GFI Group 10-K 2008
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Commission file number: 000-51103
GFI Group Inc.
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of large accelerated filer, accelerated filer, and small reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
As of June 30, 2007, the aggregate market value of the registrant's common stock held by non-affiliates of the registrant was $2,120,873,157 based upon the closing sale price of $72.48 as reported on the Nasdaq Global Select Market.
Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.
Portions of registrant's definitive proxy statement for its annual shareholders' meeting to be held on June 11, 2008 are incorporated by reference in this Annual Report on Form 10-K in response to Part III, Items 10, 11, 12, 13 and 14.
This Annual Report on Form 10-K contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain the words "believe," "anticipate," "expect," "estimate," "intend," "project," "will be," "will likely continue," "will likely result," or words or phrases of similar meaning. These forward-looking statements are based largely on the expectations of management and are subject to a number of risks and uncertainties including, but not limited to, the following:
The foregoing risks and uncertainties, as well as those risks discussed under the headings "Part II-Item 7Managements Discussion and Analysis of Financial Condition and Results of Operation" and "Part II-Item 7AQuantitative and Qualitative Disclosures About Market Risk" and elsewhere is this Annual Report on Form 10-K, may cause actual results to differ materially from the forward-looking statements. The information included herein is given as of the filing date of this Annual Report on Form 10-K with the Securities Exchange Commission (the "SEC") and future events or circumstances could differ significantly from these forward-looking statements. The Company does not undertake to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
ITEM 1. BUSINESS
We are a leading global inter-dealer broker specializing in over-the-counter ("OTC") derivatives products and related securities. We founded our business in 1987 and were incorporated under the laws of the State of Delaware in 2001 to be a holding company for our subsidiaries. We provide brokerage services and data and analytics products to institutional clients in markets for a range of credit, financial, equity and commodity instruments. We function as an intermediary on behalf of our brokerage clients by matching their trading needs with counterparties having reciprocal interests. We focus primarily on the more complex, and often less commoditized, markets for sophisticated financial instruments, primarily OTC derivatives, that offer an opportunity for strong growth and higher commissions per transaction than the markets for more standardized financial instruments. We have been recognized by various industry publications as a leading provider of inter-dealer brokerage services for certain products in the credit, financial, equity and commodity markets on which we focus.
We offer our clients a hybrid brokerage approach, combining a range of telephonic and electronic trade execution services, depending on the needs of the individual markets. We complement our hybrid brokerage capabilities with decision support services, such as value-added data and analytics products, and post-transaction services, such as straight-through processing ("STP") and transaction confirmations. We earn revenues for our brokerage services and charge fees for certain of our data and analytics products.
At December 31, 2007, we employed 1,037 brokerage personnel (consisting of 880 brokers and 157 trainees and clerks) serving over 2,200 brokerage and data and analytics clients, including leading commercial and investment banks, corporations, insurance companies and hedge funds, through our principal offices in New York, London, Paris, Singapore, Seoul, Tokyo, Hong Kong, Sydney, Cape Town, Calgary, Sugar Land (TX) and Englewood (NJ).
Based on the nature of our operations in each geographic region, our products and services, production process, customers and regulatory environment, we concluded that we have three operating segments: North America Brokerage, Europe Brokerage and Asia Brokerage. Our brokerage operations provide brokerage services in four broad product categories: credit, financial, equity and commodity. We aggregated our operating segments into two reportable segments: Brokerage and "All Other". The Brokerage segment includes operations from North America and Europe. The All Other segment captures costs that are not directly assignable to one of the operating business segments, primarily consisting of our corporate business activities and operations from analytics and market data. In addition, the All Other segment includes our Asia-Pacific brokerage operations. See Note 19 to the Consolidated Financial Statements for further information on our revenues by segment and geographic region.
Website Access to Reports
Our Internet website address is www.gfigroup.com. Through our Internet website, we make available, free of charge, the following reports as soon as reasonably practicable after electronically filing them with, or furnishing them to, the SEC: our Annual Reports on Form 10-K; our Quarterly Reports on Form 10-Q; and our Current Reports on Form 8-K; our proxy statements on Schedule 14A, Forms 3, 4 and 5 filed on behalf of directors and executive officers; and amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934, as amended (the "Exchange Act").
In addition, you may read and copy any materials that we file with the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, DC 20549. You also may obtain information on
the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site that contains our reports, proxy and information statements, and other information regarding the Company that we file electronically with the SEC at http://www.sec.gov.
Information relating to corporate governance of the Company is also available on our website, including information concerning our directors, board committees and committee charters, our Code of Business Conduct and Ethics for all employees and for senior financial officers and our compliance procedures for accounting and auditing matters. In addition, the Investor Relations page of our website includes supplemental financial information that we make available from time to time.
Our Internet website and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K.
On most business days, trillions of dollars in securities, commodities, currencies and derivative instruments are traded around the world. These products range from standardized financial instruments, such as common equity securities and futures contracts, that are typically traded on exchanges, to more complex, less standardized instruments, such as OTC derivatives, that are typically traded between institutional dealers, which are primarily global investment and money center banks and hedge funds. Buyers and sellers of exchange-traded financial instruments benefit from the price transparency and enhanced liquidity provided by liquidity facilitators, such as market makers and specialists, who participate in those markets. Buyers and sellers of many OTC instruments, on the other hand, frequently rely on an inter-dealer broker to facilitate liquidity by gathering pricing information and identifying counterparties with reciprocal interests.
We define a liquid financial market as one in which a financial instrument is easy to buy or sell quickly with minimal price disturbance. The liquidity of a market for a particular financial product or instrument depends on several factors, including: the presence of a number of market participants and facilitators of liquidity, the availability of pricing reference data, and the availability of standardized terms. Liquid markets are characterized by substantial price competition, efficient execution and high trading volume. While a market for an exchange-traded instrument is ordinarily liquid, some large OTC markets, such as the market for U.S. treasury securities, are also highly liquid. In such liquid, OTC markets, commissions are generally lower because there are often numerous, readily identifiable buyers and sellers causing the traditional telephonic brokerage services of inter-dealer brokers to be less essential and to command less of a premium.
Complex financial instruments that are traded OTC are often less commoditized and are traded primarily by more sophisticated institutional buyers and sellers. In these markets, an inter-dealer broker can provide greater value to the efficient execution of a trade by applying its market knowledge to locate a number of bids and offers so that buyers and sellers may find counterparties with which to trade, which can be especially helpful for large or non-standardized transactions. An inter-dealer broker ordinarily accomplishes this by contacting potential counterparties directly by telephone or electronic messaging and, in an increasing number of cases, market participants post prices and may execute transactions via proprietary trading technology provided by the inter-dealer broker. In addition, in a less liquid market with fewer participants, disclosure of the intention of a participant to buy or sell could disrupt the market and lead to poor pricing. By using an inter-dealer broker, the identities of the transaction parties are not disclosed in many transactions until the trade is consummated and, therefore, market participants better preserve their anonymity. For all these reasons, in a less commoditized market, an inter-dealer broker can offer important value to market participants.
As a market for a particular financial instrument develops and matures, more buyers and sellers enter the market, generally resulting in more transactions and more pricing information. In addition,
the terms of such financial instruments tend to become more standardized, generally resulting in a more highly-liquid market. In this way, a relatively illiquid market for an instrument may evolve over a period of time into a more highly-liquid market. As this evolution occurs, the characteristics of trading, the preferred mode of execution and the size of commissions that inter-dealer brokers charge, may also change. In some cases, as the market matures, an inter-dealer broker may provide a client with an electronic screen or system that displays the most current pricing information. In addition, a market may have some characteristics of both more liquid and less liquid markets, which requires an inter-dealer broker to offer integrated telephonic and electronic brokering. We refer to this integrated service as hybrid brokerage. In some cases, hybrid brokerage involves coupling traditional telephonic brokerage-services with various electronic enhancements, such as electronic communications, price discovery tools and order entry. In other cases, hybrid brokerage involves full electronic execution supported by telephonic communication between the broker and their clients.
The Derivatives Market
Derivatives are increasingly being used by financial institutions, hedge funds and large corporations to manage risk or take advantage of an anticipated direction of a market by allowing holders to guard against gains or declines in the price of underlying financial assets, indices or other investments without having to buy or sell such underlying assets, indices or other investments. The underlying asset, index or other investment may be, among other things, a physical commodity, an interest rate, a stock, an index or a currency. Derivatives are commonly used to mitigate the risks associated with interest rate movements, equity ownership, changes in the value of foreign currency, credit defaults by large corporate and sovereign debtors and changes in the prices of commodity products. Common types of derivatives include futures, options and swaps. They derive their value based on the inherent value of the underlying asset.
Derivatives are traded both OTC and on exchanges. According to a recent report of the Bank for International Settlements, OTC derivatives accounted for over 84% of the total outstanding global derivatives transactions as of June 2007 (as measured by notional amount). The liquidity of markets for particular OTC derivative instruments varies from highly liquid, such as the market for Eurodollar interest rate derivatives, to illiquid, such as the market for certain customized credit derivatives which are structured to meet specific investor needs.
The International Swaps and Derivative Association, Inc. ("ISDA") also reported in a recent survey of its members that in the first half of 2007, among the derivative instruments surveyed, credit derivatives were the fastest growing segment of the derivatives market with notional amounts outstanding growing 32% over that six month period. The survey stated that at mid-year 2007, notional amounts outstanding of credit derivatives grew to approximately $45.5 trillion from approximately $26.0 trillion at mid-year 2006. This increase represented period-over-period growth of approximately 75.0%. Although several exchanges launched exchange-traded credit derivative products in 2007, credit derivatives are currently traded almost entirely in OTC transactions, either directly or through inter-dealer brokers and other financial institutions.
Furthermore, the number of different derivative instruments is growing as companies and financial institutions develop new and innovative derivative instruments to meet industry demands for sophisticated risk management and complex financial arbitrage. In its 2007 annual survey, Risk magazine identified 119 categories of derivatives, excluding commodity derivatives. Novel derivative instruments often have distinct terms and little or no trading history with which to estimate a price. Markets for new derivative instruments therefore require market intelligence and the services of highly skilled and well-informed brokers and reliable market data and pricing tools.
An example of more novel, OTC derivative instruments would be credit default swaps on leveraged loans ("Loan CDS"). These instruments allow investors to take or offset the risk of default on senior secured debt of non-investment grade companies. The advent of the Loan CDS market is an
example of how the overall credit derivatives market is expanding to different areas of the credit spectrum. Another example of an innovative and complex OTC derivative instrument is carbon emissions options, which allow trading houses and other market participants to take or offset their exposure in the fast growing European market for carbon dioxide emissions allowances under the European Union Emissions Trading Scheme, or ETS. The ETS permits European-based companies that exceed individual carbon dioxide emissions targets to purchase emissions allowances from other companies that emit less than their emissions targets.
Our Market Opportunity
We believe the markets for financial instruments, especially the markets for derivative instruments, present us with the following opportunities to provide value to our clients:
Need for efficient execution in both liquid and less liquid markets. While the use of execution technology is becoming more common in the inter-dealer brokerage industry, only certain highly liquid and standardized financial instruments may be fully traded electronically in an efficient manner. More complex OTC products, such as derivatives, typically require telephonic brokerage to provide market intelligence to clients and to aid the execution process. We believe that inter-dealer brokers who provide a combination of telephonic and electronic brokerage services are better positioned to meet the particular needs of the markets in which they operate than competitors that cannot offer this combination of services.
Need for expertise in the development of new markets. In order to better support their clients' evolving investment and risk management strategies, our dealer clients create new products, including new derivative instruments. Dealers also modify their trading techniques in order to better support their clients' needs, such as by integrating the trading of derivative instruments with the trading of related underlying or correlated financial assets, indices or other investments. We believe the markets for these new products and trading techniques create an opportunity for those inter-dealer brokers who, through market knowledge and extensive client relationships, are able to identify these new product opportunities and to focus their brokerage services appropriately.
Need for market intelligence. Inter-dealer brokers that execute a higher volume of trades of a particular financial product and have access to more market participants are better positioned to provide valuable pricing information than brokers who less frequently serve that market. In less commoditized financial markets, including markets for novel and complex financial instruments, market leadership becomes more important because reliable pricing information is difficult to obtain. Market participants in these less liquid markets utilize the services of the leading inter-dealer brokers in order to gain access to the most bids and offers for a particular product. Similarly, inter-dealer brokers who have a leading market share can offer superior market data and analytics tools based on their access to the broadest selection of transaction and pricing information. For example, some market participants pursue trading strategies that combine credit default swaps with convertible bonds or equity derivatives of the securities of a single issuer or a basket of issuers. Inter-dealer brokers that have high volumes of bids and offers in the credit derivative markets and have access to technology which allows them to track such market data against activity in the bond and equity markets are well positioned to provide such market participants with analytical insight into correlated movements in related securities of a single issuer or related issuers or indexes.
Increasing industry consolidation. Historically, the inter-dealer brokerage industry consisted of a number of small and mid-sized private firms that used traditional telephonic brokerage methods to serve their clients and to compete against each other in various product categories. The industry has begun to consolidate in recent years, in part, due to the increasing importance of technology, including electronic execution, integrated trade processing and analytics and market data. Through acquisitions, larger inter-dealer brokers with access to capital have been better positioned to make the investments
necessary to supply their clients with this technology. We believe that inter-dealer brokers with developed technology resources which enhance brokerage execution and pre-and post-trade analysis and processing are better able to consistently meet the execution needs of their clients and recruit and retain the most capable brokers. As a result of these trends, smaller inter-dealer brokers may find it harder to compete and several have been acquired by larger inter-dealer brokers with developed technological capabilities and better access to capital. We believe that the continued consolidation of the industry provides an opportunity for these larger inter-dealer brokers to strategically expand their businesses to better serve evolving client demands.
Our Competitive Strengths
We believe our principal competitive strengths are the following.
Strong Brand and Leading Position in Key Markets. We believe that over our twenty year history, we have successfully created value in our brand that our clients associate with high quality services in the markets on which we focus. Our leadership in these markets, such as the markets for certain credit and equity derivatives, foreign exchange options and commodity products, has been recognized by rankings in industry publications such as Risk magazine, FX Week and Energy Risk magazine. In an annual survey of dealers and brokers conducted by Risk magazine, we have been ranked as the leading broker in more categories of credit derivatives than any other inter-dealer broker over the last nine years. In its 2007 annual survey, Risk magazine also ranked us as a leading broker in credit default swaps and numerous currency and equity derivative markets. Energy Risk magazine also listed GFI as #1 Energy Broker in 2007. In addition, GFI's Fenics® FX option analysis product is a leading analytic tool in the foreign exchange markets, and our electronic trading platforms, Creditmatch® and GFI ForexMatch, were also recognized for excellence by Financial News and FX Week, respectively.
We believe our leading positions in these markets provide us with greater access to market and pricing information, including a broad selection of proprietary market data that we are able to provide to our clients. In addition, we believe that our leading market share in key OTC markets, such as credit derivatives, and our ability to use technology to track such market data, enables us to provide market participants with better analytical insight into correlated movements in related securities of a single issuer, related issuers or indexes in the credit derivative, bond and equity markets. In addition, we believe that, because of these leading market positions and differentiated technological capabilities, we are better positioned, compared to many of our inter-dealer competitors, to serve the growing needs of clients who are pursuing sophisticated capital structure arbitrage strategies and correlation-based trading.
Ability to Identify and Develop High Growth, Less Commoditized Markets. We focus primarily on complex and innovative financial markets where liquidity is harder to achieve and, therefore, our services are more valuable to market participants. We believe these markets offer an opportunity for growth to inter-dealer brokers that move early to foster liquidity. We seek to anticipate the development and growth of markets for evolving, innovative financial products in which we believe we can garner a leading market position and enjoy higher commissions. For example, we entered the credit derivatives market in 1996 at a time when we believed the market showed promise but had only modest activity. According to the British Bankers' Association, the size of the global credit derivatives market was only $180 billion in 1997 (measured by notional amount outstanding). According to ISDA, notional amounts outstanding of credit derivatives have grown to $45.5 trillion at mid-year 2007, a compounded annual growth rate of over 79% for that nine and a half year period. We believe our familiarity with the needs of such rapidly growing markets and our experience with complex product structures allow us to better serve clients in high-growth, less liquid markets than many of our competitors.
Hybrid Brokerage Platforms. We seek to tailor our use of electronic trading and other technology to the transactional nuances of each specific market. While the more complex, less commoditized
markets on which we focus often require significant amounts of personal and attentive service from our brokers, some of our other markets may benefit from the introduction of electronic brokerage platforms. Depending on the needs of the individual markets, we offer a hybrid approach to our clients that combines a range of electronic and telephonic trade execution services. For example, our clients may choose between utilizing our CreditMatch®, GFI ForexMatch or EnergyMatch® electronic trading platforms to trade a range of credit derivatives, foreign exchange options or emission allowances entirely on screen or executing the same transaction over the telephone through our brokers. We also believe we add value for clients who trade in complex financial markets by offering data and Fenics® analytics products for decision support. We seek to establish data communication and STP connections with our clients' settlement, risk management and compliance operations in order to better serve their needs and to strengthen our relationships with them. STP generally involves the use of technology to automate the processing of financial transactions, from execution to settlement, in order to minimize human error, reduce operational costs and time, and enhance transaction information and reporting. We believe our hybrid brokerage approach provides us with a competitive advantage over competitors who do not offer this technology.
On January 31, 2008, we acquired Trayport Limited ("Trayport"), a provider of electronic trading software and services to the commodities, fixed income, currencies and equities markets. Trayport's GlobalVision products have an industry leading position in supplying software to the European OTC energy markets including electric power, natural gas, coal, emissions and freight. Its technology accommodates electronic trading, information sharing and STP capabilities in commodity and financial instruments. The acquisition of Trayport, with its leading position in the European OTC energy markets and its trading and processing capabilities further enhances our hybrid brokerage model.
Quality Data and Analytics Products. We are one of the few inter-dealer brokers that offer a broad array of data and analytics products to participants in the complex financial markets in which we specialize. Our data products are derived from the trade data compiled from our brokerage services in our key markets. Our analytics products benefit from the reputation of the Fenics® brand for reliability, ease of use and independence from any large dealer. Our Fenics® tools are used, not only by our traditional brokerage clients, but also by their clients, such as national and regional financial institutions and large corporations worldwide. These products are designed to serve the needs of certain markets for reliable data and trusted analytics tools and are leveraged to enhance our brokerage revenues across market products. We believe that our ability to offer these products helps to support our leadership in our key markets.
Experienced Senior Management and Skilled Brokers and Technology Developers. We have a senior management team that is experienced in identifying and exploiting markets for evolving, innovative financial instruments. Our founder and chief executive officer, Michael Gooch, has over 20 years of experience in the derivatives markets and our president, Colin Heffron, has been with our Company since 1988 and, prior to becoming our president, was instrumental in developing a number of brokerage desks and leading the growth of our European operations. Reporting to them is an experienced management team that includes senior market specialists in each of our product categories. We also employed 880 skilled and specialized brokers at December 31, 2007, many of whom have extensive product and industry experience. Although the competition for brokers is intense, we have historically experienced relatively low broker turnover, and have been able to effectively hire new brokers and establish new brokerage desks in areas in which we seek to expand our operations. In addition, our in-house technology developers are experienced at developing electronic trading platforms and commercial quality software that are tailored to the needs of certain select markets in which we focus. Our brokers utilize this technology and market information to provide their clients with enhanced services. We believe that the combination of our experienced senior management, skilled brokers and technology developers gives us a competitive advantage in executing our business strategy.
Diverse Product and Service Offerings. We offer our products and services in a diverse array of financial markets and geographic regions. Historically, the markets on which we focus have volume and revenue cycles that are relatively distinct from each other and have generally not been correlated to the direction of broad equity indices. Further, our decision support products, including our market data and analytical tools, give us an opportunity to leverage and expand our client base, providing revenue sources beyond our traditional brokerage clients. We believe our diverse product and service offerings provide us with a competitive advantage over many of our competitors that may have more limited product and service offerings and, therefore, may be more susceptible to downturns in a particular market or geographic region.
We intend to continue to grow our business and increase our profitability by being a leading provider of brokerage services and data and analytics to the markets on which we focus. We intend to employ the following strategies to achieve our goals.
Maintain and enhance our leading positions in key markets. We plan to continue leveraging the leading market share and brand recognition that we have developed for a range of derivative instruments and underlying securities in growing credit, financial, equity and commodity markets. We will continue deploying our specialized brokers in higher-margin, OTC markets, such as credit derivatives, and will seek to improve their productivity through technological innovation, such as state of the art electronic brokerage platforms. We intend to provide market participants with analytical insight into correlated movements in related securities of a single issuer or related issuers or indexes in the credit derivative, corporate bond and equity markets. We also intend to continue offering quality data and analytics products in certain select markets requiring reliable decision-support tools. Through these means, we seek to enhance our services in existing markets and deepen long-standing relationships with our global institutional clients.
Leverage Technology and infrastructure to gain market share and improve margins. We intend to continue to invest in the use and development of technology, including the development of proprietary electronic trading platforms, to further enhance broker productivity, increase customer and broker loyalty and improve our competitive position and market share. During 2007, we continued to see substantial growth in the use of our CreditMatch® electronic trading platform in Europe in both credit derivatives and cash bonds. In addition, we launched GFI ForexMatch, a browser-based electronic platform for foreign exchange products. We have also recently introduced EnergyMatch® to our emissions business of our Amerex subsidiary. We believe that as the usage of these systems becomes more widespread, we will be able to increase broker productivity and market share. Moreover, where possible, we plan to continue to install STP connections with our clients' settlement, risk management and compliance operations, in order to better serve their needs and to provide us with additional opportunities to increase our revenue. At the same time, we continue to work on ways to improve our ability to leverage our operations, infrastructure and other support areas, such as our executive and finance departments, to create cost efficiencies and improve margins.
Continue to identify and develop new products and high-growth markets. We increased our number of brokerage personnel by 105 employees to 1,037 employees at December 31, 2007 from 932 employees at December 31, 2006. Many of these recent hires are for the less commoditized, newer high-growth markets in which we specialize or cover markets that are complementary to those markets. It is often our practice to establish new brokerage desks through the strategic redeployment of experienced brokers from established brokerage desks and through the selective hiring of new brokers or trainees. Individual brokerage desks are separately tracked and monitored in an effort to drive performance. We will continue to focus on identifying high growth markets where liquidity is more valuable, thereby yielding early-mover opportunities. We also intend to continue to expand our presence globally in markets where we believe there are opportunities to increase our revenues. As part of this effort, we
commenced operations in Seoul, Cape Town and Calgary in 2007 and expect to begin operations in Israel, Ireland and Dubai in 2008.
Continue to pursue new customers and diverse revenue opportunities. We offer our products and services in a diverse range of financial markets and geographic regions and to hundreds of institutional customers. We believe this diversity will likely lessen the impact to us of a downturn in any particular market or geographic region. We will look to expand our customer base as an increasing number of sophisticated market participants, such as large hedge funds, look to participate in wholesale markets for the execution of derivative transactions. We also intend to continue managing our business with the goal of maintaining the diversity of our revenues. On a geographic basis, approximately 48% of our total revenues for the year ended December 31, 2007 were generated by our European operations, 42% was generated by our North American operations and 10% was generated by our operations in the Asia-Pacific region. Additionally, for the year ended December 31, 2007, no one customer accounted for more than approximately 6% of our total revenues from all products, services and regions, and our largest brokerage desk accounted for approximately 7% of total revenues.
Strategically expand our operations through business acquisitions. Historically, the inter-dealer brokerage industry was fragmented and concentrated mainly on specific country or regional specific marketplaces and discrete product sets, such as foreign exchange or energy products. Over time, however, the industry has experienced increasing consolidation as larger inter-dealer brokers have sought to enhance their global brokerage services and offset client commission pressure in maturing product categories by acquiring smaller competitors that specialized in specific product markets. In addition, some inter-dealer brokers have acquired technology focused companies which enhance brokerage execution and pre- and post- trade analysis and processing. We plan to continue to selectively seek opportunities to expand our use of technology and grow our business in new or existing product areas through the acquisition of complementary businesses.
In 2007, we acquired Century Chartering (UK) Limited, a small dry physical freight broker, and purchased a 33% interest in Brains Inc. Limited ("Brains"), a niche credit broker. We have an option to buy the remaining shares of Brains over a five year period. We also acquired a 9.25% percent stake in A.C.M. Shipping Limited, a London-based ship broker with which we have a joint venture in brokering wet freight derivatives. These three investments complemented our existing businesses and strengthened our positions in specific markets.
On January 31, 2008, we acquired Trayport, a provider of electronic trading software to brokers, exchanges and trading firms in the commodities, fixed income, currencies and equities markets, with particular strength in European OTC energy derivatives. This acquisition strengthened our electronic trading capabilities and bolsters our position in global energy derivatives.
Our Market Focus
Our brokerage operations focus on a wide variety of credit, financial, equity and commodity instruments around the world. Within these markets, we focus on the more complex, less commoditized markets for sophisticated financial instruments, primarily OTC derivatives. OTC derivatives are generally structured as forwards, swaps or options. A forward is an agreement between two parties to exchange assets or cash flows at a specified future date at a price agreed on the trade date. A swap is an agreement between two parties to exchange cash flows or other assets or liabilities at specified payment dates during the agreed-upon life of the contract. An option is an agreement that gives the buyer the right, but not the obligation, to buy or sell a specified amount of an underlying asset or security at an agreed upon price on, or until, the expiration of the contract. We also support and enhance our brokerage operations by providing electronic trading platforms and STP connections where applicable.
We provide brokerage services to our clients through agency or principal transactions. In agency transactions, we charge a commission for connecting buyers and sellers and assisting in the negotiation of the price and other material terms of the transaction. After all material terms of a transaction are agreed upon, we identify the buyer and seller to each other and they then settle the trade directly. Commissions charged to our clients in agency transactions vary across the products for which we provide brokerage services.
We generate revenue from principal transactions on the spread between the buy and sell price of the security that is brokered. Our principal transactions revenue is primarily derived from matched principal transactions. In matched principal transactions, we act as a "middleman" by serving as counterparty for an identified buyer and an identified seller in matching reciprocal back-to-back trades. These transactions are then settled through clearing institutions with which we have a contractual relationship. Because the buyer and seller each settle their transactions through us rather than with each other, the parties are able to maintain their anonymity. A limited number of our brokerage desks are allowed to enter into unmatched principal transactions for the purpose of facilitating a customer's execution needs for transactions initiated by such customers or to add liquidity to certain illiquid markets. These unmatched positions are intended to be held short term.
Credit Products. We provide brokerage services in a broad range of credit derivatives, bond instruments and other related credit products. The most common credit derivative, a credit default swap, was developed by global banks during the early 1990s. A credit default swap is essentially like an insurance contract, in which the insured party pays a periodic premium until the contract expires or a credit event occurs. In return for this premium, the contract seller makes a payment to the buyer if there is a credit default or other specified credit event with respect to the issuer of the underlying credit instrument referenced in the credit default swap. The credit default swap market has evolved from trading simple single-entity credit default swaps to a range of customized product structures and index products, allowing investors greater flexibility in tailoring credit positions that correspond to their desired risk level. Credit derivatives have also expanded from the corporate and sovereign bond instruments to various other credit instruments such as asset backed securities and loans, allowing investors a broader range of credit protection.
Our offices in New York, London, Sydney, Hong Kong, Singapore and Tokyo each provide brokerage services in a broad range of credit derivative products that include single-entity credit default swaps, emerging market credit default swaps, credit indices, options on single-entity credit default swaps, options on credit indices and credit index tranches. We also provide brokerage services in markets for a range of non-derivative credit instruments, such as investment grade corporate bonds, high yield corporate bonds, emerging market Eurobonds, bank capital preferred shares, asset-backed bonds and floating rate notes. Our presence in corporate bonds and equities allows us to compile data on a single issuer from each of the bond, equity and credit derivative markets and to provide investors with analytical insight into a single issuer or related issuers.
We support our credit brokerage with CreditMatch®, our electronic trading platform that provides trading, trade processing and STP functionality to our clients. Consistent with our hybrid brokerage model, clients may choose between utilizing CreditMatch® to trade certain credit derivative products entirely on screen or executing the same transaction over the telephone through our brokers. In Europe, our clients are increasingly using CreditMatch® to trade credit derivatives products while our clients in North America still primarily prefer to execute transactions telephonically through our brokers.
As part of our efforts to enhance our services in our key markets, we have agreed to jointly develop new clearing services for OTC derivative products with The Clearing Corporation, a clearinghouse for derivative instruments in which we hold a minority ownership interest. In 2007, The Clearing Corporation announced the completion of a corporate restructuring and the expectation that
the reconstituted Clearing Corporation will provide a centralized clearing facility for a number of OTC derivatives products, including credit defaults swaps. We believe this investment will complement our hybrid electronic brokerage platforms and STP capabilities. Ultimately, we anticipate that centralized clearing will further expand the market for OTC derivative products through added settlement efficiency and reliability.
Financial Products. We provide brokerage services in a range of financial instruments, including foreign exchange options, exotic options, interest rate swaps and options, repurchase agreements and certain government and municipal bond options. Exotic options include non-standard options on baskets of foreign currencies, forward contracts and non-deliverable forward contracts, which are forward contracts that do not require physical delivery of the underlying asset.
For these products, we offer telephonic brokerage services in our New York, London, Hong Kong, Singapore and Sydney offices, augmented in select markets with our GFI ForexMatch trading platform. We also offer a STP capability that automatically reports completed telephonic and electronic transactions directly to our clients' position-keeping systems and provides position updates for currency option trades executed through GFI's worldwide brokerage desks
Our New York office focuses on providing brokerage services for foreign exchange option trading among the U.S. Dollar, the Japanese Yen and the Euro, which are referred to as the G3 currencies, as well as foreign exchange options, forward contracts and non-deliverable forward contracts and interest rate swaps for certain U.S., Canadian and Latin American currencies. Our New York office also offers bond options, swap options and corporate and emerging market repo brokerage services. Our London office also covers foreign exchange option trading in the G3 currencies along with nearly all European cross currencies, including the Russian Ruble and Eastern European currencies, for which we provide brokerage services for forwards and non-deliverable forwards. In addition, our London office offers European and corporate repo, currency basis, dollar swaps and interest rate saps and options. Our brokers in Singapore, Hong Kong and Seoul provide brokerage services for foreign exchange currency options, non-deliverable forwards and interest rate swaps for regional and G3 currencies, while foreign exchange currency options are also brokered out of Sydney.
Equity Products. We provide brokerage services in a range of cash-based and derivative equity products, including U.S. domestic equity, international equity, equity derivatives, Global Depositary Receipts ("GDRs") and American Depositary Receipt ("ADRs") stocks and equity derivatives based on indices, stocks or customized stock structures. We offer telephonic equity brokerage services from our brokerage desks in New York, London, Paris, Hong Kong, Tokyo and Sydney and, where appropriate, our electronic trading platforms. Through our various offices we broker trades in the OTC market as well as certain exchange-traded securities.
Our New York office provides brokerage services in single stock cash equities, single stock options, index options, sector options, equity default swaps, variance swaps, total return swaps, convertible bonds and ADRs. Our London office provides brokerage services in equity index options, single stock options, GDRs, Pan-European equities, Japanese equity derivatives and structured equities. Our Paris office provides brokerage in Pan-European equities, structured equities, single stock and equity index options and financial futures. Our Hong Kong, Tokyo and Sydney offices provide a varying degree of brokerage services in equity index and single stock options, while the Hong Kong office also provides brokerage services in ADRs and GDRs.
In addition, through Christopher Street Capital Equities, a division of GFI Securities Limited, we operate a research driven brokerage business providing independent equity research that is focused on the relationship between the credit and equity markets. Our research analyzes the relationship between the credit default swap and equity markets using our historic credit default swap data. Christopher Street Capital focuses, in particular, on situations where credit default swap spreads and equity prices diverge outside their normal inverse relationship.
Commodity Products. We provide brokerage services in a wide range of cash-based and derivative commodity and energy products, including oil, natural gas, biofuel, electricity, wet and dry freight derivatives, dry physical freight, precious metals, coal, weather derivatives, property derivatives and emissions.
On February 1, 2008, GFI announced the acquisition of Trayport, a provider of electronic trading software and services to the commodities, fixed income, currencies and equities markets. Trayport's GlobalVision platform has an industry leading position in supplying software to the European OTC energy markets including electric power, natural gas, coal, emissions and freight. The GlobalVision platform accommodates electronic trading, information sharing and STP capabilities in commodity and financial instruments. The acquisition of Trayport with its leading position in the European OTC energy markets strengthens our global position in commodity products. In London, our telephonic brokerage capabilities are augmented with electronic brokerage capabilities we license from Trayport.
From our New York area offices, we provide brokerage services in natural gas, oil and petroleum products, electricity and weather derivatives. In addition, as a result of our October 2006 acquisition of the North American operations of Amerex, based in Sugar Land, Texas, we provide brokerage services for natural gas basis, natural gas daily, natural gas options, east power, east short term power, west power, west short term power, ERCOT, environmental commodities and retail energy management. From our Calgary office, which opened in December 2007, we broker U.S. and Canadian natural gas. Our London office provides energy product brokerage services in many European national markets, including for electricity, coal and emissions. The London office also provides brokerage services in property derivatives, dry freight derivatives, dry physical freight, and through a partnership with A.C.M. Shipping Limited, wet freight derivatives. Our Singapore office brokers dry freight derivatives, dry physical freight, and, through a joint venture with Spectron Group, crude oil, fuel oil and distillates. From brokerage desks in New York, London and Sydney, we also serve the global precious metal markets with brokerage in spot, forward, swap and options contracts focusing on gold, silver, platinum and palladium.
In 2007, we launched EnergyMatch®, an electronic trading platform for OTC energy derivatives. EnergyMatch® currently carries sulfur dioxide and nitrogen oxide emission contracts, brokered by our Amerex operations. We intend to add other emission types and energy contracts in the future. We are also a member of ConfirmHub, LLC, a company that has developed a system for electronic trade confirmations for the North American energy markets. Through this membership, we and other members of ConfirmHub are able to offer electronic trade confirmations through a single secure connection in a standard format. Over fifty large energy trading companies currently subscribe to ConfirmHub.
Through collaboration with certain divisions of CB Richard Ellis Group Inc., we provide and continue to develop brokerage services in European and U.S. property derivatives. Property derivatives allow companies and other investors to hedge or speculate on the value of real estate, as measured by an industry index, without buying or selling actual properties. The collaboration in the U.K. is now a leader in the growing property derivatives market. In addition, through a joint venture with Colliers International, we provide brokerage services in Hong Kong property derivatives. Transactions typically take the form of a total return swap, exchanging the property return for a currency interest rate plus a fixed spread.
Through a joint venture with A.C.M. Shipping Limited, we offer hybrid telephonic and electronic brokerage of wet freight derivatives in London, Singapore and New York. Wet freight derivatives allow oil companies, ship owners and other users of wet freight cargo capacity to better manage volatile shipping costs for their products by effectively locking in the cost of shipping future product.
Data and Analytics. In selected markets, we license market data and analytics products that are used to build pricing models, develop trading strategies and to manage, price and revalue derivative portfolios. These products are sold on a subscription basis through a dedicated sales team.
We provide market data in the following product areas: foreign exchange options, credit derivatives, European repurchase agreements, emerging market bonds and European and North American energy. We make our data available through a number of channels including streaming web portals, file transfer protocol downloads, Fenics analytical tools and data vendors, such as Reuters, Bloomberg, Quick and Comstock, who license our data for distribution to their global users. Revenue from market data products consists of up-front license fees and monthly subscription fees and individual large database sales.
We currently offer our Fenics® analytics products primarily for the foreign exchange option markets, and, to a lesser extent, for certain precious metals, credit derivatives, energy derivatives, property derivatives and wet and dry freight markets. Fenics FX is a leading foreign exchange option pricing and analysis tool that is licensed for use at hundreds of sites globally. Fenics FX provides an array of tools, math models and independent market data that permits clients to quickly and accurately price and revalue both standard and exotic foreign exchange options. Fenics FX can also be integrated with most aspects of a client's trading infrastructure, and allows clients to control, monitor and more effectively oversee each stage of foreign exchange option trading.
As of December 31, 2007, we provided brokerage services and data and analytics products to over 2,200 institutional clients, including leading investment and commercial banks, large corporations, insurance companies and hedge funds. Notwithstanding our large number of clients, several dozen large financial institutions generate the majority of our brokerage revenues. The dealers that are our principal brokerage clients are many of the leading financial institutions in the world, including: Barclays Bank, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Lehman Brothers, Merrill Lynch, Morgan Stanley and UBS. Despite the importance of these large financial institutions to our brokerage business, no one client accounted for more than approximately 6% of our total revenues from all products and services globally for the year ended December 31, 2007.
Sales and Marketing
In order to promote new and existing brokerage, data and analytics software services, we utilize a combination of our own marketing and public relations staff and external advisers in implementing selective advertising and media campaigns. We participate in numerous trade-shows to reach potential brokerage, data and technology clients. We also utilize speaking opportunities to help promote key brokers and market specialists and our core products and services. Additionally, we market our brokerage services through the direct interaction of our brokers with their clients. This direct interaction also permits our brokers to discuss new product and market developments with our clients. Our data and analytics products are actively marketed through a dedicated sales and support team. As of December 31, 2007, we employed 48 sales, marketing and customer support professionals, consisting of 30 sales employees and executives, 6 marketing employees and 12 customer support employees. Our sales force calls on a broad range of clients including traders, risk managers, sales staff, treasurers, analysts and e-commerce specialists at banks, hedge funds, fund managers, insurance companies and large corporations.
Brokerage Technology. We employ a technology development philosophy that emphasizes state-of-the-art technology with cost efficiency in both our electronic trading platforms, such as
CreditMatch®, GFI ForexMatch and EnergyMatch®, and our data and analytics products. We take a flexible approach by developing in-house, purchasing or leasing technology products and services and by outsourcing support and maintenance where appropriate to manage technology expense more effectively. For each market in which we operate, we seek to provide the optimal mix of electronic and telephonic brokerage.
We offer our products and services through a global communications network that is designed to ensure secure, reliable and timely access to the most current market information. We provide our clients with a variety of means to connect to our brokers and trading platforms, including dedicated point-to-point data lines, virtual private networks and the Internet.
We are working with an increasing number of our clients to implement straight-through-processing between our trading platforms and the systems used by our clients to record, report and store transaction data. These efforts seek to automate large parts of the trade reporting and settlement process, thereby reducing errors, risks and costs traditionally associated with post-trade activities. We may also develop or customize trading systems for our customers.
Market Data and Analytics Products Technology. Our market data and analytics products are developed internally using advanced development methodologies and computer languages. Through years of developing Fenics products, our in-house software development team is experienced in creating simple, intuitive software for use with complex derivative instruments.
Support and Development. At December 31, 2007, we employed a team of 222 computer, telecommunication, network, database, client support, quality assurance and software development specialists. The activities of our development staff are split approximately evenly between infrastructure support services and software development. We devote substantial resources to the continuous development and support of our electronic brokerage capabilities, the introduction of new products and services to our clients and the training of our employees. Our software development capabilities allow us to be flexible in our decisions to either purchase or license technology from third parties or to develop it internally.
Disaster Recovery. We have contingency plans in place to protect against major carrier failures, disruption in external services (market data and Internet service providers), server failures and power outages. All critical services are connected via redundant and diverse circuits and, where possible, we employ site diversity. Production applications are implemented with a primary and back-up server, and all data centers have uninterruptible power source and generator back-up power. Our servers are backed-up daily, and back-up tapes are sent off-site weekly. We have a limited number of reserved "seats" available to relocate key personnel in the event that we were unable to use certain of our offices for an extended period of time. We intend to increase this number of seats, some of which may be shared with other companies, as part of our business continuity plans.
We seek to protect our internally developed and purchased intellectual property through a combination of patent, copyright, trademark, trade secret, contract and fair business practice laws. Our proprietary technology, including our Fenics software, is generally licensed to clients under written license agreements. Where appropriate, we also license and incorporate software and technology from third parties that is protected by intellectual property rights belonging to those third parties.
We pursue registration of some of our trademarks in the United States and in other countries. "GFI Group," "GFInet," "Fenics," "CreditMatch," "EnergyMatch," "Amerex" and "Starsupply" are registered trademarks in the United States and/or numerous overseas jurisdictions. We have also applied for registration of various other trademarks, including multiple derivations of the "GFI Group," "GFInet," "CreditMatch" and "ForexMatch" names.
We have applied for several patents related to our products and services. We believe that no single patent or application or group of patents or applications will be of material importance to our business as a whole.
Competition in the inter-dealer brokerage industry is intense. Our primary competitors with respect to our OTC brokerage services are currently other inter-dealer brokers and a few electronic brokerage platforms. Additional competition may arise from securities and futures exchanges. Our primary competitors for our data and analytics products are currently other inter-dealer brokers and data and technology vendors. Certain of our larger market data competitors offer electronic trading platforms for specific products.
Inter-Dealer Brokers. The current size of the wholesale inter dealer brokerage market is difficult to estimate as there is little objective, external data on the industry and several participants are private companies and do not publicly report revenues. Historically, the inter-dealer brokerage industry has been characterized by fierce competition for clients and brokers. Over the past several years, the industry has been characterized by the consolidation of well-established, smaller firms into five principal, global inter-dealer brokers: GFI Group Inc., ICAP plc, Tullett Prebon plc, Tradition Financial Services (a subsidiary of Cie Financiere Tradition) and Cantor Fitzgerald and its subsidiaries, BGC Partners Inc. and eSpeed, Inc. We believe this consolidation has resulted from a number of factors, including: the consolidation of primary institutional dealer clients; pressure to reduce brokerage commissions, particularly in more commoditized products; greater dealer demand for technological capabilities; the need to leverage relatively fixed administrative and regulatory costs and, increasingly, greater client demand for market information about correlated financial products. Nevertheless, a number of smaller, privately held firms or consortia that tend to specialize in niche products or specific geographical areas remain in the market.
Exchanges. In general, we do not compete directly with the major derivative exchanges, such as the CME Group Inc. ("CME"), the Chicago Board Options Exchange, International Securities Exchange, IntercontinentalExchange, the New York Mercantile Exchange, Eurex and Euronext.liffe. These exchanges allow participants to trade standardized futures and options contracts. These contracts, unlike the less commoditized, OTC products that we focus on, typically contain more standardized terms, are more commoditized, and are typically traded in contracts representing smaller notional amounts. Furthermore, the introduction of such standardized exchange-traded futures and options contracts has, in the past, generally been accompanied by continuing growth in the corresponding OTC derivatives markets. We believe that exchanges will continue to seek to leverage their platforms and attempt to grow by introducing products designed to compete with certain products covered by inter-dealer brokers in the OTC marketplace or through acquisitions. In 2007, several exchanges, including the CME, launched exchange-traded credit derivative futures contracts. However, no significant trading volumes have been reported on these efforts to date.
Data and Analytics. Several large market data and information providers compete for a presence on virtually every trading desk in our industry. Some of these entities currently offer varying forms of electronic trading of the types of financial instruments in which we specialize. Some of these entities have announced their intention to expand their electronic trading platforms or to develop new platforms. In addition, these entities are currently competitors to, and in some cases clients of, our data and analytical services. Further, we face competition for certain sales of our data products from our inter-dealer broker competitors and from data vendors, such as Markit, formed as a consortium of major financial institutions.
Certain of our subsidiaries, in the ordinary course of their business, are subject to extensive regulation by government and self-regulatory organizations both in the United States and abroad. As a matter of public policy, these regulatory bodies are responsible for safeguarding the integrity of the securities and other financial markets. These regulations are designed primarily to protect the interests of the investing public generally and thus cannot be expected to protect or further the interests of our company or our stockholders and may have the effect of limiting or curtailing our activities, including activities that might be profitable.
U.S. Regulation and Certain Clearing Arrangements. GFI Securities LLC, one of our subsidiaries, is registered as a broker-dealer with the SEC, and the State of New York, and is regulated by the Financial Industry Regulatory Authority ("FINRA"). GFI Securities LLC is subject to the regulations of FINRA and industry standards of practice that cover many aspects of its business, including initial licensing requirements, sales and trading practices, safekeeping of clients' funds and securities, capital structure, record keeping, supervision and the conduct of affiliated persons, including directors, officers and employees. GFI Securities LLC also operates an electronic trading platform that is regulated pursuant to Regulation ATS under the Exchange Act.
Several of GFI Securities LLC's equity and corporate bond brokerage desks have experienced issues relating to reporting trades to FINRA on a timely basis, which is required by FINRA rules. This subsidiary has also paid fines for late trade reporting in recent years and is currently being reviewed by FINRA for similar issues relating to trade reporting. In connection with its current examinations, FINRA may seek to impose further fines on us or seek to take other corrective action.
GFI Securities LLC is also an introducing broker with the National Futures Association ("NFA"), and the Commodity Futures Trading Commission ("CFTC"). The NFA and CFTC require their members to fulfill certain obligations, including the filing of quarterly and annual financial reports. Failure to fulfill these obligations in a timely manner can result in disciplinary action against the firm. GFI Brokers LLC operates electronic trading platforms that are exempt from CFTC either as an exempt board of trade (ForexMatch) or as an exempt commercial market (EnergyMatch).
The SEC, FINRA, CFTC and various other regulatory agencies within and outside of the United States have stringent rules and regulations with respect to the maintenance of specific levels of net capital by regulated entities. Generally, a broker-dealer's capital is net worth plus qualified subordinated debt less deductions for certain types of assets. The Net Capital Rule under the Exchange Act requires that at least a minimum part of a broker-dealer's assets be maintained in a relatively liquid form.
If these net capital rules are changed or expanded, or if there is an unusually large charge against our net capital, our operations that require the intensive use of capital would be limited. A large operating loss or charge against our net capital could adversely affect our ability to expand or even maintain these current levels of business, which could have a material adverse effect on our business and financial condition.
The SEC and FINRA impose rules that require notification when net capital falls below certain predefined criteria. These rules also dictate the ratio of debt to equity in the regulatory capital composition of a broker-dealer, and constrain the ability of a broker-dealer to expand its business under certain circumstances. If a firm fails to maintain the required net capital, it may be subject to suspension or revocation of registration by the applicable regulatory agency, and suspension or expulsion by these regulators could ultimately lead to the firm's liquidation. Additionally, the Net Capital Rule and certain FINRA rules impose requirements that may have the effect of prohibiting a broker-dealer from distributing or withdrawing capital and requiring prior notice to the SEC and FINRA for certain capital withdrawals.
GFI Securities LLC is also a member of the Mortgage-Backed Securities Clearing Corporation ("MBSCC), for the purpose of clearing certain mortgage-backed securities. This membership requires
GFI Securities LLC to maintain minimum net capital of $5.0 million in excess of the minimum amount prescribed in its membership agreement, including a minimum deposit with the MBSCC of $0.25 million.
We maintain clearing arrangements with selected financial institutions in order to settle our matched principal transactions and maintain deposits with such institutions in support of those arrangements.
Foreign Regulation and Certain Clearing Arrangements. Our overseas businesses are also subject to extensive regulation by various foreign governments and regulatory bodies. In the United Kingdom, the Financial Services Authority ("FSA") regulates our subsidiaries, GFI Brokers Limited and GFI Securities Limited. The regulatory framework applicable to our U.K. regulated subsidiaries was recently revised by the implementation of the European-wide Markets in Financial Instruments Directive ("MiFID") on November 1, 2007. MiFID is intended to create a harmonized market place for the transfer of financial services throughout the European Union thus easing cross border services. Each of our subsidiaries subject to MiFID has taken the necessary steps in order to comply with the new requirements. The revised regulations are extensively and broadly similar to that described above for our U.S. regulated subsidiaries.
As with those U.S. subsidiaries subject to FINRA rules, the ability of our regulated U.K. subsidiaries to pay dividends or make capital distributions may be impaired due to applicable capital requirements. Our regulated U.K. subsidiaries are subject to "consolidated" regulation, in addition to being subject to regulation on a legal entity basis. Consolidated regulation impacts the regulated entity and its parent holding companies in the U.K, including the regulated entity's ability to pay dividends or distribute capital. The financial resources rules are also being revised by the introduction of the Capital Requirements Directive (the "CRD"), which became applicable to us from January 1, 2008.
Our regulated U.K. subsidiaries are also subject to regulations regarding changes in control similar to those described above for GFI Securities LLC. Under FSA rules, regulated entities must obtain prior approval for any transaction resulting in a change in control of a regulated entity. Under applicable FSA rules, control is broadly defined as a 10% interest in the regulated entity or its parent or otherwise exercising significant influence over the management of the regulated entity. As a result of these regulations, our future efforts to sell shares or raise additional capital may be delayed or prohibited by the FSA.
GFI Securities Limited is a member of Euroclear for the purpose of clearing certain debt and equity transactions. This membership requires GFI Securities Limited to deposit collateral or provide a letter of credit to Euroclear so that Euroclear will extend a clearing line to GFI Securities Limited.
In Hong Kong, the Securities and Futures Commission ("SFC") regulates our subsidiary, GFI (HK) Securities LLC, as a Securities Dealer. The compliance requirements of the SFC include, among other things, net capital requirements (known as the Financial Resources Rule) and stockholders' equity requirements. The SFC regulates the activities of the officers, directors, employees and other persons affiliated with GFI (HK) Securities LLC and requires the registration of such persons.
In addition, GFI (HK) Brokers Ltd. is registered with and regulated by the Hong Kong Monetary Authority ("HKMA"). As part of this registration, GFI (HK) Brokers Ltd. is required to maintain stockholders' equity of 5.0 million Hong Kong dollars.
In Tokyo, the Japan Securities Dealers Association ("JSDA") regulates GFI Securities Limited's Japanese branch. The JSDA regulates the activities of the officers, directors, employees and other persons affiliated with the branch. This branch is also subject to certain licensing requirements established by the Foreign Securities Firms Law (the "FSFL"). As part of these requirements, GFI Securities Limited's Japanese branch is required to maintain "brought-in" capital, as defined, of 50 million Japanese Yen. The branch is also subject to the net capital rule promulgated by the FSFL, which required that net worth plus "brought-in" capital exceed a ratio of 120.0% of relevant expenditure. In addition, GFI Securities Limited is required to maintain a capital base of 1 billion Japanese Yen.
In Paris, a branch of GFI Securities Limited was established through the exercise of its passport right to open a branch in an European Economic Area ("EEA") state. The establishment of the branch was approved by the FSA and acknowledged by Banque de France in France. The branch is subject to the conduct of business rules of the Autorite Des Marches Financiers ("AMF") when dealing with resident customers of France and is regulated, in part, by the FSA.
In Singapore, the Monetary Authority of Singapore ("MAS") regulates our subsidiary GFI Group PTE Ltd. The applicable compliance requirements of the MAS include, among other things, maintaining stockholders' equity of 3 million Singapore dollars and monitoring GFI Group PTE Ltd.'s trading practices and business activities. The MAS regulates the activities of certain of the officers and employees of GFI Group PTE Ltd, and requires regular reports of our financial condition.
In Sydney, our brokerage operations are conducted through a branch of GFI Brokers Limited. GFI Brokers Limited is registered as a foreign corporation in Australia and is conditionally exempt from the requirement to hold an Australian financial services license under the Australian Securities and Investments Commission Corporations Act 2001 in respect of the financial services it provides in Australia. This exemption applies to foreign companies regulated by the FSA in accordance with UK regulatory standards.
In Korea, GFI Korea Money Brokerage Limited licensed and regulated by the Ministry of Finance and Economy to engage in foreign exchange brokerage business, and is subject to certain regulatory requirements under the Foreign Exchange Transaction Act and regulations thereunder. As a licensed foreign exchange brokerage company, GFI Korea Money Brokerage Limited is required to maintain minimum requirement of paid-in-capital of 5 billion Korea Won.
At December 31, 2007, all of our subsidiaries that are subject to foreign net capital rules were, and currently are, in compliance with those rules and have net capital in excess of the minimum requirements. We do not believe that we are currently subject to any foreign regulatory inquiries that, if decided adversely, would have any material adverse effect on us and our subsidiaries taken as a whole. As we expand our foreign businesses, we will also become subject to regulation by the governments and regulatory bodies in other countries. The compliance requirements of these different overseer bodies may include, but are not limited to, net capital or stockholders' equity requirements.
Changes in Existing Laws and Rules. Additional legislation and regulations, changes in rules promulgated by the government, regulatory bodies or clearing organizations described above or changes in the interpretation or enforcement of laws and regulations may directly affect the manner of our operation, our net capital requirements or our profitability. In addition, any expansion of our activities into new areas may subject us to additional regulatory requirements that could adversely affect our business, reputation and results of operations.
Exchange Memberships. Through our various subsidiaries, we are members of the following exchanges: International Securities Exchange, Chicago Mercantile Exchange (non-member firm), London Stock Exchange, Eurex, Xetra, Euronext.liffe, Baltic Exchange, IntercontinentalExchange, VirtX and European Energy Exchange.
At December 31, 2007, we employed 1,599 employees. Of these employees, 1,037 are brokerage personnel (consisting of 880 brokers and 157 trainees and clerks), 222 are technology and telecommunications specialists and 48 comprise our data and analytics sales, marketing and customer support professionals. Approximately 44% of our employees are based in North America, 40% are based in Europe and the remaining 16% are based in Asia-Pacific. None of our employees are
represented by a labor union. We consider our relationships with our employees to be good and have not experienced any interruption of operations due to labor disagreements.
ITEM 1A. RISK FACTORS
Risks Related to Our Business and Competitive Environments.
Economic, political and market factors beyond our control could reduce trading volumes, securities prices and demand for our brokerage services, which could harm our business and our profitability.
Difficult market conditions, economic conditions and geopolitical uncertainties have in the past adversely affected and may in the future adversely affect our business and profitability. Our business and the brokerage and financial services 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, substantial fluctuations in the volume and price levels of securities transactions and changes in and uncertainty regarding tax and other laws. In each of the three years in the period ended December 31, 2007, over 94% of our revenues were generated by our brokerage operations. As a result, our revenues and profitability are likely to decline significantly during periods of low trading volume in the financial markets in which we offer our services. The financial markets and the global financial services business are, by their nature, risky and volatile and are directly affected by many national and international factors that are beyond our control. Any one of the following factors, among others, may cause a substantial decline in the U.S. and global financial markets in which we offer our services, resulting in reduced trading volume. These factors include:
Declines in the volume of trading in the markets in which we operate generally result in lower revenue from our brokerage business. In addition, although less common, some of our brokerage revenues are determined on the basis of the value of transactions or on credit spreads. Therefore, declines in the value of instruments traded in certain market sectors or the tightening of credit spreads could result in lower revenue for our brokerage business. Our profitability would be adversely affected by a decline in revenue because a portion of our costs are fixed. For these reasons, decreases in trading volume or declining prices or credit spreads could have an adverse effect on our business, financial condition or results of operations.
We operate in a rapidly evolving business and technological environment and we must adapt our business effectively and keep up with rapid technological changes in order to compete effectively.
The pace of change in our industry is extremely rapid. Operating in such a rapid business environment involves a high degree of risk. Our ability to succeed and compete effectively will depend
on our ability to adapt effectively to these changing market conditions and to keep up with rapid technological changes.
To remain competitive, we must continue to enhance and improve the responsiveness, functionality, accessibility and other features of our electronic brokerage platform software, network distribution systems and other technologies. The financial services industry is characterized by rapid technological change, changes in use and client requirements and preferences, frequent product and service introductions employing new technologies and the emergence of new industry standards and practices that could render our existing practices, technology and systems obsolete. In more liquid markets, development by our competitors of new electronic trade execution, STP, affirmation or confirmation functionality or products that gain acceptance in the market could give those competitors a "first mover" advantage that may make it difficult for us to overcome with our own technology. Our success will depend, in part, on our ability to:
The development of proprietary electronic brokerage platforms and other technology to support our business entails significant technological, financial and business risks. Further, the adoption of new Internet, networking or telecommunications technologies may require us to devote substantial resources to modify, adapt and defend our services. We may not successfully implement new technologies or adapt our electronic brokerage systems and transaction-processing systems to client requirements or emerging industry standards. We may not be able to respond in a timely manner to changing market conditions or client requirements or successfully defend any challenges to any technology we develop. If we are unable to anticipate and respond to the demand for new services, products and technologies on a timely and cost-effective basis, and to adapt to technological advancements and changing standards, we may be unable to compete effectively, which could negatively affect our business, financial condition or results of operations.
If we are unable to continue to identify and exploit new market opportunities, our ability to maintain and grow our business may be adversely affected.
When a new intermediary enters our markets or the markets become more liquid, the resulting competition or increased liquidity may lead to lower commissions. This may result in a decrease in revenue in a particular market even if the volume of trades we handle in that market has increased. As a result, we seek to broker more trades and increase market share in existing markets and to seek out new markets in which we can charge higher commissions. Pursuing this strategy may require significant management attention and broker expense. We may not be able to attract new clients or successfully enter new markets. If we are unable to continue to identify and exploit new market opportunities on a timely and cost-effective basis, our revenues may decline, which would adversely affect our profitability.
We face substantial competition that could negatively impact our market share and our profitability.
The financial services industry generally, and the inter-dealer brokerage businesses in which we are engaged in particular, are very competitive, and we expect competition to continue to intensify in the future. Our current and prospective competitors include:
Some of our competitors offer a wider range of services, have broader name recognition, have greater financial, technical, marketing and other resources than we have and have larger client bases than we do. Some of them may be able to respond more quickly to new or evolving opportunities, technologies and client requirements than we can, and may be able to undertake more extensive marketing activities. Our competitors may also seek to hire our brokers, which could result in a loss of brokers by us or in increased costs to retain our brokers. In addition to the competitors described above, our large institutional clients may increase the amount of trading they do directly with each other rather than through us, or they may decrease their trading of certain OTC products in favor of exchange-traded products. In either case, our revenues could be adversely affected. If we are not able to compete successfully in the future, our business, financial condition and results of operations would be adversely affected.
We have experienced intense price competition in our brokerage business in recent years. Some competitors may offer brokerage services to clients at lower prices than we are offering, which may force us to reduce our prices or to lose market share and revenue. In addition, we focus primarily on providing brokerage services in markets for less commoditized financial instruments. As the markets for these instruments become more commoditized, we could lose market share to other inter-dealer brokers, exchanges and electronic multi-dealer brokers who specialize in providing brokerage services in more commoditized markets. We increasingly compete with exchanges for the execution of trades in certain products, mainly in derivatives such as options. If a financial instrument for which we provide brokerage services becomes listed on an exchange or if an exchange introduces a competing product to the products we broker in the OTC market, the need for our services in relation to that instrument could be significantly reduced. Further, the recent consolidation among exchange firms, and expansion by these firms into derivative and other non-equity trading markets, will increase competition for customer trades and place additional pricing pressure on commissions and spreads.
Because competition for the services of brokers is intense, we may not be able to attract and retain the highly skilled brokers we need to support our business or we may be required to incur additional expense to do so.
We strive to provide high-quality brokerage services that allow us to establish and maintain long-term relationships with our clients. Our ability to continue to provide these services and maintain these relationships depends, in large part, upon our brokers. As a result, we must attract and retain highly qualified brokerage personnel. Competition for the services of brokers is intense, especially for brokers with extensive experience in the specialized markets in which we participate or may seek to enter. If we are unable to hire highly qualified brokers, we may not be able to enter new brokerage markets or develop new products. If we lose one or more of our brokers in a particular market in which we participate, our revenues may decrease and we may lose market share in that particular market.
We may not be successful in our efforts to recruit and retain brokerage personnel. If we fail to attract new personnel or to retain and motivate our current personnel, or if we incur increased costs associated with attracting and retaining personnel (such as sign-on or guaranteed bonuses to attract new personnel or retain existing personnel), our business, financial condition and results of operations may suffer.
In addition, recruitment and retention of qualified staff could result in substantial additional costs. We have been and are party to, or otherwise involved in, several litigations and arbitrations involving competitor claims in connection with new employee hires and claims from former employees in connection with the termination of their employment. We may also pursue our rights through litigation when competitors hire our employees who are under contract with us. We are currently involved in several litigations and arbitrations with our competitors relating to new employee hires or departures. We believe such proceedings are common in our industry due to its highly competitive nature. An adverse settlement or judgment related to these or similar types of claims could have a material adverse effect on our financial condition or results of operations. Regardless of the outcome of these claims, we generally incur significant expense and management time dealing with these claims.
Our clients' financial or other problems could adversely affect our business.
We generally provide brokerage services to our clients in the form of either agency or matched principal transactions. In agency transactions, we charge a commission for connecting buyers and sellers and assisting in the negotiation of the price and other material terms of the transaction. After all material terms of a transaction are agreed upon, we identify the buyer and seller to each other and leave them to settle the trade directly. We are exposed to credit risk for commissions we bill to clients for our agency brokerage services. In executing matched principal transactions, we are exposed to the risk that one of the counterparties to a transaction may fail to fulfill its obligations, as described in further detail in the Risk Factor captioned "The securities settlement process exposes us to risks that may impact our liquidity and profitability. In addition, liability for unmatched trades could adversely affect our results of operations and balance sheet." Our clients may default on their obligations to us arising from either agency or principal transactions due to disputes, bankruptcy, lack of liquidity, operational failure or other reasons. Any losses arising from such defaults could adversely affect our financial condition or results of operations.
There has been an increasing number of defaults in certain mortgage and asset backed markets that have recently forced a growing number of financial institutions to report losses tied to write-downs of mortgage and asset backed securities. As a result, there is an increased risk that one of our clients or counterparties could fail, shut down, file for bankruptcy or be unable to pay out their positions under certain derivative contracts. The failure of a significant number of counterparties or a counterparty that holds a significant amount of derivatives exposure, or which has significant financial exposure to, or reliance on, the mortgage, asset-backed or related markets, could have a material adverse effect on the trading volume and liquidity in a particular market for which we provide brokerage services or on the broader financial markets. It is difficult to predict how long these conditions will continue, whether they will continue to deteriorate and which of our products and services may be adversely affected. As a result, these conditions could adversely affect our financial condition and results of operations.
We have adopted policies and procedures to identify, monitor and manage our credit risk, in both agency and principal transactions, through reporting and control procedures and by monitoring credit standards applicable to our clients. These policies and procedures, however, may not be fully effective. Some of our risk management methods depend upon the evaluation of information regarding markets, clients or other matters that are publicly available or otherwise accessible by us. That information may not, in all cases, be accurate, complete, up-to-date or properly evaluated. If our policies and procedures are not fully effective or we are not always successful in monitoring or evaluating the risks to which we
are, or may, be exposed, our financial condition or results of operations could be adversely affected. In addition, our insurance policies may not provide adequate coverage for these risks.
Financial problems experienced by third parties could affect the markets in which we provide brokerage services. In addition, a disruption in the credit derivative market could affect our brokerage revenues.
Problems experienced by third parties could also affect the markets in which we provide brokerage services. For example, in recent years, hedge funds have increasingly begun to make use of credit and other derivatives as part of their trading strategies. As a result, an increasing percentage of our business, directly or indirectly, results from trading activity by hedge funds. Hedge funds typically employ a significant amount of leverage to achieve their results and, in the past, certain hedge funds have had difficulty managing this leverage, which has resulted in market-wide disruptions. If one or more hedge funds that was a significant participant in a derivatives market experienced similar problems in the future, that derivatives market could be adversely affected and, accordingly, our brokerage revenues in that market could decrease.
In addition, in recent years, reports in the U.S. and U.K. have suggested weaknesses in the way credit derivatives are assigned by participants in the credit derivative markets. Such reports expressed concern that, due to the size of the credit derivative market, the volume of assignments and the suggested weaknesses in the assignment process, one or more significant defaults by corporate issuers of debt could lead to a market-wide disruption or result in the bankruptcy or operational failure of hedge funds or other market participants. If the credit derivative markets experience a severe market disruption or if there was real or perceived lack of confidence that the credit derivative markets could orderly process one or more significant defaults of corporate issuers of debt, the use of credit derivatives could be reduced and the credit derivative market could be adversely affected and, accordingly, our brokerage revenues in that market could decrease.
Risks Related to Our Operations.
We operate in a highly regulated industry and we may face restrictions with respect to the way we conduct certain of our operations.
Our business is subject to increasingly extensive government and other regulation and our relationships with our broker-dealer clients may subject us to increasing regulatory scrutiny. These regulations are designed to protect the interests of the investing public generally rather than our stockholders. The SEC, FINRA, CFTC and other agencies extensively regulate the U.S. financial services industry, including certain of our operations in the United States. Some of our international operations are subject to similar regulations in their respective jurisdictions, including rules made by the FSA in the United Kingdom, regulations overseen by the AMF in France, the SFC in Hong Kong, the MAS in Singapore, the JSDA in Japan and the Ministry of Finance and Economy in Korea. These regulatory bodies are responsible for safeguarding the integrity of the securities and other financial markets and protecting the interests of investors in those markets. Some aspects of our business are subject to extensive regulation, including:
If we fail to comply with any of these laws, rules or regulations, we may be subject to censure, fines, cease-and-desist orders, suspension of business, suspensions of personnel or other sanctions, including revocation of our registrations with FINRA, withdrawal of our authorizations from the FSA or revocation of our registrations with other similar international agencies to whose regulation we are subject. In the past, we have been fined by the NASD for issues relating to late trade reporting. For more details, see "Item 1BusinessRegulations."
Our authority to operate as a broker in a jurisdiction is dependent on continued registration or authorization in that jurisdiction or the maintenance of a proper exemption from such registration or authorization. Our ability to comply with all applicable laws and rules is largely dependent on our compliance, credit approval, audit and reporting systems and procedures, as well as our ability to attract and retain qualified compliance, credit approval, audit and risk management personnel. Our systems and procedures may not be effective. In addition, the continued growth and expansion of our business creates additional strain on our compliance systems and procedures and has resulted, and we expect will continue to result, in increased costs to maintain and improve these systems.
Some of our subsidiaries are subject to regulations regarding changes in control of their ownership. These regulations generally provide that regulatory approval must be obtained in connection with any transaction resulting in a change in control of the subsidiary, which may include changes in control of GFI Group Inc. As a result of these regulations, our future efforts to sell shares or raise additional capital may be delayed or prohibited in circumstances in which such a transaction would give rise to a change in control as defined by the applicable regulatory body.
Changes in laws or regulations or in governmental policies could cause us to change the way we conduct our business, which could adversely affect us. The government agencies that regulate us have broad powers to investigate and enforce compliance and punish noncompliance with their rules, regulations and industry standards of practice. We or our directors, officers and employees may not comply with the rules and regulations of, and may be subject to claims or actions by, these agencies. In addition, because our industry is heavily regulated, regulatory approval may be required prior to expansion of business activities. We may not be able to obtain the necessary regulatory approvals for any desired expansion. Even if approvals are obtained, they may impose restrictions on our business or we may not be able to continue to comply with the terms of the approvals or applicable regulations. The implementation of unfavorable regulations or unfavorable interpretations of existing regulations by courts or regulatory bodies could require us to incur significant compliance costs or cause the development or continuation of business activities in affected markets to become impractical.
For example, the SEC's Regulation NMS, which was adopted in 2005 and became effective in 2007, introduced significant changes to the regulation of trading on securities exchanges and marketplaces. While Regulation NMS has not had a significant impact on our business to date, we will continue to monitor any developments in this area and the potential impact it could have on our business. Further, in April 2004, the European Union adopted MiFID. MiFID replaced the Investment Services Directive and is intended to promote a single market for wholesale and retail transactions in financial instruments. The revised regulations are extensively and broadly similar to that described above for our U.S. regulated subsidiaries and became effective and applicable to us in January 1, 2008. We continue to monitor developments in this area and the potential impacts they may have on our European businesses.
For a further description of the regulations which may limit our activities, see "Item 1BusinessRegulation."
Our regulated subsidiaries are subject to risks associated with net capital requirements, and we may not be able to engage in operations that require significant capital.
The SEC, FINRA, FSA, JSDA and various other domestic and international regulatory agencies have stringent rules and regulations with respect to the maintenance of specific levels of net capital by broker-dealers. Generally, a broker-dealer's net capital is defined as its net worth plus qualified subordinated debt less deductions for certain types of assets. If we fail to maintain the required net capital, we may be subject to suspension or revocation of registration by FINRA or withdrawal of authorization from the FSA, which would have a material adverse effect on our business. If these net capital rules are changed or expanded, or if there is an unusually large charge against net capital, operations that require the intensive use of capital would be limited. Also, our ability to withdraw capital from our regulated subsidiaries is subject to restrictions, which in turn could limit our ability to pay dividends, repay debt and redeem or purchase shares of our common stock. A large operating loss or charge against net capital could adversely affect our ability to expand or even maintain our present levels of business, which could have a material adverse effect on our business. In addition, we may become subject to net capital requirements in other foreign jurisdictions in which we currently operate or which we may enter. We cannot predict our future capital needs or our ability to obtain additional financing. For a further discussion of our net capital requirements, see "Part I-Item 1BusinessRegulation."
Our investments in expanding our brokerage services, electronic brokerage systems and market data and analytics services may not produce substantial revenue or profit.
We have made, and expect to continue to make, significant investments in our brokerage and market data and analytics services, including investments in personnel, technology and infrastructure, in order to pursue new growth opportunities. With respect to our brokerage services and electronic brokerage systems, we may not receive significant revenue and profit from the hiring of a new broker or the development of a new brokerage desk or electronic brokerage system or the revenue we do receive may not be sufficient to cover the cost of the signing-bonus or the minimum level of compensation that we may have contractually agreed with a newly hired broker or the substantial development expenses associated with creating a new electronic brokerage platform. Even when our personnel hires and systems are ultimately successful, there is typically a transition period before these hires or systems become profitable or increase productivity. In some instances, our clients may determine that they do not need or prefer an electronic brokerage system and the period before the system is successfully developed, introduced and adopted may extend over many months or years. The successful introduction of electronic brokerage system in one market or country does not ensure that the same system will be used or favored by clients in similar markets or other countries. Our continued expansion of brokerage personnel and systems to support new growth opportunities results in on-going transition periods that could adversely affect the levels of our compensation and expense as a percentage of brokerage revenue.
With respect to our market data and analytics services, we may incur substantial development, sales and marketing expenses and expend significant management effort to create a new product or service. Even after incurring these costs, we ultimately may not sell any or only small amounts of these products or services. Consequently, if revenue does not increase in a timely fashion as a result of these expansion and development initiatives, the up-front costs associated with them may exceed the related revenue and reduce our working capital and income.
If we are unable to manage the risks of international operations effectively, our business could be adversely affected.
We provide services and products to clients in Europe, Asia, Australia and Africa through offices in London, Paris, Hong Kong, Seoul, Singapore, Sydney, Tokyo and Cape Town and we may seek to
further expand our operations throughout these regions and the Middle-East in the future. For example, in 2008, we intend to provide services and products from offices in Dubai, Tel-Aviv and Dublin. On a geographic basis, approximately 48% and 44% of our total revenues for the years ended December 31, 2007 and 2006, respectively, were generated by our European operations, 42% and 47%, respectively, were generated by our North American operations and 10% and 9%, respectively, were generated by our operations in the Asia-Pacific region. There are certain additional risks inherent in doing business in international markets, particularly in the regulated brokerage industry. These risks include:
If we are unable to manage any of these risks effectively, our business could be adversely affected.
Our international operations also expose us to the risk of fluctuations in currency exchange rates. For example, a substantial portion of our revenue from our London office, our largest international office, is received in Euros and U.S. Dollars, whereas many of our expenses from our London operations are payable in British Pounds. Our risk management strategies relating to exchange rates may not prevent us from suffering losses that would adversely affect our financial condition or results of operations.
We may have difficulty managing our growth effectively.
We have experienced significant growth in our business activities over the last several years, which has placed, and is expected to continue to place, a significant strain on our management and resources. Continued growth will require continued investment in management and other personnel, facilities, information technology infrastructure, financial and management systems and controls and regulatory compliance control. We may not be successful in implementing all of the processes that are necessary to support our growth, which could result in our expenses increasing faster than our revenues, causing our operating margins and profitability to be adversely affected.
The expansion of our international operations, particularly our Asia-Pacific and European operations, involves additional challenges that we may not be able to meet, such as the difficulty in effectively managing and staffing these operations and complying with the increased regulatory requirements associated with operating in new jurisdictions. This expansion, if not properly managed, could have a material adverse effect on our business.
The securities settlement process exposes us to risks that may impact our liquidity and profitability. In addition, liability for unmatched trades could adversely affect our results of operations and balance sheet.
Through our subsidiaries, we provide brokerage services by executing transactions for our clients. An increasing number of these transactions are "matched principal transactions" in which we act as a "middleman" by serving as a counterparty to both a buyer and a seller in matching reciprocal back-to-back trades. These transactions, which generally involve cash equities and bonds, are then settled through clearing institutions with whom we have a contractual relationship.
In executing matched principal transactions, we are exposed to the risk that one of the counterparties to a transaction may fail to fulfill its obligations, either because it is not matched
immediately or, even if matched, one party fails to deliver the cash or securities it is obligated to deliver. Our focus on less commoditized markets exacerbates this risk for us because transactions in these markets tend to be more likely not to settle on a timely basis. Adverse movements in the prices of securities that are the subject of these transactions can increase our risk. In addition, widespread technological or communication failures, as well as actual or perceived credit difficulties or the insolvency of one or more large or visible market participants, could cause market-wide credit difficulties or other market disruptions. These failures, difficulties or disruptions could result in a large number of market participants not settling transactions or otherwise not performing their obligations.
We are subject to financing risk in these circumstances because if a transaction does not settle on a timely basis, the resulting unmatched position may need to be financed, either directly by us or through one of our clearing organizations at our expense. These charges may be recoverable from the failing counterparty, but sometimes are not. Finally, in instances where the unmatched position or failure to deliver is prolonged or widespread due to rapid or widespread declines in liquidity for an instrument, there may also be regulatory capital charges required to be taken by us, which depending on their size and duration, could limit our business flexibility or even force the curtailment of those portions of our business requiring higher levels of capital. Credit or settlement losses of this nature could adversely affect our financial condition or results of operations.
In the process of executing matched principal transactions, miscommunications and other errors by our clients or us can arise whereby a transaction is not completed with one or more counterparties to the transaction, leaving us with either a long or short unmatched position. These unmatched positions are referred to as "out trades," and they create a potential liability for the involved subsidiary of ours. If an out trade is promptly discovered and there is a prompt disposition of the unmatched position, the risk to us is usually limited. If the discovery of an out trade is delayed, the risk is heightened by the increased possibility of intervening market movements prior to disposition. Although out trades usually become known at the time of, or later on the day of, the trade, it is possible that they may not be discovered until later in the settlement process. When out trades are discovered, our policy is generally to have the unmatched position disposed of promptly, whether or not this disposition would result in a loss to us. The occurrence of out trades generally rises with increases in the volatility of the market and, depending on their number and amount, such out trades have the potential to have a material adverse effect on our financial condition and results of operations. In addition, the use of our fully electronic brokerage platforms, such as CreditMatch®, GFI ForexMatch and EnergyMatch®, can present these risks because of the potential for erroneous entries by our clients or brokers coupled with the potential that such errors will not be discovered promptly.
In the event of employee misconduct or error, our business may be harmed.
There have been a number of highly publicized cases involving fraud or other misconduct by employees in the financial services industry in recent years, and we run the risk that employee misconduct could occur. Employee misconduct could subject us to financial losses and regulatory sanctions and could seriously harm our reputation and negatively affect our business. It is not always possible to deter employee misconduct and the precautions taken to prevent and detect employee misconduct may not always be effective. Misconduct by employees could include engaging in unauthorized transactions or activities, failure to properly supervise other employees, engaging in improper or unauthorized activities on behalf of clients or improperly using confidential information.
Employee errors, including mistakes in executing, recording or reporting transactions for clients, could cause us to enter into transactions that clients may disavow and refuse to settle, which could expose us to the risk of material losses until the errors are detected and the transactions are unwound or reversed. If our clients are not able to settle their transactions on a timely basis, the time in which employee errors are detected may be increased and our risk of material loss can be increased. Several of our clients have in the past, experienced delays in settling credit derivative transactions that we
broker on an agency basis. As with any unsettled transaction, adverse movements in the prices of the securities involved in these transactions before they are unwound or reversed can increase this risk. The risk of employee error or miscommunication may be greater for products that are new or have non-standardized terms.
We have market risk exposure from unmatched principal transactions entered into by some of our equity and credit product brokerage desks.
We allow certain of our brokerage desks to enter into a limited number of unmatched principal transactions in the ordinary course of business for the purpose of facilitating clients' execution needs for transactions initiated by such clients or to add liquidity to certain illiquid markets. As a result, we have market risk exposure on these unmatched principal transactions. Our exposure varies based on the size of the overall positions, the terms and liquidity of the instruments brokered, and the amount of time the positions are held before we dispose of the position.
We do not track our exposure to unmatched positions on an intra-day basis. These unmatched positions are intended to be held short term. Due to a number of factors, including the nature of the position and access to the market on which it trades, we may not be able to match the position or effectively hedge our exposure and often may be forced to hold a position overnight that has not been hedged. To the extent these unmatched positions are not disposed of intra-day, we mark these positions to market. Adverse movements in the securities underlying these positions or a downturn or disruption in the markets for these positions could result in a substantial loss. In addition, any principal gains and losses resulting from these positions could on occasion have a disproportionate effect, positive or negative, on our financial condition and results of operations for any particular reporting period.
Brokerage services involve substantial risks of liability, therefore, we may become subject to risks of litigation.
Many aspects of our business, and the businesses of our clients, involve substantial risks of liability. Dissatisfied clients may make claims regarding quality of trade execution, improperly settled trades, or mismanagement against us. We may become subject to these claims as the result of failures or malfunctions of electronic trading platforms or other brokerage services provided by us, and third parties may seek recourse against us. We attempt to limit our liability to our customers through the use of written or "click-through" agreements, but we do not have such agreements with many of our clients. We could incur significant legal expenses defending claims, even those without merit. An adverse resolution of any lawsuits or claims against us could result in our obligation to pay substantial damages.
If we acquire other companies or businesses, or if we hire new brokerage personnel, we may have difficulty integrating their operations.
To achieve our strategic objectives, we have acquired or invested in, and in the future may seek to acquire or invest in, other companies and businesses. We also may seek to hire brokers for new or existing brokerage desks. These acquisitions or new hires may be necessary in order for us to enter into or develop new product areas or trading systems. Acquisitions and new hires entail numerous risks, including:
If we fail to manage these risks as we make acquisitions or make new hires, our profitability may be adversely affected, and we may never realize the anticipated benefits of the acquisitions or hires. In addition, entering into new businesses may require prior approval from our regulators. Our ability to obtain timely approval from our regulators may hinder our ability to successfully enter new businesses.
Seasonal fluctuations in trading may cause our quarterly operating results to fluctuate.
In the past, our business has experienced seasonal fluctuations, reflecting reduced trading activity during summer months, particularly in August. We also generally experience reduced activity in December due to seasonal holidays. As a result, our quarterly operating results may not be indicative of the results we expect for the full year. Our operating results may also fluctuate quarter to quarter due to a variety of factors beyond our control such as conditions in the global financial markets, terrorism, war and other economic and political events. Furthermore, we may experience reduced revenues in a quarter due to a decrease in the number of business days in that quarter compared to prior years.
Computer systems failures, capacity constraints and breaches of security could increase our operating costs and cause us to lose clients.
We internally support and maintain many of our computer systems, trading platforms and networks. Our failure to monitor or maintain these systems, trading platforms and networks or, if necessary, to find a replacement for this technology in a timely and cost-effective manner, would have a material adverse effect on our ability to conduct our operations.
We also rely and expect to continue to rely on third parties to supply and maintain various computer systems, trading platforms and communications systems, such as telephone companies, online service providers, data processors, clearing organizations, software and hardware vendors and back-up services. Our systems, or those of our third party providers, may fail or operate slowly, causing one or more of the following:
We may experience systems failures from power or telecommunications outages, acts of God, war, terrorism, human error, natural disasters, fire, sabotage, hardware or software malfunctions or defects, computer viruses, intentional acts of vandalism or similar events. Additionally, our system backup or
disaster recovery plans may not be effective. Any system failure that causes an interruption in service or decreases the responsiveness of our service, including failures caused by client error or misuse of our systems, could damage our reputation, business and brand name. In addition, if security measures contained in our systems are breached as a result of third-party action, employee error, malfeasance or otherwise, our reputation may be damaged and our business could suffer.
If systems maintained by us or third parties malfunction, our clients or other third parties may seek recourse against us. We could incur significant legal expenses defending these claims, even those which we may believe to be without merit. An adverse resolution of any lawsuits or claims against us could result in our obligation to pay substantial damages and could have a material adverse effect on our financial condition or results of operations.
We may not be able to protect our intellectual property rights or may be prevented from using intellectual property necessary for our business.
Our business depends in part on whether we are able to maintain the proprietary aspects of our technology and to operate without infringing on the proprietary rights of others. We rely primarily on trade secret, contract, copyright, trademark and patent law to protect our proprietary technology. However, these protections may not be adequate to prevent third parties from copying or otherwise obtaining and using our proprietary technology without authorization or otherwise infringing on our rights.
We may also face claims of infringement that could interfere with our ability to use technology that is material to our business operations. We may face limitations or restrictions on the distribution of some of the market data generated by our brokerage desks, which may limit the comprehensiveness and quality of the data we are able to distribute or sell.
In addition, in the past several years, there has been proliferation of so-called "business method patents" applicable to the computer and financial services industries. There has also been a substantial increase in the number of such patent applications filed. Under current law, U.S. patent applications remain secret for 18 months and may, depending upon where else such applications are filed, remain secret until a patent is issued. In light of these factors, it is not economically practicable to determine in advance whether our products or services may infringe the present or future patent rights of others. In addition, although we take steps to protect our technology, we may not be able to protect our technology from disclosure or from other developing technologies that are similar or superior to our technology. Any failure to protect our intellectual property rights could materially and adversely affect our business and financial condition.
If we are unable to adequately protect our intellectual property rights or if we infringe on the rights of others, we could become involved in costly disputes and may be required to pay royalties or enter into license agreements with third parties.
In the future, we may have to rely on litigation to enforce our intellectual property rights, protect our trade secrets, determine the validity and scope of the proprietary rights of others or defend against claims of infringement or invalidity. This litigation could result from claims that we are violating the rights of others or may be necessary to enforce our own rights. Any such litigation would be time consuming and expensive to defend or resolve and would result in the diversion of the resources and attention of management, and the outcome of any such litigation cannot be accurately predicted. Any adverse determination in such litigation could subject us to significant liabilities or require us to pay royalties or enter into license agreements with third parties, which we may not be able to obtain on terms acceptable to us or at all.
We depend on third-party software licenses. The loss of any of our key licenses could adversely affect our ability to provide our brokerage services.
We license software from third parties, some of which is integral to our electronic brokerage systems and our business. These licenses are generally terminable if we breach our obligations under the licenses or if the licensor gives us notice in advance of the termination. If any of these relationships were terminated, or if any of these third parties were to cease doing business, we may be forced to spend significant time and money to replace the licensed software. These replacements may not be available on reasonable terms, if at all. A termination of any of these relationships could have a material adverse effect on our financial condition and results of operations.
Risks Related to Our Liquidity and Financing Needs.
We may not be able to obtain additional financing, if needed, on terms that are acceptable.
Our business is dependent upon the availability of adequate funding and sufficient regulatory and clearing capital. Clearing capital is the amount of cash, guarantees or similar collateral that we must provide or deposit with our third party clearing organizations in support of our obligations under our contractual clearing arrangements with these organizations. Historically, these needs have been satisfied from internally generated funds, investments from our stockholders and lines of credit made available by commercial banking institutions. We believe that, based on current levels of operations and anticipated growth, our cash from operations, together with cash currently available, and available financing under our 2006 Credit Agreement (described below), will be sufficient to fund our operations for the foreseeable future. However, if for any reason we need to raise additional funds, including for acquisitions or meeting increased clearing capital requirements arising from growth in our brokerage business, we may not be able to obtain additional financing when needed. If we cannot raise additional funds on acceptable terms, we may not be able to develop or enhance our business, take advantage of future opportunities or acquisitions or respond to competitive pressure or unanticipated requirements.
Our credit agreement and our senior notes each contain restrictive covenants which may limit our working capital and corporate activities.
We are a party to an amended and restated credit agreement with Bank of America N.A. and certain other lenders dated February 24, 2006, as amended (the "2006 Credit Agreement"). In addition, we issued $60.0 million of senior secured notes (the "Senior Notes") which are due January 30, 2013. Our 2006 Credit Agreement and our Senior Notes impose operating and financial restrictions on us, including restrictions which may, directly or indirectly, limit our ability to:
In addition, our 2006 Credit Agreement and our Senior Notes contain covenants that require us to maintain specified financial ratios and satisfy specified financial tests. As a result of these covenants and restrictions, we may be limited in how we conduct our business, and we may be unable to raise
additional financing, to compete effectively or to take advantage of new business opportunities. We may not be able to remain in compliance with these covenants in the future.
Our 2006 Credit Agreement and our Senior Notes also contain several events of default, including for non-payment, certain bankruptcy events, covenant or representation breaches or a change in control.
Risks Related to Owning Our Stock
Jersey Partners has significant voting power and may take actions that may not be in the best interest of our other stockholders.
Jersey Partners Inc. ("JPI"), together with its subsidiaries, in which our chief executive officer and founder, Michael Gooch, is the controlling shareholder, owns approximately 43% of our outstanding common stock. Our president, Colin Heffron, is also a minority shareholder of JPI. As a result, through JPI, Michael Gooch has the ability to exert substantial influence over all matters requiring approval by our stockholders, including the election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets and other corporate transactions. This concentration of control could be disadvantageous to other stockholders with interests different from those of JPI and Michael Gooch. This concentration of voting power may have the effect of delaying or impeding actions that could be beneficial to our other stockholders, including actions that may be supported by our Board of Directors. The trading price for our common stock could be adversely affected if investors perceive disadvantages to owning our stock as a result of this significant concentration of share ownership.
Provisions of our certificate of incorporation and bylaws, agreements to which we are a party, regulations to which we are subject and provisions of our stock option plans could delay or prevent a change in control of our company and entrench current management.
Our second amended and restated certificate of incorporation and bylaws may be deemed to have an anti-takeover effect and may delay, deter or prevent a change of control of us, such as a tender offer or takeover proposal that might result in a premium over the market price for our common stock. In addition, certain of these provisions make it more difficult to bring about a change in the composition of our board of directors, which could result in entrenchment of current management. For example, our second amended and restated certificate of incorporation and bylaws:
Under our 2006 Credit Agreement and our Senior Notes, a change in control may lead the lenders to exercise remedies such as acceleration of the loan and termination of their obligations to fund additional advances under the revolving credit portion of that facility.
Our brokerage businesses are heavily regulated and some of our regulators require that they approve transactions which could result in a change of control, as defined by the then-applicable rules of our regulators. The requirement that this approval be obtained may prevent or delay transactions that would result in a change of control.
In addition, our equity incentive plans contain provisions pursuant to which options or restricted stock units that are unexercisable or unvested may become exercisable or vested as of the date immediately prior to certain change of control events. These provisions could have the effect of dissuading potential acquirers from pursuing merger discussions with us.
If we fail to maintain effective internal control over financial reporting as required by Section 404 of the Sarbanes-Oxley Act, it may have an adverse effect on our business and stock price.
We are subject to the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 ("SOX") and the applicable SEC rules and regulations that require our management to conduct an annual assessment and to report on the effectiveness of our internal controls over financial reporting. In addition, our independent registered public accounting firm must issue an attestation report addressing the operating effectiveness of the Company's internal controls over financial reporting.
While our internal controls over financial reporting currently meet all of the standards required by SOX, failure to maintain an effective internal control environment could have a material adverse effect on our business, financial condition and results of operations and the price of our common stock. We cannot be certain as to our ability to continue to comply with the requirements of SOX. If we are not able to continue to comply with the requirements of SOX in a timely manner or with adequate compliance, we may be subject to sanctions or investigation by regulatory authorities, including the SEC or FINRA. In addition, should we identify a material weakness, there can be no assurance that we would be able to remediate such material weakness in a timely manner in future periods. Moreover, if we are unable to assert that our internal control over financial reporting is effective in any future period (or if our auditors are unable to express an opinion on the effectiveness of our internal controls), we could lose investor confidence in the accuracy and completeness of our financial reports, and incur significant expenses to restructure our internal controls over financial reporting, which may have an a material adverse effect on our Company.
We cannot provide assurance that we will continue to declare and pay dividends at all or in any particular amounts and we may elect not to pay dividends in the future.
Our Board of Directors has declared a special cash dividend in 2008 and has also approved a policy of paying quarterly dividends, subject to available cash flow from operations, other considerations and the determination by our Board of Directors of the amount. Our dividend policy may be affected by, among other things, our earnings, financial condition, future capital requirements (including regulatory net capital requirements), level of indebtedness, contractual restrictions with respect to the payment of dividends and our determination to make certain investments or acquisitions. We may depend on dividends, distributions and other payments from our subsidiaries to fund a dividend payment and regulatory and other legal restrictions may limit our ability to transfer funds freely from our subsidiaries. Our ability to declare a dividend is also subject to limits imposed by Delaware corporate law, our 2006 Credit Agreement and our Senior Notes.
The market price of our common stock may fluctuate in the future, and future sales of our shares could adversely affect the market price of our common stock.
The market price of our common stock has fluctuated in the past and may fluctuate in the future depending upon many factors, including our actual results of operations and perceived prospects and the prospects of the financial marketplaces in general, differences between our actual financial and
operating results and those expected by investors and analysts, changes in analysts' recommendations or projections, seasonality, changes in general valuations for companies in our business segment, changes in general economic or market conditions and broad market fluctuations.
Future sales of our common stock also could adversely affect the market price of our common stock. If our existing stockholders sell a large number of shares, or if we issue a large number of shares of our common stock in connection with future acquisitions, strategic alliances, new or amended equity incentive plans or otherwise, the market price of our common stock could decline significantly. Moreover, the perception in the public market that these stockholders or JPI might sell shares of common stock could depress the market price of our common stock.
As of December 31, 2007, we had registered under the Securities Act of 1933, as amended (the "Securities Act"), an aggregate of 239,675 shares of our common stock which are reserved for issuance upon the exercise of outstanding options under our 2000 and 2002 Stock Option Plans. Based on outstanding grants at December 31, 2007, there are 1,545,440 shares of our common stock available for future grants of awards under the 2004 Equity Incentive Plan. In addition, as of December 31, 2007, we had registered under the Securities Act an aggregate of 2,660,053 shares of our common stock available for issuance under our 2004 Equity Incentive Plan in connection with existing and new grants of restricted stock units, stock options or similar types of equity compensation awards to our employees. These shares can be sold in the public market upon issuance, subject to any vesting requirements and restrictions under the securities laws applicable to resales by affiliates. These sales might impact the liquidity of our common stock and might have a dilutive effect on existing stockholders making it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate.
ITEM 2. PROPERTIES
Our executive headquarters are located at 100 Wall Street, New York, New York 10005, where we occupy approximately 88,000 square feet of leased space, pursuant to a lease that expires on September 30, 2013, unless earlier terminated in accordance with the terms of the lease. JPI is also liable for our obligations under this lease. In June 2007, pursuant to the terms of the lease, we terminated the lease with respect to approximately 51,000 square feet, effective June 30, 2008. We signed a new lease for approximately 89,000 square feet at 55 Water Street, New York, New York, for the period from June 2007 through December 2027. We expect to relocate to the new facility beginning in the second quarter of 2008. Our U.K. offices are located in London at 1 Snowden Street, EC2 2DQ, where we occupy approximately 44,000 square feet pursuant to a lease that expires on March 31, 2015. We also lease office space to support our brokerage operations in New Jersey, Calgary, Texas, Paris, Hong Kong, Singapore, Tokyo, Seoul, Cape Town and Sydney.
We believe our facilities will be adequate for our operations for the next twelve months.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, we are and have been party to, or otherwise involved in, litigations, claims and arbitrations that involve claims for substantial amounts. These proceedings have generally involved either competitor claims in connection with new employee hires, or claims from former employees in connection with the termination of their employment from us. We believe proceedings of these types are common in the inter-dealer brokerage industry due to its highly competitive nature. There is also potential for client claims alleging the occurrence of errors in the execution of brokerage transactions. We are also currently and will, in the future, be involved, in examinations, investigations or proceedings by government agencies and self-regulatory organizations. These examinations or investigations could result in substantial fines or administrative proceedings that could result in censure, the issuance of cease and desist orders, the suspension or expulsion of a broker dealer and its affiliated persons, officers or employees or other similar consequences.
In February 2008, our U.K. subsidiary, GFI Holdings Limited ("Holdings"), applied to the High Court in London, England, for a declaration that it was contractually entitled to terminate the employment agreements of three senior brokers in September 2007 by reason of their gross misconduct, repudiatory breaches of contract and breaches of fiduciary duty. Following the termination of their employment in September 2007, the three former employees threatened to bring claims against Holdings in respect of past and future bonuses, stock options and restricted stock units in the aggregate amount of approximately $10.0 million. Holdings is therefore also seeking a declaration that the former employees are not entitled to receive any further bonus payments or payments or benefits of any kind. The former employees have not yet responded to our action but we expect them to file a counterclaim in the amount previously threatened. While we cannot predict the outcome of any litigation, we believe that the former employees were in serious breach of their obligations and are not therefore entitled to any of the amount claimed. Based on currently available information, this matter is not expected to have a material adverse impact on our financial position. However, if the counterclaim succeeds in respect of the full amount previously threatened, this matter may be material to our results of operations or cash flows in a given period.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At a Special Meeting of stockholders, which was held on January 11, 2008 (the "Special Meeting"), our stockholders approved an amendment to our second amended and restated certificate of incorporation to increase the amount of common stock that we are authorized to issue from 100,000,000 shares to 400,000,000 shares.
The following table sets forth the number of votes cast for, against and those that abstained with respect to the proposal.
Our common stock has been traded on the Nasdaq Global Select Market ("Nasdaq") under the symbol "GFIG" since our initial public offering on January 26, 2005. Prior to that time there was no
established public trading market for our common stock. The closing share price for our common stock on February 15, 2008, as reported by on the Nasdaq Stock Market, was $87.08.
As of February 15, 2008, we had approximately 24 holders of record of our common stock.
Set forth below, for each of the last eight fiscal quarters, is the low and high sales prices per share of our common stock as reported on Nasdaq.
Prior to 2008, we retained all earnings for investment in our business. In February 2008, our Board of Directors declared a special cash dividend and has also approved a policy of paying quarterly dividends, subject to available cash flow from operations, other considerations and the determination by our Board of Directors of the amount.
Any declaration and payment of dividends will be at the discretion of our Board of Directors and will depend upon, among other things, our earnings, financial condition, capital requirements, level of indebtedness, contractual restrictions with respect to the payment of dividends, and other considerations that our board of directors deems relevant. The Board's ability to declare a dividend is also subject to limits imposed by Delaware corporate law. In addition, our subsidiaries are permitted to pay dividends to us subject to (i) certain regulatory restrictions related to the maintenance of minimum net capital in those of our subsidiaries that are subject to net capital requirements imposed by the applicable governmental regulators, and (ii) general restrictions imposed on dividend payments under the jurisdiction of incorporation or organization of each subsidiary. Finally, our 2006 Credit Agreement and our Senior Notes limit our ability to pay dividends over a certain threshold without the approval of our lenders and any instruments governing our future indebtedness may also contain various covenants that limit our ability to pay dividends.
The following performance graph shows a comparison, from January 25, 2005 (the date our common stock commenced trading on Nasdaq) through December 31, 2007, of the cumulative total return for our common stock, the Nasdaq Composite Stock Index (CCMP), the Nasdaq Other Financial Index (CFIN) and our peer group. The peer group is comprised of ICAP plc, Collins Stewart Tullet plc from January 25, 2005 until December 14, 2006 and Tullet Prebon plc from December 15, 2006 through December 31, 2007 (each of which are listed in the U.K.), Cie Financiere Tradition (a Swiss listed company), MarketAxess Holdings Inc. (MKTX), Espeed Inc. (ESPD), the International Securities Exchange (ISE) from March 8, 2005 (the date of its initial public offering) until
December 19, 2007, Deutsche Boerse Group from December 20, 2007 until December 31, 2007 and the CME.
Collins Stewart Tullet plc completed a demerger under U.K. law on December 14, 2006 that resulted in the separate listing of Collins Stewart plc and Tullet Prebon plc. Tullet Prebon plc now comprises the inter-dealer brokerage operations of the former Collins Stewart Tullet plc. In future periods, our Peer Group will include the returns of Tullet Prebon plc from and after December 15, 2006. On December 19, 2007, Duetsche Boerse completed its acquisition of ISE. In future periods, our peer group will include the results of Deutsche Boerse Group.
The performance graph assumes the value of the initial investment in the Company's common stock, each index and the peer group was $100 on January 25, 2005 and that all dividends have been reinvested. Such returns are based on historical results and are not intended to suggest future performance. The returns of each company within the peer group have been weighted according to their respective stock market capitalization for purposes of arriving at a peer group average.
Recent Sales of Unregistered Securities
For the year ended December 31, 2007, we granted a total of 687,916 restricted stock units ("RSUs") to officers, directors and employees pursuant to our 2004 Equity Incentive Plan. The grant prices of these RSUs ranged from $61.61 to $97.38. These RSUs will be converted into common stock to be issued to our officers, directors and employees on an annual basis over their respective vesting period, which is generally over three years. These RSUs were granted pursuant to exemptions from registration provided by Rule 701 and/or Section 4(2) under the Securities Act.
Purchase of Equity Securities
The table below sets forth the information with respect to purchases made by the Company of its common stock during the quarterly period ended December 31, 2007.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected consolidated financial data for the five years ended December 31, 2007. This selected consolidated financial data should be read in conjunction with "Part IIItem 7Management's Discussion and Analysis of Financial Condition and Results of
Operation" and with our consolidated financial statements and the notes thereto contained in Part IIItem 8 in this Form 10-K.
have not settled as of their stated settlement dates. These receivables are substantially offset by the corresponding payables to brokers, dealers and clearing organizations for these unsettled transactions.
The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes thereof in Part IIItem 8 hereof. This discussion contains forward-looking statements. Actual results could differ materially from the results discussed in these forward-looking statements. Please see "Forward-Looking Statements" and "Risk Factors" in items 1 and 1A, respectively, of Part I hereof for a discussion of some of the uncertainties, risks and assumptions associated with these statements.
As an inter-dealer broker, our results of operations are impacted by a number of external market factors, including market volatility, organic growth of the derivative and other markets in which we provide our brokerage services, the particular mix of transactional activity in our various products and the competitive environment in which we operate. Outlined below are management's observations of these external market factors during the most recent fiscal period. The factors outlined below are not the only factors that have impacted our results of operations for the most recent fiscal period, and additional or other factors may impact, or have different degrees of impact, on our results of operations in future periods.
As a general rule, our business benefits from volatility in the markets that we serve, as periods of increased volatility typically coincide with more robust trading by our clients and a higher volume of transactions. Market volatility is driven by a range of external factors, some of which are market specific and some of which are correlated to general macro-economic conditions. During 2007, the credit and equity markets experienced heightened volatility due to the substantial decline of the U.S. subprime mortgage market and U.S. housing markets, the prospects of a slowing U.S. economy and a reduction in the availability of credit in the later half of the year.
The bond market experienced significant volatility in 2007 as the subprime market turmoil caused the prices of many bonds and loans to plunge despite corporate defaults remaining low. The revaluing of debt securities led to many banks writing down substantial amounts of mortgage backed and collateralized debt in the second half of 2007. Credit spreads, which were at near historical lows at the beginning of 2007, widened during the year as investors became more cautious.
The global equity markets experienced considerable volatility throughout the year as demonstrated by historical price volatility on the Chicago Board Options Exchange SPX and Dow Jones Industrial Average ("DJIA") volatility indices. However, despite the credit market turmoil and the resulting global economic concerns, many global equity markets posted gains for the year. The DJIA advanced 6.4% for the year, while the Dow Jones World Index, excluding the U.S., advanced 12%. Equities performed particularly well in emerging markets in Asia and Latin America, while Europe saw mixed results. The resilient nature of the global equity markets were witnessed throughout 2007 as various credit events precipitated large drops in global equity markets, which were followed, in many cases, by significant stock price gains.
Interest rate and foreign exchange markets experienced moderate to heightened volatility during the year resulting from inflationary and economic uncertainty, as well as the divergence of world monetary policy. The commodity markets continued to be strong as emerging market demand, particularly from China, pushed up commodity prices to record or near-record levels in 2007, with crude oil futures on the New York Mercantile Exchange ending the year at $95.98 a barrel, up over 57% for the year
Growth in Underlying Markets and New Product Offerings
Our business has historically benefited from growth in the OTC derivatives markets due to either the expansion of existing markets, including increased notional amounts outstanding or increased transaction volumes, or the development of new products or classes of products. The level of growth in these markets is difficult to measure on a quarterly basis as there are only a few independent, objective measures of growth in outstanding notional amount of OTC derivatives, all of which are published retrospectively and do not measure transactional volumes. Therefore, to help gauge growth in any particular quarter, management also looks to the published results of large OTC derivatives dealers and certain futures exchanges as potential indicators of transactional activity in the related OTC derivative markets.
The ISDA released the results of a survey in the third quarter of 2007 on notional amounts outstanding in global OTC markets as of June 2007. The survey results showed that the OTC derivative markets continued to experience strong growth in notional amounts outstanding with credit derivatives growing 75% from $26.0 trillion in June 2006 to $45.5 trillion in June 2007. Notional amounts outstanding of interest rate and currency derivatives grew by 38% over the same period from $250.8 trillion to $347.1 trillion, while equity derivatives notional outstanding growth amounted to 57% from $6.4 trillion to $10.0 trillion.
For several years, exchange traded derivatives have exhibited generally similar growth rates to those of related OTC derivative markets. CME, the New York Mercantile Exchange, IntercontinentalExchange and International Securities Exchange all reported solid growth in transactional volumes during 2007. These exchanges offer trading in futures and other products in several categories, including financial, equity and commodity products. Nevertheless, because there is currently minimal or no exchange-based trading activity of credit futures, exchange-traded volumes are not necessarily an indicator of activity levels of credit products, our largest product segment.
In addition, newer products and our expansion into growing markets have also contributed to the growth in our brokerage revenues in 2007. Transactions in later generation credit products, such as index exotic, asset backed and loan credit derivatives, have been a driver of growth in the overall credit derivative market during the year. New products have also developed in certain wet and dry freight and property derivative markets in 2007, while the currency and interest rate derivative markets have grown, in part, due to the growth of emerging markets in Eastern Europe and Asia.
Another major external market factor affecting our business and results of operations is competition, which may take the form of competitive pressure on the commissions we charge for our brokerage services or competition for brokerage personnel with extensive experience in the specialized markets we serve. Competition for the services of productive brokers was intense throughout 2007, especially in the second half of the year, as other inter-dealer brokers sought to bolster their derivative brokerage capabilities by hiring, or attempting to hire several key brokerage personnel. As a result, compensation and employee benefits as a percentage of revenues will be under pressure, and may increase, in the short term.
As more fully discussed below, our results of operations are significantly impacted by our revenue growth and the amount of compensation and benefits we provide to our employees. The following factors had a significant impact on our revenues and employee costs during the three year period ended December 31, 2007:
loan should the employee voluntarily terminate his or her employment or if the employee's employment is terminated for cause during the initial term of the agreement.
Results of Consolidated Operations
The following table sets forth our consolidated results of operations for the periods indicated:
The following table sets forth our consolidated results of operations as a percentage of our total revenues for the periods indicated:
Net income for the year ended December 31, 2007 was $94.9 million as compared to net income of $61.1 million for the year ended December 31, 2006, an increase of $33.8 million or approximately 55.3%. Total revenues increased by $223.3 million, or 29.9%, to $970.5 million for the year ended December 31, 2007 from $747.2 million for the prior year. Our increased revenues were primarily due to increased brokerage revenues across each of our product categories. Total expenses increased by $174.4 million, or 27.0%, to $819.8 million for the year ended December 31, 2007 from $645.4 million for the prior year. Expenses increased primarily because of increased compensation expense for the year ended December 31, 2007, which was attributable to an increase in performance-based bonus expense as a result of higher revenues, as well as higher sign-on bonus expense.
The following table sets forth the changes in revenues for the year ended December 31, 2007 as compared to the same period in 2006 (dollars in thousands):
product brokerage personnel headcount increased by 35 to 208 employees at December 31, 2007 from 173 employees at December 31, 2006.
The decrease in other revenues in 2007 to $33.1 million from $38.1 million in 2006 was primarily related to a decrease in contract revenue of $6.8 million, which was offset by an increase in analytics and market data revenues of $0.9 million. Contract revenue consists primarily of revenues recognized under a long-term contract pursuant to which we developed an online foreign exchange currency trading system and customized it for a customer. During the second quarter of 2006, the project was substantially completed and consequently, we recorded $5.9 million in contract revenues.
The following table sets forth the changes in expenses from year ended December 31, 2007 as compared to the same period in 2006 (dollars in thousands):
principal transactions executed in our Paris office. Principal transactions are generally settled through third party clearing organizations that charge us a fee for their services. We also use the services of stock exchanges and floor brokers, to assist in the execution of transactions. Fees paid to floor brokers and execution fees paid to exchanges in these circumstances are included in clearing fees. In addition, clearing fees also includes fees incurred in certain equity transaction executed on an agency basis.
Year ended December 31, 2006 Compared to the Year Ended December 31, 2005
Net income for the year ended December 31, 2006 was $61.1 million as compared to net income of $48.1 million for the year ended December 31, 2005, an increase of $13.0 million or approximately 27.0%. Total revenues increased by $213.6 million, or 40.0%, to $747.2 million for the year ended December 31, 2006 from $533.6 million for the prior year. Our increased revenues were primarily due to increased brokerage revenues across each of our product categories. Total expenses increased by $196.1 million, or 43.6% to $645.4 million for the year ended December 31, 2006 from $449.3 million for the prior year. Expenses increased primarily because of increased compensation expense for the year ended December 31, 2006, which was attributable to an increase in performance-based bonus expense as a result of higher revenues, as well as higher sign-on bonus expense.
The following table sets forth the changes in revenues for the year ended December 31, 2006 as compared to the same period in 2005 (dollars in thousands):
The following table sets forth the changes in expenses for the year ended December 31, 2006 as compared to the same period in 2005 (dollars in thousands):
Results of Segment Operations
Our operations are managed along three operating segments: North America Brokerage, Europe Brokerage and Asia Brokerage. Our brokerage operations provide brokerage services in four broad product categories: credit, financial, equity and commodity. We aggregated our operating segments into two reportable segments: Brokerage and "All Other". The Brokerage segment includes operations from North America and Europe. The All Other segment captures costs that are not directly assignable to the Brokerage segment, primarily consisting of our corporate business activities and operations from analytics and market data. Additionally, the All Other segment includes our Asia brokerage operations as these brokerage operations do not meet the quantitative threshold for separate disclosure in accordance with Statement of Financial Accounting Standards 131 No., Disclosures About Segments of an Enterprise and Related Information.
The following tables summarize our revenues, expenses and pre-tax income by segment:
Year ended December 31, 2007 Compared to the Year Ended December 31, 2006
Year ended December 31, 2006 Compared to the Year Ended December 31, 2005
Consolidated Expenses for further discussion on these areas. Also see below for other expenses that were not allocated to the segments.
Quarterly Results of Operations
The following table sets forth, by quarter, our unaudited statement of income data for the period from January 1, 2006 to December 31, 2007. Results of any period are not necessarily indicative of results for a full year and may, in certain periods, be affected by seasonal fluctuations in our business.
The following table sets forth our quarterly results of operations as a percentage of our total revenues for the indicated periods:
The tables below detail our brokerage revenues by product category in dollars and as a percentage of our total brokerage revenues for the indicated periods.
Liquidity and Capital Resources
Throughout the year ended December 31, 2007, we have financed our operations through cash flows from operations, proceeds received from sales of our equity securities and borrowings under our credit facilities. On February 24, 2006, we amended and restated the terms of our 2004 Credit Agreement with the Bank of America and certain lenders, which we refer to as the 2006 Credit Agreement. The 2006 Credit Agreement provided for maximum borrowings to be increased from $80.0 million under the 2004 Credit Agreement to $135.0 million under the 2006 Credit Agreement and extended the expiration date from August 23, 2007 to February 24, 2011. In September 2006, we entered into an agreement that increased the maximum permitted borrowing under the 2006 Credit Agreement to $160.0 million. In January 2008, we amended the 2006 Credit Agreement to increase the maximum permitted borrowing to $265.0 million and we completed a private placement of the Senior Notes. See Note 22 to the Consolidated Financial Statements in Part IIItem 8 for further details on the amendment to the 2006 Credit agreement and the private placement of the Senior Notes.
Cash and cash equivalents consist of cash and highly liquid investments with maturities, when purchased, of three months or less. At December 31, 2007, we had $240.4 million of cash and cash equivalents compared to $181.5 million and $144.1 million at December 31, 2006 and 2005, respectively. The changes to our cash and cash equivalents balances for these periods are due to our operating, investing and financing activities as discussed below.
Net cash provided by operating activities increased to $136.0 million for the year ended December 31, 2007, compared with $72.6 million for the same period in the prior year. The improvement is primarily related to our increased net income and the increase in certain non-cash items such as deferred compensation expense, depreciation and amortization and tax benefits from share-based compensation. Additionally, the increase is partially due to the improvement in certain working capital items such as accrued compensation, the net receivable/payables to brokers, dealers and clearing organizations and other liabilities, which was partially offset by an increase in accrued commissions receivable. The increase in accrued commissions receivable balance is related to an increase in agency commission revenue, which increased by 34% for the year ended December 31, 2007 as compared to the same period in the prior year. Additionally, the average number of days to collect receivables increased in the second half of 2007 as compared to the prior year. Net cash provided by operations increased to $72.6 million for the year ended December 31, 2006, compared with $15.7 million from the same period from the prior year. The increase is primarily due to an increase in net income adjusted for non-cash items and amounts utilized for working capital. The $9.9 million utilized for working capital primarily consisted of changes in net receivables to brokers, dealers and clearing organizations and accrued commissions receivables, offset by increases in accrued compensation, income taxes payable and accounts payable and accrued liabilities. The increase in accrued commissions receivable balance is related to an increase in agency commission revenue, which increased by 42% for the year ended December 31, 2006 as compared to the same period in the prior year. Additionally, the average number of days to collect receivables increased slightly during 2006 as compared to the prior year.
Net cash used in investing activities for the year ended December 31, 2007 was $53.6 million compared to $109.4 million for the same period from the prior year. The decrease in cash used for investing activities was primarily due to a decrease in cash used for business acquisitions, which was offset by an increase in cash used in investing activities such as capital expenditures and other investments. Net cash used in investing activities for the year ended December 31, 2006 increased by $73.7 million from the same period in the prior year. The increase was primarily related to the cash used for business acquisitions.
Net cash used in financing activities for the year ended December 31, 2007 was $23.4 million compared to $73.9 million provided by the same period in the prior year. The decrease in cash provided by financing activities was primarily due to a decrease in net borrowings and an increase in cash used for repurchases of common stock, which was offset by an increase in cash received from stock option exercises and tax benefits related to share-based compensation. Net cash used in financing activities for the year ended December 31, 2005 reflected net proceeds received from our initial public offering and the exercise of stock options and a warrant, offset by the repayment of loan note payable to JPI, as well as net repayments of amounts under our credit facility.
Under the 2006 Credit Agreement, loans will bear interest at the London Interbank Offered Rate ("LIBOR") plus a margin determined by our consolidated leverage ratio as defined in the 2006 Credit
Agreement. The 2006 Credit Agreement contains covenants which restrict, among other things, our ability to borrow, pay dividends, distribute assets, guarantee debts of others and lend funds to affiliated companies and contains criteria on the maintenance of certain financial statement amounts and ratios, all as defined in the agreement. At December 31, 2007, there was $56.0 million in outstanding borrowings and $7.2 million of outstanding letters of credit under our 2006 Credit Agreement. At December 31, 2007, we had $96.8 million of availability under the 2006 Credit Agreement. Subsequent to year end, we borrowed $165.0 million to fund the acquisition of Trayport, of which $60.0 million was repaid with proceeds from the private placement of the Senior Notes described above. See Note 22 to the Consolidated Financial Statements in Part IIItem 8 for details. We are currently in compliance with all of our obligations under the 2006 Credit Agreement.
Our liquidity and available cash resources are in part restricted by the regulatory requirements of our operating subsidiaries including GFI Securities LLC, GFI Securities Limited, GFI Brokers Limited, GFI (HK) Securities LLC, GFI (HK) Brokers Ltd. and GFI Group PTE Ltd. These operating subsidiaries are subject to minimum capital requirements and/or licensing and financial requirements imposed by their respective market regulators that are intended to ensure general financial soundness and liquidity based on certain minimum capital, licensing and financial requirements. U.S. and U.K. regulations prohibit a registered broker-dealer from repaying borrowings of its parent or affiliates, paying cash dividends, making loans to its parent or affiliates or otherwise entering into transactions that result in a significant reduction in its regulatory net capital position without prior notification or approval from its principal regulator. Our non-regulated subsidiaries are not subject to these restrictions. The capital structures of each of our broker-dealer subsidiaries are designed to provide each with capital and liquidity consistent with its business and regulatory requirements.
Our U.S. broker-dealer, GFI Securities LLC, is subject to the net capital rules under the Exchange Act and the Commodity Exchange Act. As of December 31, 2007, GFI Securities LLC had Net Capital, as defined under the Exchange Act, of $49.4 million, which was $49.1 million in excess of its required minimum net capital of $0.3 million.
GFI Securities Limited and GFI Brokers Limited are subject to the capital requirements of FSA in the United Kingdom. As of December 31, 2007, GFI Securities Limited had financial resources, as defined by the FSA, of $31.9 million, which was $13.9 million in excess of its required financial resources of $18.0 million. As of December 31, 2007, GFI Brokers Limited had financial resources, as defined by the FSA, of $43.3 million, which was $32.4 million in excess of its required financial resources of $10.9 million.
GFI Securities Limited's Japanese branch is subject to certain licensing requirements established by the Foreign Securities Firms Law (the "FSFL") in Japan. As part of the licensing requirements, GFI Securities Limited's Japanese branch is required to maintain "brought-in" capital, as defined under the FSFL, of 50.0 million Japanese Yen (approximately $0.4 million). In addition, GFI Securities Limited is required to maintain a capital base of 1,000 million Japanese Yen (approximately $9.0 million). GFI Securities Limited's Japanese branch is also subject to the net capital rule promulgated by the FSFL, which requires that net worth, including "brought-in" capital, exceed a ratio of 120.0% of relevant expenditure. At December 31, 2007, GFI Securities Limited and its Japanese branch were in compliance with these capital requirements.
GFI Securities Limited's Paris branch was established through the exercise of its passport right to open a branch in an EEA state. The establishment of the branch was approved by FSA and acknowledged by Banque de France in France. The branch is subject to the conduct of business rules of AMF when dealing with resident customers of France and is regulated, in part, by the FSA.
GFI Brokers Limited's Sydney branch is registered as a foreign corporation in Australia and is conditionally exempt from the requirement to hold an Australian financial services license under the Australian Securities and Investments Commission Corporations Act 2001 in respect of the financial
services it provides in Australia. This exemption applies to foreign companies regulated by the FSA in accordance with U.K. regulatory standards.
GFI (HK) Securities LLC is subject to the capital requirements of the SFC in Hong Kong. At December 31, 2007, GFI (HK) Securities LLC had net capital of approximately $0.6 million, which was $0.2 million in excess of its required minimum net capital of $0.4 million.
GFI (HK) Brokers Ltd. is registered with and regulated by the HKMA. As part of this registration, GFI (HK) Brokers Ltd. is required to maintain stockholders' equity of 5.0 million Hong Kong dollars (or approximately $0.7 million). At December 31, 2007, GFI (HK) Brokers Ltd. Had stockholders' equity of 11.4 million Hong Kong dollars (or approximately $1.5 million), which exceeds the minimum requirement by 6.4 million Hong Kong dollars (or approximately $0.8 million).
In Singapore, the MAS regulates our subsidiary, GFI Group PTE Ltd. Our compliance requirements with the MAS include, among other things, maintaining stockholders' equity of 3.0 million Singapore dollars and monitoring GFI Group PTE Ltd.'s trading practices and business activities. At December 31, 2007, GFI Group PTE Ltd had stockholders' equity of 7.0 million Singapore dollars (approximately $4.8 million), which was 4.0 million Singapore dollars (approximately $2.8 million) in excess of its required stockholders' equity.
GFI Korea Money Brokerage Limited is licensed and regulated by the Ministry of Finance and Economy to engage in foreign exchange brokerage business, and is subject to certain regulatory requirements under the Foreign Exchange Transaction Act and regulations thereunder. As a licensed foreign exchange brokerage company, GFI Korea Money Brokerage Limited is required to maintain minimum paid-in capital of 5.0 billion Korean Won. At December 31, 2007, GFI Korea Money Brokerage Limited met the minimum requirement for paid-in-capital of 5.0 billion Korean Won (or approximately $5.3 million).
In June 2007, we signed a new lease which will serve as our primary U.S. office space. We are in the process of building out the new office space and we anticipate that personnel will be relocated beginning in the second quarter of 2008. We anticipate that the aggregate cost of the build out of the new office space and relocation costs will be approximately $30.0 million of which $11.6 million was paid through December 31, 2007. In addition, as of December 31, 2007, we had purchase commitments related to this build out of approximately $14.9 million which is expected to be paid during the first six months of 2008 and is included in our Contractual Obligations and Commitments described below.
It is our expectation that from time to time we may purchase additional shares of our common stock on the open market in accordance with a stock repurchase program authorized by the Board of Directors. See Note 11 to our Consolidated Financial Statements for further discussion of the stock repurchase program.
Prior to 2008, we retained all earnings for investment in our business. In February 2008, our Board of Directors declared a special cash dividend and has also approved a policy of paying quarterly dividends, subject to available cash flow from operations, other considerations and the determination of the amount by our Board of Directors. The special cash dividend is payable on March 31, 2008 and it is estimated it will be approximately $14.7 million.
We believe that, based on current levels of operations and anticipated growth, our cash from operations, together with cash currently available and our ability to borrow additional funds under our 2006 Credit Agreement, will be sufficient to fund our operations for at least the next twelve months. Poor financial results, unanticipated expenses, unanticipated acquisitions or unanticipated strategic investments could give rise to additional financing requirements sooner than we expect. There can be no assurance that equity or debt financing will be available when needed or, if available, that the financing will be on terms satisfactory to us and not dilutive to our then-current stockholders.
Contractual Obligations and Commitments
The following table summarizes certain of our contractual obligations as of December 31, 2007:
Off-Balance Sheet Entities
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Critical Accounting Policies and Estimates
This Management's Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements which have been prepared in accordance with U.S. generally accepted accounting principles, which require us to make estimates, judgments and
assumptions that affect the reported amounts of assets, liabilities, net revenue and expenses, and the disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience and on various other factors that we believe are reasonable under the circumstances. We believe that the accounting estimates employed and the resulting balances are reasonable; however, actual results may differ materially from these estimates under different assumptions or conditions.
An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made; if different estimates reasonably could have been used; or if changes in the estimate that are reasonably likely to occur periodically could materially impact the financial statements. We believe the following critical accounting policies reflect the significant estimates and assumptions used in the preparation of the Consolidated Financial Statements.
We provide brokerage services to our clients in the form of either agency or principal transactions. In agency transactions, we charge commissions for executing transactions between buyers and sellers. We earn revenue from principal transactions on the spread between the buy and sell price of the security that is brokered. Our principal transaction revenue is primarily derived from matched principal transactions. In matched principal transactions, we simultaneously agree to buy instruments from one party and sell them to another. Certain of our brokerage desks enter into unmatched principal transactions in the ordinary course of business, primarily for the purpose of facilitating our clients' execution needs or to add liquidity to certain illiquid markets. These unmatched positions are intended to be held short term. Brokerage revenues and related expenses from agency and principal transactions are recognized on a trade date basis. We do not receive actual payment of the commissions or the net spread until the specific account receivable is collected in an agency transaction or until the specific settlement date in a principal transaction.
We evaluate the level of our allowance for doubtful accounts based on the length of time receivables are past due and our historical experience. Also, if we are aware of a client's inability to meet its financial obligations, we record a specific provision for doubtful accounts in the amount of the estimated losses which will result from the inability of that client to meet its financial obligation. The amount of the provision will be charged against the amounts due, reducing the receivable to the amount we reasonably believe will be collected. If the financial condition of one of our clients were to deteriorate, resulting in an impairment of its ability to make payments, an additional provision could be required. Due to changing economic business and market conditions, we review the provision monthly and make changes to the provision as appropriate. Our allowance for doubtful accounts at December 31, 2007 was $4.2 million.
Software Development CapitalizationInternal-Use Software
We capitalize certain costs of software developed or obtained for internal use in accordance with the Statement of Position ("SOP") 98-1, Accounting for the Costs of Corporate Software Developed or Obtained for Internal Use. We capitalize software development costs when application development begins and it is probable that the project will be completed and the software will be used as intended. Costs associated with preliminary project stage activities, maintenance and all other post implementation stage activities are expensed as incurred. Our policy provides for the capitalization of certain payroll and payroll-related costs for employees who are directly associated with internal use computer software projects, as well as external direct costs of materials and services associated with developing or obtaining internal use software. Capitalized personnel costs are limited to time directly spent on such projects. Capitalized costs are ratably amortized, using the straight-line method, over the estimated useful lives which are typically over three years. Our judgment as to which costs to capitalize, when to begin capitalizing such costs and what period to amortize the costs over, may materially affect
our results of operations. If management determines that the fair value of the software is less than the carrying value, an impairment loss would be recognized in an amount equal to the difference between the fair value and the carrying value.
Goodwill and Intangible Assets
Under SFAS No. 142, Goodwill and Other Intangible Assets, management is required to perform a detailed review, at least annually, of the carrying value of our intangible assets, which includes goodwill. In this process, management is required to make estimates and assumptions in order to determine the fair value of our assets and liabilities and projected future earnings using various valuation techniques, including a discounted cash flow model. Management uses its best judgment and information available to it at the time to perform this review. Because management's assumptions and estimates are used in projecting future earnings as part of the valuation, actual results may differ. If management determines that the fair value of the intangible asset is less than its carrying value, an impairment loss would be recognized in an amount equal to the difference between the fair value and the carrying value.
In the normal course of business, we have been named as defendants in various lawsuits and proceedings and have been involved in certain regulatory examinations. Additional actions, investigations or proceedings may be brought from time to time in the future. We are subject to the possibility of losses from these various contingencies. Considerable judgment is necessary to estimate the probability and amount of any loss from such contingencies. An accrual is made when it is probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. We accrue a liability for the estimated costs of adjudication or settlement of asserted and unasserted claims existing as of the balance sheet date. We have recorded reserves for certain contingencies to which we may have exposure, such as reserves for certain income tax and litigation contingencies and contingencies related to the employer portion of National Insurance Contributions in the U.K. We disclose asserted claims when it is at least reasonably possible that an asset had been impaired or a liability had been incurred as of the date of the financial statements and unasserted claims when it is considered probable that a claim will be asserted and there is a reasonable possibility that the outcome will be unfavorable.
In accordance with SFAS No. 109, Accounting for Income Taxes, we provide for income taxes using the asset and liability method under which deferred income taxes are recognized for the estimated future tax effects attributable to temporary differences and carry-forwards that result from events that have been recognized either in the financial statements or the income tax returns, but not both. The measurement of current and deferred income tax liabilities and assets is based on provisions of enacted tax laws. Valuation allowances are recognized if, based on the weight of available evidence, it is more likely than not that some portion of the deferred tax assets will not be realized. Our interpretation of complex tax law may impact our measurement of current and deferred income taxes.
Effective January 1, 2007, we adopted FIN 48. It is our policy to provide for uncertain tax positions and the related interest and penalties based upon management's assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. At December 31, 2007, we believe we have appropriately accounted for any unrecognized tax benefits. To the extent we prevail in matters for which a liability for an unrecognized tax benefit is established or we are required to pay amounts in excess of the liability, our effective tax rate in a given financial statement period may be affected.
We are subject to regular examinations by the Internal Revenue Service, taxing authorities in foreign countries, and states in which we have significant business operations. We regularly assess the likelihood of additional assessments in each taxing jurisdiction resulting from on-going and subsequent years' examinations. Included in our current tax expense are charges to accruals for expected tax assessments in accordance with SFAS No. 5, Accounting for Contingencies. The resolution of these tax matters could have a material impact on our effective tax rate.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements ("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements. SFAS 157 requires companies to disclose the fair value of its financial instruments according to a fair value hierarchy, as defined. Additionally, companies are required to provide enhanced disclosure for certain financial instruments within the hierarchy, including a reconciliation of the beginning and ending balances separately for each major category of assets and liabilities. SFAS 157 is effective for financial statements for fiscal years beginning after November 15, 2007. In February 2008, the Financial Accounting Standards Board ("FASB") issued Financial Standards Position ("FSP") FAS 157-b which delays the effective date of SFAS 157 for all nonfinancial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at lease annually) to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of this FSP. We adopted SFAS 157 on January 1, 2008 except as it applies to those nonfinancial assets and liabilities within the scope of FSP FAS 157-b. The adoption of SFAS 157 as it relates to financial assets and liabilities did not have a material impact on our consolidated financial statements. We will adopt SFAS 157 for those nonfinancial assets and liabilities as noted in FSP FAS 157-b on January 1, 2009. We are currently evaluating the impact of adopting SFAS 157 for nonfinancial assets and liabilities will have on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an Amendment of FASB Statement No. 115 ("SFAS 159"). SFAS 159 provides a "Fair Value Option" under which a company may irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities. This Fair Value Option will be available on a contract-by-contract basis with changes in fair value recognized in earnings as those changes occur. We adopted SFAS 159 on January 1, 2008 and we did not elect to apply the fair value option to any specific financial assets or liabilities. The adoption of SFAS 159 did not have a material impact on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statementsan amendment of ARB No. 51 ("SFAS 160"). SFAS 160 requires reporting entities to present noncontrolling (minority) interests as equity (as opposed to as a liability or mezzanine equity) and provides guidance on the accounting for transactions between an entity and noncontrolling interests. SFAS 160 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and we will adopt SFAS 160 on January 1, 2009. We are currently evaluating the impact of adopting SFAS 160 on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (revised 2007) ("SFAS 141(R)"). SFAS 141(R) requires the acquiring entity in a business combination to recognize the full fair value of assets acquired and liabilities assumed in the transaction (where a full or partial acquisition); establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; requires the expensing of most transaction and restructuring costs; and requires the acquirer to disclose to investors and other users all of the information needed to evaluate and understand the nature and financial effect of the business combination. SFAS 141(R) applies to all transactions or other events in which we obtain control of one or more businesses, including those
sometimes referred to as "true-mergers" or "mergers of equals" and combinations achieved without the transfer of consideration, for example, by contract alone or through the lapse of minority veto rights. SFAS 141(R) is effective for financial statements issued for fiscal years beginning after December 15, 2008. Accordingly, any business combinations that we engage in will be recorded and disclosed following the existing GAAP until January 1, 2009. We are currently evaluating the impact of adopting SFAS 141(R) on our consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISLOSURE ABOUT MARKET RISK
In the normal course of business, we are exposed to foreign currency exchange rate fluctuations related to our international brokerage operations, changes in interest rates which impact our variable-rate debt obligations, credit risk associated with potential non-performance by counterparties or customers and market risk associated with our principal transactions. Our risk management strategy with respect to certain of these market risks includes the use of derivative financial instruments. We use derivatives only to manage existing underlying exposures of the Company. Accordingly, we do not use derivative contracts for speculative purposes. Our market risks, risk management strategy, and a sensitivity analysis estimating the effects of changes in fair values for exposures relating to foreign currency and interest rate exposures are outlined below.
Foreign Currency Exposure Risk
We are exposed to risks associated with changes in foreign exchange rates. As foreign currency exchange rates change, the U.S. Dollar equivalent of revenues and expenses denominated in foreign currencies change. Our U.K. operations generate a majority of their revenues in U.S. Dollars and Euros but pay a significant amount of their expenses in British Pounds. We enter into foreign exchange forward and foreign exchange collar contracts ("Foreign Exchange Derivative Contracts") to mitigate our exposure to foreign currency exchange rate fluctuations. Certain of these Foreign Exchange Derivative Contracts were designated and qualified as foreign currency cash flow hedges under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. The gain or loss on derivatives designated as cash flow hedges is included in other comprehensive income in the period that changes in fair value occur and is reclassified to income in the same period that the hedged item affects income. At December 31, 2007, we had no Foreign Exchange Derivative Contracts that were designated as foreign currency cash flow hedges.
We are also exposed to counterparty credit risk for nonperformance of Foreign Exchange Derivative Contracts and in the event of nonperformance, to market risk for changes in currency rates. The counterparties with whom we execute foreign exchange derivative contracts are major international financial institutions. We monitor our positions with, and the credit quality of, these financial institutions and we do not anticipate nonperformance by the counterparties.
While our international results of operations, as measured in U.S. Dollars, are subject to foreign exchange rate fluctuations, we do not consider the related risk to be material to our results of operations. If the Euro and the British Pound strengthened by 10% against the U.S. Dollar, the net impact to our net income would be a reduction of approximately $8.5 million as of December 31, 2007.
Interest Rate Risk
We had $56.0 million in variable-rate debt outstanding at December 31, 2007. These debt obligations are subject to fluctuations in interest rates, which impact the amount of interest we must pay. If variable interest rates were to increase by 0.50%, the annual impact to our net income would be a reduction of approximately $0.2 million.
Credit risk arises from potential non-performance by counterparties of our matched principal business, as well as from nonpayment of commissions by customers of our agency brokerage business. We have established policies and procedures to manage our exposure to credit risk. We maintain a thorough credit approval process to limit exposure to counterparty risk and employ stringent monitoring to control the market and counterparty risk from our matched principal business. Our brokers may only execute transactions for clients that have been approved by our credit committee following review by our credit department. Our credit approval process includes verification of key financial information and operating data and anti-money laundering verification checks. Our credit review process includes consideration of independent credit agency reports and a visit to the entity's premises, if necessary. We have developed and utilize a proprietary, electronic credit risk monitoring system.
Credit approval is granted by our credit committee, which is comprised of senior management and representatives from our compliance, finance and legal departments. Credit approval is granted subject to certain trading limits and may be subject to additional conditions, such as the receipt of collateral or other credit support. Counterparties are reviewed for continued credit approval on at least an annual basis, and the results are reviewed by the credit committee. Maintenance procedures include reviewing current audited financial statements and publicly available information on the client, collecting data from credit rating agencies where available and reviewing any changes in ownership, title or capital of the client. For our agency business, our approval process consists of the requisite anti-money laundering and know-your-customer verifications. In the last five years, we have had no material losses due to the nonpayment by, or the nonperformance of, our customers.
Through our subsidiaries, we execute matched principal transactions in which we act as a "middleman" by serving as counterparty to both a buyer and a seller in matching back-to-back trades. These transactions are then settled through a third-party clearing organization. Settlement typically occurs within one to three business days after the trade date. Cash settlement of the transaction occurs upon receipt or delivery of the underlying instrument that was traded. In a limited number of circumstances, we may settle a principal transaction on a free of payment basis or by physical delivery of the underlying instrument.
The number of matched principal trades we execute has continued to grow as compared to prior years. Matched principal trades in the less liquid markets on which we focus are less likely to settle on a timely basis than transactions in more liquid markets. Receivables from brokers, dealers and clearing organizations and payables to brokers, dealers and clearing organizations on our Consolidated Statements of Financial Condition primarily represent the simultaneous purchase and sale of the securities associated with those matched principal transactions that have not settled as of their stated settlement dates. Our experience has been that substantially all of these transactions ultimately settle.
Matched principal transactions expose us to risks. In executing matched principal transactions, we are exposed to the risk that one of the counterparties to a transaction may fail to fulfill its obligations, either because it is not matched immediately or, even if matched, one party fails to deliver the cash or securities it is obligated to deliver. Our focus on less liquid and OTC markets exacerbates this risk for us because transactions in these markets are less likely to settle on a timely basis. Adverse movements in the prices of securities that are the subject of these transactions can increase our risk. In addition, widespread technological or communication failures, as well as actual or perceived credit difficulties or the insolvency of one or more large or visible market participants, could cause market-wide credit difficulties or other market disruptions. These failures, difficulties or disruptions could result in a large number of market participants not settling transactions or otherwise not performing their obligations.
We are subject to financing risk in these circumstances because if a transaction does not settle on a timely basis, the resulting unmatched position may need to be financed, either directly by us or through one of our clearing organizations at our expense. These charges may be recoverable from the failing counterparty, but sometimes are not. Finally, in instances where the unmatched position or failure to deliver is prolonged or widespread due to rapid or widespread declines in liquidity for an instrument, there may also be regulatory capital charges required to be taken by us, which depending on their size and duration, could limit our business flexibility or even force the curtailment of those portions of our business requiring higher levels of capital. Credit or settlement losses of this nature could adversely affect our financial condition or results of operations.
In the process of executing matched principal transactions, miscommunications and other errors by our clients or us can arise whereby a transaction is not completed with one or more counterparties to the transaction, leaving us with either a long or short unmatched position. These unmatched positions are referred to as "out trades," and they create a potential liability for us. If an out trade is promptly discovered and there is a prompt disposition of the unmatched position, the risk to us is usually limited. If the discovery of an out trade is delayed, the risk is heightened by the increased possibility of intervening market movements prior to disposition. Although out trades usually become known at the time of, or later on the day of, the trade, it is possible that they may not be discovered until later in the settlement process. When out trades are discovered, our policy is generally to have the unmatched position disposed of promptly, whether or not this disposition would result in a loss to us. The occurrence of out trades generally rises with increases in the volatility of the market and, depending on their number and amount, such out trades have the potential to have a material adverse effect on our financial condition and results of operations.
In addition, liability for unmatched trades could adversely affect our results of operations and balance sheet. We allow certain of our brokerage desks to enter into unmatched principal transactions in the ordinary course of business, primarily for the purpose of facilitating clients' execution needs or to add liquidity to certain illiquid markets. As a result, we have market risk exposure on these unmatched principal transactions. Our exposure varies based on the size of the overall positions, the terms of the instruments brokered, and the amount of time the positions are held before we dispose of the position. We do not track our exposure to unmatched positions on an intra-day basis; however, we attempt to mitigate our market risk on these positions by hedging our exposure. These unmatched positions are intended to be held short term. However, due to a number of factors, including the nature of the position and access to the market on which it trades, we may not be able to match the position and we may be forced to hold a position overnight that has not been hedged. To the extent these unmatched positions are not disposed of intra-day, we mark these positions to market.
Adverse movements in the securities underlying these positions or a downturn or disruption in the markets for these positions could result in a substantial loss. In addition, principal gains and losses resulting from these positions could on occasion have a disproportionate effect, positive or negative, on our financial condition and results of operations for any particular reporting period.
We also attempt to mitigate the risks associated with principal transactions through our credit approval and credit monitoring processes. We maintain a credit approval process as described above under the discussion of "Credit Risk" as a means of mitigating exposure to counterparty risk. In addition, our credit risk department regularly monitors concentration of market risk to financial instruments, countries or counterparties and regularly monitors trades that have not settled within prescribed settlement periods or volume thresholds. We have developed and utilize a proprietary, electronic risk monitoring system, which provides management with twice daily credit reports that analyze credit concentration.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
the Board of Directors and Stockholders of
We have audited the accompanying consolidated statements of financial condition of GFI Group Inc. and subsidiaries (the "Company") as of December 31, 2007 and 2006, and the related consolidated statements of income, comprehensive income, cash flows and changes in stockholders' equity for each of the three years in the period ended December 31, 2007. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of GFI Group Inc. and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2007, based on the criteria established in "Internal ControlIntegrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2008 expressed an unqualified opinion on the Company's internal control over financial reporting.
/s/ DELOITTE AND TOUCHE LLP
York, New York
See notes to consolidated financial statements
See notes to consolidated financial statements
See notes to consolidated financial statements
See notes to consolidated financial statements