-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IEAbNyS93s5VmeSMY0Lx77aHmY+vTYzeEwpEvC9X3lOohJEa72n78P3cKQXKnI+s Rp6h8HPQN2eqAFTScqo/4w== 0000083125-06-000011.txt : 20060331 0000083125-06-000011.hdr.sgml : 20060331 20060331172700 ACCESSION NUMBER: 0000083125-06-000011 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20051231 FILED AS OF DATE: 20060331 DATE AS OF CHANGE: 20060331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST MONTAUK FINANCIAL CORP CENTRAL INDEX KEY: 0000083125 STANDARD INDUSTRIAL CLASSIFICATION: SECURITY BROKERS, DEALERS & FLOTATION COMPANIES [6211] IRS NUMBER: 221737915 STATE OF INCORPORATION: NJ FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-06729 FILM NUMBER: 06730170 BUSINESS ADDRESS: STREET 1: 328 NEWMAN SPRINGS RD STREET 2: PKWY 109 OFFICE CTR CITY: RED BANK STATE: NJ ZIP: 07701 BUSINESS PHONE: 7328424700 MAIL ADDRESS: STREET 1: 328 NEWMAN SPRINGS RD STREET 2: PKWY 109 OFFICE CTR CITY: RED BANK STATE: NJ ZIP: 07701 FORMER COMPANY: FORMER CONFORMED NAME: MCC PRESIDENTIAL INC DATE OF NAME CHANGE: 19871203 FORMER COMPANY: FORMER CONFORMED NAME: RENAULT WINERY INC DATE OF NAME CHANGE: 19740725 FORMER COMPANY: FORMER CONFORMED NAME: PRESIDENTIAL APARTMENTS INC DATE OF NAME CHANGE: 19740327 10-K 1 form10k2005main.txt FORM 10-K FOR YEAR ENDED DECEMBER 31, 2005 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2005 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ____________ Commission file number: 0-6729 FIRST MONTAUK FINANCIAL CORP. (Exact name of registrant as specified in its charter) NEW JERSEY 22-1737915 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) Parkway 109 Office Center, 07701 328 Newman Springs Road, Red Bank, New Jersey (Address of principal executive offices) (Zip Code) (732) 842-4700 (Registrant's telephone number, including area code) [None] (Former name, former address and former fiscal year, if changed since last report) Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered ------------------------- ----------------------------------------------- None Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes [ ] No [X] Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] As of June 30, 2005 the aggregate market value of the registrant's common stock held by non-affiliates of the registrant was $11,615,584 based on the closing sale price as reported on the Over the Counter Bulletin Board. Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at March 30, 2006 - --------------------------------------- ----------------------------------- [Common Stock, no par value per share] 16,009,793 shares DOCUMENTS INCORPORATED BY REFERENCE None Table of Contents PART I PAGE Item 1. Business 3 Item 1A. Risk Factors 17 Item 1B. Unresolved Staff Comments 18 Item 2. Properties 18 Item 3. Legal Proceedings 18 Item 4. Submission of Matters to a Vote of Security Holders 19 PART II Item 5. Market For the Company's Common Equity and Related Stockholder Matters 20 Item 6. Selected Financial Data 22 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 24 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 35 Item 8. Financial Statements and Supplemental Data 35 Item 9A. Controls and Procedures 35 Item 9B Other Information 35 PART III Item 10. Directors and Executive Officers of the Registrant 36 Item 11. Executive Compensation 40 Item 12. Security Ownership of Certain Beneficial Owners and Management 46 Item 13. Certain Relationships and Related Transactions 48 Item 14. Principal Accounting Fees and Services 49 PART IV Item 15. Exhibits and Financial Statement Schedules 50
2 PART I This Annual Report on Form 10-K contains certain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve certain known and unknown risks, uncertainties and other factors, many of which are beyond our control, and are not limited to those discussed in Item 1A, "Risk Factors." All statements that do not relate to historical or current facts are forward-looking statements. These statements may include words such as "anticipate," "estimate," "expect," "project," "intend," "plan," "believe," and other words and terms of similar meaning in connection with any discussion of future operating or financial performance. In particular, these include statements relating to present or anticipated products and markets, future revenues, capital expenditures, expansion plans, future financing and liquidity, personnel, and other statements regarding matters that are not historical facts or statements of current condition. Any or all forward-looking statements contained within this Annual Report on Form 10-K may turn out to be wrong. They can be affected by inaccurate assumptions we might make, or by known or unknown risks and uncertainties. Many factors mentioned in the discussion below will be important in determining future results. Consequently, we cannot guarantee any forward-looking statements. Actual future results may vary materially. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. You are advised, however, to consult any further disclosures we make on related subjects in our filings with the U.S. Securities and Exchange Commission (SEC). Item 1. Business Introduction First Montauk Financial Corp. ("the Company") is a New Jersey-based financial services holding company whose principal subsidiary, First Montauk Securities Corp., has operated as a full service retail and institutional securities brokerage firm since 1987. Since July 2000, First Montauk Securities Corp. has operated under the registered trade name "Montauk Financial Group". References in this Annual Report on Form 10-K to Montauk Financial Group shall refer solely to our subsidiary First Montauk Securities Corp. Montauk Financial Group provides a broad range of securities brokerage and investment services to a diverse retail and institutional clientele, as well as corporate finance and investment banking services to corporations and businesses. First Montauk Financial Corp. also sells insurance products through its subsidiary, Montauk Insurance Services, Inc. Montauk Financial Group has approximately 290 registered representatives and services over 50,000 retail and institutional customer accounts, which comprise over $3.2 billion in customer assets. With the exception of a company leased branch office in New York City, all of Montauk Financial Group's 116 other branch office and satellite locations in 27 states are owned and operated by affiliates; independent owners who maintain all applicable licenses and are responsible for all office overhead and expenses. Montauk Financial Group also employs registered representatives directly at its corporate headquarters. Montauk Financial Group is registered as a broker-dealer with the Securities and Exchange Commission, the National Association of Securities Dealers, the Municipal Securities Rule Making Board, the National Futures Association, and the Securities Investor Protection Corporation and is licensed to conduct its brokerage activities in all 50 states, the District of Columbia, the Commonwealth of Puerto Rico, and is registered as an International broker-dealer to conduct business with institutional clients in the province of Ontario, Canada. Securities transactions are cleared through National Financial Services, LLC and Penson Financial Services, Inc. with various floor brokerage and specialist firms also providing execution services. These arrangements provide Montauk Financial Group with back office support, transaction processing services on all principal national and international securities exchanges, and access to many other financial services and products which allows Montauk Financial Group to offer products and services comparable to larger brokerage firms. 3 Our revenues consist primarily of commissions and fee income from individual and institutional securities transactions, mutual fund and annuity sales and investment banking activities, such as private and public securities offerings and limited market making activities. The following table represents the percentage of revenues generated in each of these activities during the year ended December 31, 2005: Equities Listed and Over-The-Counter Stocks 35% Debt Instruments: Municipal, Government and Corporate Bonds and Unit Investment Trusts 4% Mutual Funds 11% Options: Equity & Index 3% Insurance and Annuities 7% Corporate Finance and Investment Banking 11% Investment Advisory Fees 6% Alternative Investments (1) 5% Proprietary trading 4% Miscellaneous (2) 14% --- Total 100% - -------------------------------------------------------------------------------- (1) Alternative Investments include REITs, 1031 Exchanges and promissory notes. (2) Miscellaneous includes interest income, amortization of deferred revenue and operations and marketing fees. The following table reflects our various sources of revenue and the percentage of total revenues for 2005. Revenues from agency transactions in securities for individual customers of Montauk Financial Group are shown as commissions. Montauk Financial Group also executes customer orders on a riskless principal basis, which are reflected as part of "Riskless Principal trades" on the table below. Year Ended December 31, 2005 Commissions from equity securities, options and mutual funds, insurance, management fees and alternative investments................ $37,493,733 65% Riskless Principal trades in equity and fixed income securities on behalf of customers .................. $3,572,959 6% Proprietary trading ................... $2,005,861 3% Interest and other income ........... $8,370,711 15% Investment banking (1) ............... $6,640,402 11% ----------- --- Total Revenues ........................ $58,083,666 100%
(1) Investment banking revenues consists of commissions, selling concessions, consulting fees and other income from underwriting and syndicate activities and placement agent fees. Affiliated Registered Representative Program Montauk Financial Group's primary method of operations is through its affiliated registered representatives, who operate as independent contractors. A registered representative who becomes affiliated with Montauk Financial Group establishes his/her own office and is solely responsible for the payment of all expenses associated with the operation of the branch office, including rent, utilities, furniture, equipment, market data services, and general office supplies. Under this program, the affiliated representative retains a significantly higher percentage of the commissions and fees generated by his/her sales than a registered representative in a traditional brokerage arrangement. The affiliate program is designed to attract experienced brokers with existing clientele who desire to operate their own offices, as well as other professionals in all facets of the financial services industry. Affiliated representatives must possess a sufficient level of sales and experience to enable the individual to independently support his/her own office. Financial professionals such as insurance agents, real estate brokers, financial planners, and accountants, who already provide financial services to their clients, can become registered with Montauk Financial Group to provide securities products and services to their clients. Montauk Financial Group provides full support services to each of the affiliated representatives, including access to stock and options execution and over-the-counter stock trading; products such as insurance, mutual funds, unit trusts and investment advisory programs; and compliance, supervision, accounting and related services. 4 Each affiliated representative is required to obtain and maintain in good standing each license required by the SEC and NASD to conduct the type of securities business in which the affiliate will engage, and to register in the various states in which he/she intends to service customers. Montauk Financial Group is ultimately responsible for supervising each affiliated registered representative. Montauk Financial Group can incur substantial liability from improper actions of any of the affiliated representatives. Montauk Financial Group maintains a professional liability errors and omissions insurance policy which provides coverage for certain actions taken and/or omissions made by its registered representatives, employees and other agents in connection with the purchase and sale of securities and other financial products and services. Revenue Sources Principal and Agency Transactions Through our affiliate program we derive a substantial portion of our revenues from customer commissions on brokerage transactions in equity and debt securities for retail and institutional investors such as corporations, partnerships and limited liability companies, investment advisors, hedge funds, and pension and profit sharing plans. In executing customer orders to buy or sell a security in which we make a market, we may sell to, or purchase from, customers at a price that is substantially equal to the current inter-dealer market price plus or minus a mark-up or mark-down. We may also act as agent and execute a customer's purchase or sale order with another broker-dealer market-maker at the best inter-dealer market price available and charge a commission. We believe our mark-ups, mark-downs and commissions are competitive based on the services we provide to our customers. In executing customer orders to buy or sell listed and over-the-counter securities in which we do not make a market, we generally act as an agent and charges commissions that we believe are competitive, based on the services that we provide to our customers. In addition, in the regular course of our business, we take limited securities positions as a market maker to facilitate customer transactions and for investment purposes. In trading for our own account, we expose our own capital to the risk of fluctuations in market value. Trading profits (or losses) depend primarily upon the skills of the employees engaged in market making and position taking, the amount of capital allocated to positions in securities and the general trend of prices in the securities markets. We monitor our risk by maintaining our securities positions at or below certain pre-established levels. These levels reduce certain opportunities to realize profits in the event that the value of such securities increases. However, they also reduce the risk of loss in the event of a decrease in such value and minimize interest costs incurred on funds provided to maintain such positions. Montauk Insurance Services In 1991, we formed Montauk Insurance Services, Inc. for the purpose of offering and selling variable annuities, variable and traditional life, and health insurance products. Currently, Montauk Insurance is licensed to sell life insurance and annuities in all 50 states. Montauk Insurance derives revenue from the sale of insurance-related products and services to the customers of Montauk Financial Group's registered representatives, who are also licensed to sell certain insurance products. In 2005, we earned gross commissions of $4.2 million from the sale of insurance and annuity products. Asset Management Advisory Services Montauk Financial Group is registered as an Investment Adviser with the SEC. We provide investment advisory services to clients through independent, third party sponsored advisory programs. Montauk Financial Group is registered or eligible to conduct business as an investment adviser in all 50 states and the District of Columbia. Managed account programs generally require the client to pay a fee for portfolio advisory services, brokerage execution and custody and periodic account performance reports. These fees are calculated as a percentage of client assets under management. Historically, we have only derived a relatively small percentage of our overall revenues from this business line. However in recent years, this segment of our business has continued to grow. Investment Banking Montauk Financial Group participates in private and public offerings of equity and debt securities and provides general investment banking consulting services to various public and private corporations. We continue to review investment banking opportunities and anticipate that we will engage in additional public and private offerings in the future as business and market conditions warrant. Our investment banking services include bridge and senior loan financing, private placements and public offerings of debt and equity securities, and exclusive banking consultation. Under circumstances where we act as an underwriter, we may assume greater risk than would normally be assumed in our normal trading activity. Under the federal securities laws, an underwriter is subject to substantial potential liability for material misstatements or omissions in prospectuses and other communications with respect to underwritten 5 offerings. Further, underwriting commitments constitute a charge against net capital and our underwriting commitments may be limited by the requirement that we must, at all times, be in compliance with the Uniform Net Capital Rule 15c3-1 of the Securities and Exchange Commission. During 2005, we did not serve as managing underwriter in any public offerings, but participated as a selling group member on numerous occasions. Members of selling groups do not have the same level of capital requirements in an underwritten offering as underwriters under NASD rules. Clearing Agreement In May 2000, Montauk Financial Group entered into a 10-year clearing agreement with Fiserv Securities, Inc. ("Fiserv") under which Fiserv acted as Montauk Financial Group's primary clearing broker to process and clear customer and proprietary transactions, and acted as custodian for customer and firm funds and securities. In connection with the clearing agreement, we also entered into a financial agreement that was amended and restated in February 2001, under which Fiserv provided an aggregate of $7.75 million in cash advances to us over the initial three-year term of the agreement. In November 2003, we received the final cash advance of $1.25 million from Fiserv. In connection with this amendment, we granted Fiserv a first priority lien in all of the outstanding shares of Montauk Financial Group stock. We were required to repay any unearned portion of the cash advances in the event we failed to achieve certain minimum performance criteria, or terminate the agreement under certain circumstances prior to the expiration date, as well as penalties for early termination. In December 2004, Fiserv announced that it had been acquired by National Financial Services, a unit of Fidelity Investments. Subsequently, on April 21, 2005, Montauk Financial Group entered into a clearing agreement with NFS to clear our brokerage business and custody customer and firm cash and securities. In connection with this arrangement, on April 21, 2005, we agreed to the termination of the Clearing Agreement between Montauk Financial Group and Fiserv and the termination of the Financial Agreement and Security Agreement, described above. Effective with the termination of these agreements, our contingent obligation to repay Fiserv any of the cash advances that were provided by Fiserv under the Financial Agreement and the early termination penalty were canceled. Please see "New Clearing Agreement" in the General Business Developments during 2005 and Subsequent Events section for more detailed information about our new clearing arrangement. Competition We encounter intense competition in all aspects of our business and compete directly with many other securities firms for clients, as well as registered representatives. A significant number of such competitors offer their customers a broader range of financial services and have substantially greater resources. Retail firms such as Merrill Lynch Pierce Fenner & Smith Inc., Salomon Smith Barney, Inc. and Morgan Stanley/Dean Witter dominate the industry; however, we also compete with numerous regional and local firms. Montauk Financial Group also competes for experienced brokers with other firms offering an independent affiliate program such as Raymond James Financial Services, Inc. and Linsco/Private Ledger Corp. In addition, a number of firms offer discount brokerage services to individual retail customers and generally effect transactions at substantially lower commission rates on an "execution only" basis, without offering other services such as investment recommendations and research. Moreover, there is substantial commission discounting by full-service broker-dealers competing for institutional and individual brokerage business. In 1997, we entered the discount brokerage arena through our Century Discount Investments division. Additionally, the emergence of online trading has further intensified the competition for brokerage customers. Century Discount Investments maintains a limited clientele and has not grown in revenue over the years. Other financial institutions, notably commercial and savings banks, offer customers some of the same services and products currently provided by securities firms. In addition, certain large corporations have entered the securities industry by acquiring securities firms. While it is not possible to predict the type and extent of competitive services that banks and other institutions ultimately may offer to customers, we may be adversely affected to the extent those services are offered on a large-scale basis. Montauk Financial Group competes by recruiting qualified registered representatives to join our affiliate program. Montauk Financial Group may offer incentives to qualified registered representatives to join. These incentives can include transition assistance and cash payments in the form of loans to offset the costs of moving their business to Montauk, incentive stock options and a higher payout for a period of time. Through its clearing relationship, Montauk Financial Group has implemented on-line information systems to service its 6 affiliates and to attract new brokers. These systems enable brokers from any office to instantly access customer accounts, view account positions and histories, buy and sell securities, send and receive electronic mail, and receive product information and compliance memoranda via the firm's intranet component of its website. Government Regulation The securities industry in the United States is subject to extensive regulation under various federal and state laws and regulations. The Securities and Exchange Commissions (the "SEC" or "Commission") is the federal agency charged with the administration of most of the federal securities laws. Much of the regulation of the securities industry, however, has been assigned to various self-regulatory organizations, principally in our case the NASD. The self-regulatory organizations, among other things, promulgate regulations and provide oversight in areas of: o sales practices, o trade practices among broker-dealers, o capital requirements, o record keeping, and o conduct of employees and affiliates of member organizations. In addition to promulgating regulations and providing oversight, the SEC and the self-regulatory organizations have the authority to conduct administrative proceedings which can result in the censure, fine, suspension or expulsion of a broker-dealer, its officers or employees. Furthermore, new legislation, changes in the rules and regulations promulgated by the SEC and the self-regulatory organizations, or changes in the interpretation or enforcement of existing laws and rules often directly affect the operation and profitability of broker-dealers. The stated purpose of much of the regulation of broker-dealers is the protection of customers and the securities markets rather than the protection of creditors and shareholders of broker-dealers. Net Capital Requirements. Every U.S. registered broker-dealer doing business with the public is subject to the Commission's Uniform Net Capital Rule, which specifies minimum net capital requirements. Although we are not directly subject to the Net Capital Rule, Montauk Financial Group, as a registered broker-dealer is. The Net Capital Rule provides that a broker-dealer doing business with the public shall not permit its aggregate indebtedness to exceed 15 times its adjusted net capital (the "basic method") or, alternatively, that it not permit its adjusted net capital to be less than 2% of its aggregate debit balances (primarily receivables from customers and broker-dealers) computed in accordance with the Net Capital Rule (the "alternative method"). Montauk Financial Group applies the basic method of calculation. Compliance with applicable net capital rules could limit our operations, such as underwriting and trading activities, that require the use of significant amounts of capital, and may also restrict loans, advances, dividends and other payments by our subsidiaries to us. As of December 31, 2005, Montauk Financial Group has $2,592,441 of net capital and $2,337,751 of excess net capital. Employees Currently, we have approximately 290 registered representatives of which 256 are associated with affiliate offices. These affiliated registered representatives are not employees. In addition, we employ approximately 70 support personnel in the areas of operations, compliance, legal, accounting, technology, recruiting and administration. We believe our relationship with our employees is satisfactory. Fidelity Bond and SIPC Account Protection As required by the NASD and certain other regulatory authorities, Montauk Financial Group carries a fidelity bond covering loss or theft of securities, as well as embezzlement and forgery. The bond provides total coverage of $5,000,000 (with a $50,000 deductible provision per incident). In addition, the Securities Investor Protection Corporation protects accounts for up to $500,000 for each customer, subject to a limitation of $100,000 for claims for cash balances. Customer accounts held at our clearing firm also have "Excess SIPC" net equity protection through CAPCO Insurance Company. The Securities Investor Protection Corporation is funded through assessments on registered broker-dealers and charges a flat annual fee of $150. Securities Broker/Dealer Professional Liability Insurance Montauk Financial Group carries a securities Broker/Dealer professional liability insurance policy covering negligent acts, error or omission by an insured individual acting on behalf of the insured Broker/Dealer in providing securities transactions, investment management services, financial investment advice and the purchase and/or sale of securities. This policy excludes coverage for certain types of business activities, including but not limited to, claims involving the sale of penny stocks and limited partnerships, accounts handled on a discretionary basis and deliberately fraudulent and/or criminal acts. The policy term is from January 31, 2006 to January 31, 2007, with a $1 million 7 limit of liability for each covered event and a $3 million aggregate liability limit. We are responsible for a $100,000 deductible payment per claim. In the event that the cost of this coverage becomes cost prohibitive or otherwise unavailable, the lack of coverage may have an adverse impact on our financial condition in the event of future material claims, which may not be covered by our existing policy. Executive and Organization Liability Insurance Policy We carry an executive and organization liability insurance policy (also known as Directors and Officers liability insurance), which covers our executive officers, directors and counsel against any claims for monetary damages arising from the covered individuals actual or alleged breach of duty, neglect, error, misstatement, misleading statement or omission when acting in the capacity of his/her position as an executive officer, director and/or counsel on our behalf. Policy exclusions include, but are not limited to, claims made against covered individuals attributable to the committing of any deliberate criminal or fraudulent acts, illegal or improper payments, and others. General Business Developments During 2005 and Subsequent Events Letter of Intent for Sale of the Company to a Private Investor On March 11, 2006 we entered into a letter of intent for the sale of First Montauk to a private investor. The final terms of the sale are subject to further negotiation but it is anticipated that the transaction will be all cash at approximately $1.00 per common share. The letter of intent is subject to numerous conditions, including: satisfactory completion of due diligence, negotiation and finalization of the terms of the sale and structure of the transaction; negotiation, preparation and execution of definitive transaction documents, compliance with state and federal securities laws and regulations, and corporate, shareholder and regulatory approvals. If a final agreement is reached and the other conditions satisfied, the transaction is expected to close during the third quarter of 2006. However, as a result of the foregoing uncertainties, there can be no assurance that a definitive agreement will be executed or that, if it is, the transaction will be completed. Management Changes Effective February 1, 2005 we entered into a Separation Agreement with William J. Kurinsky, our former C.E.O., which provided for the termination of Mr. Kurinsky's employment with us effective February 1, 2005. Under the terms of the Separation Agreement, Mr. Kurinsky relinquished his position as Chief Executive Officer of the Company and Montauk Financial Group. Please see "Employment Contracts, Severance and Change in Control" under Item 11 of this Report for further details regarding Mr. Kurinsky's separation agreement. Effective February 1, 2005 the Board approved the appointment of Mr. Victor K. Kurylak as our Chief Executive Officer and President. At that time, Mr. Kurylak was our President and Chief Operating Officer. Effective February 1, 2005 the Board also approved a new employment agreement for Mr. Kurylak and issued him, as a bonus payment for our performance for the year ended December 31, 2004, and in consideration of his assuming the position of Chief Executive Officer, 1,000,000 shares of our common stock. In connection with the foregoing, our prior agreement with Mr. Kurylak entered into effective January 1, 2004 was terminated. Further, Mr. Kurylak agreed to the cancellation of 250,000 of his outstanding stock options with an exercise price of $0.75 per share. The restricted stock award of 1,000,000 shares of common stock vests over two years commencing on February 1, 2005. In the event of a change of control of the Company, all unvested shares would vest. Please see "Employment Contracts, Severance and Change of Control" under Item 11 of this Report for further details regarding Mr. Kurylak's employment agreement. In addition, effective February 1, 2005, the Board also appointed Mindy Horowitz as acting Chief Financial Officer. Ms. Horowitz was previously senior vice president of finance. The Board also entered into employment agreements with Ms. Horowitz and Robert I. Rabinowitz, our Executive Vice President and General Counsel, effective February 1, 2005. These employment agreements are discussed in greater detail under Item 11 of this Annual Report. 8 Separation Agreement with Herbert Kurinsky On February 1, 2006 we entered into a Separation Agreement with Herbert Kurinsky, the Chairman of our Board of Directors. Under the terms of the Separation Agreement, the parties agreed to terminate the employment relationship and the rights and obligations of the parties under the employment agreement, effective as of February 1, 2006, however, Mr. Kurinsky continues to serve as our Chairman of the Board of Directors. Please see "Employment Agreements and Separation Agreements" under Item 11 of this Report for further details regarding Mr. Kurinsky's separation agreement. Termination of Prior Clearing Agreement and Financial Agreement with Fiserv Securities, Inc. and New Clearing Agreement with National Financial Services, LLC On April 21, 2005, we agreed to the termination of the Clearing Agreement between Montauk Financial Group and Fiserv, dated as of May 8, 2000 and amended as of February 1, 2001. In addition, as of April 21, 2005, we also agreed to the termination of a certain Financial Agreement, dated May 8, 2000 and amended as of February 1, 2001 and a certain Security Agreement, dated as of February 1, 2001. In connection with the termination of the Financial Agreement, our contingent obligation to repay Fiserv any of the cash advances that were provided by Fiserv under the Financial Agreement and the early termination penalty were canceled. (See Note 7) Contemporaneously, on April 21, 2005, Montauk Financial Group entered into a clearing agreement with National Financial Services, LLC ("NFS"), a Fidelity Investments company, to clear its brokerage business and to custody firm and customer funds and securities. The clearing agreement became effective on April 21, 2005. The new clearing agreement has an initial term of eight years and will automatically renew for successive one year terms, unless either party provides a notice of termination prior to the expiration of the initial or any renewal term. In the event of an early termination of the clearing agreement, other than for a change in control of First Montauk, First Montauk Securities Corp. will pay NFS a termination fee of between $2,000,000 in the first year of the agreement and declining to $250,000 in the last year of the agreement, depending on when such early termination occurs. Termination of Merger Agreement with Olympic Cascade Financial Corporation On October 24, 2005, we jointly announced with Olympic Cascade Financial Corporation ("Olympic") our agreement to terminate the Amended and Restated Agreement and Plan of Merger, dated as of June 27, 2005 by and among the Company, Olympic, and OLY Acquisition Corporation, a wholly owned subsidiary of the Company. Under the terms of the letter agreement, the parties had no further obligation to each other arising out of the Merger Agreement, the Merger, and the transactions contemplated thereby, and each party agreed to bear its own expenses. We had initially entered into a definitive merger agreement with Olympic in February 2005, which was amended and restated in June 2005. We expensed approximately $394,000 in professional fees relating to the proposed transaction during 2005. Election of Class III Director On February 24, 2006, the Board of Directors elected Mr. David I. Portman to our board of directors to serve as an independent Class III director. Further, as described below, the board established a new substantive committee, designated as the special committee of the board of directors, and appointed Mr. Portman to serve as the Chairman of this committee. In addition, the board also appointed Mr. Portman to its audit committee and compensation committee. Formation of Special Committee of the Board of Directors On February 24, 2006, our Board of Directors formed a special committee of the board of directors and appointed each of its independent directors to serve as members of the special committee. The initial members of this committee are Messrs. Barry D. Shapiro, Ward R. Jones, Jr. and David I. Portman, with Mr. Portman serving as its Chairman. The board established the special committee for the purpose of reviewing all potential strategic transactions or alternatives which may be presented to us or which it may be appropriate for us to consider. The special committee will, in addition, review alternatives to any potential strategic transaction in order to protect shareholder value. Each member of the special committee will receive an initial cash award of $5,000, plus an annual fee of $5,000 for each year of service after 2006. In addition, each committee member will be receiving a cash fee of $10,000 to evaluate the potential transaction described in the section entitled "Letter of Intent for Sale of the Company to a Private Investor" above. This fee will be paid to each member without regard to the committee's position on such transaction or event. 9 Debenture Conversions Between October 2004 and June 2005 holders of $1,885,000 of convertible debentures that were sold through private offerings in 2002 and 2003, converted their debentures into shares of our common stock in accordance with the terms of the debentures. As a result, we have issued 3,770,000 shares of our common stock during that time period. As of the date of this Annual Report, there is an aggregate principal amount of $1,250,000 of convertible debentures outstanding. The debentures are convertible at $.50 per share. 10 Item 1A. Risk Factors Our business, results of operations and financial condition may be materially and adversely affected due to any of the following risks. The risks described below are not the only ones we face. Additional risks we are not presently aware of or that we currently believe are immaterial may also impair our business operations. The trading price of our common stock could decline due to any of these risks. In assessing these risks, you should also refer to the other information contained or incorporated by reference in this Form 10-K, including our financial statements and related notes. Risks Related to Our Business and Industry Our business is inherently risky and we have suffered losses in previous years For the years ended December 31, 2005 and 2004 we recognized net income of $2,424,000 and $730,000, respectively, and a net loss for 2003 of $3,518,000. The losses for 2003 were primarily due to costs associated with litigation expenses and settlements. Since our business is subject to significant risk from litigation as well as weakness in the securities markets, we may incur further losses in the future, and such losses would necessarily affect the nature, scope and level of our future operations. Our results of operations to date are not necessarily indicative of the results of future operations. The securities business, by its very nature, is subject to various risks and contingencies, many of which are beyond the ability of our management to control. These contingencies include economic conditions generally and in particular those affecting securities markets, interest rates, discretionary income available for investment; losses which may be incurred from underwriting and trading activities; customer inability to meet commitments, such as margin obligations; customer fraud; and employee misconduct and errors. Further, the nature and extent of underwriting, trading and market making activities, and hence the volume and scope of our business is directly affected by our available net capital. Fluctuations in securities volume and prices increase the potential for future losses We and the securities industry in general, are directly affected by national and international economic and political conditions, broad trends in business and finance, the level and volatility of interest rates, changes in and uncertainty regarding tax laws and substantial fluctuations in the volume and price levels of securities transactions. We and the securities industry in general, are subject to other risks, including risks of loss from the underwriting of securities, counter party (a party to which we have credit or performance exposure) failures to meet commitments, customer fraud, employee errors or misconduct and litigation. In addition, price fluctuations may cause losses on securities positions. As we expand our investment banking activities and more frequently serve as manager or co-manager of public offerings of securities, we can expect to make increased commitments of capital to market-making activities in securities of those issuers. The expected additional concentration of capital in the securities of those issuers held in inventory will increase the risk of loss from reductions in the market price. Low trading volume or declining prices generally result in reduced revenues. Under these conditions, profitability is adversely affected since many costs, other than commission compensation and bonuses, are fixed. Heavy trading volume has caused serious operating problems, including delays in clearing and processing, for many securities firms in the past and may do so in the future. Our revenue and profitability may be adversely affected by declines in the volume of securities transactions and in market liquidity. Additionally, our profitability may be adversely affected by losses from the trading or underwriting of securities or failure of third parties to meet commitments. There are numerous contingencies and risks associated with our recent entry into a letter of intent with a private investor. On March 11, 2006, we entered into a letter of intent to sell our company to a private investor. There are certain contingencies and risks associated with our having entered into this agreement which could occur if the closing of transaction does not occur. In the event it is not completed, we may be subject to many risks, including the costs we incurred related to the proposed transaction, such as legal, accounting and advisory fees, which must be paid even if the transaction is not completed. Further, if the transaction does not occur due to our decision to accept a superior offer from an unaffiliated third party to pursue a transaction such as a merger, acquisition, consolidation, business combination, the sale of our assets or a controlling interest in our capital stock, we would also be obligated to pay the private investor a termination fee of $500,000. The transaction is subject to the satisfaction of closing conditions, including satisfactory completion of due diligence, negotiation and finalization of the terms of the sale and structure of the transaction, negotiation, preparation and execution of definitive transaction documents, compliance with state and federal securities laws and regulations, and corporate, shareholder and regulatory approvals. Accordingly, we cannot assure you that the transaction will be completed. If the transaction is not completed, our financial condition could be harmed and the market price of our common stock could decline. 11 Principal and brokerage transactions and lending activities expose us to losses Our trading, market making and underwriting activities involve the purchase, sale or short sale of securities as a principal and, accordingly, involve the risk of changes in the market prices of those securities and the risk of a decrease in the liquidity of markets which would limit our ability to resell securities purchased or to repurchase securities sold in principal transactions. Montauk Financial Group's brokerage activities and principal transactions are subject to credit risk. For example, a customer may not respond to a margin call, and since the securities being held as collateral have diminished in value, there is a risk that we may not recover the funds loaned to the customer. These parties include trading counterparts, customers, clearing agents, exchanges, clearing houses, and other financial intermediaries as well as issuers whose securities we hold. These parties may default on their obligations owed to us due to a variety of reasons, including without limitation, bankruptcy, lack of liquidity or operational failure. Significant failures by third parties to perform their obligations owed to us could adversely affect our revenues and results of operations. Our risk management policies and procedures may leave us exposed to unidentified risks or an unanticipated level of risk. The policies and procedures we employ to identify, monitor and manage risks may not be fully effective. Some methods of risk management are based on the use of observed historical market behavior. As a result, these methods may not accurately predict future risk exposures, which could be significantly greater than the historical measures indicate. Other risk management methods depend on evaluation of information regarding markets, clients or other matters that are publicly available or otherwise accessible by us. This information may not be accurate, complete, up-to-date or properly evaluated. Management of operational, legal and regulatory risks requires, among other things, policies and procedures to properly record and verify a large number of transactions and events. We cannot assure that our policies and procedures will effectively and accurately record and verify this information. We seek to monitor and control our risk exposure through a variety of separate but complementary financial, credit, operational and legal reporting systems. We believe that we are able to evaluate and manage the market, credit and other risks to which we are exposed. Nonetheless, our ability to manage risk exposure can never be completely or accurately predicted or fully assured. The consequences of these developments can include losses due to adverse changes in inventory values, decreases in the liquidity of trading positions, higher volatility in earnings, increases in our credit risk to customers as well as to third parties and increases in general systemic risk. Competition in the brokerage industry may adversely impact our retail business We encounter intense competition in all aspects of our business and compete directly with many other securities firms, a significant number of which offer their customers a broader range of financial services, have substantially greater resources and may have greater operating efficiencies. In addition, a number of firms offer discount brokerage services to individual retail customers and generally effect transactions at lower commission rates on an "execution only" basis without offering other services such as investment recommendations and research. The further expansion of discount brokerage firms could adversely affect our retail business. Moreover, there is substantial commission discounting by full-service broker-dealers competing for institutional and individual brokerage business. The possible increase of this discounting could adversely affect us. Other financial institutions, notably commercial banks and savings and loan associations, offer customers some of the services and products currently provided by securities firms. In addition, certain large corporations have entered the securities industry by acquiring securities firms. While it is not possible to predict the type and extent of competitive services that banks and other institutions ultimately may offer to customers, we may be adversely affected to the extent those services are offered on a large scale. 12 We are subject to various risks in the securities industry As a securities broker-dealer, our subsidiary is subject to uncertainties that are common in the securities industry. These uncertainties include: o the volatility of capital markets; o governmental regulation; o litigation; o intense competition; o substantial fluctuations in the volume and price level of securities; and o dependence on third parties. As a result, revenues and earnings may vary significantly from period to period. In periods of low volume, profitability is impaired because certain expenses remain relatively fixed. Due to our size, we have less capital than many competitors in the securities industry. In the event of a market downturn, our business could be adversely affected in many ways, including those described herein. Our revenues are likely to decline in such circumstances and, if we are unable to reduce expenses accordingly, our financial condition and results of operations would be adversely affected. We have incurred liability due to securities-related litigation Many aspects of our business involve substantial risks of liability, including exposure to liability under applicable federal and state securities laws in connection with the activity of our associated persons, as well the underwriting and distribution of securities. In recent years, there has been an increasing incidence of litigation involving the securities industry in general, which seek compensatory, rescissionary and punitive damages. During the year ended December 31, 2005, we incurred $1,774,000 in litigation costs and expenses related to various legal claims and settlements. As of December 31, 2005, we have accrued for litigation costs that are probable and can be reasonably estimated based on a review of existing claims, arbitrations and unpaid settlements. Management cannot give assurance that this accrual will be adequate to cover actual costs that may be subsequently incurred. It is not possible to predict the outcome of legal and regulatory matters pending against Montauk Financial Group. All such cases are, and will continue to be, vigorously defended. However, litigation is subject to many uncertainties, and some of these actions and proceedings may result in adverse awards or judgments. After considering all relevant facts, available insurance coverage and consultation with litigation counsel, it is possible that our consolidated financial condition, results of operations, or cash flows could be materially affected by unfavorable outcomes or settlements of certain pending litigation. We remain subject to extensive regulation and the failure to comply with these regulations could subject us to penalties or sanctions The securities industry in general and our business in particular is subject to extensive regulation by the SEC, state securities regulators and other governmental regulatory authorities. The broker-dealer is also regulated by industry self-regulatory organizations, including the NASD and the Municipal Securities Rulemaking Board. Montauk Financial Group is a registered broker-dealer with the SEC and a member firm of the NASD. Broker-dealers are subject to regulations which cover all aspects of the securities business, including: o sales practices and supervision; o trading practices among broker-dealers; o use and safekeeping of customers' funds and securities; o capital structure of securities firms; o record keeping; and o the conduct of directors, officers, agents and employees. Much of the regulation of broker-dealers has been delegated to self-regulatory organizations, principally the NASD, which is Montauk Financial Group's primary regulator. NASD adopts rules, subject to approval by the SEC, that govern its members and conducts periodic examinations of member firms' operations. Compliance with these regulations involves a number of risks, particularly where the regulations may be subject to varying interpretation. If we are found to have violated an applicable regulation, an administrative or judicial action may be initiated against us that may result in penalties which could have a material adverse effect on our operating results and financial condition, including but not limited to: o censure; o fine; o civil damage awards, including treble damages for insider trading violations; o the issuance of cease-and-desist orders; or o the deregistration or suspension of our broker-dealer activities and/or our employees. 13 The New Jersey Bureau of Securities is conducting an inquiry into First Montauk Securities Corp.'s sale of certain high-yield bonds to the firm's clients from 1998 to 2001, and the subsequent resale of those securities to other customers in 2001. We have recently begun settlement discussions with the Bureau in an attempt to resolve the matter in order to avoid a protracted legal proceeding. The final terms of the settlement are still being negotiated but may include a monetary fine, the disgorgement of markups on the sale of certain bonds and the retention of a compliance consultant to review the firm's procedures. The exact amount of civil penalty and disgorgement as well as the precise language of the proposed consent order are still being negotiated with the Bureau. We believe that we have adequately reserved for the anticipated financial impact of this matter in our financial statements. We depend upon our registered representatives Most aspects of our business are dependent on highly skilled and experienced individuals. We have devoted considerable efforts to recruiting and compensating those individuals and provide incentives to encourage them to remain employed by or associated with us. Individuals associated with us may leave our company at any time to pursue other opportunities. We face significant competition for registered representatives We are continuously adding new registered representatives to our company to either grow our operations or to replace registered representatives that have left our company. We compete with other financial services firms for these persons and the level of competition for registered representatives remains intense. The loss of a significant number of registered representatives could materially and adversely affect our operating results. We depend upon our senior management For the foreseeable future, we will be substantially dependent upon the personal efforts and abilities of our senior management, including our Chief Executive Officer and President, Mr. Victor K. Kurylak, Mr. Robert I. Rabinowitz, our General Counsel and Executive Vice President and Ms. Mindy A. Horowitz, our acting Chief Financial Officer and Senior Vice President, to coordinate, implement and manage our business plans and programs. The loss or unavailability of the services of any of them would likely have a material adverse affect on our business, operations and prospects. In addition, loss of key members of management could require us to invest capital to search for a suitable replacement. Such a search could serve as a distraction to the remaining members of management preventing them from focusing on the ongoing development of our business which, in turn, could cause us to lose money. Montauk Financial Group must comply with Net Capital Requirements The business of our broker-dealer, like that of other securities firms, is capital intensive. The SEC and the NASD have stringent provisions with respect to net capital requirements applicable to the operation of securities firms. A significant operating loss or any charge against net capital could adversely affect our ability to significantly expand or, depending upon the magnitude of the loss or charge, to maintain our present level of business. We are exposed to risks due to our investment banking activities Participation in an underwriting syndicate or a selling group involves both economic and regulatory risks. An underwriter may incur losses if it is unable to resell the securities it is committed to purchase, or if it is forced to liquidate its commitment at less than the purchase price. In addition, under federal securities laws, other laws and court decisions with respect to underwriters' liabilities and limitations on the indemnification of underwriters by issuers, an underwriter is subject to substantial potential liability for misstatements or omissions of material facts in prospectuses and other communications with respect to such offerings. Acting as a managing underwriter increases these risks. Underwriting commitments constitute a charge against net capital and our ability to make underwriting commitments may be limited by the requirement that it must at all times be in compliance with the Net Capital Rule. 14 We rely on primarily on one clearing firm and the termination of the clearing agreement with this firm could disrupt Montauk Financial Group's business Montauk Financial Group uses two clearing brokers, National Financial Services, LLC as its primary clearing broker, and Penson Financial Corp., to which we currently introduce a limited number of customer accounts, to process its securities transactions, maintain customer accounts, control, receive, custody and deliver securities, on a fee basis. We depend on the operational capacity and ability of the clearing broker for the orderly processing of transactions. If the clearing agreements are terminated for any reason, or if the clearing brokers fail to provide its functions for us in the normal course of business, we would be forced to find an alternative clearing broker. There is no assurance that we would be able to find an alternative clearing broker on acceptable terms to us or at all. Our broker-dealer subsidiary faces limitations on trading and market-making activities in our securities Due to regulatory positions and requirements of both the SEC and the NASD relating to the circumstances and extent to which a registered broker-dealer and NASD member may engage in market-making transactions in the securities of its parent company, Montauk Financial Group does not engage in trading or market-making activities relating to our common stock or warrants where Montauk Financial Group would speculate in, purchase or sell our securities for its own account. The purpose and effect of such limitation restricts Montauk Financial Group from being a factor in the determination of the market or price of our securities. Montauk Financial Group does, however, execute transactions for its customers on an "agency basis" where it does not acquire our securities for its own proprietary account. It will, however, earn usual and customary brokerage commissions in connection with the execution of such brokerage transactions. If, under current or future regulations of both the SEC and NASD, Montauk Financial Group is permitted to participate as a market maker, it may do so on the basis of showing a bid and offer for our securities at specified prices representing customer interest. We have limited the liability of our directors We have amended our certificate of incorporation to include provisions eliminating the personal liability of our directors, except for breach of a director's duty of loyalty to the company or to our shareholders, acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of the law, and in respect of any transaction in which a director receives an improper personal benefit. These provisions pertain only to breaches of duty by directors as such, and not in any other corporate capacity, e.g., as an officer. As a result of the inclusion of such provisions, neither the company nor its shareholders may be able to recover monetary damages against directors for actions taken by them which are ultimately found to have constituted negligence or gross negligence, or which are ultimately found to have been in violation of their fiduciary duties, although it may be possible to obtain injunctive or other equitable relief with respect to such actions. If equitable remedies are found not to be available to shareholders in any particular case, shareholders may not have an effective remedy against the challenged conduct. We believe that, based upon recent developments in the market for directors' and officers' liability insurance, such provisions are necessary to attract and retain qualified individuals to serve as directors. In addition, such provisions will allow directors to perform their duties in good faith without concern for the application of monetary liability on a retroactive basis in the event that a court determines their conduct to have been negligent or grossly negligent. On the other hand, such provisions significantly limit the potential remedies available to the company or a shareholder, and it is possible that the protection afforded by such provisions may reduce the level of diligence or care demonstrated by such directors. 15 Risks Related to Our Common Stock We do not pay dividends on our common stock We do not pay dividends on the issued and outstanding shares of our common stock. However, we pay 6% quarterly dividends on the outstanding shares of our Series A Convertible Preferred Stock, and 8% quarterly dividends on the outstanding shares of our Series B Convertible Redeemable Preferred Stock. Applicable laws, rules and regulations under the New Jersey Business Corporation Act and the Securities Act of 1933, as amended, have affected our ability to declare and pay dividends. The conversion or exercise of outstanding convertible securities may result in dilution to our common shareholders We have issued a significant amount of convertible securities and the dilution of the per share value of our common shares could result from the conversion or exercise of most or all of the currently outstanding convertible securities. We issued an aggregate of $1,240,000 principal amount of debentures in a private offering completed in March 2003 and subsequently issued an additional $1,895,000 principal amount of debentures in a private offering completed in December 2003. The debentures are convertible into a total of 6,270,000 shares of our common stock at an initial conversion rate of $0.50. To date, holders of $1,885,000 principal amount of debentures have converted into 3,770,000 shares of our common stock. In 1999, we issued an aggregate of 349,511 shares of Series A Preferred Stock in connection with an exchange offer. Currently, 305,369 Series A Preferred Shares remain outstanding and convertible into 610,738 shares of common stock at the rate of $2.50 per share. However, if the last sale price of the common stock is $3.50 or more a share for 20 consecutive trading days, as listed on the Over-the-Counter Bulletin Board, the Series A Shares will automatically be converted into shares of common stock. In 2005 we issued 197,824 shares of Series B Convertible Redeemable Preferred Stock that are convertible into 1,978,240 shares of our common stock. In addition, as of March 30, 2006, there were outstanding: o warrants to purchase 313,500 shares of common stock at an exercise price of $0.50 per share; o warrants to purchase 151,224 shares of common stock at an exercise price of $.25 issued in a settlement of certain claims; and o options to purchase 2,280,402 shares of common stock, at exercise prices ranging from $.20 to $2.50 per share. The conversion or exercise of these convertible securities and the sale of the underlying common stock, or even the potential of such conversion or exercise and sale, may have a depressive effect on the market price of our securities and will cause dilution to our shareholders. Moreover, the terms upon which we will be able to obtain additional equity capital may be adversely affected, since the holders of the outstanding convertible securities can be expected to convert or exercise them at a time when we would, in all likelihood, be able to obtain any needed capital on terms more favorable to us than the exercise terms provided by the outstanding options and warrants. Dilution could create significant downward pressure on the trading price of our common stock if the conversion or exercise of these securities encouraged short sales. Even the mere perception of eventual sales of common shares issued on the conversion of these securities could lead to a decline in the trading price of our common stock. We have sold restricted shares which may depress the common stock price As of March 30, 2006, of the 16,009,793 issued and outstanding shares of our common stock, approximately 5,189,864 shares may be deemed restricted shares and, in the future, may be sold in compliance with Rule 144 under the securities Act of 1933, as amended. Rule 144 provides that a person holding restricted securities for a period of one year may sell in brokerage transactions an amount equal to 1% of our outstanding common stock every three months. A person who is not affiliated with us and who has held restricted securities for over two years is not subject to the aforesaid volume limitations as long as the other conditions of the Rule are met. Possible or actual sales of our common stock by certain of our present shareholders under Rule 144 may, in the future, have a depressive effect on the price of the common stock in any market which may develop for such shares. Such sales at that time may have a depressive effect on the price of the common stock in the open market. There is a limited public market for our securities Our common stock is traded in the over-the-counter market and reported by the National Daily Quotation Service published by the National Quotation Bureau, Inc. and the Electronic Bulletin Board maintained by the NASD. Although we may apply for inclusion of our common stock in the Nasdaq Smallcap Market and/or on the American Stock Exchange, we do not currently satisfy the minimum listing requirements. Accordingly, there can be no assurance that we will be successful in obtaining listing on Nasdaq or on the Amex, or if obtained, that it will be able to maintain the Nasdaq or Amex listing. 16 There may be significant consequences associated with our stock trading on the OTCBB rather than a national exchange. The effects of not being able to list our securities on a national exchange include: o limited release of the market price of our securities; o limited interest by investors in our securities; o volatility of our stock price due to low trading volume; o increased difficulty in selling our securities in certain states due to "blue sky" restrictions; and o limited ability to issue additional securities or to secure additional financing. Because our Common Stock may be subject to "penny stock" rules, the market for the Common Stock may be limited. If our Common Stock becomes subject to the Securities and Exchange Commission's penny stock rules, broker-dealers may experience difficulty in completing customer transactions and trading activity in our securities may be adversely affected. If at any time our Common Stock has a market price per share of less than $5.00, and we do not have net tangible assets of at least $2,000,000 or average revenue of at least $6,000,000 for the preceding three years, transactions in our Common Stock may be subject to the "penny stock" rules promulgated under the Exchange Act. Under these rules, broker-dealers who recommend such securities to persons other than institutional accredited investors: o must make a special written suitability determination for the purchaser; o receive the purchaser's written agreement to a transaction prior to sale; o provide the purchaser with risk disclosure documents which identify certain risks associated with investing in "penny stocks" and which describe the market for these "penny stocks" and a purchaser's legal remedies; and o obtain a signed and dated acknowledgment from the purchaser demonstrating that the purchaser has actually received the required risk disclosure document before a transaction in a "penny stock" can be completed. If our Common Stock becomes subject to these rules, broker-dealers may find it more difficult to effectuate customer transactions and trading activity in our securities may be adversely affected. As a result, the market price of our securities may be depressed, and stockholders may find it more difficult to sell our securities. The price of our common stock is volatile The price of our common stock has fluctuated substantially (See Part II, Item 5). This volatility may be caused by factors specific to our company and the securities markets in general. Factors affecting volatility may include: variations in our annual or quarterly financial results or those of our competitors; conditions in the economy in general; and changes in applicable laws or regulations, or their judicial or administrative interpretations affecting us or the securities industry in general. In addition, volatility of the market price of our common stock is affected by the relatively low trading volume it has experienced and the fact that it is not listed for trading on a national securities exchange. Our Certificate of Incorporation and By-Laws contain provisions which may have an anti-takeover effect Our amended and restated certificate of incorporation and by-laws contain provisions which may discourage certain transactions which involve an actual or threatened change in control of the company. These provisions include a classified or staggered board of directors. As permitted by the New Jersey Corporation Law, our certificate of incorporation provides that a director or officer of our company will not be personally liable to the company or its stockholders for monetary damages for breach of the fiduciary duty of care as a director, except under certain circumstances including a breach of the director's duty of loyalty to the company or our stockholders or any transaction from which the director derived an improper personal benefit. The provisions referred to above may make the company a less attractive acquisition candidate. They may also discourage or impede offers to acquire the business not approved by the board of directors, including offers for some or all of the shares of any class or series of capital stock at substantial premiums above the then current market value of such shares. Item 1B. Unresolved Staff Comments. None 17 Item 2. Properties Offices and Facilities The Corporate Headquarters We maintain our corporate headquarters and executive offices at Parkway 109 Office Center, 328 Newman Springs Road, Red Bank, New Jersey. On September 22, 2004 we entered into a 4th Amendment to our Master Lease dated March 1997 for our corporate headquarters in Red Bank, New Jersey. The amendment provides for a lease term of five (5) years which commenced on February 1, 2005, for 27,255 square feet. The lease provides for monthly rent payments of $50,762. As additional rent, we are required to pay a proportional share of any increases in real estate taxes and operating expenses above the amount paid during the 2005 calendar year, insurance premiums relating to the premises, and all utility charges related to the premises. The amendment contains a five-year option to renew at a rental payment equal to the then-current fair market rate per square foot applicable to the leased premises. Leased Branch Offices In June 2001 we entered into a sub-lease agreement for 4,269 square feet of office space on Wall Street in New York City that had been sublet to an affiliate and operated as a branch office. This sublease expired on January 30, 2005 and was not renewed. In January 2002 we entered into a sub-lease agreement for 4,520 square feet of office space in Midtown Manhattan which is used as a retail branch office. The sub-lease term runs until September 29, 2006 and provides for a monthly rent payment $19,963 for the balance of the sub-lease term. Item 3. Legal Proceedings Many aspects of our business involve substantial risks of liability. In recent years, there has been an increasing incidence of litigation and arbitration involving the securities industry. We are a respondent or co-respondent in various legal proceedings, which are related to its securities business. Management is contesting these claims and believes that there are meritorious defenses in each case. However, litigation is subject to many uncertainties, and some of these actions and proceedings may result in adverse judgments. Further, the availability of insurance coverage is determined on a case-by-case basis by the insurance carrier, and is limited to the coverage limits within the policy for any individual claim and in the aggregate. After considering all relevant facts, available insurance coverage and consultation with litigation counsel, management believes that significant judgments or other unfavorable outcomes from pending litigation could have a material adverse impact on our consolidated financial condition, results of operations, and cash flows in any particular quarterly or annual period, or in the aggregate, and could impair our ability to meet the statutory net capital requirements of its securities business. 18 The New Jersey Bureau of Securities is conducting an inquiry into First Montauk Securities Corp.'s sale of certain high-yield bonds to the firm's clients from 1998 to 2001, and the subsequent resale of those securities to other customers in 2001. We have recently begun settlement discussions with the Bureau in an attempt to resolve the matter in order to avoid a protracted legal proceeding. The final terms of the settlement are still being negotiated but will include a monetary fine, the disgorgement of markups on the sale of certain bonds and the retention of a compliance consultant to review the firm's procedures. The exact amount of civil penalty and disgorgement as well as the precise language of the proposed consent order are still being negotiated with the Bureau. We believe that we have adequately reserved for the anticipated financial impact of this matter in our financial statements. During 2005 we settled four customer arbitrations for an aggregate of $360,000, involving the sale of high-yield bonds referenced in the Company's Form 10-K for the year ended December 31, 2004. Management believes that we have sufficiently accrued for any probable costs related to the one remaining customer arbitration related to the sale of the high-yield bonds. A shareholder, BMAC Corp., has filed a report on Schedule 13D with the Securities and Exchange Commission stating that it holds approximately 5.3% of our outstanding shares as of January 13, 2006. In addition, a company named 360 Global Wine Co., Inc., filed a joint Schedule 13D with BMAC Corp. stating that it intends to acquire the shares of our common stock held by BMAC Corp. as well as those held by certain other individuals. Based on this filing, 360 Global Wine stated that it believed it would acquire 2,986,188 shares or 18.7% of our outstanding shares of common stock. As previously disclosed, we believe that the original Schedule 13D filed by BMAC Corp. (and as amended up to an including the January 2006 amendment) did not satisfy the federal securities regulations related to the filing of Schedule 13D. Although no litigation has been commenced, we have been advised that BMAC and/or 360 Global Wine intend to undertake certain actions, which may include an attempt to change or influence control over the company, including recommendation of management changes and structure of the board of directors. In addition, certain former registered representatives of Montauk Financial Group have contacted our management and advised us that they represent BMAC Corp. and seek management changes in the company. These former brokers have stated it is their intention to put themselves in place as management of Montauk Financial Group. We are aware that many of the clients of these former registered representatives held convertible debentures that we had issued in a prior private placement and substantially all of these debenture holders converted their debentures into our Common Stock at the same time, including persons affiliated with BMAC Corp. We have advised the SEC and NASD of our belief that the persons involved have not complied with applicable law regarding Section 13D of the Securities and Exchange Act of 1934, as well as other provisions of the Securities and Exchange Act of 1934 and SEC regulations. We fully intend to seek all defenses available to us in this matter and are reviewing all available legal options against these persons. As of December 31, 2005, we have accrued litigation costs that are probable and can be reasonably estimated based on a review of existing claims, arbitrations and unpaid settlements. Management cannot give assurance that this amount will be adequate to cover actual costs that may be subsequently incurred. Further, it is not possible to predict the outcome of other matters pending against us. All such cases will continue to be vigorously defended. Item 4. Submission of Matters on a Vote of Security Holders We did not submit any matters to our shareholders for a vote during the fourth quarter of the year ended December 31, 2005. We anticipate that the next meeting of shareholders will include a vote upon the proposed transaction with a private investor as described above to proceed with the transaction as contemplated. 19 PART II Item 5. Market of and Dividends on our Common Equity and Related Stockholder Matters A. Principal Market and Market Information Our common stock is traded in the over-the-counter market. Trading in our common stock is reported on the NASD Bulletin Board system and in the pink sheets published by Pink Sheets LLC. We believe that there is an established public trading market for our common stock based on the volume of trading in our common stock and the existence of market makers who regularly publish quotations for our common stock. Our common stock commenced trading in the over-the-counter market in 1987. On March 30, 2006, our common stock had bid and offer prices of $1.01 and $1.05, respectively. At December 31, 2005 our Common Stock had a closing price of $0.85 per share. Quotations on the OTCBB reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. The following is the range of high and low bid prices for such securities for the periods indicated below: Common Stock Calendar Year 2006 High Bid Low Bid 1st Quarter (through 3/30/06) $1.22 $.80 Calendar Year 2005 High Bid Low Bid 1st Quarter $1.09 $.47 2nd Quarter $1.09 $.84 3rd Quarter $1.04 $.85 4th Quarter $.9450 $.75 Calendar Year 2004 High Bid Low Bid 1st Quarter $.42 $.30 2nd Quarter $.39 $.27 3rd Quarter $.42 $.24 4th Quarter $.80 $.49 B. Number of Record Holders The approximate number of record holders of our common stock as of March 30, 2006 was 512. Such number of record holders was determined from our stockholder records, and does not include beneficial owners of our common stock whose shares are held in the names of various security holders, dealers and clearing agencies. We believe there are in excess of 3,000 beneficial holders of our common stock. C. Dividend Policy We have not paid any dividends on our common stock since our inception, and do not expect to pay any dividends on our common stock in the foreseeable future and plan to retain earnings, if any, to finance the development and expansion of our business. We pay quarterly dividends on outstanding shares of our Series A Preferred Stock at the rate of 6% per annum, subject to the limitations under the New Jersey Business Corporation Act. There are currently outstanding 305,369 shares of Series A Preferred Stock. We also pay quarterly dividends on our Series B Convertible Redeemable Preferred Stock at the rate of 8% per annum, subject to the limitations under the New Jersey Business Corporation Act. There are currently outstanding 197,824 shares of Series B Convertible Redeemable Preferred Stock. There can be no assurance that we will continue to pay dividends in the future. 20 D. Issuance of Unregistered Securities Restricted Shares Issuance In January 2004 and February 2005 we issued an aggregate of 2,300,000 shares of restricted common stock to our top five executive officers and a senior employee. These shares were granted in conjunction with new employment agreements for each executive officer, and were issued in conjunction with the provisions of our 1996 Senior Management Stock Option Plan, as amended. In addition, in connection with the Severance Agreement entered into with William J. Kurinsky, we issued to him an aggregate of 197,824 shares of newly created Series B Preferred Stock. We relied upon the exemptions from registration provided upon in Section 4(2) of the Securities Act of 1933 in connection with these issuances. In 2004 and 2005, holders of an aggregate principal amount of $1,885,000 of debentures convert into shares of common stock in accordance with the terms of the debentures. The debentures were sold in private offerings in 2002 and 2003. We have issued an aggregate amount of 3,770,000 shares of Common Stock in connection with these conversion events. The debentures are convertible at $.50 per share. We relied upon the exemptions from registration provided upon in Section 3(a)(9) of the Securities Act of 1933 in connection with these issuances. In February 2005 we issued an aggregate of 197,824 shares of a newly created class of Series B Preferred Convertible Redeemable Stock, par value $0.10 per share, which had a deemed issue price of $1,000,000, and is convertible into Common Stock on the basis of ten shares of Common Stock for each share of Series B Preferred Stock. The Series B Preferred shares have voting rights based upon the number of shares of Common Stock into which it would be converted. The Series B Preferred Stock also includes a cumulative dividend of 8% per year. The shares are restricted securities under the Securities Act of 1933 and the regulations of the SEC and we relied upon the exemption from registration under Section 4(2) of the Securities Act of 1933 to issue the shares of Series B Preferred Stock. The Series B Preferred Stock was authorized by the Board out of, and in accordance with, the Registrants authorized but undesignated class of preferred stock under its certificate of incorporation. In addition, during the year ended December 31, 2005, we granted options to purchase 1,105,000 shares of common stock pursuant to our stock option plans to certain of our employees and registered representatives, which plans were not registered at the time of grant. The options were granted at exercise prices between $0.75 and $1.25 per share. In March 2005, a registration statement on Form S-8 was filed with the SEC registering all common shares issuable from our stock option plans. During the fourth quarter of 2005, we issued 25,000 restricted shares of our common stock as part of a legal settlement. The shares were issued pursuant to an exemption under Section 4(2) of the Securities Act. E. Stock Repurchases There were no repurchases of any securities during the fourth quarter of 2005. F. Securities Authorized For Issuance Under Equity Compensation Plans See the discussion and table at page 48. 21 Item 6. Selected Financial Data The following selected financial data should be read in conjunction with the Consolidated Financial Statements, including the related notes, and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Year Ended December 31, 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- Operations Results: Revenues: Commissions $37,493,733 $42,732,238 $41,883,669 $36,513,802 $37,807,870 Principal transactions 5,578,820 9,058,259 9,466,359 6,727,642 8,021,887 Investment banking 6,640,402 2,716,042 2,439,144 1,007,700 1,483,210 Interest and other income 8,370,711 4,680,702 4,437,510 3,717,600 3,907,448 --------- --------- --------- --------- --------- Total 58,083,666 59,187,241 58,226,682 47,966,744 51,220,415 ---------- ---------- ---------- ---------- ---------- revenues Expenses: Commissions, employee $44,398,131 46,851,474 46,218,107 39,572,851 42,356,207 compensation and benefits Executive separation 1,432,937 -- -- -- -- Clearing and floor 1,926,005 2,466,027 2,934,164 2,666,376 3,247,219 brokerage Communications and 2,483,056 2,664,256 2,659,105 3,006,117 3,249,389 occupancy Legal matters and related 1,773,604 2,714,769 5,836,960 1,259,502 2,415,374 costs Other operating expenses 3,467,972 3,489,425 3,393,335 4,029,515 5,076,806 Interest 100,123 284,093 204,054 98,918 174,632 ------- ------- ------- ------ ------- Total expenses 55,581,828 58,470,044 61,245,725 50,633,179 56,519,627 ---------- ---------- ---------- ---------- ---------- Income (loss) before income 2,501,838 717,197 (3,019,043) (2,666,435) (5,299,212) taxes Provision (benefit) for 77,544 (13,305) 499,000 294,000 (90,989) ------ -------- ------- ------- -------- income taxes Net income (loss) $2,424,294 $730,502 $(3,518,043) $(2,960,435) $(5,208,223) ========== ======== ============ ============ ============
22 Year Ended December 31, 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- Operations Results: Net income (loss) applicable to common stockholders $2,138,954 $639,813 $(3,542,882) $(3,059,722) $(5,306,976) ========== ======== ============ ============ ============ Earnings (loss) per share: Basic: $0.15 $(0.36) $(0.61) $0.07 $(0.40) $0.12 $(0.36) $(0.61) Diluted: $0.04 $(0.40) Weighted average common shares outstanding-- Basic 14,032,057 9,270,350 8,784,103 8,551,932 8,704,355 Weighted average common and common share equivalents outstanding - Diluted 20,109,178 15,629,920 8,784,103 8,551,932 8,704,355 Financial condition: Total assets $8,719,930 $9,834,374 $12,193,101 $11,425,506 $14,227,562 Total liabilities $5,492,079 $12,932,991 $16,280,540 $12,203,196 $11,934,884 Temporary Equity-Shares subject to redemption 6,500 Stockholders' equity (deficit) $3,227,851 $(3,098,617) $(4,087,439) $(777,690) $2,286,181
23 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Factors Affecting "Forward Looking Statements" From time to time, we may publish "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended, or make oral statements that constitute forward-looking statements. These forward-looking statements may relate to such matters as anticipated financial performance, future revenues or earnings, business prospects, projected ventures, new products, anticipated market performance, and similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. These risks and uncertainties, many of which are beyond our control, include, but are not limited to: (i) transaction volume in the securities markets, (ii) the volatility of the securities markets, (iii) fluctuations in interest rates, (iv) changes in regulatory requirements which could affect the cost of doing business, (v) fluctuations in currency rates, (vi) general economic and political conditions, both domestic and international, (vii) changes in the rate of inflation and related impact on securities markets, (viii) competition from existing financial institutions and other new participants in competition from existing financial institutions and other new participants in the securities markets, (ix) legal developments affecting the litigation experience of the securities industry, and (x) changes in federal and state tax laws which could affect the popularity of products sold by us. We do not undertake any obligation to publicly update or revise any forward-looking statements. Overview We are a New Jersey-based financial services holding company whose principal subsidiary, First Montauk Securities Corp., has operated as a full service retail and institutional securities brokerage firm since 1987. Since July 2000, First Montauk Securities Corp. has operated under the trade name "Montauk Financial Group" and provides a broad range of securities brokerage and investment services to a diverse retail and institutional clientele, as well as corporate finance and investment banking services to corporations and businesses. We also sell insurance products through our subsidiary, Montauk Insurance Services, Inc. Montauk Financial Group has approximately 290 registered representatives and services over 50,000 retail and institutional customers, which comprise over $3.2 billion in customer assets. With the exception of a company leased branch office in New York City, all of our other 116 branch office and satellite locations in 27 states are owned and operated by affiliates; independent representatives who maintain all appropriate licenses and are responsible for all office overhead and expenses. Montauk Financial Group also employs registered representatives directly at its corporate headquarters. Montauk Financial Group is registered as a broker-dealer with the Securities and Exchange Commission, the National Association of Securities Dealers, the Municipal Securities Rule Making Board, the National Futures Association, and the Securities Investor Protection Corporation and is licensed to conduct its brokerage activities in all 50 states, the District of Columbia, and the Commonwealth of Puerto Rico, and registered as an International broker-dealer to conduct business with institutional clients in the province of Ontario, Canada. All securities transactions are cleared through National Financial Services, LLC. ("NFS"), a Fidelity Investments company, with various floor brokerage and specialist firms also providing execution services. These arrangements provide Montauk Financial Group with back office support, transaction processing services on all principal, national and international securities exchanges, and access to many other financial services and products which allows Montauk Financial Group to offer products and services comparable to larger brokerage firms. Our revenues consist primarily of commissions and fee income from individual and institutional securities transactions, mutual fund and annuity sales and investment banking services, such as private and public securities offerings and limited market making activities. We engage in a highly competitive business. Therefore, our earnings, like those of others in the industry, reflect the activity in the securities markets and can and do fluctuate accordingly. 24 Effective February 1, 2005, we entered into a Separation Agreement ("Agreement") with William J. Kurinsky, our former Chief Executive Officer ("CEO"), which provided for the termination of his employment agreement and his position as CEO of the Company. Pursuant to the terms of the Separation Agreement, we entered into a two-year consulting agreement, and issued 197,824 shares of FMFC Series B Convertible Redeemable Preferred Stock at a deemed price of $1,000,000, convertible into 1,978,240 shares of our common stock, with voting privileges. We also executed a promissory note for $200,000 with interest of 8% per annum, paid him a lump-sum cash payment of $136,000, issued 200,000 options to purchase common stock at $0.83 per share for three years, vesting over two years, and cancelled 325,000 options with various exercise prices. In addition, all restricted common shares not previously vested were automatically vested upon his termination. Contemporaneously with the cessation of Mr. Kurinsky's service as our CEO, Victor K. Kurylak, our President and Chief Operating Officer at that time was appointed as our new CEO. Effective February 1, 2005, we entered into an employment agreement with the new CEO, which superseded his existing agreement, and issued him 1,000,000 restricted shares of our common stock, with vesting provisions, as a bonus payment for our performance for the year ended December 31, 2004, and in consideration of him being appointed to CEO. On February 10, 2005 we executed a Definitive Agreement and Plan of Merger with Olympic Cascade Financial Corporation. On May 11, 2005, we and Olympic agreed to revise the terms of the proposed merger and entered into an Amended and Restated Agreement and Plan of Merger on June 27, 2005. However, on October 24, 2005, we and Olympic Cascade Financial Corporation ("Olympic") jointly announced the agreement to terminate the Amended and Restated Agreement and Plan of Merger, by and among the Company, Olympic, and OLY Acquisition Corporation, a wholly owned subsidiary of the Company. Under the terms of the letter agreement terminating the Amended and Restated Merger Agreement, the parties shall have no further obligation to each other arising out of the Merger Agreement, the Merger, and the transactions contemplated thereby, and each party agreed to bear its own expenses. On April 21, 2005, we entered into a new clearing agreement with NFS. In connection with entering into our new clearing agreement, we terminated our clearing agreement and related Financial and Security Agreements with Fiserv and our contingent obligation to repay Fiserv any of the cash advances that were provided to us under the Financial Agreement and the early termination penalty have been canceled. Each of the termination agreements was effective as of April 21, 2005. Results of Operations Three Years Ended December 31, 2005 Overview Revenues decreased $1.1 million for the year ended December 31, 2005, to $58.1 million, compared to an increase in 2004 of $960,000 from $58.2 million in 2003. Included in total revenue for 2005 is the recognition of additional deferred revenue in excess of what would have been reported of $4,230,000 in connection with the termination of our Financial Agreement with Fiserv, our prior clearing firm. Excluding this one-time revenue, operating revenues decreased approximately $5.3 million, or 9%, compared to 2004. Our 2005 results were negatively impacted by a net reduction of approximately 80 registered representatives during 2005 and a decrease in the aggregate number of customer accounts we service from approximately 60,000 to approximately 50,000. Excluding our one-time recognition of deferred revenue, the decrease in revenues was due to a $5.2 million, or 12%, decrease in commission revenue and a $3.5 million, or 38%, decrease in principal transactions, partially offset by a $3.9 million, or 144% increase in investment banking. Expenses in 2005 decreased $2.9 million to $55.6 million, from $58.5 million in 2004 compared to a $2.8 decrease in 2004 from $61.2 million in 2003. The reduction in expense in 2005 was primarily related to lower commission and clearing expenses directly related to the reduction in commission revenue. In addition, legal matters and related costs decreased by $941,000 over 2004 due to our continued efforts to control litigation matters and our overall risk management. There were one-time and non-operational items of expense that had an adverse affect on net income during 2005. In February 2005, we expensed approximately $1,433,000 in connection with a separation agreement with our former CEO and $606,000 related to stock grants issued in February 2005 to several senior executives. In addition, during 2005, we expensed approximately $394,000 of costs related to the proposed merger with Olympic Cascade Financial Corporation. 25 Net income applicable to common shareholders increased $1.5 million, from $640,000 in 2004 to $2.1 million in 2005. Our earnings per share also increased in 2005 from $0.07 and $0.04 per basic and diluted share, respectively, for the 2004 year to $0.15 and $0.12 per basic and diluted share, respectively, for the year ending 2005. This compares to a $3.5 million net loss applicable to common shareholders or $0.40 basic and diluted loss per share in 2003. Revenues Our revenues consist primarily of commissions and fee income from individual and institutional securities transactions, mutual fund and annuity sales and investment banking services, such as private and public securities offerings and limited market making activities. The following provides a breakdown of total revenues by source for the years ended December 31, 2005, 2004 and 2003 (in thousands of dollars). Year Ended ------------------------------------------------------------------------------------------ December 31, 2005 December 31, 2004 December 31, 2003 ----------------------------- ---------------------------- ------------------------------- Amount % of Total Amount % of Total Amount % of Total Revenues Revenues Revenues -------------- -------------- ------------ --------------- -------------- --------------- Commissions Equities $ 20,530 35% $ 26,533 45% $ 28,646 49% Mutual Funds 6,348 11% 6,131 10% 5,717 10% Insurance 4,230 7% 4,750 8% 4,212 7% Investment Advisory 3,235 5% 2,614 4% 1,880 3% Alternative Products 3,009 5% 2,325 4% 1,034 2% Fixed Income 142 <1% 379 1% 395 1% -------------- -------------- ------------ --------------- -------------- --------------- Total 37,494 64% 42,732 72% 41,884 72% Principal Transactions 5,579 10% 9,058 15% 9,466 16% Investment Banking 6,640 12% 2,716 5% 2,439 4% Interest and Other Interest 2,506 4% 2,798 5% 2,640 5% Deferred revenue 5,105 9% 875 1% 726 1% Other 760 1% 1,008 2% 1,072 2% -------------- -------------- ------------ --------------- -------------- --------------- Total 8,371 14% 4,681 8% 4,438 8% -------------- -------------- ------------ --------------- -------------- --------------- Total revenues $ 58,084 100% $ 59,187 100% $58,227 100% ============== ============== ============ =============== ============== ===============
Commission Revenue Commission revenue decreased 12%, or $5.2 million, primarily due to a reduction in the number of registered representatives in 2005 whose business mix was more transactional in nature. Agency commissions on individual and institutional securities transactions, the largest segment of this category, decreased $6.0 million, or 23%, to $20.5 million in 2005, from $26.5 million in 2004. This followed a 7% decrease in 2004 agency revenues compared to $28.6 million reported in 2003. 26 Mutual fund revenues increased $217,000 from $6.1 million in 2004, to $6.3 million in 2005, compared to a 7% increase in 2004 from $5.7 million in 2003. This was in large part due to continuing increased investor interest in mutual fund investments. Insurance revenues decreased by $520,000 in 2005 to $4.2 million from $4.7 million in 2004. This followed an increase in insurance commissions from $4.2 in 2003 to $4.7 in 2004. This decrease was due to a shift of investor focus from insurance related investments toward equity markets. Commissions generated from alternative investment products, such as Real Estate Investment Trusts (REITs), IRS Section 1031 Real Estate Exchanges and medical receivables, increased 29% from $2.3 million in 2004 to $3.0 million in 2005 following an increase of 125% from $1.0 million in 2003. Fees generated from managed accounts continued to increase through the 2005 year by 24% to $3.2 million compared to a 39% increase in 2004 compared with 2003. These year-over-year increases are attributable to growth in assets under management by investors who prefer to pay a fee based on a percentage of asset value, rather than commissions paid on transactions. Principal Transactions Total revenues from principal transactions, which include mark-ups/mark-downs on transactions in which we act as principal, proprietary trading and the sale of fixed income and equity securities decreased $3.5 million, or 38%, from $9.1 million in 2004 to $5.6 million in 2005. This compares to a decrease in principal transactions of 4% or $408,000, from $9.5 million in 2003. These decreases are primarily due to a reduction in the number of registered representatives in 2004 who conducted more of these types of transactions. Revenues from all fixed income sources, which include municipal, government, and corporate bonds and unit investment trusts decreased in 2005 by $1.2 million, compared to an increase in 2004 of $746,000. Revenues from riskless principal trades of equity securities decreased $1.6 million, from $2.9 million in 2004 to $1.2 million in 2005. These decreases are also primarily attributable to a reduction in the number of registered representatives during 2004 and 2005who conducted more of these types of transactions. Riskless principal trades are transacted through the firm's proprietary account with a customer order in hand, resulting in no market risk to the firm. Investment Banking Investment banking revenues in 2005 increased $3.9 million, or 144%, from $2.7 million in 2004, to $6.6 million in 2005, compared to an increase of $277,000 in 2004 compared to 2003. This category includes private offerings of securities in which we acted as placement agent and new issues of equity and preferred stock offerings in which we participated as a selling group or syndicate member. The increase in investment banking revenues was primarily due to several larger private offerings of securities than we had during 2004. Interest and Other Income Interest and other income in 2005 totaled $8.4 million, as compared to $4.7 million in 2004, an increase of $3.7 million. Most of the increase is attributable to the additional $4.2 million of deferred income, as described above, recognized during the second quarter of 2005 in connection with the termination of our Financial Agreement with our prior clearing firm. Interest income decreased $278,000, when compared to 2004, reflecting a change in account balances and rebates received from our clearing firm in 2005. For 2005, other income decreased by $262,000 primarily due to unrealized losses on investments of $299,000. Interest and other income for 2004 totaled $4.7 million, as compared to $4.4 for 2003, a 5% increase of $243,000. The primary reason for the increase in other income in 2004 is attributable to an increase in marketing fees, unrealized investment income and the recognition of deferred income. If not for the impact of a one time recovery of bad debt in 2003, the variance in 2004 would have been approximately $676,000. 27 Expenses Total expenses decreased by approximately $2.9 million, or 5%, in 2005 to $55.6 million from $58.5 million in 2004. In February 2005, we recorded additional compensation expense of $1,433,000 in connection with a separation agreement with one of our senior officers. Excluding this one-time expense, expenses decreased $4.3 million over the 2004 year. Expenses in 2004 decreased by $2.7 million, or 4%, to $58.5 million in 2004, from $61.2 million in 2003. The following provides a breakdown of total expenses for the years ended December 31, 2005, 2004 and 2003 (in thousands of dollars). Year Ended ------------------------------------------------------------------------------- December 31, 2005 December 31, 2004 December 31, 2003 --------------------------- ----------- ------------- ------------ ------------ Amount % of Amount % of Total Amount % of Total Total Expenses Expenses Expenses -------------- ------------ ------------ ------------ ------------ ------------ Commissions, employee $44,398 80% $46,852 80% $46,218 75% compensation and benefits Executive separation 1,433 3% -- -- Clearing and floor brokerage 1,926 3% 2,466 4% 2,934 5% Communications and occupancy 2,483 5% 2,664 5% 2,659 5% Legal matters and related costs 1,774 3% 2,715 5% 5,837 10% Other operating expenses 3,468 6% 3,489 6% 3,394 5% Interest 100 <1% 284 <1% 204 <1% --- --- ---- Total operating expenses $55,582 100% $58,470 100% $61,246 100% Provision (benefit) for income taxes $78 $(13) $499
Commissions, Employee Compensation and Benefits Commission expense, consistently the largest expense category and which is directly related to commission revenue, decreased 6%, or $2.5 million, from $39.9 million for the 2004 period, to $37.4 million for the 2005 period. Commission expense increased $627,000, from $39.2 million for the 2003 year to $39.8 million in the 2004 year. Compensation and benefits expense for management, operations and clerical personnel remained relatively constant for 2005 at $7 million. Included in this category are salaries and payroll taxes, stock and option compensation, health insurance premiums, and bonuses. Salaries and related payroll taxes decreased by approximately $700,000, from $6.3 million in 2004 to $5.6 million in 2005. The decrease for the 2005 period was primarily attributable to reductions in the workforce during 2004 and 2005. Stock and option compensation costs increased $737,000 during 2005 in connection with stock grants issued in February 2005 to several senior executives. The net cost of health insurance premiums in 2005 decreased by $33,000 compared to 2004 mostly due to the reduction in the workforce. Compensation and benefits expense for management, operations and clerical personnel increased in 2004 by $62,000 when compared to the 2003 period. A reduction in force, which was implemented in late 2003, resulted in a decrease in non-officer compensation, which was offset by an increase in officer salaries and stock compensation due to new employment agreements and the addition of a new officer in 2004. Clearing and Floor Brokerage Clearing and floor brokerage costs decreased $540,000, from $2.5 million in 2004, to $1.9 million in 2005 following a decrease of $468,000 in 2004, when compared to 2003. As a percentage of transactional revenue, clearing costs remained fairly constant at 6.1%. Clearing costs, as a percentage of gross revenues, fluctuate depending upon the product mix. 28 Communications and Occupancy Communications and occupancy costs decreased $181,000 during 2005, from $2.7 million in 2004 to $2.5 million in 2005. Reductions in occupancy and related costs, which was due to the elimination of a company leased branch office in New York City, a reduction in the leased space in our home office and lower telephone costs, were partially offset by increases in market data services. Communications and occupancy costs are relatively fixed and remained basically unchanged for 2004 when compared to 2003. Legal matters and related costs Legal matters and related settlement costs decreased 35% or $941,000, from $2.7 million in 2004 to $1.8 million in 2005. The reduction in 2005 is attributable to a decline in the number of customer complaints and arbitration claims. In addition, legal costs for 2005 include $269,000 of fees related to the proposed merger with Olympic which was terminated on October 24, 2005. Legal matters and related settlement costs decreased from $5.8 million in 2003 to $2.7 million in 2004, a decrease of $3.1 million, or 53%, due to a reduction in claims and cost control measures implemented by management in 2004. Management continues to closely monitor our outstanding claims and control the costs associated with defending these matters. The New Jersey Bureau of Securities is conducting an inquiry into First Montauk Securities Corp.'s sale of certain high-yield bonds to the firm's clients from 1998 to 2001, and the subsequent resale of those securities to other customers in 2001. We have recently begun settlement discussions with the Bureau in an attempt to resolve the matter in order to avoid a protracted legal proceeding. The final terms of the settlement are still being negotiated but may include a monetary fine, the disgorgement of markups on the sale of certain bonds and the retention of a compliance consultant to review the firm's procedures. The exact amount of civil penalty and disgorgement as well as the precise language of the proposed consent order are still being negotiated with the Bureau. We believe that we have adequately reserved for the anticipated financial impact of this matter in our financial statements. During 2005 we settled four customer arbitrations for an aggregate of $360,000, involving the sale of high-yield bonds referenced above. Management believes that we have sufficiently accrued for any probable costs related to the one remaining customer arbitration related to the sale of the high-yield bonds. We are also a respondent or co-respondent in various other legal proceedings which are related to our securities business and are contesting these claims and believe there are meritorious defenses in each case. However, litigation is subject to many uncertainties, and some of these actions and proceedings may result in adverse judgments. Further, the availability of insurance coverage in any particular case is determined on a case by case basis by the insurance carrier, and is limited to the coverage limits within the policy for any individual claim and in the aggregate. After considering all relevant facts, available insurance coverage and consultation with litigation counsel, management believes that significant judgments or other unfavorable outcomes from pending litigation could have a material adverse impact on our consolidated financial condition, results of operations and cash flows in any particular quarterly or annual period, or in the aggregate, and could impair our ability to meet the statutory net capital requirements relating to our securities business. As of December 31, 2005, we have accrued for litigation costs that are probable and can be reasonably estimated based on a review of existing claims, arbitrations and unpaid settlements. Management cannot give assurance that this accrual will be adequate to cover actual costs that may be subsequently incurred. It is not possible to predict the outcome of other matters pending against us. All such cases are, and will continue to be, vigorously defended. 29 Other Operating Expenses Other operating costs in total remained constant for 2005 when compared to 2004, at approximately $3.5 million. Due to the exercise of the majority of our outstanding convertible debentures, we accelerated $130,000 of the amortization of the financing costs related to these debentures during the second quarter of 2005. Also included in operating costs are accounting and consulting fees of $123,000 expensed in September 2005 as a result of the termination of the proposed merger plans with Olympic. These increases in 2005 operating costs are offset by a decrease in depreciation expense as many of our assets approached the end of their depreciable lives. In 2004 other operating costs increased $95,000, to $3.5 million, from $3.4 in 2003, primarily resulting from an increase in professional liability insurance of $237,000 offset by a decrease in office and printing costs and consulting fees of $114,000. Interest Expense For 2005, interest expense decreased by $184,000 when compared to 2004. This reduction is primarily attributable to the conversion of $1,765,000 of our 6% convertible debentures on which interest is no longer paid. Tax Expense Income tax expense (benefit) for the years ended December 31, 2005, 2004 and 2003 was $78,000, $(13,000), and $499,000 respectively. The effective tax rate on pre-tax income (loss) was 3.0%, (2.0)%, and 16.5% during 2005, 2004 and 2003, respectively. The difference in the rate between 2005 and 2004 was due to the state loss carryback claims in 2004. The difference in the rate between 2004 and 2003 was due to the impact of the decrease of the valuation allowance relating to an adjustment of the deferred tax asset previously recorded. As of December 31, 2005, 2004 and 2003, other future tax benefits have been entirely offset by a valuation allowance because, based on the weight of available evidence, it is more likely than not that the recorded deferred tax assets will not be realized in future periods. Liquidity and Capital Resources We maintain a highly liquid balance sheet with approximately 81%, 73% and 72% of assets in 2005, 2004 and 2003, respectively, consisting of cash and cash equivalents, securities owned, and receivables from our clearing firm and other broker-dealers. The balances in these accounts can and do fluctuate significantly from day to day, depending on general economic and market conditions, volume of activity, and investment opportunities. These accounts are monitored on a daily basis in order to ensure compliance with regulatory net capital requirements and to preserve liquidity. Overall, cash and cash equivalents increased for 2005 by $956,000. Net cash provided by operating activities during 2005 was $995,000, as a result of net income of $2,424,000 adjusted by non-cash charges including depreciation and amortization of $1,449,000 and $1,200,000 from the issuance of stock and a note payable in connection with a separation agreement, offset by non-cash income of $5,105,000 from the amortization of deferred revenue. Cash was further reduced by net decreases in commissions' payable, accounts payable, other liabilities and securities sold of $472,000, $128,000, $70,000 and $171,000, respectively, partially offset by increases in accrued expenses of $295,000. Cash was increased due to reductions in due from clearing firm, employee and broker receivables, securities owned, prepaid expenses and other assets totaling $1,561,000. Cash used in operating activities in 2004 was $2,020,000, primarily attributable to decreases in commissions' payable of $1,180,000, and accrued expenses of $726,000. Cash of $626,000 used in 2003 operating activities was due to net operating losses. The New Jersey Bureau of Securities is conducting an inquiry into First Montauk Securities Corp.'s sale of certain high-yield bonds to the firm's clients from 1998 to 2001, and the subsequent resale of those securities to other customers in 2001. Since the Bureau has not commenced any formal proceedings or made any formal demands in this matter, our management is unable at this time to determine whether the outcome of this inquiry will have a material adverse affect on the Company's financial condition. We believe that we have adequately reserved for the anticipated financial impact of this matter in our financial statements. 30 As of December 31, 2005, we have accrued litigation costs that are probable and can be reasonably estimated based on a review of existing claims, arbitrations and unpaid settlements. Management cannot give assurance that this amount will be adequate to cover actual costs that may be subsequently incurred. Further, it is not possible to predict the outcome of other matters pending against us. We will continue to vigorously defend against these matters. Investing activities required cash of $43,000 in 2005 for additions to capital expenditures. In 2004 and 2003, investing activities consumed $212,000 and $167,000 respectively for additions to capital expenditures. Financing activities in 2005 provided $4,000 in cash due to the receipt of $343,000 in proceeds from the exercise of stock options, offset by payments of preferred stock dividends and capital leases of $285,000 and $54,000, respectively. Financing activities in 2004 used $175,000 in cash primarily related to capital leases and the repurchase of common shares. In 2003, financing activities contributed $1,567,000 in cash primarily due to proceeds from the issuance of convertible debentures. In connection with a settlement agreement entered into in July 2003, we issued 750,000 five-year warrants in three classes of 250,000 warrants each, with varying exercise prices. The Class A warrants were redeemed for $200,000 during the third quarter of 2004. During 2005, 174,388 each of Class B and Class C warrants were exercised at $.25 per share. In addition, our obligation for cash payments on the remaining Class B warrants expired on June 30, 2005 without any cash payment having been required. The settlement agreement provides that we may be obligated to make additional cash payments of up to $60,490 for the outstanding Class C warrants during the month of June 2006. Financing Activities In 1999, we issued 349,511 shares of Series A Preferred Stock in an exchange offering related to a settlement with holders of certain leases. Each share of the Preferred Stock is convertible into two shares of Common Stock and pays a quarterly dividend of 6%. Quarterly dividends were paid through the first quarter of 2003, at which time we suspended the dividend payments in accordance with applicable state law. In the second quarter of 2005, the board of directors declared the dividend on the preferred stock in arrears. The Company paid dividends on the Series A Preferred Stock in the amount of $233,784 during 2005, including $210,879 dividends in arrears. (See Footnote 16 to the consolidated financial statements). In October 2002, we commenced a private offering of up to $3,000,000 of 6% convertible debentures to accredited investors. Each debenture is convertible at an initial conversion price of $0.50 per share, subject to adjustment for stock dividends, combinations, splits, recapitalizations, and like events. Interest on the debentures accrues at the rate of 6% per annum and is payable in cash on a semi-annual basis on April 1st and October 1st of each year until maturity or conversion. Each debenture is due and payable five (5) years from issuance, unless previously converted into shares of Common Stock. The offering expired on March 1, 2003. In the offering, we sold an aggregate amount of $1,240,000 of debentures, $1,030,000 in 2002 and $210,000 in 2003. The proceeds of the financing will be used to satisfy general working capital needs. Neither the debentures nor the shares underlying the debentures have been registered for offer or sale under the Securities Act; such securities are being issued on the basis of the statutory exemption provided by Section 4(2) of the Securities Act, as amended, and/or Rule 506 of Regulation D, promulgated there under relating to transactions by an issuer not involving any public offering. In September 2003, we commenced an additional private offering of up to $3,000,000 of 6% convertible debentures to accredited investors. Each debenture is convertible at an initial conversion price of $0.50 per share, subject to adjustment for stock dividends, combinations, splits, recapitalizations, and like events. Interest on the debentures accrues at the rate of 6% per annum and is payable in cash on a semi-annual basis on April 1st and October 1st of each year until maturity or conversion. Each debenture is due and payable five (5) years from issuance, unless previously converted into shares of Common Stock. The offering was completed on December 31, 2003. In the offering, we sold an aggregate principal amount of $1,895,000 of debentures. The proceeds of the financing will be used to satisfy general working capital needs. The debentures have not been registered for offer or sale under the Securities Act; such securities are being issued on the basis of the statutory exemption provided by Section 4(2) of the Securities Act, as amended, and/or Rule 506 of Regulation D, promulgated there under relating to transactions by an issuer not involving any public offering. For more information, see a discussion of the debentures under the captions "Item 1. Business -- Debenture Conversions." Between October 2004 and December 2005 we received notices that holders of $1,885,000 of convertible debentures that were sold through private offerings in 2002 and 2003, have elected to convert their debentures into shares of our common stock in accordance with the terms of the debentures. As a result, we have issued 3,770,000 shares of our common stock during that time period. As of the date of this Annual Report, there is an aggregate principal amount of $1,250,000 of convertible debentures outstanding. The debentures are convertible at $.50 per share. 31 In connection with the Separation Agreement we entered into with Mr. William Kurinsky, we issued him an aggregate of 197,824 shares of a newly created class of Series B Preferred Stock, par value $0.10 per share, which will have a deemed issue price of $1,000,000, and will be convertible into Common Stock on the basis of ten shares of Common Stock for each share of Series B Preferred Stock. The Series B Preferred shares have voting rights based upon the number of shares of Common Stock into which it would be converted. The Series B Preferred Stock also includes a cumulative dividend of 8% per year. The shares are restricted securities under the Securities Act of 1933 and the regulations of the SEC and we relied upon the exemption from registration under Section 4(2) of the Securities Act of 1933 to issue the shares of Series B Preferred Stock. During 2005, the Company paid $51,556 dividends on the Series B shares (See Footnote 16 to the consolidated financial statements). Net Capital At December 31, 2005, Montauk Financial Group had net capital of $2,592,441, which was $2,337,751 in excess of its required net capital of $254,690 and the ratio of aggregate indebtedness to net capital was 1.47 to 1. Consolidated Contractual Obligations and Lease Commitments The table below provides information about our commitments related to debt obligations, leases, guarantees and investments as of December 31, 2005. This table does not include any projected payment amounts related to our potential exposure to arbitrations and other legal matters. As of December 31, 2005 Expected Maturity Date After Category 2006 2007 2008 2009 2010 2010 Total ---- ---- ---- ---- ---- ---- ----- Debt Obligations 0 $480,000 $770,000 0 0 0 $1,250,000 Capital Lease Obligations $8,555 0 0 0 0 0 $8,555 Operating Lease Obligations $1,113,314 $817,515 $616,349 $611,549 $101,525 0 $3,260,252 Note Payable $200,000 0 0 0 0 0 $200,000 Other Long-Term Obligations Reflected on Balance Sheet under GAAP $60,490(1) 0 0 0 0 0 $60,490(1) --------- --------- --------- -------- ------- -- ---------- Total $1,382,359 $1,297,515 $1,386,349 $611,549 $101,525 0 $4,779,297
(1) Maximum expected payment obligations embodied in the warrants subject to put options. Off-Balance Sheet Arrangements We execute securities transactions on behalf of our customers. If either the customer or a counter-party fail to perform, we, by agreement with our clearing broker, may be required to discharge the obligations of the non-performing party. In such circumstances, we may sustain a loss if the market value of the security is different from the contract value of the transaction. We seek to control off-balance-sheet risk by monitoring the market value of securities held or given as collateral in compliance with regulatory and internal guidelines. Pursuant to such guidelines, our clearing firm requires additional collateral or reduction of positions, when necessary. We also complete credit evaluations where there is thought to be credit risk. Critical accounting policies We prepare our financial statements in accordance with accounting principles generally accepted in the United States of America. Preparing financial statements in accordance with generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The following paragraphs include a discussion of some of the significant accounting policies and methods applied to the preparation of our consolidated financial statements. Review Note 2 to the financial statements for further discussion of significant accounting policies. 32 Use of Estimates In presenting the consolidated financial statements, management makes estimates regarding the valuation of certain securities owned, the carrying value of investments, the realization of deferred tax assets, the outcome of litigation, and other matters that affect the reported amounts and disclosure of contingencies in the financial statements. Estimates, by their nature, are based on judgment and available information. Therefore, actual results could differ from those estimates and could have a material impact on the consolidated financial statements and it is possible that such changes could occur in the near term. Revenue recognition Securities transactions, commission income, sales concessions from participation in syndicated offerings and related expenses are recorded on a trade date basis. Insurance and mutual fund commissions received from outside vendors are recognized as income when earned. Securities owned and securities sold, but not yet repurchased are stated at quoted market value with unrealized gains and losses included in earnings. Investment account securities not readily marketable are carried at estimated fair value as determined by management with unrealized gains and losses included in earnings. Long-lived Assets We evaluate impairment losses on long-lived assets used in operations, primarily fixed assets, when events and circumstances indicate that the carrying value of the assets might not be recoverable in accordance with FASB Statement No. 144 "Accounting for the Impairment or Disposal of Long-lived Assets". For purposes of evaluating the recoverability of long-lived assets, the undiscounted cash flows estimated to be generated by those assets would be compared to the carrying amounts of those assets. If and when the carrying values of the assets exceed their fair values, the related assets will be written down to fair value. Clearing Agreement Montauk Financial Group introduces all of its customer transactions, which are not reflected in the financial statements, to its clearing brokers, which maintain the customers' accounts and clears such transactions. Additionally, the clearing brokers provide the clearing and depository operations for Montauk Financial Group's proprietary securities transactions. These activities may expose us to off-balance sheet risk in the event that customers do not fulfill their obligations with the clearing brokers, as Montauk Financial Group has agreed to indemnify the clearing brokers for any resulting losses. We will record a loss from a client transaction when information becomes available to management that allows it to estimate its impact on our financial statements. Income taxes Due to significant operating losses from 2001-2003 we have established a valuation allowance against all of our deferred tax benefits as of December 31, 2005, and we intend to maintain it until we determine that it is more likely than not that deferred tax assets will be realized. Our income tax expense recorded in the future will be reduced to the extent of offsetting decreases in our valuation allowance. The realization of our remaining deferred tax assets is primarily dependent on forecasted future taxable income. New Accounting Standards In December 2004, the FASB issued SFAS 123 (revised 2004), "Share-Based Payment" ("SFAS 123(R)") which replaces SFAS 123, "Accounting for Stock-Based Compensation," and supersedes APB Opinion No.25, "Accounting for Stock Issued to Employees". Among other items, SFAS 123(R) eliminates the use of APB Opinion No. 25 and the intrinsic method of accounting, and requires all share-based payments, including grants of employee stock options, to be recognized in the financial statements based on their fair values. SFAS No. 123(R) is not effective for public entities which are small business filers until the first 33 interim or annual reporting period of the first fiscal year that begins after December 15, 2005. The Company expects to adopt SFAS 123 (R) in the first quarter of 2006 and will recognize compensation expense for all share-based payments and employee stock options based on the grant-date fair value of those awards. The Company is currently evaluating the impact of the statement on its financial statements. As the Company currently accounts for share-based payments using the intrinsic value method as allowed by APB Opinion No. 25, the adoption of the fair value method under SFAS 123(R) will have an impact on its results of operations. However, the extent of the impact cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. Had the Company adopted SFAS 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS 123 as described under Stock Based Compensation in the Notes to the Consolidated Financial Statements. In June 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections" - a replacement of APB Opinion No. 20 (Accounting Changes) and FASB No. 3 (Reporting Accounting Changes in Interim Financial Statements), which changed the requirements for the accounting for and reporting of a change in accounting principle. This statement requires retrospective application to prior periods' financial statements of changes in accounting principle unless it is impracticable to determine either the period-specific effects of the cumulative effect of the change or the cumulative effect of applying a change. When it is impracticable to determine the period-specific effects of an accounting change on one or more individual prior periods presented, this statement requires that the new accounting principle be applied to the balance of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period rather than being reported in an income statement. When it is impracticable to determine the cumulative effect of applying a change in accounting principle to all prior periods, this statement requires the new accounting principle be applied as if it were adopted prospectively from the earliest date practicable. Statement No. 154 is effective for accounting changes and error corrections made in fiscal years beginning after December 15, 2005. The Company will comply with the provisions of FAS 154 although the impact of such adoption is not determinable at this time. Impact of Inflation We believe that the impact of inflation has an effect upon the amount of capital generally available for investment purposes and also may affect the attitude or willingness of investors to buy and sell securities. The nature of the business of the broker-dealer subsidiary and the securities industry in general is directly affected by national and international economic and political conditions, broad trends in business and finance and volatility of interest rates, changes in and uncertainty regarding tax laws, and substantial fluctuation in the volume and price levels of securities transactions and the securities markets. To the extent inflation results in higher interest rates, or has other adverse effects on the securities markets and the value of securities held in inventory, it may adversely affect our financial position and results of operations. Risk Management Risk is an inherent part of our business and activities. The extent to which we properly and effectively identify, assess, monitor and manage the various types of risk involved in our activities is critical to our soundness and profitability. We seek to identify, assess, monitor and manage the following principal risks involved in its business activities: market, credit, operational and legal. Senior management takes an active role in the risk management process and requires specific administrative and business functions to assist in the identification, assessment and control of various risks. Our risk management policies and procedures are subject to ongoing review and modification. Market Risk. Certain of our business activities expose us to market risk. This market risk represents the potential for loss that may result from a change in value of a financial instrument as a result of fluctuations in interest rates, equity prices or changes in credit rating of issuers of debt securities. This risk relates to financial instruments we hold as investment and for trading. Securities inventories are exposed to risk of loss in the event of unfavorable price movements. Securities positions are marked to market on a daily basis. Market-making activities are client-driven, with the objective of meeting clients' needs while earning a positive spread. At December 31, 2005 and December 31, 2004, equity securities positions owned and sold, not yet purchased were approximately $303,612 and $3,564 and $370,720 and $174,326 respectively. In our view, the potential exposure to market risk, trading volatility and the liquidity of securities held in the firm's inventory accounts could potentially have a material effect on its financial position. Credit Risk. Credit risk represents the loss that we would incur if a client, counterparty or issuer of securities or other instruments that we hold fails to perform its contractual obligations. Client activities involve the execution, settlement, and financial of various transactions on behalf of its clients. Client activities are transacted on either a cash or margin basis. Client 34 activities may expose us to off-balance sheet credit risk. We may have to purchase or sell financial instruments at the prevailing market price in the event of the failure of a client to settle a trade on its original terms or in the event that cash and securities in the client margin accounts are not sufficient to fully cover the client losses. We seek to control the risks associated with client activities by requiring clients to maintain collateral in compliance with various regulations and company policies. Operational Risk. Operational risk generally refers to the risk of loss resulting from our operations, including, but not limited to, improper or unauthorized execution and processing of transactions, deficiencies in our operating systems, business disruptions and inadequacies or breaches in our internal control processes. We operate in diverse markets and rely on the ability of our employees and systems to process high numbers of transactions often within short time frames. In the event of a breakdown or improper operation of systems, human error or improper action by employees, we could suffer financial loss, regulatory sanctions or damage to our reputation. In order to mitigate and control operational risk, we have developed and continue to enhance policies and procedures that are designed to identify and manage operational risk at appropriate levels. Included in our operational risk management practice is disaster recovery for our critical systems. We believe that our disaster recovery program, including off-site back-up technology and operational facilities, is adequate to handle a reasonable business disruption. However, there can be no assurances that a disaster directly affecting our headquarters or operations center would not have a material adverse impact. Insurance and other safeguards might only partially reimburse us for our losses. Legal Risk. Legal risk includes the risk of non-compliance with applicable legal and regulatory requirements. We are subject to extensive regulation in the different jurisdictions in which we conduct our business. We have various procedures addressing issues such as regulatory capital requirements, sales and trading practices, use of and safekeeping of customer funds, credit granting, collection activities, anti money-laundering and record keeping. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our activities often involve the purchase, sale or short sale of securities as principal. Such activities subject our capital to significant risks from markets that may be characterized by relative illiquidity or may be particularly susceptible to rapid fluctuation in price or liquidity. Such market conditions could limit our ability to resell securities purchased or to purchase securities sold short. These activities subject our capital to significant risks, including market, credit and liquidity risks. Market risk relates to the risk of fluctuating values based on market prices without action on our part. Our primary credit risk is settlement risk, which relates to whether counterparty will fulfill its contractual obligations, such as delivery of securities or payment of funds. Liquidity risk relates to our inability to liquidate assets or redirect the deployment of assets contained in illiquid investments. Additional information pertaining to the foregoing risks is included under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management." Item 8. Financial Statements See Financial Statements attached hereto at pages F-1 to F-33. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None Item 9A. Controls and Procedures Our management, including the President and the Chief Executive Officer and Chief Financial Officer, carried out an evaluation of our disclosure controls and procedures (as defined in Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on that evaluation, our President and our Chief Executive Officer and Chief Financial Officer concluded that we had effective disclosure controls and procedures for (i) recording, processing, summarizing and reporting information that is required to be disclosed in its reports under the Securities Exchange Act of 1934, as amended, within the time periods specified in the Securities and Exchange Commission's rules and forms and (ii) ensuring that information required to be disclosed in such reports is accumulated and communicated to our management, including our President and our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure. No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the quarter ended December 31, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Item 9B. Other Information None 35 PAGE> PART III Item 10. Directors and Executive Officers Our directors and executive officers for the year ended December 31, 2005 are as set forth below. During 2005, our Board consisted of five individuals, however, on February 24, 2006, Mr. David I. Portman was elected to our Board. Board Of Directors Name Age Position Herbert Kurinsky 74 Class I Director and Chairman of the Board of Directors- First Montauk Financial Corp. William J. Kurinsky 45 Class I Director, Vice-Chairman of the Board of Directors- First Montauk Financial Corp. Victor K. Kurylak 49 Class II Director, Chief Executive Officer & President Ward R. Jones, Jr. 74 Class III Director, First Montauk Financial Corp. Barry D. Shapiro 64 Class II Director, First Montauk Financial Corp. David I. Portman 64 Class III Director, First Montauk Financial Corp. Executive Officers Name Age Position Victor K. Kurylak 49 Chief Executive Officer and President, First Montauk Financial Corp. and Montauk Financial Group Robert I. Rabinowitz 48 Executive Vice President, General Counsel and Secretary -First Montauk Financial Corp., Montauk Financial Group Mindy A. Horowitz 48 Acting Chief Financial Officer, Vice President of Finance -First Montauk Financial Corp., Chief Financial Officer, Treasurer, Fin.Op.- Montauk Financial Group
On May 4, 2005, Norma Doxey, who served as a Class II director since 1988, resigned. On that date Victor K. Kurylak, our CEO, was elected to our board to fill the vacancy created by Ms. Doxey's resignation. Our Certificate of Incorporation provides for the classification of the Board of Directors into three classes of Directors, each class as nearly equal in number as possible but not less than one Director, each director to serve for a three-year term, staggered by class. The Certificate of Incorporation further provides that a Director or the entire Board of Directors may be removed only for cause and only by the affirmative vote of the holders of at least 70% of the combined voting power of our voting stock, with vacancies on the Board being filled only by a majority vote of the remaining Directors then in office. "Cause" is defined as the willful failure of a director to perform in any substantial respect such Director's duties to our company (other than any such failure resulting from incapacity due to physical or mental illness), willful malfeasance by a Director in the performance of his duties to the company which is materially and demonstrably injurious to the company, the commission by a Director of an act of fraud in the performance of his duties, the conviction of a Director for a felony punishable by confinement for a period in excess of one year, or the ineligibility of a Director for continuation in office under any applicable rules, regulations or orders of any federal or state regulatory authority. 36 All officers serve at the discretion of the Board of Directors. Family relationships exist among the following officers and directors: Mr. Herbert Kurinsky is the uncle of Mr. William J. Kurinsky. Mr. Robert I. Rabinowitz is the brother-in-law of Mr. William J. Kurinsky. Herbert Kurinsky, our Chairman, became a Director and the President of First Montauk Financial Corp. on November 16, 1987. Mr. Kurinsky is a co-founder of Montauk Financial Group and has been its President, one of its Directors and its Registered Options Principal since September of 1986. Effective January 1, 2004, Mr. Kurinsky relinquished his duties as our Chief Executive Officer. From March 1984 to August 1986, Mr. Kurinsky was the President of Homestead Securities, Inc., a New Jersey broker/dealer. From April 1983 to March 1984, Mr. Kurinsky was a branch office manager for Phillips, Appel & Waldon, a securities broker/dealer. From February 1982 to March 1983, Mr. Kurinsky was a branch office manager for Fittin, Cunningham and Lauzon, a securities broker/dealer. From November 1977 to February 1982, he was a branch office manager for Advest Inc., a securities broker/dealer. Mr. Kurinsky received a B.S. degree in economics from the University of Miami, Florida in 1954. William J. Kurinsky serves as our Vice Chairman of the Board of Directors. In 2004, Mr. Kurinsky served as our Chief Executive Officer, Vice Chairman, Chief Financial Officer and Secretary. Mr. Kurinsky relinquished these offices on February 1, 2005. Mr. Kurinsky previously served as our Vice President, a Director and Chief Operating Officer, in addition to serving as Chief Financial Officer and Secretary, since November 16, 1987. Mr. Kurinsky relinquished the office of Chief Operating Officer and became our Chief Executive Officer and Vice Chairman, effective January 1, 2004. He is a co-founder of Montauk Financial Group and has been one of its Vice Presidents, a Director and its Financial/Operations Principal since September of 1986. Prior to that date, Mr. Kurinsky was Treasurer, Chief Financial Officer and Vice President of Operations of Homestead Securities, Inc., a securities broker/dealer. Mr. Kurinsky received a B.S. from Rutgers University in 1984. He is the nephew of Herbert Kurinsky. Ward R. Jones, Jr. has been a member of our Board of Directors since June 1991. From 1955 through 1990, he was employed by Shearson Lehman Brothers as a registered representative, eventually achieving the position of Vice President. Mr. Jones was a registered representative of Montauk Financial Group from 1991 to 2005 but did not engage in any securities business. Mr. Jones is now retired from the securities business. Barry D. Shapiro, CPA has been a member of our Board of Directors since December 6, 2000. From October 2000 to the present, Mr. Shapiro is a shareholder of the accounting firm, Withum, Smith + Brown in its Red Bank office. Mr. Shapiro was a partner of Shapiro & Weisman CPAs P.A. from 1976 thru 1996 when he became a partner of Rudolf, Cinnamon & Calafato, P.A. until joining Withum Smith + Brown. Mr. Shapiro was previously employed with the Internal Revenue Service from 1965 thru 1971, where he was responsible for audit, review and conference functions. Mr. Shapiro is a member of the New Jersey Society of Certified Public Accountants, where he currently participates on the IRS Co-Op and State Tax Committees. Mr. Shapiro is a past Trustee, Treasurer and Vice President of the NJSCPA. He has been involved and is in many civic and community activities, as well as charitable organizations, including the Monmouth County New Jersey Chapter of the American Cancer Society and the Ronald McDonald House of Long Branch, New Jersey. Mr. Shapiro received a B.S. in accounting from Rider University in 1965. David I. Portman rejoined our Board of Directors on February 24, 2006, and had previously served on our Board from 1993 until December 31, 2002. Mr. Portman is the president of TRIAD Development, a real estate company that has numerous commercial and rental properties in New Jersey, a position that he has held since 1978. In addition, Mr. Portman currently serves as a director of Pacifichealth Laboratories, Inc., a publicly held nutrition technology company, a position he has held since August 1995. The Registrant's broker-dealer subsidiary underwrote the initial public offering of the common stock of Pacifichealth Laboratories. Mr. Portman has a BS in Pharmacy and an MBA. He worked as a sales representative and marketing manager for Eli Lilly, Beecham-Massengill, Winthrop Laboratories and Sandoz Pharmaceuticals before co-founding M.E.D. Communications in 1974. In 1988, Mr. Portman sold his interest in M.E.D. Communications and became President of TRIAD Development. Victor K. Kurylak became our Chief Executive Officer on February 1, 2005, and continues to serve as President, a position he has held since January 1, 2004. Mr. Kurylak was elected to our board on May 4, 2005. From January 1, 2004 through January 31, 2005, Mr. Kurylak was our President and Chief Operating Office. From January 2001 through December 2003, Mr. Kurylak was a self-employed business consultant, and was retained by us prior to his becoming our President and Chief Operating Officer. From November 1995 through December 2000 he was the owner and Executive Vice President for Madison Consulting Group/Summit Insurance, an independent insurance brokerage firm. From February 1990 through October 1995, Mr. Kurylak was the Chief Information Officer for Rockefeller Financial Services in New York City. Mr. Kurylak received his Bachelor of Sciences degree in Engineering from Princeton University in 1979. Mr. Kurylak is registered as a general securities representative and registered principal and is licensed as a life, health and property and casualty insurance producer. 37 Robert I. Rabinowitz, Esq. has been our General Counsel since 1987. In February 2005 he became our secretary, and retained the position of Executive Vice President and General Counsel. Previously, he served as General Counsel of Montauk Financial Group from 1986 until 1998 when a new general counsel was named. Thereafter, he became the Chief Administrative Officer of Montauk Financial Group as well as a General Securities Principal. From January 1986 until November 1986, he was an associate attorney for Brodsky, Greenblatt & Renahan, a private practice law firm in Rockville, Maryland. Mr. Rabinowitz is an attorney at law licensed to practice in New Jersey, Maryland and the District of Columbia, and is a member of the Board of Arbitrators for the National Association of Securities Dealers, Department of Arbitration. Mr. Rabinowitz graduated from the American University with a BA in 1979 and from The Antioch School of Law with a JD in 1982. Mr. Rabinowitz's wife is a niece of Mr. Herbert Kurinsky and a sister of Mr. William Kurinsky. Mindy A. Horowitz, CPA, was appointed acting Chief Financial Officer of First Montauk Financial Corp. effective February 1, 2005. In January 2005, she became the Chief Financial Officer and Financial and Operations Principal of Montauk Financial Group. She had previously been Vice President of Finance for Montauk Financial Group since September 1995. Prior to that, Ms. Horowitz was a tax partner with and held other positions at the accounting firm of Broza, Block & Rubino from 1981 through 1995 when she joined First Montauk Securities Corp. Ms. Horowitz graduated with a MS in accounting from Monmouth College in 1981. Ms. Horowitz is a Certified Public Accountant. Significant Employee Mark D. Lowe, 46, has been President of Montauk Insurance Services, Inc. since October 1998. From 1982 to 1998 Mr. Lowe was a Senior Consultant with Congilose & Associates, a financial services firm specializing in insurance and estate planning. Mr. Lowe became a Certified Financial Planner (CFP) in July 1991, a Chartered Financial Planner (ChFC) in 2001 and a Chartered Life Underwriter (CLU) in 2003. Mr. Lowe graduated Ocean County College in Toms River, NJ. Mr. Lowe is the past President of the Estate and Financial Planning Council of Central New Jersey. Certain Reports No person who, during the year ended December 31, 2005, was a Director, officer or beneficial owner of more than ten percent of our common stock (which is the only class of our securities registered under Section 12 of the Securities Exchange Act of 1934) failed to file on a timely basis, reports required by Section 16 of the Securities Exchange Act during the most recent fiscal year or prior years. The foregoing is based solely upon our review of Forms 3 and 4 during the most recent fiscal year as furnished us under Rule 16a-3(d) under the Securities Exchange Act, and Forms 5 and amendments thereto furnished to us with respect to its most recent fiscal year, and any representation received by us from any reporting person that no Form 5 is required. We believe that certain shareholders, including BMAC Corp. have failed to comply with their reporting requirements under the Securities and Exchange Act of 1934, including the requirement to file Forms 3 and 4 with respect to their holdings and sale and purchases of our Common Stock. However, as a result of these failures, we cannot ascertain with certainty the extent of any potential failure to comply with the rules regarding these filings. Meetings of Directors During 2005, the Board of Directors met on six occasions and voted by unanimous written consent on two occasions. No member of the Board of Directors attended less than 75% of the aggregate number of (i) the total number of meetings of the Board of Directors or (ii) the total number of meetings held by all Committees of the Board of Directors. Committees of the Board of Directors The Board of Directors has three committees: Audit Committee, Compensation Committee and Special Committee. Our Board of Directors currently consists of six individuals, three of whom are independent directors as defined in the Marketplace Rules of the Nasdaq Stock Market. Our independent directors are Ward R. Jones, Jr., Barry D. Shapiro and David I. Portman. 38 For the year ended December 31, 2005, the members of the committees, and a description of the duties of the Committees were as follows: Audit Committee. Our Audit Committee acts to: o review with management our finances, financial condition and interim financial statements; o review with our independent auditors the year-end financial statements; and o review implementation with the independent auditors and management any action recommended by the independent auditors and the retention and termination of our independent auditors. During the year ended December 31, 2005, the audit committee met on four occasions. The audit committee adopted a written charter governing its actions effective June 23, 2000. During the year, the members of the audit committee were Ward R. Jones and Barry D. Shapiro. Both of the members of our audit committee were "independent" within the definition of that term as provided in the Marketplace Rules of the Nasdaq Stock market. The Board has determined that Mr. Barry D. Shapiro qualified as the audit committee financial expert as defined under applicable Securities and Exchange Commission rules. Mr. Shapiro serves as chairman of this committee. Mr. Portman was appointed to serve on this committee at the time of his election to our Board in February 2006. Compensation Committee. The compensation committee functions include administration of our 2002 Incentive Stock Option Plan and 1996 Senior Management Option Plan and the negotiation and review of all employment and separation agreements with our executive officers. The compensation committee's members, during 2005, were Ward R. Jones and Barry D. Shapiro. Mr. Jones serves as chairman of this committee. During the year ended December 31, 2005, the committee met on two occasions. Mr. Portman was appointed to serve on this committee at the time of his election to our Board in February 2006. Special Committee. The Special Committee of the Board was formed on February 24, 2006 for the purpose of reviewing and evaluating any transactions that may be presented to the Board for the benefit of the shareholders. The special committee, which consists of our three independent members of the Board, have engaged an investment banking firm to provide an opinion on the fairness to the shareholders of the proposed sale of our company to a private investor, and if warranted will have the authority to engage independent counsel. Compensation Committee Interlocks and Insider Participation There are no compensation committee interlocks between the members of our compensation committee and any other entity. None of the members of the Board's compensation committee are executive officers of our company. Compensation of Directors We pay our directors who are not also our employees a retainer of $250 per meeting of the Board of Directors attended and for each meeting of a committee of the Board of Directors not held in conjunction with a Board of Directors meeting. In 2004 the board authorized additional payments to our directors who are not our employees, to include an annual payment of $5,000 payable in quarterly installments. Members of the audit committee are also entitled to any additional $750 per annum payment. Directors that are also our employees are not entitled to any additional compensation as such. In addition, members of the Special Committee received an initial cash award of $5,000 and will receive an annual cash award of $5,000 per year after 2006, as well as an additional cash payment of $10,000 each to evaluate the potential transaction elsewhere described in the report. This fee will be paid to each member without regard to the committee's position on such transaction or event. Code of Ethics On March 29, 2004, our Board of Directors approved the Code of Ethics and Business Conduct for our company. Our Code of Ethics and Conduct covers all our employees and Directors, including our Chief Executive Officer and Chief Financial Officer and our President. A copy of our Code of Ethics and Conduct was filed as Exhibit 14 to our annual report on Form 10-K for 2003. We did not amend or waive any provisions of the Code of Ethics and Business Conduct during the year ended December 31, 2005. 39 Item 11. Executive Compensation Summary of Cash and Certain Other Compensation The following table provides certain information concerning all Plan and Non-Plan (as defined in Item 402 (a)(ii) of Regulation S-K) compensation awarded to, earned by, paid or accrued by us during the years ended December 31, 2005, 2004 and 2003 to each of our named executive officers. Long Term Compensation Awards Restricted No. of Securities Fiscal Stock Underlying All Other Name and Principal Position Year Salary Bonus Awards Options/SARs Compensation Herbert Kurinsky 2005 $200,000 $100,000 $ 0 0 Chairman of the Board of 2004 $200,000 $ 42,570 $131,250(1) 0 Directors - FMFC 2003 $206,218 $200,000 $ 0 0 William J. Kurinsky 2005 $ 34,231 $ 0 $ 0 200,000(3) $3,942(3) Former Chief Executive and Chief 2004 $300,000 $ 31,590 $131,250(2) 0 Financial Officer and Secretary - 2003 $206,218 $ 50,000 $ 0 0 FMFC and Montauk Financial Group Victor K. Kurylak, President, 2005 $275,000 $200,000 $570,000(4) Chief Executive Officer and Chief 2004 $250,000 $ 63,181 $ 87,500(5) 250,000 (6) Operating Officer, FMFC and Montauk Financial Group Robert I. Rabinowitz 2005 $190,000 $ 20,000 $ 57,000(7) 150,000 (8) General Counsel - FMFC and 2004 $180,000 $ 25,000 $ 0 100,000 (8) Montauk Financial 2003 $150,000 $ 10,000 $ 0 0 Group Mindy A. Horowitz 2005 $140,000 $ 20,000 $ 57,000(9) 75,000 (10) Acting Chief Financial Officer, 2004 $125,000 $ 20,000 0 0 FMFC, and Chief Financial 2003 $125,000 $ 15,000 0 100,000(10) Officer, Fin. Op. Montauk Financial Group
1) In January 2004, Mr. Herbert Kurinsky was issued 375,000 shares of restricted common stock in conjunction with his employment agreement, which said shares had a market value of $131,250 at date of issuance. 2) In January 2004, Mr. William J. Kurinsky was issued 375,000 shares of restricted common stock in conjunction with his employment agreement, which said shares had a market value of $131,250 at date of issuance. 40 3) In February 2005, the Company issued 197,824 shares of newly created Series B Preferred Stock valued at $1,000,000, made a severance payment of $136,000, and issued a note for $200,000 to Mr. William Kurinsky pursuant to the terms of a Separation Agreement as discussed below in greater detail. Mr. Kurinsky received $3,942 in commission income during 2005. Mr. Kurinsky's previously granted options to purchase 325,000 shares of our common stock with exercise prices of $0.83 to $2.00 per share have been cancelled. Mr. Kurinsky received new options to purchase an aggregate of 200,000 shares of Common Stock with an exercise price of $0.83 per share, in connection with his services as a consultant. The new options will have a three-year exercise term. Mr. Kurinsky also earned $3,942 in commissions for 2005. 4) In February 2005, the Company issued Mr. Kurylak 1,000,000 restricted shares of common stock, pursuant to the terms of his new employment agreement as discussed below in greater detail, which said shares had a market value of $570,000 at date of issuance. 5) In January 2004, Mr. Kurylak was issued 250,000 shares of restricted common stock which said shares had a market value of $87,500 at date of issuance. 6) In 2004, the Compensation Committee authorized an option grant to Mr. Victor K. Kurylak to purchase 250,000 shares of Common Stock at an exercise Price of $.75 per share for 5 years, and an option grant to purchase 250,000 shares of Common Stock at an exercise price of $.50 Per share for 5 years. Mr. Kurylak returned the option grant exercisable at $.75 in February 2005 in conjunction with a new Employment agreement, as discussed in greater detail below. 7) In February 2005, Mr. Rabinowitz was issued an aggregate of 100,000 restricted shares of common stock. Said shares had a market value of $57,000 at date of issuance. These shares were granted to Mr. Rabinowitz pursuant to the terms of his new employment agreement as discussed below in greater detail. 8) In 2005, the Compensation Committee authorized an option grant to Mr. Rabinowitz to purchase 150,000 shares of common stock at an exercise price of $1.25 per share for five years. In 2004, the Compensation Committee authorized an option grant to Mr. Robert Rabinowitz to purchase 100,000 shares of common stock at an exercise price of $.50 for five years. 9) In February 2005, Ms. Horowitz was issued an aggregate of 100,000 restricted shares of common stock. Said shares had a market value of $57,000 at date of issuance. These shares were granted to Ms. Horowitz pursuant to the terms of her new employment agreement as discussed below in greater detail. 10) In 2005, the Compensation Committee authorized an option grant to Ms. Horowitz to purchase 75,000 shares of common stock at an exercise price of $1.25 per share for five years. In 2003, the Compensation Committee authorized an option grant to Ms. Mindy Horowitz to purchase 100,000 shares of common stock at an exercise price of $.50 for five years. 41 OPTION/SAR GRANTS IN LAST FISCAL YEAR The following table contains information with respect to the named executive officers concerning options granted during the year ended December 31, 2005. INDIVIDUAL GRANTS Potential Realizable Value At Assumed Annual Rates Percent of of Stock Number of Total Price Appreciation For Securities Option/ Option Underlying SARS Granted Exercise of Term Option/SARs To Employees Base Price Expiration Name Granted (#) In Fiscal Year (S/Sh) Date 5% ($) 10% ($) (a) (b) (c) (1) (d) (c) (f) (g) Mindy A. Horowitz 75,000 12% $1.25 7/27/10 $4,500 $24,750 Robert I. Rabinowitz 150,000 24% $1.25 7/27/10 $9,000 $49,500 - ----------------------- (1) Includes options granted to non-employee registered representatives under the 2002 Incentive Stock Option Plan, as amended.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES Value of Shares Number of Unexercised Acquired Unexercised In-the-money on Value Options as of Options at Name Exercise Realized December 31, 2005 December 31, 2005 (1) ---- -------- -------- ----------------- --------------------- Exercisable/Unexercisable Exercisable/Unexercisable Herbert Kurinsky -- $0 200,000/0 $20,000/$0 William J. Kurinsky -- $0 200,000/0 $ 2,000 /$0 Victor K. Kurylak -- $0 166,667/83,333 $58,333/$29,167 Robert I. Rabinowitz -- $0 293,750/0 $35,000/$0 Mindy A. Horowitz -- $0 175,000/0 $35,000/$0 - ---------------------- (1) Based upon the closing bid price of our common stock on December 31, 2005 ($.85 per share), less the exercise price for the aggregate number of shares subject to the options.
42 Employment Contracts, Termination of Employment and Change in Control Agreements Herbert Kurinsky On February 1, 2006, we entered into a Separation Agreement with Herbert Kurinsky, the Chairman of our Board of Directors. Under the terms of the Separation Agreement, the parties agreed to terminate the employment relationship and the rights and obligations of the parties under the employment agreement, effective as of February 1, 2006. However, Mr. Kurinsky continues to serve as Chairman of our Board of Directors. In addition, the Separation Agreement provides for the following: o Mr. Kurinsky was paid a lump sum severance amount of $300,000. o We issued to Mr. Kurinsky a promissory note in the principal amount of $550,217.41, payable in monthly installments of $12,500 over a period of 48 months and bearing interest at the rate of 4.5% per annum. o We will continue to provide medical and dental benefits to Mr. Kurinsky and his wife for a period of 48 months. o Pursuant to his employment agreement, all unvested restricted stock made to Mr. Kurinsky has vested in full. o In the event of a change of control in the ownership of the Company, as defined in the Separation Agreement, (i) the total remaining principal of the promissory note, and any accrued but unpaid interest thereon, shall become immediately due and payable; (ii) Mr. Kurinsky shall have the option to require us to pay him an amount in cash equal to the costs of providing health and insurance benefits for the period of time between the effective date of his election to receive the cash payment and the balance of the 48 month period during which we are obligated to pay these benefits; and (iii) the total remaining automobile allowance payments required by the Separation Agreement shall accelerate and be immediately due and payable. We and Mr. Kurinsky have also exchanged mutual releases except to the extent each has reserved their rights as provided in the Separation Agreement. William J. Kurinsky Mr. William J. Kurinsky stepped down as our Chief Executive Officer effective February 1, 2005, at which time we entered into a Separation Agreement with William J. Kurinsky, which provides for Mr. Kurinsky to terminate his employment with us. Under the terms of the Separation Agreement, Mr. Kurinsky relinquished his position as our Chief Executive Officer and that of our subsidiaries, including our broker dealer subsidiary First Montauk Securities Corp. Mr. Kurinsky remains a member of our board of directors. The Separation Agreement includes the following provisions: o Mr. Kurinsky's employment agreement dated January 1, 2004, which had a term set to expire in December 2008, was terminated in full. o Mr. Kurinsky was retained as a consultant for a term of two years with a consulting fee of $12,645 per month. o Mr. Kurinsky was issued an aggregate of 197,824 shares of a newly created class of Series B Preferred Stock, par value $0.10 per share, which will have a deemed issue price of $1,000,000, and will be convertible into Common Stock on the basis of ten shares of Common Stock for each share of Series B Preferred Stock. The Series B Stock has voting rights based upon the number of shares of Common Stock into which it would be converted. The Series B Preferred Stock also includes a cumulative dividend of 8% per year. o We issued a promissory note in the principal amount of $200,000 bearing interest at 8% per annum which was paid in full in February 2006. o We made a lump sum cash payment in the amount of $136,000. o Mr. Kurinsky's options to purchase 325,000 shares of our common stock with exercise prices of $0.83 to $2.00 per share were cancelled, and a new option grant for an aggregate of 200,000 shares of Common Stock with an exercise price of $0.83 per share were granted to Mr. Kurinsky in connection with his services as a consultant. The new options will have a three-year exercise term. Pursuant to his employment agreement, all outstanding restricted stock grants immediately vested. o We will continue to pay for the benefits such as health and medical plans that Mr. Kurinsky was otherwise entitled to under his employment agreement for a period of 24 months. 43 Victor K. Kurylak Effective February 1, 2005, the Board approved the appointment of Mr. Victor K. Kurylak as our Chief Executive Officer and entered into a new employment agreement. Mr. Kurylak was granted 1,000,000 shares of our common stock as a bonus for our performance for the year ended December 31, 2004, and in consideration of his assuming the position of Chief Executive Officer, which shares vest in increments of one third commencing on February 1, 2005, December 31, 2005 and December 31, 2006. In the event of a change of control of the Company, all unvested shares would vest. Mr. Kurylak agreed to the cancellation of 250,000 of his outstanding stock options with an exercise price of $0.75 per share. His prior agreement entered into effective January 1, 2004 was terminated. Under the terms of Mr. Kurylak's employment agreement, which expires December 31, 2007, Mr. Kurylak receives a base salary of $275,000 per year; subject to annual increases of 10% provided we have profits of at least $500,000 per annum. In addition, Mr. Kurylak is entitled to receive medical and other benefits that we have in effect for its executives. Mr. Kurylak is entitled to participate in our executive bonus pool which has been established by the Board to constitute 15% of our net pre tax profit. Further, Mr. Kurylak is also entitled to a portion of the corporate finance bonus pool defined as 20% of all underwriters and/or placement agent warrants or options that are granted to Montauk Financial Group upon the same price, terms and conditions afforded to Montauk Financial Group as the underwriter or placement agent, but not to exceed 50% of what is retained by Montauk Financial Group after issuance to the registered representatives who participated in the placements. In the event of termination without cause, Mr. Kurylak would be entitled to a severance payment consisting of accrued compensation, continuation of his benefits and payment of his base salary for a period of the greater of three months or the unexpired term. Other Executive Officers In 2005, we entered into new employment agreements with two executive officers and a member of our senior management team; Robert Rabinowitz, Mindy Horowitz and Brian Cohen. Mr. Rabinowitz serves as Executive Vice President, General Counsel and Secretary; Ms. Horowitz serves as Chief Financial Officer and Mr. Cohen serves as Senior Vice President-Information Systems. The Board also approved restricted stock awards to each of these persons of 100,000 shares as a performance bonus award and as an incentive to continue their employment with us. The agreements have an initial term of one year ending February 1, 2006 and are renewable for successive one year terms unless we provide 120 prior notice of our intention not to renew the agreements. These agreements are currently in effect. Under his agreement, Mr. Rabinowitz will receive a base salary of $190,000 per year and is eligible to participate in our bonus and option plans, receives health and benefits as provided to our executives and is entitled to a car allowance. In the event of termination of his employment without cause, Mr. Rabinowitz would be entitled to receive a severance payment equal to the sum of (i) one year's salary, (ii) his portion of the bonus pool payments he would otherwise be entitled to and (iii) payment of the costs of health and other benefits for 12 months. The agreements with Ms. Horowitz and Mr. Cohen have similar terms except that Ms. Horowitz receives a base salary of $140,000 and Mr. Cohen receives a base salary of $130,000. Incentive Stock Option Plan In June 2002, we adopted the 2002 Incentive Stock Option Plan, which provides for the grant of options to purchase up to 5,000,000 shares of our common stock by our employees, registered representatives and consultants. Under the terms of the Incentive Plan, options granted thereunder may or may not be designated as options which qualify for incentive stock option treatment under Section 422A of the Code. The Plan is administered by our Board of Directors which has the discretion to determine the eligible employees to whom, and the times and the price at which, options will be granted; whether such options shall be Incentive Stock Options or Non-Incentive Stock Options; the periods during which each option will be exercisable; and the number of shares subject to each option. The Board has full authority to interpret the Incentive Plan and to establish and amend rules and regulations relating thereto. Under the Incentive Plan, the exercise price of an option designated as an Incentive Stock Option shall not be less than the fair market value of the common stock on the date the option is granted. However, in the event an option designated as an Incentive Stock Option is granted to a ten percent stockholder such exercise price shall be at least 110% of such fair market value. Exercise prices of Non-Incentive Stock Options may be less than such fair market value. The aggregate fair market value of shares subject to options granted to a participant which are designated as Incentive Stock Options which become exercisable in any calendar year may not exceed $100,000. 44 The Board may, in its sole discretion, grant bonuses or authorize loans to or guarantee loans obtained by an optionee to enable such optionee to pay any taxes that may arise in connection with the exercise or cancellation of an option. Unless sooner terminated, the Incentive Plan will expire in 2012. Effective as of the date of this Annual Report, since the adoption of the 2002 Incentive Plan, we have issued 979,802 options to registered representatives and employees which have not been exercised or cancelled. There remain 85,600 options outstanding from our 1992 Incentive Stock Option Plan, resulting in a total of 1,065,402 options outstanding. Director Plan In June 2002, we adopted the Non-Executive Director Stock Option Plan (the "Director Plan"). The Director Plan provides that each non-executive director will automatically be granted an option to purchase 20,000 shares each September 1, provided such person has served as a director for the 12 months immediately prior to such September 1st. A Non-Executive Director who has not served as a director for an entire year prior to September 1st of each year shall receive a pro rata number of options. Options are granted under the Director Plan until 2012 to non-executive directors who are not our full time employees. The exercise price for options granted under the Director Plan shall be 100% of the fair market value of the common stock on the date of grant. Until otherwise provided in the Director Plan the exercise price of options granted under the Director Plan must be paid at the time of exercise, either in cash, by delivery of shares of our common stock or a combination of both. The term of each option commenced on the date it is granted and unless terminated sooner as provided in the Director Plan, expires five years from the date of grant. The Director Plan is administered by a committee of the board of directors composed of not fewer than two persons who are our officers (the "Committee"). The Committee has no discretion to determine which non-executive director will receive options or the number of shares subject to the option, the term of the option or the exercisability of the option. However, the Committee will make all determinations of the interpretation of the Director Plan. Options granted under the Director Plan are not qualified for incentive stock option treatment. To date, a total of 160,000 options have been granted to our non-Executive directors under the 2002 Plan. An additional 20,000 options remain outstanding from grants made pursuant to the 1992 Non-Executive Director Stock Option Plan, which terminated in June 2002, and which was replaced by the 2002 Non-Executive Director Stock Option Plan. Senior Management Plan In 1996, we adopted the 1996 Senior Management Incentive Plan (the "Management Plan"). The Management Plan provides for the issuance of up to 2,000,000 shares of common stock either upon issuance of options issued under the Management Plan or grants of restricted stock or incentive stock rights. The Board of Directors or a committee of the board may grant awards under the Management Plan to executive management employees, if one is appointed for this purpose. The Management Plan provides for four types of awards: stock options, incentive stock rights, stock appreciation rights, and restricted stock purchase agreements. The stock options granted under the Management Plan can be either incentive stock options or non-incentive stock options, similar to the options granted under the Incentive Plan, except that the exercise price of non-Incentive Stock Option shall not be less than 85% of the fair market value of the common stock on the date of grant. Incentive stock rights consist of incentive stock units equivalent to one share of common stock in consideration for services performed for us. If services of the holder terminate prior to the incentive period, the rights become null and void unless termination is caused by death or disability. Stock appreciation rights allow a grantee to receive an amount in cash equal to the difference between the fair market value of the stock and the exercise price, payable in cash or shares of common stock. The Board or committee may grant limited stock appreciation rights, which become exercisable upon a "change of control" of our company. A change of control includes the purchase by any person of 25% or more of the voting power of our outstanding securities, or a change in the majority of the Board of Directors. Awards granted under the Management Plan are also entitled to certain acceleration provisions that cause awards granted under the Plan to immediately vest in the event of a change of control or sale of our company. Awards under the Management Plan may be made until June 2006. 45 In June 2000, at our Annual Meeting of Shareholders, a resolution was passed amending the Senior Management Stock Option Plan to increase the number of shares reserved for issuance from 2,000,000 to 4,000,000. Options to purchase 1,035,000 shares of our common stock are currently outstanding under the Senior Management Plan and to date we have issued an aggregate of 2,300,000 shares of our common stock as restricted stock awards to senior management under this Plan. Item 12. Security Ownership of Certain Beneficial Owners and Management The following table sets forth certain information as of March 30, 2006 with respect to (i) each director and each executive officer, (ii) all directors and officers as a group, and (iii) the persons (including any "group" as that term is used in Section l3(d)(3) of the Securities Exchange Act of l934), known by us to be the beneficial owner of more than five (5%) percent of our common stock. Shares of common stock subject to options exercisable within 60 days from the date of this table are deemed to be outstanding and beneficially owned for purposes of computing the percentage ownership of such person but are not treated as outstanding for purposes of computing the percentage ownership of others. Directors, Officers Amount and Percentage and 5% Shareholders (1) Of Beneficial Ownership (1) ----------------------- --------------------------- Number of Shares Percent Herbert Kurinsky Parkway 109 Office Center 328 Newman Springs Road Red Bank, NJ 07701 339,104 2.1% William J. Kurinsky Parkway 109 Office Center 328 Newman Springs Road Red Bank, NJ 07701 3,409,063(2) 18.8% Victor K. Kurylak Parkway 109 Office Center 328 Newman Springs Road 1,500,000(3) 9.2% Red Bank, NJ 07701 Robert I. Rabinowitz, Esq. Parkway 109 Office Center 328 Newman Springs Road Red Bank, NJ 07701 404,500(4) 2.5% Mindy A. Horowitz Parkway 109 Office Center 328 Newman Springs Road Red Bank, NJ 07701 275,000(5) 1.7% Ward R. Jones 300 West Jersey Road Lehigh Acres, FL 33936 110,000(6) * David I. Portman 142 Highway 35 Eatontown, NJ 07724 50,000 * Barry D. Shapiro, CPA 331 Newman Springs Road Red Bank, NJ 07701 80,000(7) * BMAC Corp. 502 E. John Street Carson City, NV 89706 837,643(8) 5.2% Amnon Kawa 10501 Wilshire Blvd. #1809 Los Angeles, CA 90024 798,800 (9) 5.0% All Directors and Officers as a group (8 persons in number) 6,167,667 32.4% - ------------------------------------------
* Indicates less than 1% (1) Unless otherwise indicated below, each director, officer and 5% shareholder has sole voting and sole investment power with respect to all shares that he beneficially owns. 46 (2) Includes vested and presently exercisable options of Mr. William J. Kurinsky to purchase 200,000 shares of common stock. Amounts and percentages indicated for Mr. Kurinsky also include an aggregate 1,978,240 shares of common stock issuable upon conversion of 197,824 shares of Series B Convertible Redeemable Preferred Stock. (3) Amounts and percentages indicated for Mr. Kurylak include an aggregate of 1,250,000 restricted shares of common stock and options to purchase 250,000 shares of common stock, all of which securities vest in equal amounts over a three-year period commencing: a) on December 31, 2004, December 31, 2005 and December 31, 2006 with respect to 250,000 common shares and 250,000 options, and b) on February 1, 2005, December 31, 2005 and December 31, 2006 with respect to 1,000,000 shares of common stock. (4) Includes vested and presently exercisable options of Mr. Robert Rabinowitz to purchase 250,000 shares of common stock. Amounts and percentages indicated for Mr. Rabinowitz include an aggregate of 100,000 shares of restricted common stock, which shares vest in equal amounts of 33.3%, on February 1, 2005, February 1, 2006 and February 1, 2007. Mr. Rabinowitz's children own 2,000 shares of common stock. (5) Includes vested and presently exercisable options of Ms. Mindy Horowitz to purchase 175,000 shares of common stock. Amounts and percentages indicated for Ms. Horowitz include an aggregate of 100,000 shares of restricted common stock, which shares vest in equal amounts of 33.3%, on February 1, 2005, February 1, 2006 and February 1, 2007. (6) Includes vested and presently exercisable options of Mr. Ward Jones to purchase 100,000 shares of common stock. (7) Includes vested and presently exercisable options of Mr. Barry Shapiro to purchase 80,000 shares of common stock. (8) As reported under Schedule 13D/A filing made by BMAC Corp. dated June 10, 2005 and subsequently amended on January 19, 2006. (9) As reported under Schedule 13D filing made by Mr. Kawa dated February 15, 2006. Equity Compensation Plan Information The following table provides information about our common stock that may be issued upon the exercise of options and rights under all of our existing equity compensation plans as of December 31, 2005, including the 2002 Incentive Stock Option Plan, the 2002 Non-Executive Director Stock Option Plan, the 1992 Incentive Stock Option Plan, as amended, the 1992 Non-Employee Director Stock Option Plan, as amended and the 1996 Senior Management Stock Option Plan, as amended. Information concerning each of the aforementioned plans is set forth below following the caption "Shareholder Approved Option Plans." Each of the 1992 Incentive Stock Option Plan and 1992 Non-Executive Director Stock Option Plan has expired and no additional options may be granted under such plans. Unexpired options granted pursuant to such plans prior to their expiration, however, remain exercisable (when vested) until the expiration of the individual option grant. 47 ============================== =========================== =========================== ============================== Number of Securities Remaining Available for Number of Securities to Future Issuance Under to be Issued upon Equity Compensation Exercise of Weighted Average Plans Excluding Outstanding Options Exercise Price of Securities Reflected in and Rights Outstanding Options Column (a) Plan Category (a) (b) (c) ============================== =========================== =========================== ============================== Equity Compensation Plans 2,707,3021 $0.85 4,155,9002,3 Approved by Stockholders - ------------------------------ --------------------------- --------------------------- ------------------------------ Equity Compensation Plans N/A N/A N/A Not Approved by Stockholders - ------------------------------ --------------------------- --------------------------- ------------------------------ Total 2,707,3021 $0.85 4,155,9002,3 - ------------------------------ --------------------------- --------------------------- ------------------------------
1. Includes 1,023,002 options issued pursuant to the our 2002 Incentive Stock Option Plan, 206,800 options issued pursuant to our 1992 Incentive Stock Option Plan, as amended, 180,000 options issued pursuant to our 2002 Director Stock Option Plan, 20,000 options issued pursuant to our 1992 Director Stock Option Plan, as amended, and 1,297,500 options and shares issued pursuant to our 1996 Senior Management Stock Option Plan, as amended. 2. Includes 3,468,400 options available for issuance under our 2002 Incentive Stock Option Plan and an aggregate of 307,500 shares reserved for issuance as options, incentive stock rights or pursuant to restricted stock purchase agreements under our 1996 Senior Management Stock Option Plan, as amended. 3. Includes 380,000 options assumed available for issuance under our 2002 Directors Stock Option Plan. We expect to have three outside directors, each of whom will receive 20,000 options over the ten years of the plan. Item 13. Certain Relationships and Related Transactions For information concerning the terms of the employment agreements entered into between us and Messrs. Victor K. Kurylak, Robert I. Rabinowitz and Ms. Mindy A. Horowitz, and the Separation Agreements entered into with William J. Kurinsky and Herbert Kurinsky, see Item 11, "Executive Compensation". 48 Item 14. Principal Accountant Fees and Service. Our Audit Committee has selected Lazar Levine & Felix LLP, Certified Public Accountants, as its independent accountants for the current fiscal year. The audit services provided by Lazar Levine & Felix LLP consist of examination of financial statements, services relative to filings with the Securities and Exchange Commission, and consultation in regard to various accounting matters. The following table presents the total fees paid for professional audit and non-audit services rendered by our independent auditors for the audit of our annual financial statements to Lazar Levine & Felix LLP for the year ended December 31, 2005, and fees billed for other services rendered by our independent auditors during those periods. - ---------------------------------------- ------------------------------------- ------------------------------------- Fiscal Year Ended December 31, 2005 Fiscal Year Ended December 31, 2004 - ---------------------------------------- ------------------------------------- ------------------------------------- Audit Fees (1) $169,400 $185,035 - ---------------------------------------- ------------------------------------- ------------------------------------- Audit-Related Fees (2) $46,325 $0 - ---------------------------------------- ------------------------------------- ------------------------------------- Tax Fees (3) $44,728 $11,600 - ---------------------------------------- ------------------------------------- ------------------------------------- All Other Fees (4) $0 $24,960 - ---------------------------------------- ------------------------------------- ------------------------------------- Total $260,453 $221,595 - ---------------------------------------- ------------------------------------- -------------------------------------
(1) Audit services consist of audit work performed in the preparation of financial statements for the fiscal year and for the review of financial statements included in Quarterly Reports on Form 10-Q during the fiscal year, as well as work that generally only the independent auditor can reasonably be expected to provide, including consents for registration statement flings and responding to SEC comment letters on annual and quarterly filings. (2) Audit-related services consist of assurance and related services that are traditionally performed by the independent auditor, including due diligence related to mergers and acquisitions, agreed upon procedures report and accounting and regulatory consultations. (3) Tax services consist of all services performed by the independent auditor's tax personnel, except those services specifically related to the audit of the financial statements, and includes fees in the areas of tax compliance, tax planning, and tax advice. (4) Other services consist of those service not captured in the other categories. Our Audit Committee has determined that the services provided by our independent auditors and the fees paid to them for such services has not compromised the independence of our independent auditors. Consistent with SEC policies regarding auditor independence, the Audit Committee has responsibility for appointing, setting compensation and overseeing the work of the independent auditor. In recognition of this responsibility, the Audit Committee has established a policy to pre-approve all audit and permissible non-audit services provided by the independent auditor. Prior to engagement of the independent auditor for the next year's audit, management will submit a detailed description of the audit and permissible non-audit services expected to be rendered during that year for each of four categories of services described below to the Audit Committee for approval. In addition, management will also provide to the Audit Committee for its approval a fee proposal for the services proposed to be rendered by the independent auditor. Prior to the engagement of the independent auditor, the Audit Committee will approve both the description of audit and permissible non-audit services proposed to be rendered by the independent auditor and the budget for all such services. The fees are budgeted and the Audit Committee requires the independent auditor and management to report actual fees versus the budget periodically throughout the year by category of service. 49 During the year, circumstances may arise when it may become necessary to engage the independent auditor for additional services not contemplated in the original pre-approval. In those instances, the Audit Committee requires separate pre-approval before engaging the independent auditor. To ensure prompt handling of unexpected matters, the Audit Committee may delegate pre-approval authority to one or more of its members. The member to whom such authority is delegated must report, for informational purposes only, any pre-approval decisions to the Audit Committee at its next scheduled meeting. The four categories of services provided by the independent auditor are as defined in the footnotes to the fee table set forth above. PART IV Item 15. Exhibits and Financial Statement Schedules 1. Financial Statements See the Consolidated Financial Statements and Notes thereto, together with the reports thereon of Lazar Levine & Felix, LLP dated March 10, 2006 beginning on page F-1 of this report. 2. Schedules Valuation and Qualifying Accounts - -------------------------------------------------------------------------------------------------------------------------------- Column A Column B Column C Column D Column E - -------------------------------------------------------------------------------------------------------------------------------- Charged (credited) Balance at to Charged to Balance at beginning to costs and other end Description of period expenses accounts Deductions of period - --------------------------------------- ------------------------------------------------------------------------------- Deferred tax assets: Year ended December 31, 2005 $ 5,120,839 $(1,542,317) $ 3,578,522 Year ended December 31, 2004 $ 5,381,000 $ (260,161) $ 5,120,839 Year ended December 31, 2003 $ 3,723,131 $ 1,657,869 $ 5,381,000 Broker loan reserves: Year ended December 31, 2005 $ 1,402,631 $ (317,496) $ 1,085,135 Year ended December 31, 2004 $ 1,805,322 $ (402,691) $ 1,402,631 Year ended December 31, 2003 $ 1,699,395 $ 105,927 $ 1,805,322 3. Exhibits Incorporated by reference to the Exhibit Index at the end of this report.
50 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRST MONTAUK FINANCIAL CORP. By /s/ Victor K. Kurylak -------------------------------------- Dated: March 31, 2006 Victor K. Kurylak Chief Executive Officer and President Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated. /s/ Herbert Kurinsky March 31, 2006 - ------------------------------------- Herbert Kurinsky, Chairman /s/ Victor K. Kurylak March 31, 2006 - ------------------------------------ Victor K. Kurylak, Chief Executive Officer, President and Director /s/ William J. Kurinsky March 31, 2006 - ------------------------------------ William J. Kurinsky, Vice Chairman, Director /s/ Mindy A. Horowitz March 31, 2006 - ------------------------------------ Mindy A. Horowitz, Acting Chief Financial Officer and Principal Accounting Officer /s/ Ward R. Jones, Jr. March 31, 2006 - ------------------------------------ Ward R. Jones, Jr., Director /s/ Barry D. Shapiro March 31, 2006 - ------------------------------------ Barry D. Shapiro, Director /s/ David I. Portman March 31, 2006 - ------------------------------------ David I. Portman, Director 51 EXHIBIT INDEX The exhibits designated with an asterisk (*) are filed herewith. All other exhibits have been previously filed with the Commission and, pursuant to 17 C.F.R. ss.230.411, are incorporated by reference to the document referenced in brackets following the descriptions of such exhibits. - ---------------- -------------------------------------------------------------------------------------------- Exhibit No. Description 2.1 Agreement and Plan of Merger dated as of February 10, 2005 by and among First Montauk Financial Corp., Olympic Cascade Financial Corp. and FMFC Acquisition Corporation (Previously filed as Exhibit 10.1 to our Current Report on Form 8-K dated February 11, 2005). 2.2 Amended and Restated Agreement and Plan of Merger dated as of June 27, 2005 by and among First Montauk Financial Corp., Olympic Cascade Financial Corp. and FMFC Acquisition Corporation (Previously filed as Exhibit 10.1 to our Current Report on Form 8-K dated June 28, 2005). 2.3 Letter Agreement dated as of October 24, 2005 terminating the Amended and Restated Agreement and Plan of Merger, dated June 27, 2005, by and among Olympic Cascade Financial Corporation, OLY Acquisition Corporation and First Montauk Financial Corp. (Previously filed as Exhibit 10.2 to our Current Report on Form 8-K dated October 25, 2005). 3.1 Amended and Restated Certificate of Incorporation adopted at 1989 Special Meeting in lieu of Annual Meeting of Shareholders (Previously filed with the Commission as an exhibit to our Registration Statement on Form S-l, File No. 33-24696). 3.2 Amended and Restated By-Laws (Previously filed with the Commission as an exhibit to our Registration Statement on Form S-l, File No. 33-24696). 3.3 Certificate of Designations of Series A Preferred Stock. (Previously filed with the Commission as an exhibit to our Annual Report on Form 10-K for the fiscal year ended December 31, 2002). 3.4 Form of Certificate of Amendment of Certificate of Designation of Rights and Preferences of Series B Preferred Stock (Previously filed as Exhibit 3.1 to our Current Report on Form 8-K dated February 9, 2005). 3.5 Amendment to Amended and Restated Certificate of Incorporation adopted at Annual Meeting of Shareholders held on June 23, 2005 (Previously filed as Exhibit A to Definitive Proxy Statement dated May 19, 2005). 4.1 Form of Common Stock. (Previously filed with the Commission as an exhibit to our Registration Statement on Form S-l, File No. 33-24696). 4.2 Form of Debenture Sold in Private Placement. (Previously filed with the Commission as Exhibit 4.1 to Report on Form 8-K dated March 27, 2003). 4.3 Form of Placement Agent Warrant (Previously filed with the Commission as Exhibit 4.2 to Report on Form 8-K dated March 27, 2003). 4.4 Form of Debenture Sold in Private Placement. (Previously filed with the Commission as Exhibit 4.1 to Report on Form 8-K dated January 5, 2004). 4.5 Form of Placement Agent Warrant (Previously filed with the Commission as Exhibit 4.2 to Report on Form 8-K dated January 5, 2004). 4.6++ Promissory Note issued to Herbert Kurinsky dated February 1, 2006 (Previously filed as Exhibit 4.1 to Current Report on Form 8-K dated February 1, 2006 10.1 Office Lease Agreement between First Montauk Securities Corp. and River Office Equities dated March 5, 1997 (Previously filed with the Commission as an exhibit to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 1997). 10.2 First Amendment to Office Lease Agreement dated March 5, 1997 between First Montauk Securities Corp. and River Office Equities dated March 3, 1998 (Previously filed with the Commission as Exhibit 28.8 to Form 10-K for the fiscal year ended December 31, 1998). 10.3 Employment Agreement between First Montauk Securities Corp. and Mark Lowe dated October 15, 1998 (Previously filed with the Commission as an exhibit to our Annual Report on Form 10-K for the fiscal year ended December 31, 1998). 10.4 Sublease Agreement between Aim net Solutions, Inc. and First Montauk Financial Corp. dated January 15, 2002 (Previously filed with the Commission as an exhibit to our Annual Report on Form 10-K for the fiscal year ended December 31, 2001). 10.5++ Employment Agreement dated as of January 1, 2004 between Herbert Kurinsky and First Montauk Financial Corp. (Previously filed as Exhibit 10.13 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2004). 52 10.6++ Employment Agreement dated as of January 1, 2004 between William J. Kurinsky and First Montauk Financial Corp. (Previously filed as Exhibit 10.14 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2004). 10.7++ Employment Agreement dated as of January 1, 2004 between Victor K. Kurylak and First Montauk Financial Corp. (Previously filed as Exhibit 10.15 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2004). 10.8++ 1992 Incentive Stock Option Plan (Previously filed with the Commission as an exhibit to our Registration Statement on Form S-l, File No. 33-24696). 10.9++ 1992 Non-Executive Director Stock Option Plan (Previously filed with the Commission as an exhibit to our Registration Statement on Form S-l, File No. 33-24696). 10.10++ Amended and Restated 1992 Incentive Stock Option Plan. (Previously filed with the Commission as an exhibit to our Proxy Statement dated May 30, 1996). 10.11++ Non-Executive Director Stock Option Plan - Amended and Restated June 28, 1996 (Previously filed with the Commission as an exhibit to our Proxy Statement dated May 30, 1996). 10.12++ 1996 Senior Management Incentive Stock Option Plan (Previously filed with the Commission as an exhibit to our Proxy Statement dated May 30, 1996). 10.13++ Second Amended and Restated 1992 Incentive Stock Option Plan (Previously filed with the Commission as an exhibit to our Proxy Statement dated May 23, 2000). 10.14++ 1996 Senior Management Incentive Plan Amended as of June 23, 2000 (Previously filed with the Commission as an exhibit to our Proxy Statement dated May 23, 2000). 10.15++ 2002 Incentive Stock Option Plan. (Previously filed with the Commission as an Exhibit A to our Proxy Statement dated May 20, 2002). 10.16++ 2002 Non-Executive Director Stock Option Plan. (Previously filed with the Commission as Exhibit B to our Proxy Statement dated May 20, 2002). 10.17++ Form of Non-Executive Director Stock Option Award. (Previously filed as Exhibit 10.1 to our Report on Form 8-K dated September 2, 2004). 10.18++ Form of Stock Option Award pursuant to Incentive Stock Option Plan. (Previously filed as Exhibit 10.26 to our Annual Report on Form 10-K for the year ended December 31, 2004). 10.19++ Form of Stock Option Award pursuant to 1996 Senior Management Stock Option Plan. (Previously filed as Exhibit 10.27 to our Annual Report on Form 10-K for the year ended December 31, 2004). 10.20 Fourth Amendment to Office Lease Agreement dated September 22, 2004 between First Montauk Securities Corp. and River Office Equities (Previously filed with the Commission as Exhibit 10.1 to Form 8-K dated September 28, 2004). 10.21++ Separation Agreement between First Montauk Financial Corp. and William J. Kurinsky, effective as of February 1, 2005. (Previously filed as Exhibit 10.29 to our Annual Report on Form 10-K for the year ended December 31, 2004). 10.22++ Consulting Agreement between First Montauk Financial Corp. and William J. Kurinsky, effective as of February 1, 2005. (Previously filed as Exhibit 10.30 to our Annual Report on Form 10-K for the year ended December 31, 2004). 10.23++ Employment Agreement dated as of February 1, 2005 between Victor K. Kurylak and First Montauk Financial Corp. (Previously filed as Exhibit 10.31 to our Annual Report on Form 10-K for the year ended December 31, 2004). 10.24++ Employment Agreement dated as of February 8, 2005 between Robert I. Rabinowitz and First Montauk Financial Corp. (Previously filed as Exhibit 10.32 to our Annual Report on Form 10-K for the year ended December 31, 2004). 10.25++ Employment Agreement dated as of February 8, 2005 between Mindy A. Horowitz and First Montauk Financial Corp. (Previously filed as Exhibit 10.33 to our Annual Report on Form 10-K for the year ended December 31, 2004). 53 10.26 Termination of Clearing Agreement between First Montauk Securities Corp. and Fiserv Securities, Inc. dated April 21, 2005 (Previously filed as Exhibit 10.1 to Current Report on Form 8-K filed on April 27, 2005). 10.27 Termination of Financial and Security Agreement among First Montauk Financial Corp., First Montauk Securities Corp. and Fiserv Securities, Inc. dated April 21, 2005 (Previously filed as Exhibit 10.2 to Current Report on Form 8-K filed on April 27, 2005). 10.28++ Separation Agreement between First Montauk Financial Corp. and Herbert Kurinsky dated February 1, 2006 (Previously filed as Exhibit 10.1 to Current Report on Form 8-K dated February 1, 2006). 14 Code of Ethics (Filed as Exhibit 14 to our Annual Report on Form 10-K for the year ended December 31, 2003. 21* Subsidiary Companies 23.1* Consent of Lazar, Levine & Felix. 31.1* Certification of Chief Executive Officer and President 31.2* Certification of Acting Chief Financial Officer 32.1 * Certification of Victor K. Kurylak pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 * Certification of Mindy A. Horowitz pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. - -------------------------------------------------------------------------------------------------------------- ++ Denotes management contracts or compensation plans or arrangements in which directors or executive officers are eligible to participate.
54 Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders First Montauk Financial Corp Red Bank, New Jersey We have audited the accompanying consolidated balance sheets of First Montauk Financial Corp. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, shareholders' equity, cash flows and the schedule listed in the accompanying index for each of the two years in the period ended December 31, 2005. These consolidated financial statements and the schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the schedule based on our audits We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and the schedule are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal controls over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting amounts and disclosures in the financial statements and the schedule. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and the schedule. We believe that our audits provide a reasonable basis for our opinion. In our opinion, based on our audits, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Montauk Financial Corp. and subsidiaries at December 31, 2005 and 2004, and the results of their operations and their cash flows for the three years in the period then ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the schedule presents fairly, in all material respects, the information set forth therein. New York, New York /s/ Lazar, Levine and Felix LLP March 10, 2006 --------------------------------------- LAZAR LEVINE AND FELIX LLP F-1 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We have audited the accompanying consolidated statement of financial condition of First Montauk Financial Corp. and subsidiaries as of December 31, 2003, and the related statements of operations, stockholders' deficit, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with standards of the Public Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of First Montauk Financial Corp. and subsidiaries as of December 31, 2003, and the results of their operations and their cash flows for the year ended December 31, 2003, in conformity with U. S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ Schneider & Associates, LLP ---------------------------------------- SCHNEIDER & ASSOCIATES, LLP Jericho, New York March 18, 2004 F-2 FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION December 31, December 31, 2005 2004 ----------------- ----------------- ASSETS Cash and cash equivalents $ 1,990,815 $ 1,034,681 Due from clearing firm 4,756,646 5,815,819 Securities owned, at market value 303,612 370,720 Prepaid expenses 287,394 340,821 Employee and broker receivables - net of reserve for bad debt of $1,085,135 and $1,402,631 respectively 309,199 548,240 Property and equipment - net 449,460 790,909 Income taxes receivable -- 40,525 Other assets 622,804 892,659 ----------------- ----------------- Total assets $ 8,719,930 $ 9,834,374 ================= ================= LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) LIABILITIES Deferred income $ - $ 5,105,116 6% convertible debentures 1,250,000 3,015,000 Securities sold, not yet purchased, at market value 3,564 174,326 Commissions payable 2,027,379 2,499,793 Accounts payable 486,676 614,784 Accrued expenses 1,373,354 1,078,185 Income taxes payable 32,167 44,546 Capital leases payable 8,555 62,460 Other liabilities 310,384 338,781 ----------------- ----------------- Total liabilities 5,492,079 12,932,991 ----------------- ----------------- Commitments and contingencies (See notes) STOCKHOLDERS' EQUITY (DEFICIT) Preferred stock, 3,929,898 shares authorized, $.10 par value, no shares issued and outstanding -- -- Series A convertible preferred stock, 625,000 shares authorized, $.10 par value, 305,369 shares issued and outstanding; liquidation preference: $1,526,845 30,537 30,537 Series B convertible redeemable preferred stock, 445,102 shares authorized, $.10 par value, 197,824 and 0 shares issued and outstanding respectively; liquidation preference: $1,000,000 19,782 -- Common stock, no par value, 60,000,000 and 30,000,000 shares authorized and 15,937,407 and 10,258,509 shares issued and outstanding, respectively 10,444,110 7,257,292 Additional paid-in capital 1,930,810 950,592 Accumulated deficit (8,809,203) (10,948,157) Less: deferred compensation (388,185) (388,881) ----------------- ----------------- Total stockholders' equity (deficit) 3,227,851 (3,098,617) ----------------- ----------------- Total liabilities and stockholders' equity (deficit) $ 8,719,930 $ 9,834,374 ================= ================= See notes to consolidated financial statements. F-3
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Twelve months ended December 31 -------------------- ------------------ ------------------ 2005 2004 2003 -------------------- ------------------ ------------------ Revenues: Commissions $ 37,493,733 $ 42,732,238 $ 41,883,669 Principal transactions 5,578,820 9,058,259 9,466,359 Investment banking 6,640,402 2,716,042 2,439,144 Interest and other income 8,370,711 4,680,702 4,437,510 -------------------- ------------------ ------------------ Total revenue 58,083,666 59,187,241 58,226,682 -------------------- ------------------ ------------------ Expenses: Commissions, employee compensation and benefits 44,398,131 46,851,474 46,218,107 Executive separation 1,432,937 -- -- Clearing and floor brokerage 1,926,005 2,466,027 2,934,164 Communications and occupancy 2,483,056 2,664,256 2,659,105 Legal matters and related costs 1,773,604 2,714,769 5,836,960 Other operating expenses 3,467,972 3,489,425 3,393,335 Interest 100,123 284,093 204,054 -------------------- ------------------ ------------------ Total expenses 55,581,828 58,470,044 61,245,725 -------------------- ------------------ ------------------ Income (loss) before income taxes 2,501,838 717,197 (3,019,043) Provision (benefit) for income taxes 77,544 (13,305) 499,000 -------------------- ------------------ ------------------ Net income (loss) $ 2,424,294 $ 730,502 $ (3,518,043) Preferred stock dividends (285,340) (90,689) (24,839) -------------------- ------------------ ------------------ Net income (loss) applicable to common stockholders $ 2,138,954 $ 639,813 $ (3,542,882) ==================== ================== ================== Earnings (loss) per share: Basic $ 0.15 $ 0.07 $ (0.40) Diluted $ 0.12 $ 0.04 $ (0.40) Weighted average number of shares of stock outstanding: Basic 14,032,057 9,270,350 8,784,103 Diluted 20,109,178 15,629,920 8,784,103 See notes to consolidated financial statements. F-4
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) FOR THE PERIOD FROM JANUARY 1, 2003 TO DECEMBER 31, 2005 Series A Convertible Series B Convertible Preferred Stock Preferred Stock Common Stock Additional --------------------- --------------------- ------------------------ Shares Amount Shares Amount Shares Amount Paid-in Capital --------------------------------------------------------------------- ------------ Balances at January 1, 2003 330,250 $33,025 - - 8,527,164 $ 6,384,558 $ 950,592 Increase in deferred compensation 142,402 Amortization of deferred compensation Common stock issued in connection with legal settlements 500,000 160,000 Issuance of common stock purchase warrants for services 35,977 Conversion of preferred stock into common stock (19,161) (1,916) 38,322 1,916 Payment of dividends Net loss for the year --------------------- --------------------- ------------------------ ------------ Balances at December 31, 2003 311,089 31,109 - - 9,065,486 6,724,853 950,592 Increase in deferred compensation 82,471 Amortization of deferred compensation Repurchase of common stock Cancellation of treasury shares (60,217) (21,162) Issuance of restricted stock in connection with employment agreements 1,000,000 350,000 Conversion of preferred stock into common stock (5,720) (572) 11,440 572 Exercise of incentive stock options 1,800 558 Conversion of bonds into common stock 240,000 120,000 Net income for the year --------------------- --------------------- ------------------------ ------------ Balances at December 31, 2004 305,369 30,537 - - 10,258,509 7,257,292 950,592 Increase in deferred compensation 154,464 Amortization of deferred compensation Common stock issued in connection with legal settlements 25,000 25,000 Issuance of restricted stock in connection with employment agreements 1,300,000 741,000 Issuance of preferred stock in connection with separation agreement 197,824 $19,782 980,218 Exercise of incentive stock options 560,998 343,071 Exercise of warrants 262,900 158,283 Conversion of bonds into common stock 3,530,000 1,765,000 Payment of preferred stock dividends Net income for the period --------------------- --------------------- ------------------------ ------------ Balances at December 31, 2005 305,369 $30,537 197,824 $19,782 15,937,407 $10,444,110 $ 1,930,810 ===================== ===================== ======================== ============ See notes to consolidated financial statements. F-5
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) FOR THE PERIOD FROM JANUARY 1, 2003 TO DECEMBER 31, 2005 Retained Earnings Stockholders' (Accumulated Deferred Treasury Stock Equity Deficit) Compensation Shares Amount (Deficit) ---------------- -------------------------------------------- -------------- Balances at January 1, 2003 $ (8,135,777) $ (10,088) -- -- $ (777,690) Increase in deferred compensation (142,402) Amortization of deferred compensation 37,156 37,156 Common stock issued in connection with legal settlements 160,000 Issuance of common stock purchase warrants for services 35,977 Conversion of preferred stock into common stock Payment of dividends (24,839) (24,839) Net loss for the year (3,518,043) (3,518,043) ---------------- -------------- ---------------------------- -------------- Balances at December 31, 2003 (11,678,659) (115,334) -- -- (4,087,439) Increase in deferred compensation (432,471) (350,000) Amortization of deferred compensation 158,924 158,924 Repurchase of common stock (60,217) $(21,162) (21,162) Cancellation of treasury shares 60,217 21,162 Issuance of restricted stock in connection with employment agreements 350,000 Conversion of preferred stock into - common stock - Exercise of incentive stock options 558 Conversion of bonds into common stock 120,000 Net income for the year 730,502 730,502 ---------------- -------------- ---------------------------- -------------- Balances at December 31, 2004 (10,948,157) (388,881) -- -- (3,098,617) Increase in deferred compensation (154,464) - Amortization of deferred compensation 896,160 896,160 Common stock issued in connection with legal settlements 25,000 Issuance of restricted stock in connection - with employment agreements (741,000) - Issuance of preferred stock in connection with separation agreement 1,000,000 Exercise of incentive stock options 343,071 Exercise of warrants 158,283 Conversion of bonds into common stock 1,765,000 Payment of preferred stock dividends (285,340) (285,340) Net income for the period 2,424,294 2,424,294 ---------------- -------------- ---------------------------- -------------- Balances at December 31, 2005 $ (8,809,203) $ (388,185) -- -- $ 3,227,851 ================ ============== ============================ ============== See notes to consolidated financial statements. F-6
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Twelve months ended December 31 ------------- ------------- ----------- 2005 2004 2003 ------------- ------------- ----------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $2,424,294 $ 730,502 $(3,518,043) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization of property and equipment 384,169 538,549 509,968 Amortization of deferred costs 1,064,619 223,708 57,932 Amortization of deferred income (5,105,116) (875,008) (726,199) Deferred income taxes - net -- -- 460,000 Common stock issued in legal settlement 25,000 -- 160,000 Preferred shares and note payable issued in connection with separation agreement 1,200,000 -- -- Loss on disposition of property and equipment -- 4,692 -- Increase (decrease) in cash attributable to changes in assets and liabilities: Due from clearing firm 1,059,173 (596,552) (627,566) Securities owned 67,108 (201,186) 14,410 Prepaid expenses 53,427 113,520 198,125 Employee and broker receivables 239,041 100,402 415,877 Income taxes receivable 40,525 (37,900) 212,300 Other assets 101,395 360,461 (557,430) Deferred income -- -- 1,250,000 Securities sold, not yet purchased (170,762) 104,996 69,330 Commissions payable (472,414) (1,179,903) 998,568 Accounts payable (128,108) (257,789) 350,429 Accrued expenses 295,169 (725,788) (183,898) Income taxes payable (12,379) (63,365) 52,829 Other liabilities (70,113) (259,836) 237,734 ------------- ------------- ----------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 995,028 (2,020,497) (625,634) ------------- ------------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property and equipment (42,720) (212,000) (165,640) Other assets -- -- 26,873 ------------- ------------- ----------- NET CASH USED IN INVESTING ACTIVITIES (42,720) (212,000) (138,767) ------------- ------------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Payment of notes payable -- -- (48,057) Payments of capital leases (53,905) (153,961) (220,949) Repurchase of common shares -- (21,162) -- Proceeds from issuance of 6% convertible debentures -- -- 2,105,000 Proceeds from exercise of incentive stock option 343,071 558 -- Payments of preferred stock dividends (285,340) -- (24,839) Other assets -- -- (243,830) ------------- ------------- ----------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 3,826 (174,565) 1,567,325 ------------- ------------- ----------- Net increase (decrease) in cash and cash equivalents 956,134 (2,407,062) 802,924 Cash and cash equivalents at beginning of year 1,034,681 3,441,743 2,638,819 ------------- ------------- ----------- CASH AND CASH EQUIVALENTS AT END OF YEAR $1,990,815 $1,034,681 $ 3,441,743 ============= ============= =========== F-7
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) Twelve months ended December 31 ------------- ------------- ----------- 2005 2004 2003 ------------- ------------- ----------- Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 133,967 $ 212,080 $ 134,055 ============= ============= =========== Income taxes $ 92,473 $ 67,960 $(187,707) ============= ============= =========== Noncash financing activity: Equipment acquired through capital lease financing -- $ 69,585 -- Exercise of warrants for common stock $ 158,283 -- -- 6% convertible debentures converted into common stock $1,765,000 $ 120,000 -- Warrants charged to deferred financing costs in connection with debenture offering -- -- $ 35,987 See notes to consolidated financial statements. F-8
FIRST MONTAUK FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - NATURE OF BUSINESS First Montauk Financial Corp. (the Company) is a holding company whose principal subsidiary, First Montauk Securities Corp. (FMSC), operates as a securities broker-dealer and investment adviser registered with the Securities and Exchange Commission (SEC). Through FMSC, the Company executes principal and agency transactions primarily for retail customers, performs investment banking services, and trades securities on a proprietary basis. Montauk Insurance Services, Inc. (MISI), the other subsidiary, sells a variety of insurance products. The Company operates in one business segment. Customers are located primarily throughout the United States. FMSC clears all customer transactions on a fully disclosed basis through independent clearing firms. Accordingly, FMSC does not carry securities accounts for customers nor does it perform custodial functions related to those securities. FMSC is a member of the National Association of Securities Dealers, Inc. (NASD) and the National Futures Association (NFA). NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. All intercompany accounts and transactions have been eliminated in consolidation. Revenue Recognition Securities transactions, commission income, sales concessions from participation in syndicated offerings and related expenses are recorded on a trade date basis. Insurance and mutual fund commissions received from outside vendors are recognized as income when earned. Securities owned and securities sold, not yet purchased are stated at quoted market value. All resulting unrealized gains and losses are included in earnings. Securities not readily marketable are carried at estimated fair value as determined by management. Advances received under the Company's financial agreement with its former clearing firm, Fiserv, were deferred and amortized to income over the term of the agreement on a straight-line basis. Upon termination of the agreement in 2005, the remaining unamortized balance of $4,886,000 was recorded as income (see Note 7). Advertising Advertising costs are expensed as incurred and totaled $68,924, $114,829 and $246,357 in 2005, 2004 and 2003, respectively. Property and Equipment Furniture, equipment and leasehold improvements are stated at cost. Depreciation on furniture and equipment is computed over the estimated useful lives of the assets, ranging from three to ten years. Capitalized lease equipment is amortized over F-9 the lease term. Leasehold improvements are amortized over the shorter of either the asset's useful life or the related lease term. Depreciation is computed on the straight-line method for financial reporting purposes and on an accelerated basis for income tax purposes. Cash Equivalents For purposes of the Statement of Cash Flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents consisted of money market funds at December 31, 2005 and 2004. Earnings (Loss) per Share Basic earnings (loss) per share is calculated by dividing net income (loss) attributable to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted earnings (loss) per share is calculated by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding for the period adjusted to reflect potentially dilutive securities. In determining basic earnings (loss) per share for the periods presented, dividends paid on Series A Convertible Preferred Stock are added (deducted) to the net income (loss). For 2003, the basic and diluted calculation is the same due to losses incurred and accordingly the result of including potentially dilutive securities is anti-dilutive. In accordance with SFAS 128, the following table reconciles basic shares outstanding to fully diluted shares outstanding: Twelve months ended December 31, 2005 2004 2003 ---- ---- ---- Numerator - basic: Net income (loss) $2,424,294 $730,502 $(3,518,043) Deduct: dividends earned/paid during the year (285,340) (90,689) (24,839) --------- -------- -------- Numerator for basic earnings (loss) per share $2,138,954 $639,813 $(3,542,882) ========= ======= =========== Numerator - diluted: Numerator for basic earnings (loss) per share $2,138,954 $639,813 $(3,542,882) Add: Preferred stock dividends 285,340 -- -- Add: convertible debenture interest 86,582 45,735 -- ------ ------ -- Numerator for diluted earnings (loss) per share $2,510,876 $685,548 $(3,542,882) ========= ======= =========== Denominator: Weighted average common shares outstanding 14,032,057 9,270,350 8,784,103 Effect of dilutive securities: Stock options and warrants 1,160,173 235,820 -- Restricted shares 438,708 93,750 -- Convertible preferred stock Series B 1,978,240 -- -- Convertible debentures 2,500,000 6,030,000 -- --------- --------- --------- Denominator for diluted earnings per share 20,109,178 15,629,920 8,784,103 ========== ========== =========
F-10 The following securities, presented on a common share equivalent basis, have been excluded from the per share computations because they are antidilutive: Year ended December 31, 2005 2004 2003 ---- ---- ---- Stock Options 1,934,844 3,514,998 3,556,498 Warrants 82,409 3,385,946 4,160,946 Convertible debt -- -- 6,270,000 Convertible preferred 610,738 610,738 622,178 stock
Use of Estimates The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Management periodically evaluates estimates used in the preparation of financial statements for continued reasonableness. Appropriate adjustments, if necessary, to the estimates used are made prospectively based upon such periodic evaluation. Actual results could differ from those estimates. Long-lived Assets The Company evaluates impairment losses on long-lived assets used in operations, primarily property and equipment, when events and circumstances indicate that the carrying value of the assets might not be recoverable in accordance with FAS No. 144 "Accounting for the Impairment or Disposal of Long-lived Assets". For purposes of evaluating the recoverability of long-lived assets, the undiscounted cash flows estimated to be generated by those assets would be compared to the carrying amounts of those assets. If and when the carrying values of the assets exceed their fair values, the related assets will be written down to fair value. Income Taxes The Company uses the liability method to determine its income tax expense as required under Statement of Financial Accounting Standards No. 109 (FAS 109). Under FAS 109, deferred tax assets and liabilities are computed based on differences between financial reporting and tax basis of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance if, based on the weight of the available evidence, it is more likely than not that all or some portion of the deferred tax assets will not be realized. The ultimate realization of the deferred tax asset depends on the Company's ability to generate sufficient taxable income in the future. Stock-based Compensation The Company periodically grants stock options to employees in accordance with the provisions of its stock option plans, with the exercise price of the stock options being set at the greater of $ .50 or 120% of the closing market price of the common stock on the date of grant. The Company accounts for stock-based compensation plans under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and accordingly accounts for employee stock-based compensation utilizing the intrinsic value method. FAS No. 123, "Accounting for Stock-Based Compensation", establishes a fair value based method of accounting for stock-based compensation plans. The Company has adopted the disclosure only alternative under FAS No. 123, which requires disclosure of the pro forma effects on earnings and earnings per share as if FAS No. 123 had been adopted as well as certain other information. F-11 Stock options granted to non-employees are recorded at their fair value, as determined in accordance with FAS No. 123 and Emerging Issues Task Force Consensus No. 96-18, and recognized over the related service period. Deferred charges for options granted to non-employees are periodically re-measured until the options vest. In December 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure" ("FAS 148"), which (i) amends FAS Statement No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation (ii) amends the disclosure provisions of FAS 123 to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to stock-based employee compensation and (iii) amends APB opinion No. 28, "Interim Financial Reporting," to require disclosure about those effects in interim financial information. The additional disclosures required by FAS 148 are as follows: Years ended December 31, 2005 2004 2003 ---- ---- ---- Net income (loss) applicable to common stockholders, as reported $2,138,954 $639,813 $(3,542,882) Deduct: total stock based employee compensation expense determined under the fair value based method for all awards, net of tax (298,682) (160,457) (105,862) --------- --------- --------- Pro forma net income (loss) - basic $1,840,272 $479,356 $(3,648,744) Add: preferred stock dividends 285,340 -- -- Add: convertible debenture interest 86,582 45,735 -- ------ ------ -- Pro forma net income (loss) - diluted $2,212,194 $525,091 $(3,648,744) ========= ======= =========== Net income (loss) per share: Basic - as reported $0.15 $.07 $(0.40) Diluted - as reported $0.12 $.04 $(0.40) Basic - pro forma $0.13 $.05 $(0.42) Diluted - pro forma $0.11 $.03 $(0.42)
Pro forma net income (loss) and net income (loss) per share information, as required by FAS No. 123, have been determined as if the Company had accounted for employee stock options under the fair value method. The fair value of these options was estimated at grant date using a Black-Scholes option-pricing model with the following weighted-average assumptions for 2005, 2004 and 2003: 2005 2004 2003 ---- ---- ---- Risk free interest rates 4.35% 3.41% 3.14% Expected option lives 5 years 5 years 5 years Expected volatilities 68.49% 102.30% 105.11% Expected dividend yields 0% 0% 0%
F-12 In 2005, the Company changed the basis for estimating the volatility component of the Black Scholes model. In 2004 and 2003 the Company used historical daily price observations of its stock as a basis for determining expected volatility. In 2005, the Company determined that monthly price observations provide a more reliable measure of its stock trading activity and resulting volatility estimate. This change is considered a change in estimate. Recent Pronouncements of the Financial Accounting Standards Board In December 2004, the FASB issued SFAS 123 (revised 2004), "Share-Based Payment" ("SFAS 123(R)") which replaces SFAS 123, "Accounting for Stock-Based Compensation," and supersedes APB Opinion No.25, "Accounting for Stock Issued to Employees". Among other items, SFAS 123(R) eliminates the use of APB Opinion No. 25 and the intrinsic method of accounting, and requires all share-based payments, including grants of employee stock options, to be recognized in the financial statements based on their fair values. SFAS No. 123(R) is not effective for public entities which are small business filers until the first interim or annual reporting period of the first fiscal year that begins after December 15, 2005. The Company expects to adopt SFAS 123 (R) in the first quarter of 2006 and will recognize compensation expense for all share-based payments and employee stock options based on the grant-date fair value of those awards. The Company is currently evaluating the impact of the statement on its financial statements. As the Company currently accounts for share-based payments using the instrinsic value method as allowed by APB Opinion No. 25, the adoption of the fair value method under SFAS 123(R) will have an impact on its results of operations. However, the extent of the impact cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. Had the Company adopted SFAS 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS 123 as described under Stock Based Compensation in the Notes to the Consolidated Financial Statements. In June 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections" - a replacement of APB Opinion No. 20 (Accounting Changes) and FASB No. 3 (Reporting Accounting Changes in Interim Financial Statements), which changed the requirements for the accounting for and reporting of a change in accounting principle. This statement requires retrospective application to prior periods' financial statements of changes in accounting principle unless it is impracticable to determine either the period-specific effects of the cumulative effect of the change or the cumulative effect of applying a change. When it is impracticable to determine the period-specific effects of an accounting change on one or more individual prior periods presented, this statement requires that the new accounting principle be applied to the balance of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period rather than being reported in an income statement. When it is impracticable to determine the cumulative effect of applying a F-13 change in accounting principle to all prior periods, this statement requires the new accounting principle be applied as if it were adopted prospectively from the earliest date practicable. Statement No. 154 is effective for accounting changes and error corrections made in fiscal years beginning after December 15, 2005. The Company will comply with the provisions of FAS 154 although the impact of such adoption is not determinable at this time. Reclassifications Certain reclassifications have been made to 2004 and 2003 financial statements to conform to 2005 presentation. NOTE 3 - SECURITIES OWNED and SECURITIES SOLD, NOT YET PURCHASED December 31, 2005 2004 ---- ---- Owned Sold not yet Owned Sold not yet ----- purchased ----- purchased --------- --------- Corporate stocks $48,661 $133,475 $173,826 U.S. government agency and municipal obligations 2,677 2,320 Corporate bonds 130,083 $1,964 14,805 Other 122,191 1,600 220,120 500 ------- ----- ------- --- $303,612 $3,564 $370,720 $174,326 ========= ====== ======== =======
Securities owned and securities sold, not yet purchased consist of trading securities at quoted market values. The Company also owns investment securities, consisting of shares of common stock and common stock purchase warrants, some of which are publicly offered and can be sold and some of which cannot be publicly offered or sold until registered under the Securities Act of 1933. At December 31, 2005 and 2004, investment securities consist of stock purchase warrants and stock at an estimated total fair value of $121,991 and $213,750 respectively. NOTE 4 - EMPLOYEE AND BROKER RECEIVABLES December 31, 2005 2004 Commission advances $293,043 $431,362 Forgivable loans 151,651 247,649 Other loans 949,640 1,271,860 ------- --------- 1,394,334 1,950,871 Less reserve for bad debts (1,085,135) (1,402,631) ----------- ----------- $309,199 $548,240 ======== =======
F-14 The Company has arrangements with certain registered representatives to forgive their loans if they remain licensed with the Company for an agreed upon period of time, generally one to five years, or meet specified performance goals. The loans are being amortized to commission expense for financial reporting purposes over the term of the loan. Loan amortization charged to compensation was $122,155, $112,171 and $230,578 in 2005, 2004, and 2003, respectively. Other loans to employees and registered representatives are payable in installments generally over periods of one to five years with interest rates ranging up to 8% per annum. NOTE 5 - PROPERTY AND EQUIPMENT December 31, Estimated 2005 2004 Useful Life ---- ---- ----------- Computer and office equipment $2,873,705 $2,834,811 3 to 7 years Furniture and fixtures 1,693,612 1,689,787 7 to 10 years Leasehold improvements 807,227 807,227 Term of lease ------- ------- 5,374,544 5,331,825 Less accumulated depreciation and amortization expense (4,925,084) (4,540,916) ----------- ----------- $449,460 $790,909 =========== ===========
Depreciation and amortization expense was $384,169, $538,549, and $509,968 in 2005, 2004 and 2003, respectively. NOTE 6 - OTHER ASSETS December 31, Other assets consist of the following: 2005 2004 ---- ---- Commissions and concessions receivable $374,185 $374,182 Deferred financing costs-net 69,868 238,328 Security deposits 144,406 244,764 Other 34,345 35,385 ------ ------ $622,804 $892,659 ======= =======
Commissions and concessions receivable include amounts earned on mutual fund, insurance transactions and concessions on syndicate offerings. F-15 NOTE 7 - DEFERRED INCOME The Company received cash advances totaling $7,750,000 over the four year period between 2000 and 2004 in accordance with an agreement with its former clearing firm, Fiserv. All advances were recorded as deferred income and were being amortized to earnings over the term of the 10 year agreement. In April 2005 the agreement with Fiserv was terminated and the remaining unamortized cash advance of $4,886,000 was recognized as income. Amortization of approximately $5,105,000, $875,000, and $726,000 in 2005, 2004, and 2003, respectively, is included in Interest and Other Income in the Consolidated Statements of Operations. Advances were subject to income taxes in the year of receipt with the exception of the advance received in 2003, which the Company elected to include in taxable income in 2004. NOTE 8 - 6% CONVERTIBLE DEBENTURES In 2002 and 2003, the Company raised gross proceeds of $1,030,000 and $2,105,000, respectively, in private placements of 6% convertible debentures with accredited investors. The offerings were made in reliance upon the exemption under Sections 4(2) of the Securities Act of 1933 and the provisions of Regulation D. The debentures are convertible into shares of common stock at $.50 per share, subject to adjustment for stock dividends and stock splits, and mature five years from the date of issuance unless previously converted. Interest is payable in cash on a semi-annual basis until maturity or conversion. In the event that the closing bid price of the Company's common stock is 200% of the conversion price for the twenty (20) consecutive trading days prior to the date of notice of conversion or prepayment, the Company may, at its option and only if the underlying shares have been registered, upon thirty (30) days written notice to the holders, demand the conversion of some or all of the debentures, or prepay some or all of the debentures at 120% of the principal amount. The debentures contain certain covenants that, among other things, prevent the sale of all or substantially all of the Company's assets without provision for the payment of the debentures from such sales proceeds, and making loans to any executive officers or 5% stockholders. The debentures provide for piggy-back registration rights relating to the underlying shares. FMSC was the Placement Agent for the offerings. Offering costs of approximately $324,000, consisting of the value of warrants issued to selling brokers, commissions and other cash expenses, have been capitalized and are being amortized on a straight-line basis over the respective terms of the debentures. In October 2004, holders of $120,000 of the subordinated convertible debentures presented their debentures to the Company for conversion. The Company issued 240,000 shares of common stock and retired $120,000 of the debentures. During 2005, holders of $1,765,000 of the 6% subordinated convertible debentures presented their debentures to the Company for conversion. The Company issued 3,530,000 shares of common stock and retired $1,765,000 of the debentures. The debentures outstanding as of December 31, 2005 are $1,250,000 and are due to mature in 2007 and 2008, as follows: 2007 - $480,000; 2008 - $770,000. F-16 NOTE 9 - ACCRUED EXPENSES December 31, Accrued expenses consist of the following: 2005 2004 ---- ---- Accrued litigation costs $751,331 $666,013 Accrued penalties and fines 50,000 84,750 Accrued payroll 340,977 137,341 Accrued professional fees 154,250 109,679 Other accrued expenses 76,796 80,402 ------ ------ $1,373,354 $1,078,185 ========= =========
NOTE 10 - OTHER LIABILITIES December 31, Other liabilities consist of the following: 2005 2004 ---- ---- Warrants subject to put options $55,320 $333,261 Note payable 200,000 0 Other 55,064 5,520 ------ ----- $310,384 $338,781 ======= =======
The Company issued warrants subject to put options as part of a legal settlement in 2003. The Company has classified its obligations under the warrants as liabilities in the Statement of Financial Condition in accordance with the provisions of FAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". The Company may be obligated to make cash payments of up to $60,490 if certain redemption conditions exist. The obligations embodied in the remaining warrants, due to expire in June 2006, were initially valued at $ 40,830 using the discounted cash flow method and are re-measured at of the end of each reporting period until the obligation is settled. The recorded value at December 31, 2005 was $55,320. Changes in value are recognized in earnings as interest expense. The Company's note payable was executed as part of a Separation Agreement entered into in February 2005 with the former CEO was paid in full, including interest at 8% per annum, in February 2006. (see Note 17). NOTE 11 - INCOME TAXES The provision (benefit) for income taxes consists of the following: Year ended December 31, 2005 2004 2003 ---- ---- ---- Currently payable (refundable): Federal $ - $ - $ - State 78,000 (13,000) 39,000 ------ -------- ------ 78,000 (13,000) 39,000 ------ -------- ------ Deferred: Federal - - 425,000 State - - 35,000 ------- - - 460,000 ------ -------- ------- Provision (benefit) for income taxes $78,000 $(13,000) $499,000 ====== ====== ========
F-17 Note 11 - (Continued) Following is a reconciliation of the income tax provision (benefit) with income taxes based on the federal statutory rate: Year ended December 31, 2005 2004 2003 ---- ---- ---- Expected federal tax benefit at statutory rate $ 851,000 $ 244,000 $(1,043,000) State taxes, net of federal tax effect 51,000 (7,000) (145,000) Non-deductible expenses 408,000 10,000 29,000 Increase (decrease) in valuation allowance (1,542,000) (260,000) 1,658,000 Other reserves not deductible 310,000 -- -- ------------ --------- --------- Provision (benefit) for income taxes $ 78,000 $ (13,000) $ 499,000 ============ ========== ========= The tax effects of the temporary differences that give rise to significant portions of the deferred tax assets and liabilities as of December 31, 2005 and 2004 are: Year ended December 31, 2005 2004 ---- ---- Deferred tax assets: Deferred income $ -- $ 2,042,000 Reserves and allowances 723,000 986,000 Federal tax loss carryforwards 1,741,000 1,152,000 State tax loss carryforwards 508,000 389,000 Accrued and stock-based compensation 387,000 454,000 Other 220,000 98,000 ------- ---------- Subtotal 3,579,000 5,121,000 Valuation allowance (3,579,000) (5,121,000) ---------- ---------- Net deferred tax assets $ -- $ -- =========== ==========
The Company has determined that, based upon available information, the probability of utilizing its deferred tax assets does not meet the "more likely than not" test under SFAS 109. As such, a valuation allowance has been provided against all deferred tax assets as of December 31, 2005 and 2004. The Company and its subsidiaries file a consolidated federal tax return and separate state returns. At December 31, 2005, the Company has approximately $5,121,000 and $4,062,000 of federal and state operating loss carryforwards, respectively, available to offset future taxable income. These losses expire at various dates through 2024. During 2004, the Company recovered approximately $38,000 of state income taxes through loss carryback refund claims. F-18 NOTE 12 - COMMITMENTS AND CONTINGENT LIABILITIES Operating Leases The Company leases office facilities and equipment under operating leases expiring at various dates through 2010. Certain leases require the Company to pay increases in real estate taxes, operating costs and repairs over certain base year amounts. Operating lease expense for the years ended December 31, 2005, 2004 and 2003 was approximately $989,000, $1,154,000, and $1,192,000, respectively. Future minimum rental commitments under all non-cancelable leases with terms greater than one year are as follows: Year ending December 31, 2006 $1,382,359 2007 1,297,515 2008 1,386,349 2009 611,549 2010 and beyond 101,525 ------- $4,779,297 =========
Employment agreements Effective February 1, 2005, the President and Chief Operating Officer ("COO") was appointed the CEO of the Company and FMSC. FMFC entered into a new employment agreement with the new CEO which superseded his existing agreement. In the event of termination without cause, the new CEO is entitled to a severance payment consisting of accrued compensation, benefit continuation and payment of base salary for the greater of three months or the unexpired term and the accelerated vesting of restricted stock grants. Legal matters The Company is a respondent or co-respondent in various legal proceedings, which are related to our securities business. Management is contesting these claims and believes that there are meritorious defenses in each case. However, litigation is subject to many uncertainties, and some of these actions and proceedings may result in adverse judgments. Further, the availability of insurance coverage is determined on a case-by-case basis by the insurance carrier, and is limited to the coverage limits within the policy for any individual claim and in the aggregate. After considering all relevant facts, available insurance coverage and consultation with litigation counsel, management believes that significant judgments or other unfavorable outcomes from pending litigation could have a material adverse impact on our consolidated financial condition, results of operations, and cash flows in any particular quarterly or annual period, or in the aggregate, and could impair our ability to meet the statutory net capital requirements of its securities business. The New Jersey Bureau of Securities is conducting an inquiry into FMSC's sale of certain high-yield bonds to the firm's clients from 1998 to 2001, and the subsequent resale of those securities to other customers in 2001. The Company has recently begun settlement discussions with the Bureau in an attempt to resolve the matter in order to avoid a protracted legal proceeding. The final terms of the settlement are still being negotiated but may include a monetary fine, the disgorgement of markups on the sale of certain bonds and the retention of a compliance consultant to review the firm's procedures. The exact amount of civil penalty and disgorgement as well as the precise language of the proposed consent order are still being negotiated with the Bureau. The Company believes that it has adequately reserved for the anticipated financial impact of this matter in the financial statements. During 2005 the Company settled four customer arbitrations for an aggregate of $360,000, involving the sale of high-yield bonds referenced above. Management believes that we have sufficiently accrued for any probable costs related to the one remaining customer arbitration related to the sale of the high-yield bonds. F-19 As of December 31, 2005, the Company has accrued litigation costs that are probable and can be reasonably estimated based on a review of existing claims, arbitrations and unpaid settlements. Management cannot give assurance that this amount will be adequate to cover actual costs that may be subsequently incurred. Further, it is not possible to predict the outcome of other matters pending against the Company. All such cases will continue to be vigorously defended. Clearing Agreement: In April 2005, FMSC entered into a clearing agreement with National Financial Services, LLC ("NFS"). The initial term of the agreement is for eight years. Should the Company decide to terminate the agreement prior to the end of the initial term, it would have to make a payment to NFS of $2,000,000 in year one of the agreement and, in decreasing amounts, down to $250,000 in year eight. The Company has no intention of terminating this agreement. NOTE 13- CAPITAL LEASE OBLIGATIONS The Company leases certain equipment under non-cancelable lease agreements, which meet the criteria for capitalization. The cost, accumulated depreciation and net book value of equipment under the capital leases as of December 31, 2005 were $44,434, $21,578, and 21,856, respectively. Future minimum lease payments under capital lease obligations at December 31, 2005 are as follows: Year ending December 31, 2006: Total minimum payments $9,110 Less amount representing interest (555) ------ Total principal $8,555 ===== NOTE 14 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK and CONCENTRATION OF CREDIT RISK The Company executes securities transactions on behalf of its customers. If either the customer or a counter-party fail to perform, the Company by agreement with its clearing broker, may be required to discharge the obligations of the non-performing party. In such circumstances, the Company may sustain a loss if the market value of the security is different from the contract value of the transaction. The Company seeks to control off-balance-sheet risk by monitoring the market value of securities held or given as collateral in compliance with regulatory and internal guidelines. Pursuant to such guidelines, the Company's clearing firm requires additional collateral or reduction of positions, when necessary. The Company also completes credit evaluations where there is thought to be credit risk. The Company has sold securities that it does not currently own and will therefore be required to purchase such securities at a future date. The Company has recorded these obligations in the financial statements at market values of the related securities of $3,564 and $174,326 at December 31, 2005 and 2004, respectively, and will incur a loss if the market value of the securities increases subsequent to year-end. Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and securities inventories. The Company maintains all inventory positions and a significant portion of its cash balances at its clearing firm. Cash balances held at commercial banks may periodically exceed federal insurance limits. NOTE 15 - PENSION PLAN The Company sponsors a defined contribution 401(k) pension plan covering substantially all employees who meet minimum age and service requirements. The Company may elect to contribute up to 100% of each participant's annual contribution to the plan. There were no employer contributions in 2005, 2004 or 2003. F-20 NOTE 16 - STOCKHOLDERS' EQUITY (DEFICIT) The Company's charter authorizes the issuance of up to 5,000,000 shares of Preferred Stock. After the issuance of the Series A and Series B Preferred Shares described below, the Company is authorized to issue an additional 3,929,898 of Preferred Stock. The rights and preferences, if any, to be given to these preferred shares would be designated by the board of directors at the time of issuance. SERIES A CONVERTIBLE PREFERRED STOCK Preferred Stock - Series A In 1999, the Company's board of directors designated a Series A Convertible Preferred Stock with the following features: Shares authorized: 625,000 Par value: $.10 per share Dividends: 6% per annum, payable quarterly at the rate of $.075 per share until conversion Voting rights: None Liquidation preference: $5.00 per share Conversion: Convertible at the option of the holder anytime into two shares of Common Stock at $2.50 per share; automatic conversion once the closing price for the Common Stock is $3.50 or above for 20 consecutive trading days, and the shares are registered for public sale. The Company issued 349,511 Series A shares in a private exchange offering in 1999. As of December 31, 2005, a total of 44,142 preferred shares have been converted into 88,284 shares of common stock. During the quarter ended June 30, 2003, the Company suspended the payment of cash dividends on its Series A Preferred stock. New Jersey Business Corporation Act prohibits the payment of any distribution by a corporation to, or for the benefit of its shareholders, if the corporation's total assets would be less than its total liabilities. Unpaid preferred dividends will continue to accumulate at 6% per annum. During the quarter ending June 2005, the board of directors declared the dividend on the preferred stock in arrears, based upon the board's expectation that in the second quarter of 2005 the Company's total assets would exceed its total liabilities, and therefore, the payment of dividends would be permitted under New Jersey law. The Company paid dividends on the Series A Preferred Stock in the amount of $233,784 during 2005, including $210,879 dividends in arrears. SERIES B CONVERTIBLE REDEEMABLE PREFERRED STOCK Preferred Stock - Series B In February 2005, the Company's board of directors designated a Series B Convertible Redeemable Preferred Stock with the following features: Shares authorized: 445,102 Par value: $.10 per share Dividends: 8% per annum, payable quarterly at the rate of $.10 per share until conversion or redemption. Voting rights: Holders of Series B Preferred Stock are entitled to vote together with common stockholders on all matters in which they are entitled to vote. The number of votes to which holders of Series B Preferred are entitled to cast are ten per each share of Series B Preferred Stock subject to certain adjustments. Liquidation preference: $5.055 per share Conversion: Convertible at the option of the holder anytime into ten shares of common stock with automatic conversion once the closing price for the common stock is $1.01 for more than 60 trading days if the average daily trading volume exceeds 20,000 shares, or $1.26 for more than 60 trading days if the average daily trading volume exceeds 10,000 shares, or $1.51 for more than 60 trading days. Redemption: Optional redemption; the holder may require the Company to redeem all or a portion of Series B Preferred Stock by paying cash equal to the issue price plus all accrued and unpaid dividends within 180 days after a Redemption Event, as defined. In February 2005, the Company issued 197,824 Series B Preferred Shares in connection with a separation agreement entered into with its former Chief Executive Officer. During 2005, the Company paid $51,556 dividends on the Series B preferred shares. F-21 Common Stock During the second quarter of 2005, the Board of Directors adopted and the shareholders approved an amendment to the Company's Restated Certificate of Incorporation, to increase the authorized number of shares of common stock from 30,000,000 to 60,000,000. In connection with a legal settlement in 2005, the Company issued 25,000 shares of common stock. The shares were valued at $25,000 based on the quoted market price of the shares on the issuance date. Warrants During 2003 and 2002, the Company issued 210,500 and 103,000 common stock purchase warrants, respectively, to FMSC registered representatives as compensation in connection with the sale of convertible debentures. The Company valued the warrants at $35,977 and $11,382 respectively, using the Black-Scholes option pricing method. The warrants are exercisable at $.50 per share for five years from the date of issuance. The Company had outstanding 3,072,446 Class C Redeemable Common Stock Purchase Warrants, which expired in February 2005 unexercised. NOTE 17 - SEPARATION AGREEMENT Effective February 1, 2005, the Company entered into a Separation Agreement ("Agreement") with its Chief Executive Officer ("CEO"), which provides for the CEO to terminate his employment and his positions as CEO of both the Company and FMSC as of February 1, 2005. The Agreement provides for the CEO to remain as a director of the Company. The Agreement also terminated the CEO's employment agreement dated January 1, 2004. Pursuant to the terms of the Agreement, the Company entered into a two year consulting agreement, issued 197,824 shares of FMFC Series B Convertible Redeemable Preferred Stock convertible into 1,978,240 shares of the Company's common stock, with voting privileges and executed a promissory note in the amount of $200,000 with interest of 8% per annum. The Company also made a one time cash payment of $136,000. The Company also issued 200,000 options valued under the Black Scholes model at $68,110 and expensed over a one year vesting period, to purchase common stock at $0.83 per share for three years, and cancelled 325,000 options with various exercise prices. Pursuant to the employment agreement restricted common shares not previously vested were automatically vested upon his termination. The promissory note was paid in full in February 2006. NOTE 18 - EMPLOYMENT AGREEMENTS Effective February 1, 2005, the President and Chief Operating Officer ("COO") was appointed the role of CEO of FMFC and FMSC. The Company entered into an employment agreement with the new CEO, which superseded his existing agreement, and allowed for issuance, as a bonus payment for our performance for the year ended December 31, 2004, and in consideration of the CEO assuming the position of Chief Executive Officer, 1,000,000 shares of our common stock. The 1,000,000 shares vest in increments of one third commencing on February 1, 2005, one third on December 31, 2005 and the final one third on December 31, 2006. In addition, the new CEO agreed to the cancellation of 250,000 of his outstanding stock options with an exercise price of $0.75 per share. In the event of a change of control of the Company, all unvested shares would vest. In the event of termination without cause, the new CEO is entitled to a severance payment consisting of accrued compensation, benefit continuation and payment of base salary for the greater of three months or the unexpired term. Three other executive officers received 100,000 shares each of restricted stock, each with annual vesting provisions. F-22 NOTE 19 - TERMINATION OF MERGER On October 24, 2005, the Company and Olympic Cascade Financial Corporation ("Olympic") jointly announced that they had agreed to terminate the Amended and Restated Agreement and Plan of Merger, dated as of June 27, 2005 (the "Amended and Restated Merger Agreement") by and among the Company, Olympic, and OLY Acquisition Corporation, a wholly owned subsidiary of the Company. Under the terms of the letter agreement terminating the Amended and Restated Merger Agreement, the parties had no further obligation to each other arising out of the Merger Agreement, the Merger, and the transactions contemplated thereby, and each party agreed to bear its own expenses. As a result of the termination of the merger plans, the Company has expensed $392,000 of merger costs. Such costs are included in the Legal Matters and Related Costs line item in the Consolidated Statements of Operations. NOTE 20 - STOCK OPTION PLANS 2002 Stock Incentive Plan In June 2002, the Company adopted and its stockholders approved the 2002 Incentive Stock Option Plan (the "2002 Plan"), replacing the 1992 Incentive Stock Option Plan (the "1992 Plan"), which expired in September 2002. The 1992 Plan provided for the granting of options to employees, consultants and registered representatives of the Company, but only options issued to employees qualify for incentive stock option treatment ("ISOs"). Option exercise periods were fixed by the Board of Directors on the grant date but no exercise period could be less than one year nor more than ten years from the date of grant. As of December 31, 2005, a total of 206,800 options issued under this plan remain outstanding. The Company has reserved up to 5,000,000 shares of common stock for issuance under the 2002 Plan. The 2002 Plan provides for the grant of options, including ISOs to employees; non-qualified stock options (NQSOs) to employees, consultants and independent registered representatives; and stock appreciation rights or any combination thereof (collectively, "Awards"). The Board of Directors determines the terms and provisions of each award granted under the 2002 Plan, including the exercise price, term and vesting schedule. In the case of ISO's, the per share exercise price must be equal to at least 100% of the fair market value of a share of common stock on the date of grant, and no individual will be granted ISOs corresponding to shares with an aggregate fair value in excess of $100,000 in any calendar year. The 2002 Plan will terminate in 2012. As of December 31, 2005, options to purchase a total of 1,023,002 shares were outstanding and 3,468,400 shares remained available for future issuance under the 2002 Plan. 2002 Non-Executive Director Stock Option Plan In June 2002, the Company adopted and its stockholders approved the 2002 Non-Executive Director Stock Option Plan (the "2002 Director Plan"), replacing the 1992 Non-Executive Director Stock Option Plan, which expired in September 2002. Under the 2002 Director Plan, each non-executive director will automatically be granted an option to purchase 20,000 shares, pro rata, on September 1st of each year or partial year of service. The Plan will be administered by the Board of Directors or a committee of the Board, which shall at all times consist of not less than two officer/directors of the Company who are ineligible to participate in the 2002 Director Plan. The 2002 Director Plan does not contain a reserve for a specific number of shares available for grant. Each option issued under the 2002 Director Plan will be immediately vested NQSOs, and will have a five-year term and an exercise price equal to the 100% of the fair market value of the shares subject to such option on the date of grant. The 2002 Director Plan will terminate in 2012. As of December 31, 2005, 20,000 options were outstanding under the 1992 Non-Executive Director Stock Plan and 160,000 options were outstanding under the 2002 Non-Executive Director Stock Plan. F-23 1996 Senior Management Plan In June 2000, the Company's stockholders approved an amendment to the 1996 Senior Management Plan (the "1996 Plan") to increase the number of shares reserved for issuance to key management employees from 2,000,000 to 4,000,000 shares. Awards can be granted through the issuance of incentive stock rights, stock options, stock appreciation rights, limited stock appreciation rights, and shares of restricted Common Stock. The exercise price of an option designated as an ISO may in no event be less than 100% of the then fair market price of the stock (110% with respect to ten percent stockholders), and not less than 85% of the fair market price in the case of other options. The 1996 Plan will terminate in June 2006. As of December 31, 2005, options to purchase 1,297,500 shares and 2,300,000 shares of restricted common stock were issued and outstanding. A summary of the activity in the Company's stock option plans (excluding restricted common shares) for the three-year period ended December 31, 2005 is presented below: Weighted Average Exercise Shares Prices Options outstanding, December 31, 2002 4,072,498 $1.52 Granted 873,000 .54 Canceled (1,389,000) 1.75 ----------- Options outstanding, December 31, 2003 3,556,498 1.19 Granted 891,000 .57 Exercised (1,800) .31 Canceled (789,500) 1.17 ----------- Options outstanding, December 31, 2004 3,656,198 1.01 Granted 1,105,000 1.07 Exercised (566,398) .61 Canceled (1,487,498) .84 ----------- Options outstanding, December 31, 2005 2,707,302 $ .85 ===========
Shares of common stock available for future grant under Company plans totaled 4,155,900 as of December 31, 2005. This number does not include options that are expected to be issued during the remaining term of the 2002 Director's Plan, but for which no specific reserve has been established. The Company has elected to use the intrinsic value-based method of APB Opinion No. 25 to account for all of its employee stock-based compensation plans. Accordingly, no compensation cost has been recognized in the accompanying financial statements for stock options issued to employees because the exercise price of each option equals or exceeds the fair value of the underlying common stock as of the grant date for each stock option. Accordingly, compensation is recognized in the consolidated financial statements only for the fair value of options issued to consultants and independent registered representatives. Such compensation is amortized to expense over the related options' vesting periods. Compensation expense recognized in 2005, 2004 and 2003 totaled $129,499, 42,256 and $37,156, respectively. The weighted-average grant date fair value of options granted during 2005, 2004 and 2003 was $.41, $.28, and $.22, respectively. F-24 Additional information as of December 31, 2005 with respect to all outstanding options is as follows: Options Outstanding Options Exercisable Weighted Average Weighted Weighted Remaining Average Average Number Contractual Exercise Number Exercise Range of prices Outstanding Life Prices Exercisable Prices $0.20 - $0.30 119,200 2.79 $.25 109,920 $.26 $0.30 - $0.49 58,800 1.65 .40 55,080 .40 $0.50 - $0.75 1,253,802 2.57 .57 1,052,121 .58 $.83 - $1.09 442,000 3.25 .92 306,800 .90 $1.10 - $1.25 626,000 4.58 1.22 525,200 1.24 $1.50 - $2.50 207,500 .18 1.67 205,500 1.67 - --------------------------------------------------------------------------------------------------------------- $0.20 - $2.50 2,707,302 2.95 $.85 2,254,621 $.86 - ---------------------------------------------------------------------------------------------------------------
NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS Financial instruments reported in the Company's consolidated statement of financial condition consist of cash, securities owned and sold, not yet purchased, loans receivable, warrants subject to put options, 6% convertible debentures, accounts payable and accrued expenses, and capital leases payable, the carrying value of which approximated fair value at December 31, 2005 and 2004. The fair value of the financial instruments disclosed is not necessarily representative of the amount that could be realized or settled nor does the fair value amount consider the tax consequences of realization or settlement. NOTE 22 - NET CAPITAL REQUIREMENTS FMSC is subject to the Securities and Exchange Commission Uniform Net Capital Rule (Rule 15c3-1), which requires FMSC to maintain minimum net capital, as defined. At December 31, 2005, FMSC had net capital of $2,592,441, which was $2,337,751 in excess of its required net capital of $254,690. FMSC's ratio of aggregate indebtedness to net capital was 1.47 to 1. NOTE 23 - UNAUDITED QUARTERLY RESULTS OF OPERATIONS March 31, June 30, September 30, December 31, 2005 2005 2005 2005 ---- ---- ---- ---- (as restated) (as restated) Revenues $15,565,645 $16,580,501 $12,524,366 $13,413,154 Expenses $16,453,061 $12,160,116 $13,178,128 $13,790,523 Net income (loss) $ (710,685) $ 4,224,134 $ (656,857) $ (432,298) Net income (loss) applicable to common stockholders $ (745,143) $ 4,016,158 $ (699,763) $ (432,298) Income (loss) per common share: Net income (loss) applicable to common stockholders - basic $ (.06) $ .28 $ .05 $ (.03) diluted $ (.06) $ .20 $ .04 $ (.03)
The Company restated its financial statements for the quarters ending March 31, 2005 and June 30, 2005 to correctly account for the amortization of deferred compensation and its affect on the provision for income taxes. F-25 March 31, June 30, September 30, December 31, 2004 2004 2004 2004 ---- ---- ---- ---- Revenues $18,821,406 $14,241,684 $11,747,309 $14,376,842 Expenses $18,583,432 $14,216,838 $11,707,408 $13,962,366 Net income $ 237,974 $ 24,846 $ 39,901 $ 427,781 Net income applicable to common stockholders $ 215,071 $ 2,251 $ 17,306 $ 405,185 Income per common share: Net income applicable to common stockholders - basic $ .02 $ -0- $ .03 $ .04 diluted $ .02 $ -0- $ .02 $ .03
Net income (loss) per share is computed independently for each of the quarters presented. Therefore, the sum of the quarterly net income (loss) per share figures in 2005 and 2004 does not necessarily equal the total computed for the entire year. NOTE 24 - SUBSEQUENT EVENTS Separation Agreement: On February 1, 2006, the Company entered into a Separation Agreement ("Agreement") with its Chairman of the Board which provides for the termination of his employment as of that date. The Agreement provides for the Chairman to remain as a director of FMFC. Pursuant to the terms of the Agreement, the company paid the Chairman a cash payment of $300,000 and issued a promissory note in the amount of $550,217 plus interest at the rate of 4.5% per annum for 48 months. Further, the Company will continue to provide the Chairman and his wife with medical insurance coverage for 48 months and an automobile allowance of $600 for 36 months. In addition, pursuant to his employment agreement all stock grants will immediately vest. Letter of Intent: On March 11, 2006, the Company entered into a letter of intent for the sale of the Company to a private investor. The final terms of the sale are subject to further negotiation but it is anticipated that the transaction will be all cash at approximately $1.00 per common share. The letter of intent is subject to numerous conditions, including: satisfactory completion of due diligence, negotiation and finalization of the terms of the sale and structure of the transaction, negotiation, preparation and execution of definitive transaction documents, compliance with state and federal securities laws and regulations, and corporate, and shareholder and regulatory approvals. If a final agreement is reached and the other conditions satisfied, the transaction is expected to close during the third quarter of 2006. However, as a result of the foregoing uncertainties, there can be no assurance that a definitive agreement will be executed or that, if it is, the transaction will be completed. F-26 EX-23 2 ex2.txt CONSENT OF LAZAR LEVINE AND FELIX Exhibit 23.1 CONSENT OF REGISTERED INDEPENDENT PUBLIC ACCOUNTING FIRM First Montauk Financial Corp. We hereby consent to the incorporation in the Company's previously filed Registration Statement on Form S-8 (Nos. 333-123066 filed March 1, 2005) of our report dated March 10, 2006 relating to the consolidated financial statements and the related financial statement schedule of First Montauk Financial Corp. and Subsidiaries included in this Form 10K for the year ended December 31, 2005. /s/ Lazar Levine & Felix LLP LAZAR LEVINE & FELIX LLP Morristown, New Jersey March 31, 2006 EX-23 3 ex3.txt CONSENT OF SCHNEIDER EHRLICH & ASSOCIATES Exhibit 23.2 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (Nos. 333-123066 filed March 1, 2005) of First Montauk Financial Corp. of our report dated March 18 2004, relating to the consolidated financial statement and financial statement schedule of First Montauk Financial Corp., which appears in its Annual Report on Form 10-K for the year ended December 31, 2005. /s/ Schneider & Associates, LLP Jericho, New York March 31, 2006 EX-21 4 ex1.txt Exhibit 21 First Montauk Financial Corp. List of Subsidiaries The following listing includes all of our subsidiaries, which are included in the consolidated financial statements: Name of Company Place of Incorporation --------------- ---------------------- First Montauk Securities Corp. New York Montauk Insurance Services, Inc. New Jersey EX-31 5 ex6.txt CERTIFICATION OF VICTOR K. KURYLAK Exhibit 31.1 CERTIFICATIONS I, Victor K. Kurylak, Chief Executive Officer, certify that: 1. I have reviewed this annual report on Form 10-K of First Montauk Financial Corp.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) (Not applicable) c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 31, 2006 /s/ Victor K. Kurylak - ---------------------------------- VICTOR K. KURYLAK CHIEF EXECUTIVE OFFICER EX-31 6 ex7.txt CERTIFICATION OF MINDY A. HOROWITZ Exhibit 31.2 CERTIFICATIONS I, Mindy A. Horowitz, Acting Chief Financial Officer, certify that: 1. I have reviewed this annual report on Form 10-K of First Montauk Financial Corp.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) (Not applicable). c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 31, 2006 /s/ Mindy A. Horowitz - ------------------------------------ MINDY A. HOROWITZ ACTING CHIEF FINANCIAL OFFICER EX-32 7 ex9.txt CERTIFICATION OF MINDY A. HOROWITZ Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of FIRST MONTAUK FINANCIAL CORP. (the "Company") on Form 10-K for the period ending December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Mindy A. Horowitz, Acting Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Mindy A. Horowitz - ------------------------------------- Mindy A. Horowitz Acting Chief Financial Officer March 31, 2006 EX-32 8 ex8.txt CERTIFICATION OF VICTOR K. KURYLAK Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of FIRST MONTAUK FINANCIAL CORP. (the "Company") on Form 10-K for the period ending December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Victor K. Kurylak, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Victor K. Kurylak - ------------------------------------------ Victor K. Kurylak President and Chief Executive Officer March 31, 2006 -----END PRIVACY-ENHANCED MESSAGE-----