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OPY > SEC Filings for OPY > Form 10-Q on 6-Nov-2012All Recent SEC Filings




Quarterly Report

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

The Company's condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. Reference is also made to the Company's consolidated financial statements and notes thereto found in its Annual Report on Form 10-K for the year ended December 31, 2011.

The Company engages in a broad range of activities in the securities industry, including retail securities brokerage, institutional sales and trading, investment banking (both corporate and public finance), research, market-making, trust services and investment advisory and asset management services. Its principal subsidiaries are Oppenheimer & Co. Inc. ("Oppenheimer") and Oppenheimer Asset Management ("OAM"). As at September 30, 2012, the Company provided its services from over 94 offices in 26 states located throughout the United States, offices in Tel Aviv, Israel, Hong Kong, China, and London, England and in two offices in Latin America through local broker-dealers. Client assets entrusted to the Company as at September 30, 2012 totaled approximately $77.4 billion. The Company provides investment advisory services through OAM and Oppenheimer Investment Management ("OIM") and Oppenheimer's Fahnestock Asset Management, ALPHA and OMEGA Group divisions. At September 30, 2012, client assets under fee-based programs offered by the asset management groups totaled approximately $21.1 billion. The Company provides trust services and products through Oppenheimer Trust Company. The Company provides discount brokerage services through Freedom and through BUYandHOLD, a division of Freedom Investments, Inc. Through OPY Credit Corp., the Company offers syndication as well as trading of issued corporate loans. Oppenheimer Multifamily Housing and Healthcare Finance, Inc. (formerly Evanston Financial Corporation) ("OMHHF") is engaged in mortgage brokerage and servicing. At September 30, 2012, the Company employed 3,535 employees (3,468 full time and 67 part time), of whom approximately 1,423 were financial advisors.

Critical Accounting Policies

The Company's accounting policies are essential to understanding and interpreting the financial results reported in the condensed consolidated financial statements. The significant accounting policies used in the preparation of the Company's condensed consolidated financial statements are summarized in notes 1 and 2 to the Company's consolidated financial statements and notes thereto found in its Annual Report on Form 10-K for the year ended December 31, 2011. Certain of those policies are considered to be particularly important to the presentation of the Company's financial results because they require management to make difficult, complex or subjective judgments, often as a result of matters that are inherently uncertain.

During the three months ended September 30, 2012, there were no material changes to matters discussed under the heading "Critical Accounting Estimates" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

Business Environment

The securities industry is directly affected by general economic and market conditions, including fluctuations in volume and price levels of securities and changes in interest rates, inflation, political events, investor participation levels, legal and regulatory, accounting, tax and compliance requirements and competition, all of which have an impact on commissions, firm trading, fees from accounts under investment management as well as fees for investment banking services, and investment income as well as on liquidity. Substantial fluctuations can occur in revenue and net income due to these and other factors.

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The Company is focused on growing its private client and asset management businesses through strategic additions of experienced financial advisors in its existing branch system and employment of experienced money management personnel in its asset management business. In addition, the Company is committed to the improvement of its technology capability to support client service and the expansion of its capital markets capabilities while addressing the issue of managing its expenses to better align them with the current investment environment. The Company will continue to nurture the growth of OMHHF as well as its business in non-U.S. markets.

Recent events have caused increased review and scrutiny of the methods utilized by financial service companies to finance their short term requirements for liquidity. The Company utilizes commercial bank loans, securities lending, and repurchase agreements (through overnight, term, and repo-to-maturity transactions) to finance its short term liquidity needs (see "Liquidity"). All repurchase agreements and reverse repurchase agreements are collateralized by short term U.S. Government obligations and U.S. Government Agency obligations. At September 30, 2012, the Company did not have any repo-to-maturity transactions outstanding. In its commodity business, the Company holds all client segregated funds in cash on deposit in commercial bank segregated accounts or in short term securities issued by the U.S. Government.

For a number of years, the Company offered auction rate securities ("ARS") to its clients. A significant portion of the market in ARS 'failed' in 2008. Clients of the Company continue to own a significant amount of ARS in their individual accounts. The absence of a liquid market for these securities presents a significant problem to clients and, as a result, to the Company. It should be noted that this is a failure of liquidity and not a default. These securities in almost all cases have not failed to pay interest or principal when due. These securities are fully collateralized for the most part and, for the most part, remain good credits. The Company did not act as an auction agent for ARS.

The Company has sought, with limited success, financing from a number of sources to try to find a means for all its clients to find liquidity from their ARS holdings and will continue to do so. There can be no assurance that the Company will be successful in finding a liquidity solution for all its clients' ARS holdings. See "Risk Factors - The Company may continue to be adversely affected by the failure of the Auction Rate Securities Market" appearing in Item 1A of the Company's Annual Report on Form 10-K for the year ended December 31, 2011 and "Factors Affecting 'Forward-Looking Statements".

Regulatory and Legal Environment

The brokerage business is subject to regulation by, among others, the Securities and Exchange Commission ("SEC") and FINRA (formerly the NYSE and NASD) in the United States, the Financial Services Authority ("FSA") in the United Kingdom, the Securities and Futures Commission in Hong Kong ("SFC"), the Israeli Securities Authority ("ISA") in Israel and various state securities regulators in the United States. Events in the early 2000's surrounding corporate accounting and other activities leading to investor losses resulted in the enactment of the Sarbanes-Oxley Act and have caused increased regulation of public companies. The resulting regulations and new interpretations and enforcement of existing regulations are creating increased costs of compliance and increased investment in systems and procedures to comply with these more complex and onerous requirements. Increasingly, the various states are imposing their own regulations that make the uniformity of regulation a thing of the past, and make compliance more difficult and more expensive to monitor.

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In July 2010, Congress enacted extensive legislation entitled the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd Frank") in which it mandated that the SEC and other regulators conduct comprehensive studies and issue new regulations to control the activities of financial institutions in order to protect the financial system, the investing public and consumers from issues and failures that occurred in the recent financial crisis. All relevant studies have not yet been completed, but they are widely expected to extensively impact the regulation and practices of financial institutions including the Company. The changes are likely to significantly reduce leverage available to financial institutions and to increase transparency to regulators and investors of risks taken by such institutions. It is impossible to presently predict the nature of such rulemaking, but rules adopted in the U.S. and the United Kingdom will likely create a new regulator for certain activities, regulate and/or prohibit proprietary trading for certain deposit taking institutions, control the amount and timing of compensation to "highly paid" employees, create new regulations around financial transactions with consumers requiring the adoption of a uniform fiduciary standard of care of broker-dealers and investment advisers providing personalized investment advice about securities to retail customers, and increase the disclosures provided to clients, and possibly create a tax on securities transactions. Recently, the SEC postponed indefinitely the planning and implementation of uniform fiduciary standard for broker-dealer activities. If and when enacted, such regulations will likely increase compliance costs and reduce returns earned by financial service providers and intensify compliance overall. It is difficult to predict the nature of the final regulations and their impact on the business of the Company.

Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity Funds (the "Volcker Rule") was published by the U.S. Federal Reserve Board as required by Dodd-Frank in 2011. The Volcker Rule is intended to restrict U.S. banks and other financial institutions that accept deposits from conducting proprietary trading activities, as well as investing in hedge funds and private equity funds for their own account. The intent of the Volcker Rule is to reduce risk to the capital of such institutions through reducing speculation and risk-taking with bank capital. The draft form of the proposed rule was exposed for comment until January 13, 2012 and is scheduled to become effective on July 21, 2014. It seems likely that additional comments will be permitted surrounding the impact of the Volker Rule on market liquidity and importantly on the liquidity of issued sovereign debt in Europe and Asia. While it is widely expected that the impact of the Volcker Rule may significantly impact the liquidity in various capital markets, the effect cannot be predicted with any certainty. The Company believes that the Volcker Rule will not directly affect its operations, but indirect effects cannot be predicted with any certainty. Additionally, the Federal Reserve in conjunction with other U.S regulatory organizations has analyzed the U.S. financial system and the impact that might result from the failure of one or more "Strategically Important Financial Institutions" ("SIFI"). To date, less than 25 such institutions have been identified and will be made subject to special regulations including the requirement to create a plan for their orderly demise in the event of a failure. The identification process has not been completed and is subject to appeal by the affected institutions. The Company has no reason to believe that it will be identified as a SIFI. Recent revelations around the fixing of the LIBOR ("London Interbank Offered Rate") during the period from 2008-2010 make it likely that more regulation surrounding the fixing of interest rates on commercial bank loans and reference rates on derivatives is likely.

The impact of the rules and requirements that were created by the passage of the Patriot Act and the anti-money laundering regulations (AML) in the U.S. and similar laws in other countries that are related thereto have created significant costs of compliance and can be expected to continue to do so.

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Other Regulatory Matters

For several quarters, Oppenheimer has been responding to information requests from the Enforcement Staff of FINRA regarding Oppenheimer's policies and procedures in relation to, and the activities of several financial advisors concerning, the sale of low-priced securities. The Company has responded to numerous document requests and there has been on-the-record testimony given by present and former financial advisors and supervisory personnel who work or worked in several of Oppenheimer's branch offices as well as its New York headquarters in connection with this inquiry.

On June 23, 2011, Oppenheimer received notice of an investigation by the SEC pursuant to which the SEC requested information from the Company regarding the sale of a number of low-priced securities effected primarily through one of Oppenheimer's financial advisors. The Company has responded to numerous document requests and there has been on-the-record testimony given by personnel who work in at least one of Oppenheimer's branch offices as well as its New York headquarters in connection with this inquiry.

Oppenheimer is continuing to cooperate with the investigating entities and will continue to closely monitor the activities of its financial advisors and their supervisors in relation to the sale of low-priced securities.

Since October 2011, Oppenheimer and OAM have been responding to information requests from the SEC and the Attorney General of the Commonwealth of Massachusetts regarding an alleged overvaluation in the fall of 2009 of a single portfolio holding in the Oppenheimer Global Resource Private Equity Fund L.P. ("OGRPE") as well as certain marketing practices associated with OGRPE that occurred during the same time period. Oppenheimer and OAM have responded to document requests and there has been on-the-record testimony given by members of OAM's private equity group as well as supervisory personnel.

On February 24, 2012, Oppenheimer and OAM received notice from the United States Attorney's Office for Massachusetts (Boston, "USAMA") that it intends to seek information from Oppenheimer and OAM regarding the foregoing matters. On March 29, 2012, the USAMA served a subpoena on OGRPE regarding the issues described above.

Oppenheimer, OAM and OGRPE intend to continue to cooperate with the investigating entities.

In February 2010, Oppenheimer finalized settlements with each of the New York Attorney General's office ("NYAG") and the Massachusetts Securities Division ("MSD" and, together with the NYAG, the "Regulators") concluding investigations and administrative proceedings by the Regulators concerning Oppenheimer's marketing and sale of ARS. Pursuant to those settlements and legal settlements, as of September 30, 2012, the Company purchased and holds approximately $79.6 million in ARS from its clients pursuant to several purchase offers and legal settlements. The Company's purchases of ARS from its clients will continue on a periodic basis pursuant to the settlements with the Regulators. In addition, the Company is committed to purchase another $40.5 million in ARS from clients through 2016. See "Legal Proceedings-Auction Rate Securities Matters" herein. The ultimate amount of ARS to be repurchased by the Company cannot be predicted with any certainty and will be impacted by redemptions by issuers and legal and other actions by clients during the relevant period, which cannot be predicted. The Company also held $150,000 in ARS in its proprietary trading account as of September 30, 2012 as a result of the failed auctions in February 2008. These ARS positions primarily represent Auction Rate Preferred Securities issued by closed-end funds and, to a lesser extent, Municipal Auction Rate Securities which are municipal bonds wrapped by municipal bond insurance and Student Loan Auction Rate Securities which are asset-backed securities backed by student loans.

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The Company's clients held at Oppenheimer approximately $231.7 million of ARS at September 30, 2012, exclusive of amounts that (1) were owned by Qualified Institutional Buyers ("QIBs"), (2) were transferred to the Company after February 2008, (3) were purchased by clients after February 2008, or (4) were transferred from the Company to other securities firms after February 2008. Of the $231.7 million of ARS referred to above, the Company has committed to repurchase $45.1 million as a result of legal settlements, resulting in a net number of client assets not subject to a legal settlement repurchase commitment of $186.6 million. See "Risk Factors - The Company may continue to be adversely affected by the failure of the Auction Rate Securities Market" appearing in Item 1A of the Company's Annual Report on Form 10-K for the year ended December 31, 2011 and "Legal Proceedings" herein.

Other Matters

The Company operates in all state jurisdictions in the United States and is thus subject to regulation and enforcement under the laws and regulations of each of these jurisdictions. The Company has been and expects that it will continue to be subject to investigations and some or all of these may result in enforcement proceedings as a result of its business conducted in the various states.

As part of its ongoing business, the Company records reserves for legal expenses, judgments, fines and/or awards attributable to litigation and regulatory matters. In connection therewith, the Company has maintained its legal reserves at levels it believes will resolve outstanding matters, but may increase or decrease such reserves as matters warrant. In accordance with applicable accounting guidance, the Company establishes reserves for litigation and regulatory matters when those matters present loss contingencies that are both probable and reasonably estimable. When loss contingencies are not both probable and reasonably estimable, the Company does not establish reserves. In some of the matters described under "Legal Proceedings", including but not limited to the U.S. Airways matter, loss contingencies are not probable and reasonably estimable in the view of management and, accordingly, reserves have not been established for those matters. See "Legal Proceedings" herein.

Business Continuity

The Company is committed to an on-going investment in its technology and communications infrastructure including extensive business continuity planning and investment. These costs are on-going and the Company believes that current and future costs will exceed historic levels due to business and regulatory requirements. This investment increased in 2008 and 2009 as a result of the January 2008 acquisition of certain businesses from CIBC and the Company's need to build out its platform to accommodate these businesses. The Company made infrastructure investments for technology in 2010 when it built a new data center both to accommodate its existing and future business and to restructure its disaster recovery planning. The recent move to new headquarters will require additional outlays for this purpose although considerable savings will be realized by the availability of independent electric generating capacity for the entire building which will support the Company's infrastructure and occupancy.

In late October 2012, Hurricane Sandy made landfall in the Eastern United States causing widespread business disruption and dislocation as well as substantial damage to five states including in particular New York and New Jersey which has experienced severe flooding and damage to critical infrastructure, municipal transportation, and electric power. The Company occupies two office buildings, including the Company's headquarters, in Zone A in lower Manhattan that were ordered evacuated by order of New York City on Sunday, October 28th. The Company has relocated critical personnel to other Company locations. Many of the Company's employees located throughout the New York metropolitan area have also been affected, as has been their access to their place of work and their personal residence. The events described above are still unfolding and their ultimate effects will not be known for some time and, as a result, the Company cannot estimate how long the relocation will last or when the restoration of critical infrastructure, municipal transportation and electric power will occur. Although the Company believes that the current relocation will allow it to continue to operate its critical business functions, there can be no guarantee that the effects of Hurricane Sandy won't have a significant negative financial impact on the Company.

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The Company's long-term plan is to continue to expand existing offices by hiring experienced professionals as well as through the purchase of operating branch offices from other broker dealers or the opening of new branch offices in attractive locations, thus maximizing the potential of each office and the development of existing trading, investment banking, investment advisory and other activities. Equally important is the search for viable acquisition candidates. As opportunities are presented, it is the long-term intention of the Company to pursue growth by acquisition where a comfortable match can be found in terms of corporate goals and personnel at a price that would provide the Company's stockholders with incremental value. The Company may review potential acquisition opportunities, and will continue to focus its attention on the management of its existing business. In addition, the Company is committed to improving its technology capabilities to support client service and the expansion of its capital markets capabilities.

Results of Operations

The Company reported a net profit of $2.3 million or $0.17 per share for the third quarter of 2012 compared to a net profit of $2.1 million or $0.15 per share in the third quarter of 2011. Revenue for the third quarter of 2012 was $231.8 million compared to revenue of $231.6 million in the third quarter of 2011.

The Company reported a net profit for the nine months ended September 30, 2012 of $87,000 or $0.01 per share compared to a net profit of $6.9 million or $0.51 per share in the same period of 2011. Revenue for the nine months ended September 30, 2012 was $703.2 million, a decrease of 3.6% compared to $729.6 million in the same period of 2011. The results for the nine months ended September, 30 2012 were negatively impacted by costs associated with auction rate securities (litigation costs and valuation adjustments to auction rate securities the Company has purchased or committed to purchase at a future date) of $10.2 million and the New York City real estate consolidation of $6.6 million.

While many of the cash expenses associated with the Company's move to its new headquarters in New York City have been reimbursed by the landlord, the required accounting treatment resulted in a significant negative impact to earnings of $6.7 million for the first nine months of the year. In addition, costs of $10.2 million resulting from the failure of the auction rate securities (ARS) market in 2008 had a significant impact on the first nine months of 2012. The impact arises from valuing ARS previously purchased and those committed to be purchased from clients as well the costs associated with resolving numerous ARS arbitrations that were pending. When the Company makes a decision to resolve these or any other ARS cases, it does so with the intent of resolving them with the least possible risk to the Company and at the lowest cost. The Company resolved four ARS cases in the third quarter of 2012 and twenty-two cases in the first nine months of 2012. These settlements were made at a cost that was substantially less than the amounts claimed in these cases and provides certainty of outcome for the Company. Such costs include both settlement costs, legal costs and liquidity allowances for commitments associated with purchasing ARS from plaintiffs over the next few years.

Client assets entrusted to the Company and under management totaled approximately $77.4 billion while client assets under fee-based programs offered by the asset management groups totaled approximately $21.1 billion at September 30, 2012 ($77.3 billion and $17.7 billion, respectively, at September 30, 2011). Client assets under administration increased by less then 0.1% while assets under fee-based programs increased 19.2% at September 30, 2012 compared to September 30, 2011.

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While uncertainty about the economy persists, including concerns about the looming "fiscal cliff", the likelihood of increased taxes and continuing sovereign debt issues in Europe, the U.S. equity markets continue to perform remarkably well with most barometers hitting their 2007 levels for the first time in five years. High levels of unemployment and the slow recovery in housing has put pressure on consumer confidence and consumer spending. Credit concerns and concerns about a slow-down in the Euro-zone and in China have kept U.S. treasury interest rates at or near their record lows, and while the European Central Bank has committed to save the Euro and to take all necessary action, the lack of concrete plans continues to impact investor sentiment and forced the U.S. Federal Reserve to launch its third campaign of quantitative easing, and to extend the period of record low short term interest rates through the end of 2015. This consistent drumbeat of news held down investor activity and held down Oppenheimer's revenues during the third quarter and this impact on revenue, combined with ongoing costs associated with litigation is reflected in the low operating results during the third quarter.

The Company derives most of its revenue from the operations of its principal subsidiaries, Oppenheimer and OAM. Although separate legal entities, the operations of the Company's brokerage subsidiaries both in the U.S. and other countries are closely related because Oppenheimer acts as clearing broker and omnibus clearing agent in transactions initiated by these subsidiaries. Except as expressly otherwise stated, the discussion below pertains to the operations of Oppenheimer.

The following table and discussion summarizes the changes in the major revenue and expense categories for the three and nine months ended September 30, 2012 compared to the same period in 2011.

Amounts are expressed in thousands of dollars.

                                                Three months ended                   Nine months ended
                                                September 30, 2012                  September 30, 2012
                                           Period to                           Period to
                                            period           Percentage          period          Percentage
                                            change             change            change            change
Revenue -
Commissions                               $    (9,843 )             -8.0 %     $  (29,425 )             -7.7 %
Principal transactions, net                     6,139               74.6 %          7,850               24.1 %
Interest                                         (338 )             -2.2 %         (1,137 )             -2.6 %
Investment banking                             (7,610 )            -26.1 %        (24,710 )            -27.0 %
. . .
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