UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): August 6, 2013
KCG HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
| DELAWARE | 000-54991 | 38-3898306 | ||
| (State or other jurisdiction of incorporation) |
(Commission File Number) |
(IRS Employer Identification No. |
545 Washington Boulevard, Jersey City, NJ 07310
(Address of principal executive offices) (Zip Code)
(201) 222-9400
(Registrant’s telephone number, including area code)
Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions (see General Instruction A.2. below):
| ¨ | Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425) |
| ¨ | Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12) |
| ¨ | Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b)) |
| ¨ | Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c)) |
Item 5.02 Departure of Directors or Certain Officers; Election of Directors; Appointment of Certain Officers; Compensatory Arrangements of Certain Officers.
On August 6, 2013, the Compensation Committee of the Board of Directors of KCG Holdings, Inc. (“KCG”) approved, and authorized KCG to enter into, employment agreements (collectively, the “Employment Agreements” and each individually, an “Employment Agreement”) with certain executive officers, including Steven Bisgay, its Chief Financial Officer, as well as John DiBacco, John McCarthy, Nick Ogurtsov, Jonathan Ross and George Sohos (collectively, the “Executives”). The Employment Agreements have an initial term of three years and thereafter renew automatically for successive one-year extension terms until either party gives notice of nonrenewal at least 90 days before the end of the applicable extension term.
The Employment Agreements provide for, among other things: (1) an initial annual base salary of $500,000; (2) an annual incentive (the “Annual Incentive”), and (3) a grant of either (i) stock options, with an exercise price equal to the fair market value on the date of grant and five-year terms, (ii) restricted stock units or (iii) a combination of options and restricted stock units (together, the “Performance Equity”). In each case, the Performance Equity will vest in three equal annual installments on each of the first three anniversaries of July 1, 2013, subject to continued employment. The Performance Equity will be granted in such numbers and forms as set forth in the full text of the Schedules to the Employment Agreements, which are filed as Exhibits 10.2 through 10.7 to this Current Report on Form 8-K, and are incorporated by reference into this Item 5.02.
The Annual Incentive will be split between a portion based on the achievement of performance goals (the “Performance Portion”) and a portion based on the achievement of initiatives established by KCG’s Board of Directors in consultation with its Chief Executive Officer (the “Initiatives Portion”). The target and maximum for the Annual Incentive for each Executive are as set forth in the full text of the Schedules to the Employment Agreements, which are filed as Exhibits 10.2 through 10.7 to this Current Report on Form 8-K.
The Executives will be subject to covenants not to compete with KCG or its affiliates during their employment and for a period of 6 months (12 months for Messrs. Ross and Sohos) following their termination of employment for any reason and to a covenant not to solicit KCG’s employees during their employment and for a period of 18 months following their termination of employment for any reason. If any Executive breaches the non-competition or non-solicitation covenant, the Executive must forfeit all unvested Performance Equity in the form of RSUs and all unexercised Performance Equity (whether vested or unvested) in the form of options. Following a “change in control” (as defined in the Employment Agreements), the non-solicitation for each Executive and the non-competition period for Messrs. Ross and Sohos will be reduced to six months following a termination for any reason. The Executives’ obligation to comply with the non-competition and non-solicitation covenants survives the end of the term of the Employment Agreements.
If any Executive’s employment is terminated during the term of the Employment Agreements by KCG without “cause” or by the Executive for “good reason” (each as defined in the Employment Agreements), subject to the Executive’s execution of a release, the Executive will be entitled to receive: (1) subject to compliance with non-competition and non-solicitation covenants described above, (A) continued vesting of the Executive’s Performance Equity, (B) continued vesting of the Executive’s Annual Incentive paid in the form of equity and (C) non-compete/non-solicit payments equal, in the aggregate, to the Executives’ base salary (300% of base salary for Messrs. Ross and Sohos) paid in equal monthly installments over the course of the Executives’ non-competition period described above; (2) any earned but unpaid annual incentive for the fiscal year ending immediately before termination, paid 100% in cash; (3) an annual incentive for the fiscal year in which the termination occurs, paid 100% in cash, prorated for the number of days elapsed during the year and based on actual performance; and (4) payment of COBRA health insurance premiums for up to 12 months following termination.
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Upon a resignation by any Executive without “good reason” during the term of the Employment Agreement: (1) subject to the Executive’s execution of a release and the Executive’s compliance with non-competition and non-solicitation covenants described above, (A) the Executive’s vested Performance Equity in the form of stock options will remain exercisable for three months, (B) the Executive’s Annual Incentive paid in the form of equity that was earned during the term will continue to vest and (C) the Executive will be entitled to receive the non-compete/non-solicit payments described above (except that, during the term of the Employment Agreements, KCG may elect to waive the non-compete and non-solicit obligations and to not make these payments); and (2) the Executive will forfeit any unpaid Annual Incentives and any unvested Performance Equity.
KCG expects to enter into Employment Agreements with each of the Executives reflecting the foregoing terms.
The foregoing summary does not purport to be complete and is subject to, and qualified in its entirety by, the full text of the Employment Agreements, which are filed as Exhibits 10.1 through 10.7 to this Current Report on Form 8-K, and are incorporated by reference into this Item 5.02.
Item 8.01 Other Events.
On July 1, 2013, Knight Capital Group, Inc. (“Knight”) merged with and into Knight Acquisition Corp, a wholly owned subsidiary of KCG, with Knight surviving the merger (the “Knight Merger”), GETCO Holding Company, LLC (“GHC”) merged with and into GETCO Acquisition, LLC, a wholly owned subsidiary of KCG, with GHC surviving the merger (the “GETCO Merger”) and GA-GTCO, LLC (“GA-GTCO”), a unit holder of GHC, merged with and into GA-GTCO Acquisition, LLC, a wholly owned subsidiary of KCG, with GA-GTCO Acquisition, LLC surviving the merger (the “GA-GTCO Merger” and, together with the Knight Merger and the GETCO Merger, the “Mergers”), in each case, pursuant to the Amended and Restated Agreement and Plan of Merger, dated as of December 19, 2012 and amended and restated as of April 15, 2013 (the “Merger Agreement”). Following the Mergers, each of Knight and GHC became wholly owned subsidiaries of KCG.
Exhibit 99.1 and Exhibit 99.2 to this Current Report on Form 8-K contain information with respect to the operations of GETCO Holding Company, LLC and its Subsidiaries as of and for the period ended June 30, 2013.
In addition to this Current Report on Form 8-K, KCG will also file a Form 10-Q on or about August 9, 2013, which will include Knight’s financial statements, notes and management discussion and analysis as of and for the period ended June 30, 2013.
In September 2013 KCG will file a Form 8-K which will include a pro forma combined statement of financial condition for KCG as of June 30, 2013 and pro forma combined statements of operations for the six months ended June 30, 2013 and for the year ended December 31, 2012. The combined financial statements for KCG will include the pro forma impact of purchase accounting adjustments resulting from the Mergers.
Beginning with the third quarter of 2013, the quarter in which the Mergers were completed and KCG began operations, KCG will report on a consolidated basis, including the legacy operations of Knight and GETCO Holding Company, LLC and its subsidiaries (“GETCO” or the “Company”). As GETCO is the accounting acquirer, all historical financial information will be that of GETCO.
Except as otherwise indicated herein, the information contained within Exhibit 99.1 and Exhibit 99.2 to this Current Report on Form 8-K relates only to the operations of GETCO as of and for the period ended June 30, 2013. All references to “the Company,” “we,” “our” or “GETCO” in Exhibit 99.1 and Exhibit 99.2 of
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this Current Report on Form 8-K relate solely to GETCO Holding Company, LLC and its Subsidiaries, and not KCG. In addition, Exhibit 99.3 to this Current Report on Form 8-K contains updated risk factors relating to the business and operations of KCG as a consolidated entity as of the date of this report. These risk factors update the risk factors previously disclosed in the Registration Statement on Form S-4 (Registration No. 333-186624) filed by KCG with respect to the Mergers (the “Registration Statement”).
For additional information relating to the Mergers and KCG see the Registration Statement, the Form 8-K filed by KCG on July 1, 2013 with the SEC, Note 17 to the financial statements contained in Exhibit 99.1 to this Current Report on Form 8-K and the risk factors contained in Exhibit 99.3 to this Current Report on Form 8-K.
Item 9.01 Financial Statements and Exhibits
Exhibit 10.1 Form of Employment Agreement by and between KCG Holdings, Inc. and [Executive].
Exhibit 10.2 Term Schedule to Employment Agreement for Steven Bisgay.
Exhibit 10.3 Term Schedule to Employment Agreement for John DiBacco.
Exhibit 10.4 Term Schedule to Employment Agreement for John McCarthy.
Exhibit 10.5 Term Schedule to Employment Agreement for Nick Ogurtsov.
Exhibit 10.6 Term Schedule to Employment Agreement for Jonathan Ross.
Exhibit 10.7 Term Schedule to Employment Agreement for George Sohos.
Exhibit 99.1 Unaudited consolidated statement of financial condition of GETCO Holding Company, LLC and subsidiaries as of June 30, 2013 and December 31, 2012, the unaudited consolidated statements of comprehensive income and cash flows for the six months ended June 30, 2013 and June 30, 2012, and the unaudited consolidated statement of members’ equity for the six months ended June 30, 2013.
Exhibit 99.2 Management’s discussion and analysis of GETCO’s financial condition as of June 30, 2013 and December 31, 2012 and results of operations for the three and six months ended June 30, 2013 and 2012.
Exhibit 99.3 Risk factors relating to KCG.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned’s duly authorized signatory.
Dated: August 9, 2013
| KCG HOLDINGS, INC. | ||
| By: | /s/ John McCarthy | |
| Name: | John McCarthy | |
| Title: | General Counsel and Corporate Secretary | |
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Exhibit 10.1
—, 2013
—
at the address
in the Schedule
| Re: | Employment Agreement |
Dear —:
This letter agreement (“Agreement”) sets forth the terms of your employment with KCG Holdings, Inc., a Delaware corporation (the “Company”) and its affiliates (together, the “Group”).
1. Terms Schedule
Some of the terms of your employment are in the attached schedule (your “Schedule”), which is part of this Agreement.
2. Term of Your Employment
Your employment under this Agreement will begin on the date stated in your Schedule and is scheduled to end as stated in your Schedule (your “Scheduled Term”).
3. Your Position, Performance and Other Activities
(a) Position. You will be employed in the position stated in your Schedule.
(b) Authority, Responsibilities, and Reporting. Your authority, responsibilities and reporting relationships will correspond to your position and will include any particular authority, responsibilities and reporting relationships stated in your Schedule or that, consistent with your position, the Chief Executive Officer of the Company or the Board of Directors of the Company (the “Board”) may assign to you from time to time.
(c) Performance. You will devote substantially all of your business time and attention to the Group and will use good faith efforts to discharge your responsibilities under this Agreement to the best of your ability. During your employment, you will not engage in any other business activity that conflicts with your duties and obligations to the Group.
4. Your Compensation
(a) Salary. You will receive an annual base salary (your “Salary”). The starting amount of your Salary is in your Schedule. The Company will review your Salary consistent with its general practice for senior executives and may increase it at any time for any reason. However, your Salary may not be decreased at any time (including after any increase) other than as part of an across-the-board salary reduction that applies in the same manner to all senior executives, and any increase in your Salary will not reduce or limit any other obligation to you under this Agreement. Your Salary will be paid in accordance with the Company’s normal practices for senior executives. The term Salary as used in this Agreement shall refer to your Salary as it may be increased from time to time.
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(b) Annual Incentive. Commencing with the 2013 fiscal year, you will be eligible to receive an annual incentive (your “Annual Incentive”) for each fiscal year of the Company ending during your employment. The amount of your Annual Incentive will be determined by the Company in accordance with your Schedule. A portion of your Annual Incentive will be paid in cash and the remaining portion will be settled in equity-based awards over the Company’s common stock (your “Annual Incentive Equity”), as determined by the Company in accordance with your Schedule. The vesting schedule and any other features of your Annual Incentive Equity will be determined by the Company in accordance with your Schedule. Except as provided in this Agreement, your Annual Incentive Equity will be subject to the terms of the Company equity plan under which it is granted and to the terms of any applicable award agreements. Your Annual Incentive will be paid or granted, as applicable, within two and one-half months after the end of the fiscal year to which it relates. Your Annual Incentive will be subject to the terms of the Company annual incentive plan under which it is awarded, any Group clawback or recoupment policy in effect from time to time that is triggered by the Company’s filing of restated financial statements with the Securities and Exchange Commission (a “Group Recoupment Policy”), and any other clawback or recoupment to the extent required by applicable law. You expressly agree to comply with any Group Recoupment Policy in all regards.
(c) Performance Awards. In addition to your Salary and Annual Incentive, within 3 business days of the release of the Company’s earnings for the second quarter of 2013, you will be granted equity-based awards over the Company’s common stock (your “Performance Awards”) in accordance with your Schedule; provided, that you will forfeit the Performance Awards unless you execute the Agreement within 30 days of it being approved by the Board and executed on behalf of the Company. The number and form of Performance Awards you will receive is in your Schedule. The applicable terms of your Performance Awards, such as exercise price, expiration date and vesting schedule, are stated in your Schedule. Your Performance Awards also will have any other features stated in your Schedule. Except as provided in this Agreement, your Performance Awards will be subject to the terms of the Company equity plan under which they are granted and to the terms of the applicable award agreements.
5. Your Benefits
(a) Employee Benefit Plans. During your employment, you will be entitled to participate in each of the Group’s employee benefit and welfare plans, including plans providing retirement benefits or medical, dental, hospitalization, life or disability insurance, or fringe benefits on a basis that is at least as favorable as that provided to other senior executives of the Company. For purposes of determining eligibility to participate in, and vesting under, any employee benefit or welfare plan, you will be credited fully for your service with any member of the “controlled group of corporations” of which GETCO Holding Company, LLC (“GETCO”) was a member, or if applicable, with any member of the “controlled group of corporations” of which Knight Capital Group, Inc. (“Knight”) was a member (in each case, other than with respect to any newly adopted plan of the Group for which past service credit is not granted to employees generally). Your service need not be counted or credited for purposes of benefit accrual under any defined benefit retirement plan, any Knight employee benefit and welfare plans that provide retiree welfare benefits or any Knight employee benefit and welfare plans that are frozen or provide grandfathered benefits, or to the extent such recognition would
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result in the duplication of benefits for the same period of service. In addition, the Group will waive any preexisting conditions, waiting periods and actively at-work requirements under any employee benefit or welfare plan and will cause them to honor, for purposes of any deductible, co-insurance or maximum out-of-pocket expenses provisions, any expenses incurred by you or your beneficiaries during the portion of the fiscal year before the date you commence participation in any such plan, to the extent such expenses were credited under any similar plans of GETCO, or if applicable, Knight.
(b) Vacation. You will be entitled to paid annual vacation on a basis that is at least as favorable as that provided to other senior executives of the Company.
(c) Business Expenses. You will be reimbursed for all reasonable business and entertainment expenses incurred by you in performing your responsibilities under this Agreement that are submitted in accordance with the Group’s policy.
(d) Indemnification; Advancement of Expenses. To the extent permitted by law and the Company’s bylaws, the Company will indemnify you against any actual or threatened action, suit or proceeding against you, whether civil, criminal, administrative or investigative, arising by reason of your status as a director, officer, employee and/or agent of the Group during your employment. In addition, to the extent permitted by law, the Company will advance or reimburse any expenses, including reasonable attorney’s fees, you incur in investigating and defending any actual or threatened action, suit or proceeding for which you may be entitled to indemnification under this Section 5(d). However, you agree to repay any expenses paid or reimbursed by the Company to the extent it is ultimately determined that you are not legally entitled to be indemnified by the Company. If the Company’s ability to make any payment contemplated by this Section 5(d) depends on an investigation or determination by the board of directors of any member of the Group, at your request the Company will use its best efforts to cause the investigation to be made (at the Company’s expense) and to have the relevant board reach a determination in good faith as soon as reasonably possible.
(e) Additional Benefits. During your employment, you will be provided any additional benefits stated in your Schedule.
6. Termination of Your Employment
(a) No Reason Required. Neither you nor the Company is under any obligation to continue your employment beyond your Scheduled Term. In addition, you or the Company may terminate your employment early at any time for any reason, or for no reason, subject to compliance with this Section 6.
(b) Related Definitions.
(1) “Cause” means, subject to the provisions of your Schedule, a finding by the Board of any of the following:
(A) Your continued and willful failure to perform substantially your responsibilities to the Group under this Agreement, after demand for substantial performance has been given by the Board that specifically identifies how you have not substantially performed your responsibilities.
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Cause does not, however, include failure resulting from your incapacity due to mental or physical illness or injury or from any permitted leave required by law.
(B) You engage in illegal conduct, gross misconduct, or gross neglect, that in any case causes material financial or reputational harm to either the Group or the Company.
(C) Your conviction of, or plea of guilty or nolo contendere to, a felony, other than any felony with respect to which your involvement is limited to your position with the Group, you had no direct involvement and you had no actual knowledge of the actions underlying the felony until after they were taken.
(D) Your material breach of Sections 3(c), 7, 8(c), 8(d), 8(e) or 8(f). However, to the extent the breach is curable, the Company must give you notice and a reasonable opportunity to cure.
(E) Your expulsion, or subjection to an order permanently or temporarily (more than 90 days) enjoining you, from the securities, investment management or investment banking business or your disqualification or bar from acting in the capacity contemplated by this Agreement by the Securities and Exchange Commission, the Financial Industry Regulatory Authority (the “FINRA”), any national securities exchange or any self-regulatory agency or governmental authority, in each case after you have exhausted all appeals or have admitted to such finding by consent, unless such expulsion, permanent injunction, disqualification or bar is due to your engagement in conduct with the recorded authorization of the Board or in good faith, reasonable reliance on the advice of the Company’s counsel.
(F) Your habitual abuse of narcotics or alcohol.
(G) Your fraud or material dishonesty in connection with the business of the Group.
(H) Your willful misappropriation of any of the Group’s funds or property.
The Company may place you on paid leave for up to 60 consecutive days while it is determining whether there is a basis to terminate your employment for Cause. This leave will not constitute Good Reason.
(2) “Good Reason” means, without your written consent, a material breach by the Company of this Agreement or any other material financial obligation to you or the occurrence of any other event or condition set forth in your Schedule as constituting Good Reason. You must provide written notice to the Company of the existence of any event or condition that constitutes Good Reason within 90 days of its existence. Upon receipt of such notice, the Company shall have a period of 30 days during which it may remedy such event or condition that constitutes Good Reason (the “Cure Period”). Notwithstanding
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any other provision herein, your termination of employment shall not constitute a termination with Good Reason unless such termination occurs within 60 days following the last day of the Cure Period.
(3) “Disability” has the same meaning as that contained in the Group’s long-term disability policy that triggers eligibility for benefits.
(4) “Change in Control” shall have the meaning set forth in the Company’s Amended and Restated Equity Incentive Plan, as assumed by the Company on July 1, 2013.
(c) With Good Reason or Without Cause. If, during your Scheduled Term, the Company terminates your employment without Cause or you terminate your employment with Good Reason:
(1) The Company will, within 30 days of the end of your employment, pay the following as of the end of your employment: (A) your unpaid Salary; (B) your Salary for any accrued but unused vacation; and (C) reimbursement of any business expenses submitted in accordance with the Group’s policy (together, your “Accrued Compensation”).
(2) The Company will pay your Earned Annual Incentive at the time such Earned Annual Incentive would otherwise have been paid had your employment not ended; provided, however, that it will be paid all in cash. Your “Earned Annual Incentive” means any earned but unpaid Annual Incentive for the fiscal year ending immediately before the end of your employment and, to the extent it has not been determined before the end of your employment, determined based on actual performance consistent with this Agreement and the Company annual incentive plan under which it was awarded.
(3) The Company will pay your Accrued Annual Incentive at the time such Accrued Annual Incentive would otherwise have been paid had your employment not ended; provided, however, that it will be paid all in cash. Your “Accrued Annual Incentive” means the Annual Incentive for the year of your termination based on the actual performance of the Company consistent with this Agreement and the Company annual incentive plan under which it was awarded and prorated for the number of days you worked for the Company during such year.
(4) The Company will pay your premiums for continued health coverage under “COBRA” during the one-year period following your termination (the “Benefits Continuation Period”); provided and to the extent that you are eligible for and timely and properly elect to receive such COBRA coverage; provided further, that in the event you cease COBRA coverage, the Company shall not be obligated to pay you any future installments of the Health Payment (as defined below); provided further, that if the Company’s making payments under this Section 6(c)(4) would violate the nondiscrimination rules applicable to non-grandfathered plans, or result in the imposition of penalties under the Patient Protection and Affordable Care Act of 2010 (“PPACA”) and related regulations and guidance promulgated thereunder, the parties agree to reform this provision in
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such manner as is necessary to comply with the PPACA. The Company shall pay you in advance an amount equal to three times the monthly premium amount payable by you for such COBRA coverage (the “Health Payment”), no later than the first date of the month following your date of termination and on the first business day of each of the third, sixth and ninth months thereafter. The Benefits Continuation Period shall be concurrent with and applied toward any coverage period required under COBRA.
(5) Subject to Section 6(h)(2), your Annual Incentive Equity will continue to vest on the vesting dates specified in the applicable award agreement (as if your employment had continued).
(6) You will be provided any additional benefits, and be subject to any additional terms, stated in your Schedule.
(d) For Cause. If the Company terminates your employment for Cause: (1) the Company will pay your Accrued Compensation; (2) you will forfeit your Earned Annual Incentive; (3) you will forfeit your Accrued Annual Incentive; (4) you will forfeit any unvested Performance Awards (and any unexercised Performance Awards in the form of options and stock appreciation rights (whether vested or unvested)); and (5) you will forfeit any unvested Annual Incentive Equity.
(e) Without Good Reason. If, during your Scheduled Term, you terminate your employment without Good Reason: (1) the Company will pay your Accrued Compensation; (2) you will forfeit your Earned Annual Incentive; (3) you will forfeit your Accrued Annual Incentive; (4) you will forfeit any unvested Performance Awards; and (5) you will be provided any additional benefits, and be subject to any additional terms, stated in your Schedule.
(f) For Your Disability or Death. If, during your Scheduled Term, your employment terminates as a result of your death or Disability: (1) the Company will pay your Accrued Compensation; (2) the Company will pay your Earned Annual Incentive; (3) the Company will pay your Accrued Annual Incentive; (4) your Performance Awards will vest and become immediately payable and, to the extent your Performance Awards are in the form of options or stock appreciation rights, become immediately exercisable and remain exercisable until they expire (as if your employment had continued); and (5) your Annual Incentive Equity will vest and become immediately payable.
(g) Other Termination Benefits. You will be provided any other benefits, and be subject to any additional terms, stated in your Schedule.
(h) Conditions.
(1) Notwithstanding anything contained in this Agreement to the contrary, the Company will not be required to make the payments and provide the benefits stated in this Section 6 (other than the Accrued Compensation) unless you execute and deliver to the Company the Release of Claims in the form attached hereto as Attachment A (the “Release”). For the avoidance of doubt, the parties acknowledge that your right to elect COBRA coverage is not subject to your execution of a Release. The Release shall be provided to you no later than two days after your termination, and must be executed by you and become
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effective and not be revoked by you by the 55th day following your termination (the period following your termination until the Release becomes effective being the “Release Period”). Any payments or benefits in this Section 6 (other than the Accrued Compensation) that would have been paid or provided to you during the Release Period shall be paid or provided on the next regularly scheduled Company payroll date following the Release Period.
(2) The Company will not be required to make the payments and provide the benefits stated in Section 6(c), (e) or (g) (other than the Accrued Compensation, the Earned Annual Incentive, the Accrued Annual Incentive and the Health Payments) unless you comply with Section 8(c) until the end of the “Non-Competition Period” and Section 8(d) until the end of the “Non-Solicitation Period,” in each case, as stated in your Schedule. If you fail to comply with Section 8(c) until the end of your Non-Competition Period or Section 8(d) until the end of your Non-Solicitation Period, other than any isolated, insubstantial and inadvertent failure that is not in bad faith, you will:
(A) forfeit all Performance Awards that have not vested at the time of determination (and any Performance Awards in the form of options and stock appreciation rights that have not been exercised at the time of determination (whether vested or unvested)) and all Annual Incentive Equity that have not vested at the time of determination; and
(B) pay to the Group the amount of all gain to you from the end of your employment through the time of determination from (A) the vesting and/or exercise of any Performance Awards, and (B) the vesting of any Annual Incentive Equity.
(3) To determine the amount you owe under Section 6(h)(2)(B):
(A) The value of the Company’s common stock on any date will be calculated using the average closing price of the Company’s common stock for the 20 full trading days ending on that date.
(B) Gain on the exercise of Performance Awards in the form of options or stock appreciation rights will be based on the value of the Company’s common stock on the date of exercise.
(C) Gain on the vesting of any Performance Awards and Annual Incentive Equity will be based on the value of the Company’s common stock on the date of vesting.
(4) You will pay the Group under Section 6(h)(2) within 5 days of notice by the Company, and the date of notice will be the date of determination for purposes of this Section. You will pay the Group in cash. However, you may choose to deliver Company common stock (valued in accordance with Section 6(h)(3)) in partial or full satisfaction of your obligation. Your obligations under Section 6(h)(2) are full recourse obligations. The Company will have the right to offset your obligations under Section 6(h)(2) against any amounts otherwise owed to you by any member of the Group, including under this Agreement.
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(i) End of Scheduled Term. For the avoidance of doubt, if your employment with the Company continues after the end of your Scheduled Term, the provisions of Section 3 through this Section 6 will cease to apply and you will continue as an at-will employee of the Company. The remaining provisions of this Agreement will continue in accordance with their terms.
7. Proprietary Information
(a) Definition. “Proprietary Information” means confidential or proprietary information, knowledge or data concerning the Group’s businesses, strategies, operations, financial affairs, organizational matters, personnel matters, budgets, business plans, marketing plans, studies, policies, procedures, products, ideas, processes, software systems, trade secrets and technical know-how. However, Proprietary Information does not include information (1) that was or becomes generally available to you on a non-confidential basis, if the source of this information was not reasonably known to you to be bound by a duty of confidentiality, (2) that was or becomes generally available to the public, other than as a result of a disclosure by you, directly or indirectly, that is not authorized by the Company or (3) that you can establish was independently developed by you without reference to any Proprietary Information.
(b) Use and Disclosure. You will obtain or create Proprietary Information in the course of your involvement in the Group’s activities and may already have Proprietary Information. You agree that the Proprietary Information is the exclusive property of the Group, and that, during your employment, you will use and disclose Proprietary Information only for the Group’s benefit and in accordance with any restrictions placed on its use or disclosure by the Group. After your employment, you will not use or disclose any Proprietary Information. In addition, nothing in this Agreement will operate to weaken or waive any rights the Group may have under statutory or common law to the protection of trade secrets, confidential business information and other confidential information.
(c) Return of Proprietary Information. When your employment terminates, you agree to return to the Group all Proprietary Information, including all notes, mailing lists and computer files that contain any Proprietary Information. However, notwithstanding anything to the contrary, you will be permitted to retain copies of documents relating to your personal entitlements, benefits, obligations and tax liabilities. You agree to do anything reasonably requested by the Group in furtherance of perfecting the Group’s possession of, and title to, any Proprietary Information that was at any time in your possession.
(d) Limitations. Nothing in this Agreement prohibits you from providing truthful testimony concerning the Group to governmental, regulatory or self-regulatory authorities, or from disclosing Proprietary Information (1) to the extent necessary to comply with any law, subpoena or other professional or governmental order; provided, however, that you have first provided the Group with the opportunity to defend the necessity of such disclosure, (2) in any arbitration or proceeding to the extent necessary to defend or enforce your rights under this Agreement or (3) in confidence to an attorney or other professional for the purpose of obtaining professional advice. Also the parties (and their respective employees, representatives and agents) may disclose to any and all
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persons, without any limitation of any kind, the tax treatment and tax structure of this Agreement and all materials of any kind (including opinions and other tax analysis) that are provided to either party related to such tax treatment and structure.
8. Ongoing Restrictions on Your Activities
(a) General Effect. This Section 8 applies during your employment and for some time after your employment ends. This Section uses the following defined terms:
(1) “Competitive Enterprise” means any business enterprise that either (A) engages in the business of providing a Conflicting Product or Service or Conflicting Intellectual Property anywhere in the United States, Europe or Asia or (B) holds a 5% or greater equity, voting or profit participation interest in any enterprise that engages in such a competitive activity.
(2) “Conflicting Product or Service or Conflicting Intellectual Property” means a product, service and/or intellectual property (or related service) that is the same or similar in function or purpose to a Group product, service or intellectual property (or related service) sold, used, provided to, performed for or employed by the Group, such that it would replace, modify or compete with: (A) a product and/or service the Group provides to, or performs for, its customers or is used, provided to or performed for Group internal purposes; (B) intellectual property (or related service) developed, used, provided to or performed for the Group in its activities (including, but not limited to, trading strategies, models, algorithms, trading hardware and software) or as part of its IT design or infrastructure; or (C) a product, service or intellectual property (or related service) that is under development or planning by the Group but not yet provided to or performed for customers or used, provided to or performed for internal purposes and regarding which you were provided Proprietary Information in the course of your employment.
(3) “Solicit” means any direct or indirect communication of any kind, regardless of who initiates it, that in any way invites, advises, encourages or requests any person to take or refrain from taking any action.
(b) Your Importance to the Group and the Effect of this Section 8. You acknowledge that:
(1) In the course of your involvement in the Group’s activities, you will have access to Proprietary Information and the Group’s client base and will profit from the goodwill associated with the Group. On the other hand, in view of your access to Proprietary Information and your importance to the Group, if you compete with the Group for some time after your employment, the Group will likely suffer significant harm. This Agreement provides you with substantial additional benefits over your prior arrangements with GETCO, or if applicable, Knight. In return for the benefits you will receive from the Group and to induce the Company to enter into this Agreement, and in light of the potential harm you could cause the Group, you agree to the provisions of this Section 8. The Company would not have entered into this Agreement if you did not agree to this Section 8.
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(2) This Section 8 limits your ability to earn a livelihood in a Competitive Enterprise. You acknowledge, however, that complying with this Section 8 will not result in severe economic hardship for you or your family.
(c) Non-Competition. Except as stated in your Schedule, from the date hereof until the end of your Non-Competition Period, you will not directly or indirectly:
(1) hold a 5% or greater equity, voting or profit participation interest in a Competitive Enterprise; or
(2) associate (including as a director, officer, employee, partner, consultant, agent or advisor) with a Competitive Enterprise and in connection with your association engage, or directly or indirectly manage or supervise personnel engaged, in any activity:
(A) that is substantially related to any activity that you were engaged in,
(B) that is substantially related to any activity for which you had direct or indirect managerial or supervisory responsibility, or
(C) that calls for the application of specialized knowledge or skills substantially related to those used by you in your activities;
in each case, for the Group at any time during the year before the end of your employment (or, if earlier, the year before the date of determination).
(d) Non-Solicitation of Group Employees. From the date hereof until the end of your Non-Solicitation Period, you will not attempt to Solicit anyone who is then an employee of the Group (or who was an employee of the Group within the prior six months (other than any such employees who were terminated without cause by the Group)) to resign from the Group or to apply for or accept employment with any Competitive Enterprise.
(e) Notice to New Employers; Response from Company. Before you accept employment with any other person or entity while any of Section 8(c) or (d) is in effect, you will provide the prospective employer with written notice of the provisions of this Section 8. You will also deliver a copy of such notice to the Group before you commence such employment. The Company will respond, as soon as reasonably practicable, to any request you have regarding a determination as to whether any contemplated action by you would constitute a breach of this Section 8.
(f) No Public Statements or Disparagement. You agree that you will not make any public statement regarding your employment or the termination of your employment (for whatever reason) that are not agreed to by the Group. You agree that you will not make any public statement that would libel, slander or disparage any member of the Group or any of their respective past or present officers, directors, employees or agents. This Section 8(f) is subject to Section 7(d).
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9. Future Cooperation
You agree that upon the Company’s reasonable request following your termination of employment, you will use reasonable efforts to assist and cooperate with the Company in connection with the defense or prosecution of any claim that may be made against or by the Group arising out of events occurring during your employment, or in connection with any ongoing or future investigation or dispute or claim of any kind involving the Group, including any proceeding before any arbitral, administrative, regulatory, self-regulatory, judicial, legislative, or other body or agency. You will be entitled to prompt reimbursement for reasonable out-of-pocket expenses (including travel expenses) incurred in connection with providing such assistance.
10. Key Man Insurance
While you are employed by the Company, the Company may at any time effect insurance on your life and/or health in such amounts and in such form as the Company may in its sole discretion decide. Except as provided under the applicable terms of a policy or other arrangement, you will not have any interest in such insurance, but shall, if the Company requests, submit to such medical examinations, supply such information and execute such documents as may be required in connection with, or so as to enable the Company to effect, such insurance.
11. Sections 280G and 409A of the Code
| (a) | Contingent Cutback. |
(1) If the aggregate of all amounts and benefits due to you (or your beneficiaries), under this Agreement or any other plan, program, agreement or arrangement of the Group (or any payments, benefits or entitlements by or on behalf of any person or entity that effectuates a related transaction) (collectively, “Change in Control Benefits”), would cause you to have “parachute payments” as such term is defined in and under Section 280G of the Internal Revenue Code of 1986, as amended (the “Code”), and would result in the imposition of excise taxes pursuant to Section 4999 of the Code (the “Parachute Tax”), the Company will reduce such payments and benefits so that the Parachute Value of all Change in Control Benefits, in the aggregate, equals the Safe Harbor Amount minus $1,000.00, but only if, by reason of such reduction, the Net After-Tax Benefit shall exceed the Net After-Tax Benefit if such reduction were not made (the “Required Reduction”). The determinations with respect to this Section 11(a)(1) shall be made by an independent public accounting firm (the “Auditor”) paid by the Company. The Auditor shall be a nationally-recognized United States public accounting firm chosen, and paid for, by the Company and approved by you (which approval shall not be unreasonably withheld or delayed). Notwithstanding any provision to the contrary in this Agreement or in any other applicable agreement or plan, any reduction in payments required under this Section 11(a)(1) shall be implemented as follows: first, by reducing any payments to be made to you under Sections 6(c)(4) and 6(c)(5); second, by reducing any other cash payments to be made to you; third, by cancelling any outstanding equity-based compensation awards that are subject to performance vesting (“Performance-Based Equity”) for which the performance goals have not been met as of the event giving rise to the Change in Control Benefit; and fourth, by cancelling the acceleration of vesting of (i) any of your outstanding
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Performance-Based Equity for which the performance goals were met as of the event giving rise to the Change in Control Benefit, and (ii) any of your outstanding equity awards not subject to performance vesting. In the case of the reductions to be made pursuant to each of the above mentioned clauses, the payment and/or benefit amounts to be reduced, and the acceleration of vesting to be cancelled, shall be reduced or cancelled in the inverse order of their originally scheduled dates of payment or vesting, as applicable, and shall be so reduced (x) only to the extent that the payment and/or benefit otherwise to be paid, or the vesting of the award that otherwise would be accelerated, would be treated as a “parachute payment” within the meaning section 280G(b)(2)(A) of the Code, and (y) only to the extent necessary to achieve the Required Reduction.
(2) It is possible that after the determinations and selections made pursuant to Section 11(a)(1) you will receive Change in Control Benefits that are, in the aggregate, either more or less than the limitations provided in Section 11(a)(1) above (hereafter referred to as an “Excess Payment” or “Underpayment”, respectively). If it is established, pursuant to a final determination of a court or an Internal Revenue Service proceeding that has been finally and conclusively resolved, that an Excess Payment has been made, then you shall refund the Excess Payment to the Company promptly on demand, together with an additional payment in an amount equal to the product obtained by multiplying the Excess Payment times the applicable annual federal rate (as determined in and under Section 1274 (d) of the Code), or such higher rate as is necessary to ensure that the Change in Control Benefits are less than the Safe Harbor Amount, times a fraction whose numerator is the number of days elapsed from the date of your receipt of such Excess Payment through the date of such refund and whose denominator is 365. In the event that it is determined (x) by arbitration under Section 14 below, (y) by a court of competent jurisdiction, or (z) by the Auditor upon request by you or the Company, that an Underpayment has occurred, the Company shall pay an amount equal to the Underpayment to you within 10 days of such determination together with an additional payment in an amount equal to the product obtained by multiplying the Underpayment times the applicable annual federal rate (as determined in and under Section 1274(d) of the Code) times a fraction whose numerator is the number of days elapsed from the date of the Underpayment through the date of such payment and whose denominator is 365.
(3) All determinations made by the Auditor under Section 11(a)(1) shall be binding upon the Company and you and shall be made as soon as reasonably practicable following the event giving rise to the Change in Control Benefits, or such later date on which a Change in Control Benefit has been paid or a request under clause (z) of Section 11(a)(2) has been made.
(4) Definitions. The following terms shall have the following meanings for purposes of this Section 11(a).
(A) “Net After-Tax Benefit” means the present value (as determined in accordance with Section 280G(d)(4) of the Code) of the Change in Control Benefits net of all taxes imposed on you with respect thereto under Sections 1 and 4999 of the Code and under applicable state and local laws, determined by applying the highest marginal rate under Section 1 of the Code and under
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| — | - 13 - |
state and local laws which applied to your taxable income for the immediately preceding taxable year, or such other rate(s) as you certify as likely to apply to you in the relevant tax year(s).
(B) “Parachute Value” of a Change in Control Benefit shall mean the present value as of the date of the change of control for purposes of Section 280G of the Code of the portion of such Change in Control Benefit that constitutes a “parachute payment” under Section 280G(b)(2) of the Code and its implementing regulations, as determined by the Auditor for purposes of determining whether and to what extent the Parachute Tax will apply to such Change in Control Benefit.
(C) The “Safe Harbor Amount” means 2.99 times your “base amount,” within the meaning of Section 280G(b)(3) of the Code and its implementing regulations.
(b) This Agreement is intended to comply with Section 409A of the Code (“Section 409A”) to the extent it is subject thereto, and the Agreement shall be interpreted on a basis consistent with such intent. If and to the extent that any payment or benefit under this Agreement, or any plan, award agreement or arrangement of the Group, constitutes “non-qualified deferred compensation” subject to Section 409A, such payments and benefits may only be made or satisfied under this Agreement upon an event and in a manner permitted by Section 409A. Each payment of compensation under this Agreement shall be treated as a separate payment of compensation for purposes of Section 409A to the extent Section 409A is relevant to such payments. The Health Payments are intended to qualify for the exception from deferred compensation as a medical benefit provided in accordance with the requirements of Treas. Reg. §1.409A-1(b)(9)(v)(B).
(c) Notwithstanding anything in this Agreement to the contrary, if you are considered a “specified employee” for purposes of Section 409A, (1) if payment of any amounts under this Agreement is required to be delayed for a period of six months after separation from service pursuant to Section 409A, payment of such amounts shall be delayed as required by Section 409A, and the accumulated amounts and interest on such amounts (calculated based on the Applicable Federal Rate in effect on the date of termination) shall, subject to Section 6(h), be paid in a lump sum payment within fifteen days after the end of the six-month period and (2) in the event any Annual Incentive Equity or other equity-based awards held by you that vest upon termination of your employment constitute “non-qualified deferred compensation” subject to Section 409A, the delivery of shares or cash (as applicable) in settlement of such awards shall be made on the earliest permissible payment date (including the date that is six months after separation from service pursuant to Section 409A) or event under Section 409A on which the shares or cash would otherwise be delivered or paid. If you die during the postponement period prior to the payment of any amounts or benefits or delivery of shares, the amounts and entitlements delayed on account of Section 409A shall be paid or provided to the personal representative of your estate within 60 days after the date of your death.
(d) All payments to be made upon a termination of employment under this Agreement may only be made upon a “separation from service” under Section 409A. In
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no event may you, directly or indirectly, designate the calendar year of a payment. Any payments and/or equity-based awards which constitute “non-qualified deferred compensation” subject to Section 409A which are payable upon a Change in Control shall only be paid upon transactions or events which give rise to a “change in ownership or effective control” or a change in the “ownership of a substantial portion of the assets” of the Company under Section 409A, and in the event such transactions or events do not give rise to a “change in ownership or effective control” or a change in the “ownership of a substantial portion of the assets” of the Company, such amounts shall become vested and nonforfeitable but shall be distributed on the otherwise applicable distribution date or event. All reimbursements and in-kind benefits provided under this Agreement shall be made or provided in accordance with the requirements of Section 409A (or an exemption therefrom), including, where applicable, the requirement that (1) any reimbursement is for expenses incurred during your lifetime (or during a shorter period of time specified in this Agreement); (2) the amount of expenses eligible for reimbursement, or in-kind benefits provided, during a calendar year may not affect the expenses eligible for reimbursement, or in-kind benefits to be provided, in any other calendar year; (3) the reimbursement of an eligible expense will be made no later than the last day of the calendar year following the year in which the expense is incurred; and (4) the right to reimbursement or in-kind benefits is not subject to liquidation or exchange for another benefit. The Company may offset any of your payment obligations under Section 6(h)(2) against any “non-qualified deferred compensation” subject to Section 409A of the Code only to the extent it would not cause such “non-qualified deferred compensation” to violate Section 409A of the Code.
12. Effect on Other Agreements
(a) Prior Employment Agreements and Severance Rights. After the term of your employment starts, this Agreement will supersede any earlier employment agreement and any earlier severance or similar rights you may have with GETCO or any of GETCO’s affiliates, or if applicable, Knight or any of Knight’s affiliates.
(b) Entire Agreement; No Conflicts. This Agreement is the entire agreement between you and the Company with respect to the relationship contemplated by this Agreement. In entering into this Agreement, no party has relied on or made any representation, warranty, inducement, promise or understanding that is not in this Agreement. You represent and warrant to the Company that your performance of your duties will not conflict with or result in a violation or breach of, or constitute a default under, any contract, agreement or understanding to which you are or were a party or of which you are aware and that there are no restrictions, covenants, agreements or limitations on your right or ability to enter into and perform the terms of this Agreement. The Company represents and warrants to you that: (1) it is fully authorized by action of any person whose action is required to enter into this Agreement and to perform the Company’s obligations under it; (2) the execution, delivery and performance of this Agreement by the Company does not violate any applicable law, regulation, order, judgment or decree or any agreement, arrangement, plan or corporate governance document to which it is a party or by which it is bound; and (3) upon the execution and delivery of this Agreement by the parties hereto, this Agreement shall be a valid and binding obligation of the Company, enforceable against the Company in accordance with its terms, except to the extent that enforceability may be limited by applicable bankruptcy, insolvency or similar laws affecting the enforcement of creditors’ rights generally.
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13. Successors
(a) Payments on Your Death or Incapacity. If you die and any amounts become payable under this Agreement, we will pay those amounts to your estate, designated beneficiaries or other legal representative. Upon your death or a judicial determination of your incapacity, references to you shall be deemed, where appropriate, to be references to your beneficiaries, estate or other legal representative(s).
(b) Assignment by You. You may not assign this Agreement without the Company’s consent; provided, however, that you will be entitled, to the extent permitted under applicable law, to select and change a beneficiary or beneficiaries to receive any compensation or benefit under this Agreement following your death by giving the Company written notice thereto. Also, except as required by law, your right to receive payments or benefits under this Agreement may not be subject to execution, attachment, levy or similar process. Any attempt to effect any of the preceding in violation of this Section 13(b), whether voluntary or involuntary, will be void.
(c) Assumption by Any Surviving Company. Before the effectiveness of any Change in Control, the Company will cause (1) the surviving company to unconditionally assume this Agreement in writing and (2) a copy of the assumption to be provided to you. After the Change in Control, the surviving company will be treated for all purposes as the Company under this Agreement.
14. Disputes
(a) Mandatory Arbitration. Subject to the provisions of this Section 14, any dispute involving your employment or this Agreement will be finally settled by binding arbitration in the County of New York administered by the American Arbitration Association, the FINRA, JAMS/Endispute, or any other similar association mutually agreed to by the Company and you. The award of the arbitrators shall be final and binding and judgment upon the award may be entered in any court having jurisdiction thereof. This procedure shall be the exclusive means of settling any disputes that may arise under this Agreement. All fees and expenses of the arbitrators and all other expenses of the arbitration, except for attorneys’ fees and witness expenses, shall be borne by the Company if you prevail. Each party shall bear its own witness expenses and attorneys’ fees; provided that if you prevail on any material issue (as determined by the arbitrators), the Company shall reimburse you for attorney’s fees incurred in connection with such claim.
(b) Limitation on Damages. You and the Group agree that there will be no punitive damages payable as a result of any dispute involving your employment or this Agreement and agree not to request punitive damages.
(c) Injunctions and Enforcement of Arbitration Awards. You or the Group may bring an action or special proceeding in a state or federal court of competent jurisdiction sitting in the County of New York to enforce any arbitration award under Section 14(a). Also, the Group may bring such an action or proceeding, in addition to its rights under Section 14(a) and whether or not an arbitration proceeding has been or is ever initiated, to temporarily, preliminarily or permanently enforce any part of Sections 7 and 8. You agree that (1) your violating any part of Sections 7 and 8 would cause damage to the Group that cannot be measured or repaired, (2) the Group therefore is entitled to an injunction,
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restraining order or other equitable relief restraining any actual or threatened violation of those Sections, (3) no bond will need to be posted for the Group to receive such an injunction, order or other relief, and (4) no proof will be required that monetary damages for violations of those Sections would be difficult to calculate and that remedies at law would be inadequate.
(d) Waiver of Jury Trial. To the extent permitted by law, you and the Group waive any and all rights to a jury trial with respect to any dispute involving your employment or this Agreement.
(e) Governing Law. This Agreement will be governed by and construed in accordance with the law of the State of New York applicable to contracts made and to be performed entirely within that State except as to equity-based awards under any stockholder-approved stock plan, where the governing law provisions contained in such plans shall control.
15. General Provisions
(a) Construction. References (A) to Sections are to sections of this Agreement unless otherwise stated; (B) to any contract (including this Agreement) are to the contract as amended, modified, supplemented or replaced from time to time; (C) to any statute, rule or regulation are to the statute, rule or regulation as amended, modified, supplemented or replaced from time to time (and, in the case of statutes, include any rules and regulations promulgated under the statute) and to any section of any statute, rule or regulation include any successor to the section; (D) to any governmental authority include any successor to the governmental authority; (E) to any plan include any programs, practices and policies; (F) to any entity include any corporation, limited liability company, partnership, association, business trust and similar organization and include any governmental authority; and (G) to any affiliate of any entity are to any person or other entity directly or indirectly controlling, controlled by or under common control with the first entity.
(1) The various headings in this Agreement are for convenience of reference only and in no way define, limit or describe the scope or intent of any provisions or Sections of this Agreement.
(2) Unless the context requires otherwise, (A) words describing the singular number include the plural and vice versa, (B) words denoting any gender include all genders and (C) the words “include”, “includes” and “including” will be deemed to be followed by the words “without limitation.”
(3) It is your and the Group’s intention that this Agreement not be construed more strictly with regard to you or the Group.
(b) Withholding. You and the Group will treat all payments to you under this Agreement as compensation for services. Accordingly, the Group may withhold from any payment any taxes that are required to be withheld under any law, rule or regulation.
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(c) Severability. If any provision of this Agreement is found by any court of competent jurisdiction (or legally empowered agency) to be illegal, invalid or unenforceable for any reason, then (1) the provision will be amended automatically to the minimum extent necessary to cure the illegality or invalidity and permit enforcement and (2) the remainder of this Agreement will not be affected. In particular, if any provision of Section 8 is so found to violate law or be unenforceable because it applies for longer than a maximum permitted period or to greater than a maximum permitted area, it will be automatically amended to apply for the maximum permitted period and maximum permitted area.
(d) Survival. The end of your employment or of this Agreement (or breach of this Agreement by you or the Company) shall have no effect on the continuing operation of Sections 7, 8, 9, 13(a), 13(b) and 14. Accordingly, and without limitation, the restrictions of Section 8 will apply to any termination of your employment, even if such termination occurs after the expiration of your Scheduled Term.
(e) Notices. All notices, requests, demands and other communications under this Agreement must be in writing and will be deemed given (1) on the business day sent, when delivered by hand or facsimile transmission (with confirmation) during normal business hours, (2) on the business day after the business day sent, if delivered by a nationally recognized overnight courier or (3) on the third business day after the business day sent if delivered by registered or certified mail, return receipt requested, in each case to the following address or number (or to such other addresses or numbers as may be specified by notice that conforms to this Section 15(e)):
If to you, to the address stated in your Schedule.
If to the Company or any other member of the Group, to:
KCG Holdings, Inc.
545 Washington Boulevard
Jersey City, New Jersey 07310
Attention: General Counsel
Telephone: (201) 222-9400
with a copy to:
Sullivan & Cromwell
125 Broad Street
New York, New York 10004
Attention: Marc Trevino
Facsimile: (212) 558-3588
Telephone: (212) 558-4000
(f) Consideration. You and the Company acknowledge the receipt and sufficiency of the consideration to this Agreement and intend this Agreement to be legally binding.
(g) Amendments and Waivers. Any provision of this Agreement may be amended or waived but only if the amendment or waiver is in a writing that expressly
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refers to the provision of this Agreement that is being amended or waived, and that is signed, in the case of an amendment, by you and the Company or, in the case of a waiver, by the party that would have benefited from the provision waived. Except as this Agreement otherwise provides, no failure or delay by you or the Company to exercise any right or remedy under this Agreement will operate as a waiver, and no partial exercise of any right or remedy will preclude any further exercise. In the event of any inconsistency between any provision of this Agreement and any provision of any applicable Company equity plan or award agreement, the provisions of this Agreement will control to the extent more favorable to you.
(h) Third Party Beneficiaries. Subject to Section 13, this Agreement will be binding on, inure to the benefit of and be enforceable by the parties and their respective heirs, personal representatives, successors and assigns. This Agreement does not confer any rights, remedies, obligations or liabilities to any entity or person other than you and the Company and your and the Company’s permitted successors and assigns, although (1) this Agreement will inure to the benefit of the Company and (2) Section 13(a) will inure to the benefit of the most recent persons named in a notice under Section 13(b).
(i) No Other Restrictions; No Offset. There shall be no contractual, or similar, restrictions on your right to terminate your employment with the Group, or on your post-employment activities, except as expressly set forth in this Agreement. You have no obligation to seek other employment or otherwise mitigate the Company’s obligations under this Agreement, and the Company will not offset or reduce your entitlements under this Agreement for subsequent employment.
(j) Counterparts. This Agreement may be executed in one or more counterparts, all of which shall be considered one agreement, and shall become a binding agreement when one or more counterparts have been signed by each party and delivered to the other party. Delivery of an executed counterpart by facsimile or “pdf” shall be sufficient.
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| Very truly yours, | ||||
| KCG HOLDINGS, INC. | ||||
| By: | ||||
| Name: | John McCarthy | |||
| Title: | General Counsel and Secretary | |||
Agreed to and Accepted on •, 2013:
| By: | ||
| • |
[Signature Page to Employment Agreement]
19
ATTACHMENT A
Form of General Release of Claims
Consistent with Section 6(h) of the letter agreement dated •, 2013 (the “Employment Agreement”) between me and KCG Holdings, Inc. (“Company”), and in consideration for and as a condition of my receipt of certain payments set forth in the Employment Agreement, as applicable, I, for myself, my attorneys, heirs, executors, administrators, successors, and assigns, do hereby fully and forever release and discharge the Company, GETCO Holding Company, LLC (“GETCO”), Knight Capital Group, Inc. (“Knight”) and their respective current and former parents and affiliated companies, as well as its and their successors, assigns, and current and former members, managers, stockholders, directors, officers, partners, agents, employees, attorneys, and administrators, from all lawsuits, causes of action, claims, demands and entitlements of any nature whatsoever, whether known, unknown, or unforeseen, which I have or may have against any of them arising out of or in connection with: (1) my employment with the Company and GETCO, or if applicable, Knight, (2) my separation from employment with the Company, (3) the Employment Agreement and/or any other agreement between me and the Company (except for obligations in such agreements that survive my separation from employment), or (4) any event, fact, transaction, or matter occurring or existing on or before the date of my signing of this General Release; provided, however, that I am not releasing any claims for indemnification, claims arising from my ownership of equity interests in the Company, claims for benefits and reimbursements in accordance with the terms of the Company’s benefit plans and arrangements, or claims that may not be released as a matter of law. I agree not to file or otherwise institute any claim, demand or lawsuit seeking damages or other relief and not to otherwise assert any claims or demands that are lawfully released herein. I further hereby irrevocably and unconditionally waive any and all rights to recover any relief or damages concerning the lawsuits, claims, demands, or actions that are lawfully released herein. I represent and warrant that I have not previously filed or joined in any such lawsuits, claims, demands, or actions against any of the persons or entities released herein and that I will indemnify and hold them harmless from all liabilities, claims, demands, costs, expenses and/or attorneys’ fees incurred by them as a result of any such lawsuits, claims, demands, or actions.
This General Release specifically includes, but is not limited to, all released claims (as described above) with respect to breach of contract, employment discrimination (including any alleged violation of any federal, state or local statute or ordinance, any claims coming within the scope of Title VII of the Civil Rights Act, the Age Discrimination in Employment Act, the Older Workers Benefit Protection Act, the Equal Pay Act, the Worker Adjustment and Retraining Notification Act, the Americans with Disabilities Act, and the Family and Medical Leave Act, all as amended, or any other applicable federal, state, or local law), claims under the Employee Retirement Income Security Act, as amended, claims under the Fair Labor Standards Act, as amended (or any other applicable federal, state or local statute relating to payment of wages), claims concerning recruitment, hiring, termination, salary rate, severance pay, equity, stock options, benefits due, sick leave, life insurance, libel, slander, defamation, intentional or negligent misrepresentation and/or infliction of emotional distress, together with any and all tort or other claims which might have been asserted by me or on my behalf in any lawsuit, charge of discrimination, demand, or claim against any of the persons or entities released herein.
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I agree and understand that I am specifically releasing all claims under the Age Discrimination in Employment Act, as amended, 29 U.S.C. § 621 et seq., a federal statute that prohibits employers from discriminating against employees who are age 40 or over. I acknowledge that:
(1) I have read and understand this General Release and sign it voluntarily and without coercion;
(2) I have been given an opportunity of twenty-one (21) days to consider this General Release;
(3) I have been encouraged by the Company to discuss fully the terms of this General Release with legal counsel of my own choosing; and
(4) for a period of seven (7) days following my signing of this General Release, I shall have the right to revoke the waiver of claims arising under the Age Discrimination in Employment Act.
If I elect to revoke this General Release within this seven-day period, I must inform the Company by delivering a written notice of revocation to the Company, c/o the General Counsel, no later than 11:59 p.m. on the seventh calendar day after I sign this General Release. I understand that, if I elect to exercise this revocation right, this General Release shall be voided in its entirety at the election of the Company and the Company shall be relieved of all obligations to provide the payments set forth in Section 6 of the Employment Agreement that are subject to my executing, and not revoking, this General Release. I further understand that such payments will not begin to be provided unless and until the revocation period expires without my exercising the revocation right. I may, if I wish, elect to sign this General Release prior to the expiration of the 21-day consideration period, and I agree that if I elect to do so, my election is made freely and voluntarily and after having an opportunity to consult counsel.
| AGREED: |
| — |
Date:
21
Exhibit 10.2
Terms Schedule to Employment Agreement
| Name |
Steven Bisgay | |
| Scheduled Term |
From —, 2013 through the 3rd anniversary of that date (the “Initial Term”) and shall then renew automatically for one-year periods (each, an “Extension Term”) until you or the Company gives notice to the other of nonrenewal at least 90 days before the end of the then applicable Extension Term (the Initial Term together with any Extension Terms, the “Scheduled Term”). | |
| Positions; Reporting |
Chief Financial Officer of the Company
You will also be employed as a senior executive officer of such other members of the Group as designated by the Board and approved by the board of directors of such subsidiaries without additional compensation.
Initially, you will report directly to the Chief Executive Officer (“CEO”). | |
| Starting Salary |
$500,000 | |
| Annual Incentive |
2013 and 2014 Calendar Year Annual Incentive:
• Amount:
¡ Target: $2,750,000
¡ Maximum: $5,500,000
¡ Minimum: $0
• Determination:
¡ 50% will be based on the achievement of performance goals; provided that such amount may not be more than $2,750,000 (“Performance Portion”)
¡ 50% will be determined by the CEO and approved by the Board based on the achievement of initiatives to be established by the CEO and approved by the Board; provided that such amount may not be more than $2,750,000 (the “Initiatives Portion”)
• Form:
¡ 2013 Calendar Year: 50% paid in cash and 50% paid in Annual Incentive Equity
¡ 2014 Calendar Year: 40% paid in cash and 60% paid in Annual Incentive Equity |
1
| For the avoidance of doubt, your eligibility for an Annual Incentive relating to the 2013 calendar year is in lieu of any other right you may have had to receive an incentive relating to the 2013 calendar year other than as set forth in the Agreement.
Post-2014 Calendar Year Annual Incentive:
The amount, method of determination and form of your Annual Incentive for periods after the 2014 calendar year will be determined in the discretion of the Company. | ||
| Annual Incentive Equity |
Your Annual Incentive Equity with respect to the 2013 and 2014 Calendar Year Annual Incentive will vest in three equal annual installments on each of the first three anniversaries of the date of grant if you remain employed with the Company through such dates, subject to the terms of Section 6 of the Agreement, the terms of the Company equity plan under which it is granted and the terms of your award agreement.
The form and vesting schedule of your Annual Incentive Equity for periods after the 2014 calendar year will be determined in the discretion of the Company. | |
| Performance Awards |
• Form: Restricted stock units
• Number: With respect to 266,667 shares of Company common stock
• Vesting: Your Performance Awards will vest in three equal annual installments on each of the first three anniversaries of July 1, 2013 if you remain employed with the Company through such dates, subject to the terms of Section 6 of the Agreement, the terms of the Company equity plan under which it is granted and the terms of your award agreement. For the avoidance of doubt, you will not be eligible for retirement treatment with respect to your Performance Awards. | |
| Good Reason |
Good Reason will include a material diminution in your authority or responsibilities (not including any authority or responsibilities assumed on an interim basis); provided that Good Reason does not include a change in your reporting relationships. | |
| Additional Benefits upon a Termination without Cause or with Good Reason |
If, during your Scheduled Term, the Company terminates your employment without Cause or you terminate your employment with Good Reason, subject to Section 6(h), your Performance Awards will continue to vest on the vesting dates specified in your award agreement (as if your employment had continued). |
2
| Additional Benefits upon a Termination without Good Reason |
If, during your Scheduled Term, you terminate your employment without Good Reason, subject to Section 6(h), your Annual Incentive Equity earned with respect to service during the Scheduled Term will continue to vest on the vesting dates specified in the applicable award agreement (as if your employment had continued) (provided that, if such Annual Incentive Equity is in the form of options or stock appreciation rights, they will remain exercisable for 90 days after vesting). | |
| Non-Competition Period |
The Non-Competition Period will be 6 months after the end of your employment for any reason
Notwithstanding the preceding, the continued vesting of your Performance Awards after a termination without Cause or termination for Good Reason that occurs before a Change in Control is conditioned upon your compliance with Section 8(c) of the Agreement until your Performance Awards are fully vested. If you fail to comply with Section 8(c) of the Agreement from the end of the Non-Competition Period until your Performance Awards are fully vested, you will forfeit the portion of your Performance Awards that remains unvested at the time of such failure. | |
| Non-Solicitation Period |
The Non-Solicitation Period will be 18 months after the end of your employment for any reason; provided, however, that the Non-Solicitation Period will be reduced to 6 months after a termination without Cause or termination for Good Reason following a Change in Control.
Notwithstanding the preceding, the continued vesting of your Performance Awards after a termination without Cause or termination for Good Reason that occurs before a Change in Control is conditioned upon your compliance with Section 8(d) of the Agreement until your Performance Awards are fully vested. If you fail to comply with Section 8(d) of the Agreement from the end of the Non-Solicitation Period until your Performance Awards are fully vested, you will forfeit the portion of your Performance Awards that remains unvested at the time of such failure. | |
| Non-Compete/Non-Solicit Payments |
If either (1) during your Scheduled Term, the Company terminates your employment without Cause or you terminate your employment with Good Reason or (2) during your Scheduled Term, you resign without Good Reason and the Company elects to have you comply with Section 8(c) and Section 8(d) of the Agreement, subject to your execution of the Release in accordance with Section 6(h)(1) of the Agreement, the Company will pay you a non-compete/non-solicit payment equal to your Salary but payable in equal installments at the end of each month during your Non-Competition Period (the “Non-Compete/Non-Solicit Payments”). If you fail to comply with |
3
| Section 8(c) until the end of the Non-Competition Period or Section 8(d) until the end of the Non-Solicitation Period, other than any isolated, insubstantial and inadvertent failure that is not in bad faith, you will repay to the Group any paid Non-Compete/Non-Solicit Payments and forfeit any unpaid Non-Compete/Non-Solicit Payments. For the avoidance of doubt, if the Company does not elect, pursuant to clause (2) of the first sentence of this section to make the Non-Compete/Non-Solicit Payments, (i) you will not be obligated to comply with Section 8(c) or Section 8(d) of the Agreement after your employment with the Company and (ii) the benefits referred to in the section entitled “Additional Benefits upon a Termination without Good Reason” will not be subject to your complying with Section 8(c) and Section 8(d) of the Agreement. | ||
| Address |
[Redacted] |
4
Exhibit 10.3
Terms Schedule to Employment Agreement
| Name |
John DiBacco | |
| Scheduled Term |
From —, 2013 through the 3rd anniversary of that date (the “Initial Term”) and shall then renew automatically for one-year periods (each, an “Extension Term”) until you or the Company gives notice to the other of nonrenewal at least 90 days before the end of the then applicable Extension Term (the Initial Term together with any Extension Terms, the “Scheduled Term”). | |
| Positions; Reporting |
Global Head of Equities Trading of the Company
You will also be employed as a senior executive officer of such other members of the Group as designated by the Board and approved by the board of directors of such subsidiaries without additional compensation.
Initially, you will report directly to the Chief Executive Officer (“CEO”). | |
| Starting Salary |
$500,000 | |
| Annual Incentive |
2013 and 2014 Calendar Year Annual Incentive:
• Amount:
¡ Target: $2,250,000
¡ Maximum: $4,500,000
¡ Minimum: $0
• Determination:
¡ 2013 Calendar Year:
• 50% will be based on the achievement of performance goals (“Performance Portion”); provided that such amount may not be more than $2,250,000
• 50% will be determined by the CEO and approved by the Board based on the achievement of initiatives to be established by the CEO and approved by the Board (the “Initiatives Portion”); provided that such amount may not be more than $2,250,000
¡ 2014 Calendar Year:
• 75% Performance Portion; provided that such amount may not exceed $3,375,000
• 25% Initiatives Portion; provided that such amount may not exceed $1,125,000 |
1
| • Form:
¡ 2013 Calendar Year: 50% paid in cash and 50% paid in Annual Incentive Equity
¡ 2014 Calendar Year: 40% paid in cash and 60% paid in Annual Incentive Equity
For the avoidance of doubt, your eligibility for an Annual Incentive relating to the 2013 calendar year is in lieu of any other right you may have had to receive an incentive relating to the 2013 calendar year other than as set forth in the Agreement.
Post-2014 Calendar Year Incentive:
The amount, method of determination and form of your Annual Incentive for periods after the 2014 calendar year will be determined in the discretion of the Company. | ||
| Annual Incentive Equity |
Your Annual Incentive Equity with respect to the 2013 and 2014 Calendar Year Annual Incentive will vest in three equal annual installments on each of the first three anniversaries of the date of grant if you remain employed with the Company through such dates, subject to the terms of Section 6 of the Agreement, the terms of the Company equity plan under which it is granted and the terms of your award agreement.
The form and vesting schedule of your Annual Incentive Equity for periods after the 2014 calendar year will be determined in the discretion of the Company. | |
| Performance Awards |
• Form: Restricted stock units and options
• Number of Restricted Stock Units: with respect to 53,333 shares of Company common stock
• Number of Options: to purchase 97,978 shares of Company common stock
• Exercise Price of Options: The fair market value of a share of Company common stock on the date of grant (as determined in accordance with the terms of the Company equity plan under which it is granted)
• Term of Options: 5 years from the date of grant
• Vesting: Your Performance Awards will vest in three equal annual installments on each of the first three anniversaries of July 1, 2013 if you remain employed with the Company through such dates, subject to the terms of Section 6 of the Agreement, the terms of the Company equity plan under which it is granted and the terms of your award agreement. For the avoidance of doubt, you will not be eligible for retirement treatment with respect to your Performance Awards. |
2
| Good Reason |
Good Reason will include a material diminution in your authority or responsibilities (not including any authority or responsibilities assumed on an interim basis); provided that Good Reason does not include a change in your reporting relationships. | |
| Additional Benefits upon a Termination without Cause or with Good Reason |
If, during your Scheduled Term, the Company terminates your employment without Cause or you terminate your employment with Good Reason, subject to Section 6(h), your Performance Awards will continue to vest and become exercisable on the vesting dates specified in your award agreement and will remain exercisable until they expire (as if your employment had continued). | |
| Additional Benefits upon a Termination without Good Reason |
If, during your Scheduled Term, you terminate your employment without Good Reason, subject to Section 6(h), (1) your Annual Incentive Equity earned with respect to service during the Scheduled Term will continue to vest on the vesting dates specified in the applicable award agreement (as if your employment had continued) (provided that, if such Annual Incentive Equity is in the form of options or stock appreciation rights, they will remain exercisable for 90 days after vesting); and (2) your vested Performance Awards that are in the form of options will remain exercisable for three months following your termination. | |
| Non-Competition Period |
The Non-Competition Period will be 6 months after the end of your employment for any reason
Notwithstanding the preceding, the continued vesting of your Performance Awards after a termination without Cause or termination for Good Reason that occurs before a Change in Control is conditioned upon your compliance with Section 8(c) of the Agreement until your Performance Awards in the form of restricted stock units are fully vested and, in the case of Performance Awards in the form of options, until the end of the term of the options. If you fail to comply with Section 8(c) of the Agreement from the end of the Non-Competition Period until your Performance Awards in the form of restricted stock units are fully vested, and, in the case of Performance Awards in the form of options, until the end of the term of the options, you will forfeit the portion of your Performance Awards that remains unvested at the time of such failure and the Performance Awards in the form of options (whether vested or unvested) that have not been exercised at the time of such failure. | |
| Non-Solicitation Period |
The Non-Solicitation Period will be 18 months after the end of your employment for any reason; provided, however, that the Non-Solicitation Period will be reduced to 6 months after a termination without Cause or termination for Good Reason following a Change in Control. |
3
| Notwithstanding the preceding, the continued vesting of your Performance Awards after a termination without Cause or termination for Good Reason that occurs before a Change in Control is conditioned upon your compliance with Section 8(d) of the Agreement until your Performance Awards in the form of restricted stock units are fully vested and, in the case of Performance Awards in the form of options, until the end of the term of the options. If you fail to comply with Section 8(d) of the Agreement from the end of the Non-Solicitation Period until your Performance Awards in the form of restricted stock units are fully vested, and, in the case of Performance Awards in the form of options, until the end of the term of the options, you will forfeit the portion of your Performance Awards that remains unvested at the time of such failure and the Performance Awards in the form of options (whether vested or unvested) that have not been exercised at the time of such failure. | ||
|
Non-Compete/Non- Solicit Payments |
If either (1) during your Scheduled Term, the Company terminates your employment without Cause or you terminate your employment with Good Reason or (2) during your Scheduled Term, you resign without Good Reason and the Company elects to have you comply with Section 8(c) and Section 8(d) of the Agreement, subject to your execution of the Release in accordance with Section 6(h)(1) of the Agreement the Company will pay you a non-compete/non-solicit payment equal to your Salary but payable in equal installments at the end of each month during your Non-Competition Period (the “Non-Compete/Non-Solicit Payments”). If you fail to comply with Section 8(c) until the end of the Non-Competition Period or Section 8(d) until the end of the Non-Solicitation Period, other than any isolated, insubstantial and inadvertent failure that is not in bad faith, you will repay to the Group any paid Non-Compete/Non-Solicit Payments and forfeit any unpaid Non-Compete/Non-Solicit Payments. For the avoidance of doubt, if the Company does not elect, pursuant to clause (2) of the first sentence of this section to make the Non-Compete/Non-Solicit Payments, (i) you will not be obligated to comply with Section 8(c) or Section 8(d) of the Agreement after your employment with the Company and (ii) the benefits referred to in the section entitled “Additional Benefits upon a Termination without Good Reason” will not be subject to your complying with Section 8(c) and Section 8(d) of the Agreement. | |
| Address |
[Redacted] |
4
Exhibit 10.4
Terms Schedule to Employment Agreement
| Name |
John McCarthy | |
| Scheduled Term |
From —, 2013 through the 3rd anniversary of that date (the “Initial Term”) and shall then renew automatically for one-year periods (each, an “Extension Term”) until you or the Company gives notice to the other of nonrenewal at least 90 days before the end of the then applicable Extension Term (the Initial Term together with any Extension Terms, the “Scheduled Term”). | |
| Positions; Reporting |
General Counsel and Corporate Secretary of the Company
You will also be employed as a senior executive officer of such other members of the Group as designated by the Board and approved by the board of directors of such subsidiaries without additional compensation.
Initially, you will report directly to the Chief Executive Officer (“CEO”). | |
| Starting Salary |
$500,000 | |
| Annual Incentive |
2013 and 2014 Calendar Year Annual Incentive:
• Amount:
¡ Target: $1,500,000
¡ Maximum: $3,000,000
¡ Minimum: $0
• Determination:
¡ 50% will be based on the achievement of performance goals; provided that such amount may not be more than $1,500,000 (“Performance Portion”)
¡ 50% will be determined by the CEO and approved by the Board based on the achievement of initiatives to be established by the CEO and approved by the Board; provided that such amount may not be more than $1,500,000 (the “Initiatives Portion”)
• Form:
¡ 2013 Calendar Year: 50% paid in cash and 50% paid in Annual Incentive Equity
¡ 2014 Calendar Year: 40% paid in cash and 60% paid in Annual Incentive Equity |
1
| For the avoidance of doubt, your eligibility for an Annual Incentive relating to the 2013 calendar year is in lieu of any other right you may have had to receive an incentive relating to the 2013 calendar year other than as set forth in the Agreement.
Post-2014 Calendar Year Annual Incentive:
The amount, method of determination and form of your Annual Incentive for periods after the 2014 calendar year will be determined in the discretion of the Company. | ||
| Annual Incentive Equity |
Your Annual Incentive Equity with respect to the 2013 and 2014 Calendar Year Annual Incentive will vest in three equal annual installments on each of the first three anniversaries of the date of grant if you remain employed with the Company through such dates, subject to the terms of Section 6 of the Agreement, the terms of the Company equity plan under which it is granted and the terms of your award agreement.
The form and vesting schedule of your Annual Incentive Equity for periods after the 2014 calendar year will be determined in the discretion of the Company. | |
| Performance Awards |
• Form: Restricted stock units
• Number: With respect to 44,444 shares of Company common stock
• Vesting: Your Performance Awards will vest in three equal annual installments on each of the first three anniversaries of July 1, 2013 if you remain employed with the Company through such dates, subject to the terms of Section 6 of the Agreement, the terms of the Company equity plan under which it is granted and the terms of your award agreement. For the avoidance of doubt, you will not be eligible for retirement treatment with respect to your Performance Awards. | |
| Good Reason |
Good Reason will include a material diminution in your authority or responsibilities (not including any authority or responsibilities assumed on an interim basis); provided that Good Reason does not include a change in your reporting relationships. | |
| Additional Benefits upon a Termination without Cause or with Good Reason |
If, during your Scheduled Term, the Company terminates your employment without Cause or you terminate your employment with Good Reason, subject to Section 6(h), your Performance Awards will continue to vest on the vesting dates specified in your award agreement (as if your employment had continued). |
2
| Additional Benefits upon a Termination without Good Reason |
If, during your Scheduled Term, you terminate your employment without Good Reason, subject to Section 6(h), your Annual Incentive Equity earned with respect to service during the Scheduled Term will continue to vest on the vesting dates specified in the applicable award agreement (as if your employment had continued) (provided that, if such Annual Incentive Equity is in the form of options or stock appreciation rights, they will remain exercisable for 90 days after vesting). | |
| Non-Competition Period |
The Non-Competition Period will be 6 months after the end of your employment for any reason
Notwithstanding the preceding, the continued vesting of your Performance Awards after a termination without Cause or termination for Good Reason that occurs before a Change in Control is conditioned upon your compliance with Section 8(c) of the Agreement until your Performance Awards are fully vested. If you fail to comply with Section 8(c) of the Agreement from the end of the Non-Competition Period until your Performance Awards are fully vested, you will forfeit the portion of your Performance Awards that remains unvested at the time of such failure. | |
| Non-Solicitation Period |
The Non-Solicitation Period will be 18 months after the end of your employment for any reason; provided, however, that the Non-Solicitation Period will be reduced to 6 months after a termination without Cause or termination for Good Reason following a Change in Control.
Notwithstanding the preceding, the continued vesting of your Performance Awards after a termination without Cause or termination for Good Reason that occurs before a Change in Control is conditioned upon your compliance with Section 8(d) of the Agreement until your Performance Awards are fully vested. If you fail to comply with Section 8(d) of the Agreement from the end of the Non-Solicitation Period until your Performance Awards are fully vested, you will forfeit the portion of your Performance Awards that remains unvested at the time of such failure. | |
| Non-Compete/Non-Solicit Payments |
If either (1) during your Scheduled Term, the Company terminates your employment without Cause or you terminate your employment with Good Reason or (2) during your Scheduled Term, you resign without Good Reason and the Company elects to have you comply with Section 8(c) and Section 8(d) of the Agreement, subject to your execution of the Release in accordance with Section 6(h)(1) of the Agreement, the Company will pay you a non-compete/non-solicit payment equal to your Salary but payable in equal installments at the end of each month during your Non-Competition Period (the “Non-Compete/Non-Solicit Payments”). If you fail to comply |
3
| with Section 8(c) until the end of the Non-Competition Period or Section 8(d) until the end of the Non-Solicitation Period, other than any isolated, insubstantial and inadvertent failure that is not in bad faith, you will repay to the Group any paid Non-Compete/Non-Solicit Payments and forfeit any unpaid Non-Compete/Non-Solicit Payments. For the avoidance of doubt, if the Company does not elect, pursuant to clause (2) of the first sentence of this section to make the Non-Compete/Non-Solicit Payments, (i) you will not be obligated to comply with Section 8(c) or Section 8(d) of the Agreement after your employment with the Company and (ii) the benefits referred to in the section entitled “Additional Benefits upon a Termination without Good Reason” will not be subject to your complying with Section 8(c) and Section 8(d) of the Agreement. | ||
| Address |
[Redacted] |
4
Exhibit 10.5
Terms Schedule to Employment Agreement
| Name |
Nick Ogurtsov | |
| Scheduled Term |
From —, 2013 through the 3rd anniversary of that date (the “Initial Term”) and shall then renew automatically for one-year periods (each, an “Extension Term”) until you or the Company gives notice to the other of nonrenewal at least 90 days before the end of the then applicable Extension Term (the Initial Term together with any Extension Terms, the “Scheduled Term”). | |
| Positions; Reporting |
Chief Risk Officer and Chief Operating Officer of the Company
You will also be employed as a senior executive officer of such other members of the Group as designated by the Board and approved by the board of directors of such subsidiaries without additional compensation.
Initially, you will report directly to the Chief Executive Officer (“CEO”). | |
| Starting Salary |
$500,000 | |
| Annual Incentive |
2013 and 2014 Calendar Year Annual Incentive:
• Amount:
¡ Target: $3,000,000
¡ Maximum: $6,000,000
¡ Minimum: $0
• Determination:
¡ 50% will be based on the achievement of performance goals; provided that such amount may not be more than $3,000,000 (“Performance Portion”)
¡ 50% will be determined by the CEO and approved by the Board based on the achievement of initiatives to be established by the CEO and approved by the Board; provided that such amount may not be more than $3,000,000 (the “Initiatives Portion”)
• Form:
¡ 2013 Calendar Year: 50% paid in cash and 50% paid in Annual Incentive Equity
¡ 2014 Calendar Year: 40% paid in cash and 60% paid in Annual Incentive Equity |
1
| For the avoidance of doubt, your eligibility for an Annual Incentive relating to the 2013 calendar year is in lieu of any other right you may have had to receive an incentive relating to the 2013 calendar year other than as set forth in the Agreement.
Post-2014 Calendar Year Annual Incentive:
The amount, method of determination and form of your Annual Incentive for periods after the 2014 calendar year will be determined in the discretion of the Company. | ||
| Annual Incentive Equity |
Your Annual Incentive Equity with respect to the 2013 and 2014 Calendar Year Annual Incentive will vest in three equal annual installments on each of the first three anniversaries of the date of grant if you remain employed with the Company through such dates, subject to the terms of Section 6 of the Agreement, the terms of the Company equity plan under which it is granted and the terms of your award agreement.
The form and vesting schedule of your Annual Incentive Equity for periods after the 2014 calendar year will be determined in the discretion of the Company. | |
| Performance Awards |
• Form: Restricted stock units and options
• Number of Restricted Stock Units: with respect to 115,556 shares of Company common stock
• Number of Options: to purchase 171,461 shares of Company common stock
• Exercise Price of Options: The fair market value of a share of Company common stock on the date of grant (as determined in accordance with the terms of the Company equity plan under which it is granted)
• Term of Options: 5 years from the date of grant
• Vesting: Your Performance Awards will vest in three equal annual installments on each of the first three anniversaries of July 1, 2013 if you remain employed with the Company through such dates, subject to the terms of Section 6 of the Agreement, the terms of the Company equity plan under which it is granted and the terms of your award agreement. For the avoidance of doubt, you will not be eligible for retirement treatment with respect to your Performance Awards. | |
| Good Reason |
Good Reason will include a material diminution in your authority or responsibilities (not including any authority or responsibilities assumed on an interim basis); provided that Good Reason does not include a change in your reporting relationships. |
2
| Additional Benefits upon a Termination without Cause or with Good Reason |
If, during your Scheduled Term, the Company terminates your employment without Cause or you terminate your employment with Good Reason, subject to Section 6(h), your Performance Awards will continue to vest and become exercisable on the vesting dates specified in your award agreement and will remain exercisable until they expire (as if your employment had continued). | |
| Additional Benefits upon a Termination without Good Reason |
If, during your Scheduled Term, you terminate your employment without Good Reason, subject to Section 6(h), (1) your Annual Incentive Equity earned with respect to service during the Scheduled Term will continue to vest on the vesting dates specified in the applicable award agreement (as if your employment had continued) (provided that, if such Annual Incentive Equity is in the form of options or stock appreciation rights, they will remain exercisable for 90 days after vesting); and (2) your vested Performance Awards that are in the form of options will remain exercisable for three months following your termination. | |
| Non-Competition Period |
The Non-Competition Period will be 6 months after the end of your employment for any reason
Notwithstanding the preceding, the continued vesting of your Performance Awards after a termination without Cause or termination for Good Reason that occurs before a Change in Control is conditioned upon your compliance with Section 8(c) of the Agreement until your Performance Awards in the form of restricted stock units are fully vested and, in the case of Performance Awards in the form of options, until the end of the term of the options. If you fail to comply with Section 8(c) of the Agreement from the end of the Non-Competition Period until your Performance Awards in the form of restricted stock units are fully vested, and, in the case of Performance Awards in the form of options, until the end of the term of the options, you will forfeit the portion of your Performance Awards that remains unvested at the time of such failure and the Performance Awards in the form of options (whether vested or unvested) that have not been exercised at the time of such failure. | |
| Non-Solicitation Period |
The Non-Solicitation Period will be 18 months after the end of your employment for any reason; provided, however, that the Non-Solicitation Period will be reduced to 6 months after a termination without Cause or termination for Good Reason following a Change in Control.
Notwithstanding the preceding, the continued vesting of your Performance Awards after a termination without Cause or termination for Good Reason that occurs before a Change in |
3
| Control is conditioned upon your compliance with Section 8(d) of the Agreement until your Performance Awards in the form of restricted stock units are fully vested and, in the case of Performance Awards in the form of options, until the end of the term of the options. If you fail to comply with Section 8(d) of the Agreement from the end of the Non-Solicitation Period until your Performance Awards in the form of restricted stock units are fully vested, and, in the case of Performance Awards in the form of options, until the end of the term of the options, you will forfeit the portion of your Performance Awards that remains unvested at the time of such failure and the Performance Awards in the form of options (whether vested or unvested) that have not been exercised at the time of such failure. | ||
| Non-Compete/Non-Solicit Payments |
If either (1) during your Scheduled Term, the Company terminates your employment without Cause or you terminate your employment with Good Reason or (2) during your Scheduled Term, you resign without Good Reason and the Company elects to have you comply with Section 8(c) and Section 8(d) of the Agreement, subject to your execution of the Release in accordance with Section 6(h)(1) of the Agreement the Company will pay you a non-compete/non-solicit payment equal to your Salary but payable in equal installments at the end of each month during your Non-Competition Period (the “Non-Compete/Non-Solicit Payments”). If you fail to comply with Section 8(c) until the end of the Non-Competition Period or Section 8(d) until the end of the Non-Solicitation Period, other than any isolated, insubstantial and inadvertent failure that is not in bad faith, you will repay to the Group any paid Non-Compete/Non-Solicit Payments and forfeit any unpaid Non-Compete/Non-Solicit Payments. For the avoidance of doubt, if the Company does not elect, pursuant to clause (2) of the first sentence of this section to make the Non-Compete/Non-Solicit Payments, (i) you will not be obligated to comply with Section 8(c) or Section 8(d) of the Agreement after your employment with the Company and (ii) the benefits referred to in the section entitled “Additional Benefits upon a Termination without Good Reason” will not be subject to your complying with Section 8(c) and Section 8(d) of the Agreement. | |
| Address |
7701 NE 8th Avenue Miami, Florida 33138 |
4
Exhibit 10.6
Terms Schedule to Employment Agreement
| Name |
Jonathan Ross | |
| Scheduled Term |
From —, 2013 through the 3rd anniversary of that date (the “Initial Term”) and shall then renew automatically for one-year periods (each, an “Extension Term”) until you or the Company gives notice to the other of nonrenewal at least 90 days before the end of the then applicable Extension Term (the Initial Term together with any Extension Terms, the “Scheduled Term”). | |
| Positions; Reporting |
Chief Technology Officer of the Company
You will also be employed as a senior executive officer of such other members of the Group as designated by the Board and approved by the board of directors of such subsidiaries without additional compensation.
Initially, you will report directly to the Chief Executive Officer (“CEO”). | |
| Starting Salary |
$500,000 | |
| Annual Incentive |
2013 and 2014 Calendar Year Annual Incentive:
• Amount:
¡ Target: $3,250,000
¡ Maximum: $6,500,000
¡ Minimum: $0
• Determination:
¡ 50% will be based on the achievement of performance goals; provided that such amount may not be more than $3,250,000 (“Performance Portion”)
¡ 50% will be determined by the CEO and approved by the Board based on the achievement of initiatives to be established by the CEO and approved by the Board; provided that such amount may not be more than $3,250,000 (the “Initiatives Portion”)
• Form:
¡ 2013 Calendar Year: 50% paid in cash and 50% paid in Annual Incentive Equity
¡ 2014 Calendar Year: 40% paid in cash and 60% paid in Annual Incentive Equity |
1
| For the avoidance of doubt, your eligibility for an Annual Incentive relating to the 2013 calendar year is in lieu of any other right you may have had to receive an incentive relating to the 2013 calendar year other than as set forth in the Agreement.
Post-2014 Calendar Year Annual Incentive:
The amount, method of determination and form of your Annual Incentive for periods after the 2014 calendar year will be determined in the discretion of the Company. | ||
| Annual Incentive Equity |
Your Annual Incentive Equity with respect to the 2013 and 2014 Calendar Year Annual Incentive will vest in three equal annual installments on each of the first three anniversaries of the date of grant if you remain employed with the Company through such dates, subject to the terms of Section 6 of the Agreement, the terms of the Company equity plan under which it is granted and the terms of your award agreement.
The form and vesting schedule of your Annual Incentive Equity for periods after the 2014 calendar year will be determined in the discretion of the Company. | |
| Performance Awards |
• Form: Restricted stock units and options
• Number of Restricted Stock Units: with respect to 71,111 shares of Company common stock
• Number of Options: to purchase 293,933 shares of Company common stock
• Exercise Price of Options: The fair market value of a share of Company common stock on the date of grant (as determined in accordance with the terms of the Company equity plan under which it is granted)
• Term of Options: 5 years from the date of grant
• Vesting: Your Performance Awards will vest in three equal annual installments on each of the first three anniversaries of July 1, 2013 if you remain employed with the Company through such dates, subject to the terms of Section 6 of the Agreement, the terms of the Company equity plan under which it is granted and the terms of your award agreement. For the avoidance of doubt, you will not be eligible for retirement treatment with respect to your Performance Awards. | |
| Good Reason |
Good Reason will include a material diminution in your authority or responsibilities (not including any authority or responsibilities assumed on an interim basis); provided that Good Reason does not include a change in your reporting relationships. |
2
| Additional Benefits upon a Termination without Cause or with Good Reason |
If, during your Scheduled Term, the Company terminates your employment without Cause or you terminate your employment with Good Reason, subject to Section 6(h), your Performance Awards will continue to vest and become exercisable on the vesting dates specified in your award agreement and will remain exercisable until they expire (as if your employment had continued). | |
| Additional Benefits upon a Termination without Good Reason |
If, during your Scheduled Term, you terminate your employment without Good Reason, subject to Section 6(h), (1) your Annual Incentive Equity earned with respect to service during the Scheduled Term will continue to vest on the vesting dates specified in the applicable award agreement (as if your employment had continued) (provided that, if such Annual Incentive Equity is in the form of options or stock appreciation rights, they will remain exercisable for 90 days after vesting); and (2) your vested Performance Awards that are in the form of options will remain exercisable for three months following your termination. | |
| Non-Competition Period |
The Non-Competition Period will be 12 months after the end of your employment for any reason; provided, however, that the Non-Competition Period will be reduced to 6 months after a termination without Cause or termination for Good Reason following a Change in Control.
Notwithstanding the preceding, the continued vesting of your Performance Awards after a termination without Cause or termination for Good Reason that occurs before a Change in Control is conditioned upon your compliance with Section 8(c) of the Agreement until your Performance Awards in the form of restricted stock units are fully vested and, in the case of Performance Awards in the form of options, until the end of the term of the options. If you fail to comply with Section 8(c) of the Agreement from the end of the Non-Competition Period until your Performance Awards in the form of restricted stock units are fully vested, and, in the case of Performance Awards in the form of options, until the end of the term of the options, you will forfeit the portion of your Performance Awards that remains unvested at the time of such failure and the Performance Awards in the form of options (whether vested or unvested) that have not been exercised at the time of such failure. | |
| Non-Solicitation Period |
The Non-Solicitation Period will be 18 months after the end of your employment for any reason; provided, however, that the Non-Solicitation Period will be reduced to 6 months after a termination without Cause or termination for Good Reason following a Change in Control. |
3
| Notwithstanding the preceding, the continued vesting of your Performance Awards after a termination without Cause or termination for Good Reason that occurs before a Change in Control is conditioned upon your compliance with Section 8(d) of the Agreement until your Performance Awards in the form of restricted stock units are fully vested and, in the case of Performance Awards in the form of options, until the end of the term of the options. If you fail to comply with Section 8(d) of the Agreement from the end of the Non-Solicitation Period until your Performance Awards in the form of restricted stock units are fully vested, and, in the case of Performance Awards in the form of options, until the end of the term of the options, you will forfeit the portion of your Performance Awards that remains unvested at the time of such failure and the Performance Awards in the form of options (whether vested or unvested) that have not been exercised at the time of such failure. | ||
| Non-Compete/Non-Solicit Payments |
If either (1) during your Scheduled Term, the Company terminates your employment without Cause or you terminate your employment with Good Reason or (2) during your Scheduled Term, you resign without Good Reason and the Company elects to have you comply with Section 8(c) and Section 8(d) of the Agreement, subject to your execution of the Release in accordance with Section 6(h)(1) of the Agreement the Company will pay you a non-compete/non-solicit payment equal to three times your Salary but payable in equal installments at the end of each month during your Non-Competition Period (the “Non-Compete/Non-Solicit Payments”). If you fail to comply with Section 8(c) until the end of the Non-Competition Period or Section 8(d) until the end of the Non-Solicitation Period, other than any isolated, insubstantial and inadvertent failure that is not in bad faith, you will repay to the Group any paid Non-Compete/Non-Solicit Payments and forfeit any unpaid Non-Compete/Non-Solicit Payments. For the avoidance of doubt, if the Company does not elect, pursuant to clause (2) of the first sentence of this section to make the Non-Compete/Non-Solicit Payments, (i) you will not be obligated to comply with Section 8(c) or Section 8(d) of the Agreement after your employment with the Company and (ii) the benefits referred to in the section entitled “Additional Benefits upon a Termination without Good Reason” will not be subject to your complying with Section 8(c) and Section 8(d) of the Agreement. | |
| Address |
[Redacted] |
4
Exhibit 10.7
Terms Schedule to Employment Agreement
| Name |
George Sohos | |
| Scheduled Term |
From —, 2013 through the 3rd anniversary of that date (the “Initial Term”) and shall then renew automatically for one-year periods (each, an “Extension Term”) until you or the Company gives notice to the other of nonrenewal at least 90 days before the end of the then applicable Extension Term (the Initial Term together with any Extension Terms, the “Scheduled Term”). | |
| Positions; Reporting |
Global Head of Client Market Making of the Company
You will also be employed as a senior executive officer of such other members of the Group as designated by the Board and approved by the board of directors of such subsidiaries without additional compensation.
Initially, you will report directly to the Chief Executive Officer (“CEO”). | |
| Starting Salary |
$500,000 | |
| Annual Incentive |
2013 and 2014 Calendar Year Annual Incentive:
• Amount:
¡ Target: $4,250,000
¡ Maximum: $8,500,000
¡ Minimum: $0
• Determination:
¡ 2013 Calendar Year:
¡ 50% will be based on the achievement of performance goals (“Performance Portion”); provided that such amount may not be more than $4,250,000
¡ 50% will be determined by the CEO and approved by the Board based on the achievement of initiatives to be established by the CEO and approved by the Board (the “Initiatives Portion”); provided that such amount may not be more than $4,250,000
¡ 2014 Calendar Year:
¡ 75% Performance Portion; provided that such amount may not exceed $6,375,000
¡ 25% Initiatives Portion; provided that such amount may not exceed $2,125,000 |
1
| • Form:
¡ 2013 Calendar Year: 50% paid in cash and 50% paid in Annual Incentive Equity
¡ 2014 Calendar Year: 40% paid in cash and 60% paid in Annual Incentive Equity
For the avoidance of doubt, your eligibility for an Annual Incentive relating to the 2013 calendar year is in lieu of any other right you may have had to receive an incentive relating to the 2013 calendar year other than as set forth in the Agreement.
Post-2014 Calendar Year Incentive:
The amount, method of determination and form of your Annual Incentive for periods after the 2014 calendar year will be determined in the discretion of the Company. | ||
| Annual Incentive Equity |
Your Annual Incentive Equity with respect to the 2013 and 2014 Calendar Year Annual Incentive will vest in three equal annual installments on each of the first three anniversaries of the date of grant if you remain employed with the Company through such dates, subject to the terms of Section 6 of the Agreement, the terms of the Company equity plan under which it is granted and the terms of your award agreement.
The form and vesting schedule of your Annual Incentive Equity for periods after the 2014 calendar year will be determined in the discretion of the Company. | |
| Performance Awards |
• Form: Restricted stock units and options
• Number of Restricted Stock Units: with respect to 53,333 shares of Company common stock
• Number of Options: to purchase 97,978 shares of Company common stock
• Exercise Price of Options: The fair market value of a share of Company common stock on the date of grant (as determined in accordance with the terms of the Company equity plan under which it is granted)
• Term of Options: 5 years from the date of grant
• Vesting: Your Performance Awards will vest in three equal annual installments on each of the first three anniversaries of July 1, 2013 if you remain employed with the Company through such dates, subject to the terms of Section 6 of the Agreement, the terms of the Company equity plan under which it is granted and the terms of your award agreement. For the avoidance of doubt, you will not be eligible for retirement treatment with respect to your Performance Awards. |
2
| Good Reason |
Good Reason will include a material diminution in your authority or responsibilities (not including any authority or responsibilities assumed on an interim basis); provided that Good Reason does not include a change in your reporting relationships. | |
| Additional Benefits upon a Termination without Cause or with Good Reason |
If, during your Scheduled Term, the Company terminates your employment without Cause or you terminate your employment with Good Reason, subject to Section 6(h), your Performance Awards will continue to vest and become exercisable on the vesting dates specified in your award agreement and will remain exercisable until they expire (as if your employment had continued). | |
| Additional Benefits upon a Termination without Good Reason |
If, during your Scheduled Term, you terminate your employment without Good Reason, subject to Section 6(h), (1) your Annual Incentive Equity earned with respect to service during the Scheduled Term will continue to vest on the vesting dates specified in the applicable award agreement (as if your employment had continued) (provided that, if such Annual Incentive Equity is in the form of options or stock appreciation rights, they will remain exercisable for 90 days after vesting); and (2) your vested Performance Awards that are in the form of options will remain exercisable for three months following your termination. | |
| Non-Competition Period |
The Non-Competition Period will be 12 months after the end of your employment for any reason; provided, however, that the Non-Competition Period will be reduced to 6 months after a termination without Cause or termination for Good Reason following a Change in Control.
Notwithstanding the preceding, the continued vesting of your Performance Awards after a termination without Cause or termination for Good Reason that occurs before a Change in Control is conditioned upon your compliance with Section 8(c) of the Agreement until your Performance Awards in the form of restricted stock units are fully vested and, in the case of Performance Awards in the form of options, until the end of the term of the options. If you fail to comply with Section 8(c) of the Agreement from the end of the Non-Competition Period until your Performance Awards in the form of restricted stock units are fully vested, and, in the case of Performance Awards in the form of options, until the end of the term of the options, you will forfeit the portion of your Performance Awards that remains unvested at the time of such failure and the Performance Awards in the form of options (whether vested or unvested) that have not been exercised at the time of such failure. |
3
| Non-Solicitation Period |
The Non-Solicitation Period will be 18 months after the end of your employment for any reason; provided, however, that the Non-Solicitation Period will be reduced to 6 months after a termination without Cause or termination for Good Reason following a Change in Control.
Notwithstanding the preceding, the continued vesting of your Performance Awards after a termination without Cause or termination for Good Reason that occurs before a Change in Control is conditioned upon your compliance with Section 8(d) of the Agreement until your Performance Awards in the form of restricted stock units are fully vested and, in the case of Performance Awards in the form of options, until the end of the term of the options. If you fail to comply with Section 8(d) of the Agreement from the end of the Non-Solicitation Period until your Performance Awards in the form of restricted stock units are fully vested, and, in the case of Performance Awards in the form of options, until the end of the term of the options, you will forfeit the portion of your Performance Awards that remains unvested at the time of such failure and the Performance Awards in the form of options (whether vested or unvested) that have not been exercised at the time of such failure. | |
| Non-Compete/Non-Solicit Payments |
If either (1) during your Scheduled Term, the Company terminates your employment without Cause or you terminate your employment with Good Reason or (2) during your Scheduled Term, you resign without Good Reason and the Company elects to have you comply with Section 8(c) and Section 8(d) of the Agreement, subject to your execution of the Release in accordance with Section 6(h)(1) of the Agreement the Company will pay you a non-compete/non-solicit payment equal to three times your Salary but payable in equal installments at the end of each month during your Non-Competition Period (the “Non-Compete/Non-Solicit Payments”). If you fail to comply with Section 8(c) until the end of the Non-Competition Period or Section 8(d) until the end of the Non-Solicitation Period, other than any isolated, insubstantial and inadvertent failure that is not in bad faith, you will repay to the Group any paid Non-Compete/Non-Solicit Payments and forfeit any unpaid Non-Compete/Non-Solicit Payments. For the avoidance of doubt, if the Company does not elect, pursuant to clause (2) of the first sentence of this section to make the Non-Compete/Non-Solicit Payments, (i) you will not be obligated to comply with Section 8(c) or Section 8(d) of the Agreement after your employment with the Company and (ii) the benefits referred to in the section entitled “Additional Benefits upon a Termination without Good Reason” will not be subject to your complying with Section 8(c) and Section 8(d) of the Agreement. | |
| Address |
[Redacted] |
4
Exhibit 99.1
GETCO Holding Company, LLC and Subsidiaries
Consolidated Statements of Comprehensive (Loss) Income (unaudited)
| Three months ended June 30 |
Six months ended June 30 |
|||||||||||||||
| (in thousands except for per unit data) | 2013 | 2012 | 2013 | 2012 | ||||||||||||
| Revenues |
||||||||||||||||
| Trading gains and losses, net |
$ | 127,176 | $ | 141,714 | $ | 239,661 | $ | 294,935 | ||||||||
| Interest and dividends, net |
582 | (809) | 546 | (967) | ||||||||||||
| Loss from investments, net |
(9,184) | - | (8,817) | - | ||||||||||||
| Other (loss) income, net |
(457) | 211 | (421) | 730 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total revenues |
118,117 | 141,116 | 230,969 | 294,698 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Expenses |
||||||||||||||||
| Employee compensation and related benefits |
69,041 | 39,571 | 101,661 | 81,121 | ||||||||||||
| Regulatory, exchange and execution fees |
45,950 | 52,587 | 86,908 | 102,390 | ||||||||||||
| Colocation and data line expenses |
20,365 | 21,750 | 40,041 | 42,719 | ||||||||||||
| Professional fees |
23,230 | 4,046 | 30,264 | 8,669 | ||||||||||||
| Depreciation and amortization |
7,746 | 7,728 | 15,913 | 19,606 | ||||||||||||
| Occupancy, communication, and office |
4,239 | 3,848 | 8,184 | 7,535 | ||||||||||||
| Restructuring costs and lease loss |
1,074 | - | 3,697 | - | ||||||||||||
| Travel and entertainment |
1,645 | 2,754 | 3,031 | 5,799 | ||||||||||||
| Computer supplies and maintenance |
882 | 1,190 | 1,832 | 2,592 | ||||||||||||
| Order flow expense |
806 | 675 | 1,701 | 1,470 | ||||||||||||
| Interest expense on corporate borrowings and capital lease obligations |
2,172 | 531 | 2,645 | 1,296 | ||||||||||||
| Other expenses |
10,578 | 404 | 12,008 | 1,189 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total expenses |
187,728 | 135,084 | 307,885 | 274,386 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| (Loss) income before income taxes |
(69,611) | 6,032 | (76,916) | 20,312 | ||||||||||||
| Provision for income taxes |
3,315 | 2,279 | 5,289 | 5,563 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Net (loss) income |
$ | (72,926) | $ | 3,753 | $ | (82,205) | $ | 14,749 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Net (loss) income attributable to preferred and participating units |
$ | (20,775) | $ | 1,200 | $ | (23,430) | $ | 4,439 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Net (loss) income available to common units |
$ | (52,151) | $ | 2,553 | $ | (58,775) | $ | 10,310 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Basic (loss) earnings per common unit |
$ | (6.47) | $ | 0.29 | $ | (7.30) | $ | 1.15 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Weighted average common units outstanding |
8,066 | 8,900 | 8,055 | 8,951 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Other comprehensive income: |
||||||||||||||||
| Unrealized (losses) gains on available for sale securities |
$ | (7,394) | $ | - | $ | 4,550 | $ | - | ||||||||
| Cumulative translation adjustment |
(487) | - | (403) | - | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total other comprehensive (loss) income |
$ | (7,881) | $ | - | $ | 4,147 | $ | - | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total comprehensive (loss) income attributable to members |
$ | (80,807) | $ | 3,753 | $ | (78,058) | $ | 14,749 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
The accompanying unaudited notes are an integral part of these consolidated financial statements.
1
GETCO Holding Company, LLC and Subsidiaries
Consolidated Statements of Financial Condition (unaudited)
| (in thousands) | June 30, 2013 |
December 31, 2012 |
||||||
| Assets |
||||||||
| Cash and cash equivalents |
$ | 466,502 | $ | 427,631 | ||||
| Restricted cash and cash equivalents |
308,081 | - | ||||||
| Receivables from exchanges |
20,259 | 11,544 | ||||||
| Receivables from clearing brokers and clearing organizations |
290,038 | 85,282 | ||||||
| Deposits with clearing organizations and exchanges |
40,394 | 43,245 | ||||||
| Securities and options owned, at fair value: |
||||||||
| Equity securities |
434,308 | 381,991 | ||||||
| Listed equity options |
111,587 | 92,305 | ||||||
| Debt securities |
21,455 | 183,637 | ||||||
|
|
|
|
|
|||||
| Total securities and options owned, at fair value |
567,350 | 657,933 | ||||||
| Securities borrowed |
97,123 | 55,141 | ||||||
| Exchange memberships, at cost (fair value $5,557 and $5,042 at June 30, 2013 and December 31, 2012, respectively) | 6,267 | 6,267 | ||||||
| Investments |
240,854 | 245,398 | ||||||
| Intangibles and goodwill, net of amortization |
48,009 | 50,768 | ||||||
| Fixed assets and leasehold improvements, net |
81,357 | 83,341 | ||||||
| Other receivables and other assets |
28,140 | 20,986 | ||||||
|
|
|
|
|
|||||
| Total assets |
$ | 2,194,374 | $ | 1,687,536 | ||||
|
|
|
|
|
|||||
| Liabilities and Members’ Equity |
||||||||
| Securities and options sold, not yet purchased, at fair value: |
||||||||
| Equity securities |
645,700 | $ | 423,740 | |||||
| Listed equity options |
80,496 | 69,757 | ||||||
| Debt securities |
16,465 | 19,056 | ||||||
|
|
|
|
|
|||||
| Total securities and options sold, not yet purchased, at fair value |
742,661 | 512,553 | ||||||
| Payables to clearing brokers and clearing organizations |
34,101 | 24,185 | ||||||
| Compensation payable |
39,140 | 30,197 | ||||||
| Capital lease obligation |
15,466 | 24,191 | ||||||
| Notes payable |
320,000 | 15,000 | ||||||
| Accounts payable and accrued expenses |
137,826 | 115,492 | ||||||
| Distributions payable |
2,136 | 107 | ||||||
|
|
|
|
|
|||||
| Total liabilities |
1,291,330 | 721,725 | ||||||
| Members’ equity |
903,044 | 965,811 | ||||||
|
|
|
|
|
|||||
| Total liabilities and members’ equity |
$ | 2,194,374 | $ | 1,687,536 | ||||
|
|
|
|
|
|||||
The accompanying unaudited notes are an integral part of these consolidated financial statements.
2
GETCO Holding Company, LLC and Subsidiaries
Consolidated Statements of Changes in Members’ Equity (unaudited)
| Unrestricted Members’ Equity |
Unrecognized Compensation |
Other Comprehensive Income |
Total Members’ Equity |
|||||||||||||
| Balance at December 31, 2012 |
$ | 870,431 | $ | (18,939) | $ | 114,319 | $ | 965,811 | ||||||||
| Contributions |
4,239 | 18,939 | - | 23,178 | ||||||||||||
| Repurchase of membership interests |
(5,833) | - | - | (5,833) | ||||||||||||
| Distributions |
(2,054) | - | - | (2,054) | ||||||||||||
| Net (loss) income |
(82,205) | - | 4,147 | (78,058) | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Balance at June 30, 2013 |
$ | 784,578 | $ | - | $ | 118,466 | $ | 903,044 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
The accompanying unaudited notes are an integral part of these consolidated financial statements.
3
GETCO Holding Company, LLC and Subsidiaries
Consolidated Statements of Cash Flows (unaudited)
| Six months ended June 30, | ||||||||
| (in thousands) | 2013 | 2012 | ||||||
| Cash flows from operating activities |
||||||||
| Net (loss) income |
$ | (82,205) | $ | 14,749 | ||||
| Adjustments to reconcile net (loss) income to net cash (used in)/provided by operating activities: | ||||||||
| Loss from investments, net |
8,817 | - | ||||||
| Amortization of debt issuance costs |
473 | 49 | ||||||
| Impairment of fixed assets due to restructuring |
3,697 | - | ||||||
| Unit award compensation |
19,860 | 3,858 | ||||||
| Depreciation and amortization |
15,913 | 19,606 | ||||||
| Changes in operating assets and liabilities: |
||||||||
| Receivables from exchanges |
(8,865) | (2,176) | ||||||
| Receivables from/payables to clearing brokers and clearing organizations, net |
(194,840) | (309,122) | ||||||
| Deposits with clearing organizations and exchanges |
2,851 | 20,711 | ||||||
| Securities and options owned and sold, not yet purchased, net |
320,691 | 475,480 | ||||||
| Securities borrowed |
(41,982) | (131,081) | ||||||
| Other receivables and other assets |
(395) | 4,473 | ||||||
| Compensation payable |
8,943 | (18,667) | ||||||
| Accounts payable and accrued expenses |
38,325 | (5,931) | ||||||
|
|
|
|
|
|||||
| Net cash provided by operating activities |
91,283 | 71,949 | ||||||
|
|
|
|
|
|||||
| Cash flows from investing activities |
||||||||
| Proceeds from sale of exchange memberships |
774 | - | ||||||
| Purchase of fixed assets and leasehold improvements |
(12,396) | (20,011) | ||||||
| Purchase of investments |
- | (1,273) | ||||||
| Proceeds from investment distribution |
427 | 573 | ||||||
|
|
|
|
|
|||||
| Net cash used in investing activities |
(11,195) | (20,711) | ||||||
|
|
|
|
|
|||||
| Cash flows from financing activities |
||||||||
| Borrowings under secured credit facility |
25,000 | - | ||||||
| Repayment of secured credit facility borrowings |
(25,000) | - | ||||||
| Proceeds from issuance of senior secured notes, net of issuance costs |
296,994 | - | ||||||
| Cash held under restrictions |
(308,081) | - | ||||||
| Borrowings from capital lease obligations |
- | 9,895 | ||||||
| Principal payments on capital lease obligations |
(8,725) | (10,840) | ||||||
| Members’ distributions |
- | (25,523) | ||||||
| Repurchase of members’ interest |
(21,002) | (6,851) | ||||||
|
|
|
|
|
|||||
| Net cash used in financing activities |
(40,814) | (33,319) | ||||||
|
|
|
|
|
|||||
| Effect of exchange rate on cash and cash equivalents |
(403) | - | ||||||
|
|
|
|
|
|||||
| Net (decrease) increase in cash and cash equivalents |
38,871 | 17,919 | ||||||
| Cash and cash equivalents |
||||||||
| Beginning of period |
$ | 427,631 | $ | 607,689 | ||||
|
|
|
|
|
|||||
| End of period |
$ | 466,502 | $ | 625,608 | ||||
|
|
|
|
|
|||||
| Supplemental disclosure of cash flow information |
||||||||
| Cash paid for interest |
$ | 3,950 | $ | 3,406 | ||||
| Cash paid for income taxes |
6,197 | 13,196 | ||||||
| Non-cash transactions - unrecognized compensation |
18,939 | 19,511 | ||||||
The accompanying unaudited notes are an integral part of these consolidated financial statements.
4
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
| 1. | Organization and Description of the Business |
Nature of Operations and Organization
The Company’s primary business is a proprietary trading business that involves both buying and selling securities to provide two-sided markets on exchanges around the world. The Company supplies liquidity to allow investors to immediately transfer securities positions. As of June 30, 2013, GETCO Holding Company, LLC (“GHC”) was governed by the Fifth Amended and Restated Limited Liability Company Operating Agreement dated June 30, 2012 (the “LLC Agreement”). GHC had two managing members that jointly had power and authority to carry out management responsibilities and control the day-to-day operations of GHC. In connection with completion of the Mergers (as defined in Note 2 herein) and GHC becoming a subsidiary of KCG Holdings, Inc. (“KCG”), GHC amended and restated the LLC Agreement as of July 1, 2013 and adopted the Sixth Amended and Restated Limited Liability Company Operating Agreement.
Operating Segments
The Company has three operating segments – Market Making, Execution Services and Corporate and Other. The operating segments are determined based on the products and services provided as well as the markets and customers that they serve and they reflect the manner in which the business is managed. As of June 30, 2013, the Company’s operating segments comprised the following:
Market Making
The Market Making segment principally consists of market making in securities such as global equities, futures, options, fixed income, commodities, and foreign currencies. As a market maker, the Company commits capital for trade executions by offering to buy securities from, or sell securities to, institutions and broker-dealers. The Market Making segment primarily consists of non-client electronic market making activities in which the Company operates as a market maker in securities quoted and traded on the NASDAQ Stock Market (“NASDAQ”); the over-the-counter (“OTC”) market for the New York Stock Exchange (“NYSE”), NYSE Amex Equities, NYSE Arca listed securities; Chicago Mercantile Exchange (“CME”), Chicago Board Options Exchange, and several other exchanges primarily located throughout Europe and Asia. The segment provides trade executions as an equities Designated Market Maker (“DMM”) on the NYSE. Through the Market Making segment, the Company trades securities, using its own capital, and, with the intent of generating trading revenue.
Execution Services
The Execution Services segment offers clients access to markets and self-directed trading via its electronic agency-based platforms. In contrast to Market Making, the businesses within this segment generally act as agents to execute transactions and earn commissions. This segment also provides institutions with access to a customizable suite of trading tools which are built to capture advantages across markets.
Corporate and Other
The Corporate and Other segment invests in strategic financial services-oriented opportunities, allocates, deploys and monitors all capital, and maintains corporate overhead expenses and all other income and expenses that are not attributable to the other segments.
5
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
Basis of Presentation
GHC was organized in the State of Delaware on October 16, 2002 as a limited liability company. The consolidated financial statements include the accounts of GHC and its wholly owned subsidiaries, including GETCO, LLC (“Getco”), OCTEG, LLC (“Octeg”), GETCO Execution Services (“GES”) and GETCO Securities, LLC (“GTS”). Getco is an active clearing member of the CME. Octeg, GES and GTS are registered broker-dealers with the Securities and Exchange Commission (the “SEC”). GETCO Europe Limited (“GEL”) and Automat Limited (“AT”) are registered with the Financial Conduct Authority in the United Kingdom. GETCO Execution Services Limited (“GESL”) is a nonregistered intermediary in the United Kingdom. GETCO Asia Pte. Ltd. (“GAL”) is a nonregistered trading firm in Singapore. GETCO Asia Hong Kong Ltd. (“GAHK”) was established in August of 2011 as a subsidiary of GES and, in 2012, GAHK became a registered trading firm with the Securities and Futures Commission (“SFC”) in Hong Kong. On March 25, 2013 the Company decided to close its office in Hong Kong and withdraw its membership from SFC. The impact on earnings, related to this office closure, is included in restructuring costs and lease loss in the Consolidated Statements of Comprehensive (Loss) Income. GETCO Australia Pty. Ltd. (“GAUS”) is a registered trading firm with the Australian Securities and Investments Commission (“ASIC”) in Australia. GAUS is a subsidiary of GAL. Global Colocation Services, LLC (“GCO”), a wholly owned subsidiary of GHC, provides network services to the group and is located primarily in the United States. GEL, AT and GAL are also wholly owned subsidiaries of GHC. The primary operating subsidiaries of GHC are Getco, Octeg, GEL, GES, GTS, GAL, GCO and AT.
Consolidation
These unaudited consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. All such adjustments are of a normal recurring nature. All material intercompany accounts and transactions have been eliminated in consolidation.
Membership Unit-Based Compensation
The Company follows ASC 718 Compensation - Stock Compensation (“ASC 718”) to account for employee member unit-based compensation. ASC 718 requires entities to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award, with limited exceptions. The Company has unit-based payment programs as part of its incentive program. The details of the specific plans are outlined in Note 13 Membership Unit Award Plan and Incentive Unit Plan.
Accounting Standards Updates
Recently adopted accounting guidance
In December 2011, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standard Update (“ASU”) that requires additional disclosures about financial assets and liabilities that are subject to netting arrangements. Under the ASU, financial assets and liabilities must be disclosed at their respective gross asset and liability amounts, the amounts offset on the balance sheet and a description of the respective netting agreements. The new disclosures are required for reporting periods beginning on or after January 1, 2013, and are to
6
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
be applied retrospectively. Other than requiring additional disclosures, the adoption of this ASU did not have an impact on the Company’s consolidated financial statements.
In February 2013, the FASB issued an ASU that requires additional disclosure requirements for items reclassified out of accumulated other comprehensive income. This new guidance requires entities to present either on the face of the income statement or in the notes to the financial statements; the effects on the specific line items of the income statement for amounts reclassified out of accumulated other comprehensive income. This ASU is effective for reporting periods beginning after December 15, 2012. The adoption of this ASU did not have an impact on the Company’s consolidated financial statements.
Recent accounting guidance to be adopted in future periods
In March 2013, the FASB issued an ASU concerning parent’s accounting for the cumulative translation adjustment upon recognition of certain subsidiaries of groups of assets within a foreign entity or of an investment in a foreign entity. This ASU provides for the release of the cumulative translation adjustment into net income when a parent sells a part or all of its investment within a foreign entity, no longer holds a controlling interest in an investment in a foreign entity or obtains control of an investment in a foreign entity that was previously recognized as an equity method investment. This ASU is effective for reporting periods beginning after December 15, 2013, however early adoption is permitted. We are evaluating the impact of this ASU on the consolidated financial statements.
In July 2013, the FASB issued an ASU to clarify the financial statement presentation of an unrecognized tax benefit when a net operating loss (“NOL”) carryforward, a similar tax loss, or a tax credit carryforward exists. This ASU requires entities to present an unrecognized tax benefit as a reduction of a deferred tax asset for a NOL carryforward whenever the NOL or tax credit carryforward would be available to reduce the additional taxable income or tax due if the tax position is disallowed. The ASU is required for reporting periods after December 31, 2013. Upon adoption, entities are required to apply the provisions of the ASU prospectively for all unrecognized tax benefits that exist at the adoption date, however, the ASU also indicates that retrospective application is permitted. The Company is currently evaluating the impact that such adoption will have on its consolidated financial statements.
| 2. | Merger with Knight and formation of KCG Holdings Inc. |
Background
On December 19, 2012, Knight Capital Group Inc. (“Knight”), GHC and GA-GTCO, LLC (“GA-GTCO”) entered into an agreement and plan of merger (as amended on April 15, 2013 (the “Merger Agreement”) for a strategic business combination, pursuant to which Knight merged with and into Knight Acquisition Corp (the “Knight Merger”), GHC merged with and into GETCO Acquisition, LLC (the “GETCO Merger”) and GA-GTCO Acquisition, LLC merged with and into GA-GTCO (the “GA-GTCO Merger” and, together with the Knight Merger and the GETCO Merger, the “Mergers”). The Mergers were approved by the shareholders of Knight and the unit holders of GHC at special meetings held on June 25, 2013, and the Mergers were completed on July 1, 2013. As a result of the Mergers, Knight and GHC each became wholly owned subsidiaries of KCG.
7
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
Pursuant to the Merger Agreement, upon completion of the Knight Merger, subject to proration and certain specified exceptions, each outstanding share of Knight Class A common stock, par value $0.01 per share (“Knight Common Stock”) was converted into the right to elect to receive either $3.75 per share in cash or one third of a share of KCG Class A common stock, par value $0.01 per share (“KCG Class A Common Stock”). Pursuant to the proration procedures provided in the Merger Agreement and taking into account the waiver by Jefferies LLC, Knight’s largest shareholder before the Knight Merger, of its right to receive cash consideration with respect to certain of its shares, former Knight shareholders eligible for election received (in the aggregate) a cash payment of approximately $720,000.
Upon completion of the GETCO Merger, GETCO Class A, Class B and Class P units received shares of KCG Class A Common Stock and warrants (“KCG Warrants”) to acquire shares of KCG Class A Common Stock, in each case, based on the ratios set forth below:
| GETCO Unitholder |
Number of shares of KCG Class A Common Stock to be issued per unit, upon completion of the Mergers |
Number of warrants to be issued per unit, upon | ||
| GA-GTCO and/or its affiliates |
8.260763827 shares of KCG Class A Common Stock per GETCO unit | 2.832794484 warrants per GETCO unit | ||
| Daniel V. Tierney and affiliates |
5.458793673 shares of KCG Class A Common Stock per GETCO unit | 1.871938351 warrants per GETCO unit | ||
| Stephen Schuler and affiliates |
5.458793673 shares of KCG Class A Common Stock per GETCO unit | 1.871938351 warrants per GETCO unit | ||
| All other holders of Class A units and Class B units |
5.914567307 shares of KCG Class A Common Stock per GETCO Class A or Class B unit | 2.028232981 warrants per GETCO Class A or Class B unit |
Upon completion of the GA-GTCO Merger, GA-GTCO Interholdco, LLC (the parent of GA-GTCO) received shares of KCG Class A Common Stock and KCG Warrants, in accordance with the ratios set forth above. Additionally, pursuant to an equity commitment letter, GA-GTCO provided GETCO with $55,000 of equity financing prior to the Mergers and was issued Class B units in return, which in the Mergers were exchanged for 4,888,889 shares of KCG Class A Common Stock.
After taking into account the election results and the proration described above, 116.8 million shares (including unvested RSUs) of KCG Common Stock were outstanding as of July 1, 2013. In addition, as of July 1, 2013 warrants to purchase approximately 24.3 million shares of KCG Class A common stock were outstanding.
Accounting Treatment of the Mergers
The Mergers are accounted for as a purchase of Knight by the Company under accounting principles generally accepted in the United States of America (“GAAP”). Under the purchase method of accounting, the assets and liabilities of Knight will be recorded, as of completion of the Mergers, at their respective fair values and added to the carrying value of the Company’s
8
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
existing assets and liabilities. The reported financial condition and results of operations of KCG going forward will reflect the Company’s and Knight’s balances and results after completion of the Mergers, but will not be restated retroactively to reflect the historical financial position or results of operations of Knight. Going forward, the earnings of the combined company will reflect purchase accounting adjustments, including revised amortization and depreciation expense for acquired assets.
As a result of the Mergers, the Company incurred certain expenses in the second quarter of 2013. Given the Mergers were substantially complete as of the close of business on June 30, 2013, the Company recorded these merger-related expenses in the period ended June 30, 2013. These expenses primarily included success-based professional fees and accelerated unit award vesting. The unit award vesting was accelerated due to the capital event provisions that were triggered by the Mergers.
| 3. | Summary of Significant Accounting Policies |
The accompanying unaudited interim financial statements have been prepared in accordance with the accounting policies described in the financial statements and related notes for the year ended December 31, 2012 (“2012 Financial Statements”) included in the 8-K filed by KCG on July 1, 2013 and should be read in conjunction with such financial statements and related notes. The December 31, 2012 consolidated statement of financial condition included in these interim financial statements was derived from the audited 2012 Financial Statements, but does not include all the disclosures required by GAAP. The following notes to these interim financial statements highlight significant changes to the notes included in the 2012 Financial Statements and present interim disclosures as required by the SEC. In order to conform with GAAP, the Company, in preparing its financial statements, is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of June 30, 2013 and December 31, 2012, and the reported amounts of revenues and expenses for the three months ended and six months ended June 30, 2013 and 2012. Actual results could differ from those estimates.
| 4. | Fair Value of Financial Instruments |
ASC 820-10 Fair Value and Disclosures (“ASC 820-10”) establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The Company values its financial instruments using a hierarchy of fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. The three levels of the fair value hierarchy under ASC 820-10 are as follows:
| Level 1 | Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access, which does not require significant managerial judgment. |
9
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
| Level 2 | Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. | |
| Level 3 | Valuations based on inputs that are unobservable and significant to the overall fair value measurement. | |
The Company deems the best observable data to be that market data which is readily available, regularly distributed or updated, reliable and verifiable, not proprietary, and provided by independent sources that are actively involved in the relevant market. The categorization of a financial instrument within the hierarchy is based upon this pricing transparency of the instrument and does not necessarily correspond to the Company’s perceived risk of that instrument. The more transparent the market value of the asset will dictate the Company’s assessment of the level that the asset is placed in the hierarchy.
Securities and options whose values are based on quoted market prices in active markets, and are therefore classified within Level 1 include active listed equities, certain U.S. government and sovereign obligations and the Company’s available for sale holdings of common shares of Knight. Prior to February 28, 2013 the Company invested in Series A-1 Cumulative Perpetual Convertible Preferred Stock (“Preferred Shares”) of Knight. The value of the Preferred Shares was determined using the quoted price of the Knight Common Stock multiplied by the common stock equivalent of the Preferred Shares as defined in the share agreement. The Company has assessed that this investment met the requirements of a Level 1 asset since the price is transparent and the conversion of common stock is in the control of the Company.
Money market instruments included in cash and cash equivalents on the consolidated statements of financial condition are classified within Level 1. Fair value for money market instruments is based upon published net asset values.
Securities and options that trade in markets that are not considered to be active, but are valued based on quoted market prices, dealer quotations or alternative pricing sources supported by observable inputs, are classified within Level 2.
Level 3 instruments held by the Company include Depository Trust Clearing Corporation common shares required to ensure status as a clearing member, and preferred shares held as part of a joint back office account agreement with one of the Company’s clearing brokers. These securities do not have active markets and do not have comparable marketable securities. Currently, we believe that the price originally paid for the shares approximates fair value of the stock given the recent purchase of these shares and the closed nature of the investment.
There were no transfers between Levels 1, 2 and 3 during the periods ended June 30, 2013 or December 31, 2012.
10
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
The following table presents the financial instruments carried on the consolidated statements of financial condition by level within the valuation hierarchy as of June 30, 2013 and December 31, 2012.
| Balance Sheet Classification |
Assets at Fair Value as of June 30, 2013 | |||||||||||||||||
| Asset Category |
Level 1 | Level 2 | Level 3 | Total | ||||||||||||||
| Money market securities |
A | $ | 123,383 | $ | - | $ | - | $ | 123,383 | |||||||||
| United States government obligations on deposit with exchanges |
B | 6,748 | - | - | 6,748 | |||||||||||||
| Corporate debt securities |
C | 21,455 | - | - | 21,455 | |||||||||||||
| Swaps and forwards |
G | - | 991 | - | 991 | |||||||||||||
| Futures |
G | (1,348) | - | - | (1,348) | |||||||||||||
| Options |
C | 111,587 | - | - | 111,587 | |||||||||||||
| Equity securities* |
C | 637,710 | - | 780 | 638,490 | |||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||
| Total |
$ | 899,535 | $ | 991 | $ | 780 | $ | 901,306 | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||
| Liability Category |
Balance Sheet Classification |
Liabilities at Fair Value as of June 30, 2013 | ||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | |||||||||||||||
| Swaps and forwards |
F | $ | - | $ | 13 | $ | - | $ | 13 | |||||||||
| Debt securities |
D | 16,465 | - | - | 16,465 | |||||||||||||
| Options |
D | 80,496 | - | - | 80,496 | |||||||||||||
| Equity securities |
D | 645,700 | - | - | 645,700 | |||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||
| Total |
$ | 742,661 | $ | 13 | $ | - | $ | 742,674 | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||
| Asset Category |
Balance Sheet Classification |
Assets at Fair Value as of December 31, 2012 | ||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | |||||||||||||||
| Money market securities |
A | $ | 296,065 | $ | - | $ | - | $ | 296,065 | |||||||||
| United States government obligations on deposit with exchanges |
B | 7,147 | - | - | 7,147 | |||||||||||||
| Preferred stock |
E | 199,632 | - | - | 199,632 | |||||||||||||
| Corporate debt securities |
C | 68,765 | - | - | 68,765 | |||||||||||||
| Mutual funds - bond funds |
C | 114,872 | - | - | 114,872 | |||||||||||||
| Swaps and forwards |
G | - | 570 | - | 570 | |||||||||||||
| Futures |
G | (1,115) | - | - | (1,115) | |||||||||||||
| Options |
C | 92,305 | - | - | 92,305 | |||||||||||||
| Equity securities |
C | 381,218 | - | 773 | 381,991 | |||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||
| Total |
$ | 1,158,889 | $ | 570 | $ | 773 | $ | 1,160,232 | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||
| Liability Category |
Balance Sheet Classification |
Liabilities at Fair Value as of December 31, 2012 | ||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | |||||||||||||||
| Swaps and forwards |
F | $ | - | $ | 110 | $ | - | $ | 110 | |||||||||
| Debt securities |
D | 19,056 | - | - | 19,056 | |||||||||||||
| Options |
D | 69,757 | - | - | 69,757 | |||||||||||||
| Equity securities |
D | 423,740 | - | - | 423,740 | |||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||
| Total |
$ | 512,553 | $ | 110 | $ | - | $ | 512,663 | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||
| A. | Cash and cash equivalents |
| B. | Deposits with clearing organizations and exchanges |
| C. | Securities and options owned, at fair value |
| D. | Securities and options sold, not yet purchased, at fair value |
| E. | Investments |
| F. | Accounts payable and accrued expenses |
| G. | Receivables from clearing brokers and clearing organizations |
* Level 1 equity securities includes common shares of Knight valued at $204,182 which are included in investments on the consolidated statements of financial condition.
11
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
The following table includes a roll forward of the amounts for the periods ended June 30, 2013 and December 31, 2012 for investments classified within Level 3.
Fair Value Measurement using Level 3 inputs
| Balance at December 31, 2011 |
$ | 600 | ||
| Purchases of equity |
173 | |||
|
|
|
|||
| Balance at December 31, 2012 |
$ | 773 | ||
| Purchases of equity |
7 | |||
|
|
|
|||
| Balance at June 30, 2013 |
$ | 780 | ||
|
|
|
Effective January 1, 2013, the Company adopted the amended disclosure guidance about offsetting certain assets and liabilities, which required additional information about derivative instruments, repurchase agreements and securities borrowing and securities lending transactions. For financial statement purposes, the Company does not offset derivative instruments, any repurchase agreements or securities borrowing transactions. For the period ended June 30, 2013, the Company did not participate in securities loaned transactions. The Company’s derivative instruments, repurchase agreements and securities borrowing transactions are transacted under master agreements that are widely used by counterparties and that may allow for net settlements of payments in the normal course as well as offsetting of all contracts with a given counterparty in the event of bankruptcy or default of one of the two parties to the transactions; therefore, all of these transactions are presented in the amended disclosures. The gross amounts of assets and liabilities subject to netting and gross amounts offset in the consolidated statements of financial condition were as follows:
| Gross Amounts Recognized |
Gross Amounts Offset in the Consolidated Balance Sheet |
Net Amounts Presented in the Consolidated Balance Sheet |
Gross Amounts Not Offset in the Consolidated Balance Sheet |
|||||||||||||||||||||
| Financial Instruments |
Cash Collateral Received or Pledged |
Net Amount | ||||||||||||||||||||||
| June 30, 2013 |
||||||||||||||||||||||||
| Assets: |
||||||||||||||||||||||||
| Deposits paid for securities borrowed |
$ | 90,597 | $ | - | $ | 90,597 | $ | 86,442 | $ | - | $ | 4,155 | ||||||||||||
| Derivative assets |
111,587 | - | 111,587 | - | - | 111,587 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total |
$ | 202,184 | $ | - | $ | 202,184 | $ | 86,442 | $ | - | $ | 115,742 | ||||||||||||
| Liabilities: |
||||||||||||||||||||||||
| Derivative liabilities |
$ | 80,496 | $ | - | $ | 80,496 | $ | - | $ | 1,026 | $ | 79,470 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total |
$ | 80,496 | $ | - | $ | 80,496 | $ | - | $ | 1,026 | $ | 79,470 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| December 31, 2012 |
||||||||||||||||||||||||
| Assets: |
||||||||||||||||||||||||
| Deposits paid for securities borrowed |
$ | 52,261 | $ | - | $ | 52,261 | $ | 50,717 | $ | - | $ | 1,544 | ||||||||||||
| Listed equity options |
92,305 | - | 92,305 | - | - | 92,305 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total |
$ | 144,566 | $ | - | $ | 144,566 | $ | 50,717 | $ | - | $ | 93,849 | ||||||||||||
| Liabilities: |
||||||||||||||||||||||||
| Listed equity options |
$ | 69,757 | $ | - | $ | 69,757 | $ | - | $ | 1,393 | $ | 68,364 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total |
$ | 69,757 | $ | - | $ | 69,757 | $ | - | $ | 1,393 | $ | 68,364 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
12
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
| 5. | Investments |
Below is a schedule of the strategic investments as of June 30, 2013 and December 31, 2012 and loss from investments for the three months ended and six months ended June 30, 2013 and 2012:
| June 30, 2013 |
December 31, 2012 |
|||||||||||||||||||
| Strategic Investments at Cost: |
||||||||||||||||||||
| Investments in exchanges |
$ | 35,531 | $ | 44,625 | ||||||||||||||||
| Investments in other companies |
1,141 | 1,141 | ||||||||||||||||||
|
|
|
|
|
|||||||||||||||||
| 36,672 | 45,766 | |||||||||||||||||||
| Investments Available for Sale: |
||||||||||||||||||||
| Investment in Knight |
204,182 | 199,632 | ||||||||||||||||||
|
|
|
|
|
|||||||||||||||||
| Total Investments |
$ | 240,854 | $ | 245,398 | ||||||||||||||||
|
|
|
|
|
|||||||||||||||||
| Three months ended June 30, |
Six months ended June 30, |
|||||||||||||||||
| 2013 | 2012 | 2013 | 2012 | |||||||||||||||
| Dividends received from strategic investments |
$ | - | $ | - | $ | 91 | $ | - | ||||||||||
| Impairment of strategic investments |
(9,184) | - | (9,184) | - | ||||||||||||||
| Preferred dividend from Knight |
- | - | 276 | - | ||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||
| Total loss on investments |
$ | (9,184) | $ | - | $ | (8,817) | $ | - | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||
Impairment Charges
The impairment charges for investments are calculated as the difference between the carrying value of the investments and the estimated fair value. The impairment charges recorded during the six months ended June 30, 2013 were triggered by the proposed repurchase of an investment by the majority shareholder and the cessation of a trading relationship by the Company with an investment.
The accounting guidance for the fair value measurement provisions for the impairment of investments establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets for identical assets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.
The following table presents information about the Company’s strategic investments that were measured at fair value on a non-recurring basis during the six months ended June 30,
13
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
2013. The table indicates the fair value hierarchy of the valuation techniques we utilized to determine fair value.
| Fair Value Measurements on a Non-Recurring Basis | ||||||||||||||||||||
| Description |
Six Months Ended June 30, 2013 |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Unobservable Inputs (Level 3) |
Total Impairment | |||||||||||||||
| Investment in Exchange |
$ | 3,127 | $ | - | $ | - | $ | 3,127 | $ | (7,184) | ||||||||||
| Investment in Exchange |
- | - | - | - | (2,000) | |||||||||||||||
|
|
|
|||||||||||||||||||
| $ | (9,184) | |||||||||||||||||||
|
|
|
|||||||||||||||||||
The following table presents quantitative information about the Level 3 fair value measurements at June 30, 2013.
| Quantitative Information about Level 3 Fair Value Measurements: | ||||||||||
| Description |
Fair value at June 30, 2013 |
Valuation technique | Unobservable Inputs |
Range | ||||||
| Investment in Exchange |
$ | 3,127 | 3rd Party Pricing | (A) | N/A | |||||
| Investment in Exchange |
$ | - | Discounted Cash Flow | (B) | N/A | |||||
(A) Based on purchase offer from the majority shareholder
(B) Based on projected trading volumes and negative cash flows
| 6. | Notes Payable |
On October 25, 2011, the Company issued $15,000 in notes to a single lender. The notes bear interest at 5.95% per annum, require no principal amortization over the term and mature in October 2018. The note agreement includes certain covenants which require the Company, among other things, to maintain compliance with debt to net worth ratios, maintain minimum levels of liquid net assets and maintain minimum net capital levels in its regulated subsidiaries. At June 30, 2013 and December 31, 2012, the Company was in compliance with these covenants. In connection with the Mergers, on May 31, 2013, the Company provided irrevocable notice to the lender that it intended to prepay the notes, inclusive of accrued interest. The notes were subsequently repaid on July 1, 2013.
In connection with the Mergers, GETCO Financing Escrow, LLC (“Finance LLC”), a wholly owned subsidiary of GHC, issued $305,000 of senior secured notes which mature on June 15, 2018 (the “Senior Secured Notes”) pursuant to the Senior Secured Notes Indenture (as defined in Note 17 herein). The Senior Secured Notes bear an interest rate of 8.25%, payable semi-annually. As of June 30, 2013, the proceeds from the debt issuance were held in a segregated escrow account contingent upon the closing of the Mergers, and therefore, the proceeds are presented as restricted cash within the consolidated statements of financial condition. Additionally, the Company was obligated to include in the segregated escrow account $3,075, which is sufficient for interest due from June 5, 2013 through July 19, 2013, the outside date for the closing of the Mergers. On July 1, 2013, Finance LLC merged into KCG. In connection with the merger with Finance LLC, KCG assumed the Senior Secured Notes.
The Senior Secured Notes contain certain optional redemption features that allow for the redemption of some or all of the Senior Secured Notes at a premium, which varies depending
14
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
on the timing of the redemption. The Senior Secured Notes contain certain covenants, including limitations on incurrence of debt, investments, and issuance of additional equity.
In connection with the issuance of the Senior Secured Notes, underwriting fees and legal fees of $8,006 and $3,600, respectively, were incurred and were capitalized as debt placement costs, which will be amortized over the contractual term of the debt.
In connection with the Mergers, the Company obtained a bridge loan financing commitment. During the three months ended June 30, 2013, the Company incurred and expensed $8,937 for fees related to the commitment. The Company did not draw on the bridge loan through the closing of the Mergers, at which time the commitment was terminated.
The total interest and related expense for the three months ended and six month ended June 30, 2013 and 2012 included in the Consolidated Statements of Comprehensive (Loss) Income is as follows:
| Three months ended June 30, |
Six months ended June 30, |
|||||||||||||||
| 2013 | 2012 | 2013 | 2012 | |||||||||||||
| Interest expense - Notes payable * |
$ | 223 | $ | 223 | $ | 446 | $ | 446 | ||||||||
| Interest expense - 2018 Secured Notes * |
1,747 | - | 1,747 | - | ||||||||||||
| Debt placement cost amortization ** |
359 | 49 | 472 | 49 | ||||||||||||
| Commitment fee - bridge loan** |
8,937 | - | 8,937 | - | ||||||||||||
* Included in Interest expense on corporate borrowings and capital lease obligations
** Included in Other expenses
| 7. | Revolving Credit Facilities |
On June 30, 2011, the Company entered into a $30,000 one year unsecured revolving credit facility. On March 30, 2012, the Company amended the unsecured revolving credit facility to increase the limit to $50,000, extend the maturity to July 5, 2015, and create a sub limit for Letters of Credit. Borrowings under the facility may have maturities up to six months and will bear interest at the then current LIBOR rate plus a margin of 2.5% per annum. This facility was retired on May 21, 2013, at which time there were $3,000 of letters of credit outstanding, which were subsequently cash collateralized.
On August 12, 2011, Octeg entered into a $50,000 one year Secured Revolving Credit Facility with a single lender, which was retired on June 6, 2012. Borrowings under the facility were used to finance the purchase and settlement of securities, and bore interest at LIBOR plus a margin of 1.75% per annum. A commitment fee of 0.30% per annum on the average daily unused portion of the facility was payable quarterly in arrears.
On June 6, 2012, Octeg retired the August 12, 2011 secured revolving credit facility and entered into a $350,000 syndicated secured revolving credit facility (the “OCTEG Facility”) with the lenders from time to time party thereto, BMO Harris Bank N.A., as administrative agent and
15
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
collateral agent, and JPMorgan Chase Bank, N.A., as syndication agent. Borrowings under the facility bore interest at the then current LIBOR rate plus a margin of 1.75% per annum and could be used to finance the purchase and settlement of securities. A commitment fee at a rate of 0.35% per annum on the average daily unused portion of the facility was payable quarterly in arrears. The ability to draw on this facility was limited to a percentage of the market value of temporary positions pledged as collateral. The facility required, among other restrictions, the maintenance of total regulatory capital of $150,000, excess regulatory net capital and limits total assets to total regulatory capital. At June 30, 2013, the Company was in compliance with these covenants. During the first quarter of 2013, the Company drew $25,000 on the OCTEG Facility, which was repaid as of June 30, 2013. The OCTEG Facility was replaced by the OCTEG-KCA Facility Agreement on July 1, 2013, as discussed in Note 17.
| 8. | Capital Leases |
During 2012, the Company entered into capitalized lease obligations related to certain computer equipment. These obligations represent drawdowns under a revolving secured lending facility with a single lender. At June 30, 2013, the obligations have a weighted-average interest rate of 3.87% per annum and are on varying 3-year terms. The carrying amounts of the capital leases approximate fair value. The future minimum payments under capitalized leases at June 30, 2013 consist of:
| Minimum Payments |
||||||||||||||||||||||||||||||||||||||||||||||
| For the six months ended December 31, 2013 |
$ | 6,177 | ||||||||||||||||||||||||||||||||||||||||||||
| 2014 |
8,222 | |||||||||||||||||||||||||||||||||||||||||||||
| 2015 |
2,072 | |||||||||||||||||||||||||||||||||||||||||||||
|
|
|
|||||||||||||||||||||||||||||||||||||||||||||
| $ | 16,471 | |||||||||||||||||||||||||||||||||||||||||||||
The total interest expense for the three months and six months ended June 30, 2013 and 2012 included in the Consolidated Statements of Comprehensive (Loss) Income is as follows:
| Three months ended June 30, |
Six months ended June 30, |
|||||||||||||||
| 2013 | 2012 | 2013 | 2012 | |||||||||||||
| Interest expense - Capital leases |
$ | 201 | $ | 308 | $ | 451 | $ | 850 | ||||||||
* Included as Interest expense on corporate borrowings and capital lease obligations
| 9. | Commitments and Contingencies |
In the normal course of business, the Company may enter into contracts that contain representations or warranties which may provide general or specific indemnifications to others. Additionally, the Company is subject to certain pending and threatened legal and regulatory actions which arise in the normal course of business. The outcome of these matters is inherently uncertain, particularly with respect to unasserted claims and proceedings in their early stages. Accordingly, estimates may change from time to time and actual losses may be more or less
16
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
than the current estimate. The Company accounts for potential losses related to these actions in accordance with ASC 450-10, Contingencies. As of June 30, 2013 and December 31, 2012, reserves provided for potential losses and the range of reasonably possible losses, in excess of reserves, related to litigation, regulatory and related matters were not material, and based on currently available information, the outcome of any proceedings will not have a material adverse effect on the Company’s consolidated operating results or financial condition.
The Company is a member of various exchanges that trade and clear securities and/or futures contracts. Associated with its membership, the Company may be contractually required to pay a proportionate share of the obligations of another unaffiliated member who may default on its obligation to the exchange. While the rules governing different exchange memberships vary, in general, the Company’s guarantee obligations would arise only if the exchange had previously exhausted its resources. In addition, any such guarantee obligation would be apportioned among the other non-defaulting members of the exchange. Any potential liability under these membership agreements cannot be estimated. The Company has not recorded any contingent liability in the financial statements for these agreements and believes that any potential requirement to make payments under these agreements is remote.
| 10. | Related Parties |
Certain exchanges in which the Company has strategic investments provide execution services to the Company. Prior to February 28, 2013, the Company also held an investment in Knight Preferred Shares, which previously paid preferred dividends. Such dividends ceased upon the mandatory conversion of the Preferred Shares into shares of Knight Common Stock on February 28, 2013. As of June 30, 2013, the Company still maintained the investment in Knight Common Stock. Amounts related to these investments are summarized as follows:
| For three months ended June 30, |
For six months ended June 30, |
|||||||||||||||||
| Transactions |
Financial Statement Line Item |
2013 | 2012 | 2013 | 2012 | |||||||||||||
| Execution rebate income |
Trading gains and losses, net | $ | 4,932 | $ | 4,477 | $ | 10,942 | $ | 12,130 | |||||||||
| Execution fees |
Regulatory, exchange and execution fees |
(1,200) | (1,357) | (2,316) | (2,436) | |||||||||||||
| Execution rebate receivable |
Receivables from exchanges | 2,038 | 1,938 | 2,038 | 1,938 | |||||||||||||
| Dividends |
Income from investments, net | - | - | 367 | - | |||||||||||||
| 11. | Financial Instruments with Off-Balance-Sheet Risk |
The Company, in connection with its proprietary trading activities, may enter into transactions involving derivative financial instruments, including options contracts and other financial instruments with similar characteristics. As of June 30, 2013 and December 31, 2012, the Company held primarily options and futures related to U.S. listed equities and foreign exchange contracts.
Options held provide the Company with the opportunity to deliver or take delivery of specified financial instruments at a contract price. Options written obligate the Company to deliver or take delivery of specified financial instruments at a contract price in the event the option is exercised by the holder. Futures provide for the delayed delivery of the underlying
17
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
instrument. Futures contracts are executed on an exchange and cash settlement is made on a daily basis for market movements. These contracts are marked-to-market based upon quoted market prices, with gains and losses recorded in the Consolidated Statements of Comprehensive (Loss) Income in trading gains and losses, net.
The volume of derivative financial instruments can fluctuate significantly based on the trading strategy employed by the Company from time to time. As such, the amounts disclosed in the tables below may not be representative of the overall trading activities in these asset classes and related hedge instruments during the reporting period.
The following tables summarize the fair value of derivatives by type of derivative contract on a gross basis at June 30, 2013 and December 31, 2012.
| At June 30, 2013 | ||||||||||||||||
| Assets | Liabilities | |||||||||||||||
| Fair Value | Contracts | Fair Value | Contracts | |||||||||||||
| Foreign exchange |
||||||||||||||||
| Futures contracts |
$ | (40) | 537 | $ | 65 | 128 | ||||||||||
| Forward contracts |
- | - | 13 | 1 | ||||||||||||
| Equity |
||||||||||||||||
| Futures contracts |
(431) | 3,095 | (26) | 1,218 | ||||||||||||
| Swap contracts |
991 | 1 | - | - | ||||||||||||
| Options |
111,587 | 269,185 | 80,496 | 262,388 | ||||||||||||
| Fixed income |
||||||||||||||||
| Futures contracts |
675 | 14,813 | (2,045) | 15,152 | ||||||||||||
| Commodity |
||||||||||||||||
| Futures contracts |
(209) | 1,711 | 663 | 1,775 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total |
$ | 112,573 | 289,342 | $ | 79,166 | 280,662 | ||||||||||
| At December 31, 2012 | ||||||||||||||||
| Assets | Liabilities | |||||||||||||||
| Fair Value | Contracts | Fair Value | Contracts | |||||||||||||
| Foreign exchange |
||||||||||||||||
| Futures contracts |
$ | 8 | 500 | $ | - | 95 | ||||||||||
| Forward contracts |
- | - | 110 | 1 | ||||||||||||
| Equity |
||||||||||||||||
| Futures contracts |
114 | 671 | (314) | 590 | ||||||||||||
| Swap contracts |
570 | 1 | - | |||||||||||||
| Options |
92,305 | 199,324 | 69,757 | 196,804 | ||||||||||||
| Fixed income |
||||||||||||||||
| Futures contracts |
(705) | 51,566 | 864 | 51,975 | ||||||||||||
| Commodity |
||||||||||||||||
| Futures contracts |
(11) | 1,611 | (29) | 1,598 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total |
$ | 92,281 | 253,673 | $ | 70,388 | 251,063 | ||||||||||
18
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
The fair values of these contracts are recorded on the consolidated statements of financial condition in Securities and options owned and Securities and options sold, not yet purchased and Receivables from and Payables to clearing brokers and clearing organizations.
The majority of the Company’s transactions with off-balance sheet risk are short-term in duration due to the nature of the Company’s trading strategies.
Financial instruments sold, not yet purchased, at fair value represent obligations to purchase such securities (or underlying securities) at a future date. The Company may incur a loss if the market value of the securities subsequently increases.
The table below summarizes trading gains and losses, net on the derivative instruments for the three months and six months ended June 30, 2013 and 2012.
| For three months ended June 30, |
For six months ended June 30, |
|||||||||||||||
| 2013 | 2012 | 2013 | 2012 | |||||||||||||
| Fixed income |
||||||||||||||||
| Futures contracts |
$ | 22,178 | $ | 21,489 | $ | 42,202 | $ | 51,015 | ||||||||
| Foreign exchange |
||||||||||||||||
| Futures contracts |
2,562 | 5,564 | 5,132 | 11,952 | ||||||||||||
| Forward contracts |
75 | 201 | 584 | (103) | ||||||||||||
| Commodities |
||||||||||||||||
| Futures contracts |
13,975 | 9,352 | 25,279 | 17,273 | ||||||||||||
| Options contracts |
(517) | - | (517) | 158 | ||||||||||||
| Equity |
||||||||||||||||
| Futures contracts |
16,238 | 23,258 | 26,664 | 51,517 | ||||||||||||
| Swap contracts |
5,435 | 1,071 | 8,871 | 3,022 | ||||||||||||
| Options contracts |
28,805 | 5,366 | 46,794 | 16,873 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total |
$ | 88,751 | $ | 66,301 | $ | 155,009 | $ | 151,707 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
Market Risk
Market risk is the potential for changes in the value of financial instruments as a result of changes in the markets. Categories of market risk include, but are not limited to, exposures to equity prices, interest rates and commodity prices. A description of each such market risk category is set forth below:
| • | Equity price risks result from exposures to changes in prices and volatilities of individual equities, equity baskets and equity indices. |
| • | Interest rate risks primarily result from exposures to changes in the level, slope and curvature of the yield curve, the volatility of interest rates and credit spreads. |
| • | Commodity price risks result from exposures to changes in spot prices, forward prices and volatilities of commodities, such as electricity, natural gas, crude oil and petroleum products. |
19
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
Market risk is directly affected by the volatility and liquidity of the markets in which the underlying financial instruments are traded. In many cases, the use of derivative financial instruments serves to modify or offset market risk associated with other transactions and, accordingly, serves to decrease the Company’s overall exposure to market risk. The Company manages its exposure to market risk arising from the use of these derivative financial instruments through various analytical monitoring techniques.
Credit Risk
Credit risk arises from the potential inability of counterparties to perform in accordance with the terms of a contract. The Company’s exposure to credit risk associated with counterparty nonperformance is limited to the current cost to replace all contracts in which the Company has a gain. Exchange traded financial instruments, including options and futures, generally do not give rise to significant counterparty exposure due to the cash settlement procedures for daily market movements through a central clearing organization or the margin requirements of the individual exchanges and clearing brokers. Substantially all of the Company’s transactions are executed in exchange traded instruments.
Concentrations of Credit Risk
The Company clears the majority of its trades internally, but also uses other third party clearing brokers. Cash and financial instruments held at the Company’s clearing brokers collateralize amounts due to the clearing brokers, if any, and may serve to satisfy regulatory or clearing broker margin requirements. In the event these clearing brokers do not fulfill their obligations, the Company may be exposed to risk. This risk of default also depends on the creditworthiness of the counterparties to each of these transactions. The Company attempts to minimize these credit risks by monitoring the creditworthiness of its clearing brokers.
The Company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. The Company has not experienced and does not expect to experience any losses in such accounts.
Management believes that the Company is not exposed to any significant credit risk as a result of its monitoring procedures and the nature of its financial instruments.
| 12. | Members’ Equity |
The components of members’ equity for each unit class at June 30, 2013 and December 31, 2012 are as follows:
| June 30, 2013 |
December 31, 2012 |
|||||||
| Class A units |
$ | 235,612 | $ | 261,799 | ||||
| Class B units |
399,464 | 422,118 | ||||||
| Class P units |
198,897 | 218,673 | ||||||
| Class E units |
69,071 | 63,221 | ||||||
|
|
|
|
|
|||||
| Total equity |
$ | 903,044 | $ | 965,811 | ||||
|
|
|
|
|
|||||
20
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
A summary of the changes in the Company’s units is as follows:
| A Units | B Units | P Units | E Units | |||||||||||||||||||||||||||||
| Units | Weighted Average Price |
Units | Weighted Average Price |
Units | Weighted Average Price |
Units | Weighted Average Price |
|||||||||||||||||||||||||
| Balance, December 31, 2011 |
3,754,250 | $ | 0.11 | 6,015,696 | $ | 30.75 | 2,785,689 | $ | 125.64 | 1,104,147 | $ | 73.89 | ||||||||||||||||||||
| Issued |
- | - | 112,272 | 88.43 | - | - | 83,626 | 32.93 | ||||||||||||||||||||||||
| Retired |
(66,031) | 0.15 | (1,348,918) | 54.41 | - | - | (380,122) | 59.06 | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Balance, December 31, 2012 |
3,688,219 | $ | 0.11 | 4,779,050 | $ | 25.42 | 2,785,689 | $ | 125.64 | 807,651 | $ | 45.26 | ||||||||||||||||||||
| Issued |
- | - | 58,326 | 73.54 | - | - | - | - | ||||||||||||||||||||||||
| Retired |
- | - | (55,926) | 105.96 | - | - | (57,919) | 49.39 | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Balance, June 30, 2013 |
3,688,219 | $ | 0.11 | 4,781,450 | $ | 25.06 | 2,785,689 | $ | 125.64 | 749,732 | $ | 44.94 | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| 13. | Membership Unit Award Plan and Incentive Unit Plan |
As of June 30, 2013, the managing members could, at their discretion, award membership units or options to purchase membership units in the Company. There were no outstanding options to purchase membership units at June 30, 2013 or December 31, 2012.
During 2013 and 2012, the Company granted membership unit awards to employees in the form of Class B units. Prior to 2012, these primarily consisted of non-voting units which vest three years from the grant date, provided certain conditions of employment and performance are met by the employee. In 2012, the Company changed the vesting of units granted in 2012 to an annual vesting of one-third of the units over the three year period. Upon termination of employment, the Company had the option to repurchase all or a portion of the units granted within six months. The purchase price for the unvested units was determined as a percentage of grant date fair value. The Company classified these unit awards as equity as the employees received full membership rights with respect to allocation of income and participation in member distributions. In connection with the Mergers, all outstanding unvested Class B units vested on June 25, 2013. The accelerated amortization of Class B units recorded during the three months ended June 30, 2013 was $9,433.
The following is a schedule of the changes in the Company’s unvested Class B units:
| Units | Weighted Average Grant Price |
|||||||
| Unvested as of December 31, 2011 |
748,489 | $ | 98.01 | |||||
| Issued |
112,272 | 88.43 | ||||||
| Vested |
(249,105) | 110.50 | ||||||
| Forfeited |
(194,699) | 93.69 | ||||||
|
|
|
|
|
|||||
| Unvested as of December 31, 2012 |
416,957 | $ | 89.99 | |||||
|
|
|
|||||||
| Issued |
58,326 | 73.54 | ||||||
| Vested |
(438,498) | 87.86 | ||||||
| Forfeited |
(36,785) | 89.28 | ||||||
|
|
|
|
|
|||||
| Unvested as of June 30, 2013 |
- | $ | - | |||||
|
|
|
|||||||
21
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
The Company granted employees profit interests in the form of Class E units. Prior to 2012, Class E units primarily vested three years from the grant date. For units granted in 2012, the Company changed the vesting of Class E units to an annual vesting of one-third of the units over the three year period and provided the Company an option to repurchase the units at the end of 5 years. Class E units allowed for future appreciation in excess of the Company’s value over a certain strike price per unit and allocation of income once the units are vested. Upon the departure of an associate, the Class E units were forfeited whether vested or not, and if vested, the cash value of the Class E units above their strike price was paid to the associate. The Company classifies these unit awards as equity. In connection with the Mergers all outstanding unvested Class E units vested on June 25, 2013. The accelerated amortization of E units recorded during the three months ended June 30, 2013 was $3,542.
The following is a schedule of the changes in the Company’s unvested Class E units:
| Units | Weighted Average Grant Price |
|||||||
| Unvested as of December 31, 2011 |
858,397 | $ | 43.49 | |||||
| Issued |
83,626 | 32.93 | ||||||
| Vested |
(341,017) | 55.04 | ||||||
| Forfeited |
(124,922) | 30.43 | ||||||
|
|
|
|
|
|||||
| Unvested as of December 31, 2012 |
476,084 | $ | 36.78 | |||||
|
|
|
|||||||
| Issued |
- | |||||||
| Vested |
(441,765) | 37.24 | ||||||
| Forfeited |
(34,319) | 30.89 | ||||||
|
|
|
|
|
|||||
| Unvested as of June 30, 2013 |
- | $ | - | |||||
|
|
|
|||||||
As of June 30, 2013, the managing members could also award deferred compensation in the form of incentive units under the Incentive Unit Plan (the “Plan”). The incentive units were nonvoting and did not have membership rights or participate in allocation of income. They were eligible to participate in discretionary distributions of the firm as defined in the LLC Agreement. The Plan provided that the incentive units vest at the end of three years from the date of grant and would be redeemed at the end of the ten-year anniversary of the associates’ entrance into the Plan based on the value of the Company at that time. In 2013 and 2012, the incentive units were awarded under the 2012 Incentive Unit Plan (the “2012 Plan”). The 2012 Plan provided that the incentive units granted vest proportionally on anniversary date of the grant over three years, or that they could be vested immediately. The value of these incentive units is determined based on the same methodology used to value the Class B unit awards and the amount expensed is determined based on this valuation multiplied by the percent vested. In connection with the Mergers all outstanding unvested incentive units vested on June 25, 2013 and therefore the Company fully amortized the awards as of June 30, 2013. The accelerated amortization of incentive units recorded during the three months ended June 30, 2013 was $1,336. Deferred compensation payable at June 30, 2013 and December 31, 2012 related to incentive units was $5,766, and
22
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
$3,480, respectively, and is included in accounts payable and accrued expenses on the consolidated statements of financial condition.
The following is a summary of the changes in the incentive units for the periods ended June 30, 2013 and December 31, 2012:
| Vested | Unvested | Weighted Average Value |
||||||||||||||||||
| Incentive units at December 31, 2011 |
26,314 | 35,218 | $ | 106.85 | ||||||||||||||||
| Issued |
786 | 19,147 | 86.83 | |||||||||||||||||
| Vested |
1,169 | (1,169) | ||||||||||||||||||
| Canceled |
(4,393) | (8,203) | 95.06 | |||||||||||||||||
|
|
|
|
|
|
|
|||||||||||||||
| Incentive units at December 31, 2012 |
23,876 | 44,993 | $ | 93.58 | ||||||||||||||||
|
|
|
|
|
|
|
|||||||||||||||
| Issued |
1,203 | 11,872 | 73.54 | |||||||||||||||||
| Vested |
53,307 | (53,307) | ||||||||||||||||||
| Canceled |
(1,483) | (3,558) | 93.76 | |||||||||||||||||
|
|
|
|
|
|
|
|||||||||||||||
| Incentive units at June 30, 2013 |
76,903 | - | $ | 90.16 | ||||||||||||||||
|
|
|
|
|
|
|
|||||||||||||||
The following is a summary of expenses recorded within Employee compensation and related benefits on the consolidated statements of comprehensive (loss) income for the various compensation plans:
| Three months ended | Six months ended | |||||||||||||||
| June 30, | June 30, | |||||||||||||||
| 2013 | 2012 | 2013 | 2012 | |||||||||||||
| Membership unit expense - Class B units |
$ | 12,029 | $ | (1,380) | $ | 14,010 | $ | (922) | ||||||||
| Profits interest unit expense - Class E units |
4,913 | 2,197 | 5,850 | 4,780 | ||||||||||||
| Incentive unit expense |
1,884 | 91 | 2,293 | 420 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total |
$ | 18,826 | $ | 908 | $ | 22,153 | $ | 4,278 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| 14. | Regulatory Requirements |
Getco is subject to Commodity Futures Trading Commission (“CFTC”) net capital requirements. Octeg, GES and GTS are SEC registered broker-dealers subject to the minimum net capital requirement of SEC Rule 15c3-1. These subsidiaries claim exemptions from SEC Rule 15c3-3 under provisions of section k (2) (i-ii) of that rule. GEL and AT are regulated by the Financial Conduct Authority and subject to minimum net capital requirements. As of June 30, 2013 and December 31, 2012, GET, OCT, GES, GTS, AT and GEL were all in compliance with their respective net capital requirements. GAHK was regulated by the Securities and Futures Commission and was subject to net capital requirements. As described in Note 1, effective March 25, 2013, the Company closed its office in Hong Kong and withdrew its membership from SFC.
23
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
| 15. | Earnings per unit |
Basic earnings per unit (‘‘EPU’’) is calculated by dividing the net income or loss available to the Company’s common unit holders by the weighted average number of common units outstanding during the period. Net income or loss is allocated among the various classes of units using the two-class method. This method is an earnings allocation formula that determines earnings per unit for each class of common units and other participating units according to participation rights in undistributed earnings.
For the three and six month periods ended June 30, 2013 and June 30, 2012, undistributed earnings were allocated to the Class E, Class P, and unvested Class B units based on the weighted average number of each class of unit outstanding during each period as follows:
| Three months ended June 30, |
Six months ended June 30, |
|||||||||||||||
| 2013 | 2012 | 2013 | 2012 | |||||||||||||
| Class E units |
$ | - | $ | 205 | $ | - | $ | 369 | ||||||||
| Class P units |
(18,032) | 809 | (20,326) | 3,209 | ||||||||||||
| Unvested Class B units |
(2,743) | 186 | (3,104) | 861 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Net (loss) income attributable to preferred and participating shares |
$ | (20,775) | $ | 1,200 | $ | (23,430) | $ | 4,439 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
As of June 30, 2013, the Company’s Class A and vested Class B units were considered equivalent to common units due to their pro rata participation in earnings and subordination to all other classes of units issued by the Company. Class E unit holders were entitled to distributions only if and when declared, at the discretion of the Board of Directors. Class P unit holders were entitled to distributions on a pro-rata basis with the Class A and Class B unitholders, but had a liquidation preference over Class A and Class B unitholders. The unvested Class B unitholders were entitled to distributions on a pro-rata basis with the vested Class B unitholders; however upon termination of their employment, the unvested Class B unitholders would receive an amount less than what they would have received if the Class B units had vested. As a result, the unvested Class B units were not considered equivalent to the vested Class B units and therefore were considered to be participating securities. In calculating net income or loss available to common unit holders, distributions made to Class E units during the period and the pro rata share of income or loss attributable to Class P and unvested Class B units are deducted from net income or loss. The remaining earnings are allocated to the common units and participating units to the extent that each security may share in earnings as if all of the earnings for the period had been distributed.
Diluted EPU is calculated by giving effect to all potential common units outstanding during the period. Diluted EPU is calculated by giving effect to all potential common units outstanding during the period. At June 30, 2013 and 2012, there were 0 and 535,625 unvested Class B units outstanding, respectively.
24
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
| 16. | Segment Reporting |
The Company has three operating segments: (i) Market Making; (ii) Execution Services; and (iii) Corporate and Other. See Note 1 for discussion of the operating segments. The Company’s revenues, expenses and income (loss) from continuing operations before income taxes (“Pre-tax earnings”) are summarized in the following table:
| Three months ended June 30, |
Six months ended June 30, |
|||||||||||||||
| 2013 | 2012 | 2013 | 2012 | |||||||||||||
| Market Making |
||||||||||||||||
| Revenues |
$ | 118,367 | $ | 135,745 | $ | 225,384 | $ | 285,075 | ||||||||
| Expenses |
120,335 | 126,083 | 222,207 | 258,061 | ||||||||||||
| Pre-Tax (Loss) Earnings1 |
(1,968) | 9,662 | 3,177 | 27,014 | ||||||||||||
| Execution Services |
||||||||||||||||
| Revenues |
$ | 13,024 | $ | 9,173 | $ | 22,228 | $ | 16,905 | ||||||||
| Expenses |
15,943 | 10,715 | 26,560 | 20,003 | ||||||||||||
| Pre-Tax Loss1 |
(2,919) | (1,542) | (4,332) | (3,098) | ||||||||||||
| Corporate & Other |
||||||||||||||||
| Revenues |
$ | (8,802) | $ | 398 | $ | (7,598) | $ | 1,118 | ||||||||
| Expenses |
55,922 | 2,486 | 68,163 | 4,722 | ||||||||||||
| Pre-Tax Loss1 |
(64,724) | (2,088) | (75,761) | (3,604) | ||||||||||||
| Eliminations2 |
||||||||||||||||
| Revenues/Expenses |
$ | (4,472) | $ | (4,200) | $ | (9,045) | $ | (8,400) | ||||||||
| Consolidated |
||||||||||||||||
| Revenues |
$ | 118,117 | $ | 141,116 | $ | 230,969 | $ | 294,698 | ||||||||
| Expenses |
187,728 | 135,084 | 307,885 | 274,386 | ||||||||||||
| Pre-Tax (Loss) Earnings |
(69,611) | 6,032 | (76,916) | 20,312 | ||||||||||||
| 1 | Pre-tax earnings/(loss) represents segment profit/loss after allocation of support function costs. Support functions include administration, clearing, communications, core technology, facilities, finance, human resources, legal, compliance, risk, and senior leadership. |
| 2 | Eliminations revenues/expenses represent fees paid to Execution Services from Market Making. |
25
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
The Company operates in the U.S. and internationally, primarily in Europe and Asia Pacific. The following table presents revenues by geographic area:
| Three months ended June 30, | Six months ended June 30, | |||||||||||||||
| 2013 | 2012 | 2013 | 2012 | |||||||||||||
| Americas |
||||||||||||||||
| Revenues |
$ | 68,119 | $ | 89,965 | $ | 139,253 | $ | 179,351 | ||||||||
| Europe |
||||||||||||||||
| Revenues |
29,987 | 29,633 | 55,234 | 69,067 | ||||||||||||
| Asia Pacific (1) |
||||||||||||||||
| Revenues |
20,011 | 21,518 | 36,482 | 46,280 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total Company |
$ | 118,117 | $ | 141,116 | $ | 230,969 | $ | 294,698 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| 1. | Asia Pacific includes Singapore, Hong Kong, Japan, and Australia. As of June 30, 2013, the Hong Kong office is closed. |
| 17. | Subsequent Events |
The Company has evaluated the events and transactions that have occurred through August 9, 2013, the date the consolidated financial statements were available to be issued.
As described in Note 2, the Mergers were completed on July 1, 2013.
Long-Term Debt
In connection with the Merger, KCG entered into a series of debt agreement transactions, including the refinancing of substantially all of Knight’s and the Company’s long-term debt. Described below are the details of these transactions and the impact of the transactions on the KCG’s long-term debt, liquidity and capital resources.
First Lien Credit Facility
On July 1, 2013, KCG, as borrower, entered into a first lien senior secured credit agreement (the “Credit Agreement”) with the lenders party thereto (the “First Lien Lenders”), Jefferies Finance LLC, as documentation agent, administrative agent, collateral agent and syndication agent, and Jefferies Finance LLC and Goldman Sachs Bank USA, as arrangers and book managers. The term loan commitment of the First Lien Lenders under the Credit Agreement is in the aggregate amount of $535,000 (the “First Lien Credit Facility”), all of which was drawn on July 1, 2013. The First Lien Credit Facility also provides for a future incremental first lien senior secured revolving credit facility of up to $50,000, including letter of credit and swingline sub-facilities, on certain terms and conditions contained in the Credit Agreement.
The First Lien Credit Facility bears interest, at KCG’s option, at a rate based on the prime rate (such loans referred to as “First Lien Prime Rate Loans”) or based on LIBOR (such loans referred to as “First Lien Eurodollar Loans”). First Lien Prime Rate Loans bear interest at a rate per annum equal to the greatest of the prime rate, 2.25%, the federal funds rate plus 0.50%, and an adjusted one-month LIBOR rate plus 1.00%, in each case plus an applicable margin of 3.50%. First Lien Eurodollar Loans bear interest at a rate per annum equal to the adjusted LIBOR rate (subject to a 1.25% LIBOR floor) corresponding to the interest period plus an applicable margin of 4.50% per annum.
26
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
The First Lien Credit Facility matures on December 5, 2017. The First Lien Credit Facility requires an amortization payment of $235,000 on July 1, 2014, followed by quarterly amortization payments of $7,500 on each September 30, December 31, March 31 and June 30, with the balance due on maturity.
Subject to certain exceptions, the First Lien Credit Facility is subject to mandatory prepayments in amounts equal to (i) 100% of the net cash proceeds of any incurrence of indebtedness by KCG or any of its restricted subsidiaries after July 1, 2013 (other than indebtedness permitted under the Credit Agreement), (ii) 100% of the net cash proceeds of any non-ordinary course sale or other disposition of assets by KCG or its restricted subsidiaries (including as a result of casualty or condemnation and any issuance or sale of equity by any of KCG’s restricted subsidiaries) (with customary exceptions, thresholds, and reinvestment rights of up to 12 months) and (iii) 50% of “excess cash flow” for each fiscal year beginning with the fiscal year ending December 31, 2014, subject to total leverage ratio-based step-downs.
Optional prepayments of borrowings under the First Lien Credit Facility are permitted at any time, without premium or penalty, subject, however, to a 1% prepayment premium for optional prepayments of the First Lien Credit Facility made prior to July 1, 2014 with a new or replacement term loan facility with an “effective” interest rate less than that applicable to the First Lien Credit Facility.
The First Lien Credit Facility is fully and unconditionally guaranteed on a joint and several basis by all of KCG’s existing and future direct and indirect 100% owned domestic subsidiaries, including the Company, other than certain subsidiaries including regulated broker-dealers and other regulated subsidiaries that, in each case, are not permitted to provide such guarantees under applicable law, certain immaterial subsidiaries and certain subsidiaries that would be investment companies as a result of being guarantors (the “Guarantors”). The First Lien Credit Facility is secured by first-priority pledges of all of the equity interests in each of KCG’s and the Guarantors’ existing and future domestic subsidiaries (but limited to 66% of the voting equity interests of controlled foreign company subsidiaries and other than equity interests in regulated subsidiaries to the extent that such pledge would have a material adverse regulatory effect or is not permitted by applicable law) and first-priority security interests in, and mortgages on, substantially all other tangible and intangible assets of KCG and the Guarantors, in each case subject to customary exclusions.
The First Lien Credit Facility contains customary affirmative and negative covenants for facilities of its type, including limitations on indebtedness, liens, hedging agreements, investments, loans and advances, asset sales, mergers and acquisitions, dividends, transactions with affiliates, prepayments of other indebtedness, modifications of organizational documents and other material agreements, restrictions on subsidiaries, capital expenditures, issuance of capital stock, negative pledges and business activities. The negative covenants are subject to customary exceptions, qualifications and “baskets,” including in respect of indebtedness and liens incurred in the ordinary course of business by broker-dealer subsidiaries, other operating regulated entities, licensed mortgage subsidiaries or any other subsidiary substantially all of whose business and operations are substantially similar to some or all of the business and operations of the foregoing entities that are in existence as of July 1, 2013, including margin lending, stock lending and repurchase agreements and reverse
27
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
repurchase agreements. The First Lien Credit Facility contains financial maintenance covenants establishing a maximum consolidated first lien leverage ratio, a minimum consolidated interest coverage ratio and a minimum consolidated tangible net worth.
The First Lien Credit Facility contains events of default customary for facilities of its type, including: nonpayment of principal, interest, fees and other amounts when due, inaccuracy of representations and warranties in any material respect; violation of covenants; cross-default and cross-acceleration to material indebtedness; bankruptcy and insolvency events; material judgments; ERISA events; collateral matters; certain regulatory matters; and a “change of control”; subject, where appropriate, to threshold, notice and grace period provisions.
Revolving Credit Agreement
On July 1, 2013, Octeg and KCA, each of which are wholly owned broker-dealer subsidiaries of KCG effective July 1, 2013, as borrowers, KCG, as guarantor, the lenders from time to time party thereto, BMO Harris Bank N.A., as administrative agent and collateral agent, JPMorgan Chase Bank N.A. and Bank of America, N.A., as syndication agents, and BMO Capital Markets, JPMorgan Securities, LLC and Merrill Lynch, Pierce, Fenner & Smith Incorporated, as joint lead arrangers and joint book runners entered into a credit agreement (the “OCTEG-KCA Facility Agreement”). The OCTEG-KCA Facility Agreement replaces an existing credit agreement, dated as of June 6, 2012, among Octeg, the lenders from time to time party thereto, BMO Harris Bank N.A., as administrative agent and collateral agent, and JPMorgan Chase Bank, N.A., as syndication agent.
The OCTEG-KCA Facility Agreement is comprised of two classes of revolving loans in a total committed amount of $450,000, together with a swingline facility with a $50,000 sub-limit, subject to two borrowing bases (collectively, the “OCTEG-KCA Revolving Facility”): Borrowing Base A and Borrowing Base B (each as defined in the OCTEG-KCA Revolving Facility). The proceeds of the Borrowing Base A loans are available to both Octeg and KCA and may be used solely to finance the purchase and settlement of securities. The proceeds of the Borrowing Base B loans are available solely to KCA and may be used solely to fund clearing fund deposits with the National Securities Clearing Corporation (the “NSCC”). Octeg and KCA shall each be obligated only with respect to the principal and interest of their own borrowings, and not the interest and principal of the other borrower’s borrowings. KCG fully and unconditionally guarantees the obligations of each of Octeg and KCA on an unsecured basis. The OCTEG-KCA Revolving Facility also provides for a future increase of the revolving credit facility of up to $300,000 to a total of $750,000 on certain terms and conditions.
Borrowings under the OCTEG-KCA Revolving Facility shall bear interest, at the applicable borrower’s option, at a rate based on the federal funds rate (such loans referred to as “Base Rate Loans”) or based on Libor (such loans referred to as “Eurodollar Loans”), in each case plus an applicable margin. For each Base Rate Loan, the interest rate per annum is equal to the greater of the federal funds rate or an adjusted one-month LIBOR rate plus (a) for each Borrowing Base A loan, a margin of 1.75% per annum and (b) for each Borrowing Base B loan, a margin of 2.25% per annum. For each Eurodollar Loan, the interest rate per annum is equal to an adjusted LIBOR rate corresponding to the interest period plus (a) for each Borrowing Base A loan, a margin of 1.75% per annum and (b) for each Borrowing Base B loan, a margin of 2.25%
28
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
per annum. Depending on the applicable borrowing base, availability under the OCTEG-KCA Revolving Facility is limited to either (i) a percentage of the market value of certain eligible securities pledged as collateral in the case of Borrowing Base A loans, or (ii) the lesser of $15,000 and a percentage of the excess over the clearing deposit required by the NSCC in the case of Borrowing Base B loans.
The borrowers will be charged a commitment fee at a rate of 0.35% per annum on the average daily amount of the unused portion of the OCTEG-KCA Facility Agreement.
The loans under the OCTEG-KCA Facility Agreement will mature on June 6, 2015. Subject to certain exceptions, the OCTEG-KCA Revolving Facility is subject to mandatory prepayments by the applicable borrower (i) in the case of Borrowing Base A loans and Borrowing Base B loans, if the amount of Borrowing Base A loans or Borrowing Base B loans, as applicable, exceeds the Borrowing Base A or the Borrowing Base B and the applicable borrower does not deliver additional collateral to support such excess, (ii) in the case of Borrowing Base B loans, on the earlier of the return of the applicable NSCC margin deposits funded from the proceeds of such Borrowing Base B loans are returned and five days after the date such Borrowing Base B loans were made and (iii) in the case of Borrowing Base B loans, if Borrowing Base B loans have been outstanding for more than 30 days in any 90 day period. Loans under the OCTEG-KCA Revolving Facility are also subject to mandatory prepayment by the applicable borrower where Customer Loans, Firm Loans or Non-Customer Loans exceed the Customer Loan Limit, the Firm Loan Limit and the Non-Customer Loan Limit (each as defined in the OCTEG-KCA Revolving Facility), respectively, and the applicable borrower does not deliver additional collateral to support such excess. Optional prepayments of borrowings under the OCTEG-KCA Revolving Facility are permitted at any time, without premium or penalty.
The OCTEG-KCA Revolving Facility is fully and unconditionally guaranteed on an unsecured basis by KCG and, to the extent elected by Octeg or KCA, any of their respective subsidiaries. It is secured by first-priority pledges of and liens on certain eligible securities, subject to applicable concentration limits, in the case of Borrowing Base A loans, and by first-priority pledges of and liens on the right to the return of certain eligible NSCC margin deposits, in the case of Borrowing Base B loans.
The OCTEG-KCA Revolving Facility includes customary affirmative and negative covenants for facilities of its type, including limitations on indebtedness, liens, hedging agreements, investments, loans and advances, asset sales, mergers and acquisitions, dividends, transactions with affiliates, restrictions on subsidiaries, issuance of capital stock, negative pledges and business activities. The negative covenants are subject to customary exceptions, qualifications and “baskets.” It contains financial maintenance covenants establishing a minimum total regulatory capital for each of Octeg and KCA, a maximum total assets to total regulatory capital ratio for each of Octeg and KCA, a minimum excess net capital limit for each of Octeg and KCA, a minimum liquidity ratio for KCA, and a minimum tangible net worth threshold for KCG.
The OCTEG-KCA Facility Agreement contains events of default customary for facilities of its type, including: nonpayment of principal, interest, fees and other amounts when due; inaccuracy of representations and warranties in any material respect; violation of covenants;
29
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
cross-default and cross-acceleration to material indebtedness; bankruptcy and insolvency events; material judgments; ERISA events; collateral matters; certain regulatory matters; and a “change of control”; subject, where appropriate, to threshold, notice and grace period provisions.
In connection with the OCTEG-KCA Revolving Facility, KCG incurred $547 of lender fees. These lender fees will be recorded within Other assets on the KCG Consolidated Statements of Financial Condition and will be amortized over the term of the OCTEG-KCA Revolving Facility.
Senior Secured Notes Indenture
On June 5, 2013 Finance LLC, issued the 8.250% Senior Secured Notes due 2018 in the aggregate principal amount of $305,000 pursuant to the Senior Secured Notes Indenture (as defined below). On July 1, 2013, KCG entered into a first supplemental indenture (the “First Supplemental Indenture”) with The Bank of New York Mellon, as trustee (the “Indenture Trustee”). Under the First Supplemental Indenture, KCG assumed all of the obligations of Finance LLC under (1) that certain indenture (the “Original Indenture,” as amended by the First Supplemental Indenture and the Second Supplemental Indenture (as defined below), the “Senior Secured Notes Indenture”), dated June 5, 2013, between Finance LLC and the Indenture Trustee and (2) the 8.250% senior secured notes due 2018 in the aggregate principal amount of $305,000 (the “Senior Secured Notes”) issued pursuant to the Original Indenture. Previously, on June 5, 2013, the net proceeds from the sale of the Senior Secured Notes, certain additional amounts to fund the mandatory redemption rights of the holders thereunder and certain escrow agent fees and expenses were funded into an escrow account (such amounts collectively, the “Escrowed Amount”). Upon KCG’s execution of the First Supplemental Indenture and the Second Supplemental Indenture, the assumption by KCG of the Senior Secured Notes and the fulfillment of certain additional conditions to the release of the Escrowed Amount, the Escrowed Amount less certain escrow agent fees and expenses were released to KCG, in the amount of approximately $308,049.
The Senior Secured Notes mature on June 15, 2018 and bear interest at a rate of 8.250% per year, payable on June 15 and December 15 of each year, beginning on December 15, 2013. On or after June 15, 2015, KCG may redeem all or a part of the Senior Secured Notes upon not less than 30 nor more than 60 days’ notice, at the redemption prices (expressed as percentages of principal amount) set forth below plus accrued and unpaid interest and additional interest under the Senior Secured Notes Registration Rights Agreement, if any, on the Senior Secured Notes redeemed, to the applicable redemption date, if redeemed during the 12-month period beginning on June 15 of the years indicated below, subject to the rights of holders of the Senior Secured Notes on the relevant record date to receive interest on the relevant interest payment date:
| Year |
Percentage | |||
| 2015 |
104.125 | % | ||
| 2016 |
102.063 | % | ||
| 2017 and thereafter |
100.000 | % | ||
KCG may also redeem the Senior Secured Notes, in whole or in part, at any time prior to June 15, 2015 at a price equal to 100% of the aggregate principal amount of the Senior Secured Notes to be redeemed, plus a make-whole premium and accrued and unpaid interest and
30
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
additional interest arising under the Senior Secured Notes Registration Rights Agreement, if any. In addition, at any time on or prior to June 15, 2015, KCG may redeem up to 35% of the aggregate principal amount of the Senior Secured Notes with the net cash proceeds of certain equity offerings, at a price equal to 108.25% of the aggregate principal amount of the Senior Secured Notes, plus accrued and unpaid interest and additional interest arising under the Senior Secured Notes Registration Rights Agreement, if any.
On July 1, 2013, KCG and the Guarantors under the First Lien Credit Facility entered into a Second Supplemental Indenture (the “Second Supplemental Indenture”) with the Indenture Trustee, whereby the Senior Secured Notes and the obligations under the Senior Secured Notes Indenture will be fully and unconditionally guaranteed on a joint and several basis by the Guarantors. The Senior Secured Notes and the obligations under the Senior Secured Notes Indenture are secured by second-priority pledges and second-priority security interests in, and mortgages on, the collateral securing the First Lien Credit Facility, subject to certain exceptions; provided, however, that pursuant to the terms of an intercreditor agreement among KCG, the Guarantors, Jefferies Finance, LLC as first lien collateral agent under the First Lien Credit Facility and the Indenture Trustee, such lien will be contractually subordinated to all of KCG’s and the Guarantors’ obligations under the First Lien Credit Facility to the extent of the value of the collateral securing such obligations. The Senior Secured Notes will be effectively subordinated to any existing and future indebtedness that is secured by assets that do not constitute collateral under the Senior Secured Notes, to the extent of the value of such assets.
The Senior Secured Notes Indenture contains customary affirmative and negative covenants for notes of its type, including: nonpayment of principal, interest, fees and other amounts when due; violation of covenants; cross-payment default and cross-acceleration to material indebtedness; bankruptcy and insolvency events; material judgments; collateral matters; and the failure to make a repurchase offer in the event of a change of control or certain asset sales; subject, where appropriate, to threshold, notice and grace period provisions.
On July 1, 2013, KCG and the Guarantors entered into a a joinder (the “Senior Secured Notes Registration Rights Joinder”) to that certain registration rights agreement (the “Original Senior Secured Notes Registration Rights Agreement”), dated June 5, 2013, between Finance LLC and Jefferies LLC as representative of the initial purchasers of the Senior Secured Notes (the Original Senior Secured Notes Registration Rights Agreement as amended by the Senior Secured Notes Registration Rights Joinder, the “Senior Secured Notes Registration Rights Agreement”). Pursuant to the Senior Secured Notes Registration Rights Joinder, KCG acceded to the terms of the Original Senior Secured Notes Registration Agreement and assumed all of Finance LLC’s obligations thereunder and the Guarantors, on a joint and several basis, acceded to the terms of the Original Senior Secured Notes Registration Rights Agreement and assumed all the obligations of “Guarantors” as set forth therein. Pursuant to the Senior Secured Notes Registration Rights Joinder, KCG shall (and shall cause each Guarantor to) use commercially reasonable efforts to (i) file an exchange offer registration statement with the SEC with respect to a registered offer to exchange the Senior Secured Notes, (ii) issue exchange securities within 365 days after June 5, 2013, and, (iii) in certain circumstances, file a shelf registration statement with respect to resales of the Senior Secured Notes. If KCG and the Guarantors fail to comply with certain obligations under the Senior Secured Notes Registration Rights Agreement, additional interest of up to 1.00% per annum will accrue on the Senior Secured Notes.
31
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
Cash Convertible Senior Subordinated Notes
In connection with the Knight Merger, on July 1, 2013, KCG became a party to the Indenture (the “Original Convertible Notes Indenture”), dated March 19, 2010, between Knight and The Bank of New York Mellon (the “Convertible Notes Trustee”), as successor in interest to Deutsche Bank Trust Company Americas, with respect to the 3.50% Cash Convertible Senior Subordinated Notes due 2015 (the “Convertible Notes”), pursuant to a supplemental indenture (the “Convertible Notes Supplemental Indenture” and, together with the Original Convertible Notes Indenture, the “Convertible Notes Indenture”), dated as of July 1, 2013, by and among KCG, Knight and the Convertible Notes Trustee.
Under the Original Convertible Notes Indenture, holders of the Convertible Notes may convert the Convertible Notes into cash at any time on or after December 15, 2014 until the second trading day after maturity. Holders of Convertible Notes may also convert their Convertible Notes at their option prior to December 15, 2014, under the following circumstances: (1) if the last reported sale price of Knight’s Class A common stock, par value $0.01 per share (“Knight Common Stock”) for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the preceding fiscal quarter is greater than or equal to 150% of the applicable conversion price on each applicable trading day; (2) during the five business day period after any 10 consecutive trading day period (the “measurement period”) in which the trading price per $1 principal amount of notes for each trading day of that measurement period was less than 98% of the product of the last reported sale price of Knight’s Common Stock and the applicable conversion rate on each such trading day; or (3) upon the occurrence of specified corporate events, as more fully described in the Convertible Notes Indenture. The conversion rate was initially set at 47.9185 shares of Knight’s Common Stock per $1 principal amount of Convertible Notes (equivalent to an initial conversion price of approximately $20.87 per share of Knight’s Common Stock). The Convertible Notes Indenture, as supplemented by the Convertible Notes Supplemental Indenture, replaces Knight Common Stock as the reference property for the determination of the rights of holders of the Convertible Notes with the weighted average of the types and amounts of consideration received by the Knight stockholders making an affirmative election attributable to one share of Knight Common Stock. The Convertible Notes Indenture, as supplemented by the Convertible Notes Supplemental Indenture, provides for certain other adjustments to adjust the conversion rights under the Original Convertible Notes Indenture to refer to such reference property and to refer to KCG corporate actions in the place of Knight corporate actions, and certain other changes to protect the interests of holders of the Convertible Notes.
July 1, 2013, Knight delivered a notice (the “Convertible Notes Notice”) to the holders of the Convertible Notes. The Convertible Notes Notice advised holders of the Convertible Notes of the following:
| • | The weighted average of the types and amounts of consideration for each share of Knight Common Stock to be received by the holders of Knight Common Stock who validly made a cash election based on the proration provisions in the Merger Agreement consists of (1) $2.67 in cash and (2) .096 of a share of KCG Class A Common Stock. |
| • | Knight entered into the Convertible Notes Supplemental Indenture on July 1, 2013. |
32
GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
| • | The completion of the Mergers in accordance with the Merger Agreement on July 1, 2013 and the results of the election of the holders of Knight Common Stock to receive cash consideration for such Knight Common Stock constitutes a “Fundamental Change” and a “Make-Whole Fundamental Change,” each as defined under the Convertible Notes Indenture; |
| • | Each holder of the Convertible Notes has the right to deliver a Fundamental Change Repurchase Notice requiring Knight to repurchase all or any portion of the principal amount of the Convertible Notes at a Fundamental Change Repurchase Price of 100% of the principal amount plus accrued and unpaid interest thereon to, but excluding, the Fundamental Change Repurchase Date. To exercise such right, (1) such Fundamental Change Repurchase Notice must be delivered on or prior to the close of business on the scheduled trading day immediately preceding the Fundamental Change Repurchase Date, which Knight has specified as August 5, 2013, and (2) the Convertible Notes included in such Fundamental Change Repurchase Notice shall be transferred to the paying agent by book-entry transfer in compliance with the procedures of the depositary on or before the close of business on the scheduled trading day immediately preceding the Fundamental Change Repurchase Date; |
| • | Knight will deposit with the paying agent on August 5, 2013 an amount of money sufficient to repurchase all of the Convertible Notes to be repurchased at the appropriate Fundamental Change Repurchase Price. Subject to the receipt of funds and/or Convertible Notes by the paying agent, payment for Convertible Notes surrendered (and not withdrawn prior to the close of business on the scheduled trading day immediately preceding the Fundamental Change Repurchase Date) will be made on the later of (i) the Fundamental Change Repurchase Date with respect to such Convertible Note (provided the holder has satisfied the conditions in the Convertible Notes Indenture) and (ii) the time of book-entry transfer of such Convertible Note to the paying agent by the holder thereof; |
| • | If on the Fundamental Change Repurchase Date, the paying agent holds money sufficient to make payment on all the Convertible Notes or portions thereof that are to be repurchased on such Fundamental Change Repurchase Date, then (1) such Convertible Notes will cease to be outstanding, (2) interest will cease to accrue on such Convertible Notes and (3) all other rights of the holders of such Convertible Notes will terminate (other than the right to receive the Fundamental Change Repurchase Price). |
| • | Any holder delivering a Fundamental Change Company Notice to the paying agent shall have the right to withdraw, in whole or in part, such Fundamental Change Repurchase Notice at any time prior to the close of business on the scheduled trading day immediately preceding the Fundamental Change Repurchase Date by delivery of a written notice of withdrawal to the paying agent. |
| • | The holders of the Convertible Notes are entitled to surrender the Convertible Notes for conversion into cash at any time from and after July 1, 2013 until the scheduled trading day immediately prior to the Fundamental Change Repurchase Date based on an applicable Conversion Rate on the Convertible Notes of 47.9185, including the cash make-whole premium (calculated in accordance with the Convertible Notes Indenture), if any. |
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GETCO Holding Company, LLC and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except unit and share data)
| • | The Convertible Notes with respect to which a Fundamental Change Repurchase Notice has been delivered by a holder of Convertible Notes may be converted into cash only if the holder withdraws the Fundamental Change Repurchase Notice in accordance with the terms of the Convertible Notes Indenture. The Fundamental Change Repurchase Date for the Convertible Notes was August 5, 2013. |
On July 1, 2013, $375,000, which is the amount needed to repurchase the aggregate principal amount of the Convertible Notes in full at maturity, was deposited in a cash collateral account under the sole dominion and control of the collateral agent under the First Lien Credit Facility.
Holders of $249,241 in aggregate principal amount (the “Repurchased Principal Amount”) of the Convertible Notes, elected to have their Convertible Notes repurchased as of the August 2, 2013 deadline under the Convertible Notes Notice. The repurchase occurred on August 5, 2013 and included accrued and unpaid interest on the Repurchased Principal Amount. The payment of the Repurchased Principal Amount was funded out of the cash collateral account (described in the preceding paragraph).
Private Placement Notes
In connection with the Mergers, on May 31, 2013, the Company provided irrevocable notice to the lender of the $15,000 of notes issued on October 25, 2011, that it intended to repay the notes, inclusive of accrued interest. On July 1, 2013, the notes were subsequently repaid along with accrued interest and a $2,962 early termination payment.
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Exhibit 99.2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following presents GETCO management’s discussion and analysis of GETCO’s financial condition as of June 30, 2013 and December 31, 2012 and results of operations for the three and six months ended June 30, 2013 and 2012, and should be read in conjunction with the accompanying Consolidated Financial Statements (unaudited) as of June 30, 2013 and notes thereto. The discussion highlights the principal factors affecting earnings and significant changes in the balance sheet and is intended to help the reader understand, from GETCO management’s perspective, the consolidated financial statements and notes to the financial statements.
Certain statements contained in this Exhibit 99.2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein (“MD&A”), including, without limitation, those under “Quantitative and Qualitative Disclosures About Market Risk” and “Trends Affecting GETCO” may constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. You should not place undue reliance on these statements because they are subject to numerous uncertainties and factors relating to GETCO’s operations and business environment or the operations and business environment of KCG Holdings, Inc. (“KCG”), all of which are difficult to predict and many of which are beyond GETCO’s or KCG’s control. Forward-looking statements include information concerning GETCO’s possible or assumed future results of operations, including descriptions of GETCO’s business strategy. These statements often include words such as “believe,” “expect,” “anticipate,” “intend,” “target,” “estimate,” “continue,” “positions,” “prospects” or “potential,” by future conditional verbs such as “will,” “would,” “should,” “could” or “may”, or by variations of such words or by similar expressions. These forward-looking statements are subject to numerous assumptions, risks and uncertainties which change over time. These statements are based on assumptions that GETCO has made in light of GETCO’s experience in the industry as well as GETCO’s perceptions of historical trends, current conditions, expected future developments and other factors GETCO believes are appropriate under the circumstances. Forward-looking statements speak only as of the date they are made and neither GETCO nor KCG assumes any duty to update forward-looking statements.
Readers should carefully review the risks and uncertainties disclosed under “Certain Factors Affecting Results of Operations” in MD&A herein and “Risk Factors” in Exhibit 99.3 to this Current Report on Form 8-K, as well as the risks and uncertainties disclosed under “Risk Factors” in the Joint Proxy Statement/Prospectus on Form S-4, which was filed with the SEC by KCG on February 13, 2013 and amended thereafter, and in other reports or documents KCG files with, or furnishes to, the SEC from time to time.
In addition to factors previously disclosed in KCG reports filed with the SEC, the following factors could cause actual results to differ materially from forward-looking statements or historical performance: (i) the strategic combination of Knight Capital Group, Inc. (“Knight”) and GETCO, including, among other things, (a) difficulties and delays in integrating the Knight and GETCO businesses or fully realizing cost savings and other benefits, (b) the inability to sustain revenue and earnings growth, and (c) customer and client reactions; (ii) the August 1, 2012 technology issue at Knight that resulted in Knight’s broker-dealer subsidiary sending numerous erroneous orders in NYSE-listed and NYSE Arca securities into the market and the impact to Knight’s capital structure and business as well as actions taken in response thereto and consequences thereof; (iii) the costs and risks associated with KCG’s sale of its reverse mortgage business; (iv) the ability of Knight’s broker-dealer subsidiary to recover all or a portion of the damages that are attributable to the manner in which NASDAQ handled the Facebook IPO; (v) changes in market structure, legislative, regulatory or financial reporting rules, including the continuing legislative and regulatory scrutiny of high-frequency trading; (v) past or future changes to
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organizational structure and management; (vi) KCG’s’ ability to develop competitive new products and services in a timely manner and the acceptance of such products and services by KCG’s customers and potential customers; (vii) KCG’s ability to keep up with technological changes; (viii) KCG’s ability to effectively identify and manage market risk, operational risk, legal risk, liquidity risk, reputational risk, counterparty risk, international risk, regulatory risk, and compliance risk; (ix) the cost and other effects of material contingencies, including litigation contingencies, and any adverse judicial, administrative or arbitral rulings or proceedings; and (x) the effects of increased competition and KCG’s ability to maintain and expand market share. The list above is not exhaustive.
Executive Overview
GETCO is a global financial services firm that specializes in helping investors efficiently manage risk via proprietary market making in securities, futures, foreign exchange and options instruments, and routing orders on behalf of clients in cash equity securities. GETCO operates through its broker-dealers and other subsidiaries and maintains a diversified footprint across asset classes, trading venues and geographies. GETCO trades on more than 50 exchanges and venues in North and South America, Europe and Asia-Pacific and as of June 30, 2013 employs approximately 396 Associates in Chicago, California, New York, London, Singapore, and Mumbai.
GETCO’s business consists of three operating segments: (i) Market Making, (ii) Execution Services, and (iii) Corporate and Other.
Market Making
GETCO’s Market Making segment consists of trading in global equities, fixed income, commodities, options, and foreign exchange markets. As a market maker, GETCO commits capital for trade executions and provides liquidity by maintaining continuous buy and sell quotes, or two-sided markets, and commits its capital for buy and sell trade executions when other institutions and broker-dealers place orders on various exchanges and OTC platforms that match the quotes.
GETCO is a registered market maker on various equity and options exchanges and makes markets in over 6,000 securities across more than 50 exchanges and trading venues world-wide. GETCO operates as a market maker in cash and futures products quoted and traded on the NYSE, CME, BATS Global Markets (“BATS”), the NASDAQ, the London Stock Exchange (“LSE”), the Tokyo Stock Exchange (“TSE”) and several other U.S., European and Asian-Pacific exchanges. GETCO is a DMM on the NYSE, where it is responsible for providing fair and orderly markets for approximately 900 NYSE-listed securities. GETCO is a Supplemental Liquidity Provider in over 200 securities and generally receives rebates from the NYSE when trading these securities as consideration for providing quotes in these securities. In addition, GETCO is the primary market maker for GETMatched, which is an off-exchange, dark liquidity pool for cash equities. GETMatched is an SEC-registered Alternative Trading System (“ATS”) and pays clients for some of its order flow. GETCO is also the sole market maker for GETDirect, a service that allows customers to directly access firm, executable prices and liquidity from GETCO’s fixed income market making teams.
GETCO conducts its market making activity as a principal through the use of proprietary automated models and derives revenues from the difference between the amount paid when securities are bought and the amount received when securities are sold. GETCO’s models are heavily reliant upon quantitative data, sophisticated trading technologies and other infrastructure to efficiently maintain two-sided markets and provide liquidity to market participants.
The majority of GETCO’s market making revenue is derived from trading strategies that typically have very short time horizons and little overnight risk exposure. These revenues tend to be driven by two factors: (i) demand for liquidity and (ii) profitability. Demand is best measured through market volumes while profitability generally increases in conjunction with the spread between the sell price
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(ask) and the buy price (bid) of a security. This difference, or spread, between bid price and ask price is often greatest during times of increasing market volatility. GETCO has also begun to develop and expand its market making business to include trading strategies that are less market volume dependent. These are referred to as arbitrage and mid-frequency strategies and involve holding positions for longer periods than GETCO’s historical market making strategies.
Execution Services
The Execution Services segment offers clients access to GETCO’s market making capabilities for cash equity and fixed income securities. In addition, this segment provides third party clients with algorithms that facilitate their buy and sell orders and a routing system that supports best execution requirements through its client services business, which we refer to as GES.
GES operates an ATS, branded as GETMatched, which executes trades in U.S. and European cash equities and U.S. cash treasuries, offering clients access to the dedicated liquidity provided by GETCO’s market making businesses. GETMatched only matches (executes) orders that meet or are priced better than the National Best Bid and Offer (“NBBO”) in the U.S. or the European Best Bid and Offer (“EBBO”) in Europe. The NBBO and EBBO are the best available ask price when buying securities and the best available bid price when selling securities based on quotes from available exchanges. As a complement to the GETMatched product, GETCO provides streaming quotes of fixed income liquidity through GETDirect, which allows customers to view GETCO’s fixed income quotes and trade directly with GETCO’s fixed income market making team.
GES also provides third party clients with a suite of proprietary trading algorithms, known as GETAlpha, that execute and route orders in U.S. cash equities to more than a dozen exchanges and off-exchange venues. GETAlpha includes numerous execution algorithms, providing institutional investors with the ability to execute trades to their exact specifications. The intent of GETAlpha is to provide the investment community with some of the same trading tools as a dedicated electronic market maker.
In contrast to Market Making, GETCO’s Execution Services segment does not act as a principal and generally derives revenue from commissions or fees for acting as agent on behalf of clients, including affiliates. Historically, the majority of the revenue from Execution Services has been earned from fees that are paid by an affiliate in connection with the affiliate posting liquidity on GETMatched and routing orders to other execution destinations on behalf of the affiliate. GETCO expects the growth of the GETAlpha product to contribute to increased third-party revenues in this segment over time.
Corporate and Other
The Corporate and Other segment includes gains and losses associated with GETCO’s strategic investments, including costs related to the Mergers and integration, currency translation gains and losses, restructuring costs and lease loss expenses, interest expense and bank fees related to corporate funding, members interest expense (interest paid to former members on outstanding amounts owed for prior unit repurchases), and unit amortization costs. GETCO’s strategic investments generally include interests held in other companies or exchanges such as Knight and BATS. Currency translation gains and losses relate primarily to fluctuations in non-U.S. dollar denominated cash deposits held at clearing firms. Interest expense and bank fees related to corporate funding primarily consist of interest and fees related to GETCO’s unsecured borrowings and interest on capital leases.
Certain Factors Affecting Results of Operations
GETCO may experience significant variation in its future results of operations. These fluctuations may result from numerous factors including, among others, market conditions and the resulting
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changes in market volume and volatility and counterparty risks; introductions of, or enhancements to, trade execution services by GETCO or its competitors; the value of GETCO’s securities positions and other financial instruments and its ability to manage the risks attendant thereto; the volume of GETCO’s trade execution activities; the dollar value of securities and other instruments traded; the composition and profile of GETCO’s order flow; GETCO’s access to order flow; the performance of GETCO’s principal trading activities; the overall size of GETCO’s balance sheet and capital usage; the effectiveness of GETCO’s trading and operational risk management processes; the effectiveness of GETCO’s self-clearing platform and GETCO’s ability to manage risk related thereto; the availability of credit and liquidity in the marketplace; GETCO’s ability to manage personnel, compensation, overhead and other expenses, including GETCO’s occupancy expenses under GETCO’s office leases and expenses and charges relating to legal and regulatory proceedings; changes to execution quality and changes in clearing, execution and regulatory transaction costs; the addition or loss of executive management, sales, trading and technology professionals; legislative, legal, regulatory and financial reporting changes; legal and regulatory matters or proceedings; geopolitical risk; the amount, timing and cost of capital expenditures, acquisitions and divestitures; the integration, performance and operation of acquired businesses; the incurrence of costs associated with acquisitions and dispositions; investor sentiment; technological changes and events; seasonality; competition; and other economic conditions.
If GETCO’s performance deteriorates significantly and GETCO is unable to adjust its cost structure on a timely basis, operating results could be materially and adversely affected. As a result, period-to-period comparisons cannot be relied upon as indicators of future performance.
Trends
Global Economic Trends
GETCO’s businesses are affected by many macroeconomic factors. Such factors include the growth of gross domestic product in the U.S., Europe, and the Asia-Pacific region, the existence of transparent, efficient and liquid equity, debt, commodities and foreign exchange markets, the level of market volumes and volatility in global markets, central bank monetary policies and investor confidence.
For the three months ended June 30, 2013, volatility across the U.S. and European equity markets decreased from the three months ended June 30, 2012. In addition, volumes in both the U.S. and European equity markets also declined for the three months ended June 30, 2013 as compared to the three months ended June 30, 2012. The average realized 20-day volatility of the 10-year Treasury Note Future and the average daily market volumes for CME interest rate products increased for the three months ended June 30, 2013 as compared to the three months ended June 30, 2012.
Trends Affecting GETCO
GETCO believes that its businesses are affected by the aforementioned macroeconomic trends as well as more specific industry trends. Industry trends that impact operations include the following:
| • | Growth in the number of global electronic trading market participants has resulted in greater competition for order flow. At the same time, the current market environment, characterized by low levels of market volume and volatility, is reducing market making opportunities. As volume and volatility decline, the opportunity for market making firms to readily buy and sell securities declines, which increases the probability that these participants will hold positions for longer periods. Additionally, as volume and volatility decline, the spread between the bid price and ask price narrows, which inherently reduces the profit opportunity for market makers who rely on their ability to capture the spread in order to generate profits. Although the impact is difficult to quantify, the recent sustained levels of low volume and volatility across the U.S. and European equity markets in particular, have exposed GETCO and other |
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| market making firms to greater risk with lower profit potential. GETCO has seen its market share in U.S. cash equities decline from as high as approximately 19% in 2009 to approximately 3% for the three months ended June 30, 2013 (based on GETCO’s internal calculations). Given this challenging environment, many participants in the electronic trading space have made or are currently making decisions about their long-term ability to compete across asset classes and product types, resulting in a period of rationalization and consolidation where some market participants have closed and others have exited geographies or asset classes. Over time, GETCO believes that it stands to benefit from this period of rationalization and consolidation as it is positioned to potentially capture a greater share of activity if and when market volumes and volatilities increase. |
| • | Internalized order flow, which occurs when a broker fills customer orders from its own inventory, as opposed to filling orders from third party inventory posted on an exchange, particularly in U.S. cash equities, currently constitutes a significant portion of total market volume, which limits the market making opportunity for companies like GETCO. In periods with low volatility, such as 2012 and the six months ended June 30, 2013, there has historically been a strong inverse correlation between off-exchange activity and implied volatility. GETCO expects this relationship to hold, prompting higher levels of activity conducted away from the public exchanges during periods of lower volatility, which could continue to negatively impact GETCO’s market share. Conversely, periods of increasing volatility should bring a greater portion of consolidated market volume to public venues and GETCO would expect to benefit. |
| • | Technology has played, and continues to play, an important role in shaping the global competitive environment in which GETCO operates. Market participants are generally quick to adopt emerging technologies when it is believed that the speed and/or accuracy with which they send, receive, and process data will improve. GETCO, like others, has made substantial investments to modify and adapt its services and infrastructure to remain competitive. For example, for the six months ended June 30, 2013, GETCO invested $9.2 million to develop new or expand existing technologies. GETCO expects that the rate of technological change will continue at, or increase from, the historical trend, necessitating incremental technology investments in the future. Should GETCO fail to anticipate and respond to technological advancements appropriately, it could have a material adverse effect on operating results. |
| • | The capital markets industry is subject to extensive oversight under federal, state, and applicable foreign laws, rules, and regulations. Increasing scrutiny of the capital markets by the regulatory and legislative authorities, both in the U.S. and abroad, has created an increasingly complex regulatory framework that has negatively impacted GETCO’s operating results in recent years due to the ongoing costs associated with maintaining and improving internal controls around proper adherence to the various rules and regulations. Compliance with additional legislation or regulation, or changes in the interpretation of existing laws, rules, and regulations could adversely impact GETCO’s future results. |
| • | Global regulatory recommendations, such as those found in the Dodd-Frank Act and Basel III, are believed to create incentives for major market participants to conduct portions of their OTC derivatives businesses on electronic trading venues. These trades would be cleared by central counterparty organizations that clear and settle market transactions between buyers and sellers, providing efficiency and stability to those markets. The ultimate rules and their impact are still unknown, but the potential for new electronic market making opportunities represents a potentially material medium- and long-term business opportunity for market participants like GETCO. |
| • | The financial services industry has experienced rapid product innovation and new product proliferation in recent years, with numerous cash, futures and options instruments being |
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| introduced in the exchange traded fund, which we refer to as ETF, exchange traded product, which we refer to as ETP, and derivatives markets; this trend is expected to continue both in the U.S. and globally. The proliferation of newly created, electronically traded products across product types, asset classes and geographies expands the potential opportunity for market participants. GETCO believes it should continue to be well positioned to capitalize on such opportunities given its global footprint and a proven ability to make markets across a diverse set of product types and asset classes. |
Significant Developments
Merger with Knight. On July 1, 2013, KCG completed the previously announced business combination whereby Knight and GETCO became subsidiaries of KCG, a new publicly traded holding company. The Mergers, which were announced on December 19, 2012, were approved by the shareholders of Knight and unit holders of GETCO at special meetings held on June 25, 2013.
Income Statement Items
The following section briefly describes the key components of, and drivers to, GETCO’s significant revenues and expenses.
Revenues
GETCO’s revenues consist principally of trading gains and losses generated from the Market Making segment. These revenues are supplemented by commissions and fees earned from the Execution Services segment which are included in trading gains and losses, net; interest and dividend income, net; gain or loss on investments; and other income.
Trading gains and losses are primarily affected by GETCO’s ability to derive trading gains through market making, which is directly impacted by market volumes and volatilities, competition, performance of the trading algorithms (or models), and access to order flow. Trading gains and losses are also impacted by commissions and fees earned from Execution Services. The commissions and fees from Execution Services are primarily affected by GETCO’s ability to receive and effectively match customer orders and to engage clients to use GETCO’s proprietary algorithms to establish order routing and fulfillment criteria. Execution Services receives orders from clients and generally routes these orders for execution in GETCO’s ATS, national exchanges or non-public venues such as dark pools. If GETCO is able to successfully match its customers’ orders, GETCO generally receives a commission as payment for providing the order matching service. In addition, Execution Services often receives a fee as payment for allowing clients to use its proprietary algorithms to establish specific order routing instructions and execution criteria.
Interest and dividend revenue primarily reflects interest earned from cash held at banks and third party clearing firms, and from GETCO’s short-term investments, less interest expense incurred to fund long trading inventory. The amount of net interest income is impacted by the balances of these items and the level of interest rates. Net dividend income includes dividends earned on long trading inventory less dividends owed on short trading inventory.
Income from investments represents the changes in carrying value, including charges for impairment, dividends received, and gains and losses on disposals of investments held in GETCO’s strategic investment portfolio.
Other income relates to currency translation gains and losses and mark to market adjustments on GETCO’s short-term bond investment portfolio. Currency translation gains and losses are impacted by the level of foreign currency denominated net assets and fluctuations in the value of the U.S. dollar relative to foreign currencies.
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Expenses
Employee compensation and related benefits expense represents wages and benefits paid to employees, inclusive of cash and amortization of equity compensation. Employee compensation and benefits fluctuate based on the number of employees and changes in GETCO’s profitability and acceleration of awards upon a change in control.
Regulatory, exchange, and execution fees primarily represent fees paid to regulatory bodies, exchanges, and clearing organizations. These fees fluctuate based on changes in trading volume, type of execution, and the level of fees charged.
Colocation and data line expenses consist of costs for obtaining and transmitting market data, obtaining telecommunications services, and performing recurring and non-recurring system maintenance. Colocation expenses vary based upon leased square footage, contractual rental payments, the number of GETCO’s collocated servers, and associated power requirements.
Professional fees represent fees paid to third parties for services performed including audit, tax, legal, consulting, placement, retained search, marketing and external communications.
Depreciation and amortization expense results from the amortization of acquired intangible assets and depreciation of fixed assets, which consist of equipment, computer hardware, furniture, fixtures, purchased software, and leasehold improvements. Acquired intangible assets are amortized over their estimated useful lives. Fixed assets are depreciated on a straight-line basis. Equipment and software are depreciated over three years, furniture is depreciated over seven years and leasehold improvements and fixtures are depreciated over the shorter of the life of the asset or the term of the related lease, ranging from three to 15 years.
Occupancy, communication and office expense consists primarily of rent, utilities, supplies, and maintenance related to leased properties. New office expansions, leases, and maintenance renewal agreements are the primary drivers of fluctuations in occupancy expense. Since 2012, GETCO has invested in the build out of new and existing office locations, including the build out and development of the Palo Alto and Mumbai offices and the relocation of GETCO’s New York office. GETCO has no plans for significant office expansions in the near term. On March 18, 2013, GETCO determined to close its office in Hong Kong. This decision will not have a material effect on GETCO’s operations or results in Asia, which are generally conducted out of Singapore and Mumbai. On March 22, 2013 GETCO entered into an agreement to sublet a former New York office located at 55 Broad Street. This sublet agreement extends through the term of GETCO’s original lease. On June 30, 2013, GETCO determined to close its Palo Alto office. This decision will not have a material effect on GETCO’s operations or results; GETCO is seeking to sublet the Palo Alto office space through the term of the lease.
Restructuring costs and lease loss expense represents asset impairment charges and severance costs associated with the closing of GETCO’s Hong Kong and Palo Alto office locations, lease loss expenses from the sublet of GETCO’s New York office located at 55 Broad Street and Palo Alto office, and the write down of GETCO’s Hong Kong office lease.
Travel and entertainment expense represents airfare, hotel, and meals resulting from domestic and international travel as well as teambuilding and client entertainment expenses.
Computer supplies and maintenance expense consists primarily of computer hardware and software purchases and annual software maintenance and licensing programs. The primary drivers of fluctuations to computer supplies and maintenance costs include the timing of investments in ongoing technology upgrades and improvements.
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Order flow expense represents commissions and fees paid to liquidity providers by GETCO’s ATS, GETMatched.
Interest expense on corporate borrowings and capital lease obligations consists primarily of interest from collateralized financing arrangements, capital lease obligations and long-term debt.
Other expenses relate primarily to bank commitment fees, exchange fees/dues, exchange memberships, regulatory dues, member interest expense, and value added tax, which we refer to as VAT recovery (U.K. sales tax).
Segment Commentary—Three Months Ended June 30, 2013 and 2012
The following table sets forth: (i) Revenues, (ii) Expenses, and (iii) Pre-tax earnings/(loss) from GETCO’s segments and on a consolidated basis for the three months ended June 30, 2013 and 2012 (dollars in millions):
| For the three months ended June 30, |
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| 2013 |
2012 |
$ Change |
% Change |
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| Market Making |
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| Revenues |
$ | 118.4 | $ | 135.7 | $ | (17.4) | (12.8%) | |||||||||
| Expenses |
120.3 | 126.1 | (5.8) | (4.6) | ||||||||||||
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|
|
|
|
|
|
|
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| Pre-tax earnings/(loss) 1 |
(1.9) | 9.7 | (11.6) | n/m | ||||||||||||
| Execution Services |
||||||||||||||||
| Revenues |
$ | 13.0 | $ | 9.2 | $ | 3.9 | 42.0% | |||||||||
| Expenses |
15.9 | 10.7 | 5.2 | 48.5 | ||||||||||||
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|
|
|
|
|
|
|
|
|||||||||
| Pre-tax loss 1 |
(2.9) | (1.5) | (1.3) | (87.4) | ||||||||||||
| Corporate & Other |
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| Revenues |
$ | (8.8) | $ | 0.4 | $ | (9.2) | n/m | |||||||||
| Expenses |
55.9 | 2.5 | 53.4 | n/m | ||||||||||||
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|
|
|
|
|
|
|
|||||||||
| Pre-tax loss 1 |
(64.7) | (2.1) | (62.6) | n/m | ||||||||||||
| Eliminations 2 |
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| Revenues/expenses |
$ | (4.5) | $ | (4.2) | $ | (0.3) | (6.5%) | |||||||||
| Consolidated |
||||||||||||||||
| Revenues |
$ | 118.1 | $ | 141.1 | $ | (23.0) | (16.3%) | |||||||||
| Expenses |
187.7 | 135.1 | 52.6 | 39.0 | ||||||||||||
|
|
|
|
|
|
|
|
|
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| Pre-tax earnings/(loss) |
(69.6) | 6.0 | (75.6) | n/m | ||||||||||||
*Totals may not add due to rounding; “n/m” denotes percentage change calculations deemed not meaningful.
| 1. | Pre-Tax Earnings/(Loss) represents segment profit/loss after allocation of support function costs. Support functions include administration, clearing, communications, core technology, facilities, finance, human resources, legal and compliance, risk and senior leadership. |
| 2. | Eliminations revenues/expenses represent fees paid to Execution Services from Market Making, which are netted against revenues and regulatory, exchange, and execution fees financial statement line items. |
8
Consolidated revenues decreased $23.0 million (-16.3%) to $118.1 million for the three months ended June 30, 2013 from $141.1 million for the three months ended June 30, 2012. The decline in consolidated revenues was primarily attributable to lower trading revenues from the Market Making segment as well as one-time asset impairment charges related to certain strategic investments in Corporate and Other. Market Making revenues were negatively impacted by lower U.S. and European equity market volumes and volatilities as well as continued market share contraction due to increased competition. For the three months ended June 30, 2013, the average daily market volumes for U.S. cash equities and the total notional volume for European cash equities declined approximately 4% and 1%, respectively, compared to the three months ended June 30, 2012. Compounding the impact of the volume declines was lower U.S. and European equity market volatility. For the three months ended June 30, 2013, the average realized 20-day volatility of the S&P 500 and Euro Stoxx 50 Futures, and the average implied volatility of the VIX declined approximately 15%, 18%, and 26%, respectively, as compared to the three months ended June 30, 2012. For the three months ended June 30, 2013, GETCO’s market share in U.S. cash equities and U.S. equity futures declined by approximately 2 percentage points and 1 percentage point, respectively, from the three months ended June 30, 2012 (based on GETCO’s internal calculations and data from the U.S. consolidated tapes; the CME and the IntercontinentalExchange, respectively).
Consolidated expenses increased $52.6 million (39.0%) to $187.7 million for the three months ended June 30, 2013 from $135.1 million for the three months ended June 30, 2012. The increase in consolidated expenses was primarily attributable to higher employee compensation and related benefits and higher professional fees related to the Mergers, which were partially offset by lower regulatory, exchange and execution fees. The increase in employee compensation and related benefits was primarily due to an increase in unit-based compensation, which resulted from the vesting of all outstanding GETCO units on June 25, 2013, and higher discretionary compensation. Upon approval of the Mergers by the shareholders of Knight and the unit holders of GETCO at the special meetings held on June 25, 2013, the unit vesting was triggered by a change in control provision. Professional fees increased due to higher consulting and legal fees associated with the Mergers. Total headcount at June 30, 2013 was 396 compared to 398 at June 30, 2012. For the three months ended June 30, 2013, GETCO incurred $48.2 million of merger-related expenses and $1.1 million of restructuring costs and lease loss expense related to the closing of the Palo Alto and Hong Kong office locations.
The changes in pre-tax earnings (loss) by segment for the three months ended June 30, 2013 and June 30, 2012 are summarized as follows:
| • | Market Making—Pre-tax results from Market Making decreased $11.6 million to a loss of $1.9 million for the three months ended June 30, 2013 from a profit of $9.7 million for the three months ended June 30, 2012. The decline was primarily attributable to a decline in revenues, partially offset by lower expenses. Revenues were adversely impacted by lower U.S. and European equity market volumes and volatilities as well as continued market share contraction in both the equities and fixed income asset classes. For the three months ended June 30, 2013, the average daily market volumes for U.S. cash equities and the total notional volume for European cash equities declined approximately 4% and 1%, respectively, compared to the three months ended June 30, 2012. Compounding the impact of the volume declines was lower U.S. and European equity market volatilities. For the three months ended June 30, 2013, the average realized 20-day volatility of the S&P 500 and Euro Stoxx 50 Futures, and the average implied volatility of the VIX declined approximately 15%, 18%, and 26%, respectively, as compared to the three months ended June 30, 2012. For the three months ended June 30, 2013, GETCO’s market share in U.S. cash equities, U.S. equity futures, U.S. fixed income cash treasuries, and U.S. fixed income treasury futures declined by approximately 2 percentage points, 1 percentage point, 4 percentage points, and 3 percentage points respectively, from the three months ended June 30, 2012 |
9
| (based on GETCO’s internal calculations and data from the U.S. consolidated tapes; the CME and the IntercontinentalExchange; Brokertec, Espeed, and GovEx; and the CME and ELX Futures, L.P., respectively). Expenses were lower primarily due to lower regulatory, exchange, and execution fees due to lower trading volumes, lower colocation and data line expenses, and lower travel and entertainment costs. |
| • | Execution Services—Pre-tax loss from Execution Services increased $1.3 million (-87.4%) to a loss of $2.9 million for the three months ended June 30, 2013 from a loss of $1.5 million for the three months ended June 30, 2012. The increase in the pre-tax loss is primarily attributable to higher severance and discretionary compensation expense. |
| • | Corporate and Other—Pre-tax loss from Corporate and Other increased $62.6 million to a loss of $64.7 million for the three months ended June 30, 2013 from a loss of $2.1 million for the three months ended June 30, 2012. The increase in pre-tax loss was primarily attributable to higher professional fees and compensation and related benefit expenses associated with the Mergers (including costs related to unit vesting), strategic asset write-downs, higher bank fees and bank loan interest related to the issuance of $305.0 million of senior secured notes to help fund the merger, and restructuring and lease loss costs associated with closing the Palo Alto and Hong Kong offices. For the three months ended June 30, 2013, merger-related expenses (including unit vesting and interest and bank fees related to the $305.0 million of senior notes), strategic asset write-downs, and restructuring and lease loss costs totaled $48.2 million, $9.2 million, and $1.1 million, respectively. |
10
Segment Commentary—Six Months Ended June 30, 2013 and 2012
The following table sets forth: (i) Revenues, (ii) Expenses, and (iii) Pre-tax earnings/(loss) from GETCO’s segments and on a consolidated basis for the six months ended June 30, 2013 and 2012 (dollars in millions):
| For the six months ended June 30, |
||||||||||||||||
| 2013 |
2012 |
$ Change |
% Change |
|||||||||||||
| Market Making |
||||||||||||||||
| Revenues |
$ | 225.4 | $ | 285.1 | $ | (59.7) | (20.9%) | |||||||||
| Expenses |
222.2 | 258.1 | (35.8) | (13.9) | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Pre-tax earnings 1 |
3.2 | 27.0 | (23.8) | (88.3) | ||||||||||||
| Execution Services |
||||||||||||||||
| Revenues |
$ | 22.2 | $ | 16.9 | $ | 5.3 | 31.5% | |||||||||
| Expenses |
26.6 | 20.0 | 6.6 | 32.8 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Pre-tax loss 1 |
(4.3) | (3.1) | (1.2) | (39.8) | ||||||||||||
| Corporate & Other |
||||||||||||||||
| Revenues |
$ | (7.6) | $ | 1.1 | $ | (8.7) | n/m | |||||||||
| Expenses |
68.2 | 4.7 | 63.4 | n/m | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Pre-tax loss 1 |
(75.8) | (3.6) | (72.2) | n/m | ||||||||||||
| Eliminations 2 |
||||||||||||||||
| Revenues/expenses |
$ | (9.0) | $ | (8.4) | $ | (0.6) | (7.7%) | |||||||||
| Consolidated |
||||||||||||||||
| Revenues |
$ | 231.0 | $ | 294.7 | $ | (63.7) | (21.6%) | |||||||||
| Expenses |
307.9 | 274.4 | 33.5 | 12.2 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Pre-tax earnings/(loss) 1 |
(76.9) | 20.3 | (97.2) | n/m | ||||||||||||
*Totals may not add due to rounding; “n/m” denotes percentage change calculations deemed not meaningful.
| 1. | Pre-Tax Earnings/(Loss) represents segment profit/loss after allocation of support function costs. Support functions include administration, clearing, communications, core technology, facilities, finance, human resources, legal and compliance, risk and senior leadership. |
| 2. | Eliminations revenues/expenses represent fees paid to Execution Services from Market Making, which are netted against revenues and regulatory, exchange, and execution fees financial statement line items. |
Consolidated revenues decreased $63.7 million (-21.6%) to $231.0 million for the six months ended June 30, 2013 from $294.7 million for the six months ended June 30, 2012. The decline in consolidated revenues was primarily attributable to lower trading revenues from the Market Making segment and lower strategic investment income from the Corporate and Other segment. Market Making revenues were negatively impacted by generally lower market volatilities across the equities and fixed income asset classes and lower U.S. and European equity volumes, as well as market share contraction primarily due to increased competition in the U.S., Europe and Asia-Pacific regions. For the six months ended June 30, 2013, the average realized 20-day volatility of the S&P 500, Euro Stoxx 50, the 10-year Treasury Note Future, and the average implied volatility of the VIX declined approximately 8%, 13%, 12%, and 26%, respectively, as compared to the six months ended June 30, 2012. For the
11
six months ended June 30, 2013, the average daily market volumes for U.S. cash equities declined approximately 5%, as compared to the six months ended June 30, 2012; total notional volume for European cash equities declined approximately 6% for the six months ended June 30, 2013 as compared to the six months ended June 30, 2012. For the six months ended June 30, 2013, GETCO’s market share in U.S. cash equities, U.S. equity futures, U.S. fixed income cash treasuries, and U.S. fixed income treasury futures declined by approximately 2 percentage points, 2 percentage points, 5 percentage points, and 6 percentage points, respectively, from the six months ended June 30, 2012 (based on GETCO’s internal calculations and data from the U.S. consolidated tapes; the CME and the IntercontinentalExchange; Brokertec, Espeed, and GovEx; and the CME and ELX Futures, L.P., respectively). Strategic investment write-downs for the six months ended June 30, 2013 totaled $9.2 million.
Consolidated expenses increased $33.5 million (12.2%) to $307.9 million for the six months ended June 30, 2013 from $274.4 million for the six months ended June 30, 2012. The increase in consolidated expenses was primarily attributable to higher employee compensation and related benefits and higher professional fees related to the Mergers. The increase in employee compensation and related benefits was primarily due to an increase in unit-based compensation, which resulted from the vesting of all outstanding GETCO units on June 25, 2013. Upon approval of the Mergers by the shareholders of Knight and the unit holders of GETCO at the special meetings held on June 25, 2013, the unit vesting was triggered by a change in control provision. Professional fees increased due to higher merger-related consulting and legal fees. For the six months ended June 30, 2013, GETCO incurred $53.8 million of merger-related expenses and $3.7 million of restructuring costs and lease loss expense related to the closing of the Palo Alto and Hong Kong office locations.
The changes in pre-tax earnings (loss) by segment for the six months ended June 30, 2013 and June 30, 2012 are summarized as follows:
| • | Market Making—Pre-tax earnings from Market Making decreased $23.8 million (-88.3%) to $3.2 million for the six months ended June 30, 2013 from $27.0 million for the six months ended June 30, 2012. The decline was primarily attributable to lower revenues, which were partially offset by lower expenses. Revenues were adversely impacted by reduced levels of volatility, lower U.S. and European equity market volumes, increased competition, and a higher percentage of internalization in U.S. cash equity markets. For the six months ended June 30, 2013, the average realized 20-day volatility of the S&P 500, Euro Stoxx 50, and the 10-year Treasury Note Future, and the average implied volatility of the VIX declined approximately 8%, 13%, 12%, and 26%, respectively, as compared to the six months ended June 30, 2012. For the six months ended June 30, 2013, the average daily market volumes for U.S. cash equities declined approximately 5%, as compared to the six months ended June 30, 2012; total notional volume for European cash equities declined approximately 6% for the six months ended June 30, 2013 as compared to the six months ended June 30, 2012. For the six months ended June 30, 2013, GETCO’s market share in U.S. cash equities, U.S. equity futures, U.S. fixed income cash treasuries, and U.S. fixed income treasury futures declined by approximately 2 percentage points, 2 percentage points, 5 percentage points, and 6 percentage points respectively, from the six months ended June 30, 2012 (based on GETCO’s internal calculations and data from the U.S. consolidated tapes; the CME and the IntercontinentalExchange; Brokertec, Espeed, and GovEx; and the CME and ELX Futures, L.P., respectively). Expenses were lower primarily due to lower regulatory, exchange, and execution fees resulting from lower trading volumes and lower colocation and data line expenses. |
| • | Execution Services—Pre-tax loss from Execution Services increased $1.2 million (-39.8%) to a loss of $4.3 million for the six months ended June 30, 2013 from a loss of $3.1 million for the six months ended June 30, 2012. The increase in the pre-tax loss is primarily |
12
| attributable to higher severance and discretionary compensation expense, which was partially offset by higher GETAlpha and GETDirect revenues. |
| • | Corporate and Other—Pre-tax loss from Corporate and Other increased $72.2 million to a loss of $75.8 million for the six months ended June 30, 2013 from a loss of $3.6 million for the six months ended June 30, 2012. The increase in pre-tax loss was primarily attributable to higher professional fees and compensation and related benefit expenses associated with the Mergers, strategic asset write-downs, higher merger related bank loan interest, and restructuring and lease loss costs associated with closing the Palo Alto and Hong Kong offices. For the six months ended June 30, 2013, merger-related expenses, strategic asset write-downs, and restructuring and lease loss costs totaled $53.8 million, $9.2 million, and $3.7 million, respectively. |
Results of Operations for the Three Months Ended June 30, 2013 and 2012
The following table sets forth the consolidated statements of operations for the three months ended June 30, 2013 and 2012 (dollars in millions):
Consolidated Statement of Operations
| (Unaudited) Three Months Ended June 30, |
||||||||||||||||||
| 2013 | 2012 | $ Change | % Change | |||||||||||||||
| Revenues |
||||||||||||||||||
| Trading gains and losses, net |
$ | 127.2 | $ | 141.7 | $ | (14.5) | (10.3%) | |||||||||||
| Interest and dividends, net |
0.6 | (0.8) | 1.4 | n/m | ||||||||||||||
| Loss on investments, net |
(9.2) | - | (9.2) | n/m | ||||||||||||||
| Other (loss) income, net |
(0.5) | 0.2 | (0.7) | n/m | ||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||
| Total revenues |
118.1 | 141.1 | (23.0) | (16.3) | ||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||
| Expenses |
||||||||||||||||||
| Employee compensation and related benefits |
69.0 | 39.6 | 29.5 | 74.5 | ||||||||||||||
| Regulatory, exchange and execution fees |
46.0 | 52.6 | (6.6) | (12.6) | ||||||||||||||
| Colocation and data line expenses |
20.4 | 21.8 | (1.4) | (6.4) | ||||||||||||||
| Professional fees |
23.2 | 4.0 | 19.2 | 474.1 | ||||||||||||||
| Depreciation and amortization |
7.7 | 7.7 | 0.0 | 0.2 | ||||||||||||||
| Occupancy, communication, and office |
4.2 | 3.8 | 0.4 | 10.2 | ||||||||||||||
| Restructuring costs and lease loss |
1.1 | - | 1.1 | n/m | ||||||||||||||
| Travel and entertainment |
1.6 | 2.8 | (1.1) | (40.3) | ||||||||||||||
| Computer supplies and maintenance |
0.9 | 1.2 | (0.3) | (25.9) | ||||||||||||||
| Order flow expense |
0.8 | 0.7 | 0.1 | 19.4 | ||||||||||||||
| Interest expense on corporate borrowings and capital lease obligations |
2.2 | 0.5 | 1.6 | n/m | ||||||||||||||
| Other expenses |
10.6 | 0.4 | 10.2 | n/m | ||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||
| Total expenses |
187.7 | 135.1 | 52.6 | 39.0 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||
| (Loss) income before income taxes |
(69.6) | 6.0 | (75.6) | n/m | ||||||||||||||
| Provision for income taxes |
3.3 | 2.3 | 1.0 | 45.5 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||
| Net (loss) income |
$ | (72.9) | $ | 3.8 | $ | (76.7) | n/m | |||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||
* Totals may not add due to rounding; “n/m” denotes percentage change calculations deemed not meaningful.
13
Revenues
Market Making
| For the three months ended June 30, |
||||||||||||||||
| 2013 | 2012 | $ Change | % Change | |||||||||||||
| Total Revenues From Market Making (dollars in millions)1 |
$ | 118.4 | $ | 135.7 | $ | (17.4) | (12.8%) | |||||||||
| 1. | Includes debit, credit, and short stock interest, as well as dividend income and expense resulting from trading operations. |
Total revenues from Market Making declined $17.4 million (-12.8%) to $118.4 million for the three months ended June 30, 2013 from $135.7 million for the three months ended June 30, 2012. Market Making revenues for the three months ended June 30, 2013 primarily represent trading gains and losses and were negatively impacted by industry-specific trends such as lower market volatilities and volumes, as well as continued market share contraction primarily due to a continued increase in competition.
Execution Services
| For the three months ended June 30, |
||||||||||||||||
| 2013 | 2012 | $ Change | % Change | |||||||||||||
| Total Revenues From Execution Services (dollars in millions) | $ | 13.0 | $ | 9.2 | $ | 3.9 | 42.0% | |||||||||
Total revenues from Execution Services, which includes fees from GETCO’s Market Making segment and commissions and fees from agency execution activities, increased $3.9 million (42.0%) to $13.0 million for the three months ended June 30, 2013 from $9.2 million for the three months ended June 30, 2012. The increase in revenue was primarily attributable to increased third party revenues from GETCO’s GETAlpha product and higher trading revenues from the GETDirect fixed income product.
Corporate and Other
| For the three months ended June 30, |
||||||||||||||||
| 2013 | 2012 | $ Change | % Change | |||||||||||||
| Total Revenues From Corporate and Other (dollars in millions)1 | $ | (8.8 | ) | $ | 0.4 | $ | (9.2 | ) | n/m | |||||||
1. Includes non-trading position related interest income, dividend income related to certain strategic investments, income (loss) from certain strategic investments, mark-to-market gains and losses on GETCO’s short term investments, and currency conversion gains/(losses) related to non-U.S. dollar denominated cash deposits held at clearing firms. Intercompany rebates and fees paid to Execution Services from Market Making are accounted for through intercompany eliminations and are not included in Corporate and Other.
14
Total revenues from the Corporate and Other segment decreased $9.2 million to a loss of $8.8 million for the three months ended June 30, 2013 from $0.4 million for the three months ended June 30, 2012. The decrease in revenue was primarily attributable to $9.2 million of strategic asset write-downs.
Expenses
Employee compensation and related benefits increased $29.5 million (74.5%) to $69.0 million for the three months ended June 30, 2013 from $39.6 million for the three months ended June 30, 2012. This increase was primarily attributable to higher discretionary compensation in the quarter and an increase in unit-based compensation costs, which resulted from the vesting of all outstanding GETCO units on June 25, 2013. Upon approval of the Mergers by the shareholders of Knight and the unit holders of GETCO at the special meetings held on June 25, 2013 the unit vesting was triggered by a change in control provision. Severance costs decreased $3.0 million (-57.5%) to $2.2 million for the three months ended June 30, 2013 from $5.1 million for the three months ended June 30, 2012.
Regulatory, exchange, and execution fees declined $6.6 million (-12.6%) to $46.0 million for the three months ended June 30, 2013 from $52.6 million for the three months ended June 30, 2012. The decline in expenses was primarily driven by lower trading volumes.
Colocation and data line expenses decreased $1.4 million (-6.4%) to $20.4 million for the three months ended June 30, 2013 from $21.8 million for the three months ended June 30, 2012. The decrease in colocation and data line expenses is primarily attributable to negotiated contractual cost savings.
Professional fees increased $19.2 million (474.1%) to $23.2 million for the three months ended June 30, 2013 from $4.0 million for the three months ended June 30, 2012. The increase in professional fees is primarily attributable to the Mergers. For the three months ended June 30, 2013 GETCO incurred $21.6 million of professional fees related to the Mergers. Excluding merger-related costs, professional fees decreased primarily due to lower placement fees and non-merger related legal, audit, and communication fees.
Depreciation and amortization expense remained unchanged at $7.7 million for the three months ended June 30, 2013 and three months ended June 30, 2012.
Occupancy, communication and office expenses increased $0.4 million (10.2%) to $4.2 million for the three months ended June 30, 2013 from $3.8 million for the three months ended June 30, 2012. Increases were primarily attributable to higher rent from the opening of GETCO’s New York office in late 2012.
Restructuring costs and lease loss expenses increased $1.1 million to $1.1 million for the three months ended June 30, 2013 from $0.0 million for the three months ended June 30, 2012. The increase in restructuring costs and lease loss expense was attributable to asset impairment charges, lease loss, and employee costs associated with the closing of GETCO’s Palo Alto and Hong Kong office locations.
Travel and entertainment expenses decreased $1.1 million (-40.3%) to $1.6 million for the three months ended June 30, 2013 from $2.8 million for the three months ended June 30, 2012. The decline in travel and entertainment costs was primarily attributable to lower air travel and lodging expenses resulting from changes in GETCO’s travel policy, limiting non-essential travel, and the elimination of GETCO’s fractional jet share. For the three months ended June 30, 2013, GETCO incurred $0.4 million of travel expenses related to the Merger.
15
Computer supplies and maintenance expense decreased $0.3 million (-25.9%) to $0.9 million for the three months ended June 30, 2013 from $1.2 million for the three months ended June 30, 2012. The decrease in computer supplies and maintenance expense was primarily attributable to lower equipment, software, and maintenance purchases.
Interest expense on corporate borrowings increased $1.6 million to $2.2 million for the three months ended June 30, 2013 from $0.5 million for the three months ended June 30, 2012. The increase in interest expense primarily relates to interest on the $305.0 million of 8.25% senior secured notes that were issued on June 5, 2013 and placed into escrow until the closing of the Mergers on July 1, 2013. See Note 17—Subsequent Events in the consolidated financial statements contained in Exhibit 99.1 to this Current Report on Form 8-K.
Other expenses increased $10.2 million to $10.6 million for the three months ended June 30, 2013 from $0.4 million for the three months ended June 30, 2012 primarily due to $8.9 million of bank commitment fees related to the Mergers as well as fees associated with GETCO’s $350.0 million secured revolving credit facility, which closed in June 2012. See Note 17—Subsequent Events in the consolidated financial statements contained in Exhibit 99.1 to this Current Report on Form 8-K.
Results of Operations for the Six Months Ended June 30, 2013 and 2012
The following table sets forth the consolidated statements of operations for the six months ended June 30, 2013 and 2012 (dollars in millions):
Consolidated Statement of Operations
| (Unaudited) Six Months Ended June 30, |
||||||||||||||||
| 2013 |
2012 |
$ Change | % Change | |||||||||||||
| Revenues |
||||||||||||||||
| Trading gains and losses, net |
$ | 239.7 | $ | 294.9 | $ | (55.3) | (18.7%) | |||||||||
| Interest and dividends, net |
0.5 | (1.0) | 1.5 | n/m | ||||||||||||
| Loss on investments, net |
(8.8) | - | (8.8) | n/m | ||||||||||||
| Other (loss) income, net |
(0.4) | 0.7 | (1.2) | n/m | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total revenues |
231.0 | 294.7 | (63.7) | (21.6) | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Expenses |
||||||||||||||||
| Employee compensation and related benefits |
101.7 | 81.1 | 20.5 | 25.3 | ||||||||||||
| Regulatory, exchange and execution fees |
86.9 | 102.4 | (15.5) | (15.1) | ||||||||||||
| Colocation and data line expenses |
40.0 | 42.7 | (2.7) | (6.3) | ||||||||||||
| Professional fees |
30.3 | 8.7 | 21.6 | 249.1 | ||||||||||||
| Depreciation and amortization |
15.9 | 19.6 | (3.7) | (18.8) | ||||||||||||
| Occupancy, communication, and office |
8.2 | 7.5 | 0.6 | 8.6 | ||||||||||||
| Restructuring costs and lease loss |
3.7 | - | 3.7 | n/m | ||||||||||||
| Travel and entertainment |
3.0 | 5.8 | (2.8) | (47.7) | ||||||||||||
| Computer supplies and maintenance |
1.8 | 2.6 | (0.8) | (29.3) | ||||||||||||
| Order flow expense |
1.7 | 1.5 | 0.2 | 15.7 | ||||||||||||
| Interest expense on corporate borrowings and capital lease obligations |
2.6 | 1.3 | 1.3 | 104.1 | ||||||||||||
| Other expenses |
12.0 | 1.2 | 10.8 | 909.8 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total expenses |
307.9 | 274.4 | 33.5 | 12.2 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| (Loss) income before income taxes |
(76.9) | 20.3 | (97.2) | n/m | ||||||||||||
| Provision for income taxes |
5.3 | 5.6 | (0.3) | (4.9) | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Net (loss) income |
$ | (82.2) | $ | 14.7 | $ | (97.0) | n/m | |||||||||
|
|
|
|
|
|
|
|
|
|||||||||
* Totals may not add due to rounding; “n/m” denotes percentage change calculations deemed not meaningful.
16
Revenues
Market Making
| For the six months ended June 30, |
||||||||||||||||
| 2013 |
2012 |
$ Change | % Change | |||||||||||||
| Total Revenues From Market Making (dollars in millions) 1 | $ | 225.4 | $ | 285.1 | $ | (59.7) | (20.9 | %) | ||||||||
| 1. | Includes debit, credit, and short stock interest. |
Total revenues from Market Making declined $59.7 million (-20.9%) to $225.4 million for the six months ended June 30, 2013 from $285.1 million for the six months ended June 30, 2012. Market Making revenues for the six months ended June 30, 2013 primarily represent trading gains and losses and were negatively impacted by industry-specific trends such as reduced levels of volatility, lower U.S. and European equity market volumes, increased competition, and a higher percentage of internalization in U.S. cash equity markets.
Execution Services
| For the six months ended June 30, |
||||||||||||||||
| 2013 |
2012 |
$ Change | % Change | |||||||||||||
| Total Revenues From Execution Services (dollars in millions) | $ | 22.2 | $ | 16.9 | $ | 5.3 | 31.5 | % | ||||||||
Total revenues from Execution Services, which includes fees from GETCO’s Market Making segment and commissions and fees from agency execution activities, increased $5.3 million (31.5%) to $22.2 million for the six months ended June 30, 2013 from $16.9 million for the six months ended June 30, 2012. The increase in revenue was primarily attributable to increased third party revenues from GETCO’s GETAlpha product and higher trading revenues from the GETDirect fixed income product.
Corporate and Other
| For the six months ended June 30, |
||||||||||||||||
| 2013 |
2012 |
$ Change | % Change | |||||||||||||
| Total Revenues From Corporate and Other (dollars in millions) 1 | $ | (7.6) | $ | 1.1 | $ | (8.7) | n/m | |||||||||
| 1. | Includes non-trading position related interest income, dividend income related to certain strategic investments, income (loss) from certain strategic investments, mark-to-market gains and losses on GETCO’s short-term investments, and currency conversion gains/(losses) related to non-U.S. dollar denominated cash deposits held at clearing firms. Intercompany rebates and fees paid to Execution Services from Market Making are accounted for through intercompany eliminations and are not included in Corporate and Other. |
Total revenues from the Corporate and Other segment decreased $8.7 million to a loss of $7.6 million for the six months ended June 30, 2013 from a profit of $1.1 million for the six months ended June 30, 2013. The decline in revenue was primarily attributable to a $9.2 million loss resulting from strategic asset write-downs.
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Expenses
Employee compensation and related benefits increased $20.5 million (25.3%) to $101.7 million for the six months ended June 30, 2013 from $81.1 million for the six months ended June 30, 2012. This increase was primarily attributable to higher discretionary compensation and an increase in unit-based compensation costs, which resulted from the vesting of all outstanding GETCO units on June 25, 2013. Upon approval of the Mergers by the Knight shareholders and the GETCO unit holders at the special meetings held on June 25, 2013 the unit vesting was triggered by a change in control provision. Severance costs decreased $3.1 million (-39.1%) to $4.8 million for the six months ended June 30, 2013 from $7.9 million for the six months ended June 30, 2012.
Regulatory, exchange, and execution fees declined $15.5 million (-15.1%) to $86.9 million for the six months ended June 30, 2013 from $102.4 million for the six months ended June 30, 2012. The decline in expenses was primarily driven by lower trading volumes.
Colocation and data line expenses decreased $2.7 million (-6.3%) to $40.0 million for the six months ended June 30, 2013 from $42.7 million for the six months ended June 30, 2012. The decrease in colocation and data line expenses is primarily attributable to negotiated contractual costs savings.
Professional fees increased $21.6 million (249.1%) to $30.3 million for the six months ended June 30, 2013 from $8.7 million for the six months ended June 30, 2012. The increase in professional fees was attributable to the Mergers, which were partially offset by lower placement fees and non-merger related legal fees. For the six months ended June 30, 2013, GETCO incurred $26.9 million of professional fees related to the Mergers.
Depreciation and amortization decreased $3.7 million (-18.8%) to $15.9 million for the six months ended June 30, 2013 from $19.6 million for the six months ended June 30, 2012. The decline in depreciation and amortization expense was primarily attributable to lower equipment depreciation resulting from depreciation run-off in excess of new spending for equipment purchases.
Occupancy, communication and office expenses increased $0.6 million (8.6%) to $8.2 million for the six months ended June 30, 2013 from $7.5 million for the six months ended June 30, 2012. The increase in occupancy, communication and office expense was primarily attributable to higher rent associated with the relocation of GETCO’s New York office in late 2012.
Restructuring costs and lease loss expenses increased $3.7 million to $3.7 million for the six months ended June 30, 2013 from $0.0 million for the six months ended June 30, 2012. The increase in restructuring costs and lease loss expenses was attributable to asset impairment charges and employee costs associated with the closing of GETCO’s Palo Alto and Hong Kong offices, lease loss expense from the sublet of GETCO’s Palo Alto office and New York office located at 55 Broad Street, and a write down of GETCO’s Hong Kong office lease.
Travel and entertainment expenses decreased $2.8 million (-47.7%) to $3.0 million for the six months ended June 30, 2013 from $5.8 million for the six months ended June 30, 2012. The decline in travel and entertainment costs was primarily attributable to lower airfare and lodging expenses resulting from changes in GETCO’s travel policy, limiting non-essential travel, and the elimination of GETCO’s fractional jet share. For the six months ended June 30, 2013, GETCO incurred $0.7 million of travel expenses related to the Merger.
Computer supplies and maintenance expense decreased $0.8 million (-29.3%) to $1.8 million for the six months ended June 30, 2013 from $2.6 million for the six months ended June 30, 2012. The decrease in computer supplies and maintenance expense was primarily attributable to lower equipment and software purchases.
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Interest expense on corporate borrowings increased $1.3 million (104.1%) to $2.6 million for the six months ended June 30, 2013 from $1.3 million for the six months ended June 30, 2012. The increase in interest expense primarily relates to interest on the $305.0 million of 8.25% senior secured notes that were issued on June 5, 2013 and placed into escrow until the closing of the Merger on July 1, 2013. See Note 17—Subsequent Events in the consolidated financial statements contained in Exhibit 99.1 to this Current Report on Form 8-K.
All other expenses increased $10.8 million (909.8%) to $12.0 million for the six months ended June 30, 2013 from $1.2 million for the six months ended June 30, 2012 primarily due to $8.9 million of bank commitment fees as well as fees associated with GETCO’s $350.0 million secured revolving credit facility, which closed in June 2012. See Note 17—Subsequent Events in the consolidated financial statements contained in Exhibit 99.1 to this Current Report on Form 8-K.
Reconciliation of GAAP Pre-Tax to Non-GAAP Pre-Tax Earnings
We believe that certain non-GAAP financial presentations, when taken into consideration with the corresponding GAAP financial presentations, are important in understanding our operating results. The adjustments incorporate the effects of losses from strategic asset impairments, expenses associated with the Mergers, severance and non-compete expenses related to termed employees, and restructuring and lease loss costs related to the closing of certain office locations and sublet of leaseholds. We believe this presentation provides meaningful information to shareholders and investors as they provide comparability for our results of operations for the three and six months ended June 30, 2013 with the results for the three and six months ended June 30, 2012. The following table provides a full reconciliation of GAAP to non-GAAP pre-tax results for the three and six months ended June 30, 2013 (dollars in millions):
| Three months ended June 30, 2013 |
Market Making |
Execution Services |
Corporate and Other |
Consolidated | ||||||||||||
| GAAP pre-tax loss: |
$ (1.9) | $ | (2.9) | $ | (64.7) | $ | (69.6) | |||||||||
| Merger - professional fees, bank fees, interest expense, and other |
- | - | 33.3 | 33.3 | ||||||||||||
| Merger - unit and deferred compensation acceleration |
- | - | 14.9 | 14.9 | ||||||||||||
| Strategic asset impairments |
- | - | 9.2 | 9.2 | ||||||||||||
| Severance and non-compete |
1.9 | 0.3 | - | 2.2 | ||||||||||||
| Restructuring and lease loss |
- | - | 1.1 | 1.1 | ||||||||||||
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|
|
|
|
|
|
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| Non-GAAP loss from operations before income taxes |
$ | (0.1) | $ | (2.6) | $ | (6.2) | $ | (8.9) | ||||||||
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|
|
|
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| Six months ended June 30, 2013 |
Market Making |
Execution Services |
Corporate and Other |
Consolidated | ||||||||||||
| GAAP pre-tax income (loss): |
$ | 3.2 | $ | (4.3) | $ | (75.8) | $ | (76.9) | ||||||||
| Merger - professional fees, bank fees, interest expense, and other |
- | - | 38.9 | 38.9 | ||||||||||||
| Merger - unit and deferred compensation acceleration |
- | - | 14.9 | 14.9 | ||||||||||||
| Strategic asset impairments |
- | - | 9.2 | 9.2 | ||||||||||||
| Severance and non-compete |
4.0 | 0.9 | - | 4.8 | ||||||||||||
| Restructuring and lease loss |
- | - | 3.7 | 3.7 | ||||||||||||
|
|
|
|
|
|
|
|
|
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| Non-GAAP income (loss) from operations before income taxes |
$ | 7.1 | $ | (3.5) | $ | (9.1) | $ | (5.4) | ||||||||
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*Totals may not add due to rounding
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Financial Condition as of June 30, 2013 and December 31, 2012
GETCO has historically maintained a highly liquid balance sheet, with a substantial portion of total assets consisting of cash and cash equivalents, highly liquid marketable securities and short term receivables.
As of June 30, 2013 and December 31, 2012, GETCO had $2,194.4 million and $1,687.5 million of total assets, respectively. The assets consisting of cash and other assets readily convertible into cash were as follows (dollars in millions):
| (Unaudited) As of June 30, |
As of December 31, |
|||||||
| 2013 |
2012 |
|||||||
| Cash and cash equivalents |
$ | 466.5 | $ | 427.6 | ||||
| Restricted cash and cash equivalents |
308.1 | — | ||||||
| Receivables from exchanges |
20.3 | 11.5 | ||||||
| Receivables from clearing brokers and clearing organizations |
290.0 | 85.3 | ||||||
| Securities and options owned, at fair value |
||||||||
| Equity securities |
434.3 | 382.0 | ||||||
| Listed equity options |
111.6 | 92.3 | ||||||
| Debt securities |
21.5 | 183.6 | ||||||
| Collateralized agreements: |
||||||||
| Securities borrowed |
97.1 | 55.1 | ||||||
|
|
|
|
|
|||||
| Total cash and assets readily convertible to cash |
$ | 1,749.4 | $ | 1,237.4 | ||||
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|
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It is GETCO’s expectation that substantially all of the amounts disclosed in the table above could be liquidated to cash within five business days under normal market conditions; however, the liquidated values may be subjected to haircuts during distressed markets.
Securities and options owned, at fair value, principally consist of equities and listed equity options that trade primarily on U.S. and European equity markets, as well as corporate debt securities, which include short-term bond funds held as part of GETCO’s cash management.
Securities borrowed represent the value of cash or other collateral deposited with securities lenders to facilitate GETCO’s trade settlement process.
Receivables from exchanges are related to market volume based liquidity rebates.
Receivables from clearing brokers include interest bearing cash balances held with third party clearing brokers, including, or net of, amounts related to securities transactions. Receivables from clearing organizations include interest bearing cash balances including, or net of, securities transactions that have not yet reached their contracted settlement date.
Other assets primarily represent deposits and other miscellaneous receivables.
Total assets increased $506.8 million (30.0%) to $2,194.4 million at June 30, 2013 from $1,687.5 million at December 31, 2012. The majority of the increase in assets related to an increase in restricted cash and cash equivalents, receivables from clearing brokers and clearing organizations, equity securities and listed equity options owned, securities borrowed, and cash and cash equivalents, which were partially offset by a decline in debt securities owned. Restricted cash and cash equivalents increased $308.1 million to $308.1 million at June 30, 2013 from $0.0 million at December 31, 2012 primarily due to the $305.0 million of senior secured notes issued June 5, 2013. Receivables from clearing brokers and clearing organizations increased $204.8 million (240.1%) to $290.0 million at
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June 30, 2013 from $85.3 million at December 31, 2012 due to higher deposits at third party clearing organizations resulting from an increase in positions. Securities borrowed increased $42.0 million (76.1%) to $97.1 million at June 30, 2013 from $55.1 million at December 31, 2012. This increase is primarily related to growth of the options market making and international arbitrage businesses. Cash and cash equivalents increased $38.9 million (9.1%) to $466.5 million at June 30, 2013 from $427.6 million at December 31, 2012 primarily due to proceeds from the sale of GETCO’s short-term bond funds, which were partially offset by cash required to fund the operations during the six months ended June 30, 2013. Securities and options owned, which fluctuate based on trading volumes, market conditions, GETCO’s short-term investment holdings, and trading strategies utilized in the options market making and international arbitrage businesses, decreased $90.6 million (-13.8%) to $567.4 million at June 30, 2013 from $657.9 million at December 31, 2012, primarily due to the sale of GETCO’s short-term bond funds, partially offset by an increase in equity securities and listed equity options related to the growth of GETCO’s options market making and international arbitrage businesses.
Total liabilities increased $569.6 million (78.9%) to $1,291.3 million at June 30, 2013 from $721.7 million at December 31, 2012 primarily due to an increase in notes payable and securities and options sold, not yet purchased. Notes payable increased $305.0 million to $320.0 million due to the $305.0 million of senior secured notes issued June 5, 2013. Securities and options sold, not yet purchased increased $230.1 million (44.9%) to $742.7 million at June 30, 2013 from $512.6 million at December 31, 2012, primarily reflecting the impact of growth in the options market making and international arbitrage businesses. Payables to clearing brokers increased $9.9 million (41.0%) to $34.1 million at June 30, 2013 from $24.2 million at December 31, 2012, primarily due to higher net trading positions. Compensation payable increased $8.9 million (29.6%) to $39.1 million at June 30, 2013 from $30.2 million at December 31, 2012. The increase was primarily due to higher incentive compensation, partially offset by the payment of 2012 year-end bonuses.
Members’ equity decreased $62.8 million (-6.5%) to $903.0 million at June 30, 2013 from $965.8 million at December 31, 2012. The decrease primarily reflects a decrease in retained earnings.
Liquidity and Capital Resources
GETCO finances its business primarily with cash generated by operations, member contributions and clearing firm borrowings. GETCO had net current assets, which consist of net assets readily convertible into cash less current liabilities, of $793.5 million at June 30, 2013.
GETCO has completed several acquisitions over the last few years. In March 2010, GETCO acquired NYSE DMM rights from Barclays for $21.0 million and in December 2011, GETCO acquired additional DMM rights from Bank of America for $30.8 million. In July 2011, GETCO acquired Automat Limited for $11.9 million in cash and equity. In each case, there is no earn-out or contingent obligations.
Loss before income taxes was $69.6 million and income before income taxes was $6.0 million for the three months ended June 30, 2013 and 2012, respectively. Included in these amounts were certain non-cash expenses such as unit-based compensation, depreciation, and amortization. Unit-based compensation was $16.9 million and $0.8 million for the three months ended June 30, 2013 and 2012, respectively. Depreciation and amortization expense was $7.7 million and $7.7 million for the three months ended June 30, 2013 and 2012, respectively.
Capital expenditures related to GETCO’s operations were $6.2 million and $10.1 million for the three months ended June 30, 2013 and 2012, respectively. There were no payments related to acquisitions of businesses, trading rights and other items for the three months ended June 30, 2013 or 2012.
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On June 30, 2011, GETCO entered into a $30.0 million one year unsecured revolving credit facility with a single lender, which was amended on March 30, 2012 to increase the amount to $50.0 million, extend the maturity to July 5, 2015, and create a sub limit for letters of credit. Borrowings under the facility bore interest at LIBOR plus a margin of 2.5%. This facility was retired on May 21, 2013, at which time there were $3.0 million of letters of credit outstanding, which were subsequently cash collateralized.
On August 12, 2011, Octeg entered into a $50.0 million one year Secured Revolving Credit Facility with a single lender, which was retired on June 6, 2012. Borrowings under the facility were used to finance the purchase and settlement of securities, and bore interest at LIBOR plus a margin of 1.75% per annum. A commitment fee of 0.30% per annum on the average daily unused portion of the facility was payable quarterly in arrears.
On October 25, 2011, GETCO issued $15.0 million of seven year senior unsecured notes to a single lender, which were repaid in full (including accrued interest) upon the closing of the Mergers on July 1, 2013. The notes bore interest at a rate of 5.95% per annum and required, among other restrictions, the maintenance of certain financial covenants. At June 30, 2013, GETCO was in compliance with these covenants.
On June 6, 2012, Octeg entered into a $350.0 million three year secured revolving credit facility with a consortium of banks. Borrowings under the facility can be used to finance the purchase and settlement of securities and bear interest at LIBOR plus a margin of 1.75% per annum. A commitment fee at a rate of 0.35% per annum on the average daily unused portion of the facility is payable quarterly in arrears. The facility requires, among other restrictions, the maintenance of certain financial covenants. At June 30, 2013, Octeg was in compliance with these covenants. No amount was drawn under the facility at June 30, 2013. Upon the closing of the Mergers on July 1, 2013, the facility was terminated and replaced with the OCTEG-KCA Revolving Facility described in Note 17 to the financial statements included as Exhibit 99.1 to this Current Report on Form 8-K, which includes changes to add Knight Capital Americas LLC as a borrower, add KCG as a guarantor, increase the amount of revolving loans available to be drawn to $450.0 million, make loans available to KCA to fund margin deposits with the NSCC and make certain financial covenant and other changes.
On June 5, 2013, in connection with the closing of the Mergers, GETCO Financing Escrow, LLC (“Finance LLC”) issued the $305.0 million of 8.25% senior secured notes due June 15, 2018 (the “Senior Secured Notes”). Proceeds from the notes were placed into escrow until the closing of the Mergers on July 1, 2013, at which time Finance LLC was merged into KCG, with KCG surviving. The proceeds from the Senior Secured Notes, along with proceeds from $535.0 million of first lien term loans borrowed by KCG and $55.0 million of contributed equity by General Atlantic LLC, were used to fund the cash consideration paid to former shareholders of Knight in the Knight Merger, redeem existing debt of Knight, redeem existing debt of GETCO, and pay fees and expenses associated with the Mergers. The Senior Secured Notes require compliance with negative and affirmative covenants, that limit KCG’s ability to make distributions and investments, among other restrictions.
GETCO’s U.S. registered broker-dealers are subject to regulatory requirements intended to ensure the general financial soundness and liquidity of broker-dealers and require the maintenance of minimum levels of net capital, as defined in Rule 15c3-1 of the Exchange Act. These regulations also prohibit a broker-dealer from repaying subordinated borrowings, paying cash dividends, making loans to its parent, affiliates or employees, or otherwise entering into transactions which would result in a reduction of its total net capital to less than 120.0% of its required minimum capital. Moreover, a broker-dealer is required to notify the SEC and other regulators prior to repaying subordinated borrowings, paying dividends and making loans to its parent, affiliates or employees, or otherwise entering into transactions, which, if executed, would result in a reduction of 30.0% or more of its excess
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net capital (net capital less minimum requirement). The SEC has the ability to prohibit or restrict such transactions if the result is detrimental to the financial integrity of the broker-dealer. As of June 30, 2013, all of GETCO’s U.S. broker-dealers were in compliance with the applicable regulatory net capital rules.
The following table sets forth the net capital levels and requirements for the following domestic regulated broker-dealer subsidiaries at June 30, 2013, as reported in their respective regulatory filings (dollars in millions):
| Entity |
Net Capital | Net Capital Requirement |
Excess Net Capital |
|||||||||
| OCTEG, LLC |
$ | 100.0 | $ | 1.0 | $ | 99.0 | ||||||
| GETCO Securities, LLC |
$ | 60.8 | $ | 1.0 | $ | 59.8 | ||||||
| GETCO Execution Services, LLC |
$ | 3.7 | $ | 0.3 | $ | 3.4 | ||||||
GETCO, LLC, is a clearing member of the Chicago Mercantile Exchange, a self-regulatory organization (“SRO”), and is subject to net capital requirements as determined by SRO rules. The following table sets forth the net capital levels and requirements at June 30, 2013, as reported in its regulatory filing (dollars in millions):
| Entity |
Net Capital | Net Capital Requirement |
Excess Net Capital |
|||||||||
| GETCO, LLC |
$ | 106.5 | $ | 5.0 | $ | 101.5 | ||||||
GETCO’s foreign registered broker-dealers are subject to certain financial resource requirements of either the Financial Conduct Authority (“FCA”) or the Australian Securities and Investment Commission. Effective June 2013 GETCO is no longer operating in Hong Kong and therefore is no longer subject to compliance with the Hong Kong Securities and Futures Commission. GETCO’s Australia subsidiary was in compliance with its financial resource requirement at June 30, 2013. The following table sets forth the financial resource requirement for GETCO Europe Limited, GETCO’s FCA regulated broker-dealer subsidiary, at June 30, 2013 (dollars in millions):
| Entity |
Financial Resources |
Resource Requirement |
Excess Financial Resources |
|||||||||
| GETCO Europe Limited |
$ | 162.1 | $ | 110.9 | $ | 51.2 | ||||||
Off-Balance Sheet Arrangements
As of June 30, 2013, GETCO did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Effects of Inflation
Because the majority of GETCO’s assets are liquid in nature, they are not significantly affected by inflation. However, the rate of inflation may affect expenses, such as employee compensation, office leasing costs and trading infrastructure expenses, which may not be readily offset by higher revenues. To the extent inflation results in rising interest rates and has other adverse effects on the securities markets, it may adversely affect GETCO’s financial position and results of operations.
Critical Accounting Policies
GETCO’s annual consolidated financial statements are based on the application of GAAP, which requires GETCO to make estimates and assumptions about future events that affect the amounts reported in GETCO’s annual consolidated financial statements and the accompanying notes. Future
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events and their effects cannot be determined with certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates and any such differences may be material to GETCO’s annual consolidated financial statements. GETCO management believes that the estimates set forth below may involve a higher degree of judgment and complexity in their application than other accounting estimates and represent the critical accounting estimates used in the preparation of GETCO’s annual consolidated financial statements. GETCO management believes its judgments related to these accounting estimates are appropriate. However, if different assumptions or conditions were to prevail, the results could be materially different from the amounts recorded.
Financial Instruments and Fair Value
GETCO values its financial instruments using a hierarchy of fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value.
The fair value hierarchy can be summarized as follows:
| • | Level 1—Valuations based on quoted prices in active markets for identical assets or liabilities that GETCO has the ability to access, which does not require significant managerial judgment. |
| • | Level 2—Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. |
| • | Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement. |
Changes in fair value are recognized in earnings each period for financial instruments that are carried at fair value.
GETCO’s financial instruments owned and financial instruments sold, not yet purchased will generally be classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices or broker or dealer quotations with reasonable levels of price transparency.
The types of instruments that trade in markets that are not considered to be active, but are valued based on observable inputs such as quoted market prices or alternative pricing sources with reasonable levels of price transparency are generally classified within Level 2 of the fair value hierarchy.
The fair value of options and derivatives is determined using an option pricing model based on observable inputs such as implied volatility and risk-free interest rate, and are classified within Level 2 of the fair value hierarchy.
Certain instruments are classified within Level 3 of the fair value hierarchy because they trade infrequently and therefore have little or no price transparency. For those instruments that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used.
Goodwill and Intangible Assets
GETCO determines the values and useful lives of intangible assets upon acquisition. Goodwill is the cost of acquired companies or businesses in excess of the fair value of net assets, including identifiable intangible assets, at the acquisition date. Goodwill and intangible assets are assessed for impairment annually or when events indicate that the amounts may not be recoverable.
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GETCO assesses goodwill and intangibles for impairment at the reporting unit level. GETCO’s reporting units are the components of its business segments for which discrete financial information is available and is regularly reviewed by GETCO’s chief operating decision maker. As part of the assessment for impairment, GETCO considers the fair value of the respective reporting unit as well as the overall market value of GETCO compared to its net book value. The fair value estimate of the reporting units is principally performed using a discounted cash flow methodology with a risk-adjusted weighted average cost of capital which GETCO believes to be the most reliable indicator of the fair values of its respective reporting units.
If goodwill or an intangible asset is deemed impaired, it is written down to its estimated impaired value.
Strategic Investments
Strategic investments are accounted for under the equity method, at cost or at fair value. GETCO uses the equity method of accounting where GETCO is considered to exert significant influence on the investee. GETCO holds strategic investments at cost, less impairment if any, when GETCO is not considered to exert significant influence on operating and financial policies of the investee. Investments deemed to be available for sale assets are re-measured to fair value at the end of each period with changes in fair value recorded through other comprehensive income.
GETCO reviews investments on an ongoing basis to ensure that the carrying values of the investments have not been impaired. If GETCO assesses that an impairment loss on a strategic investment has occurred due to a decline in fair value or other market conditions, GETCO writes the investment down to its estimated impaired value.
Accounting Standards Updates
Recently adopted accounting guidance
In December 2011, the FASB issued an ASU that requires additional disclosures about financial assets and liabilities that are subject to netting arrangements. Under the ASU, financial assets and liabilities must be disclosed at their respective gross asset and liability amounts, the amounts offset on the balance sheet and a description of the respective netting agreements. The new disclosures are required for reporting periods beginning on or after January 1, 2013, and are to be applied retrospectively. Other than requiring additional disclosures, the adoption of this ASU did not have an impact on GETCO’s Consolidated Financial Statements.
In February 2013, the FASB issued an ASU that requires additional disclosure requirements for items reclassified out of accumulated other comprehensive income. This new guidance requires entities to present either on the face of the income statement or in the notes to the financial statements; the effects on the specific line items of the income statement for amounts reclassified out of accumulated other comprehensive income. This ASU is effective for reporting periods beginning after December 15, 2012. Other than requiring additional disclosures, the adoption of this ASU did not have an impact on GETCO’s Consolidated Financial Statements.
Recent accounting guidance to be adopted in future periods
In March 2013, the FASB issued an ASU concerning parent’s accounting for the cumulative translation adjustment upon recognition of certain subsidiaries of groups of assets within a foreign entity or of an investment in a foreign entity. This ASU provides for the release of the cumulative translation adjustment into net income when a parent sells a part or all of its investment within a foreign entity, no longer holds a controlling interest in an investment in a foreign entity or obtains control of an investment in a foreign entity that was previously recognized as an equity method investment. This
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ASU is effective for reporting periods beginning after December 15, 2013, however early adoption is permitted. We are evaluating the impact of this ASU on GETCO’s Consolidated Financial Statements.
In July 2013, the FASB issued an ASU to clarify the financial statement presentation of an unrecognized tax benefit when a net operating loss (“NOL”) carryforward, a similar tax loss, or a tax credit carryforward exists. This ASU requires entities to present an unrecognized tax benefit as a reduction of a deferred tax asset for a NOL carryforward whenever the NOL or tax credit carryforward would be available to reduce the additional taxable income or tax due if the tax position is disallowed. The ASU is required for reporting periods after December 31, 2013. Upon adoption, entities are required to apply the provisions of the ASU prospectively for all unrecognized tax benefits that exist at the adoption date, however, the ASU also indicates that retrospective application is permitted. The Company is currently evaluating the impact that such adoption will have on its consolidated financial statements.
Quantitative and Qualitative Disclosures About Market Risk
GETCO is exposed to numerous risks in the ordinary course of business and activities; therefore, effective risk management is critical to the Company’s financial soundness and profitability. GETCO maintains a comprehensive risk management structure and processes to monitor and evaluate the principal risks assumed in conducting business. The Company’s risk management policies, procedures, and methodologies are subject to ongoing review and modification. GETCO’s principal risks are as follows:
Market Risk
GETCO’s market making and trading activities expose GETCO’s capital to significant risks. These risks include, but are not limited to, absolute and relative price movements, price volatility, interest rates, credit terms, and changes in liquidity, over which GETCO has virtually no control. Equity price risks result from exposure to changes in prices and volatilities of individual equities, equity indices and other equity baskets or portfolios. Interest rate risks result primarily from exposure and changes in the relative yields of different fixed income instruments, the volatility of interest rates and credit spreads.
For working capital purposes, GETCO invests in money market funds or maintains interest-bearing balances at banks and in GETCO’s trading accounts with clearing brokers, which are classified as cash and cash equivalents and receivable from clearing brokers and clearing organizations, respectively, on the annual consolidated financial statements. These balances do not have maturity dates, effectively alleviating significant market risk, as the balances are short-term in nature and subject to daily repricing. GETCO’s cash and cash equivalents held in foreign currencies are subject to the exposure of foreign currency fluctuations. These balances are monitored daily and are not material to GETCO’s overall cash position.
GETCO employs proprietary position management and trading systems that provide real-time, on-line position management and inventory control. GETCO monitors its risks by reviewing trading positions and their appropriate risk measures. GETCO has established a system whereby transactions are monitored by senior management and an independent risk control function on a real-time basis as are individual and aggregate dollar and inventory position totals, risk allocations, and real-time profits and losses. GETCO’s management of trading positions is enhanced by GETCO’s review of mark-to-market valuations and position summaries on a daily basis.
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In the normal course of business, GETCO maintains inventories of exchange-listed and OTC equity securities, listed equity options, and fixed income products. The following table illustrates the fair values of these financial instruments at June 30, 2013 and June 30, 2012 (dollars in millions):
| (Unaudited) | ||||||||
| As of June 30, | As of June 30, | |||||||
| 2013 |
2012 |
|||||||
| Long stocks 1 |
$ | 433.5 | $ | 369.4 | ||||
| Short stocks |
645.7 | 748.3 | ||||||
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|
|
|
|
|||||
| Net short |
(212.2) | (378.9) | ||||||
| Long options |
$ | 111.6 | $ | 98.9 | ||||
| Short options |
80.5 | 99.0 | ||||||
|
|
|
|
|
|||||
| Net long/(short) |
31.1 | (0.1) | ||||||
| Long bonds 2 |
$ | 21.5 | $ | - | ||||
| Short bonds |
16.5 | - | ||||||
|
|
|
|
|
|||||
| Net long |
5.0 | - | ||||||
| Long treasury bills |
$ | 6.7 | $ | 5.5 | ||||
| 1. | Long stocks as of June 30, 2013 excludes $204.2 million of Knight common shares and $0.8 million of joint back office stock holdings, which we refer to as JBO stock. Long stocks as of June 30, 2012 excludes JBO stock amounts of $0.8 million. JBO stock relates to GETCO’s investments in certain of its clearing organizations that were made to reduce GETCO’s margin requirements under Regulation T. |
| 2. | Excludes short term bond fund amounts of $3.0 million as of June 30, 2012. |
Based on the above position levels, the potential change in fair value, using a hypothetical 10% decline in prices, is estimated to be a loss of $0.1 million as of June 30, 2013 and a gain of $3.8 million as of June 30, 2012, due to the offset of gains in short positions against losses in long positions.
Operational Risk
Operational risk can arise from many factors ranging from routine processing errors to potentially costly incidents arising, for example, from major systems failures. GETCO’s businesses are highly dependent on GETCO’s ability to process, on a daily basis, a large number of transactions across numerous and diverse markets in several currencies. GETCO incurs operational risk across all of its business activities, including revenue generating activities as well as support functions. Legal and compliance risk is included in the scope of operational risk and is discussed below under “Legal Risk.”
Primary responsibility for the management of operational risk lies with GETCO’s operating segments and supporting functions. GETCO’s operating segments maintain controls designed to manage and mitigate operational risk for existing activities. As new products and business activities are developed, GETCO endeavors to identify operational risks and design controls to seek to mitigate the identified risks.
Disaster recovery plans are in place for critical facilities related to GETCO’s primary operations and resources and redundancies are built into the systems as deemed reasonably appropriate. GETCO has also established policies, procedures and technologies designed to protect its systems and other assets from unauthorized access.
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Liquidity Risk
Liquidity risk is the risk that GETCO would be unable to meet its financial obligations as they arise in both normal and strained funding environments. To that end, GETCO has established a comprehensive and conservative set of policies that govern the management of liquidity risk for GETCO at the holding company and at the subsidiary entity level.
GETCO maintains readily available liquidity primarily in the form of cash and other highly liquid instruments to satisfy intraday and day-to-day funding needs, as well as potential cash needs under stressed liquidity conditions. In addition, GETCO maintains committed and uncommitted credit facilities with a number of unaffiliated financial institutions. In connection with the uncommitted credit facilities, the lender is at no time under any obligation to make any advance under the credit line, and any outstanding loans must be repaid on demand from the lender.
GETCO’s holding company and subsidiary level readily available liquidity as of June 30, 2013 and December 31, 2012 was comprised of the following (dollars in millions):
| (Unaudited) As of June 30, |
As of December 31, |
|||||||
| 2013 |
2012 |
|||||||
| HOLDING COMPANY: |
||||||||
| Liquidity Composition |
||||||||
| Cash Held at Banks |
$146.0 | $3.7 | ||||||
| Money Market and Other Highly Liquid Investments |
0.0 | 110.8 | ||||||
|
|
|
|
|
|||||
| Total Liquidity Pool |
$146.0 | $114.5 | ||||||
|
|
|
|
|
|||||
| SUBSIDIARIES: |
||||||||
| Cash and Other Highly Liquid Investments Held by Subsidiaries |
$628.6 | $313.1 | ||||||
GETCO regularly performs liquidity risk stress testing based on a scenario that considers both market-wide and company-specific stresses. Given the nature of GETCO’s business activity and balance sheet composition, survival over the first one to three days of a severe stress environment are most critical, after which management actions could be effectively implemented to navigate through prolonged periods of financial stress. The modeled cash inflows and outflows from the stress test serve as a quantitative input to assist GETCO in establishing its liquidity risk and targeted amount of liquid assets to be held. The liquidity stress test considers cash flow risks arising from, but not limited to, operational events, a severe and adverse change in market prices, and additional margin requirements. Over the course of the first six months of 2013 and the year ended December 31, 2012, GETCO generally maintained sufficient liquidity and liquid resources to satisfy the stress test.
Capital Risk
Government regulators, both in the U.S. and globally, as well as self-regulatory organizations, have supervisory responsibility over GETCO’s regulated activities and require GETCO to maintain specified minimum levels of regulatory capital in its broker-dealer subsidiaries. If not properly monitored, regulatory capital levels could fall below the required minimum amounts set by regulators, which could expose GETCO to various sanctions ranging from fines and censure to imposing partial or complete restrictions on its ability to conduct business. In addition, GETCO has borrowing and other arrangements under which it is obligated to maintain minimum levels of regulatory capital and/or net worth. Failure to maintain the minimum levels under borrowing arrangements could result in a requirement for GETCO to promptly repay outstanding balances under these arrangements regardless of the stated maturity or could cause these arrangements to become unavailable to GETCO.
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To mitigate the above risks, GETCO continuously evaluates the levels of capital at each relevant entity and adjusts the amounts of capital as necessary to ensure compliance with all external requirements. Guided by a capital stress scenario, GETCO targets minimum levels of excess capital to accommodate expected and unexpected increases in capital requirements, including from expected changes in regulatory rules, and a potential reduction in capital due to financial losses.
Legal Risk
Legal risk includes the risk of non-compliance with applicable legal and regulatory requirements and standards. GETCO is generally subject to extensive regulation in the different jurisdictions in which GETCO conducts business. 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. GETCO’s ability to comply with all applicable laws and rules is largely dependent on its internal system to ensure compliance, as well as its ability to attract and retain qualified compliance personnel. GETCO could be subject to disciplinary or other actions in the future due to claimed noncompliance, which could have a material adverse effect on its business, financial condition and results of operations. To continue to operate and to expand GETCO’s services internationally, GETCO may have to comply with the regulatory controls of each country in which it conducts, or intends 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 GETCO’s ability to continue existing international operations and further expand internationally. Changes in laws or government regulations may result in the prohibition or restriction of certain types of activities GETCO may engage in or in the imposition of new or additional requirements that could reduce GETCO’s revenues and earnings. Any future changes in laws or government regulations may make it more difficult or expensive for GETCO to conduct its business and could have a material adverse effect on its business, financial condition and results of operations. GETCO has established procedures based on legal and regulatory requirements that are designed to foster compliance with applicable statutory and regulatory requirements. GETCO has also established procedures that are designed to require that its policies relating to conduct, ethics and business practices are followed.
GETCO is subject to the risk of losses which may arise from litigation or other claims that may arise in connection with the operation of its businesses. GETCO may become involved with commercial disputes with clearing firms, suppliers, landlords or other companies with which it does business, and which may include contractual and commercial risk such as the unenforceability of a counterparty’s performance obligations. GETCO may also be subject to litigation or other claims involving its associates, including claims relating to wages or other compensation, employment discrimination, wrongful termination or similar matters. In addition, GETCO may inadvertently infringe third-party patents or interfere with other third-party intellectual property rights. These third parties could bring claims against GETCO that, even if resolved in its favor, could cause GETCO to incur substantial expenses and, if resolved against GETCO, could additionally cause GETCO to pay substantial damages. Further, if a patent infringement or other suit were brought against GETCO, it could be forced to discontinue certain of its investment activities, which could have a material adverse effect on GETCO’s business.
GETCO’s success depends in part on its ability to obtain and maintain intellectual property protection for its technology and know-how, including proprietary trading algorithms and information technology systems. GETCO relies primarily on trade secrets and other confidential information to maintain its proprietary position. To maintain the confidentiality of trade secrets and proprietary information, GETCO has entered into confidentiality agreements with its associates, consultants and collaborators upon the commencement of their relationships with GETCO. These agreements require that all confidential information developed by the individual or made known to the individual by GETCO
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during the course of the individual’s relationship with GETCO be kept confidential and not disclosed to third parties. GETCO’s agreements with associates also provide that inventions conceived by the individual in the course of rendering services to GETCO will be GETCO’s exclusive property. Individuals with whom GETCO has these agreements may not comply with their terms. In the event of the unauthorized use or disclosure of GETCO’s trade secrets or proprietary information, these agreements, even if obtained, may not provide meaningful protection for its trade secrets or other confidential information. To the extent that GETCO Associates, consultants or contractors use technology or know-how owned by others in their work for GETCO, disputes may arise as to the rights in related inventions. Adequate remedies may not exist in the event of unauthorized use or disclosure of GETCO’s confidential information. The disclosure of GETCO’s trade secrets could impair its competitive position and could have a material adverse effect on its operating results, financial condition and future growth prospects.
Credit Risk
Credit risk represents the loss that GETCO would incur if a counterparty fails to perform its contractual obligations in a timely manner. There are two types of activities that give rise to credit risk exposures at GETCO: trading operations and cash management/investing activities. With regards to trading operations, GETCO transacts primarily on exchanges with central clearing, so GETCO does not in the normal course of business incur material amounts of credit risk from these operations. However, the volume of trading activity that does expose GETCO to credit risk, namely activity conducted within GETCO’s Execution Services segment, is growing. Regarding GETCO’s cash management investing operations, its business model enables GETCO to hold a large portion of its capital in the form of investable cash, which it invests with banks and money managers. These invested balances expose GETCO to credit risk.
Responsibility for monitoring and controlling GETCO’s trading related counterparty credit risks lies primarily within GETCO’s Global Risk Management function. GETCO’s credit risk function’s process for managing credit risk includes a qualitative and quantitative risk assessment of significant counterparties prior to engaging in business activity, as well as, on an ongoing basis. The review includes formal financial analysis and due diligence when appropriate.
GETCO’s credit risk function is responsible for approving trading counterparties and establishing credit limits to manage credit risk exposure by counterparty. The assigned limits reflect the various elements of assessed credit risk and are revised as warranted to correspond with changes in the counterparties’ credit profiles or GETCO’s risk tolerance. GETCO’s credit risk function communicates counterparty limits to the business areas as well as senior management, and monitors compliance with the established limits.
Responsibility for monitoring and controlling GETCO’s cash management related counterparty credit risks lies principally within its internal treasury function. The treasury function’s process for managing credit risk relies on a combination of qualitative and quantitative inputs. The function also establishes and utilizes maximum concentration guidelines to limit GETCO’s exposure to any single counterparty.
Foreign Currency Risk
As an international organization, GETCO incurs foreign currency exposure as a result of trading instruments, and maintaining assets and liabilities, denominated in currencies other than the U.S. Dollar, primarily the Euro. A portion of these risks are actively hedged, but fluctuations in currency exchange rates could impact GETCO’s results of operations, financial position and cash flows.
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Exhibit 99.3
RISK FACTORS
In addition to the other information set forth below and in this Current Report on Form 8-K, you should carefully consider the factors discussed in the Registration Statement on Form S-4 (Registration No. 333-186624) filed by KCG with respect to the Mergers and the Current Report on Form 8-K filed by KCG with the SEC on July 1, 2013, which could materially affect our business, financial condition or future results.
Risk Factors Relating to the Mergers
The market price for KCG Class A Common Stock may be affected by factors different from those that historically have affected Knight
KCG’s businesses differ from those of Knight and the results of operations of KCG will be affected by some factors that are different from those that affected the results of operations of Knight. For example, KCG’s high frequency trading operations are more substantial than those of Knight on a stand-alone basis. High frequency trading continues to be the focus of extensive and rigorous regulatory scrutiny by federal, state and foreign regulators and self-regulatory organizations, which we refer to as SROs. Knight’s market making segment primarily includes client-facing market making activities, while GETCO’s market making activities have historically been non-client-facing (i.e., proprietary). Following the Mergers, KCG’s operations include both substantial client- and non-client facing activities. Accordingly, KCG may be affected by factors relating to both such types of market making activities, including client sensitivities to KCG’s non-client trading activities such as high frequency trading operations. KCG’s clients may also be sensitive to the need to ensure proper information barriers are created between KCG’s high frequency trading operations and its client-facing market making activities. Further, GETCO was a private company prior to completion of the Mergers. As a public company, KCG’s business and operations, including the business and operations conducted by GETCO prior to the completion of the Mergers, are subject to public company requirements, including periodic reporting requirements, compliance with the standards contemplated by Section 404 of the Sarbanes-Oxley Act of 2002, as amended, and the rules promulgated thereunder by the SEC, which we refer to as the Sarbanes-Oxley Act, and scrutiny by industry or financial analysts. As a result of the above, the market price of KCG Class A Common Stock may be subject to regulatory and client risk and be affected by KCG’s ability to comply with public company requirements, which were not applicable to GETCO prior to the completion of the Mergers.
KCG has significant leverage
As a result of the Mergers, KCG has significantly more leverage than either Knight or GETCO did independently prior to the Mergers. The total amount of funds required to pay the cash portion of the merger consideration, refinance substantially all of Knight’s and GETCO’s existing long-term debt, and pay related fees and expenses, was approximately $1.2 billion, which was funded through a combination of cash on hand at Knight and GETCO, the contribution in cash of $55.0 million from the equity financing by affiliates of General Atlantic and the proceeds of the first lien credit facility and an offering of senior secured second lien notes.
As a result of the credit facility entered into, and the notes issued, in connection with the Mergers, KCG has a significant amount of leverage. This leverage may have important negative consequences for KCG, including:
| • | increasing its vulnerability to general adverse economic and industry conditions; |
| • | requiring it to dedicate a portion of its cash flow from operations to payments on its indebtedness, thereby reducing the availability of cash flow to fund working capital, capital expenditures, acquisitions and investments and other general corporate purposes; |
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| • | making it difficult for it to optimally manage the cash flow for its businesses; |
| • | limiting its flexibility in planning for, or reacting to, changes in its businesses and the markets in which it operates; |
| • | placing it at a competitive disadvantage compared to its competitors that have less debt; |
| • | subjecting it to a number of restrictive covenants that, among other things, limit its ability to pay dividends and distributions, make acquisitions and dispositions, borrow additional funds, and make capital expenditures and other investments, and |
| • | exposing it to interest rate risk due to the variable interest rate on borrowings under its credit facility. |
KCG’s ability to make payments of the principal on and refinance its indebtedness will depend on its future performance, its ability to generate cash flow and market conditions, each of which is subject to economic, financial, competitive and other factors beyond its control. KCG’s business may not continue to generate cash flow from operations sufficient to service its debt and make necessary capital expenditures. If KCG is unable to generate such cash flow, it may be required to adopt one or more alternatives, such as selling assets, restructuring debt, undertaking additional borrowings or issuing additional debt or obtaining additional equity capital on terms that may be onerous or highly dilutive. KCG’s ability to refinance all or a portion of its indebtedness will depend on the capital markets, the credit markets and its financial condition at such time. KCG may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in increased financing costs or a default on its debt obligations.
KCG may fail to realize the anticipated benefits of the Mergers
The success of the Mergers will depend on, among other things, KCG’s ability to combine the businesses of GETCO and Knight in a manner that permits growth opportunities and does not materially disrupt the existing customer relationships of Knight or GETCO nor result in materially decreased revenues due to loss of customers. If KCG is not able to successfully achieve these objectives, the anticipated benefits of the Mergers may not be realized fully or at all or may take longer to realize than expected.
Moreover, certain key employees of Knight and GETCO that KCG wishes to retain may elect to terminate their employment after the Mergers, which could delay or disrupt the integration process or the current KCG businesses. It is possible that the post-closing integration process could result in the disruption of GETCO’s or Knight’s ongoing businesses or cause issues with standards, controls, procedures and policies that adversely affect the ability of GETCO or Knight to maintain relationships with customers and employees or to achieve the anticipated benefits of the Mergers.
The market price of KCG Class A Common Stock may decline if, among other factors, the integration of the Knight and GETCO businesses is unsuccessful, the operational cost savings estimates are not realized, key employees leave KCG, or the transaction costs related to the Mergers are greater than expected. The market price of KCG Class A Common Stock also may decline if KCG does not achieve the perceived benefits of the Mergers as rapidly as, or to the extent, anticipated by financial or industry analysts or if the effect of the Mergers on KCG’s financial results is not consistent with the expectations of financial or industry analysts.
Shares of KCG Class A Common Stock are subject to dilution as a result of exercise of the warrants
The shares of KCG Class A Common Stock are subject to dilution upon exercise of the warrants issued in connection with the Mergers. Approximately 24.3 million shares of KCG Class A Common
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Stock may be issued in connection with exercise of the warrants. These warrants have exercise prices ranging from $12.00 to $15.00 and terms of between four and six years. The warrants may be exercised at any time, even if the current market price of the KCG Class A Common Stock is below the applicable exercise price.
The market price of KCG Class A Common Stock will likely be influenced by the warrants. For example, the market price of KCG Class A Common Stock could become more volatile and could be depressed by investors’ anticipation of the potential resale in the market of a substantial number of additional shares of KCG Class A Common Stock received upon exercise of the warrants.
Knight and GETCO incurred and KCG will continue to incur substantial transaction-related costs in connection with the Mergers
Knight and GETCO incurred a number of non-recurring transaction-related costs associated with completing the Mergers, and KCG has incurred and expects to continue to incur costs relating to combining the operations of the two companies and achieving desired synergies. These fees and costs have been, and will continue to be, substantial. Non-recurring transaction costs include, but are not limited to, fees paid to legal, financial and accounting advisors, severance and benefit costs, filing fees and printing costs. Additional unanticipated costs may be incurred in the integration of the businesses of Knight and GETCO. These costs could have a material adverse effect on KCG’s financial condition and operating results.
There can be no assurance that the elimination of certain duplicative costs, as well as the realization of other efficiencies related to the integration of the two businesses, will offset these and other incremental transaction-related costs over time. Thus, any net benefit may not be achieved in the near term, the long term or at all.
The liquidity of the KCG common stock may be less than that of Knight common stock prior to the Mergers.
The number of outstanding shares of KCG common stock following the mergers is significantly less than number of outstanding shares of Knight common stock immediately prior to the Mergers. As of August 7, 2013, there were 120.9 million shares of KCG common stock outstanding, compared to approximately 374.8 million shares of Knight common stock outstanding as of May 1, 2013 (in each case, including RSUs). The lower number of shares of KCG common stock outstanding following the Mergers, relative to the shares of Knight common stock outstanding prior to the completion of the Mergers, may result in relatively lower liquidity in the market for the shares of KCG common stock, which in turn may increase the transaction costs of buying and selling the shares.
Risk Factors Relating to KCG
A number of industry-related risks may adversely affect the business, financial condition and operating results of KCG. The risks described below are all material risks currently known to be facing KCG. Additional risks and uncertainties not currently known to us also may adversely affect our business, financial condition and/or operating results in a material manner. In addition, KCG may also be affected by general risks not directly related to its business, including, but not limited to, acts of war, terrorism and natural disasters.
Conditions in the financial services industry and the securities markets may adversely affect KCG’s trading volumes and market liquidity
KCG’s revenues are primarily transaction-based, and declines in global trading volumes, volatility levels, securities prices, commission rates or market liquidity could adversely affect the business and
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its profitability. To date in 2013, conditions in the financial services industry and across the securities markets are best characterized as stable with low trading volumes and volatility levels. There is no single factor or trend suggesting either a clearly favorable or adverse opportunity set for KCG’s current businesses.
Market conditions, however, are not static. There may be periods when these conditions may have an adverse impact on KCG’s business and profitability, such as those witnessed in 2012. Declines in the volume of equities, fixed income and other financial transactions will generally result in lower revenues from market making and transaction execution activities. Lower levels of volatility, which tends to be correlated with trading volume, will have the same directional impact. Lower price levels of securities and other instruments, as well as tighter spreads, can result in reduced revenue capture, and thereby reduced profitability from trade executions. Increased competition can pressure commission rates, spreads and related fee schedules. Declines in market values of securities or other financial instruments can result in illiquid markets, which can increase the potential for losses on securities or other instruments held in inventory, the failure of buyers and sellers to fulfill their obligations and settle their trades, and increases in claims and litigation. Accordingly, reductions in trading volumes, volatility levels, securities prices, commission rates or market liquidity could materially affect KCG’s business and profitability.
KCG’s future operating results may fluctuate significantly as a result of numerous factors
KCG may experience significant variation in its future results of operations. These fluctuations in KCG’s future performance may result from numerous factors, including, among other things, global financial market conditions and the resulting competitive, credit and counterparty risks; cyclicality, seasonality and other economic conditions; the value of KCG’s securities positions and other financial instruments and KCG’s ability to manage the risks attendant thereto; the volume, notional dollar value traded and volatility levels within the core markets where KCG’s market making and trade execution businesses operate; the composition, profile and scope of KCG’s relationships with institutional and broker-dealer clients; the performance, size and volatility of KCG’s client market making portfolios; the performance, size and volatility of KCG’s non-client principal trading activities (including high frequency trading); KCG’s ability to design, build and effectively deploy the necessary technologies and operations to support all of its trading activities and enable KCG to remain competitive across markets and geographies; the effectiveness of KCG’s self-clearing and futures platforms and KCG’s ability to manage risk related thereto; our ability to prevent erroneous trade orders from being submitted by KCG on account of technology or other issues (such as the events that occurred at Knight on August 1, 2012) and avoiding the consequences thereof; changes in payments for order flow or in clearing, execution and regulatory transaction costs; the addition or loss of executive management, sales, trading and technology professionals; geopolitical, legislative, legal, regulatory, and financial reporting changes specific to financial services and global trading; legal or regulatory matters and proceedings; KCG’s high level of indebtedness and covenants that limit its operational flexibility and increase sensitivity to interest rate movements; the amount, timing and costs of business divestitures/acquisitions or strategic investments; the integration of the businesses of Knight and GETCO; KCG’s ability to eliminate certain duplicative costs and realize other efficiencies and revenue opportunities as a result of the Mergers; the integration, performance and operation of acquired businesses; investor sentiment; technological changes and events.
Such factors may also have an impact on KCG’s ability to achieve its strategic objectives, including, without limitation, increases in market share, growth and profitability in its operating segments. If demand for KCG’s services declines or its performance deteriorates significantly due to any of the above factors, and KCG is unable to adjust its cost structure on a timely basis, its operating results could be materially and adversely affected.
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KCG trading activities will expose it to the risk of significant losses
KCG conducts the majority of its trading activities as principal, which subjects its capital to significant risks. These activities involve the purchase, sale or short sale of securities and other financial instruments for KCG’s own account and, accordingly, involve risks of price fluctuations and illiquidity, or rapid changes in the liquidity of markets that may limit or restrict KCG’s ability to either resell securities or other financial instruments KCG purchases or to repurchase securities or other financial instruments KCG sells in such transactions. From time to time, KCG may have large position concentrations in securities or other financial instruments of a single issuer or issuers engaged in a specific industry, which could result in higher trading losses than would occur if KCG’s positions and activities were less concentrated. Neither Knight nor GETCO historically maintained such large position concentrations in the ordinary course of its business, but both Knight and GETCO have nonetheless occasionally acquired or held such positions as a result of various market conditions or other facts or circumstances. The performance of KCG’s trading activities primarily depend upon its ability to attract order flow, the composition and profile of its order flow, the dollar value of securities and other financial instruments traded, the performance, size and volatility of KCG’s market making portfolios, the performance, size and volatility of KCG’s client and non-client principal trading activities (including high frequency trading), market interaction, the skill of KCG’s trading personnel, the ability of KCG to design, build and effectively deploy the necessary technologies and operations to support all of its trading activities and enable KCG to remain competitive, general market conditions, effective hedging strategies and risk management processes, the price volatility of specific securities or other financial instruments, and the availability and allocation of capital. To attract order flow, KCG must be competitive on price, size of securities positions and other financial instruments traded, liquidity offerings, order execution speed, technology, reputation, payment for order flow, and client relationships and service. In KCG’s role as a market maker, it attempts to derive a profit from the difference between the prices at which it buys and sells securities. However, competitive forces and regulatory requirements often require KCG to match, or improve upon, the quotes other market makers display and to hold varying amounts of securities in inventory. By having to maintain inventory positions, KCG is subject to a high degree of risk. There can be no assurance that KCG will be able to manage such risk successfully or that KCG will not experience significant losses from such activities. For example, on August 1, 2012, at the open of trading at the NYSE, Knight experienced a technology issue related to the installation of trading software which resulted in Knight’s broker dealer subsidiary, Knight Capital Americas LLC, sending numerous erroneous orders in NYSE-listed and NYSE Arca securities into the market. Knight Capital Americas LLC subsequently traded out of its entire erroneous trade position, which resulted in a realized pre-tax loss of approximately $457.6 million. All of the above factors could have a material adverse effect on KCG’s business, financial condition and operating results.
Regulatory and legal uncertainties could harm KCG’s business
The capital markets industry in the U.S. and the foreign jurisdictions in which KCG conducts its business is subject to extensive oversight under federal, state and applicable foreign laws, rules and regulations, as well as the rules of SROs. Broker-dealers, investment advisors, mortgage brokers and financial services firms are subject to regulations concerning all aspects of their businesses, including trade practices, best execution practices, capital adequacy, record-keeping, anti-money laundering, fair and requisite disclosure, and the conduct of their officers, supervisors and employees. KCG’s operations and profitability may be directly affected by, among other things, additional legislation or regulation, or changes in rules promulgated by domestic or foreign governments or regulators; and changes in the interpretation or enforcement of existing laws, regulations and rules. Failure to comply with these laws, rules or regulations could result in, among other things, administrative or court proceedings, censure, fines, the issuance of cease-and-desist orders or injunctions, loss of membership, or the suspension or disqualification of the market participant or broker-dealer, and/or
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their officers, supervisors or employees. KCG’s ability to comply with applicable laws, regulations and rules is largely dependent on its internal systems to ensure compliance, as well as its ability to attract and retain qualified compliance personnel. Each of KCG’s regulators engages in a series of periodic and special examinations and investigations to monitor compliance with such laws, rules and regulations that may result in disciplinary actions in the future due to alleged noncompliance. KCG is currently the subject of regulatory reviews and investigations that may result in disciplinary actions in the future due to alleged non-compliance.
Federal, state and foreign legislators, regulators and SROs are constantly proposing, or enacting, new regulations which may impact KCG’s business. These include rules regarding: a consolidated audit trail designed to improve the ability of the SEC and others to oversee trading in the U.S. securities markets, private or over-the-counter markets, sometimes referred to as dark liquidity pools, increased transaction and other fees, transaction taxes, enhanced requirements regarding market access (including SEC Rule 15c3-5) and for technology testing and implementation, increased obligations for market makers, higher capital requirements, and order routing limitations. A number of new regulations that impact market makers were recently either adopted or implemented. Additionally, Section 31 fees, sometimes described as “SEC Fees”, are reviewed regularly. These could increase substantially in the future in order to recover the costs incurred by the government, including the SEC, for supervising and regulating the securities markets.
Further, in January 2010, the SEC issued a Concept Release seeking public comment on certain market structure issues such as high frequency trading, the colocation of servers with exchange matching engines, off-exchange trading, including internalization where brokers match orders with their own inventory, and markets that do not publicly display price quotations including dark liquidity pools. In particular, high frequency trading continues to be the focus of extensive and rigorous regulatory scrutiny by federal, state and foreign regulators and SROs, and such scrutiny is likely to continue. Although no rules have yet been proposed in the U.S., there are market participants that continue to call upon the U.S. Congress and the SEC to propose and adopt rules that could curtail (or eliminate) high-frequency trading in some fashion, including: restrictions on colocation, order-to-execution ratios, minimum quote life, and further transaction taxes.
In addition, the financial services industry in many foreign countries is heavily regulated, much like the U.S. The varying compliance requirements of these different regulatory jurisdictions and other factors may limit KCG’s ability to conduct business or expand internationally. For example, the Markets in Financial Instruments Directive, which we refer to as the MiFID, which was implemented in November 2007, continues to be under review by the European Parliament. In October 2012, the European Parliament adopted, with amendments, MiFID 2/MiFIR. MiFID 2/MiFIR will not be finalized until completion of trialogues among the European Commission, European Parliament, and Council of the European union, which may begin in the third quarter of 2013. The MiFID 2/MiFIR proposals include many changes likely to affect KCG’s business. For example, the current proposal would require firms like KCG to conduct all trading on European markets through authorized investment firms. MiFID 2/MiFIR will also require certain types of firms, including KCG, to post firm quotes at competitive prices and will supplement current requirements with regard to investment firms’ risk controls related to the safe operation of electronic system. MiFID 2/MiFIR may also impose additional requirements on trading platforms on which KCG will trade, such as a minimum order resting time, cancellation fees, circuit breakers, and limits on the ratio of unexecuted orders to trades. Each of these proposals may impose technological and compliance costs on KCG as a participant in those trading platforms.
In addition, public debate in Europe regarding high-frequency trading is leading policymakers to consider laws and regulations that may impact KCG’s business. For example, France and Italy have adopted a financial transactions tax. In addition, in Germany, proposed legislation could, among other things, place limits on order-to-execution ratios and require all high-frequency traders on German exchanges to be authorized to trade in Germany.
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Any of these laws, rules or regulations, if adopted, as well as any regulatory or legal actions or proceedings, changes in legislation or regulation, and changes in market customs and practices could have a material adverse effect on KCG’s business, financial condition and operating results.
Urban Financial Group, Inc., which we refer to as Urban, which was acquired by Knight in 2010, is subject to a complex and diverse framework of federal, state, and local laws and regulations. Failure to adhere to these laws and regulations could result in written citation, fines, suspension, or potential loss of licensing.
KCG’s business is subject to substantial risk from litigation, regulatory investigations and potential liability under federal, state and international laws, rules and regulations
Many aspects of KCG’s business involve substantial risks of liability. KCG is exposed to potential liability under federal, state and foreign securities laws, other federal, state and foreign laws and court decisions, as well as rules and regulations promulgated by U.S. and foreign regulators. KCG is also be subject to the risk of potential litigation. From time to time, Knight and GETCO, and certain of its past and present officers, directors and employees, were, and KCG may be in the future, named as parties in legal actions, regulatory investigations and proceedings, arbitrations and administrative claims and have been subject to claims alleging the violation of such laws, rules and regulations, some of which have resulted in the payment of fines, awards, judgments and settlements. Moreover, KCG may be required to indemnify past and present officers, directors and employees in regards to these matters (including officers, directors and employees of Knight and GETCO). Certain corporate events, such as a reduction in KCG’s workforce, could also result in additional litigation or arbitration.
KCG could incur significant legal expenses in defending such litigations or proceedings. An adverse resolution of any current or future lawsuits, legal or regulatory proceedings or claims against KCG could have a material adverse effect on its business and reputation, financial condition and operating results. By way of example, litigation, regulatory and liability risks may arise, and the Knight technology issue of August 1, 2012 and related events are an example of developments that may result in these risks being realized.
Substantial competition could reduce KCG’s market share and harm KCG’s financial performance
All aspects of KCG’s business are intensely competitive. KCG faces competition in its businesses primarily from global, national and regional broker-dealers, exchanges, and alternative trading systems, which we refer to as ATSs. ATSs include crossing networks that match orders in private or without a public quote, electronic communication networks that match orders off-exchange based on a displayed public quote, which we refer to as ECNs, and dark liquidity pools which offer a variety of market models enabling investors to trade off-exchange. Equities competition is based on a number of factors, including KCG’s execution standards (e.g., price, liquidity, speed and other client-defined measures), client relationships and service, reputation, payment for order flow, market structure, product and service offerings, and technology. KCG will continue to face intense competition in connection with its high frequency trading activities, and KCG’s ability to effectively compete will depend on a number of factors including its ability to design, build and effectively deploy the necessary technologies and operations to support all of its trading activities. A number of competitors of KCG’s businesses have greater financial, technical, marketing and other resources than KCG. Some of KCG’s competitors offer a wider range of services and financial products than KCG does and have greater name recognition and a more extensive client base. These competitors may be able to respond more quickly than KCG to new or evolving opportunities and technologies, market changes, and client requirements and may be able to undertake more extensive promotional activities and offer more attractive terms to clients. Moreover, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties or may consolidate to enhance their services and products. It is possible that new competitors, or alliances among
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competitors, may also emerge and they may acquire significant market share. The trend toward increased competition in KCG’s businesses is expected to continue and it is possible that KCG’s competitors may acquire increased market share.
As a result of the above, there can be no assurance that KCG will be able to compete effectively with current or future competitors, which could have a material adverse effect on KCG’s business, financial condition and operating results.
KCG could lose significant sources of revenues if it loses any of its larger clients
At times, a limited number of clients could account for a significant portion of KCG’s order flow, revenues and profitability, and KCG expects a large portion of the future demand for, and profitability from, its trade execution services to remain concentrated within a limited number of clients. Although neither Knight nor GETCO had any individual non-affiliate clients which it considered to be significant in 2012, 2011 or 2010 (which each of Knight and GETCO considered to be any client who accounted for 10% or more of its U.S. equity dollar value traded or fixed income value traded), the loss of one or more larger clients could nonetheless have an adverse effect on KCG’s revenues and profitability following the completion of the Mergers.
None of KCG’s clients is currently contractually be obligated to utilize KCG for trade execution services and, accordingly, these clients may direct their trade execution activities to other execution providers or market centers at any time. Some of these clients have grown organically or acquired market makers and specialist firms to internalize order flow or will have entered into strategic relationships with competitors. There can be no assurance that KCG will be able to retain these major clients or that such clients will maintain or increase their demand for KCG’s trade execution services. There is a risk that the Mergers themselves (i.e., the combination of Knight and GETCO), could cause certain former clients of either firm to reduce the orders they send to KCG or to cease trading with KCG altogether. The loss of that order flow could have a material adverse impact on KCG’s business. Further, the integration process related to the Mergers could result in disruption to KCG’s ongoing businesses or cause issues with standards, controls, procedures and policies that adversely affect the ability of KCG to maintain relationships with customers, or to solicit new customers. The loss, or a significant reduction, of demand for KCG’s services from any of these clients could have a material adverse effect on KCG’s business, financial condition and operating results. By way of example, as a result of the aforementioned Knight technology issue on August 1, 2012 and the resultant loss, Knight experienced reduced order flow from its clients and lost certain clients. In July 2012, Knight executed approximately 60 million market making trades in U.S. equities, while in August and September 2012 Knight executed approximately 45 million and approximately 51 million of such trades, respectively (such trades having returned to more normalized levels since September 2012). Losses similar to these could have a material adverse impact on KCG’s business. There is a risk that order flow from former clients of Knight may not return to historical levels.
Exposure to credit risk may adversely affect KCG’s results of operations
KCG will be at risk if issuers whose securities or other instruments KCG holds, customers, trading counterparties, counterparties under derivative contracts or financing agreements, clearing agents, exchanges, clearing houses or other financial intermediaries or guarantors default on their obligations to KCG due to bankruptcy, insolvency, lack of liquidity, adverse economic conditions, operational failure, fraud or other reasons. Such defaults could have a material adverse effect on KCG’s results of operations, financial condition and cash flows.
KCG conducts the majority of its trade executions as principal or riskless-principal with broker-dealers, financial services firms and institutional counterparties. KCG self-clears a considerable portion of its trade executions, which requires that KCG compare and match trades, record all transaction details,
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finance inventory and maintain deposits with clearing organizations, rather than rely upon an outside party to provide those services. When KCG self-clears its securities transactions, it is required to hold the securities subject to those transactions until the transactions settle, which typically occurs three trading days following the date of execution of the transaction. During the period of time from the execution to the settlement of a securities transaction, the securities to be transferred in the transaction may incur a significant change in value or the counterparty to the transaction may become insolvent, may default on its obligation to settle the transaction or may otherwise become unable to comply with its securities financing contractual obligations, resulting in potential losses to KCG. KCG is also exposed to credit risk from its counterparties when it self-clears securities transactions and when it clears securities transactions through an unaffiliated clearing broker, the latter of which is the case with a minority of KCG’s trade executions. Counterparty credit risk relates to both the deposits held with clearing organizations and instances where a trade might have failed, or be contested, adjusted or generally deviate from the terms understood at the time of execution. Under the terms of the agreements between KCG and its clearing brokers, the clearing brokers have the right to charge KCG for losses that result from a counterparty’s failure to fulfill its contractual obligations. No assurance can be given that any such counterparty will not default on its obligations, which default could have a material adverse effect on KCG’s business, financial condition and operating results.
Self-clearing exposes KCG to significant operational, financial, and liquidity risks
In 2009, Knight undertook an initiative to self-clear its securities transactions using an internally-developed platform. In addition, GETCO historically self-cleared a portion of its transactions. These practices remain with KCG, which self-clears substantially all of its domestic and international equities transactions using proprietary platforms and intends to expand self-clearing across product offerings and asset classes in the future. Self-clearing requires KCG to finance the majority of its inventory and maintain margin deposits at clearing organizations. Self-clearing exposes KCG’s business to operational risks, including business and technology disruption, operational inefficiencies, liquidity and financing risks and potentially increased expenses and lost revenue opportunities. While KCG’s clearing platform, operational processes, enhanced infrastructure, and current and future financing arrangements, have been carefully designed, KCG may nevertheless encounter difficulties that may lead to operating inefficiencies, including technology issues, dissatisfaction amongst KCG’s client base, disruption in the infrastructure that supports the business, inadequate liquidity (as Knight experienced during the events of August 1, 2012), increased margin requirements with clearing organizations and counterparties who provide financing with respect to inventories, reductions in available borrowing capacity and financial loss. Any such delay, disruption, expense or failure could adversely affect KCG’s ability to effect transactions and manage its exposure to risk. Moreover, any of these events could have a material adverse effect on KCG’s business, financial condition and operating results.
KCG may not be able to keep up with rapid technological and other changes or adequately protect its intellectual property
The markets in which KCG competes are characterized by rapidly changing technology, evolving industry standards, frequent new product and service announcements, introductions and enhancements, and changing client demands. If KCG is not able to keep up with these rapid changes on a timely and cost-effective basis, it may be at a competitive disadvantage. The widespread adoption of new internet, networking or telecommunications technologies or other technological changes could require KCG to incur substantial expenditures to modify or adapt our services or infrastructure. Any failure by KCG to anticipate or respond adequately to technological advancements (including advancements related to telecommunications, data transfer, execution and messaging speeds), client requirements or changing industry standards or to adequately protect its intellectual property, or any delays in the development, introduction or availability of new services, products or enhancements, could have a material adverse effect on KCG’s business, financial condition and operating results.
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Capacity constraints, systems failures and delays could harm KCG’s business
KCG’s business activities are heavily dependent on the integrity and performance of the computer and communications systems supporting them and the services of certain third parties. KCG’s systems and operations are vulnerable to damage or interruption from human error, technological or operational failures, natural disasters, power loss, computer viruses, intentional acts of vandalism, terrorism and other similar events. Extraordinary trading volumes or other events could cause KCG’s computer systems to operate at an unacceptably slow speed or even fail. In addition, the challenges associated with integrating Knight’s and GETCO’s technology may heighten such vulnerabilities or constraints. While KCG has invested significant amounts of capital to upgrade the capacity, reliability and scalability of its systems, there can be no assurance that its systems will be sufficient to handle current or future trading volumes and modifications themselves may result in unanticipated and undesirable consequences. For example, the August 1, 2012 Knight technology issue that led to the aforementioned trading losses related to an update of trading software. Although KCG will continually update and modify its trading software in response to changes in its business, rule changes and for various other reasons, there will be no assurances that such updates and modifications to KCG’s trading software will not result in future trading losses. Many of KCG’s systems are, and much of its infrastructure is, designed to accommodate additional growth without material redesign or replacement; however, KCG may need to make significant investments in additional hardware and software to accommodate growth. Failure to make necessary expansions and upgrades to its systems and infrastructure could lead to failures and delays. Such failures and delays could cause substantial losses for KCG and for its clients and could subject KCG to claims from its clients for losses, including litigation claiming, among other matters, fraud or negligence. In the past, the trading systems of both Knight and GETCO experienced performance issues that resulted in some clients’ orders being executed at prices they did not anticipate. From time to time, Knight and GETCO have reimbursed their respective clients for losses incurred in connection with systems failures and delays.
Capacity constraints, systems failures and delays may occur in the future and could cause, among other things, unanticipated problems with KCG’s trading or operating systems, disruptions in our client and non-client market making activities, disruptions in service to our clients, slower system response times resulting in transactions not being processed as quickly as KCG’s clients desire, decreased levels of client service and client satisfaction, and harm to KCG’s reputation. If any of these events were to occur, KCG could suffer substantial financial losses, a loss of clients, or a reduction in the growth of its client base, increased operating expenses, litigation or other client claims, and regulatory sanctions or additional regulatory burdens.
For example, the aforementioned technology issue resulted in Knight’s trading systems not functioning properly, resulting in Knight’s broker dealer subsidiary, Knight Capital Americas LLC, sending numerous erroneous orders in NYSE-listed and NYSE Arca securities into the market. As a result of trading out of its entire erroneous trade position, Knight realized a pre-tax loss of approximately $457.6 million. There is no assurance that KCG will not be faced with the same or similar occurrence in the future.
Knight and GETCO developed business continuity capabilities that could be utilized in the event of a disaster or disruption, and KCG inherited these capabilities. The challenges associated with integrating Knight’s and GETCO’s business continuity capabilities following the completion of the Mergers may heighten such vulnerabilities or constraints. Since the timing and impact of disasters and disruptions are unpredictable, KCG has to be flexible in responding to actual events as they occur. Significant business disruptions can vary in their scope. A disruption might only affect KCG, a building that KCG occupies, a business district in which KCG is located, a city in which KCG is located or an entire region. Within each of these areas, the severity of the disruption can also vary from minimal to severe. KCG’s business continuity facilities are designed to allow it to substantially continue operations if KCG is prevented from accessing or utilizing its primary offices for an extended period of time. Although
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KCG has employed significant effort to develop, implement and maintain reasonable business continuity plans, KCG will not be able to guarantee its systems will properly or fully recover after a significant business disruption in a timely fashion. If KCG is prevented from using any of its current trading operations or any third party services, or if its business continuity operations do not work effectively, KCG may not have complete business continuity. This could have a material adverse effect on KCG’s business, financial condition and operating results.
KCG could experience additional losses and liabilities as a result of the technology issue that arose and impacted Knight on August 1, 2012, and the events of August 1, 2012 could cause customers and counterparties to lose confidence in KCG’s systems and adversely affect KCG’s reputation, results of operations and ability to attract and maintain its business, and may also result in lawsuits, regulatory investigations and other burdensome costs for KCG
Knight experienced a technology issue at the opening of trading at the NYSE on August 1, 2012. This issue was related to its installation of trading software and resulted in Knight’s broker dealer subsidiary, Knight Capital Americas LLC, sending numerous erroneous orders in NYSE-listed and NYSE Arca securities into the market. Although this software was subsequently removed from Knight’s systems and the software issue was limited to the routing of certain NYSE-listed stocks, it resulted in Knight realizing a pre-tax loss of approximately $457.6 million. This severely impacted Knight’s capital base and business operations, and Knight experienced reduced order flow, liquidity pressures and harm to customer and counterparty confidence.
On account of this technology issue and its impact, Knight is currently subject to litigation by former stockholders alleging that were been damaged by this technology issue. In addition, Knight is subject to an investigation by the SEC relating to the technology issue, and other regulatory or governmental agencies may decide to conduct further investigations into similar issues and related matters. While KCG is unable to predict the outcome of any existing or future litigation or regulatory or governmental investigation, an unfavorable outcome in one or more of these matters could have a material adverse effect on KCG’s financial condition or ongoing operations. In addition, KCG may incur significant expenses in defending against the existing litigation or any other future litigation, or in connection with any regulatory or governmental investigations, and in implementing technical changes and remedial measures which may be necessary or advisable. KCG may also be required to take remedial steps that could be burdensome for its business operations.
Additionally, if existing or potential future clients and/or counterparties do not believe that KCG has addressed the technology issues related to the events of August 1, 2012, or if they have concerns about future technology issues, this could cause existing or future customers of KCG to lose confidence in KCG’s systems and could adversely affect its reputation and its ability to attract or maintain customers and counterparty relationships. Following the events of August 1, 2012, Knight took several measures designed to enhance its controls, such as enhancing change management controls and implementing additional market access controls. Knight carefully reviewed the matter internally, including through an internal review conducted under the direction of internal and outside counsel. Knight’s review covered a number of areas, including change management controls, market access controls, software development and implementation. The review is ongoing, however certain measures have been taken to address suggestions stemming from its review – which include, enhancing change management controls and implementing additional market access controls. Since August 1, 2012, Knight took several measures designed to enhance its processes and controls, which have been adopted by KCG, including: appointing a Chief Risk Officer; establishing a formal Risk Committee of its Board; implementing change management controls, which require at different stages an additional layer of review and supervisory approval for significant software installations; adding market access controls designed to more closely monitor outbound routers and enable the rapid automatic shut-down of the routers; and deploying various kill switches for specific applications and
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market access. KCG will continue to carefully monitor, enhance and strengthen its controls as needed. However, in the event that KCG is not able to restore the confidence of former Knight customers or counterparties as a result of the events of August 1, 2012, KCG may experience reduced business activity in its trading, market making and other businesses, which could adversely impact the results of KCG’s operations.
KCG is highly dependent on key personnel
KCG is highly dependent on a limited number of key personnel. KCG’s success is dependent to a large degree on our ability to retain the services of its existing key executives and to attract and retain additional qualified personnel in the future. Competition for such personnel is intense. The loss of the services of any of KCG’s key executives or the inability to identify, hire and retain necessary highly qualified executive management in the future could have a material adverse effect on KCG’s business, financial condition and operating results.
KCG’s success also depends, in part, on the highly skilled, and often specialized, individuals KCG employs. KCG’s ability to attract and retain management, trading, market-making, sales and technology professionals, as well as quantitative analysts and programmers is important to KCG’s business strategy. KCG strives to provide high quality services that allow it to establish and maintain long-term relationships with its clients. KCG’s ability to do so depends, in large part, upon the individual employees who represent KCG in its dealings with such clients. There can be no assurance that KCG will not lose such professionals due to increased competition or other factors in the future, or that such professionals will not leave KCG voluntarily as a result of the Mergers and/or the integration of Knight and GETCO businesses. The loss of sales, trading or technology professionals, particularly senior professionals with broad industry or technical expertise and long-term relationships with clients, could have a material adverse effect on KCG’s business, financial condition and operating results.
KCG’s failure to achieve and maintain effective internal control in accordance with Section 404 of the Sarbanes-Oxley Act could cause investors to lose confidence in its financial statements and have a material adverse effect on KCG’s business and stock price
Although Knight was subject to the standards contemplated by the Sarbanes-Oxley Act, GETCO and its subsidiaries have not previously been subject to the requirements of Section 404 or 302 of the Sarbanes-Oxley Act. Accordingly, it is possible that KCG’s internal control over financial reporting will not meet all of the requirements of the Sarbanes-Oxley Act.
KCG expects to devote considerable resources, including management’s time and other internal resources, to complying with regulatory requirements relating to internal control and the preparation of financial statements. In particular, these efforts will focus on compliance by GETCO and its subsidiaries with Section 404 and 302 of the Sarbanes-Oxley Act. If KCG cannot successfully integrate the two companies’ financial reporting processes with adequate internal controls over financial reporting, management’s assessment may be negative and/or KCG’s independent registered public accounting firm may be unable to issue an unqualified attestation report on the effectiveness of KCG’s internal control over financial reporting. This could lead to a negative reaction in the financial markets due to a loss in investor confidence, and, in turn, the market price of KCG Class A Common Stock could be materially adversely affected.
Acquisitions, strategic investments, divestitures and other strategic relationships involve certain risks
KCG is the product of strategic relationships and acquisitions, and it may continue to pursue opportunistic strategic acquisitions of, investments in, or divestitures of businesses and technologies.
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Acquisitions may entail numerous risks, including difficulties in assessing values for acquired businesses, intangible assets and technologies, difficulties in the assimilation of acquired operations and products, diversion of management’s attention from other business concerns, employee retention issues, assumption of unknown material liabilities of acquired companies, amortization of acquired intangible assets and the potential writedown of goodwill due to impairment, which could reduce future reported earnings, or result in potential loss of clients or key employees of acquired companies. KCG may not be able to integrate successfully certain operations, personnel, services or products that it has acquired or may acquire in the future. Divestitures also entail numerous risks. The divestiture of an existing business could reduce KCG’s future operating cash flows and revenues, make our financial results more volatile, and/or cause a decline in revenues and profits. A divestiture could also cause a decline in the price of KCG Class A Common Stock and increased reliance on other elements of our core business operations. If we do not successfully manage the risks associated with a divestiture, our business, financial condition, and results of operations could be adversely affected. KCG also may not find suitable purchasers for businesses it may wish to divest. In addition, the decision to pursue acquisitions, divestitures or other strategic transactions may jeopardize KCG’s ability to retain the services of its existing key employees and to attract and retain additional qualified personnel in the future. Strategic investments may also entail some of the other risks described above. If these investments are unsuccessful, KCG may need to incur charges against earnings. KCG may build and establish a number of strategic relationships. These relationships and others KCG may enter into in the future may be important to its business and growth prospects. KCG may not be able to maintain these relationships or develop new strategic alliances.
International activities involve certain risks
KCG’s international operations expose it to financial, cultural, regulatory and governmental risks. Approximately 25% of the pro forma combined revenues of Knight and GETCO in the three years ended December 31, 2012, resulted from international operations. The financial services industry in many foreign countries is heavily regulated, much like the U.S., but differences, whether cultural, legal or otherwise, do exist. KCG is exposed to risks and uncertainties, including political, economic and financial instability, changes in requirements, exchange rate fluctuations, staffing challenges and the requisite controls needed to manage such operations. To continue to operate and expand its services globally, KCG will have to comply with the unique legal and regulatory controls of each country in which it conducts, or intends to conduct business, the requirements of which may be onerous or may not be clearly defined. The varying compliance requirements of these different regulatory jurisdictions and other factors may limit KCG’s ability to successfully conduct or expand our business internationally. It may increase KCG’s costs of investment. Additionally, operating international locations involves both execution and reputational risk.
Specifically, in Europe, there are market participants (including the European Commission) that continue to call for regulatory changes, such as transaction taxes or messaging fees, that if widely enacted, would have a material adverse effect on the business, financial condition and operating results of KCG’s European operations. In addition, the MiFID 2/MiFIR proposals described under “Regulatory and legal uncertainties could harm KCG’s business” include many changes likely to affect KCG’s business in Europe. For example, the current proposal would require firms like KCG to conduct all trading on European markets through authorized investment firms. MiFID 2/MiFIR will also require certain types of firms, including KCG, to post firm quotes at competitive prices and will supplement current requirements with regard to investment firms’ risk controls related to the safe operation of electronic systems. MiFID 2/MiFIR may also impose additional requirements on trading platforms on which KCG will trade, such as a minimum order resting time, cancellation fees, circuit breakers, and limits on the ratio of unexecuted orders to trades. Further, public debate in Europe regarding high-frequency trading is leading policymakers to consider laws and regulations that may impact KCG’s business. For example, France and Italy have adopted a financial transactions tax. In addition, in
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Germany, proposed legislation could, among other things, place limits on order-to-execution ratios and require all high-frequency traders on German exchanges to be authorized to trade in Germany. Additionally, growing competition in the Asian markets among financial services companies (in addition to increased regulatory scrutiny of proprietary trading activities) could have a material adverse effect on KCG’s Asia business, financial condition and operating results.
KCG may not be able to manage these costs or risks effectively.
Fluctuations in currency exchange rates could adversely affect KCG’s earnings
A significant portion of KCG’s international business is conducted in currencies other than the U.S. dollar, and changes in foreign exchange rates relative to the U.S. dollar can therefore affect the value of non-U.S. dollar net assets, revenues and expenses. Potential exposures as a result of these fluctuations in currencies are closely monitored, and, where cost-justified, strategies are adopted that are designed to reduce the impact of these fluctuations on KCG’s financial performance. These strategies may include the financing of non-U.S. dollar assets with borrowings in the same currency and the use of various hedging transactions related to net assets, revenues, expenses or cash flows. Any material fluctuations in currencies could have a material effect on our operating results.
The market price of KCG’s common stock could fluctuate significantly
The U.S. securities markets in general have experienced significant price fluctuations in recent years. If the market price of KCG Class A Common Stock fluctuates significantly, KCG may become the subject of securities class action litigation which may result in substantial costs and a diversion of management’s attention and resources. KCG’s future quarterly operating results may not consistently meet the expectations of securities analysts or investors, which could have a material adverse effect on the market price of KCG Class A Common Stock.
KCG may not pay dividends
KCG does not currently expect to pay dividends on its common stock. Any determination to pay dividends in the future will be at the discretion of the KCG board of directors and will depend upon among other factors, KCG’s cash requirements, financial condition, requirements to comply with the covenants under its debt instruments and credit facilities, earnings and legal considerations. If KCG does not pay dividends, then the return on an investment in its common stock will depend entirely upon any future appreciation in its stock price. There is no guarantee that KCG Class A Common Stock will appreciate in value or maintain its value.
KCG is a holding company and depends on its subsidiaries for dividends, distributions and other payments
KCG is a legal entity separate and distinct from its broker-dealer and other subsidiaries. KCG’s principal source of cash flow, including cash flow to pay principal and interest on its outstanding debt, will be dividends and distributions from its subsidiaries. There are statutory and regulatory limitations on the payment of dividends or distributions by regulated subsidiaries, such as broker-dealers. If KCG’s subsidiaries are unable to make dividend payments or distributions to it and sufficient cash or liquidity is not otherwise available, KCG may not be able to make principal and interest payments on its outstanding debt and could default on its debt obligations. In addition, KCG’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization will be subject to the prior claims of the subsidiary’s creditors.
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KCG may be unable to remain in compliance with the financial maintenance and other affirmative and negative covenants contained in its debt instruments and the obligation to comply with such covenants may adversely affect its ability to operate its business
KCG’s current debt instruments contain financial maintenance and other affirmative and negative covenants that impose significant requirements on KCG and limit its ability to engage in certain transactions or activities. In addition, in the future KCG may enter into other debt instruments with covenants different from, and potentially more onerous than, those expected to be included in the KCG debt facilities. These covenants could limit KCG’s flexibility in managing its businesses. Further, there can be no assurance that KCG will be able to generate sufficient earnings to enable KCG to satisfy the financial maintenance and other affirmative and negative covenants included in its debt instruments. In the event that KCG is unable to either comply with these restrictions and other covenants or obtain waivers from its lenders, KCG would be in default under these debt instruments and, among other things, KCG’s debt could be accelerated by its lenders. In such case, KCG might not be able to repay its debt or borrow sufficient funds to refinance its debt on commercially reasonable terms, or on terms that are acceptable to KCG, resulting in a default on its debt obligations, which could have an adverse effect on its financial condition.
In connection with the Mergers, KCG entered into the first lien credit facility and assumed the senior secured second lien notes, which contain customary affirmative and negative covenants for facilities of their type and customary exceptions, qualifications and “baskets”. The negative covenants include, among other things, limitations on indebtedness, liens, hedging agreements, investments, loans and advances, asset sales, mergers and acquisitions, dividends, transactions with affiliates, prepayments of other indebtedness, modifications of organizational documents and other material agreements, restrictions on subsidiaries, capital expenditures, issuance of capital stock, negative pledges and business activities.
The first lien credit facility also has financial maintenance covenants establishing a maximum consolidated first lien leverage ratio, a minimum consolidated interest coverage ratio and a minimum consolidated tangible net worth.
KCG is required to make a $235.0 million amortization payment with respect to the first lien credit facility on July 1, 2014, which may be difficult for KCG to make unless KCG has sufficient cash from operations and from sales of non-core or non-strategic assets
KCG is required to make a $235.0 million amortization payment with respect to the first lien credit facility on July 1, 2014, the first anniversary of the closing date of the facility. KCG expects to fund the $235.0 million amortization payment from available cash on the balance sheet from continuing operations and, to the extent required, any proceeds from, and funds released from capital requirements as a result, of the sale of any non-core or non-strategic assets, including Urban. There is no assurance, however, that KCG will have sufficient cash on its balance sheet by the time the amortization payment is required to be made to make the $235.0 million amortization payment, or that KCG will be able to sell non-core or non-strategic assets, or obtain sufficient funds from the sale of such assets, to make up for any shortfall. Further, there can be no assurance that KCG will be able to complete the sale of Urban prior to July 1, 2014 or at all. If KCG is unable to make the $235.0 million amortization payment, it would constitute a default under the planned first lien credit facility, which could in turn constitute a default under its other debt obligations, including the senior secured second lien notes. KCG’s ability to make the required amortization payment or alternatively refinance its indebtedness will depend on its future performance, its ability to generate cash flow, its ability to sell non-core and non-strategic assets, and market conditions, each of which is subject to economic, financial, competitive and other factors beyond our control.
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KCG’s futures business will present various risks
Knight acquired certain assets of the futures division of Penson Financial Services, Inc. in June 2012, and KCG’s continuation of this business, which we refer to as the futures commission merchant, or FCM, business, presents various risks. The FCM business is relatively new, and moreover, client activities could expose KCG to several risks including the risk that an FCM client is unable to fulfill its contracted obligation as KCG guarantees the performance of its clients to the respective clearing houses or other brokers. There can be no assurance that KCG will be able to manage the credit risk effectively, or that KCG will profitably operate the FCM business. Additionally, the bankruptcy of MF Global Holdings, Ltd., Penson Financial Services, Inc. and the fraud allegations against Peregrine Financial Group Inc. in 2012 have led to increased regulatory scrutiny and decreased client confidence in the U.S. futures industry. As has been widely reported in the news media, MF Global Holdings, Ltd. declared bankruptcy in October of 2011 following a liquidity crisis that prevented it from meeting contractual trading obligations. Penson Financial Services, Inc. declared bankruptcy in January of 2013 citing a decrease in counterparty trading activity and a resulting decline in revenue due to customer concerns regarding its financial viability. Following its filing for bankruptcy, Peregrine Financial Group, Inc. and its Chief Executive Officer were accused of embezzling over $200 million of customer funds over a period of approximately 20 years. These circumstances may result in reduced client confidence in the futures industry, and clients may become increasingly unwilling to trade with a futures firm if such firm is perceived as unsafe, if its financial viability is in question or if it is subject to other reputational risk. Further, futures clients may become increasingly sensitive to the fact that their assets may be frozen or become unrecoverable in the event a futures firm becomes illiquid or declares bankruptcy. Any additional regulatory restrictions enacted in response to these developments could be costly or KCG may be unable to comply. Reduced client confidence in the futures industry or the FCM business could lead to significantly decreased trading volume and a loss of, or inability to attract, client assets. Additionally, KCG may be exposed to regulatory risk if it is not in compliance with the various rules and regulations that apply to custodians of client funds. If any of these risks were to materialize, they could cause KCG to experience losses that could affect the profitability of KCG’s FCM business and potentially restrict KCG’s ability to grow the FCM business.
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