy systems assembled through acquisitions. Virtually all of our software has been developed and maintained with a unified purpose.
For over 30 years, we have built and continuously refined our automated and integrated, real-time systems for world-wide trading, risk management, clearing and cash management, among others. We have also assembled a proprietary connectivity network between us and exchanges around the world. Efficiency and speed in performing prescribed functions are always crucial requirements for our systems. As a result, our trading systems are able to assimilate market data, recalculate and distribute streaming quotes for tradable products in all product classes each second.
Risk Management Activities
The core of our risk management philosophy is the utilization of our fully integrated computer systems to perform critical, risk-management activities on a real-time basis. In our market making business, our real-time integrated risk management system seeks to ensure that overall IBG positions are continuously hedged at all times, curtailing risk. In our electronic brokerage business, integrated risk management seeks to ensure that each customer's positions are continuously credit checked and brought into compliance if equity falls short of margin requirements, curtailing bad debt losses.
We actively manage our global currency exposure on a continuous basis by maintaining our equity in a basket of major currencies we call GLOBALs. We define the GLOBAL as consisting of fractions of a U.S. dollar, Euro, Japanese yen, British pound, Canadian dollar and Australian dollar. The currencies comprising the GLOBAL and their relative proportions can change over time.
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Market Making
We employ certain hedging and risk management techniques to protect us from a severe market dislocation. Our risk management policies are developed and implemented by our Chairman and our steering committee, which is comprised of senior executives of our various companies. Our strategy is to calculate quotes a few seconds ahead of the market and execute small trades at a tiny but favorable differential as a result. This is made possible by our proprietary pricing model, which evaluates and monitors the risks inherent in our portfolio, assimilates market data and reevaluates the outstanding quotes in our portfolio each second. Our model automatically rebalances our positions throughout each trading day to manage risk exposures both on our options and futures positions and the underlying securities, and will price the increased risk that a position would add to the overall portfolio into the bid and offer prices we post. Under risk management policies implemented and monitored primarily through our computer systems, reports to management, including risk profiles, profit and loss analysis and trading performance, are prepared on a real-time basis as well as daily and periodical bases. Although our market making is completely automated, the trading process and our risk are monitored by a team of individuals who, in real time, observe various risk parameters of our consolidated positions. Our assets and liabilities are marked-to-market daily for financial reporting purposes and re-valued continuously throughout the trading day for risk management and asset/liability management purposes.
Since 1990 we have continually expanded our market presence and the number of financial instruments in which we make markets. This diversification acts as a passive form of portfolio risk management.
We trade primarily the options on stocks (and individual stocks) where the underlying equity market capitalization is greater than $1 billion. Throughout the trading day we produce online, real-time profit and loss, risk evaluation, activity and other management reports. Our software assembles from external sources a balance sheet and income statements for our accounting department to reconcile the trading system results.
The adaptability of our portfolio risk management system and trading methods have allowed us to expand (1) the number of financial instruments traded and (2) across markets.
Electronic Brokerage
IB calculates margin requirements for each of its customers on a real-time basis across all product classes (stocks, options, futures, forex, bonds and mutual funds) and across all currencies. Recognizing that IB's customers are experienced investors, we expect our customers to manage their positions proactively and we provide tools to facilitate our customers' position management. However, if a customer's equity falls below what is required to support that customer's margin, IB will automatically liquidate positions on a real-time basis to bring the customer's account into margin compliance. This is done to protect IB, as well as the customer, from excessive losses and further contributes to our low-cost structure. The entire credit management process is completely automated, and IB does not employ a margin department.
As a safeguard, all liquidations are displayed on custom built liquidation monitoring screens that are part of the toolset our technical staff uses to monitor performance of our systems at all times the markets around the world are open. In the event our systems absorb erroneous market data from exchanges, which prompts liquidations, risk specialists on our technical staff have the capability to halt liquidations that meet specific criteria. The liquidation halt function is highly restricted.
IB's customer interface includes color coding on the account screen and pop-up warning messages to notify customers that they are approaching their margin limits. This feature allows customers to take action, such as entering margin reducing trades, to avoid having IB liquidate their positions. These
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tools and real-time margining allow IB's customers to understand their trading risk at any moment of the day and help IB maintain low commissions, by not having to price in the cost of credit losses.
Operational Controls
We have automated the full cycle of controls surrounding the market making and brokerage business. Key automated controls include the following:
Transaction Processing
Our transaction processing is automated over the full life cycle of a trade. Our market making software generates and disseminates to exchanges and market centers continuous bid and offer quotes on over 620,000 tradable, exchange listed products. Our fully automated smart router system searches for the best possible combination of prices available at the time a customer order is placed and immediately seeks to execute that order electronically or send it where the order has the highest possibility of execution at the best price.
At the moment a trade is executed, our systems capture and deliver this information back to the source, either the market making system or via the brokerage system to the customer, in most cases within a fraction of a second. Simultaneously, the trade record is written into our clearing system, where it flows through a chain of control accounts that allow us to reconcile trades, positions and money until the final settlement occurs. Our integrated software tracks other important activities, such as dividends, corporate actions, options exercises, securities lending, margining, risk management and funds receipt and disbursement.
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IB SmartRoutingSM
IB SmartRoutingSM searches for the best destination price in view of the displayed prices, sizes and accumulated statistical information about the behavior of market centers at the time an order is placed, and IB SmartRoutingSM immediately seeks to execute that order electronically. Unlike other smart routers, IB SmartRoutingSM never relinquishes control of the order, and constantly searches for the best price. It continuously evaluates fast-changing market conditions and dynamically re-routes all or parts of the order seeking to achieve optimal execution. IB SmartRoutingSM represents each leg of a spread order independently and enters each leg at the best possible venue. IB SmartRouting AutorecoverySM re-routes a customer's U.S. options order in the case of an exchange malfunction, with IB undertaking the risk of double executions. In addition, IB SmartRoutingSM checks each new order to see if it could be executed against any of its pending orders. As the system gains more users, this feature becomes more important for customers in a world of multiple exchanges and trading venues and penny priced orders because it increases the possibility of best executions for our customers ahead of customers of other brokers. As a result of this feature, our customers have a greater chance of executing limit orders and can do so sooner than those who use other routers.
Clearing and Margining
Our activities in the United States are almost entirely self-cleared. We are a full clearing member of The Options Clearing Corporation ("OCC"), the Chicago Mercantile Exchange Clearing House ("CMECH"), The Depository Trust and Clearing Corporation and ICE Clear U.S.
Due to our large positions in broad based index products, we benefit from the cross-margin system maintained by these clearing houses. For example, if we hold a position in an OCC-cleared product and have an offsetting position in a CMECH cleared product, the cross-margin computation takes both positions into account, thereby reducing the overall margin requirement. The reduced margin benefit proves especially useful during times of market stress, such as on days with large price movements when intra-day margin calls may be reduced or eliminated by the cross-margin calculation.
In addition, we are self-cleared in Canada, Great Britain, Switzerland, France, Ireland, Germany, Belgium, Austria, the Netherlands, Norway, Sweden, Denmark, Finland, Hong Kong and India; and we began self-clearing in Japan in March 2010.
Customers
We established our electronic brokerage subsidiary, IB, in 1993 to enhance the use of our global network of trading interfaces, exchange and clearinghouse memberships and regulatory registrations assembled over the prior 16 years to serve our market making business. We realized that electronic access to market centers worldwide through our network could easily be utilized by the very same floor traders and trading desk professionals who, in the coming years, would be displaced by the conversion of exchanges from open outcry to electronic systems.
We currently service approximately 158,000 cleared customer accounts. Our customers reside in approximately 137 countries around the world.
The target IB customer is one that requires the latest in trading technology, derivatives expertise, and worldwide access and expects low overall transaction costs. IB's customers are mainly comprised of "self-service" individuals, former floor traders, trading desk professionals, electronic retail brokers, financial advisors who are comfortable with technology, banks that require global access and hedge funds.
Our customers fall into three groups based on services provided: cleared customers, trade execution customers and wholesale customers. With the advent of portfolio margining, we have been able to persuade more of our trade execution hedge fund customers to utilize our cleared business
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solution, which benefits the hedge funds in terms of cost savings. Many prime brokers once offered increased leverage over Regulation T credit limitations and NYSE margin requirements through offshore entities and joint back office arrangements. Following the market turmoil of late 2008 and the resulting tightening of credit, we observed competition in this area diminish. Through portfolio margining, IB is able to offer similar leverage with lower margin requirements that reflect the reduced risk of a hedged portfolio.
Our non-cleared customers include large online brokers and increasing numbers of the proprietary and customer trading units of U.S., Canadian and European commercial banks. These customers are attracted by the IB SmartRoutingSM technology as well as our direct access to stock, options, futures, forex and bond markets worldwide.
Our customers receive worldwide electronic access connectivity in one of three ways: the Trader Workstation (our real-time Java-based trading platform), our proprietary API, and/or industry standard FIX connectivity.
Employees and Culture
We take pride in our technology-focused company culture and embrace it as one of our fundamental strengths. We remain committed to improving our technology, and we try to minimize corporate hierarchy to facilitate efficient communication among employees. We have assembled what we believe is a highly talented group of employees. As we grow, we expect to continue to provide significant rewards for our employees who provide significant value to us and the world's financial markets.
As of December 31, 2010, we had 857 employees, all of whom were employed on a full-time basis. None of our employees are covered by collective bargaining agreements. We believe that our relations with our employees are good.
Competition
Market making
Historically, competition has come from registered market making firms which range from sole proprietors with very limited resources to large, integrated broker-dealers. Today, Timber Hill's major competitors continue to be large broker-dealers, such as Goldman Sachs, Morgan Stanley, UBS, Citigroup, and Bank of America Merrill Lynch, and niche players such as Citadel, Susquehanna, Wolverine Trading, Group One Trading, Peak6 and Getco. The financial market turmoil and large losses experienced by some of these firms during the past few years have diminished their effectiveness
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as strong competitors. Some of our competitors in market making are larger than we are and have more captive order flow, although this is less true with respect to our narrow focus on options, futures and ETFs listed on electronic exchanges.
The competitive environment for market makers has evolved considerably in the past two years, most notably with the rise in high frequency trading firms (HFTs). HFTs transact significant trading volume on electronic exchanges by using complex algorithms and high speed execution software that analyzes market conditions. Before 2010, many HFTs that were not registered market makers were able to act similarly to market makers on exchanges that maintain a traditional fee model, and use their customer status to gain advantages over registered market makers. In particular, they did not pay exchange fees and their orders were given priority over registered market makers who were bidding and offering at the same prices. In early 2010, several exchanges implemented rules to remove these advantages and charge HFTs exchanges fees, thus helping to level the playing field for market participants. However, HFTs that are not registered market makers operate with fewer regulatory restrictions and are able to move more quickly and trade more cheaply. This is currently an area of focus amongst regulators who are examining the practices of HFTs and their impact on market structure.
In order to compete successfully, we believe that we must have more sophisticated, versatile and robust software than our competitors. This is our primary focus, as contrasted with many of our competitors. With respect to these competitors, Timber Hill maintains the advantage of having had much longer experience with the development and usage of its proprietary electronic brokerage and market making systems. Market conditions that are difficult for other market participants often present Timber Hill with the opportunities inherent in diminished competition. Our advantage is our expertise and decades of single-minded focus on developing our technology. This enables us to have a unique platform specializing strictly in electronic market making and brokerage.
Electronic brokerage
The market for electronic brokerage services is rapidly evolving and highly competitive. IB believes that it neither fits within the definition of a traditional broker nor a prime broker. IB's primary competitors include offerings targeted to professional traders by large retail online brokers (such as TD Ameritrade's thinkorswim, E*TRADE's Power E*TRADE Pro business and The Charles Schwab Corporation's StreetSmart Pro business) and the prime brokerage and electronic brokerage arms of major investment banks and brokers (such as Goldman Sachs' REDIPlus business and Morgan Stanley's Passport business). We also encounter competition to a lesser extent from full commission brokerage firms including Bank of America Merrill Lynch and Morgan Stanley Smith Barney, as well as other financial institutions, most of which provide online brokerage services. The electronic brokerage businesses of many of our competitors are relatively insignificant in the totality of their firms' business. IB provides access to a global range of products from a single IB Universal AccountSM and professional level executions and pricing, which positions it in competition with niche direct-access providers and prime brokers. In 2010, IB was awarded a 4.2 star rating by Barron's for its low cost. IB has received 4 or more stars in this category for six straight years. In addition to offering low commissions and financing rates, IB provides sophisticated order types and analytical tools that give a competitive edge to its customers.
Regulation
Our securities and derivatives businesses are extensively regulated by U.S. federal and state regulators, foreign regulatory agencies, and numerous exchanges and self-regulatory organizations of which our subsidiaries are members. In the current era of heightened regulation of financial institutions, we expect to incur increasing compliance costs, along with the industry as a whole.
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Overview
As registered U.S. broker-dealers, Interactive Brokers LLC ("IB LLC") and TH LLC are subject to the rules and regulations of the Exchange Act, and as members of various exchanges, we are also subject to such exchanges' rules and requirements. Additionally, as registered futures commission merchants, IB LLC and TH LLC are subject to the Commodity Exchange Act and rules promulgated by the Commodity Futures Trading Commission ("CFTC") and the various commodity exchanges of which they are members. Finally, we are subject to the requirements of various self-regulatory organizations such as the Financial Industry Regulatory Authority ("FINRA") and the National Futures Association ("NFA"). Our foreign affiliates are similarly regulated under the laws and institutional framework of the countries in which they operate.
U.S. broker-dealers and futures commission merchants are subject to laws, rules and regulations that cover all aspects of the securities and derivatives business, including:
In addition, the businesses that we may conduct are limited by our agreements with and our oversight by FINRA. Participation in new business lines, including trading of new products or participation on new exchanges or in new countries often requires governmental and/or exchange approvals, which may take significant time and resources. As a result, we may be prevented from entering new businesses that may be profitable in a timely manner, or at all.
As certain of our subsidiaries are members of FINRA, we are subject to certain regulations regarding changes in control of our ownership. FINRA Rule 1017 generally provides that FINRA approval must be obtained in connection with any transaction resulting in a change in control of a member firm. The FINRA defines control as ownership of 25% or more of the firm's equity by a single entity or person and would include a change in control of a parent company. As a result of these regulations, our future efforts to sell shares or raise additional capital may be delayed or prohibited by FINRA.
Net Capital Rule
The SEC, FINRA, CFTC and various other regulatory agencies within the United States have stringent rules and regulations with respect to the maintenance of specific levels of net capital by regulated entities. Generally, a broker-dealer's capital is net worth plus qualified subordinated debt less deductions for certain types of assets. The Net Capital Rule requires that at least a minimum part of a broker-dealer's assets be maintained in a relatively liquid form.
If these net capital rules are changed or expanded, or if there is an unusually large charge against our net capital, our operations that require the intensive use of capital would be limited. A large operating loss or charge against our net capital could adversely affect our ability to expand or even maintain these current levels of business, which could have a material adverse effect on our business and financial condition.
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The SEC and FINRA impose rules that require notification when net capital falls below certain predefined criteria. These rules also dictate the ratio of debt-to-equity in the regulatory capital composition of a broker-dealer, and constrain the ability of a broker-dealer to expand its business under certain circumstances. If a firm fails to maintain the required net capital, it may be subject to suspension or revocation of registration by the applicable regulatory agency, and suspension or expulsion by these regulators could ultimately lead to the firm's liquidation. Additionally, the Net Capital Rule and certain FINRA rules impose requirements that may have the effect of prohibiting a broker-dealer from distributing or withdrawing capital and requiring prior notice to and approval from the SEC and FINRA for certain capital withdrawals.
At December 31, 2010, aggregate excess regulatory capital for all of the operating companies was $2.75 billion.
TH LLC, IB LLC and THSC are subject to the Uniform Net Capital Rule (Rule 15c3-1) under the Exchange Act and the CFTC's minimum financial requirements (Regulation 1.17). At December 31, 2010, TH LLC had net capital of $1.0 billion which was $986.2 million in excess of required net capital of $37.8 million, IB LLC had net capital of $1.2 billion, which was $993.2 million in excess of required net capital of $161.8 million, and THSC had net capital of $1.7 million, which was $0.7 million in excess of required net capital of $1.0 million.
THE is subject to the Swiss National Bank eligible equity requirement. At December 31, 2010, THE had eligible equity of $602.1 million which was $411.7 million in excess of the minimum requirement of $190.4 million.
THSHK is subject to the Hong Kong Securities Futures Commission liquid capital requirement, THA is subject to the Australian Stock Exchange liquid capital requirement, THC and Interactive Brokers Canada Inc. ("IBC") are subject to the Investment Industry Regulatory Organization of Canada risk adjusted capital requirement, Interactive Brokers (U.K.) Limited ("IBUK") is subject to the U.K. Financial Services Authority financial resources requirement, IBI is subject to the National Stock Exchange of India net capital requirements and Interactive Brokers Securities Japan, Inc. ("IBSJ") is subject to the Japanese Financial Supervisory Agency capital requirements.
At December 31, 2010, all of the operating companies were in compliance with their respective regulatory capital requirements.
For additional information regarding our net capital requirements see note 17 to the consolidated financial statements in Part II , Item 8 of the Annual Report on Form 10-K.
Supervision and Compliance
Our Compliance Department supports and seeks to ensure proper operations of our market making and electronic brokerage businesses. The philosophy of the Compliance Department, and our company as a whole, is to build automated systems to try to eliminate manual steps and errors in the compliance process and then to augment these systems with human staff who apply their judgment where needed. We have built automated systems to handle wide-ranging compliance issues such as trade and audit trail reporting, financial operations reporting, enforcement of short sale rules, enforcement of margin rules and pattern day trading restrictions, review of employee correspondence, archival of required records, execution quality and order routing reports, approval and documentation of new customer accounts, and anti-money laundering and anti-fraud surveillance. In light of our automated operations and our automated compliance systems, we have a smaller and more efficient Compliance Department than many traditional securities firms. Nonetheless, we have increased the staffing in our Compliance Department over the past several years to meet the increased regulatory burdens faced by all industry participants.
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IB LLC and TH LLC each has a Chief Compliance Officer who reports to its General Counsel and its internal audit and compliance committee. These Chief Compliance Officers, plus certain other senior staff members, are FINRA-registered principals with supervisory responsibility over the various aspects of our businesses. Staff members in the Compliance Department or in other departments of the firm are also registered with FINRA, NFA or other regulatory organizations.
Patriot Act and Increased Anti-Money Laundering ("AML") and "Know Your Customer" Obligations
Registered broker-dealers traditionally have been subject to a variety of rules that require that they "know their customers" and monitor their customers' transactions for suspicious financial activities. With the passage of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "Patriot Act"), broker-dealers are now subject to even more stringent requirements. Likewise, the SEC, CFTC, foreign regulators, and the various exchanges and SROs, of which IB companies are members, have passed numerous new AML and customer due diligence rules. Significant criminal and civil penalties can be imposed for violations of the Patriot Act, and significant fines and regulatory penalties for violations of other governmental and SRO AML rules.
As required by the Patriot Act and other new rules, we have established comprehensive anti-money laundering and customer identification procedures, designated an AML compliance officer, trained our employees and conducted independent audits of our program. Our anti-money laundering screening is conducted using a mix of automated and manual review and has been structured to comply with recent regulations. We collect required information through our new account opening process and then screen accounts with databases for the purposes of identity verification and for review of negative information and appearance on the Office of Foreign Assets and Control, Specially Designated Nationals and Blocked Persons lists. Additionally, we have developed methods for risk control and continue to add upon specialized processes, queries and automated reports designed to identify money laundering, fraud and other suspicious activities.
Business Continuity Planning
Federal regulators and industry self-regulatory organizations have passed a series of rules in the past several years requiring regulated firms to maintain business continuity plans that describe what actions firms would take in the event of a disaster (such as a fire, natural disaster or terrorist incident) that might significantly disrupt operations. IB has developed business continuity plans that describe steps that the firm and its employees would take in the event of various scenarios. The firm has built a backup site for certain key operations at its Chicago facilities that would be utilized in the event of a significant outage at the firm's Greenwich headquarters. In addition, the firm has strengthened the infrastructure at its Greenwich headquarters and has built redundancy of systems so that certain operations can be handled from multiple offices. The firm continually evaluates opportunities to further its business continuity planning efforts.
Foreign Regulation
Our international subsidiaries are subject to extensive regulation in the various jurisdictions where they have operations. The most significant of our international subsidiaries are: THE, registered to do business in Switzerland as a securities dealer; THSHK, registered to do business in Hong Kong as a securities dealer; THA, registered to do business in Australia as a securities dealer and futures broker; IBUK, registered to do business in the U.K. as a broker; IBC and THC, registered to do business in Canada as an investment dealer and securities dealer, respectively; IBI, registered to do business in India as a stock broker and IBSJ, registered in Japan as a Financial Instruments Firm with the Kanto Regional Finance Bureau and the Financial Supervisory Agency.
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As with those U.S. subsidiaries subject to FINRA rules, the ability of our regulated U.K. subsidiary, IBUK, to pay dividends or make capital distributions may be impaired due to applicable capital requirements. IBUK is subject to "consolidated" regulation, in addition to being subject to regulation on a legal entity basis. Consolidated regulation impacts the regulated entity and its parent holding companies in the United Kingdom, including the regulated entity's ability to pay dividends or distribute capital.
IBUK is also subject to regulations regarding changes in control similar to those described above under "Overview." Under Financial Services Authority ("FSA") rules, regulated entities must obtain prior approval for any transaction resulting in a change in control of a regulated entity. Under applicable FSA rules, control is broadly defined as a 10% interest in the regulated entity or its parent or otherwise exercising significant influence over the management of the regulated entity. As a result of these regulations, our future efforts to sell shares or raise additional capital may be delayed or prohibited by the FSA.
In Hong Kong, the Securities and Futures Commission ("SFC") regulates our subsidiary, THSHK, as a securities dealer. The compliance requirements of the SFC include, among other things, net capital requirements and stockholders' equity requirements. The SFC regulates the activities of the officers, directors, employees and other persons affiliated with THSHK and requires the registration of such persons.
In Canada, both THC and IBC are subject to the Investment Industry Regulatory Organization of Canada ("IROC") risk adjusted capital requirement. In Switzerland, THE is subject to the Swiss National Bank eligible equity requirement. In Australia, THA is subject to the Australian Stock Exchange liquid capital requirement.
In India, IBI is subject to the National Stock Exchange and Bombay Stock Exchange capital requirements. In Japan, IBSJ is subject to the Financial Supervisory Agency, the Osaka Securities Exchange and the Tokyo Stock Exchange capital requirements.
Executive Officers and Directors of Interactive Brokers Group
The following table sets forth the names, ages and positions of our current directors and executive officers.
Name
|
Age | Position | |||
---|---|---|---|---|---|
Thomas Peterffy |
66 | Chairman of the Board of Directors, Chief Executive Officer and President | |||
Earl H. Nemser |
63 | Vice Chairman and Director | |||
Paul J. Brody |
50 | Chief Financial Officer, Treasurer, Secretary and Director | |||
Thomas A. Frank |
55 | Executive Vice President and Chief Information Officer | |||
Milan Galik |
44 | Senior Vice President, Software Development and Director | |||
Lawrence E. Harris |
54 | Director | |||
Hans R. Stoll |
71 | Director | |||
Ivers W. Riley |
78 | Director | |||
Robert Trudeau |
42 | Director |
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Thomas Peterffy. Mr. Peterffy emigrated from Hungary to the United States in 1965. After working for 10 years as a computer programmer, he became a member of the American Stock Exchange in 1977. As an individual floor trader, he founded the firm which became our company. As Chief Executive Officer and President, Mr. Peterffy is active in our day-to-day management.
Earl H. Nemser. Mr. Nemser has been our Vice Chairman since 1988 and also serves as a director and/or officer for various subsidiaries of IBG LLC. Mr. Nemser has served as Special Counsel to the law firm Dechert LLP since January 2005. Prior to such time Mr. Nemser served as Partner at the law firms of Swidler Berlin Shereff Friedman, LLP from 1995 to December 2004 and Cadwalader, Wickersham & Taft LLP prior to 1995. Mr. Nemser received a Bachelor of Arts degree in economics from New York University in 1967 and a Juris Doctor, magna cum laude, from Boston University School of Law in 1970.
Paul J. Brody. Mr. Brody joined us in 1987 and has served as Chief Financial Officer since December 2003. Mr. Brody serves as a director and/or officer for various subsidiaries of IBG LLC. Mr. Brody also serves as a director and member Vice Chairman of The Options Clearing Corporation, of which Timber Hill LLC and IB LLC are members. Mr. Brody received a Bachelor of Arts degree in economics from Cornell University in 1982.
Thomas A. Frank. Dr. Frank joined us in 1985 and has served since July 1999 as Executive Vice President and Chief Information Officer of Interactive Brokers LLC. In addition, Dr. Frank has served as Vice President of Timber Hill LLC since December 1990. Dr. Frank received a Ph.D. in physics from the Massachusetts Institute of Technology in 1985.
Milan Galik. Mr. Galik joined us in 1990 as a software developer and has served since October 2003 as Senior Vice President, Software Development of IBG LLC. In addition, Mr. Galik has served as Vice President of Timber Hill LLC since April 1998. Mr. Galik received a Master of Science degree in electrical engineering from the Technical University of Budapest in 1990.
Lawrence E. Harris. Dr. Harris has been a director since July 2007. He is a professor of Finance and Business Economics at the University of Southern California, where he holds the Fred V. Keenan Chair in Finance at the Marshall School of Business. Dr. Harris also serves as a director of the Clipper Fund and as the research coordinator of the Institute for Quantitative Research in Finance. Dr. Harris formerly served as Chief Economist of the U.S. Securities and Exchange Commission. Dr. Harris earned his Ph.D. in Economics from the University of Chicago, and is a CFA charterholder. He is an expert in the economics of securities market microstructure and the uses of transactions data in financial research. He has written extensively about trading rules, transaction costs, index markets, and market regulation. Dr. Harris is also the author of the widely respected textbook "Trading and Exchanges: Market Microstructure for Practitioners."
Hans R. Stoll. Dr. Stoll has been a director since April 2008. Dr. Stoll has been The Anne Marie and Thomas B. Walker, Jr., Professor of Finance and Director of the Financial Markets Research Center at the Owen Graduate School of Management, Vanderbilt University since 1980. Dr. Stoll has published several books and more than 60 articles on numerous securities and finance related subjects. He is known for developing the put call parity relation and for his work in market microstructure. Dr. Stoll served as a member of the board of directors of the Options Clearing Corporation from 2005 to 2008. He has been President of the American Finance Association. Dr. Stoll received his A.B. degree from Swarthmore College in 1961 and his M.B.A. and Ph.D. degrees from the Graduate School of Business of the University of Chicago in 1963 and 1966, respectively.
Ivers W. Riley. Mr. Riley has been a director since April 2008. He served as chairman of the International Securities Exchange, the first fully electronic U.S. options exchange, until 2006. From 1994 to 1997, and again from 1999 to 2000, he was chief executive of the Hong Kong Futures Exchange and chairman of the HKFE Clearing Corporation. Mr. Riley was Senior Executive Vice President in
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charge of all derivatives activity at the American Stock Exchange from 1986 to 1993. While at Amex, he was the driving force in the development of SPDRs, a popular exchange-traded fund based on the S&P 500 index. Mr. Riley received his Bachelor of Science degree in finance from The University of California, Los Angeles in 1955 and completed an advanced management program at Harvard University in 1986.
Robert W. Trudeau. Mr. Trudeau has been a director since September 2009. He has been a General Partner of Technology Crossover Ventures ("TCV") since 2005. He is the head of TCV's Financial Technology Sector. Prior to joining TCV, he served as a Principal of General Atlantic Partners from 2003 to 2005, Managing Director of iFormation Group from 2000 to 2002 and Manager at The Boston Consulting Group from 1995 to 2000. He earned his M.B.A. from The University of Western Ontario in 1995 and his B.A.H. degree from Queens University in 1991. He currently serves on the Boards of MarketAxess Holdings Inc., FxAll and Trading Screen.
We face a variety of risks that are substantial and inherent in our businesses, including market, liquidity, credit, operational, legal and regulatory. In addition to the risks identified elsewhere in this Annual Report on Form 10-K, the following risk factors apply to our business results of operations and financial condition:
Risks Related to Our Company Structure
Control by Thomas Peterffy of a majority of the combined voting power of our common stock may give rise to conflicts of interests and could discourage a change of control that other stockholders may favor, which could negatively affect our stock price, and adversely affect stockholders in other ways.
Thomas Peterffy, our founder, Chairman and Chief Executive Officer, and his affiliates beneficially own approximately 86% of the economic interests and all of the voting interests in IBG Holdings LLC, which owns all of our Class B common stock, representing approximately 89.2% of the combined voting power of all classes of our voting stock. As a result, Mr. Peterffy has the ability to elect all of the members of our board of directors and thereby to control our management and affairs, including determinations with respect to acquisitions, dispositions, material expansions or contractions of our business, entry into new lines of business, borrowings, issuances of common stock or other securities, and the declaration and payment of dividends on our common stock. In addition, Mr. Peterffy is able to determine the outcome of all matters requiring stockholder approval and will be able to cause or prevent a change of control of our company or a change in the composition of our board of directors and could preclude any unsolicited acquisition of our company. The concentration of ownership could discourage potential takeover attempts that other stockholders may favor and could deprive stockholders of an opportunity to receive a premium for their common stock as part of a sale of our company and this may adversely affect the market price of our common stock.
Moreover, because of Mr. Peterffy's substantial ownership, we are eligible to be and are, treated as a "controlled company" for purposes of the NASDAQ Marketplace Rules. As a result, we are not be required by NASDAQ to have a majority of independent directors or to maintain Compensation and Nominating and Corporate Governance Committees composed entirely of independent directors to continue to list the shares of our common stock on The NASDAQ Global Select Market ("NASDAQ GS"). Our Compensation Committee is comprised of Messrs. Thomas Peterffy (Chairman of the Compensation Committee) and Earl H. Nemser (our Vice Chairman). Mr. Peterffy's membership on the Compensation Committee may give rise to conflicts of interests in that Mr. Peterffy is able to influence all matters relating to executive compensation, including his own compensation.
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We are dependent on IBG LLC to distribute cash to us in amounts sufficient to pay our tax liabilities and other expenses.
We are a holding company and our primary assets are our approximately 10.8% equity interest in IBG LLC and our controlling interest and related rights as the sole managing member of IBG LLC and, as such, we operate and control all of the business and affairs of IBG LLC and are able to consolidate IBG LLC's financial results into our financial statements. We have no independent means of generating revenues. IBG LLC is treated as a partnership for U.S. federal income tax purposes and, as such, is not subject to U.S. federal income tax. Instead, its taxable income is allocated on a pro rata basis to IBG Holdings LLC and us. Accordingly, we incur income taxes on our proportionate share of the net taxable income of IBG LLC, and also incur expenses related to our operations. We intend to cause IBG LLC to distribute cash to its members in amounts at least equal to that necessary to cover their tax liabilities, if any, with respect to the earnings of IBG LLC. To the extent we need funds to pay such taxes, or for any other purpose, and IBG LLC is unable to provide such funds, it could have a material adverse effect on our business, financial condition or results of operations.
We are required to pay IBG Holdings LLC for the benefit relating to additional tax depreciation or amortization deductions we claim as a result of the tax basis step-up our subsidiaries received in connection with our IPO.
In connection with our IPO, we purchased interests in IBG LLC from IBG Holdings LLC for cash. In addition, IBG LLC membership interests held by IBG Holdings LLC may be sold in the future to us and financed by our issuances of shares of our common stock. The initial purchase did, and the subsequent purchases may, result in increases in the tax basis of the tangible and intangible assets of IBG LLC and its subsidiaries that otherwise would not have been available. Such increase will be approximately equal to the amount by which our stock price at the time of the purchase exceeds the income tax basis of the assets of IBG LLC underlying the IBG LLC interests acquired by us. These increases in tax basis will result in increased deductions in computing our taxable income and resulting tax savings for us generally over the 15 year period which commenced with the initial purchase. We have agreed to pay 85% of these tax savings, if any, to IBG Holdings LLC as they are realized as additional consideration for the IBG LLC interests that we acquire.
As a result of the IPO, the increase in the tax basis attributable to our interest in IBG LLC is $0.95 billion. The tax savings that we would actually realize as a result of this increase in tax basis likely would be significantly less than this amount multiplied by our effective tax rate due to a number of factors, including the allocation of a portion of the increase in tax basis to foreign or non-depreciable fixed assets, the impact of the increase in the tax basis on our ability to use foreign tax credits and the rules relating to the amortization of intangible assets, for example. Based on current facts and assumptions, including that subsequent purchases of IBG LLC interests will occur in fully taxable transactions, the potential tax basis increase resulting from the initial and future purchases of the IBG LLC interests held by IBG Holdings LLC could be as much as $3.50 billion. The tax receivable agreement requires 85% of such tax savings, if any, to be paid to IBG Holdings LLC, with the balance to be retained by us. The actual increase in tax basis depends, among other factors, upon the price of shares of our common stock at the time of the purchase and the extent to which such purchases are taxable and, as a result, could differ materially from this amount. Our ability to achieve benefits from any such increase, and the amount of the payments to be made under the tax receivable agreement, depends upon a number of factors, as discussed above, including the timing and amount of our future income.
The tax basis of $3.50 billion assumes that (a) all remaining IBG LLC membership interests held by IBG Holdings LLC are purchased by the Company and (b) such purchases in the future are made at prices that reflect the closing share price at December 31, 2010. In order to have a $3.50 billion tax
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basis, the offering price per share of Class A common stock in such future public offering will need to exceed the then current cost basis per share of Class A common stock by approximately $7.20.
If either immediately before or immediately after any purchase or the related issuance of our stock, the IBG Holdings LLC members own or are deemed to own, in the aggregate, more than 20% of our outstanding stock, then all or part of any increase in the tax basis of goodwill may not be amortizable and, thus, our ability to realize the annual tax savings that otherwise would have resulted if such tax basis were amortizable may be significantly reduced. Although the IBG Holdings LLC members are prohibited under the exchange agreement from purchasing shares of Class A common stock, grants of our stock to employees and directors who are also members or related to members of IBG Holdings LLC and the application of certain tax attribution rules, such as among family members and partners in a partnership, could result in IBG Holdings LLC members being deemed for tax purposes to own shares of Class A common stock.
If the IRS successfully challenges the tax basis increase, under certain circumstances, we could be required to make payments to IBG Holdings LLC under the tax receivable agreement in excess of our cash tax savings.
Our senior secured revolving credit facility and our senior notes impose certain restrictions. A failure to comply with these restrictions could lead to an event of default, resulting in an acceleration of indebtedness, which may affect our ability to finance future operations or capital needs, or to engage in other business activities.
As of December 31, 2010, our total indebtedness (consisting of the aggregate amounts outstanding under senior notes, senior secured revolving credit facility and short-term borrowings) was approximately $482.0 million. On May 18, 2010, IBG LLC entered into a new $100 million two-year senior secured revolving credit facility with a syndicate of banks, which replaced an expiring $100 million one-year senior secured revolving credit facility. At maturity, subject to meeting certain terms of the facility, IBG LLC will have an option to convert the facility to a one-year term loan. IBG LLC is the sole borrower under this credit facility, which is required to be guaranteed by IBG LLC's domestic non-regulated subsidiaries (currently there are no such entities). In addition, subject to restrictions in our senior secured revolving credit facility and our senior notes, we may incur additional first-priority secured borrowings under the senior secured revolving credit facility.
The operating and financial restrictions and covenants in our debt agreements, including the senior secured revolving credit facility and our senior notes, may adversely affect our ability to finance future operations or capital needs or to engage in other business activities. Our senior secured revolving credit facility requires us to maintain specified financial ratios and tests, including interest coverage and total leverage ratios and maximum capital expenditures, which may require that we take action to reduce debt or to act in a manner contrary to our business objectives. In addition, the senior secured revolving credit facility and the senior notes restrict our ability to, among other things:
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A more detailed discussion of the restrictions contained in our senior secured revolving credit facility can be found in Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Annual Report on Form 10-K. A failure to comply with the restrictions contained in the senior secured revolving credit facility could lead to an event of default, which could result in an acceleration of our indebtedness. Such an acceleration would constitute an event of default under our senior notes. A failure to comply with the restrictions in our senior notes could result in an event of default under our senior notes. Our future operating results may not be sufficient to enable compliance with the covenants in the senior secured revolving credit facility, our senior notes or other indebtedness or to remedy any such default. In addition, in the event of an acceleration, we may not have or be able to obtain sufficient funds to refinance our indebtedness or make any accelerated payments, including those under the senior notes. In addition, we may not be able to obtain new financing. Even if we were able to obtain new financing, we would not be able to guarantee that the new financing would be on commercially reasonable terms or terms that would be acceptable to us. If we default on our indebtedness, our business financial condition and results of operation could be materially and adversely affected.
Future sales of our common stock in the public market could lower our stock price, and any additional capital raised by us through the sale of equity or convertible securities may dilute your ownership in us.
The members of IBG Holdings LLC have the right to cause the redemption of their IBG Holdings LLC membership interests over time in connection with offerings of shares of our common stock. We intend to sell additional shares of common stock in public offerings in the future, which may include offerings of our common stock to finance future purchases of IBG LLC membership interests which, in turn, will finance corresponding redemptions of IBG Holdings LLC membership interests. These offerings and related transactions were anticipated to occur on or about each of the first eight years following the IPO. Given the absence of any public offering subsequent to our IPO in 2007 and depending on the timing of redemptions, this offering schedule will be extended into the future in accordance with an exchange agreement among us, IBG LLC, IBG Holdings LLC and the historical members of IBG LLC. The size and occurrence of these offerings may be affected by market conditions. We may also issue additional shares of common stock or convertible debt securities to finance future acquisitions or business combinations. We currently have approximately 42.2 million outstanding shares of common stock. Assuming no anti dilution adjustments based on combinations or divisions of our common stock, the offerings referred to above could result in the issuance by us of up to an additional approximately 354.7 million shares of common stock. It is possible, however, that such shares could be issued in one or a few large transactions.
We cannot predict the size of future issuances of our common stock or the effect, if any, that future issuances and sales of shares of our common stock may have on the market price of our common stock. Sales of substantial amounts of our common stock (including shares issued in connection with an acquisition), or the perception that such sales could occur, may cause the market price of our common stock to decline.
Certain provisions in our amended and restated certificate of incorporation may prevent efforts by our stockholders to change our direction or management.
Provisions contained in our amended and restated certificate of incorporation could make it more difficult for a third party to acquire us, even if doing so might be beneficial to our stockholders. For example, our amended and restated certificate of incorporation authorizes our board of directors to determine the rights, preferences, privileges and restrictions of unissued series of preferred stock, without any vote or action by our stockholders. We could issue a series of preferred stock that could impede the completion of a merger, tender offer or other takeover attempt. These provisions may discourage potential acquisition proposals and may delay, deter or prevent a change of control of us, including through transactions, and, in particular, unsolicited transactions, that some or all of our stockholders might consider to be desirable. As a result, efforts by our stockholders to change our direction or management may be unsuccessful.
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Our business may be harmed by global events beyond our control, including overall slowdowns in securities trading.
Like other brokerage and financial services firms, our business and profitability are directly affected by elements that are beyond our control, such as economic and political conditions, broad trends in business and finance, changes in volume of securities and futures transactions, changes in the markets in which such transactions occur and changes in how such transactions are processed. A weakness in equity markets, such as a slowdown causing reduction in trading volume in U.S. or foreign securities and derivatives, has historically resulted in reduced transaction revenues and would have a material adverse effect on our business, financial condition and results of operations.
Because our revenues and profitability depend on trading volume, they are prone to significant fluctuations and are difficult to predict.
Our revenues are dependent on the level of trading activity on securities and derivatives exchanges in the United States and abroad. In the past, our revenues and operating results have varied significantly from period to period due primarily to the willingness of competitors to trade more aggressively by decreasing their bid/offer spreads and thereby assuming more risk in order to acquire market share, to movements and trends in the underlying markets, and to fluctuations in trading levels. As a result, period to period comparisons of our revenues and operating results may not be meaningful, and future revenues and profitability may be subject to significant fluctuations or declines.
Our reliance on our computer software could cause us great financial harm in the event of any disruption or corruption of our computer software. We may experience technology failures while developing our software.
We rely on our computer software to receive and properly process internal and external data. Any disruption for any reason in the proper functioning or any corruption of our software or erroneous or corrupted data may cause us to make erroneous trades or suspend our services and could cause us great financial harm. In order to maintain our competitive advantage, our software is under continuous development. As we identify and enhance our software, there is risk that software failures may occur and result in service interruptions and have other unintended consequences.
Our business could be harmed by a systemic market event.
Some market participants could be overleveraged. In case of sudden, large price movements, such market participants may not be able to meet their obligations to brokers who, in turn, may not be able to meet their obligations to their counterparties. As a result, the financial system or a portion thereof could collapse, and the impact of such an event could be catastrophic to our business.
We may incur material trading losses from our market making activities.
A substantial portion of our revenues and operating profits is derived from our trading as principal in our role as a market maker and specialist. We may incur trading losses relating to these activities since each primarily involves the purchase or sale of securities for our own account. In any period, we may incur trading losses in a significant number of securities for a variety of reasons including:
These risks may limit or restrict our ability to either resell securities we purchased or to repurchase securities we sold. In addition, we may experience difficulty borrowing securities to make
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delivery to purchasers to whom we sold short, or lenders from whom we have borrowed. From time to time, we have large position concentrations in securities of a single issuer or issuers engaged in a specific industry or traded in a particular market. Such a concentration could result in higher trading losses than would occur if our positions and activities were less concentrated.
In our role as a market maker, we attempt to derive a profit from the difference between the prices at which we buy and sell, or sell and buy, securities. However, competitive forces often require us to match the quotes other market makers display and to hold varying amounts of securities in inventory. By having to maintain inventory positions, we are subjected to a high degree of risk. We cannot assure you that we will be able to manage such risk successfully or that we will not experience significant losses from such activities, which could have a material adverse effect on our business, financial condition and operating results.
Reduced spreads in securities pricing, levels of trading activity and trading through market makers and/or specialists could harm our business.
Computer-generated buy/sell programs and other technological advances and regulatory changes in the marketplace may continue to tighten spreads on securities transactions. Tighter spreads and increased competition could make the execution of trades and market making activities less profitable. In addition, new and enhanced alternative trading systems such as ECNs have emerged as an alternative for individual and institutional investors, as well as broker-dealers, to avoid directing their trades through market makers, and could result in reduced revenues derived from our market making business.
We may incur losses in our market making activities in the event of failures of our proprietary pricing model.
The success of our market making business is substantially dependent on the accuracy of our proprietary pricing mathematical model, which continuously evaluates and monitors the risks inherent in our portfolio, assimilates market data and reevaluates our outstanding quotes each second. Our model is designed to automatically rebalance our positions throughout the trading day to manage risk exposures on our positions in options, futures and the underlying securities. In the event of a flaw in our pricing model and /or a failure in the related software, our pricing model may lead to unexpected and/or unprofitable trades, which may result in material trading losses.
The valuation of the financial instruments we hold may result in large and occasionally anomalous swings in the value of our positions and in our earnings in any period.
The market prices of our long and short positions are reflected on our books at closing prices which are typically the last trade price before the official close of the primary exchange on which each such security trades. Given that we manage a globally integrated portfolio, we may have large and substantially offsetting positions in securities that trade on different exchanges that close at different times of the trading day. As a result, there may be large and occasionally anomalous swings in the value of our positions daily and, accordingly, in our earnings in any period. This is especially true on the last business day of each calendar quarter.
We are exposed to losses due to lack of perfect information.
As market makers, we provide liquidity by buying from sellers and selling to buyers. Quite often, we trade with others who have different information than we do, and as a result, we may accumulate unfavorable positions preceding large price movements in companies. Should the frequency or magnitude of these events increase, our losses will likely increase correspondingly.
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Rules governing specialists and designated market makers may require us to make unprofitable trades or prevent us from making profitable trades.
Specialists and designated market makers are granted certain rights and have certain obligations to "make a market" in a particular security. They agree to specific obligations to maintain a fair and orderly market. In acting as a specialist or designated market maker, we are subjected to a high degree of risk by having to support an orderly market. In this role, we may at times be required to make trades that adversely affect our profitability. In addition, we may at times be unable to trade for our own account in circumstances in which it may be to our advantage to trade, and we may be obligated to act as a principal when buyers or sellers outnumber each other. In those instances, we may take a position counter to the market, buying or selling securities to support an orderly market. Additionally, the rules of the markets which govern our activities as a specialist or designated market maker are subject to change. If these rules are made more stringent, our trading revenues and profits as specialist or designated market maker could be adversely affected.
We are subject to potential losses as a result of our clearing and execution activities.
As a clearing member firm providing financing services to certain of our brokerage customers, we are ultimately responsible for their financial performance in connection with various stock, options and futures transactions. Our clearing operations require a commitment of our capital and, despite safeguards implemented by our software, involve risks of losses due to the potential failure of our customers to perform their obligations under these transactions. If our customers default on their obligations, we remain financially liable for such obligations, and although these obligations are collateralized, we are subject to market risk in the liquidation of customer collateral to satisfy those obligations. There can be no assurance that our risk management procedures will be adequate. Any liability arising from clearing operations could have a material adverse effect on our business, financial condition and/or operating results.
As a clearing member firm of securities and commodities clearing houses in the United States and abroad, we are also exposed to clearing member credit risk. Securities and commodities clearing houses require member firms to deposit cash and/or government securities to a clearing fund. If a clearing member defaults in its obligations to the clearing house in an amount larger than its own margin and clearing fund deposits, the shortfall is absorbed pro rata from the deposits of the other clearing members. Many clearing houses of which we are members also have the authority to assess their members for additional funds if the clearing fund is depleted. A large clearing member default could result in a substantial cost to us if we are required to pay such assessments.
We may not pay dividends on our common stock at any time in the foreseeable future.
As a holding company for our interest in IBG LLC, we will be dependent upon the ability of IBG LLC to generate earnings and cash flows and distribute them to us so that we may pay any dividends to our stockholders. To the extent (if any) that we have excess cash, any decision to declare and pay dividends in the future will be made at the discretion of our board of directors and will depend on, among other things, our results of operations, financial conditions, cash requirement, contractual restrictions and other factors that our board of directors may deem relevant. In December 2010, a special cash dividend was paid to holders of our common stock. We have made no determination as to whether to pay dividends on our common stock at any time in the foreseeable future.
Regulatory and legal uncertainties could harm our business.
The securities and derivatives businesses are heavily regulated. Firms in financial service industries have been subject to an increasingly regulated environment over recent years, and penalties and fines
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sought by regulatory authorities have increased accordingly. This regulatory and enforcement environment has created uncertainty with respect to various types of transactions that historically had been entered into by financial services firms and that were generally believed to be permissible and appropriate. Our broker-dealer subsidiaries are subject to regulations in the United States and abroad covering all aspects of their business. Regulatory bodies include, in the United States, the SEC, FINRA, the Board of Governors of the Federal Reserve System, the Chicago Board Options Exchange, the Chicago Mercantile Exchange, the Commodity Futures Trading Commission, and the National Futures Association; in Switzerland, the Federal Banking Commission; in the United Kingdom, the Financial Services Authority; in Hong Kong, the Securities and Futures Commission; in Australia, the Australian Securities and Investment Commission; in India, the Securities and Exchange Board of India; and in Canada, the Investment Industry Regulatory Organization of Canada and various Canadian securities commissions; in Japan, the Financial Supervisory Agency and the Japan Securities Dealers Association. Our mode of operation and profitability may be directly affected by additional legislation changes in rules promulgated by various domestic and foreign government agencies and self-regulatory organizations that oversee our businesses, and changes in the interpretation or enforcement of existing laws and rules, including the potential imposition of transaction taxes. Noncompliance with applicable laws or regulations could result in sanctions being levied against us, including fines and censures, suspension or expulsion from a certain jurisdiction or market or the revocation or limitation of licenses. Noncompliance with applicable laws or regulations could adversely affect our reputation, prospects, revenues and earnings. In addition, changes in current laws or regulations or in governmental policies could adversely affect our operations, revenues and earnings.
Domestic and foreign stock exchanges, other self-regulatory organizations and state and foreign securities commissions can censure, fine, issue cease-and-desist orders, suspend or expel a broker-dealer or any of its officers or employees. Our ability to comply with all applicable laws and rules is largely dependent on our internal system to ensure compliance, as well as our ability to attract and retain qualified compliance personnel. We could be subject to disciplinary or other actions in the future due to claimed noncompliance, which could have a material adverse effect on our business, financial condition and results of operations. To continue to operate and to expand our services internationally, we may have to comply with the regulatory controls of each country in which we conduct, or intend to conduct business, the requirements of which may not be clearly defined. The varying compliance requirements of these different regulatory jurisdictions, which are often unclear, may limit our ability to continue existing international operations and further expand internationally.
Our future efforts to sell shares or raise additional capital may be delayed or prohibited by regulations.
As certain of our subsidiaries are members of FINRA, we are subject to certain regulations regarding changes in control of our ownership. FINRA Rule 1017 generally provides that FINRA approval must be obtained in connection with any transaction resulting in a change in control of a member firm. FINRA defines control as ownership of 25% or more of the firm's equity by a single entity or person and would include a change in control of a parent company. Interactive Brokers (U.K.) Limited is subject to similar change in control regulations promulgated by the FSA in the United Kingdom. As a result of these regulations, our future efforts to sell shares or raise additional capital may be delayed or prohibited. We may be subject to similar restrictions in other jurisdictions in which we operate.
We depend on our proprietary technology, and our future results may be impacted if we cannot maintain technological superiority in our industry.
Our success in the past has largely been attributable to our sophisticated proprietary technology that has taken many years to develop. We have benefited from the fact that the type of proprietary technology equivalent to that which we employ has not been widely available to our competitors. If our
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technology becomes more widely available to our current or future competitors for any reason, our operating results may be adversely affected. Additionally, adoption or development of similar or more advanced technologies by our competitors may require that we devote substantial resources to the development of more advanced technology to remain competitive. The markets in which we compete are characterized by rapidly changing technology, evolving industry standards and changing trading systems, practices and techniques. Although we have been at the forefront of many of these developments in the past, we may not be able to keep up with these rapid changes in the future, develop new technology, realize a return on amounts invested in developing new technologies or remain competitive in the future.
The loss of our key employees would materially adversely affect our business.
Our key executives have substantial experience and have made significant contributions to our business, and our continued success is dependent upon the retention of our key management executives, as well as the services provided by our staff of trading system, technology and programming specialists and a number of other key managerial, marketing, planning, financial, technical and operations personnel. The loss of such key personnel could have a material adverse effect on our business. Growth in our business is dependent, to a large degree, on our ability to retain and attract such employees.
We are exposed to risks associated with our international operations.
During 2010, approximately 19% of our net revenues were generated by our operating companies outside the United States. We are exposed to risks and uncertainties inherent in doing business in international markets, particularly in the heavily regulated brokerage industry. Such risks and uncertainties include political, economic and financial instability; unexpected changes in regulatory requirements, tariffs and other trade barriers; exchange rate fluctuations; applicable currency controls; and difficulties in staffing, including reliance on newly hired local experts, and managing foreign operations. These risks could cause a material adverse effect on our business, financial condition or results of operations.
We do not have fully redundant systems. System failures could harm our business.
If our systems fail to perform, we could experience unanticipated disruptions in operations, slower response times or decreased customer service and customer satisfaction. Our ability to facilitate transactions successfully and provide high quality customer service also depends on the efficient and uninterrupted operation of our computer and communications hardware and software systems. Our service has experienced periodic system interruptions, which we believe will continue to occur from time to time. Our systems and operations also are vulnerable to damage or interruption from human error, natural disasters, power loss, telecommunication failures, break-ins, sabotage, computer viruses, intentional acts of vandalism and similar events. While we currently maintain redundant servers to provide limited service during system disruptions, we do not have fully redundant systems, and our formal disaster recovery plan does not include restoration of all services. For example, we have backup facilities at our disaster recovery site that enable us, in the case of complete failure of our main North America data center, to recover and complete all pending transactions, provide customers with access to their accounts to deposit or withdraw money, transfer positions to other brokers and manage their risk by continuing trading through the use of marketable orders. These backup services are currently limited to U.S. markets. We do not currently have separate backup facilities dedicated to our non-U.S. operations. It is our intention to provide for and progressively deploy backup facilities for our global facilities over time. In addition, we do not carry business interruption insurance to compensate for losses that could occur to the extent not required. Any system failure that causes an interruption in our
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service or decreases the responsiveness of our service could impair our reputation, damage our brand name and materially adversely affect our business, financial condition and results of operations.
Failure of third-party systems on which we rely could adversely affect our business.
We rely on certain third-party computer systems or third-party service providers, including clearing systems, exchange systems, Internet service, communications facilities and other facilities. Any interruption in these third-party services, or deterioration in their performance, could be disruptive to our business. If our arrangement with any third party is terminated, we may not be able to find an alternative source of systems support on a timely basis or on commercially reasonable terms. This could have a material adverse effect on our business, financial condition and results of operations.
We face competition in our market making activities.
In our market making activities, we compete with other firms based on our ability to provide liquidity at competitive prices and to attract order flow. These firms include registered market makers as well as high frequency trading firms ("HFTs") that act as market makers. Both types of competitors range from sole proprietors with very limited resources to a few highly sophisticated groups which have substantially greater financial and other resources, including research and development personnel, than we do. These larger and better capitalized competitors may be better able to respond to changes in the market making industry, to compete for skilled professionals, to finance acquisitions, to fund internal growth and to compete for market share generally. HFTs that are not registered market makers have certain advantages over registered market making firms that may allow them to bypass regulatory restrictions and trade more quickly and cheaply than registered market makers at some exchanges. We may not be able to compete effectively against HFTs or market makers with greater financial resources, and our failure to do so could materially and adversely affect our business, financial condition and results of operations. As in the past, we may in the future face enhanced competition, resulting in narrowing bid/offer spreads in the marketplace that may adversely impact our financial performance. This is especially likely if HFTs continue to receive advantages in capturing order flow or if others can acquire systems that enable them to predict markets or process trades more efficiently than we can.
Our direct market access clearing and non-clearing brokerage operations face intense competition.
With respect to our direct market access brokerage business, the market for electronic and interactive bidding, offering and trading services in connection with equities, options and futures is relatively new, rapidly evolving and intensely competitive. We expect competition to continue and intensify in the future. Our current and potential future competition principally comes from five categories of competitors:
In addition, we compete with financial institutions, mutual fund sponsors and other organizations, many of which provide online, direct market access or other investing services. A number of brokers
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provide our technology and execution services to their customers, and these brokers will become our competitors if they develop their own technology. Some of our competitors in this area have greater name recognition, longer operating histories and significantly greater financial, technical, marketing and other resources than we have and offer a wider range of services and financial products than we do. Some of our competitors may also have an ability to charge lower commissions. We cannot assure you that we will be able to compete effectively or efficiently with current or future competitors. These increasing levels of competition in the online trading industry could significantly harm this aspect of our business.
We are subject to risks relating to litigation and potential securities laws liability.
We are exposed to substantial risks of liability under federal and state securities laws, other federal and state laws and court decisions, as well as rules and regulations promulgated by the SEC, the CFTC, the Federal Reserve, state securities regulators, the self-regulatory organizations and foreign regulatory agencies. We are also subject to the risk of litigation and claims that may be without merit. We could incur significant legal expenses in defending ourselves against and resolving lawsuits or claims. An adverse resolution of any future lawsuits or claims against us could result in a negative perception of our company and cause the market price of our common stock to decline or otherwise have an adverse effect on our business, financial condition and/or operating results. See Part I, Item 3, "Legal Proceedings and Regulatory Matters."
Any future acquisitions may result in significant transaction expenses, integration and consolidation risks and risks associated with entering new markets, and we may be unable to profitably operate our consolidated company.
Although our growth strategy has not focused historically on acquisitions, we may in the future engage in evaluations of potential acquisitions and new businesses. We may not have the financial resources necessary to consummate any acquisitions in the future or the ability to obtain the necessary funds on satisfactory terms. Any future acquisitions may result in significant transaction expenses and risks associated with entering new markets in addition to integration and consolidation risks. Because acquisitions historically have not been a core part of our growth strategy, we have no material experience in successfully utilizing acquisitions. We may not have sufficient management, financial and other resources to integrate any such future acquisitions or to successfully operate new businesses and we may be unable to profitably operate our expanded company.
Internet-related issues may reduce or slow the growth in the use of our services in the future.
Critical issues concerning the commercial use of the Internet, such as ease of access, security, privacy, reliability, cost, and quality of service, remain unresolved and may adversely impact the growth of Internet use. If Internet usage continues to increase rapidly, the Internet infrastructure may not be able to support the demands placed on it by this growth, and its performance and reliability may decline. Although our larger institutional customers use leased data lines to communicate with us, our ability to increase the speed with which we provide services to consumers and to increase the scope and quality of such services is limited by and dependent upon the speed and reliability of our customers' access to the Internet, which is beyond our control. If periods of decreased performance, outages or delays on the Internet occur frequently or other critical issues concerning the Internet are not resolved, overall Internet usage or usage of our web based products could increase more slowly or decline, which would cause our business, results of operations and financial condition to be materially and adversely affected.
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Our computer infrastructure may be vulnerable to security breaches. Any such problems could jeopardize confidential information transmitted over the Internet, cause interruptions in our operations or cause us to have liability to third persons.
Our computer infrastructure is potentially vulnerable to physical or electronic computer break-ins, viruses and similar disruptive problems and security breaches. Any such problems or security breaches could cause us to have liability to one or more third parties, including our customers, and disrupt our operations. A party able to circumvent our security measures could misappropriate proprietary information or customer information, jeopardize the confidential nature of information transmitted over the Internet or cause interruptions in our operations. Concerns over the security of Internet transactions and the privacy of users could also inhibit the growth of the Internet or the electronic brokerage industry in general, particularly as a means of conducting commercial transactions. To the extent that our activities involve the storage and transmission of proprietary information such as personal financial information, security breaches could expose us to a risk of financial loss, litigation and other liabilities. Our estimated annual losses from reimbursements to customers whose accounts have been negatively affected by unauthorized access have historically been less than $500,000 annually, but instances of unauthorized access of customer accounts have been increasing recently on an industry-wide basis. Our current insurance program may protect us against some, but not all, of such losses. Any of these events, particularly if they (individually or in the aggregate) result in a loss of confidence in our company or electronic brokerage firms in general, could have a material adverse effect on our business, results of operations and financial condition.
We may not be able to protect our intellectual property rights or may be prevented from using intellectual property necessary for our business.
We rely primarily on trade secret, contract, copyright, patent and trademark laws to protect our proprietary technology. It is possible that third parties may copy or otherwise obtain and use our proprietary technology without authorization or otherwise infringe on our rights. We may also face claims of infringement that could interfere with our ability to use technology that is material to our business operations.
In the future, we may have to rely on litigation to enforce our intellectual property rights, protect our trade secrets, determine the validity and scope of the proprietary rights of others or defend against claims of infringement or invalidity. Any such litigation, whether successful or unsuccessful, could result in substantial costs and the diversion of resources and the attention of management, any of which could negatively affect our business.
Our future success will depend on our response to the demand for new services, products and technologies.
The demand for market making services, particularly services that rely on electronic communications gateways, is characterized by:
New services, products and technologies may render our existing services, products and technologies less competitive. Our future success will depend, in part, on our ability to respond to the demand for new services, products and technologies on a timely and cost-effective basis and to adapt to technological advancements and changing standards to address the increasingly sophisticated requirements and varied needs of our customers and prospective customers. We cannot assure you that
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we will be successful in developing, introducing or marketing new services, products and technologies. In addition, we may experience difficulties that could delay or prevent the successful development, introduction or marketing of these services and products, and our new service and product enhancements may not achieve market acceptance. Any failure on our part to anticipate or respond adequately to technological advancements, customer requirements or changing industry standards, or any significant delays in the development, introduction or availability of new services, products or enhancements could have a material adverse effect on our business, financial condition and operating results.
The expansion of our market making activities into forex-based products entails significant risk, and unforeseen events in such business could have an adverse effect on our business, financial condition and results of operation.
Over the past several years we entered into market making for forex-based products. This includes the trading of cash in foreign currencies with banks and exchange-listed futures, options on futures, options on cash deposits and currency-based ETFs. All of the risks that pertain to our market making activities in equity-based products also apply to our forex-based market making. In addition, we have comparatively less experience in the forex markets and even though we are expanding this activity slowly, any kind of unexpected event can occur that can result in great financial loss.
We are subject to counterparty risk whereby defaults by parties with whom we do business can have an adverse effect on our business, financial condition and/or operating results.
In our electronic brokerage business, our customer margin credit exposure is to a great extent mitigated by our policy of automatically evaluating each account throughout the trading day and closing out positions automatically for accounts that are found to be under-margined. While this methodology is effective in most situations, it may not be effective in situations in which no liquid market exists for the relevant securities or commodities or in which, for any reason, automatic liquidation for certain accounts has been disabled. If no liquid market exists or automatic liquidation has been disabled, we are subject to risks inherent in extending credit, especially during periods of rapidly declining markets. Any loss or expense incurred due to defaults by our customers in failing to repay margin loans or to maintain adequate collateral for these loans would cause harm to our business.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
Our headquarters are located in Greenwich, Connecticut. We also lease facilities in 15 other locations throughout parts of the world where we conduct our operations as set forth below. Unless otherwise indicated, all properties are used by both our market making and electronic brokerage segments. We believe our present facilities, together with our current options to extend lease terms, are adequate for our current needs.
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The following table sets forth certain information with respect to our leased facilities:
Location
|
Space | Expiring In | Principal Usage | ||||
---|---|---|---|---|---|---|---|
Greenwich, CT |
107,431 sq. feet | 2019 | Headquarters and data center | ||||
Jersey City, NJ |
7,698 sq. feet | 2011 | Office space | ||||
Chicago, IL |
62,446 sq. feet | 2017 | Office space and data center | ||||
Washington, D.C. |
450 sq. feet | 2012 | Office space | ||||
Montreal, Canada |
4,566 sq. feet | 2014 | Office space | ||||
London, United Kingdom |
2,283 sq. feet | 2015 | Office space | ||||
Zug, Switzerland |
27,115 sq. feet | 2015 | Office space and data center | ||||
Sydney, Australia |
2,649 sq. feet | 2014 | Office space | ||||
Hong Kong |
5,611 sq. feet | 2012 | Office space and data center | ||||
Budapest, Hungary |
4,297 sq. feet | 2011 | Office space | ||||
St. Petersburg, Russia |
2,563 sq. feet | 2011 | Office space | ||||
Tallinn, Estonia |
3,638 sq. feet | 2011 | Office space | ||||
Mumbai, India |
7,365 sq. feet | 2015 | Office space | ||||
Tokyo, Japan |
2,161 sq. feet | 2012 | Office space | ||||
Shanghai, China |
2,177 sq. feet | 2011 | Office space | ||||
Sao Paulo, Brazil |
65 sq. feet | 2011 | Office space |
ITEM 3. LEGAL PROCEEDINGS AND REGULATORY MATTERS
The securities industry is highly regulated and many aspects of our business involve substantial risk of liability. In recent years, there has been an increasing incidence of litigation involving the securities brokerage industry, including class action suits that generally seek substantial damages, including in some cases punitive damages. Compliance and trading problems that are reported to federal, state and provincial securities regulators, securities exchanges or other self-regulatory organizations by dissatisfied customers are investigated by such regulatory bodies, and, if pursued by such regulatory body or such customers, may rise to the level of arbitration or disciplinary action. We are also subject to periodic regulatory audits and inspections.
Like other securities brokerage firms, we have been named as a defendant in lawsuits and from time to time we have been threatened with, or named as a defendant in, arbitrations and administrative proceedings. The following contains information regarding potentially material pending litigation and pending regulatory inquiries. We may in the future become involved in additional litigation or regulatory proceedings in the ordinary course of our business, including litigation or regulatory proceedings that could be material to our business.
Trading Technologies Matter
On February 3, 2010, Trading Technologies International, Inc. ("Trading Technologies") filed a complaint, in the United States District Court for the Northern District of Illinois Eastern Division, against Interactive Brokers Group, Inc., IBG LLC, IBG Holdings LLC, and Interactive Brokers LLC ("Defendants"). The complaint, as amended, alleges that the Defendants have infringed and continue to infringe six U.S. patents held by Trading Technologies. Trading Technologies is seeking, among other things, unspecified damages and injunctive relief. The case is in the pleadings stage. While it is too early to predict the outcome of the matter, we believe we have meritorious defenses to the allegations made in the complaint and intend to defend ourselves vigorously against them. However, litigation is inherently uncertain and there can be no guarantee that the Company will prevail or that the litigation can be settled on favorable terms.
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Pending Regulatory Inquiries
IB's businesses are heavily regulated by state, federal and foreign regulatory agencies as well as numerous exchanges and self-regulatory organizations. IB's various companies are regulated under state securities laws, U.S. and foreign securities, commodities and financial services laws and under the rules of more than 25 exchanges and SROs. In the current era of dramatically heightened regulatory scrutiny of financial institutions, IB has incurred sharply increased compliance costs, along with the industry as a whole. Increased regulation also creates increased barriers to entry, however, and IB has built human and automated infrastructure to handle increased regulatory scrutiny, which provides IB an advantage over potential newcomers to the business.
IB receives hundreds of regulatory inquiries each year in addition to being subject to frequent regulatory examinations. The great majority of these inquiries do not lead to fines or any further action against IB. Most often, regulators do not inform IB as to when and if an inquiry has been concluded. IB is currently the subject of regulatory inquiries regarding topics such as order audit trail reporting, trade reporting, short sales, market making obligations, anti-money laundering, business continuity planning and other topics of recent regulatory interest. There are no formal regulatory enforcement actions pending against IB's regulated entities, except as specifically disclosed herein and IB is unaware of any specific regulatory matter that, itself, or together with similar regulatory matters, would have a material impact on IB's financial condition. Nonetheless, in the current climate, we expect to pay significant regulatory fines on various topics on an ongoing basis, as other regulated financial services businesses do. The amount of any fines, and when and if they will be incurred, is impossible to predict given the nature of the regulatory process.
34
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY; RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Common Stock Information
The following table shows the high and low sale prices for the periods indicated for the Company's common stock, as reported by NASDAQ.
|
Sales Price | |||||||
---|---|---|---|---|---|---|---|---|
|
High | Low | ||||||
2009 |
||||||||
First Quarter |
$ | 19.41 | $ | 12.89 | ||||
Second Quarter |
$ | 17.42 | $ | 13.89 | ||||
Third Quarter |
$ | 20.06 | $ | 15.00 | ||||
Fourth Quarter |
$ | 20.93 | $ | 16.01 | ||||
2010 |
||||||||
First Quarter |
$ | 17.75 | $ | 15.80 | ||||
Second Quarter |
$ | 17.63 | $ | 16.15 | ||||
Third Quarter |
$ | 18.09 | $ | 15.97 | ||||
Fourth Quarter(1) |
$ | 19.24 | $ | 16.85 | ||||
2011 |
||||||||
YTDThrough February 25, 2011 |
$ | 18.20 | $ | 15.40 |
The closing price of our common stock on February 25, 2011, as reported by NASDAQ, was $15.55 per share.
Holders
On February 25, 2011, there were five holders of record, which does not reflect those shares held beneficially or those shares held in "street" name. Accordingly, the number of beneficial owners of our common stock exceeds this number.
Dividends and Other Restrictions
In December 2010, the Company effected a series of dividend payments, including a dividend of $1.79 per share, which was paid to the Company's common shareholders. We have made no determination as to whether to pay any dividends on our common stock in the foreseeable future. Restrictions contained in our loan agreements limit our ability to pay dividends on our common stock. See "Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital Resources" in Part II Item 7 of this Annual Report on Form 10-K.
Stockholder Return Performance Graph
The following graph compares cumulative total stockholder return on our common stock, the S&P 500 Index and the NASDAQ Financial-100 Index from May 4, 2007 to December 31, 2010. The
35
comparison assumes $100 was invested on May 4, 2007 in our common stock and each of the foregoing indices and assumes reinvestment of dividends before consideration of income taxes.
The stock performance depicted in the graph above is not to be relied upon as indicative of future performance. The stock performance graph shall not be deemed to be incorporated by reference into any of our filings under the Securities Act or the Exchange Act, except to the extent that we specifically incorporate the same by reference, nor shall it be deemed to be "soliciting material" or to be "filed" with the SEC or subject to Regulations 14A or 14C or to the liabilities of Section 18 of the Exchange Act.
36
Securities Authorized for Issuance under Equity Compensation Plans
The following table provides information about shares of common stock available for future awards under all of the Company's equity compensation plans as of December 31, 2010. The Company has not made grants of common stock outside of its equity compensation plans:
|
Number of securities to be issued upon exercise of outstanding options, warrants and rights |
Weighted-average exercise price of outstanding options warrants and rights |
Number of securities remaining available for future issuance under equity compensation plans(1) |
|||||||
---|---|---|---|---|---|---|---|---|---|---|
Equity compensation plans approved by security holders |
N/A | N/A | 151,976 | |||||||
Equity compensation plans not approved by security holders |
N/A | N/A | | |||||||
Total |
| | 151,976 |
ITEM 6. SELECTED FINANCIAL DATA
The following tables set forth selected historical consolidated financial and other data of IBG LLC as of and for the year ended December 31, 2006, prior to the IPO. The historical financial and other data of IBG, Inc., the public company, is presented for the years ended, and as of, December 31, 2007, 2008, 2009 and 2010.
On May 3, 2007, IBG, Inc. priced its initial public offering of shares of Common Stock. In connection with the IPO, IBG, Inc. purchased 10.0% of the membership interests in IBG LLC, became the sole managing member for IBG LLC and began to consolidate IBG LLC's financial results into its financial statements. The consolidated statement of income data for the periods presented reflect the consolidated operating results of IBG LLC and its subsidiaries prior to May 4, 2007 and reflect the consolidated operating results of IBG, Inc. and its subsidiaries from May 4, 2007 through December 31, 2007. This represents 100% of the earnings prior to our IPO and actual earnings attributable to IBG, Inc. following the IPO. The consolidated statement of financial condition data as of December 31, 2006 reflects the audited condensed consolidated statement of financial condition of IBG LLC and its subsidiaries, and the consolidated statements of financial condition data as of December 31, 2007, 2008, 2009 and 2010 reflect the audited condensed consolidated statement of financial condition of IBG, Inc. and its subsidiaries.
For all periods presented, IBG LLC has operated in the United States as a limited liability company that was treated as a partnership for U.S. federal income tax purposes. As a result, IBG LLC has not been subject to U.S. federal income taxes on its income; and historical results of operations prior to the IPO do not include Delaware franchise tax, and federal and certain other state income taxes. Such items are included in periods subsequent to May 3, 2007.
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The following selected historical consolidated financial and other data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," and the audited consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.
|
Year Ended December 31, | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||
|
(in millions, except share and per share data) |
||||||||||||||||||
Consolidated Statement of Income Data: |
|||||||||||||||||||
Revenues: |
|||||||||||||||||||
Trading gains |
$ | 368.6 | $ | 633.9 | $ | 1,304.0 | $ | 888.1 | $ | 805.1 | |||||||||
Commissions and execution fees |
386.8 | 353.0 | 359.5 | 261.1 | 174.4 | ||||||||||||||
Interest income |
172.5 | 121.6 | 437.2 | 782.2 | 672.1 | ||||||||||||||
Other income |
60.4 | 61.3 | 81.7 | 92.2 | 85.2 | ||||||||||||||
Total revenues |
988.3 | 1,169.8 | 2,182.4 | 2,023.6 | 1,736.8 | ||||||||||||||
Interest expense |
66.2 | 69.5 | 332.0 | 555.2 | 484.4 | ||||||||||||||
Total net revenues |
922.1 | 1,100.3 | 1,850.4 | 1,468.4 | 1,252.4 | ||||||||||||||
Non-interest expenses: |
|||||||||||||||||||
Execution and clearing |
272.6 | 273.2 | 322.7 | 335.7 | 313.3 | ||||||||||||||
Employee compensation and benefits |
200.2 | 175.8 | 158.0 | 118.8 | 110.1 | ||||||||||||||
Occupancy, depreciation and amortization |
37.3 | 40.4 | 37.7 | 26.5 | 22.7 | ||||||||||||||
Communications |
23.5 | 22.8 | 18.7 | 14.9 | 12.6 | ||||||||||||||
General and administrative |
47.7 | 43.6 | 63.3 | 40.7 | 32.1 | ||||||||||||||
Total non-interest expenses |
581.3 | 555.8 | 600.4 | 536.6 | 490.8 | ||||||||||||||
Income before income taxes |
340.8 | 544.5 | 1,250.0 | 931.8 | 761.6 | ||||||||||||||
Income tax expense |
60.4 | 54.4 | 128.4 | 63.0 | 27.4 | ||||||||||||||
Net Income |
280.4 | 490.1 | 1,121.6 | 868.8 | 734.2 | ||||||||||||||
Less Income attributable to non-controlling interests(1) |
289.7 | 453.9 | 1,028.6 | 568.3 | 0.0 | ||||||||||||||
Net income available for common stockholders |
$ | (9.3 | ) | $ | 36.2 | $ | 93.0 | $ | 300.5 | $ | 734.2 | ||||||||
Earnings per share |
|||||||||||||||||||
Basic |
$ | (0.22 | ) | $ | 0.88 | $ | 2.30 | $ | 1.20 | ||||||||||
Diluted |
$ | (0.22 | ) | $ | 0.87 | $ | 2.24 | $ | 1.16 | ||||||||||
Weighted average common shares outstanding |
|||||||||||||||||||
Basic |
41,870,926 | 40,973,290 | 40,434,273 | 41,153,606 | |||||||||||||||
Diluted |
42,498,705 | 41,799,489 | 41,461,018 | 41,327,844 |
38
|
Year Ended December 31, | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2010 | 2009 | 2008 | 2007 | 2006 | |||||||||||
|
(in millions) |
|||||||||||||||
Cash, cash equivalents and short-term investments(1) |
$ | 9,578.6 | $ | 7,948.5 | $ | 6,651.4 | $ | 5,789.3 | $ | 3,878.8 | ||||||
Total assets(2)(3) |
28,498.8 | 26,605.6 | 28,356.6 | 34,542.1 | 32,080.5 | |||||||||||
Total liabilities(3) |
24,278.3 | 21,728.5 | 23,948.5 | 30,968.3 | 29,278.6 | |||||||||||
Non-controlling interests(4)(5) |
3,732.7 | 4,302.2 | 3,894.2 | 3,165.4 | 2,801.9 | |||||||||||
Stockholders' equity(5) |
487.8 | 574.9 | 513.9 | 408.4 |
39
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the audited consolidated financial statements and the related notes in Item 8, included elsewhere in this report. In addition to historical information, the following discussion also contains forward-looking statements that include risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under the heading "Risk Factors" in Part I, Item 1A of this Annual Report on Form 10-K.
Business Overview
We are an automated global electronic market maker and broker specializing in routing orders and executing and processing trades in securities, futures and foreign exchange instruments on more than 90 electronic exchanges and trading venues around the world. Since our inception in 1977, we have focused on developing proprietary software to automate broker-dealer functions. The advent of electronic exchanges in the last 20 years has provided us with the opportunity to integrate our software with an increasing number of exchanges and trading venues into one automatically functioning, computerized platform that requires minimal human intervention.
In connection with the IPO priced on May 3, 2007, IBG, Inc. purchased 10.0% of the membership interests in IBG LLC, became the sole managing member of IBG LLC and began to consolidate IBG LLC's financial results into its financial statements.
Overview of Recapitalization Transactions and Our Organizational Structure
Prior to the IPO, we had historically conducted our business through a limited liability company structure. Our primary assets are our ownership of approximately 10.8% of the membership interests of IBG LLC, the current holding company for our businesses, and our controlling interest and related contractual rights as the sole managing member of IBG LLC. The remaining approximately 89.2% of IBG LLC membership interests are held by IBG Holdings LLC, a holding company that is owned by our founder, Chairman and Chief Executive Officer, Thomas Peterffy, and his affiliates, management and other employees of IBG LLC, and certain other members. The IBG LLC membership interests held by IBG Holdings LLC will be subject to purchase by us over time in connection with offerings by us of shares of our common stock.
Purchases of IBG LLC membership interests, held by IBG Holdings LLC, by the Company are governed by the Exchange Agreement by and among the Company, IBG Holdings LLC, IBG LLC and the members of IBG LLC, dated as of May 3, 2007 (the "Exchange Agreement"), a copy of the fully executed agreement was filed as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 and filed with the SEC on November 9, 2009. Under the Exchange Agreement, IBG Holdings LLC may request redemption of its membership interests in IBG LLC and the Company is required to use its commercially reasonable efforts to consummate a public offering of a number of shares of Class A common stock approximately equal to the aggregate number of the IBG Holdings LLC membership interests for which redemption has been requested. Upon consummation of such public offering, the Company is required to purchase from IBG Holdings LLC that number of IBG LLC membership interests equal to the aggregate number of the IBG Holdings LLC membership interests subject to redemption, at a purchase price per membership interest equal to the offering price in such public offering. However, under the Exchange Agreement, the Company is not obligated to effect any purchase of the IBG LLC membership interests held by IBG Holdings LLC unless and until the Company has consummated a public offering of a number of shares of Class A common stock approximately equal to the aggregate number of the IBG Holdings LLC membership interests subject to redemption. In 2008, 2009 and 2010, public offerings were not consummated.
40
As an alternative, at the option of, and upon mutual agreement of, the Company, IBG Holdings LLC and IBG LLC, instead of, or in addition to, consummating one or more public offerings, redemptions of IBG Holdings LLC membership interests may be effected by using cash on hand at IBG LLC and corresponding redemptions by IBG LLC of its membership interests held by IBG Holdings LLC. This alternative funding method would not impose any obligations on the Company. In 2008, 2009 and 2010 some of the IBG Holdings LLC membership interests were, in fact, redeemed using cash from IBG LLC.
As part of a redeployment of the Company's capital to its shareholders, the Company effected a series of dividend payments, including a dividend of $1.79 per share, which was paid to the Company's common shareholders in December 2010. We have made no determination as to whether to pay any dividends on our common stock in the foreseeable future.
Business Segments
The Company reports its results in two business segments, market making and electronic brokerage. These segments are analyzed separately as we derive our revenues from these two principal business activities as well as allocate resources and assess performance.
Business Environment
The past year was marked by two major events: the signing of the DoddFrank Wall Street Reform and Consumer Protection Act into law and the May 6th "flash crash."
It is difficult to predict what rule changes will be implemented by the regulators as a result of the Dodd-Frank legislation and what impact these changes will have on our business. As a well capitalized market participant and a registered market maker, we would view stricter capital requirements and increased regulation over OTC derivatives as, on balance, positive.
41
The immediately noticeable fall out from May 6, on the business environment for 2010, was the reduction of trading by the retail and, to a lesser extent, the institutional investor, which also resulted in diminished volatilities in the markets.
As a result of the Flash Crash, rule changes may be implemented in the future that would increase regulation of high frequency traders ("HFTs") and curtail naked sponsored access, a practice whereby HFTs can send orders directly to an exchange by using an exchange member's access and bypassing that exchange member's pre-trade risk controls. However, the only changes that were implemented in 2010 were the circuit breakers that place trading restrictions on stocks that exhibit substantial price moves, which had no impact on our operations.
During 2010, global volumes in exchange traded derivatives continued to grow, while markets were generally calmer than the preceding year, with the exception of the brief spike in volatility around the May 6th event. We continued to face challenging conditions as market makers, including intense competition from high frequency traders, historically tight bid/offer spreads and low volatility levels. These factors were exacerbated by currency movements that negatively impacted our reported earnings.
Since we typically maintain an overall long volatility position, which protects us against a severe market dislocation in either direction, our market making profits are generally correlated with market volatility. Based on the Chicago Board Options Exchange Volatility Index ("VIX"), the average volatility level fell approximately 29% compared to 2009. The ratio of actual to implied volatility is also meaningful to our results. Because the cost of hedging our positions is based on implied volatility, while our trading profits are, in part, based on actual market volatility, a higher ratio is generally favorable and a lower ratio generally has a negative effect on our trading gains. During 2010, this ratio averaged approximately 75% compared to approximately 77% in 2009.
Lower volatility levels also contributed to the trend of contracting bid/offer spreads that began in late 2008. During 2010, spreads, as reported by the NASDAQ OMX PHLX market, were approximately 33% narrower than in 2009.
Currency fluctuations negatively impacted our reported earnings, as measured in U.S. dollars. As a global market maker trading on exchanges around the world in multiple currencies, we are exposed to foreign currency risk. We actively hedge this exposure by keeping our net worth in proportion to a defined basket of major currencies we call the GLOBAL. The overall impact of foreign currency exchange rate changes on our equity in 2010 was relatively small. However, U.S. GAAP accounting convention resulted in a gain being reported in the consolidated statement of financial condition, while a loss was reported in the consolidated statement of income. Further detail is provided below in the Section entitled "Non-GAAP Financial Measures". In addition, a discussion of our approach to managing foreign currency exposure is contained in Part II, Item 7A of this Annual Report on Form 10-K entitled "Quantitative and Qualitative Disclosures about Market Risk."
According to data received from exchanges worldwide, volumes in exchange-listed equity-based options increased in 2010 by approximately 14% globally and 8% in the U.S., compared to 2009. During the year we accounted for approximately 10.1% of the exchange-listed equity based options (including options on ETFs and stock index products) volume traded worldwide and approximately 13.1% of exchange-listed equity based options volume traded in the U.S. This compares to approximately 10.9% of the exchange-listed equity based options volume traded worldwide and approximately 13.6% of the exchange-listed equity based options volume traded in the U.S. compared to 2009. We believe the decrease in our market share can partly be attributed to the surge in high frequency trading firms and certain advantages they had over registered market makers, which had allowed them to take a larger share of the listed options volume. See the tables on pages 56 - 57 of this Annual Report on Form 10-K for additional details regarding our trade volumes, contract and share volumes and brokerage statistics.
42
Financial Overview
Diluted earnings per share were $(0.22) for year ended December 31, 2010. The calculation of diluted earnings per share is detailed in Note 4, "Initial Public Offering and Recapitalization," to the audited consolidated financial statements, in Part II, Item 8 of this Annual Report on Form 10-K. Diluted earnings per share were $0.87 for the year ended December 31, 2009. In December 2010, the Company paid a dividend of $1.79 per share to holders of the Company's common stock which had a negative impact on our earnings per share of approximately $0.71 for the year ended December 31, 2010. On a consolidated reporting basis, the dividends had no effect on our reported income before tax. However, the U.S. federal income tax liability triggered by the dividends is reported as income tax expense in the consolidated statement of income. The above dividend resulted from the following transaction. On December 21, 2010, Timber Hill Europe AG ("THE AG") paid its sole shareholder, IBG LLC, a dividend of $990.3 million. THE AG's pretax earnings had not previously been subject to taxation in the United States. U.S. federal income taxes on the Company's share of this dividend were $40.8 million. Please refer to the section below entitled "Non-GAAP Financial Measures" for a discussion of the impact of the dividend on our reported results.
For the year ended December 31, 2010, our net revenues were $922.1 million and income before income taxes was $340.8 million, compared to net revenues of $1,100.3 million and income before income taxes of $544.5 million for 2009. Compared to 2009, trading gains decreased 42% in 2010, commissions and execution fees increased by 10% and net interest income increased 104%. Our pre-tax margin for the year ended December 31, 2010 was 37%, compared to 50% for 2009.
During the year ended December 31, 2010, income before income taxes in our market making segment decreased 73%, compared with 2009. Trading gains were hampered by increased competition from high frequency traders, the continued tightening of bid/offer spreads in the market and currency fluctuations. Pre-tax margin decreased to 24% in 2010 compared to 53% in 2009.
During the year ended December 31, 2010, income before income taxes in our electronic brokerage segment grew 19% compared to 2009. Customer accounts grew 18% from the prior year and customer equity increased 45% during 2010. Commissions and execution fees increased by 10% and net interest income grew by 78% from the prior year. Pre-tax margin increased from 49% to 50% in the same time periods. Total Daily Average Revenue Trades ("DARTs") for cleared and execution-only customers increased 9% to 379,000 during the year ended December 31, 2010, compared to 347,000 during the year ended December 31, 2009.
Market making, by its nature, does not produce predictable earnings. Our results in any given period may be materially affected by volumes in the global financial markets, the level of competition and other factors. Electronic brokerage is more predictable, but it is dependent on customer activity, growth in customer accounts and assets, interest rates and other factors. For a further discussion of the factors, that may affect our future operating results, please see the description of risk factors in Part I, Item 1A of this Annual Report on Form 10-K.
43
The following two tables present net revenues and income before income taxes for each of our business segments for the periods indicated.
Net revenues of each of our business segments and our total net revenues are summarized below:
|
Year Ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2010 | 2009 | 2008 | |||||||
|
(in millions) |
|||||||||
Market making |
$ | 379.2 | $ | 626.4 | $ | 1,343.5 | ||||
Electronic brokerage |
547.3 | 474.4 | 505.8 | |||||||
Corporate(1) |
(4.4 | ) | (0.5 | ) | 1.1 | |||||
Total |
$ | 922.1 | $ | 1,100.3 | $ | 1,850.4 | ||||
Income before income taxes of each of our business segments and our total income before income taxes are summarized below:
|
Year Ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2010 | 2009 | 2008 | |||||||
|
(in millions) |
|||||||||
Market making |
$ | 89.5 | $ | 330.8 | $ | 1,027.6 | ||||
Electronic brokerage |
274.8 | 231.2 | 224.0 | |||||||
Corporate(1) |
(23.5 | ) | (17.5 | ) | (1.6 | ) | ||||
Total |
$ | 340.8 | $ | 544.5 | $ | 1,250.0 | ||||
Revenue
Trading Gains
Trading gains are generated in the normal course of market making. Trading revenues are, in general, proportional to the trading activity in the markets. Our revenue base is highly diversified and comprised of millions of relatively small individual trades of various financial products traded on electronic exchanges, primarily stocks, options and futures. Trading gains accounted for approximately 37%, 54% and 60% of our total revenues for the years ended December 31, 2010, 2009 and 2008, respectively. Trading gains include a portion of translation gains and losses stemming from the basket of foreign currencies we call GLOBALs, which we employ to carry out our currency hedging strategy. This impact is further described below in the section entitled "Non-GAAP Financial Measures" and in Item 8, Financial Statements and Supplementary Data. A discussion of our approach to managing foreign currency exposure is contained in Part II, Item 7A of this Annual Report on Form 10-K entitled "Quantitative and Qualitative Disclosures about Market Risk."
Trading gains also include revenues from net dividends. Market making activities require us to hold a substantial inventory of equity securities. We derive significant revenues in the form of dividend income from these equity securities. This dividend income is largely offset by dividend expense incurred when we make significant payments in lieu of dividends on short positions in securities in our portfolio. Dividend income and expense arise from holding market making positions over dates on which dividends are paid to shareholders of record. When a stock pays a dividend, its market price is generally adjusted downward to reflect the value paid to the shareholders of record, which will not be received by those who purchase the stock after the dividend date. Hence, the apparent gains and losses
44
due to these price changes must be taken together with the dividends paid and received, respectively, in order to accurately reflect the results of our market making operations.
As a result of the way we have integrated our market making and securities lending systems, our trading gains and our net interest income from the market making segment are interchangeable and depend on the mix of market making positions in our portfolio. When implied interest rates in the equity and equity options and futures markets exceed the actual interest rates available to us, our market making systems tend to buy stock and sell it forward, which produces higher trading gains and lower net interest income. When these rates are inverted, our market making systems tend to sell stock and buy it forward, which produces lower trading gains and higher net interest income.
Our trading gains are geographically diversified. In 2010, 2009 and 2008, we generated 17%, 41% and 53% respectively, of our trading gains from operations conducted internationally.
Commissions and Execution Fees
We earn commissions and execution fees from our cleared customers for whom we act as executing and clearing brokers and from our non-cleared customers for whom we act as an executing broker only. We have a commission structure that allows customers to choose between an all-inclusive "bundled" rate or an "unbundled" rate that has lower commissions for high volume customers. For "unbundled" commissions, we charge regulatory and exchange fees, at our cost, separately from our commissions, adding transparency to our fee structure. Commissions and execution fees accounted for 39%, 30% and 16% of our total revenues for the years ended December 31, 2010, 2009 and 2008, respectively.
Our commissions and execution fees are geographically diversified. In 2010, 2009 and 2008 we generated 27%, 26% and 23%, respectively of commissions and execution fees from operations conducted internationally.
Interest Income and Interest Expense
We earn interest on customer funds segregated in safekeeping accounts; on customer borrowings on margin, secured by marketable securities these customers hold with us; from our investment in government treasury securities; from borrowing securities in the general course of our market making and brokerage activities, and on bank balances. Interest income accounted for 17%, 10% and 20% of total revenues for the years ended December 31, 2010, 2009 and 2008, respectively. Interest income is partially offset by interest expense.
We pay interest on cash balances customers hold with us; for cash received from lending securities in the general course of our market making and brokerage activities; and on our borrowings. Interest expense was 7%, 6% and 15% of total revenues for the years ended December 31, 2010, 2009 and 2008, respectively.
We have automated and integrated our securities lending system with our trading system. As a result, we have been able to tailor our securities lending activity to produce more optimal results when taken together with trading gains (see description under "Trading Gains" above). Our net interest income accounted for approximately 12%, 5% and 6% of our total net revenues for the years ended December 31, 2010, 2009 and 2008, respectively.
Other Income
Other income consists primarily of payment for order flow income, market data fee income and mark-to-market gains or losses on non-traded securities (primarily investments in exchanges). Our other income accounted for approximately 6%, 5% and 4% of our total revenues for each of the years ended December 31, 2010, 2009 and 2008, respectively.
45
Costs and Expenses
Execution and Clearing Expenses
Our largest single expense category is execution and clearing expenses, which includes the costs of executing and clearing our market making and electronic brokerage trades, as well as other direct expenses, including payment for order flow, regulatory fees and market data fees. Execution fees are paid primarily to electronic exchanges and market centers on which we trade. Clearing fees are paid to clearing houses and clearing agents. Payments for order flow are made as part of exchange-mandated programs and to otherwise attract order volume to our system. Market data fees are fees that we must pay to third parties to receive streaming quotes and related information.
Employee Compensation and Benefits
Employee compensation and benefits includes salaries, bonuses and other incentive compensation plans, group insurance, contributions to benefit programs and other related employee costs.
Occupancy, Depreciation and Amortization
Occupancy expense consists primarily of rental payments on office and data center leases and related occupancy costs, such as utilities. Depreciation and amortization expense results from the depreciation of fixed assets such as computing and communications hardware as well as amortization of leasehold improvements and capitalized in-house software development.
Communications
Communications expense consists primarily of the cost of voice and data telecommunications lines supporting our business including connectivity to exchanges around the world.
General and Administrative
Expenses in this category are primarily incurred for professional services, such as legal and audit work, and other operating expenses such as advertising and exchange membership lease expenses.
Income Tax Expense
Before our IPO in 2007, our business was operated through a limited liability company that was not subject to U.S. federal and certain state income taxes; our income tax expense consisted primarily of corporate subsidiary taxes, and our net income did not reflect cash distributions to IBG LLC's members to pay their taxes related to their proportionate shares of our net income. Those distributions reduced IBG LLC's members' capital. After the IPO, we became subject to taxes applicable to "C" corporations. As a corporation, we are required to pay U.S. federal, state and local income taxes on our taxable income, which is proportional to the percentage of IBG LLC owned by IBG. Our subsidiaries will continue to be subject to income tax in the respective jurisdictions in which they operate.
Non-controlling Interest
We are the sole managing member of IBG LLC and, as such, operate and control all of the business and affairs of IBG LLC and its subsidiaries and consolidate IBG LLC's financial results into our financial statements. We hold approximately 10.8% ownership interest in IBG LLC. IBG Holdings LLC is owned by the original members of IBG LLC and holds approximately 89.2% ownership interest in IBG LLC. We reflect IBG Holdings LLC's ownership as a non-controlling interest in our consolidated statement of financial condition, consolidated statement of income and consolidated statement of changes in equity. Our pre-IPO results are those of IBG LLC, as our predecessor company. As a result, our net income, after excluding IBG Holdings LLC's non-controlling interest, represents approximately 10.8% of IBG LLC's net income and similarly, outstanding shares of our common stock represent approximately 10.8% of the outstanding membership interests of IBG LLC.
46
Certain Trends and Uncertainties
We believe that our continuing operations may be favorably or unfavorably impacted by the following trends that may affect our financial condition and results of operations.
See "Risk Factors" in Part I, Item 1A of this Annual Report on Form 10-K for a discussion of other risks that may affect our financial condition and results of operations.
Non-GAAP Financial Measures
Non-GAAP measures are used to isolate items that the Company's management views as non-operating in nature, which is intended to give a clearer presentation of operating results. Given their material impact on our reported financial results, the following two non-GAAP measures are presented for 2010:
At December 31, 2010, approximately $480 million of accumulated earnings that have not been previously subject to income tax in the U.S. were held in the Company's non-U.S. subsidiaries. Additional dividends originating from these subsidiaries up to this amount (as adjusted over time)
47
would be subject to U.S. income tax, as described above. Dividends paid from the remaining equity capital would not be subject to additional income tax.
The company also decided to pay a dividend equivalent to employees holding unvested shares in our Stock Incentive Plan. This amounted to about $10 million and was recorded as a compensation expense.
A portion of the GLOBALs effect was, in effect, shifted from the reported earnings to the consolidated statement of financial condition. The purpose of this non-GAAP measure is to report all currency translation gains and losses as if they were included in the consolidated statement of income. This analysis contains certain assumptions about tax rates and should, therefore, be considered an estimate.
In summary, these two items reduced diluted EPS by approximately $0.95 for the year. The dividend had an estimated $0.71 impact and the U.S. GAAP presentation of currency translation accounted for an estimated $0.24.
The Company believes that it is appropriate to adjust these non-operating items in the consolidated statement of income in order to achieve a proper representation of the Company's financial performance. For a reconciliation of our U.S. GAAP to non-GAAP results see the 'Supplementary Data' section of Part II, Item 8 "Financial Statements and Supplementary Data," of this Annual Report on Form 10-K.
Results of Operations
The tables in the period comparisons below provide summaries of our revenues and expenses. The period-to-period comparisons below of financial results are not necessarily indicative of future results. The following table sets forth our consolidated results of operations for the indicated periods as well as a comparison of results using non-GAAP measures. Non-GAAP measures are used to isolate items that we view as non-operating in nature and are intended to give a clearer presentation of our operating results. For a reconciliation of our U.S. GAAP to non-GAAP results see the 'Supplementary Data'
48
section of Part II, Item 8 "Financial Statements and Supplementary Data," of this Annual Report on Form 10-K.
|
As Reported Year Ended December 31, |
Non-GAAP Year Ended December 31, |
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2010 | 2009 | 2008 | 2010 | 2009 | 2008 | ||||||||||||||||
|
(in millions) |
(in millions) |
||||||||||||||||||||
Revenues: |
||||||||||||||||||||||
Trading gains |
$ | 368.6 | $ | 633.9 | $ | 1,304.0 | $ | 516.9 | $ | 738.6 | $ | 1,302.3 | ||||||||||
Commissions and execution fees |
386.8 | 353.0 | 359.5 | 386.8 | 353.0 | 359.5 | ||||||||||||||||
Interest income |
172.5 | 121.6 | 437.2 | 172.5 | 121.6 | 437.2 | ||||||||||||||||
Other income |
60.4 | 61.3 | 81.7 | 60.4 | 61.3 | 81.6 | ||||||||||||||||
Total revenues |
988.3 | 1,169.8 | 2,182.4 | 1,136.6 | 1,274.5 | 2,180.6 | ||||||||||||||||
Interest expense |
66.2 | 69.5 | 332.0 | 66.2 | 69.4 | 332.0 | ||||||||||||||||
Total net revenues |
922.1 | 1,100.3 | 1,850.4 | 1,070.4 | 1,205.1 | 1,848.6 | ||||||||||||||||
Non-interest expenses: |
||||||||||||||||||||||
Execution and clearing |
272.6 | 273.2 | 322.7 | 272.6 | 273.2 | 322.7 | ||||||||||||||||
Employee compensation and benefits |
200.2 | 175.8 | 158.0 | 190.7 | 175.8 | 158.0 | ||||||||||||||||
Occupancy, depreciation and amortization |
37.3 | 40.4 | 37.7 | 37.3 | 40.3 | 37.7 | ||||||||||||||||
Communications |
23.5 | 22.8 | 18.7 | 23.5 | 22.8 | 18.7 | ||||||||||||||||
General and administrative |
47.7 | 43.6 | 63.3 | 47.7 | 43.7 | 63.3 | ||||||||||||||||
Total non-interest expenses |
581.3 | 555.8 | 600.4 | 571.8 | 555.8 | 600.4 | ||||||||||||||||
Income before income taxes |
340.8 | 544.5 | 1,250.0 | 498.6 | 649.3 | 1,248.2 | ||||||||||||||||
Income tax expense |
60.4 | 54.4 | 128.4 | 59.0 | 81.5 | 128.0 | ||||||||||||||||
Net Income |
280.4 | 490.1 | 1,121.6 | 439.6 | 567.8 | 1,120.2 | ||||||||||||||||
Less Income attributable to non-controlling interest(1) |
289.7 | 453.9 | 1,028.6 | 408.5 | 524.5 | 1,027.4 | ||||||||||||||||
Net income available for common stockholders |
$ | (9.3 | ) | $ | 36.2 | $ | 93.0 | $ | 31.1 | $ | 43.3 | $ | 92.8 | |||||||||
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The following table sets forth our consolidated results of operations as a percent of our total revenues for the indicated periods:
|
As Reported Year Ended December 31, |
Non-GAAP Year Ended December 31, |
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2010 | 2009 | 2008 | 2010 | 2009 | 2008 | ||||||||||||||||
Revenues: |
||||||||||||||||||||||
Trading gains |
37.3 | % | 54.2 | % | 59.8 | % | 45.5 | % | 58.0 | % | 59.7 | % | ||||||||||
Commissions and execution fees |
39.1 | % | 30.2 | % | 16.5 | % | 34.0 | % | 27.7 | % | 16.5 | % | ||||||||||
Interest income |
17.5 | % | 10.4 | % | 20.0 | % | 15.2 | % | 9.5 | % | 20.0 | % | ||||||||||
Other income |
6.1 | % | 5.2 | % | 3.7 | % | 5.3 | % | 4.8 | % | 3.7 | % | ||||||||||
Total revenues |
100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||||
Interest expense |
6.7 | % | 5.9 | % | 15.2 | % | 5.8 | % | 5.4 | % | 15.2 | % | ||||||||||
Total net revenues |
93.3 | % | 94.1 | % | 84.8 | % | 94.2 | % | 94.6 | % | 84.8 | % | ||||||||||
Non-interest expenses: |
||||||||||||||||||||||
Execution and clearing |
27.6 | % | 23.4 | % | 14.8 | % | 24.0 | % | 21.4 | % | 14.8 | % | ||||||||||
Employee compensation and benefits |
20.3 | % | 15.0 | % | 7.2 | % | 16.8 | % | 13.8 | % | 7.2 | % | ||||||||||
Occupancy, depreciation and amortization |
3.8 | % | 3.5 | % | 1.7 | % | 3.3 | % | 3.2 | % | 1.7 | % | ||||||||||
Communications |
2.4 | % | 1.9 | % | 0.9 | % | 2.1 | % | 1.8 | % | 0.9 | % | ||||||||||
General and administrative |
4.8 | % | 3.7 | % | 2.9 | % | 4.2 | % | 3.4 | % | 2.9 | % | ||||||||||
Total non-interest expenses |
58.8 | % | 47.5 | % | 27.5 | % | 50.3 | % | 43.6 | % | 27.5 | % | ||||||||||
Income before income taxes |
34.5 | % | 46.5 | % | 57.3 | % | 43.9 | % | 50.9 | % | 57.2 | % | ||||||||||
Income tax expense |
6.1 | % | 4.7 | % | 5.9 | % | 5.2 | % | 6.4 | % | 5.9 | % | ||||||||||
Net Income |
28.4 | % | 41.9 | % | 51.4 | % | 38.7 | % | 44.6 | % | 51.4 | % | ||||||||||
Less Income attributable to non-controlling interest |
29.3 | % | 38.8 | % | 47.1 | % | 35.9 | % | 41.2 | % | 47.1 | % | ||||||||||
Net income available for common stockholders |
(0.9 | )% | 3.1 | % | 4.3 | % | 2.7 | % | 3.4 | % | 4.3 | % | ||||||||||
Year Ended December 31, 2010 Compared to the Year Ended December 31, 2009
Net Revenues
Total net revenues for the year ended December 31, 2010 decreased $178.2 million or 16%, to $922.1 million from $1,100.3 million during the year ended December 31, 2009. On a non-GAAP basis, total net revenues for the year ended December 31, 2010 decreased $134.7 million or 11% to $1,070.4 million from $1,205.1 million during the year ended December 31, 2009. Trading volume is an important driver of revenues and costs for both our market making and electronic brokerage segments. During 2010, options and futures contracts and stock shares volume executed by our subsidiaries increased by 6%, 17% and 12% respectively. The increase in contract and share volumes was driven by our brokerage segment which saw increases in options and futures contracts and stock shares volume of 14%, 20% and 33% respectively. This increased volume contributed to an increase of $33.8 million in commissions and execution fees while increased customer cash and margin balances contributed to an increase of $43.1 million in net interest income in that segment. In our market making segment, increased competition from HFT's, contracted bid/offer spreads and losses from foreign currency translation contributed to a decrease of $265.3 million in trading gains.
Trading Gains. Overall trading gains for the year ended December 31, 2010 decreased $265.3 million, or 42%, to $368.6 million from $633.9 million for the year ended December 31, 2009. On a non-GAAP basis, trading gains for the year ended December 31, 2010 decreased $221.7 million, or 30% to $516.9 million from $738.6 million for the year ended December 31, 2009. As market
50
makers, we provide liquidity by buying from sellers and selling to buyers. During the year ended December 31, 2010, our market making operations executed 75.2 million trades, a decrease of 20% compared to the number of trades executed in the year ended December 31, 2009. Options and futures contracts increased 1% and 2%, respectively, and stock shares volume decreased by 27% for the year ended December 31, 2010 compared to 2009. The decrease in trading gains was primarily due to tighter bid/offer spreads on exchange listed options versus the previous year, increased competition from high frequency traders and foreign currency fluctuations as explained in the Business Environment section above.
Included in trading gains are net dividends, net bond trading interest and currency translation gains and losses from market making activities. Dividend income and expense arise from holding market making positions over dates on which dividends are paid to shareholders of record. When a stock pays a dividend, its market price is generally adjusted downward to reflect the value paid to the shareholders of record, which will not be received by those who purchase stock after the ex-dividend date. Hence, the apparent gains and losses due to these price changes, reflecting the value of dividends paid to shareholders, must be taken together with the dividends paid and received, respectively, in order to accurately reflect the results of our market making operations. As part of managing our overall exposure to foreign currency fluctuations, we maintain a portion of our capital in foreign currencies. Translation losses of $244.0 million were recognized in the year ended December 31, 2010, primarily from foreign currency balances held by our subsidiaries, compared to translation losses of $8.7 million for the year ended December 31, 2009. Translation gain or loss is reported in accordance with the FASB Codification and does not contain the full translation effects of our policy of maintaining our equity in proportion to the basket of currencies we refer to as the GLOBAL, part of which may be reported as trading gains and part as other comprehensive income, which is reported in the consolidated statement of financial condition. A discussion of our approach to managing foreign currency exposure is contained in Part II, Item 7A of this Annual Report on Form 10-K entitled "Quantitative and Qualitative Disclosures about Market Risk."
Commissions and Execution Fees. Commissions and execution fees for the year ended December 31, 2010 increased $33.8 million, or 10%, to $386.8 million, as compared to the year ended December 31, 2009. The increase was driven by higher overall trade volume from our customers. Volume in options and futures contracts and stock shares increased by 14%, 20% and 33%, respectively, for the year ended December 31, 2010 from 2009. In the second quarter we lowered our commissions for U.S. futures by approximately 10% on an average order, which further helped the growth of our U.S. futures customer business. Total DARTs for cleared and execution-only customers for the year ended December 31, 2010 increased 9% to approximately 379,000, compared to approximately 347,000 during the year ended December 31, 2009. DARTs for cleared customers, i.e., customers for whom we execute trades as well as clear and carry positions, increased 9% to approximately 343,000, for the year ended December 31, 2010, compared to approximately 316,000 for the year ended December 31, 2009. The number of customer accounts grew by 18% to approximately 158,000 at December 31, 2010, compared to approximately 134,000 at December 31, 2009. Average commission per DART for cleared customers, for the year ended December 31, 2010, increased by 1% to $4.28, as compared to $4.24 for the year ended December 31, 2009.
Interest Income and Interest Expense. Net interest income (interest income less interest expense) for the year ended December 31, 2010 increased $54.2 million, or 104%, to $106.3 million, as compared to the year ended December 31, 2009. Net interest income was derived primarily from the electronic brokerage segment during the year ended December 31, 2010. Net interest earned by electronic brokerage increased $43.1 million, or 78%, to $98.5 million, as compared to the year ended December 31, 2009. Average customer cash balances increased by 46%, to $12.41 billion, and average customer fully secured margin borrowings increased 98%, to $4.91 billion, for the year ended December 31, 2010, as compared to $8.49 billion and $2.48 billion, on average, respectively, for the
51
year ended December 31, 2009. The average Fed Funds effective rate increased 2 basis points to 0.18% for the year ended December 31, 2010 compared to the year ended December 31, 2009. For market making, net interest income increased $11.3 million from the same period last year to $7.5 million. As a result of the way we have integrated our market making and securities lending systems, our trading income and our net interest income are interchangeable and depend on the mix of market making positions in our portfolio. When implied interest rates in the equity and equity options and futures markets exceed the actual interest rates available to us, our market making systems tend to buy stock and sell it forward, which produces higher trading gains and lower net interest income. When these rates are inverted, our market making systems tend to sell stock and buy it forward, which produces lower trading gains and higher net interest income. The relative interest rates during the year ended December 31, 2010 resulted in a mix of positions that produced more interest income and less trading income than in the year ended December 31, 2009. Average securities borrowed decreased by 3%, to $4.86 billion and average securities loaned increased by 78%, to $1.44 billion, for the year ended December 31, 2010.
Other Income. Other income, for the year ended December 31, 2010, decreased $0.9 million, or 2%, to $60.4 million, as compared to the year ended December 31, 2009. This decrease was primarily attributable to a $10.8 million decrease in order flow income due to the continued expansion of the penny pricing pilot and increased options volume executed on exchanges using the make-or-take pricing model, where we are paid for providing liquidity and charged for taking liquidity instead of collecting payment for order flow. This decrease was partially offset by an increase of $6.6 million in market data fee income, a result of our expanding customer base.
Non-Interest Expenses
Non-interest expenses, for the year ended December 31, 2010, increased by $25.5 million, or 5%, to $581.3 million from $555.8 million, during the year ended December 31, 2009. The increase was primarily due to higher employee compensation and benefits costs as well as higher general and administrative expenses. As a percentage of total net revenues, non-interest expenses increased to 63% for the year ended December 31, 2010 from 51% during the same period in 2009.
Execution and Clearing. Execution and clearing expenses, for the year ended December 31, 2010, decreased $0.6 million, or less than 1%, to $272.6 million, as compared to the year ended December 31, 2009. Despite higher trading volume in all product classes, the decrease resulted from lower exchange fees at certain U.S. options exchanges with the make-or-take pricing models, offset by an increase in exchange and clearing fees on a 17% rise in futures contract volume traded during the year ended December 31, 2010.
Employee Compensation and Benefits. Employee compensation and benefits expenses, for the year ended December 31, 2010, increased by $24.4 million, or 14%, to $200.2 million, as compared to the year ended December 31, 2009. This increase reflects the 8% growth in the average number of employees to 836 for the year ended December 31, 2010, as compared to 777 for the same period in 2009. It also includes a $9.5 million dividend equivalent payment to employees holding unvested shares of IBKR stock in the Company's Stock Incentive Plan, which the Company elected to make in connection to the special dividend paid in December 2010. As we continue to grow, our focus on automation has allowed us to maintain a relatively small staff. The continued recognition of costs associated with of our stock incentive plan also increased employee compensation and benefits expense. As a percentage of total net revenues and including the special dividend equivalent payment, employee compensation and benefits expenses were 22% and 16%, for the years ended December 31, 2010 and 2009, respectively.
Occupancy, Depreciation and Amortization. Occupancy, depreciation and amortization expenses decreased $3.1 million, or 8%, to $37.3 million for the year ended December 31, 2010 from
52
$40.4 million for the year ended December 31, 2009 primarily due to decreased depreciation and amortization expenses related to capitalized software from one of our subsidiaries which was fully amortized at the end of 2009. As a percentage of total net revenues, occupancy, depreciation and amortization expenses were 4% in both of the years ended December 31, 2010 and 2009.
Communications. Communications expenses increased $0.7 million, or 3%, to $23.5 million for the year ended December 31, 2010 from $22.8 million for the year ended December 31, 2009. This increase was driven by additional telecommunications bandwidth required to support increased trading volume at electronic exchanges and an expansion in the number of markets in which IBG LLC operates. As a percentage of total net revenues, communications expenses were 3% and 2% for the years ended December 31, 2010 2009, respectively.
General and Administrative. General and administrative expenses, for the year ended December 31, 2010, increased $4.1 million, or 9% to $47.7 million, as compared to the year ended December 31, 2009. The increase in general and administrative expenses was attributable to bad debt expense, which was primarily a result of unusual market volatility during the "flash crash" on May 6, 2010.
Income Tax Expense. Income tax expense for the year ended December 31, 2010 increased $6.0 million or 11% compared to income tax expense for the year ended December 31, 2009, while income before taxes decreased by $203.7 million or 37% during the same period. The increase in income tax expense is primarily due to the special dividend paid in December 2010. In December 2010, the Company effected a series of dividend payments, including a dividend of $1.79 per share, which was paid to holders of the Company's common stock. On a consolidated reporting basis, the dividends had no effect on the Company's reported income before taxes. However, the U.S. federal income tax liability triggered by the dividends is reported as income tax expense in the consolidated statement of income. On December 21, 2010, Timber Hill Europe (AG) ("THE AG") paid its sole shareholder, IBG LLC, a dividend of $990.3 million. THE AG's pretax earnings had not previously been subject to taxation in the United States. U.S. federal income taxes on the Company's share of this dividend were $40.8 million.
Year Ended December 31, 2009 Compared to the Year Ended December 31, 2008
Net Revenues
Total net revenues for the year ended December 31, 2009 decreased $750.1 million, or 41%, to $1,100.3 million from $1,850.4 million, during the year ended December 31, 2008. Trading volume is one of the most important drivers of revenues and costs for both our market making and electronic brokerage segments. Based on data received from options exchanges worldwide, global equity options volume in 2009 increased approximately 3%, compared to 2008. For the year ended December 31, 2009, options contracts executed by our subsidiaries decreased by 114.4 million, or 15%, to 643.4 million contracts from 757.7 million contracts for the year ended December 31, 2008.
Trading Gains. Trading gains for the year ended December 31, 2009 decreased $670.1 million, or 51%, to $633.9 million from $1,304.0 million for the year ended December 31, 2008. As market makers, we provide liquidity by buying from sellers and selling to buyers. During 2009, our market making operations executed 93.6 million trades, a decrease of 8% compared to the number of trades executed in the year ended December 31, 2008. Market making options contract volume in the year ended December 31, 2009 decreased by 17% from the same period in 2008.
Included in trading gains are net dividends and currency translation gains and losses from market making activities. Dividend income and expense arise from holding market making positions over dates on which dividends are paid to shareholders of record. When a stock pays a dividend, its market price is generally adjusted downward to reflect the value paid to the shareholders of record, which will not
53
be received by those who purchase stock after the ex-dividend date. Hence, the apparent gains and losses due to these price changes, reflecting the value of dividends paid to shareholders, must be taken together with the dividends paid and received, respectively, in order to accurately reflect the results of our market making operations. As part of managing our overall exposure to foreign currency fluctuations, we maintain a portion of our capital in foreign currencies. Translation losses of $8.7 million were recognized in the year ended December 31, 2009, on foreign currency balances held by our subsidiaries, compared to translation losses of $56.0 million for the year ended December 31, 2008. A discussion of our approach to managing foreign currency exposure is contained in Part II, Item 7A of this Annual Report on Form 10-K entitled "Quantitative and Qualitative Disclosures about Market Risk."
Commissions and Execution Fees. Commissions and execution fees for the year ended December 31, 2009 decreased $6.5 million, or 2%, to $353.0 million, as compared to the year ended December 31, 2008 This was due to a 23% decrease in futures volume and a 12% decrease in options volume offset, in part, by a 65% increase in stock share volume. Total DARTs for cleared and execution-only customers for the year ended December 31, 2009 decreased 3% to approximately 347,000, compared to approximately 357,000 during the year ended December 31, 2008. DARTs for cleared customers, i.e., customers for whom we execute trades as well as clear and carry positions, remained consistent at approximately 316,000, for the years ended December 31, 2009 and 2008, respectively. The number of customer accounts grew by 21% to approximately 134,000 at December 31, 2009, compared to approximately 111,000 at December 31, 2008. Average commission per DART for cleared customers, for the year ended December 31, 2009, increased by 2%, to $4.24, as compared to $4.17 for the year ended December 31, 2008 primarily due to an increase in the average trade sizes across the products our customers traded.
Interest Income and Interest Expense. Net interest income (interest income less interest expense) for the year ended December 31, 2009 decreased $53.1 million, or 51%, to $52.1 million, as compared to the year ended December 31, 2008. Net interest income was derived entirely from the electronic brokerage segment during the year ended December 31, 2009. For market making, net interest declined $41.3 million from the same period last year to a net expense of $3.8 million. As a result of the way we have integrated our market making and securities lending systems, our trading income and our net interest income are interchangeable and depend on the mix of market making positions in our portfolio. When implied interest rates in the equity and equity options and futures markets exceed the actual interest rates available to us, our market making systems tend to buy stock and sell it forward, which produces higher trading gains and lower net interest income. When these rates are inverted, our market making systems tend to sell stock and buy it forward, which produces lower trading gains and higher net interest income. The relative interest rates during 2009 resulted in a mix of positions that produced more trading income and less interest income. Average securities borrowed decreased by 16%, to $4.98 billion and average securities loaned decreased by 73%, to $0.85 billion, for the year ended December 31, 2009, as market making short stock positions contracted and our strong liquidity position reduced our financing needs in the securities lending markets. Customer cash balances increased by 53%, to $10.59 billion, end-of-period, and customer fully secured margin borrowings increased 108%, to $3.23 billion, end-of-period, at December 31, 2009, as compared to $6.93 billion and $1.55 billion, end-of-period, respectively, at December 31, 2008. Lower interest rates had a negative effect on the net interest income we earned on customer cash balances. The average Fed Funds effective rate dropped approximately 1.76% to 0.16% for the year ended December 31, 2009 as compared to 1.92% for the year ended December 31, 2008. Net interest earned in electronic brokerage decreased $20.7 million, or 27%, to $55.4 million, as compared to the year ended December 31, 2008.
Other Income. Other income, for the year ended December 31, 2009, decreased $20.4 million, or 25%, to $61.3 million, as compared to the year ended December 31, 2008. This decrease was primarily attributable to a $13.6 million decrease in payment for order flow income received by our brokerage
54
unit, resulting from increased options volume executed on exchanges using the make-or-take model, where we do not receive payments for order flow, and the expansion of the options penny pricing program in the U.S., which was introduced in February 2007 and extended to 63 options classes in March 2008 and 138 classes in October of 2009, under which payments for order flow are smaller on a per contract basis. Also contributing to other income was a $2.7 million mark-to-market loss on non-trading securities recognized during the year ended December 31, 2009 compared to $8.9 million in mark-to-market gains on non-trading securities recognized during the year ended December 31, 2008 and a decrease of $7.8 million in liquidity rebates earned by our U.S. market making unit. This was partially offset by a $6.0 million increase in market data fee income.
Non-Interest Expenses
Non-interest expenses, for the year ended December 31, 2009, decreased by $44.6 million, or 7%, to $555.8 million from $600.4 million, during the year ended December 31, 2008. Execution and clearing expenses made up 49% and employee compensation and benefits were 32% of non-interest expenses. As a percentage of total net revenues, non-interest expenses increased to 51% for the year ended December 31, 2009 from 32% during the same period in 2008.
Execution and Clearing. Execution and clearing expenses, for the year ended December 31, 2009, decreased $49.5 million, or 15%, to $273.2 million, as compared to the year ended December 31, 2008 primarily due to decreased trading volume across the futures and options markets in which the Group and its customers traded as well as to a shift in volume towards products with lower execution costs or liquidity rebates. Trading volume for options and futures decreased 15% and 24% respectively while stock shares volume increased 35% for the year ended December 31, 2009 compared to the prior year.
Employee Compensation and Benefits. Employee compensation and benefits expenses, for the year ended December 31, 2009, increased by $17.8 million, or 11%, to $175.8 million, as compared to the year ended December 31, 2008. This increase reflected the 9% growth in the average number of employees to 776 for the year ended December 31, 2009, as compared to 714 for the year ended December 31, 2008. The continued phase in of our stock incentive plan also increased employee compensation and benefits expense. As we continue to grow, our focus on automation has allowed us to maintain a relatively small staff. As a percentage of total net revenues, employee compensation and benefits expenses were 16% and 9%, for the years ended December 31, 2009 and 2008, respectively.
Occupancy, Depreciation and Amortization. Occupancy, depreciation and amortization expenses increased $2.7 million, or 7%, to $40.4 million for the year ended December 31, 2009 from $37.7 million for the year ended December 31, 2008 primarily due to increased expenses for additional office and data center space and expenses related to the termination of an office lease. As a percentage of total net revenues, occupancy, depreciation and amortization expenses were 4% in the year ended December 31, 2009 and 2% in the year ended December 31, 2008.
Communications. Communications expenses increased $4.1 million, or 22%, to $22.8 million for the year ended December 31, 2009 from $18.7 million for the year ended December 31, 2008. This increase was driven by additional telecommunications bandwidth required to support increased trading volume at electronic exchanges and the expansion in the number of markets in which IBG LLC operates. As a percentage of total net revenues, communications expenses were 2% for the year ended December 31, 2009 and 1% for the year ended December 31, 2008.
General and Administrative. General and administrative expenses, for the year ended December 31, 2009, decreased $19.7 million, or 31%, to $43.6 million, as compared to the year ended December 31, 2008, primarily due to decreased expenses for legal contingencies and customer bad debts, partially offset by increased local value added and other "non-income" tax expenses incurred by our foreign operating companies and increased advertising expenses.
Income Tax Expense. Income tax expense for the year ended December 31, 2009 decreased $74 million or 58% compared to income tax expense for the year ended December 31, 2008. The decrease in income tax expense is primarily due to the decrease in the company's taxable income.
55
Supplemental Information
The following tables present historical trading volumes for our business. However, volumes are not the only drivers in our business.
TRADE VOLUMES:
(in 000's, except %)
Period
|
Market Making Trades |
% Change | Brokerage Cleared Trades |
% Change | Brokerage Non Cleared Trades |
% Change | Total Trades |
% Change | Avg. Trades per U.S. Trading Day |
|||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2006 |
66,043 | 51,238 | 12,828 | 130,109 | 518 | |||||||||||||||||||||||
2007 |
99,086 | 50 | % | 72,931 | 42 | % | 16,638 | 30 | % | 188,655 | 45 | % | 752 | |||||||||||||||
2008 |
101,672 | 3 | % | 120,195 | 65 | % | 16,966 | 2 | % | 238,833 | 27 | % | 944 | |||||||||||||||
2009 |
93,550 | (8 | )% | 127,338 | 6 | % | 13,636 | (20 | )% | 234,524 | (2 | )% | 934 | |||||||||||||||
2010 |
75,169 | (20 | )% | 133,658 | 5 | % | 18,732 | 37 | % | 227,559 | (3 | )% | 905 |
CONTRACT AND SHARE VOLUMES:
(in 000's, except %)
TOTAL
Period
|
Options (contracts) |
% Change | Futures* (contracts) |
% Change | Stocks (shares) |
% Change | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2006 |
563,623 | 62,419 | 34,493,410 | ||||||||||||||||
2007 |
673,144 | 19 | % | 83,134 | 33 | % | 47,324,798 | 37 | % | ||||||||||
2008 |
757,732 | 13 | % | 108,984 | 31 | % | 55,845,428 | 18 | % | ||||||||||
2009 |
643,380 | (15 | )% | 82,345 | (24 | )% | 75,449,891 | 35 | % | ||||||||||
2010 |
678,856 | 6 | % | 96,193 | 17 | % | 84,469,874 | 12 | % |
MARKET MAKING
Period
|
Options (contracts) |
% Change | Futures* (contracts) |
% Change | Stocks (shares) |
% Change | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2006 |
371,929 | 14,818 | 21,180,377 | ||||||||||||||||
2007 |
447,905 | 20 | % | 14,520 | (2 | )% | 24,558,314 | 16 | % | ||||||||||
2008** |
514,629 | 15 | % | 21,544 | 48 | % | 26,008,433 | 6 | % | ||||||||||
2009** |
428,810 | (17 | )% | 15,122 | (30 | )% | 26,205,229 | 1 | % | ||||||||||
2010** |
435,184 | 1 | % | 15,371 | 2 | % | 19,165,000 | (27 | )% |
BROKERAGE TOTAL
Period
|
Options (contracts) |
% Change | Futures* (contracts) |
% Change | Stocks (shares) |
% Change | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2006 |
191,694 | 47,601 | 13,313,033 | ||||||||||||||||
2007 |
225,239 | 17 | % | 68,614 | 44 | % | 22,766,484 | 71 | % | ||||||||||
2008 |
243,103 | 8 | % | 87,440 | 27 | % | 29,836,995 | 31 | % | ||||||||||
2009 |
214,570 | (12 | )% | 67,223 | (23 | )% | 49,244,662 | 65 | % | ||||||||||
2010 |
243,672 | 14 | % | 80,822 | 20 | % | 65,304,874 | 33 | % |
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CONTRACT AND SHARE VOLUMESContinued:
(in 000's, except %)
BROKERAGE CLEARED
Period
|
Options (contracts) |
% Change | Futures* (contracts) |
% Change | Stocks (shares) |
% Change | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2006 |
32,384 | 45,351 | 12,492,870 | ||||||||||||||||
2007 |
51,586 | 59 | % | 66,278 | 46 | % | 20,353,584 | 63 | % | ||||||||||
2008 |
77,207 | 50 | % | 85,599 | 29 | % | 26,334,752 | 29 | % | ||||||||||
2009 |
93,868 | 22 | % | 66,241 | (23 | )% | 46,627,344 | 77 | % | ||||||||||
2010 |
103,054 | 10 | % | 79,144 | 19 | % | 62,077,741 | 33 | % |
BROKERAGE STATISTICS:
(in 000's, except % and where noted)
|
4Q2010 | 4Q2009 | % Change | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Total Accounts |
158 | 134 | 18 | % | ||||||
Customer Equity (in billions)* |
$ | 22.1 | $ | 15.2 | 45 | % | ||||
Cleared DARTs |
337 | 309 | 9 | % | ||||||
Total Customer DARTs |
373 | 346 | 8 | % | ||||||
(in $'s, except DART per account) |
||||||||||
Commission per DART |
$ | 4.35 | $ | 4.36 | 0 | % | ||||
DART per Avg. Account (Annualized) |
550 | 597 | (8 | )% | ||||||
Net Revenue per Avg. Account (Annualized) |
$ | 3,569 | $ | 3,529 | 1 | % |
Business Segments
The following sections discuss results of our operations by business segment, excluding a discussion of corporate income and expense. In the following tables, revenues and expenses directly associated with each segment are included in determining income before income taxes. Due to the integrated nature of the business segments, estimates and judgments have been made in allocating certain revenue and expense items. Transactions between segments generally result from one subsidiary facilitating the business of another subsidiary through the use of its existing trading memberships and clearing arrangements. In such cases, certain revenue and expense items are eliminated in order to accurately reflect the external business conducted in each segment. Rates on transactions between segments are designed to approximate full costs. In addition to execution and clearing expenses, which are the main cost driver for both the market making segment and the electronic brokerage segment, each segment's operating expenses include (i) employee compensation and benefits expenses that are incurred directly in support of the businesses, (ii) general and administrative expenses, which include directly incurred expenses for property leases, professional fees, travel and entertainment, communications and information services, equipment, and (iii) indirect support costs (including compensation and other related operating expenses) for administrative services provided by IBG LLC. Such administrative services include, but are not limited to, computer software development and support, accounting, tax, legal and facilities management.
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Market Making
The following table sets forth the results of our market making operations for the indicated periods:
|
As Reported Year Ended December 31, |
Non-GAAP Year Ended December 31, |
|||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2010 | 2009 | 2008 | 2010 | 2009 | 2008 | |||||||||||||||
|
(in millions) |
(in millions) |
|||||||||||||||||||
Revenues: |
|||||||||||||||||||||
Trading gains |
$ | 358.4 | $ | 621.5 | $ | 1,277.0 | $ | 506.8 | $ | 726.3 | $ | 1,275.3 | |||||||||
Interest income |
57.5 | 62.5 | 244.6 | 57.5 | 62.5 | 244.6 | |||||||||||||||
Other income |
13.3 | 8.7 | 29.0 | 13.3 | 8.7 | 29.0 | |||||||||||||||
Total revenues |
429.2 | 692.7 | 1,550.6 | 577.6 | 797.5 | 1,548.9 | |||||||||||||||
Interest expense |
50.0 | 66.3 | 207.1 | 50.0 | 66.3 | 207.1 | |||||||||||||||
Total net revenues |
379.2 | 626.4 | 1,343.5 | 527.6 | 731.2 | 1,341.8 | |||||||||||||||
Non-interest expenses: |
|||||||||||||||||||||
Execution and clearing |
144.8 | 165.2 | 195.3 | 144.8 | 165.2 | 195.3 | |||||||||||||||
Employee compensation and benefits |
70.3 | 65.3 | 59.8 | 70.3 | 65.3 | 59.8 | |||||||||||||||
Occupancy, depreciation and amortization |
10.1 | 10.5 | 9.6 | 10.1 | 10.5 | 9.7 | |||||||||||||||
Communications |
12.6 | 12.5 | 10.5 | 12.6 | 12.5 | 10.4 | |||||||||||||||
General and administrative |
51.9 | 42.1 | 40.7 | 51.9 | 42.1 | 40.7 | |||||||||||||||
Total non-interest expenses |
289.7 | 295.6 | 315.9 | 289.7 | 295.6 | 315.9 | |||||||||||||||
Income before income taxes |
$ | 89.5 | $ | 330.8 | $ | 1,027.6 | $ | 237.9 | $ | 435.6 | $ | 1,025.9 | |||||||||
Year Ended December 31, 2010 Compared to the Year Ended December 31, 2009
Market making total net revenues for the year ended December 31, 2010 decreased $247.2 million, or 39%, to $379.2 million, from $626.4 million during the year ended December 31, 2009. On a non-GAAP basis, market making total net revenues for the year ended December 31, 2010 decreased $203.6 million or 28% to $527.6, from $731.2 million during the year ended December 31, 2009. Trading gains for the year ended December 31, 2010 decreased $263.1 million, or 42%, primarily due to tighter bid/offer spreads on exchange-traded options and low levels of volatility during the year ended December 31, 2010. On a non-GAAP basis, trading gains for the year ended December 31, 2010 decreased $219.5 million, or 30% to $506.8 million, from $726.3 million during the year ended December 31, 2009. Market making futures and options contract volume increased 2% and 1% respectively and stock share volume decreased 27%, in the year ended December 31, 2010 as compared to the same period in 2009. In 2010 we began selectively to pare down trading in less profitable products. Trading gains also include translation gains and losses. Translation losses, for the year ended December 31, 2010 were $243.9 million as compared to translation losses of $8.4 million, for the year ended December 31, 2009. Translation gain or loss is reported in accordance with the FASB Codification and does not contain the full translation effects of our policy of maintaining our equity in proportion to the basket of currencies we refer to as the GLOBAL, part of which may be reported as trading gains and part as Other Comprehensive Income, which is reported in the Statement of Financial Condition. A discussion of our approach to managing foreign currency exposure is contained in Part I, Item 3 of this Annual Report on Form 10-K entitled "Quantitative and Qualitative Disclosures about Market Risk." Net interest income for the year ended December 31, 2010 increased by $11.3 million to $7.5 million. As described above, our trading gains and our net interest income are interchangeable and depend on the mix of market making positions in our portfolio and on relative
58
interest rates in the stock and options markets. In the year ended December 31, 2010, these factors produced more interest income and less trading gains than in 2009.
Market making non-interest expenses for the year ended December 31, 2010 decreased $5.9 million, or 2%, as compared to the year ended December 31, 2009. The decrease primarily resulted from a $20.4 million decrease in execution and clearing fees, partially offset by a $9.8 million increase in general and administrative fees and a $5.0 million increase in employee compensation and benefits expenses during the year ended December 31, 2010 compared to 2009. Within execution and clearing fees, exchange order flow expenses decreased $15.9 million during the year ended December 31, 2010 compared to the same period in 2009. This decrease was driven by a greater proportion of our U.S. options volume executed on exchanges with make-or-take pricing, which do not collect payment for order flow. The increase in general and administrative fees was largely a result of a $7.8 million increase in administrative and consulting fees during the year ended December 31, 2010 compared to the same period in 2009. Employee compensation expenses increased as a result of a $2.2 million increase in expenses related to our employee stock incentive plan and a $6.1 million increase in expenses related to salaries and bonuses. As a percentage of total net revenues, market making non-interest expenses increased to 76% from 47% for the year ended December 31, 2010 and 2009, respectively.
Market making income before income taxes decreased $241.3 million, or 73%, to $89.5 million for the year ended December 31, 2010 from $330.8 million for the year ended December 31, 2009. As a percentage of total net revenues for the market making segment, income before income taxes were 24% and 53% for the years ended December 31, 2010 and 2009, respectively. On a non-GAAP basis, market making income before income taxes for the year ended December 31, 2010 decreased $197.7 million, or 45%, to $237.9 million from $435.6 million for the year ended December 31, 2009.
Year Ended December 31, 2009 Compared to the Year Ended December 31, 2008
Market making total net revenues for the year ended December 31, 2009 decreased $717.1 million, or 53%, to $626.4 million, from $1,343.5 million during the year ended December 31, 2009. Trading gains for the year ended December 31, 2009 decreased $655.5 million, or 51%, primarily due to the compression of bid/offer spreads which have narrowed substantially in 2009, an increasing level of competition from high frequency traders and adverse changes in the implied volatilities at which options trade. Market making options contract volume in the year ended December 31, 2009 decreased by 17% from the same period in 2008. Trading gains also include translation gains and losses. Translation losses, for the year ended December 31, 2009, were $8.4 million, as compared to translation losses of $68.7 million, for the year ended December 31, 2008. Net interest income, for the year ended December 31, 2009, decreased by $41.3 million to a net expense of $3.8 million. As described above, our trading income and our net interest income are interchangeable and depend on the mix of market making positions in our portfolio and on the relative interest rates in the stock and options markets. In 2009 these factors produced more trading income and less interest income.
Market making non-interest expenses for the year ended December 31, 2009 decreased $20.3 million, or 6%, as compared to the year ended December 31, 2008. This change was driven by a $30.1 million decrease in execution and clearing costs, which reflects lower options and futures volume and liquidity rebates on stock trading. For the year ended December 31, 2009 options and futures contract volumes decreased by 17% and 30%, respectively, as compared to the year ended December 31, 2008. Stock share volume rose a modest 1% compared to the year ended December 31, 2008. As a percentage of total net revenues, market making non-interest expenses increased to 47% from 24% for the years ended December 31, 2009 and 2008.
Market making income before income taxes decreased $696.8 million, or 68%, to $330.8 million for the year ended December 31, 2009 from $1,027.6 million for the year ended December 31, 2008. As
59
a percentage of total net revenues for the market making segment, income before income taxes were 53% and 77% for the years ended December 31, 2009 and 2008, respectively.
Electronic Brokerage
The following table sets forth the results of our electronic brokerage operations for the indicated periods:
|
Year Ended December 31, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2010 | 2009 | 2008 | |||||||||
|
(in millions) |
|||||||||||
Revenues: |
||||||||||||
Commissions and execution fees |
$ | 386.8 | $ | 353.0 | $ | 359.5 | ||||||
Interest income |
119.1 | 66.5 | 206.4 | |||||||||
Other income |
62.0 | 66.0 | 70.2 | |||||||||
Total revenues |
567.9 | 485.5 | 636.1 | |||||||||
Interest expense |
20.6 | 11.1 | 130.3 | |||||||||
Total net revenues |
547.3 | 474.4 | 505.8 | |||||||||
Non-interest expenses: |
||||||||||||
Execution and clearing |
127.5 | 108.6 | 129.2 | |||||||||
Employee compensation and benefits |
56.8 | 51.0 | 47.8 | |||||||||
Occupancy, depreciation and amortization |
13.6 | 17.3 | 16.5 | |||||||||
Communications |
10.7 | 10.2 | 8.2 | |||||||||
General and administrative |
63.9 | 56.1 | 80.1 | |||||||||
Total non-interest expenses |
272.5 | 243.2 | 281.8 | |||||||||
Income before income taxes |
$ | 274.8 | $ | 231.2 | $ | 224.0 | ||||||
Year Ended December 31, 2010 Compared to the Year Ended December 31, 2009
Electronic brokerage total net revenues for the year ended December 31, 2010 increased $72.9 million, or 15%, to $547.3 million, from $474.4 million during the year ended December 31, 2009, primarily due to higher commission and execution fees and an increase in net interest income. Commission and execution fees increased $33.8 million, or 10%, and net interest income increased $43.1 million, or 78%, for the year ended December 31, 2010 compared to the same period in 2009. The increase in net interest income was attributable to an increase of $3.92 billion in average customer cash balances and an increase of $2.44 billion in average fully secured margin borrowings. Contributing to the increase in net interest income, the average Fed Funds effective rate increased approximately 2 basis points to 0.18% for the year ended December 31, 2010 as compared to 0.16% for the year ended December 31, 2009. The increase in commission and execution fees is mainly due to increased customer trading volume. Volume in options and futures contracts and stock shares increased by 14%, 20% and 33%, respectively, for the year ended December 31, 2010 from the same period in 2009. Total DARTs from cleared and execution-only customers for the year ended December 31, 2010 increased 9% to approximately 379,000, compared to approximately 347,000 during the year ended December 31, 2009. DARTs from cleared customers for the year ended December 31, 2010 increased 9% to approximately 343,000, compared to approximately 316,000 during the year ended December 31, 2009. Total customer equity grew by 45% to $22.1 billion at December 31, 2010, from $15.2 billion at December 31, 2009. The number of customer accounts grew 18% from December 31, 2009 to approximately 158,000.
60
Electronic brokerage non-interest expenses for the year ended December 31, 2010 increased $29.3 million, or 12%, as compared to the year ended December 31, 2009. Within non-interest expenses, execution and clearing expenses increased by $18.9 million, driven by a 20% increase in customer futures trading volume, as well as increases in fees charged by certain U.S. options exchanges, resulting from a greater proportion of make-or-take volume, where we are charged for taking liquidity. Employee compensation and benefits expenses increased by $5.8 million, or 11% during the year ended December 31, 2010 compared to 2009. General and administrative expenses increased $7.8 million as bad debt expense increased $3.1 million during the year ended December 31, 2010 compared to 2009. As a percentage of total net revenues, non-interest expenses decreased to 50% from 51% for the year ended December 31, 2010 as compared to 2009.
Electronic brokerage income before income taxes increased $43.6 million, or 19%, to $274.8 million for the year ended December 31, 2010 from $231.2 million for the year ended December 31, 2009. As a percentage of total net revenues for the electronic brokerage segment, income before income taxes was 50% and 49% for the years ended December 31, 2010 and 2009, respectively.
Year ended December 31, 2009 Compared to the Year ended December 31, 2008
Electronic brokerage total net revenues for the year ended December 31, 2009 decreased $31.4 million, or 6%, to $474.4 million, from $505.8 million during the year ended December 31, 2008, primarily due to lower net interest income. This decrease reflects lower interest rates which reduced the spreads we earned on customer cash balances. The average Fed Funds effective rate dropped approximately 1.76% to 0.16% for the year ended December 31, 2009 as compared to 1.92% for the year ended December 31, 2008. Commission and execution fees decreased $6.5 million, or 2%, for the year ended December 31, 2009 compared to the prior year due to a 23% decrease in futures volume, which generates higher per unit revenue but lower gross profit margin, for cleared customers along with a 12% decrease in options volume. Total DARTs from cleared and execution-only customers for the year ended December 31, 2009 decreased 3% to approximately 347,000, compared to approximately 357,000 during the year ended December 31, 2008. DARTs from cleared customers for the year ended December 31, 2009 were unchanged at approximately 316,000. Total customer equity grew by 71% to $15.2 billion at December 31, 2009, from $8.9 billion at December 31, 2008. The number of customer accounts grew 21% from December 31, 2008 to approximately 134,000. Other Income was lower primarily due to a decrease in payment for order flow ("PFOF"), received through programs administered by U.S. options exchanges. PFOF decreased $13.6 million, or 28%, primarily due to the expansion of the penny pricing program, as well as, increased options volume executed on exchanges using the make-or-take model where we do not receive payments for order flow.
Electronic brokerage non-interest expenses for the year ended December 31, 2009 decreased $38.6 million, or 14%, as compared to the year ended December 31, 2008. Within non-interest expenses, execution and clearing expenses decreased by $20.6 million, which reflects a shift in trade volume to products with lower costs or liquidity rebates. Stock shares traded by our customers increased 65% over the year ended December 31, 2008. In comparison, options and futures volume decreased 12% and 23%, respectively, compared to the year ended December 31, 2008. General and administrative expenses decreased by $24.0 million, or 30%, primarily due to a decrease in expenses for legal contingencies and bad debt provisions. As a percentage of total net revenues, non-interest expenses decreased to 51% from 56% for the years ended December 31, 2009 and 2008, respectively.
Electronic brokerage income before income taxes increased $7.2 million, or 3%, to $231.2 million for the year ended December 31, 2009 from $224.0 million for the year ended December 31, 2008. As a percentage of total net revenues for the electronic brokerage segment, income before income taxes was 49% and 44% for the years ended December 31, 2009 and 2008, respectively.
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Liquidity and Capital Resources
We maintain a highly liquid balance sheet. The majority of our assets consist of exchange-listed marketable securities inventories, which are marked-to-market daily, investment of customer funds and collateralized receivables arising from customer-related and proprietary securities transactions. Collateralized receivables consist primarily of customer margin loans, securities borrowed, receivables from clearing houses for settlement of securities transactions and, to a lesser extent, securities purchased under agreements to resell. At December 31, 2010, total assets were $28.50 billion of which approximately $28.03 billion, or 98% were considered liquid.
Daily monitoring of liquidity needs and available collateral levels is undertaken to help ensure that an appropriate liquidity cushion, in the form of unpledged collateral, is maintained at all times. Our ability to quickly reduce funding needs by balance sheet contraction without adversely affecting our core businesses and to pledge additional collateral in support of secured borrowings is continuously evaluated to ascertain the adequacy of our capital base.
We actively manage our excess liquidity and we maintain significant borrowing facilities through the securities lending markets and with banks. In response to changes in the credit market environment during late 2008 and into the first quarter of 2009, we continue to maintain sufficient levels of cash on hand to provide us with a buffer should we need immediately available funds for any reason.
In order to provide additional liquidity and to further increase our regulatory capital reserves, we issue senior notes and we maintain a committed senior secured revolving credit facility from a syndicate of banks (see "Principal Indebtedness" below). As of December 31, 2010, borrowings under these facilities totaled $294.6 million, which represented 7% of the Company's total capitalization. Liability balances in connection with our short-term borrowings and senior notes payable approximated their respective average monthly balances during the year ended December 31, 2010. Liability balances in connection with our payables to customers and securities loaned as of December 31, 2010 exceeded their respective average monthly balances during the year ended December 31, 2010. Based on our current level of operations, we believe our cash flows from operations, available cash and available borrowings under our senior secured revolving credit facility will be adequate to meet our future liquidity needs for more than the next twelve months.
Historically, our consolidated equity has consisted primarily of accumulated retained earnings, which to date have been sufficient to fund our operations and growth. The consolidated equity decreased 14% from $4.88 billion at December 31, 2009 to $4.22 billion at December 31, 2010, which is attributable to the, approximately $1 billion special dividend paid in December of 2010, partially offset by total comprehensive income for 2010. The amounts presented at December 31, 2009 and 2010 include non-controlling interests as prescribed by ASC 810.
Cash Flows
The following table sets forth our cash flows from operating activities, investing activities and financing activities for the periods indicated:
|
Year Ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2010 | 2009 | 2008 | |||||||
|
(in millions) |
|||||||||
Cash provided by operating activities |
$ | 1,693.4 | $ | 150.7 | $ | 2,092.3 | ||||
Cash used in investing activities |
(17.3 | ) | (27.5 | ) | (20.2 | ) | ||||
Cash used in financing activities |
(1,174.8 | ) | (290.5 | ) | (1,598.2 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents |
46.4 | 30.4 | (52.2 | ) | ||||||
Increase (decrease) in cash and cash equivalents |
$ | 547.7 | $ | (136.9 | ) | $ | 421.7 | |||
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Our cash flows from operating activities are largely a reflection of the size and composition of trading positions held by our market making subsidiaries, and of the changes in customer cash and margin debit balances in our electronic brokerage business. Our cash flows from investing activities are primarily related to capitalized internal software development, purchases and sales of memberships at exchanges where we trade and strategic investments where such investments will enable us to offer better execution alternatives to our current and prospective customers, or create new opportunities for ourselves as market makers or where we can influence exchanges to provide competing products at better prices using sophisticated technology. Our cash flows from financing activities are comprised of short-term borrowings, long-term borrowings and capital transactions. Short-term borrowings from banks are part of our daily cash management in support of operating activities. Other borrowings provide us with flexible sources of excess liquidity and regulatory capital. These borrowings include senior notes issued in private placements to certain qualified customers of IB LLC and a committed two-year $100.0 million senior secured revolving credit facility, from a syndicate of banks. This facility was entered into in May 2010 and replaced a one-year $100.0 million facility that expired at the same time. Capital transactions consist primarily of the approximately $1 billion special dividend in December 2010.
Year Ended December 31, 2010: Our cash and cash equivalents increased by $547.7 million to $1,354.2 million at the end of 2010. We raised $1,693.4 million in net cash from operating activities. We used net cash of $17.3 million in our investing and $1,174.8 million in our financing activities primarily due to dividends paid to public shareholders and to IBG Holdings LLC and redemption of member interests from IBG Holdings LLC.
Year Ended December 31, 2009: Our cash and cash equivalents decreased by $136.9 million to $806.6 million at the end of 2009. We raised $150.7 million in net cash from operating activities. We used net cash of $318.0 million in our investing and financing activities primarily due to repayments on our senior secured revolving credit facility and dividends paid to and redemption of member interests from IBG Holdings LLC.
Year Ended December 31, 2008: Our cash and cash equivalents increased by $421.7 million to $943.5 million at the end of 2008. We raised net cash of $2.07 billion in our operating and investing activities primarily from net income, including minority interest, and reducing trading positions during the year. We used $1.60 billion in net cash in financing activities primarily from the reduction of short-term borrowings, payment of dividends to and redemption of member interests from IBG Holdings LLC.
Regulatory Capital Requirements
Our principal operating subsidiaries are subject to separate regulation and capital requirements in the United States and other jurisdictions. TH LLC and IB LLC are registered U.S. broker-dealers and futures commission merchants, and their primary regulators include the SEC, the Commodity Futures Trading Commission, the Chicago Board Options Exchange, the Chicago Mercantile Exchange, the Financial Industry Regulatory Authority and the National Futures Association. THE is registered to do business in Switzerland as a securities dealer and is regulated by the Swiss Federal Banking Commission. IBUK is subject to regulation by the U.K. Financial Services Authority. Our various other operating subsidiaries are similarly regulated. See the notes to the consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K for further information regarding our regulated subsidiaries.
At December 31, 2010, aggregate excess regulatory capital for all of the operating companies was $2.75 billion.
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Principal Indebtedness
IBG LLC is the borrower under a $100.0 million senior secured revolving credit facility, which had a $100.0 million outstanding balance as of December 31, 2010, and is the issuer of senior notes, of which $194.6 million were outstanding as of December 31, 2010.
Senior Secured Revolving Credit Facility
On May 18, 2010, IBG LLC entered into a new $100 million two-year senior secured revolving credit facility with a syndicate of banks. IBG LLC is the sole borrower under this credit facility, which is required to be guaranteed by IBG LLC's domestic non-regulated subsidiaries (currently there are no such entities). The facility's interest rate is indexed to the LIBOR rate for the relevant term, at the borrower's option, and is secured by a first priority interest in all of the capital stock of each entity owned directly by IBG LLC (subject to customary limitations with respect to foreign subsidiaries). The facility may be used to finance working capital needs and general corporate purposes. The financial covenants contained in this credit facility are as follows:
At maturity, subject to meeting certain terms of the facility, IBG LLC will have an option to convert the facility to a one-year term loan. As of December 31, 2010, $100 million in borrowings were outstanding under this credit facility and IBG LLC was in compliance with all of the covenants. These borrowings were repaid in full on January 18, 2011. This credit facility replaced a $100 million senior secured revolving credit facility that expired on May 19, 2010.
Senior Notes
IBG LLC periodically issues senior notes in private placements to certain qualified customers of IB LLC. IBG LLC uses the proceeds from sales of the senior notes to provide capital to IBG LLC's broker-dealer subsidiaries in the form of subordinated loans and for other general purposes. In September of this year we reduced the interest rate on new notes to 5% per annum. The outstanding senior notes have a 7% and 5% per annum interest rate, and either a 15-month or an 18-month maturity. IBG LLC may, solely at its option, redeem the senior notes at any time on or after a specified date in the third month or the sixth month, respectively, after the date on which the senior notes are issued and sold, at a redemption price equal to 100% of the principal amount of the senior notes to be redeemed plus accrued interest.
Total senior notes outstanding at December 31, 2010 were $194.6 million, with $46.9 million being 7% notes and $147.7 million being 5% notes. Senior notes outstanding at December 31, 2009 of $205.8 million all carried a 7% per annum rate. During the period from January 1 through December 31, 2010, total senior notes issued were $602.0 million, and senior notes redeemed totaled $613.2 million.
The senior notes are secured, as is the senior secured revolving credit facility, by a first priority interest in all of the capital stock of each entity owned directly by IBG LLC (subject to customary limitations with respect to foreign subsidiaries). The senior notes contain covenants that may limit IBG LLC's ability to:
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Capital Expenditures
Our capital expenditures are comprised of compensation costs of our software engineering staff for development of software for internal use and expenditures for computer, networking and communications hardware. These expenditure items are reported as property and equipment. Capital expenditures for property and equipment were approximately $18.1, $18.5 and $26.7 million for the three years ended December 31, 2010, 2009 and 2008, respectively. We anticipate that our 2011 gross capital expenditures will be at a similar level, including costs related to expansion of our data center and backup facilities. We expect our future capital expenditures to rise as we continue our focus on technology infrastructure initiatives in order to further enhance our competitive position. We anticipate that we will fund capital expenditures with cash from operations and cash on hand. In response to changing economic conditions, we believe we have the flexibility to modify our capital expenditures by adjusting them (either upward or downward) to match our actual performance. If we pursue any strategic acquisitions, we may incur additional capital expenditures.
Contractual Obligations Summary
Our contractual obligations principally include obligations associated with our outstanding indebtedness and interest payments as of December 31, 2010.
|
Payments Due by Year | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Total | 2011-2012 | 2013-2014 | Thereafter | |||||||||
|
(Dollars in Millions) |
||||||||||||
Senior Notes |
$ | 194.6 | $ | 194.6 | $ | | $ | | |||||
Interest payments on senior notes(1) |
13.0 | 13.0 | | | |||||||||
Senior secured revolving credit facility |
100.0 | 100.0 | | | |||||||||
Interest payments on senior secured revolving credit facility(1) |
0.6 | 0.6 | | | |||||||||
Operating leases |
45.6 | 21.4 | 13.6 | 10.6 | |||||||||
Total contractual cash obligations |
$ | 353.8 | $ | 329.6 | $ | 13.6 | $ | 10.6 | |||||
Seasonality
Our businesses are subject to seasonal fluctuations, reflecting varying numbers of market participants at times during the year and varying numbers of trading days from quarter-to-quarter, including declines in trading activity due to holidays. Typical seasonal trends may be superseded by market or world events, which can have a significant impact on prices and trading volume.
Inflation
Although we cannot accurately anticipate the effect of inflation on our operations, we believe that inflation has not had for the three most recent years, and is not likely in the foreseeable future to have, a material impact on our results of operations.
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Strategic Investments and Acquisitions
We periodically engage in evaluations of potential strategic investments and acquisitions. The Company holds strategic investments in electronic trading exchanges including: Boston Options Exchange, LLC, OneChicago LLC and CBOE Stock Exchange, LLC. During 2009, the Company made investments in Quadriserv Inc., an electronic securities lending platform provider and Factor Advisors, LLC, an Exchange Traded Funds ("ETF") issuer. In 2009, as a result of a recapitalization transaction and the sale of assets, the Company recorded a permanent impairment loss of $6.4 million on its loans to and warrants to purchase approximately 25.86% of W.R. Hambrecht + Co. Inc., reducing the book value of these investments to $-0-. See Note 7 to the Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K.
We intend to continue making acquisitions on an opportunistic basis, generally only when the acquisition candidate will, in our opinion, enable us to acquire either technology or customers faster than we could develop them on our own. At December 31, 2010, there were no definitive agreements with respect to any material acquisition.
Certain Information Concerning Off-Balance-Sheet Arrangements
IBG, Inc. may be exposed to a risk of loss not reflected in the consolidated financial statements for futures products, which represent obligations of the Company to settle at contracted prices, which may require repurchase or sale in the market at prevailing prices. Accordingly, these transactions result in off-balance sheet risk as IBG, Inc.'s cost to liquidate such futures contracts may exceed the amounts reported in our consolidated statements of financial condition.
Critical Accounting Policies
Valuation of Financial Instruments
Due to the nature of our operations, substantially all of our financial instrument assets, comprised of securities owned, securities purchased under agreements to resell, securities borrowed and receivables from brokers, dealers and clearing organizations are carried at fair value based on published market prices and are marked to market daily, or are assets which are short-term in nature (such as U.S. government treasury bills or spot foreign exchange) and are reflected at amounts approximating fair value. Similarly, all of our financial instrument liabilities that arise from securities sold but not yet purchased, securities sold under agreements to repurchase, securities loaned and payables to brokers, dealers and clearing organizations are short-term in nature and are reported at quoted market prices or at amounts approximating fair value. Our long and short positions are valued at either the last consolidated trade price or the last consolidated bid/offer mid-point (where applicable) at the close of regular trading hours, in their respective markets. Given that we manage a globally integrated market making portfolio, we have large and substantially offsetting positions in securities and commodities that trade on different exchanges that close at different times of the trading day. As a result, there may be large and anomalous swings in the value of our positions daily and, accordingly, in our earnings in any period. This is especially true on the last business day of each calendar quarter, although such swings tend to come back into equilibrium on the first business day of the succeeding calendar quarter.
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Contingencies
Our policy is to estimate and accrue for potential losses that may arise out of litigation and regulatory proceedings, to the extent that such losses are probable and can be estimated, in accordance with ASC 450, Contingencies. Potential losses that might arise out of tax audits, to the extent that such losses are "more likely than not," would be estimated and accrued in accordance with ASC 740-10. Significant judgment is required in making these estimates and our final liabilities may ultimately be materially different. Our total liability accrued with respect to litigation and regulatory proceedings is determined on a case-by-case basis and represents an estimate of probable losses based on, among other factors, the progress of each case, our experience with and industry experience with similar cases and the opinions and views of internal and external legal counsel. Given the inherent difficulty of predicting the outcome of our litigation and regulatory matters, particularly in cases or proceedings in which substantial or indeterminate damages or fines are sought, or where cases or proceedings are in the early stages, we cannot estimate losses or ranges of losses for cases or proceedings where there is only a reasonable possibility that a loss may be incurred.
We have been from time to time subject to certain pending and legal actions which arise out of the normal course of business. Litigation is inherently unpredictable, particularly in proceedings where claimants seek substantial or indeterminate damages, or which are in their early stages. We cannot predict with certainty the actual loss or range of loss related to such legal proceedings, the manner in which they will be resolved, the timing of final resolution or the ultimate settlement. Consequently, we cannot estimate losses or ranges of losses related to such legal matters, even in instances where it is reasonably possible that a future loss will be incurred. As of December 31, 2010, we, along with certain of our subsidiaries, have been named parties to legal actions, which we and/or such subsidiaries intend to defend vigorously. Although the results of legal actions cannot be predicted with certainty, it is the opinion of management that the resolution of these actions is not expected to have a material adverse effect, if any, on our business or financial condition, but may have a material impact on the results of operations for a given period. As of December 31, 2010 and 2009, reserves provided for potential losses related to litigation matters were not material.
Use of Estimates
The preparation of financial statements in conformity with the Codification requires management to make estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements and accompanying notes. Estimates, by their nature, are based on judgment and available information. Therefore, actual results could differ materially from those estimates. Such estimates include the estimated value of investments accounted for under the equity method of accounting, the estimated useful lives of property and equipment, including capitalized internally developed software, the allowance for doubtful accounts, compensation accruals, tax liabilities and estimated contingency reserves.
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Recent Accounting Pronouncements
Subsequent to the adoption of the ASC, the FASB will issue Accounting Standards Updates ("ASU's") as the means to add to or delete from, or otherwise amend the ASC. In 2010 and 2011, prior to the issuance of the Company's consolidated financial statements, ASU's 2010-1 through ASU 2010-29 and ASU 2011-01 were issued. Following is a summary of recently issued ASU's that may affect the Company's consolidated financial statements:
|
Affects | Status | ||
---|---|---|---|---|
ASU 2009-13 | Multiple Deliverable Revenue ArrangementsAmends ASC 605-25 | Fiscal years beginning on or after June 15, 2010, early adoption permitted | ||
ASU 2009-14 |
Certain Revenue Arrangements That Include Software ElementsAmends ASC985-605 and 985-605-13 to exclude from their scope tangible products that contain software and non-software components that function together to deliver the products essential functionality |
Fiscal years beginning on or after June 15, 2010, early adoption permitted |
||
ASU 2009-15 |
Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing |
Periods beginning on or after December 15, 2009 |
||
ASU 2009-16 |
Transfers and Servicing: Accounting or Transfers of Financial AssetsAmends ASC 860eliminates exceptions for qualifying special purpose entities and for certain mortgage securitizations |
Periods beginning after November 15, 2009 |
||
ASU 2009-17 |
Improvements to Financial Reporting by Enterprises Involved with Variable Interest EnterprisesAmends ASC 810 for the issuance of SFAS No. 167 |
Periods beginning on or after December 15, 2009 |
||
ASU 2010-09 |
Subsequent Events (Topic 855)Amendments to Certain Recognition and Disclosure Requirements |
Effective on issuance |
||
ASU 2010-11 |
Derivatives and Hedging (Topic 815)Scope Exception related to Embedded Credit Derivatives |
First fiscal quarter beginning after June 15, 2010, early adoption permitted at the beginning of the first fiscal quarter after issuance. |
||
ASU 2010-12 |
Income Taxes (Topic 740)Accounting for Certain Tax Effects of the 2010 Health Care Reform Acts |
Effective on issuance. |
||
ASU 2010-13 |
CompensationStock Compensation (Topic 718)Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades |
Fiscal years, and interim periods within those fiscal years, beginning after December 15, 2010. Early application is permitted. |
||
ASU 2010-20 |
Receivables (Topic 310)Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses |
Periods ending on or after December 15, 2010. |
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|
Affects | Status | ||
---|---|---|---|---|
ASU 2010-21 | Accounting for Technical Amendments to Various SEC Rules and SchedulesAmendments to SEC Paragraphs Pursuant to Release No. 33-9026 | Effective on Issuance. | ||
ASU 2010-22 |
Accounting for Various TopicsTechnical Corrections to SEC Paragraphs |
Effective on Issuance. |
Adoption of those ASU's that became effective during 2009, 2010 and in 2011, prior to the issuance of the Company's consolidated financial statements, did not have a material effect on those financial statements. Management is assessing the potential impact on the Company's financial statements of adopting ASU's that will become effective in the future.
ASC/IFRS Convergence
In February 2010, the SEC issued "Commission Statement in Support of Convergence and Global Accounting Standards", a formal statement updating the status of its November 2008 "Roadmap for the Potential Use of Financial Statements Prepared in Accordance with International Financial Reporting Standards by U.S. Issuers" ("IFRS Roadmap"). The statement supported convergence of accounting standards and the development of a single set of global accounting standards. As directed in this statement, the SEC staff issued "Work Plan for the Consideration of Incorporating International Financial Reporting Standards into the Financial Reporting System for U.S. Issuers" (the "Work Plan") in May 2010. The Work Plan is expected to provide the SEC with information to be able to conclude whether IFRS should be adopted for U.S. registrants. While neither the February statement nor the Work Plan define a certain date for adoption of IFRS, both documents stated an expectation that a decision on whether the SEC would mandate adoption of IFRS is expected to be made in 2011. If a decision to adopt IFRS is made at that point in time, initial adoption for U.S. registrants would be approximately December 31, 2015 or 2016, with a transition date of either January 1, 2013 or 2014 for the initial three year retrospective comparative reporting period. Certain of the non-U.S. Operating Companies currently report or will be required to report their separate company financial statements under IFRS, as adopted in their local jurisdictions, as of December 31, 2010 or in the future. Management continues to assess the potential impact of adopting IFRS on the Company's consolidated financial statements.
Other
ASC 860, Transfers and Servicing, incorporates former SFAS No. 166, Accounting for Transfers of Financial Assets, an amendment of FASB No. 140, was issued in June 2009 and became effective for interim and annual periods beginning after January 1, 2010. These provisions of ASC 860 require more information about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets. The concept of a "qualifying special-purpose entity" ("SPE") was eliminated under these provisions of ASC 860, which also changed the requirements for derecognizing financial assets and requires additional disclosures. Adoption of these provisions did not have a material effect on the Company's consolidated financial statements.
ASC 810, Consolidations, incorporates former SFAS No. 167, Amendments to FASB Interpretation No. 46(R). These pending provisions of ASC 810 revise former FASB Interpretation No. 46 (Revised December 2003), Consolidation of Variable Interest Entities, and changes how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) and therefore should be consolidated. Consolidation of Variable Interest Entities ("VIE's") would be based on the target entity's purpose and design as well as the reporting entity's ability to direct the target's activities, among other criteria. SFAS No. 167 was issued in June 2009 and became effective for interim and annual periods beginning after January 1, 2010. Adoption of these provisions did not have a material effect on the Company's consolidated financial statements.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to various market risks. Our exposures to market risks arise from assumptions built into our pricing models, equity price risk, foreign currency exchange rate fluctuations related to our international operations, changes in interest rates which impact our variable-rate debt obligations, and risks relating to the extension of margin credit to our customers.
Pricing Model Exposure
Our strategy as a market maker is to calculate quotes a few seconds ahead of the market and execute small trades at tiny but favorable differentials as a result. This is made possible by our proprietary pricing model, which continuously evaluates and monitors the risks inherent in our portfolio, assimilates market data and reevaluates the outstanding quotes in our entire portfolio each second. Certain aspects of the model rely on historical prices of securities. If the behavior of price movements of individual securities diverges substantially from what their historical behavior would predict, we might incur trading losses. We attempt to limit such risks by diversifying our portfolio across many different options, futures and underlying securities and avoiding concentrations of positions based on the same underlying security. Historically, our losses from these events have been immaterial in comparison to our annual trading profits.
Foreign Currency Exposure
As a result of our international market making activities and accumulated earnings in our foreign subsidiaries, our income and net worth is exposed to fluctuations in foreign exchange rates. Our European operations and some of our Asian operations are conducted by our Swiss subsidiary, THE. THE is regulated by the Swiss Financial Market Supervisory Authority as a securities dealer and its financial statements are presented in Swiss francs. Accordingly, THE is exposed to certain foreign exchange risks as described below:
Historically, we have taken the approach of not hedging the above exposures to the U.S. dollar, based on the notion that the cost of constantly hedging over the years would amount to more than the random impact of rate changes on our non-U.S. dollar balances. For instance, an increase in the value of the Swiss franc would be unfavorable to the earnings of THE but would be counterbalanced to some extent by the fact that the yearly translation gain or loss into U.S. dollars is likely to move in the opposite direction.
In late 2005, we began to expand our market making systems to incorporate cash forex and forex options in order to hedge our currency exposure at little or no cost. In September 2006, we began
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hedging our currency exposure throughout the day on a continuous basis. In connection with the development of our currency hedging strategy, we have determined to base our net worth in GLOBALs. We define GLOBAL as consisting of a basket of major currencies that currently includes U.S. dollar, Euro, Japanese yen, British pound, Canadian dollar and Australian dollar. With the growth of our international operations, we foresee including other currencies in our definition of the GLOBAL. As our forex market making systems continue to develop, and as more exchanges trade more forex-based products electronically, we expect more trading volume to flow through this system and, accordingly, we expect to be able to manage the risks in forex in the same low cost manner as we currently manage the risks of our market making in equity-based products.
Because we actively manage our global currency exposure by maintaining our equity in GLOBALs, we consider ourselves a global enterprise based in a diversified basket of currencies rather than a U.S. dollar based company. Approximately half of our equity is denominated in currencies other than U.S. Dollars.
Interest Rate Risk
We had $100.0 million in variable-rate debt outstanding at December 31, 2010. These debt obligations are subject to fluctuations in interest rates at the end of each borrowing term, which impact the amount of interest we must pay. If the debt were to remain at this level and variable interest rates were to increase by 1.0% per annum, the annual impact to our net income from debt obligations of this amount would be a reduction of $1.0 million. Under our senior secured revolving credit facility, we have the ability to choose borrowing tenors from overnight to twelve months, which permits us to minimize the risk of interest rate fluctuations.
We pay our electronic brokerage customers interest based on benchmark overnight interest rates in various currencies. In a normal rate environment, we typically invest a portion of these funds in U.S. government treasury securities with maturities of up to three months. Under these circumstances, if interest rates were to increase rapidly and substantially, in increments that were not reflected in the yields on these treasury securities, our net interest income from customer deposits would decrease. Based upon investments outstanding at December 31, 2010, we had minimal exposure of this nature.
We also face the potential for reduced net interest income from customer deposits due to interest rate spread compression in a low rate environment. Due to a currently low rate environment, a decrease of U.S. benchmark interest rates to zero, or roughly 0.18%, would reduce our net interest income by approximately $2.1 million on an annualized basis.
We also face substantial interest rate risk due to positions carried in our market making business to the extent that long or short stock positions may have been established for future or forward dates on options or futures contracts and the value of such positions are impacted by interest rates. We hedge such risks by entering into interest rate futures contracts. To the extent that these futures positions do not perfectly hedge this interest rate risk, our trading gains may be adversely affected. The amount of such risk cannot be quantified.
Dividend Risk
We face dividend risk in our market making business as we derive significant revenues and incur significant expenses in the form of dividend income and expense, respectively, from our substantial inventory of equity securities, and must make significant payments in lieu of dividends on short positions in securities in our portfolio. Projected future dividends are an important component of pricing equity options and other derivatives, and incorrect projections may lead to trading losses. The amount of these risks cannot be quantified.
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Margin Credit
We extend margin credit to our customers, which is subject to various regulatory requirements. Margin credit is collateralized by cash and securities in the customers' accounts. The risks associated with margin credit increase during periods of fast market movements or in cases where collateral is concentrated and market movements occur. During such times, customers who utilize margin credit and who have collateralized their obligations with securities may find that the securities have a rapidly depreciating value and may not be sufficient to cover their obligations in the event of a liquidation. We are also exposed to credit risk when our customers execute transactions, such as short sales of options and equities, that can expose them to risk beyond their invested capital.
We expect this kind of exposure to increase with growth in our overall business. Because we indemnify and hold harmless our clearing firms from certain liabilities or claims, the use of margin credit and short sales may expose us to significant off-balance-sheet risk in the event that collateral requirements are not sufficient to fully cover losses that customers may incur and those customers fail to satisfy their obligations. As of December 31, 2010, we had $6.97 billion in margin credit extended to our customers. The amount of risk to which we are exposed from the margin credit we extend to our customers and from short sale transactions by our customers is unlimited and not quantifiable as the risk is dependent upon analysis of a potential significant and undeterminable rise or fall in stock prices. Our account level margin credit requirements meet or exceed those required by Regulation T of the Board of Governors of the Federal Reserve. As a matter of practice, we enforce real-time margin compliance monitoring and liquidate customers' positions if their equity falls below required margin requirements.
We have a comprehensive policy implemented in accordance with regulatory standards to assess and monitor the suitability of investors to engage in various trading activities. To mitigate our risk, we also continuously monitor customer accounts to detect excessive concentration, large orders or positions, patterns of day trading and other activities that indicate increased risk to us.
Our credit exposure is to a great extent mitigated by our policy of automatically evaluating each account throughout the trading day and closing out positions automatically for accounts that are found to be under-margined. While this methodology is effective in most situations, it may not be effective in situations where no liquid market exists for the relevant securities or commodities or where, for any reason, automatic liquidation for certain accounts has been disabled.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements
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Financial Statements Introductory Note
Interactive Brokers Group, Inc. ("IBG, Inc." or the "Company") is a holding company whose primary asset is its ownership of approximately 10.8% of the membership interests of IBG LLC (the "Group"). See Notes 1 and 4 to the consolidated financial statements for further discussion of the Company's capital and ownership structure.
We are an automated global electronic market maker and broker specializing in routing orders and executing and processing trades in securities, futures, foreign exchange instruments, bonds and mutual funds on more than 90 electronic exchanges and trading venues around the world. In the U.S., our business is conducted from our headquarters in Greenwich, Connecticut and from Chicago, Illinois and Jersey City, New Jersey. Abroad, we conduct business through offices located in Canada, England, Switzerland, Hong Kong, India, Australia and Japan. At December 31, 2010 we had 857 employees worldwide.
In December 2007, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51, which SFAS is now a sub-topic within FASB Accounting Standards Codification (the "Codification" or "ASC"), 810, Consolidation (Note 2). Adoption of ASC 810 as of January 1, 2009 required the Company to report non-controlling interests in subsidiaries (formerly reported as "minority interests") as a separate component of equity in the current period and had the retrospective effect of increasing reported equity by $3.89 billion as of December 31, 2008. ASC 810 also required changes in presentation and retrospective disclosure of non-controlling interests in the statements of income, of cash flows and of changes in equity for all periods presented. Accordingly, the accompanying consolidated financial statements are presented as if ASC 810 had been applicable historically. The reclassifications made to prior periods had no effect on previously reported results of operations or cash flows.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the Board of Directors and Stockholders of
Interactive Brokers Group, Inc.
Greenwich, CT
We have audited the accompanying consolidated statements of financial condition of Interactive Brokers Group, Inc. and subsidiaries (the "Company") as of December 31, 2010 and 2009, and the related consolidated statements of income, changes in equity, and cash flows for each of the three years in the period ended December 31, 2010. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Interactive Brokers Group, Inc. and subsidiaries at December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2011 expressed an unqualified opinion on the Company's internal control over financial reporting.
/s/
Deloitte & Touche LLP
New York, New York
February 28, 2011
75
Interactive Brokers Group, Inc. and Subsidiaries
Consolidated Statements of Financial Condition
|
December 31, | |||||||
---|---|---|---|---|---|---|---|---|
(in thousands, except share data)
|
2010 | 2009 | ||||||
Assets |
||||||||
Cash and cash equivalents |
$ | 1,354,219 | $ | 806,560 | ||||
Cash and securitiessegregated for regulatory purposes |
7,888,093 | 6,728,936 | ||||||
Securities borrowed |
3,292,345 | 5,063,026 | ||||||
Securities purchased under agreements to resell |
336,299 | 413,005 | ||||||
Trading assets, at fair value: |
||||||||
Financial instruments owned |
5,420,929 | 7,809,944 | ||||||
Financial instruments owned and pledged as collateral |
2,001,488 | 1,534,038 | ||||||
|
7,422,417 | 9,343,982 | ||||||
Other receivables: |
||||||||
Customers, less allowance for doubtful accounts of $17,871 and $16,637 at December 31, 2010 and 2009 |
6,973,033 | 3,239,625 | ||||||
Brokers, dealers and clearing organizations |
732,869 | 493,063 | ||||||
Receivable from affiliate |
1,185 | 1,160 | ||||||
Interest |
18,502 | 14,720 | ||||||
|
7,725,589 | 3,748,568 | ||||||
Other assets |
479,806 | 501,474 | ||||||
Total assets |
$ | 28,498,768 | $ | 26,605,551 | ||||
Liabilities and equity |
||||||||
Liabilities: |
||||||||
Trading liabilitiesfinancial instruments sold but not yet purchased, at fair value |
$ | 6,125,224 | $ | 8,763,201 | ||||
Securities loaned |
1,659,611 | 1,133,658 | ||||||
Short-term borrowings |
187,380 | 320,803 | ||||||
Other payables: |
||||||||
Customers |
15,060,479 | 10,587,701 | ||||||
Brokers, dealers and clearing organizations |
248,685 | 164,523 | ||||||
Payable to affiliate |
284,860 | 298,982 | ||||||
Accounts payable, accrued expenses and other liabilities |
409,757 | 244,715 | ||||||
Interest |
7,682 | 9,060 | ||||||
|
16,011,463 | 11,304,981 | ||||||
Senior notes payable |
194,603 | 205,777 | ||||||
Senior secured credit facility |
100,000 | | ||||||
|
24,278,281 | 21,728,420 | ||||||
Commitments, contingencies and guarantees |
||||||||
Equity: |
||||||||
Stockholders' equity: |
||||||||
Common stock, $0.01 par value per share: |
||||||||
Class AAuthorized1,000,000,000, Issued50,298,024 and 47,784,286, Outstanding42,231,551 and 41,216,779 shares at December 31, 2010 and 2009 |
503 | 478 | ||||||
Class BAuthorized, Issued and Outstanding100 shares at December 31, 2010 and 2009 |
| | ||||||
Additional paid-in capital |
535,630 | 528,586 | ||||||
Retained earnings |
92,504 | 177,409 | ||||||
Accumulated other comprehensive income, net of income taxes of $12,284 and $10,914 at December 31, 2010 and 2009 |
21,137 | 10,914 | ||||||
Treasury stock, at cost, 8,066,473 and 6,567,507 shares at December 31, 2010 and 2009 |
(161,947 | ) | (142,441 | ) | ||||
Total stockholders' equity |
487,827 | 574,946 | ||||||
Non-controlling interests |
3,732,660 | 4,302,185 | ||||||
Total equity |
4,220,487 | 4,877,131 | ||||||
Total liabilities and stockholders' equity |
$ | 28,498,768 | $ | 26,605,551 | ||||
See accompanying notes to the consolidated financial statements.
76
Interactive Brokers Group, Inc. and Subsidiaries
Consolidated Statements of Income
Three Years Ended December 31, 2010
(in thousands, except for shares or per share amounts)
|
2010 | 2009 | 2008 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
Revenues: |
||||||||||||
Trading gains |
$ | 368,634 | $ | 633,865 | $ | 1,303,994 | ||||||
Commissions and execution fees |
386,765 | 353,030 | 359,529 | |||||||||
Interest income |
172,504 | 121,618 | 437,172 | |||||||||
Other income |
60,414 | 61,260 | 81,630 | |||||||||
Total revenues |
988,317 | 1,169,773 | 2,182,325 | |||||||||
Interest expense |
66,209 |
69,433 |
331,968 |
|||||||||
Total net revenues |
922,108 | 1,100,340 | 1,850,357 | |||||||||
Non-interest expenses: |
||||||||||||
Execution and clearing |
272,608 | 273,203 | 322,746 | |||||||||
Employee compensation and benefits |
200,155 | 175,827 | 158,018 | |||||||||
Occupancy, depreciation and amortization |
37,336 | 40,340 | 37,663 | |||||||||
Communications |
23,488 | 22,789 | 18,650 | |||||||||
General and administrative |
47,702 | 43,688 | 63,308 | |||||||||
Total non-interest expenses |
581,289 | 555,847 | 600,385 | |||||||||
Income before income taxes |
340,819 | 544,493 | 1,249,972 | |||||||||
Income tax expense |
60,413 |
54,379 |
128,371 |
|||||||||
Net income |
280,406 | 490,114 | 1,121,601 | |||||||||
Less net income attributable to non-controlling interests |
289,722 | 453,912 | 1,028,554 | |||||||||
Net income (loss) available for common stockholders |
$ | (9,316 | ) | $ | 36,202 | $ | 93,047 | |||||
Earnings per share: |
||||||||||||
Basic |
$ | (0.22 | ) | $ | 0.88 | $ | 2.30 | |||||
Diluted |
$ | (0.22 | ) | $ | 0.87 | $ | 2.24 | |||||
Weighted average common shares outstanding: |
||||||||||||
Basic |
41,870,926 | 40,973,290 | 40,434,273 | |||||||||
Diluted |
42,498,705 | 41,799,489 | 41,461,018 | |||||||||
See accompanying notes to the consolidated financial statements.
77
Interactive Brokers Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
|
Year ended December 31, | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(in thousands)
|
2010 | 2009 | 2008 | ||||||||||
Cash flows from operating activities: |
|||||||||||||
Net income |
$ | 280,406 | $ | 490,114 | $ | 1,121,601 | |||||||
Adjustments to reconcile net income to net cash provided by operating activities: |
|||||||||||||
Translation losses(2008, as adjusted) |
254,615 | 10,555 | 59,201 | ||||||||||
Deferred income taxes |
5,996 | (22,073 | ) | 50,099 | |||||||||
Depreciation and amortization |
18,702 | 21,074 | 17,897 | ||||||||||
Employee stock plan compensation |
38,296 | 33,192 | 25,921 | ||||||||||
Losses on non-trading investments, net |
3,383 | 8,939 | 14,107 | ||||||||||
Bad debt expense and other |
2,571 | (559 | ) | 20,287 | |||||||||
Change in operating assets and liabilities (2008, as adjusted): |
|||||||||||||
Increase in cash and securitiessegregated for regulatory purposes |
(977,661 | ) | (1,608,806 | ) | (69,148 | ) | |||||||
Decrease in securities borrowed |
1,759,236 | 855,874 | 956,426 | ||||||||||
Decrease (increase) in securities purchased under agreements to resell |
(105,026 | ) | 174,821 | (371,111 | ) | ||||||||
Decrease in trading assets |
1,873,475 | 1,810,626 | 5,764,571 | ||||||||||
Decrease (increase) in receivables from customers |
(3,736,448 | ) | (1,618,959 | ) | 295,559 | ||||||||
Decrease (increase) in other receivables |
(252,147 | ) | 2,053,253 | 26,138 | |||||||||
Decrease in other assets |
13,694 | 1,024 | 12,343 | ||||||||||
Decrease in trading liabilities |
(2,672,066 | ) | (4,683,259 | ) | (820,817 | ) | |||||||
Increase (decrease) in securities loaned |
520,549 | 479,335 | (4,310,029 | ) | |||||||||
Increase (decrease) in payable to customers |
4,465,272 | 3,656,289 | (698,735 | ) | |||||||||
Increase (decrease) in other payables |
200,497 | (1,510,787 | ) | (1,986 | ) | ||||||||
Net cash provided by operating activities |
1,693,344 | 150,653 | 2,092,324 | ||||||||||
Cash flows from investing activities: |
|||||||||||||
(Purchase) sale of investments |
817 | (11,300 | ) | 5,866 | |||||||||
Distributions received from equity investment |
| 2,292 | 635 | ||||||||||
Purchase of property and equipment |
(18,108 | ) | (18,492 | ) | (26,695 | ) | |||||||
Net cash used in investing activities |
(17,291 | ) | (27,500 | ) | (20,194 | ) | |||||||
Cash flows from financing activities: |
|||||||||||||
Redemption of member interests from IBG Holdings LLC |
(27,204 | ) | (14,738 | ) | (72,015 | ) | |||||||
Redemption of former member interest |
(1,226 | ) | (164 | ) | (3,986 | ) | |||||||
Reduction in non-controlling interest in subsidiary |
| 22 | | ||||||||||
Repurchase of Class A Common Stock |
| | (866 | ) | |||||||||
Dividends paid to shareholders |
(75,589 | ) | | | |||||||||
Dividends paid to non-controlling interests |
(999,171 | ) | (124,757 | ) | (222,776 | ) | |||||||
Issuances of senior notes |
601,980 | 508,116 | 474,566 | ||||||||||
Redemptions of senior notes |
(613,154 | ) | (445,393 | ) | (491,968 | ) | |||||||
Borrowings under senior secured credit facility |
100,000 | 800 | 550,000 | ||||||||||
Repayments of senior secured credit facility |
| (300,800 | ) | (550,000 | ) | ||||||||
(Decrease) increase in short-term borrowings, net |
(160,445 | ) | 86,464 | (1,281,108 | ) | ||||||||
Net cash used in financing activities |
(1,174,809 | ) | (290,450 | ) | (1,598,153 | ) | |||||||
Effect of exchange rate changes on cash and cash equivalents |
46,415 | 30,360 | (52,256 | ) | |||||||||
Net increase (decrease) in cash and cash equivalents |
547,659 | (136,937 | ) | 421,721 | |||||||||
Cash and cash equivalents at beginning of period |
806,560 | 943,497 | 521,776 | ||||||||||
Cash and cash equivalents at end of period |
$ | 1,354,219 | $ | 806,560 | $ | 943,497 | |||||||
Supplemental disclosures of cash flow information: |
|||||||||||||
Cash paid for interest |
$ | 67,587 | $ | 76,507 | $ | 368,968 | |||||||
Cash paid for taxes |
$ | 85,047 | $ | 102,809 | $ | 83,319 | |||||||
Non-cash financing activities: |
|||||||||||||
Adjustments to Additional Paid in Capital for changes in proportionate ownership in IBG LLC |
$ | (36,047 | ) | $ | | $ | | ||||||
Adjustments to Non-Controlling Interests for changes in proportionate ownership in IBG LLC |
$ | 36,047 | $ | | $ | | |||||||
See accompanying notes to the consolidated financial statements.
78
Interactive Brokers Group, Inc. and Subsidiaries
Consolidated Statements of Changes in Equity
Three years ended December 31, 2010
|
Common Stock | |
|
|
|
|
|
|
||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
|
|
|
Accumulated Other Comprehensive Income |
|
|
|
|||||||||||||||||||||||
(in thousands, except for share amounts)
|
Shares | Par Value |
Additional Paid-In Capital |
Treasury Stock |
Retained Earnings |
Total Stockholders' Equity |
Non- controlling Interests |
Total Equity | ||||||||||||||||||||||
Balance, December 31, 2007 |
40,143,860 | $ | 433 | $ | 450,667 | $ | (94,966 | ) | $ | 48,160 | $ | 4,109 | $ | 408,403 | $ | 3,165,421 | $ | 3,573,824 | ||||||||||||
Common Stock distributed to employees |
458,655 | 13,881 | 13,881 | 13,881 | ||||||||||||||||||||||||||
Common Stock acquired under Stock Repurchase Program |
(65,800 | ) | (866 | ) | (866 | ) | (866 | ) | ||||||||||||||||||||||
Common Stock issued pursuant to stock plans |
2,065,432 | 20 | 35,579 | 35,599 | 35,599 | |||||||||||||||||||||||||
Treasury stock, unearned compensation |
(2,065,432 | ) | (35,599 | ) | (35,599 | ) | (35,599 | ) | ||||||||||||||||||||||
Redemption of non-controlling interests |
(72,015 | ) | (72,015 | ) | ||||||||||||||||||||||||||
Redemption of former members' interest |
(409 | ) | (409 | ) | (3,577 | ) | (3,986 | ) | ||||||||||||||||||||||
Dividends paid by IBG LLC to non-controlling interests |
(222,784 | ) | (222,784 | ) | ||||||||||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||||
Net income |
93,047 | 93,047 | 1,028,554 | 1,121,601 | ||||||||||||||||||||||||||
Cumulative translation adjustment, net of income taxes of ($117) |
(202 | ) | (202 | ) | (1,392 | ) | (1,594 | ) | ||||||||||||||||||||||
Total comprehensive income |
93,047 | (202 | ) | 92,845 | 1,027,162 | 1,120,007 | ||||||||||||||||||||||||
Balance, December 31, 2008 |
40,536,715 | 453 | 485,837 | (117,550 | ) | 141,207 | 3,907 | 513,854 | 3,894,207 | 4,408,061 | ||||||||||||||||||||
Common Stock distributed to employees |
680,164 | 17,898 | 17,898 | 17,898 | ||||||||||||||||||||||||||
Common Stock issued pursuant to stock plans |
2,448,031 | 25 | 42,764 | 42,789 | 42,789 | |||||||||||||||||||||||||
Treasury stock, unearned compensation |
(2,448,031 | ) | (42,789 | ) | (42,789 | ) | (42,789 | ) | ||||||||||||||||||||||
Redemption of non-controlling interests |
(14,738 | ) | (14,738 | ) | ||||||||||||||||||||||||||
Redemption of former-member interests |
(17 | ) | (17 | ) | (147 | ) | (164 | ) | ||||||||||||||||||||||
Dividends paid by IBG LLC to non-controlling interests |
(124,757 | ) | (124,757 | ) | ||||||||||||||||||||||||||
Reduction in non-controlling interest in subsidiary |
2 | 2 | 20 | 22 | ||||||||||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||||
Net income |
36,202 | 36,202 | 453,912 | 490,114 | ||||||||||||||||||||||||||
Cumulative translation adjustment, net of income taxes of $4,072 |
7,007 | 7,007 | 93,688 | 100,695 | ||||||||||||||||||||||||||
Total comprehensive income |
36,202 | 7,007 | 43,209 | 547,600 | 590,809 | |||||||||||||||||||||||||
Balance, December 31, 2009 |
41,216,879 | 478 | 528,586 | (142,441 | ) | 177,409 | 10,914 | 574,946 | 4,302,185 | 4,877,131 | ||||||||||||||||||||
Common Stock distributed to employees |
1,014,772 | 23,742 | 23,742 | 23,742 | ||||||||||||||||||||||||||
Common Stock issued pursuant to stock plans |
2,513,738 | 25 | 43,223 | 43,248 | 43,248 | |||||||||||||||||||||||||