Item 7. Management’s Discussion and Analysis
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The purpose of this section is to discuss and analyze our consolidated financial condition, liquidity and capital resources and results of operations for the years ended December 31, 2021 and 2020. For a discussion of our results of operations and liquidity and capital resources for the year ended December 31, 2019, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2020.
This analysis should be read in conjunction with the consolidated financial statements and related footnote disclosures contained in this report.
BACKGROUND
The consolidated financial statements include the accounts of Oppenheimer Holdings Inc. and its consolidated subsidiaries (together, the "Company", "Firm", "we", "our" or "us"). The Company's consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The following discussion should be read in conjunction with the consolidated financial statements and notes thereto which appear elsewhere in this annual report.
Oppenheimer Holdings Inc., through its operating subsidiaries, is a leading middle market investment bank and full service broker-dealer that is engaged in a broad range of activities in the securities industry, including retail securities brokerage, institutional sales and trading, market-making, research, investment banking (both corporate and public finance), investment advisory and asset management services and trust services. Its principal subsidiaries are Oppenheimer & Co. Inc. ("Oppenheimer") and Oppenheimer Asset Management Inc. ("OAM"). As of December 31, 2021, we provided our services from 92 offices in 24 states located throughout the United States, offices in Puerto Rico, Tel Aviv, Israel, Hong Kong, China, London, England, St. Helier, Isle of Jersey, Munich, Germany and Geneva, Switzerland. Client assets under administration ("CAUA") as of December 31, 2021 totaled $122.1 billion. The Company provides investment advisory services through OAM and Oppenheimer Investment Management LLC ("OIM") and Oppenheimer's financial advisor directed programs. At December 31, 2021, client assets under management LLC ("AUM") totaled $46.2 billion. We also provide trust services and products through Oppenheimer Trust Company of Delaware and discount brokerage services through Freedom Investments, Inc. ("Freedom"). Through OPY Credit Corp., we offer syndication as well as trading of issued syndicated corporate loans. At December 31, 2021, the Company employed 2,913 employees (2,868 full-time and 45 part-time), of whom 996 were financial advisors.
Outlook
We are focused on growing our private client and asset management businesses through strategic additions of experienced financial advisors in our existing branch system and employment of experienced money management personnel in our asset management business as well as deploying our capital for expansion through targeted acquisitions. We are increasingly creating and investing in private market opportunities on our own behalf and on behalf of qualified clients. We are also focused on opportunities in our capital market businesses where we can employ individual experienced personnel and/or small units that will improve our ability to attract institutional clients in both equities and fixed income without significantly raising our risk profile. In investment banking we are committed to grow our footprint by adding experienced bankers within our existing industry practices as well as in new industry areas in which we believe we can be successful.
We continuously invest in and improve our technology platform to support client service and to remain competitive while carefully managing expenses. The Company's long-term growth plan is to continue to expand existing offices by hiring experienced professionals as well as expand through the purchase of operating branch offices from other broker-dealers or the opening of new branch offices in attractive locations, and to continue to grow and develop the existing trading, investment banking, investment advisory and other divisions. We are committed to continuing to improve our technology capabilities to ensure compliance with industry regulations, support client service and expand our wealth management and capital markets capabilities. We recognize the importance of compliance with applicable regulatory requirements and are committed to performing rigorous and ongoing assessments of our compliance and risk management effort, and investing in people and programs, while providing a platform with first class investment programs and services.
The Company is also reviewing its full service business model to determine the opportunities available to build or acquire closely related businesses in areas where others have shown some success. Equally important is the search for viable acquisition candidates. Our long-term intention is to pursue growth by acquisition where we can find a comfortable match in terms of
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corporate goals and personnel at a price that would provide our shareholders with incremental value. We review potential acquisition opportunities from time to time on the basis of fulfilling the Company's strategic goals, while evaluating and managing our existing businesses. In addition, the Company may from time to time make minority private investments out of excess capital in allied or unrelated businesses with the goal of either syndicating the investment to eligible clients or retaining ownership because we believe them to be an attractive investment.
Impact of Interest Rates
The Federal Reserve has reduced short-term interest rates, largely due to the impact of the COVID-19 Pandemic and its out-sized negative impact on the economy, resulting in a decrease in fees the Company earned from FDIC-insured deposits of clients through a program offered by the Company. Decreases in short-term interest rates, increases in deposits rates paid to clients, and/or a significant decline in our clients' cash balances have a negative impact on our earnings. The Federal Reserve reduced its benchmark rate significantly during two separate unscheduled meetings in March 2020. Low interest rates have continued to negatively impact our earnings in an otherwise favorable environment. The Federal Reserve has commenced tapering its purchase of U.S. Treasuries and mortgage-backed securities which is scheduled to be completed by March 2022 with no further planned purchases thereafter. Recently the Federal Reserve announced its intention to begin increasing the discount rate in increments beginning in March 2022 with the markets believing that there may be up to five such increases during 2022. The increase in interest rates if and when they take place will be favorable to the Company’s interest-based revenues. However, such increases while bringing down inflationary pressures may also prove detrimental to economic expansion and thereby to financial markets in general. The impact of rate increases seems likely to increase volatility in financial markets, decrease the value of fixed income investments and impact equity share prices.
CORONAVIRUS DISEASE 2019 ("COVID-19 PANDEMIC")
The Company continues to monitor the effects of the COVID-19 pandemic both on a national level as well as regionally and locally and is responding accordingly. In addition, we continue to provide frequent communications to clients, employees, and regulators regarding the impact of COVID-19 on our business. We have adopted enhanced cleaning practices and other health protocols in our offices, taken measures to significantly restrict non-essential business travel and have practices in place to mandate that employees who may have been exposed to COVID-19, or show any relevant symptoms, self-quarantine. In early March 2020, the Company executed on its Business Continuity Plan whereby the vast majority of our employees began to work remotely with only "essential" employees reporting to our offices. We accomplished this by significantly expanding the use of technology infrastructure that facilitates remote operations. Our ability to avoid significant business disruptions is reliant on the continued ability to have the vast majority of employees work remotely. To date, there have been no significant disruptions to our business or control processes as a result of this dispersion of employees. Given the recent surge in COVID-19 cases related to the omicron variant, many employees from our home office and branch locations are working remotely while employees from select groups are working from office locations given the nature of their responsibilities. We anticipate employees returning to offices once the risks associated with the omicron variant subside while maintaining flexible work arrangements.
EXECUTIVE SUMMARY
The record results for the full year 2021 demonstrate the strength of our franchise and the countercyclical and balanced nature of our businesses. The record results in our Capital Markets business helped offset the significantly lower incentive fees from alternative investments and bank deposit sweep income in Wealth Management. Despite this, the Wealth Management business had record management fees and steady commission revenue contributing to very solid results during the year. The performance of the Investment Banking division helped propel the Capital Markets business to record revenue and earnings for the year on very strong equity underwriting and M&A advisory fees. The operating results of Capital Markets were also positively impacted by the establishment of a deferred compensation plan in December 2021. The Company's operating results were the best in its history. Operating results, however, were negatively impacted by an increase in legal and regulatory costs during the fourth quarter reversing a trend of decreases in those costs over the past several years.
Concerns impacting market sentiment continue to persist around inflation, higher oil prices, and the Federal Reserve's tapering of bond buying. However, the prospects of moderately higher interest rates, a strong economy, and low unemployment, should provide a constructive backdrop for investors. While our comparative operating results for the quarter were significantly impacted by the outsized impact of incentive fees in the fourth quarter of 2020, the overall business performed exceptionally well with record contributions from our Investment Bank and strong results across the board from our other businesses.
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RESULTS OF OPERATIONS
The following table and discussion summarizes the changes in the major revenue and expense categories for the past three
years:
(Expressed in thousands )
For the Years Ended December 31, For the Years Ended December 31,
2021 2020 % Change 2020 2019 % Change
REVENUE
Commissions $ 401,607 $ 395,097 1.6 $ 395,097 $ 320,114 23.4
Advisory fees 451,197 455,261 (0.9) 455,261 353,671 28.7
Investment banking 435,870 222,298 96.1 222,298 126,211 76.1
Bank deposit sweep income 15,557 34,829 (55.3) 34,829 117,422 (70.3)
Interest 36,482 33,477 9.0 33,477 50,723 (34.0)
Principal transactions, net 23,984 27,874 (14.0) 27,874 30,094 (7.4)
Other 29,338 29,831 (1.7) 29,831 35,144 (15.1)
Total revenue 1,394,035 1,198,667 16.3 1,198,667 1,033,379 16.0
EXPENSES
Compensation and related expenses 886,840 770,997 15.0 770,997 657,714 17.2
Communications and technology 80,520 82,132 (2.0) 82,132 81,588 0.7
Occupancy and equipment costs 60,069 62,352 (3.7) 62,352 62,198 0.2
Clearing and exchange fees 22,306 22,978 (2.9) 22,978 21,962 4.6
Interest 9,855 15,680 (37.1) 15,680 45,687 (65.7)
Other 109,804 75,528 45.4 75,528 89,318 (15.4)
Total expenses 1,169,394 1,029,667 13.6 1,029,667 958,467 7.4
Pre-tax income 224,641 169,000 32.9 169,000 74,912 125.6
Income taxes 65,677 46,014 42.7 46,014 21,959 109.5
Net Income $ 158,964 $ 122,986 29.3 $ 122,986 $ 52,953 132.3
Fiscal 2021 compared to Fiscal 2020
Revenue
• Commission revenue was $401.6 million for the year ended December 31, 2021, an increase of 1.6% compared with $395.1 million for the year ended December 31, 2020 due to increased client activity in mutual funds, options, annuities, and mortgage backed securities partially offset by lower commission income on municipal bonds.
• Advisory fees were $451.2 million for the year ended December 31, 2021, a decrease of 0.9% compared with $455.3 million for the year ended December 31, 2020 due to a significant decrease in incentive fees from alternative investments partially offset by higher management fees from advisory programs during 2021.
• Investment banking revenue was $435.9 million for the year ended December 31, 2021, an increase of 96.1% compared with $222.3 million for the year ended December 31, 2020 driven by increased M&A activity and fees associated with a significant number of capital raising transactions (PIPES) in the healthcare and technology sectors completed during the 2021 year.
• Bank deposit sweep income was $15.6 million for the year ended December 31, 2021, a decrease of 55.3% compared with $34.8 million for the year ended December 31, 2020 due to lower short-term interest rates partially offset by higher average cash sweep balances.
• Interest revenue was $36.5 million for the year ended December 31, 2021, an increase of 9.0% compared with $33.5 million in 2020 due to higher average margin balances partially offset by lower short-term interest rates .
• Principal transactions revenue was $24.0 million for the year ended December 31, 2021, a decrease of 14.0% compared with $27.9 million for the year ended December 31, 2020 driven by lower income from investment grade,
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high yield, emerging markets, and municipal bonds partially offset by higher income from corporate and convertible bonds.
• Other revenue was $29.3 million for the year ended December 31, 2021, a decrease of 1.7% compared to $29.8 million for the year ended December 31, 2020 primarily due to a decrease in the cash surrender value of Company-owned life insurance during 2021.
Expenses
• Compensation and related expenses totaled $886.8 million during the year ended December 31, 2021, an increase of 15.0% compared with the year ended December 31, 2020. The increase was due to increased incentive compensation costs during the year tied to significant increases in revenue during the year ended December 31, 2021. Compensation and related expenses as a percentage of revenue was 63.6% for the year ended December 31, 2021 compared with 64.3% for the year ended December 31, 2020.
• Non-compensation expenses were $282.6 million during the year ended December 31, 2021, an increase of 9.2% compared with $258.7 million during the year ended December 31, 2020 due to increased legal, underwriting, travel and entertainment, and conference costs partially offset by reduced interest costs during the year ended December 31, 2021.
• The effective income tax rate for the year ended December 31, 2021 was 29.2% compared with 27.2% for the year ended December 31, 2020. The higher tax rate in 2021 was primarily due to an increase in apportionment factors in state and local jurisdictions with higher statutory tax rates.
Fiscal 2020 compared to Fiscal 2019
Revenue
• Commission revenue was $395.1 million for the year ended December 31, 2020, an increase of 23.4% compared with $320.1 million for the year ended December 31, 2019 as a result of increased volatility and client participation in active equities-related markets.
• Advisory fees were $455.3 million for the year ended December 31, 2020, an increase of 28.7% compared with $353.7 million for the year ended December 31, 2019 due to higher management fees and incentive fees from alternative investments.
• Investment banking revenue was $222.3 million for the year ended December 31, 2020, an increase of 76.1%compared with $126.2 million for the year ended December 31, 2019 due to significantly higher underwriting revenues from equities transactions and increased M&A activity later in the 2020.
• Bank deposit sweep income was $34.8 million for the year ended December 31, 2020, a decrease of 70.3% compared with $117.4 million for the year ended December 31, 2019 due to lower short-term interest rates partially offset by higher average cash sweep balances.
• Interest revenue was $33.5 million for the year ended December 31, 2020, a decrease of 34.0% compared with $50.7 million in 2019 due to lower short-term interest rates partially offset by higher average margin balances.
• Principal transactions revenue was $27.9 million for the year ended December 31, 2020, a decrease of 7.4% compared with $30.1 million for the year ended December 31, 2019 as a result of lower client involvement in markets during the early months of the COVID Pandemic.
• Other revenue was $29.8 million for the year ended December 31, 2020, a decrease of 15.1% compared to $35.1 million for the year ended December 31, 2019 primarily due to a decrease in the cash surrender value of Company-owned life insurance during 2020.
Expenses
• Compensation and related expenses totaled $771.0 million during the year ended December 31, 2020, an increase of 17.2% compared with the year ended December 31, 2019. The increase was due to increased production and incentive compensation tied to increases in revenue during the year ended December 31, 2020. Compensation and related expenses as a percentage of revenue was 64.3% for the year ended December 31, 2020 compared with 63.6% for the year ended December 31, 2019.
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• Non-compensation expenses were $258.7 million during the year ended December 31, 2020, a decrease of 14.0% compared with $300.8 million during the year ended December 31, 2019 due to decreased interest costs, lower legal and regulatory costs and reduced costs associated with business travel and entertainment and conferences during the year ended December 31, 2020.
• The effective income tax rate for the year ended December 31, 2020 was 27.2% compared with 29.3% for the year ended December 31, 2019. The lower effective tax rate for 2020 was primarily due to lower state and local income taxes, valuation allowance on foreign operations and other non-deductible expenses over higher pre-tax income in 2020 compared to 2019.
BUSINESS SEGMENTS
The table below presents information about the reported revenue and pre-tax income (loss) of the Company's reportable business segments for the three months and years ended December 31, 2021 and 2020:
(Expressed in thousands)
For the Three Months Ended December 31, For the Years Ended December 31,
2021 2020 % Change 2021 2020 % Change
Revenue
Private Client $ 173,310 $ 217,743 (20.4) $ 665,060 $ 642,083 3.6
Asset Management 27,930 72,851 (61.7) 104,598 130,274 (19.7)
Capital Markets 165,575 131,651 25.8 625,704 426,752 46.6
Corporate/Other (1,697) 663 * (1,327) (442) 200.2
Total 365,118 422,908 (13.7) 1,394,035 1,198,667 16.3
Pre-Tax Income (Loss)
Private Client 17,784 39,362 (54.8) 101,146 122,844 (17.7)
Asset Management 10,270 56,911 (82.0) 35,874 71,625 (49.9)
Capital Markets 96,838 41,894 131.2 204,090 83,442 144.6
Corporate/Other (32,940) (24,372) 35.2 (116,469) (108,911) (6.9)
Total $ 91,952 $ 113,795 (19.2) $ 224,641 $ 169,000 32.9
* Percentage not meaningful
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Private Client
Private Client reported revenue of $665.1 million for the year ended December 31, 2021, 3.6% higher compared with a year ago. Pre-tax income of $101.1 million in the year ended December 31, 2021 resulted in a pre-tax profit margin of 15.2%. Financial advisor headcount declined amid retirements to 996 at the end of 2021 compared to 1,002 at the end of 2020, although the productivity of our financial advisors increased significantly reflecting higher individual production levels.
(Expressed in thousands, except financial advisor headcount or otherwise indicated)
For the Years Ended December 31,
2021 2020 % Change
Revenue $ 665,060 $ 642,083 3.6
Commissions 217,724 209,447 4.0
Advisory fees 346,559 326,858 6.0
Bank deposit sweep income 15,557 34,829 (55.3)
Interest 29,290 25,148 16.5
Other 55,930 45,801 22.1
Total Expenses $ 563,914 $ 519,239 8.6
Compensation 446,968 412,021 8.5
Non-compensation 116,946 107,218 9.1
Pre-Tax Income $ 101,146 $ 122,844 (17.7)
Compensation Ratio 67.2 % 64.2 % 4.7
Non-compensation Ratio 17.6 % 16.7 % 5.4
Pre-Tax Margin 15.2 % 19.1 % (20.4)
CAUA (billions) $ 122.1 $ 104.8 16.5
Cash Sweep Balances (billions) $ 7.9 $ 7.3 8.2
Financial Advisor Headcount 996 1,002 (0.6)
• Retail commissions were $217.7 million for the year ended December 31, 2021, an increase of 4.0% from a year ago due to increased client activity in mutual funds, options, annuities, and mortgage backed securities partially offset by lower commission income on municipal bonds.
• Advisory fees increased 6.0% due to increases in management fees from advisory programs partially offset by significantly lower incentive fees from alternative investments. Incentive fees allocated to this segment were $0.6 million for the 2021 year versus $61.7 million for the prior year.
• Bank deposit sweep income decreased 55.3% from 2020 due to lower short-term interest rates partially offset by higher average cash sweep balances.
• Interest revenue increased 16.5% from a year ago due to higher average margin balances partially offset by lower short-term interest rates.
• Other revenue increased 22.1% primarily due to increases in the cash surrender value of Company-owned life insurance policies.
• Compensation expenses increased 8.5% from 2020 primarily due to increased production and share-based compensation costs.
• Non-compensation expenses increased 9.1% from 2020 primarily due to higher legal costs.
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Asset Management
Asset Management reported revenue of $104.6 million for the year ended December 31, 2021, 19.7% higher compared with a year ago. Pre-tax income was $35.9 million, an increase of 49.9% compared with a year ago.
(Expressed in thousands, unless otherwise indicated)
For the Years Ended December 31,
2021 2020 % Change
Revenue $ 104,598 $ 130,274 (19.7)
Advisory fee revenue 104,584 128,258 (18.5)
Other 14 2,016 (99.3)
Total Expenses $ 68,724 $ 58,649 17.2
Compensation 27,811 25,128 10.7
Non-compensation 40,913 33,521 22.1
Pre-Tax Income $ 35,874 $ 71,625 (49.9)
Compensation Ratio 26.6 % 19.3 % 37.8
Non-compensation Ratio 39.1 % 25.7 % 52.1
Pre-Tax Margin 34.3 % 55.0 % (37.6)
AUM (billions) $ 46.2 $ 38.8 19.1
• Advisory fee revenue on traditional and alternative managed products was $104.6 million for the year ended December 31, 2021, a decrease of 18.5% due to significantly lower incentive fees from alternative investments partially offset by higher management fees from advisory programs. Incentive fees allocated to this segment were $1.8 million for the 2021 year versus $49.4 million in 2020.
• AUM hit a record level of $46.2 billion at December 31, 2021, which is the basis for advisory fee billings for the first quarter of 2022. The increase in AUM was comprised of higher asset values of $6.4 billion on existing client holdings and a net contribution of assets of $1.0 billion.
• Compensation expenses increased 10.7% when compared to the prior year driven primarily by higher incentive compensation costs.
• Non-compensation expenses were up 22.1% when compared to the prior year primarily due to higher external portfolio management costs which are directly related to the increase in AUM.
The following table provides a breakdown of the change in assets under management for the year ended December 31, 2021:
(Expressed in millions)
For the Year Ended December 31, 2021
Beginning
Balance Appreciation
(Depreciation) Ending
Balance
Fund Type Contributions Redemptions
Traditional (1)
$ 31,749 $ 7,182 $ (6,708) $ 5,612 $ 37,835
Institutional Fixed Income (2)
798 144 (122) 46 866
Alternative Investments:
Hedge funds (3)
5,449 520 (561) (730) 4,678
Private Equity Funds (4)
435 561 (30) 1,478 2,444
Portfolio Enhancement Program (5)
396 9 (25) — 380
$ 38,827 $ 8,416 $ (7,446) $ 6,406 $ 46,203
(1) Traditional investments include third party advisory programs, Oppenheimer financial advisor managed and advisory programs, and Oppenheimer Asset Management taxable and tax-exempt portfolio management strategies.
(2) Institutional fixed income provides solutions to institutional investors including: Taft-Hartley Funds, Public Pension Funds, Corporate Pension Funds, and Foundations and Endowments.
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(3) Hedge funds represent single manager hedge fund strategies in areas including hedged equity, technology and financial services, and multi-manager and multi-strategy fund of funds.
(4) Private equity funds represent private equity fund of funds including portfolios focused on natural resources and related assets.
(5) The portfolio enhancement program sells uncovered, far out-of-money puts and calls on the S&P 500 Index. The program is market neutral and uncorrelated to the index. Valuation is based on collateral requirements for a series of contracts representing the investment strategy.
Capital Markets
Capital Markets reported revenue of $625.7 million for 2021, 46.6% higher compared with a year ago. Pre-Tax income was $204.1 million compared with a pre-tax income of $83.4 million a year ago.
(Expressed in thousands )
For the Years Ended December 31,
2021 2020 % Change
Revenue $ 625,704 $ 426,752 46.6
Investment Banking $ 410,539 $ 206,098 99.2
Advisory fees 194,753 80,534 141.8
Equities underwriting 186,736 103,276 80.8
Fixed income underwriting 27,004 20,394 32.4
Other 2,046 1,894 8.0
Sales and Trading $ 213,491 $ 217,711 (1.9)
Equities 138,363 130,668 5.9
Fixed income 75,128 87,043 (13.7)
Other $ 1,674 $ 2,943 (43.1)
Total Expenses $ 421,614 $ 343,310 22.8
Compensation 318,850 251,697 26.7
Non-compensation 102,764 91,613 12.2
Pre-Tax Income $ 204,090 $ 83,442 144.6
Compensation Ratio 51.0 % 59.0 % (13.6)
Non-compensation Ratio 16.4 % 21.5 % (23.7)
Pre-Tax Margin 32.6 % 19.6 % 66.3
• Advisory fees earned from investment banking activities increased 141.8% to $194.8 million for the year ended December 31, 2021 compared with $80.5 million for the year ended December 31, 2020 driven by increased M&A activity and fees associated with a significant number of capital raising transactions (PIPES) in the healthcare and technology sectors completed during 2021.
• Equities underwriting fees increased 80.8% to $186.7 million for the year ended December 31, 2021 compared with $103.3 million for the year ended December 31, 2020 due to significantly higher levels of capital issuances in the equity markets particularly in the healthcare and technology sectors.
• Fixed income underwriting fees increased 32.4% to $27.0 million for the year ended December 31, 2021 compared with $20.1 million for the year ended December 31, 2020 primarily driven by public finance issuances during 2021.
• Equities sales and trading increased to $138.4 million for the year ended December 31, 2021, 5.9% higher compared to $130.7 million for the year ended December 31, 2020 due to higher income from institutional agency and convertible bonds.
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• Fixed income sales and trading decreased 13.7% driven by lower income from investment grade, high yield, emerging markets, and municipal bonds partially offset by higher income from corporate and convertible bonds.
• Compensation expenses increased 26.7% primarily due to increased incentive compensation costs during the year tied to significant increases in revenue.
• Non-compensation expenses were 12.2% higher compared with the prior year due to increased legal, underwriting, travel and entertainment, and conference costs partially offset by reduced interest costs.
CRITICAL ACCOUNTING ESTIMATES
The Company's accounting estimates are essential to understanding and interpreting the financial results reported on the consolidated financial statements. The significant accounting policies used in the preparation of the Company's consolidated financial statements are summarized in note 2 to those statements. Certain of those policies are considered to be particularly important to the presentation of the Company's financial results because they require management to make difficult, complex or subjective judgments, often as a result of matters that are inherently uncertain. The following is a discussion of these estimates:
Fair Value Measurements
Critical estimates - The accounting guidance for the fair value measurement (ASC 820) of financial assets defines fair value, establishes a framework for measuring fair value, establishes a fair value measurement hierarchy, and expands fair value measurement disclosures. Fair value, as defined by the accounting guidance, is the price that would be received in the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When market observable inputs are not available, our judgment is applied to reflect those judgments that a market participant would use in valuing the same asset or liability.
Assumption and judgement - The fair value hierarchy established by ASC 820 prioritizes the inputs used in valuation techniques into the following three categories (highest to lowest priority):
• Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets;
• Inputs other than quoted prices included in Level 1 that are observable for the asset or liability either directly or indirectly; and
• Unobservable inputs that are significant to the overall fair value measurement.
The availability of observable inputs can vary for different products. We use prices and inputs that are current as of the measurement date even in periods of market disruption or illiquidity. Financial instruments are classified as Level 3 if observable pricing inputs are not available due to limited market activity for the asset or liability. The valuation of financial instruments are classified in Level 3 of the fair value hierarchy consists of valuation techniques that incorporate one or more significant unobservable input, and therefore requires the greatest amount of management judgment. As of December 31, 2021 the Company had $31.8 million in financial instruments, comprised of auction rate securities, classified within Level 3 of the fair value hierarchy. See note 7 to the consolidated financial statements appearing in Item 8 for further information on the fair value definition, Level 1, Level 2 and Level 3 and related valuation technique.
I mpact if actual results differ from assumptions – we established an independent valuation process to evaluate and approve the valuation of our financial instruments. For financial instruments that classified in Level 3, we review the appropriateness of the unobservable inputs to ensure consistency with how a market participant would arrive at the unobservable input. Although an independent review process is in place, the fair value of the Level 3 financial instrument could be significantly different due to the sensitivity of some unobservable inputs (for example, interest rates) and it could also have a material adverse effect on our consolidated financial statements.
Legal and Regulatory Reserves
Critical estimates – In the normal course of business, the Company has been named as defendant or co-defendant in various legal actions, including arbitrations, class actions and other litigation, creating substantial exposure and periodic expenses. Management is required to assess the probability of loss and estimate the amount of such loss when preparing its consolidated financial statements.
Assumption and judgement - The determination of the levels of these reserves requires significant judgment on the part of management. In accordance with applicable accounting guidance, we established reserves for litigation and regulatory matters where available information indicates that it is probable a liability had been incurred at the date of the consolidated financial
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statements and we can reasonably estimate the amount of that loss. When loss contingencies are not probable or cannot be reasonably estimated, we do not establish reserves. When determining whether to record a reserve, management considers many factors including, but not limited to, the amount of the claim; the stage and forum of the proceeding, the sophistication of the claimant, the amount of the loss, if any, in the client's account and the possibility of wrongdoing, if any, on the part of an employee of the Company; the basis and validity of the claim; previous results in similar cases; and applicable legal precedents and case law. Each legal and regulatory proceeding is reviewed with counsel in each accounting period and the reserve is adjusted as deemed appropriate by management. Any change in the reserve amount is recorded in the results of that period. See note 17 to the consolidated financial statements appearing in Item 8 for further details.
Impact if actual results differ from assumptions – Due to the inherent uncertainties of the legal and regulatory proceedings, our judgement may be materially different from the actual outcome. The assumptions we used to determine the estimates of reserves may be incorrect and the actual disposition of a legal or regulatory proceeding could be greater or less than the reserve amount.
Income Taxes
Critical estimates – we are subject to the income tax laws of the U.S., its states, and the municipalities in which we operate. We are also subject to the tax laws of our international subsidiaries and branches. These tax laws are complex and subject to different interpretations by the taxpayer and the relevant government taxing authorities. We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. We record uncertain tax positions in accordance with ASC 740, "Income Taxes" on the basis of a two-step process whereby we determined whether it is more-likely-than-not that the tax positions will be sustained on the basis of the technical merits of the position and, for those tax positions that meet the more-likely-than-not recognition threshold, we will recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority.
Assumption and judgement - We recognize deferred tax assets to the extent we believe these assets are more likely than not to be realized. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies, and the results of recent operations. In establishing a provision for income tax expense, we must make judgements and interpretations about the application of these inherently complex tax laws. We estimate when certain items will affect taxable income in the various jurisdictions in the future. We are also required to evaluate and measure all uncertain tax positions taken or expected to be taken on tax returns and to record liabilities for the amount of such positions that may not be sustained, may only be partially sustained, upon examination by the relevant taxing authorities. See note 15 to the consolidated financial statements appearing in Item 8 for further details.
Impact if actual results differ from assumptions – Although we believe that our estimates and judgements are reasonable, actual results may differ from these estimates. Some or all of these judgements are subject to review by the relevant taxing authorities. If one or more of the taxing authorities were to successfully challenge our right to realize some or all of the tax benefit we recorded, and we were not able to realize this benefit, our effective income tax rate in a given financial statement period could be materially affected and it could also have a material adverse effect on our consolidated financial statements.
New Accounting Pronouncements
Recently issued accounting pronouncements are described in note 2 to the consolidated financial statements appearing in Item 8.
LIQUIDITY AND CAPITAL RESOURCES
Total assets increased by 12.1% from December 31, 2020 to December 31, 2021. The Company satisfies its need for short-term financing from internally generated funds and collateralized and uncollateralized borrowings, consisting primarily of bank call loans, stock loans, and uncommitted lines of credit. We finance our trading in government securities through the use of securities sold under agreements to repurchase ("repurchase agreements"). We met our longer-term capital needs through the issuance of the 5.50% Senior Secured Notes due 2025 (see "Senior Secured Notes" below). Oppenheimer has arrangements with banks for borrowings on a fully-collateralized basis. The amount of Oppenheimer's bank borrowings fluctuates in response to changes in the level of the Company's securities inventories and customer margin debt, changes in notes receivable from employees, investment in furniture, equipment and leasehold improvements, changes in stock loan balances and financing through repurchase agreements. At December 31, 2021, the Company had $69.5 million of such borrowings outstanding compared to outstanding borrowings of $82.0 million at December 31, 2020. The Company also has some availability of short-term bank financing on an unsecured basis.
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The Company's overseas subsidiaries, Oppenheimer Europe Ltd. and Oppenheimer Investments Asia Limited, are subject to local regulatory capital requirements that restrict our ability to utilize their capital for other purposes. The regulatory capital requirements for Oppenheimer Europe Ltd. and Oppenheimer Investments Asia Limited were $4.4 million and $385,000, respectively, at December 31, 2021. The liquid assets at Oppenheimer Europe Ltd. are primarily comprised of cash deposits in bank accounts.
The liquid assets at Oppenheimer Investments Asia Limited are primarily comprised of investments in U.S. Treasuries and cash deposits in bank accounts. Any restrictions on transfer of these liquid assets from Oppenheimer Europe Ltd. and Oppenheimer Investments Asia Limited to the Company or its other subsidiaries would be limited by regulatory capital requirements.
The Company permanently reinvests eligible earnings of its foreign subsidiaries and, accordingly, does not accrue any U.S. income taxes that would arise if these earnings were repatriated. The unrecognized deferred tax liability associated with the outside basis difference of its foreign subsidiaries is estimated at $3.9 million for those subsidiaries. We have continued to reinvest permanently the excess earnings of Oppenheimer Israel (OPCO) Ltd. in its own business and in the businesses in Europe and Asia to support business initiatives in those regions. We will continue to review our historical treatment of these earnings to determine whether our historical practice will continue or whether a change is warranted. The Company has been assessing the impact that the current new presidential administration’s tax proposals will have on its operations and cash flows.
Senior Secured Notes
On September 22, 2020, in a private offering, we issued $125.0 million aggregate principal amount of 5.50% Senior Secured Notes due 2025 (the "Unregistered Notes") under an Indenture at an issue price of 100% of the principal amount. Interest on the Unregistered Notes is payable semi-annually on April 1st and October 1st. We used the net proceeds from the offering of the Unregistered Notes, along with cash on hand, to redeem in full our 6.75% Senior Secured Notes due July 1, 2022 in the principal amount of $150.0 million (the Company held $1.4 million in treasury for a net outstanding amount of $148.6 million), and pay all related fees and expenses related thereto. On November 23, 2020, we completed an exchange offer in which we exchanged 99.8% of our Unregistered Notes for a like principal amount of notes with identical terms except that such new notes have been registered under the Securities Act of 1933, as amended (the "Notes"). We did not receive any proceeds in the exchange offer. See note 12 to the consolidated financial statements appearing in Item 1 for further discussion.
The Notes are jointly and severally and fully and unconditionally guaranteed on a senior secured basis by E.A. Viner International Co. and Viner Finance Inc. (together, the "Guarantors"), unless released as described below. Each of the Guarantors is 100% owned by the Parent. The indenture for the Notes contains covenants with restrictions which are discussed in note 12.
The guarantees are senior secured obligations of each Guarantor. The guarantees rank:
• effectively senior in right of payment to all unsecured and unsubordinated obligations of such Guarantor, to the extent of the value of the collateral owned by such Guarantor (and, to the extent of any unsecured remainder after payment of the value of the collateral, rank equally in right of payment with such unsecured and unsubordinated indebtedness of such Guarantor); and
• senior in right of payment to any subordinated debt of such Guarantor ( The Notes are secured on a first-priority basis by the collateral, subject to certain exceptions and permitted liens, and it is intended that pari passu lien indebtedness, if any, will be secured on an equal and ratable basis).
Each subsidiary guarantee is limited so that it does not constitute a fraudulent conveyance under applicable law, which may reduce the subsidiary’s obligation under the guarantee. There are no externally imposed restrictions on transfers of assets between the Company and its subsidiaries.
Each Guarantor will be automatically and unconditionally released and discharged upon: the sale, exchange or transfer of the capital stock of a Guarantor and the Guarantor ceasing to be a direct or indirect subsidiary of the Parent if such sale does not constitute an asset sale under the Indenture for the Notes or does not constitute an asset sale effected in compliance with the asset sale and merger covenants of the Indenture for the Notes; a Guarantor being dissolved or liquidated; a Guarantor being designated unrestricted in compliance with the applicable provisions of the Notes; or the exercise by the Parent of its legal defeasance option or covenant defeasance option or the discharge of the Parent's obligations under the Indenture for the Notes in accordance with the terms of such indenture.
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The following tables present results of operations for the twelve months ended December 31, 2021 and balance sheet at December 31, 2021 for the Parent and Guarantors.
(Expressed in thousands) As of
December 31, 2021
Total Assets $ 1,996,164
Due From Non-Guarantor Subsidiary 14,475
Total Liabilities 487,294
Due To Non-guarantor Subsidiary 651
For the Year Ended
December 31, 2021
Total Revenue $ 10,193
Pre-Tax Loss 210
Net Loss 545
On June 17, 2021, S&P upgraded the Company's Corporate Family rating and rating on the Unregistered Notes from 'B+' with a stable outlook to 'BB-' with a stable outlook. On August 23, 2021, Moody’s upgraded the Company's Corporate Family rating and the rating on the Unregistered Notes from “B1” with a stable outlook to “Ba3” with a stable outlook.
Liquidity
For the most part, the Company's assets consist of cash and cash equivalents and assets that it can readily convert into cash. The receivable from brokers, dealers and clearing organizations represents deposits for securities borrowed transactions, margin deposits or current transactions awaiting settlement. The receivable from customers represents margin balances and amounts due on transactions awaiting settlement. Our receivables are, for the most part, collateralized by marketable securities. Our collateral maintenance policies and procedures are designed to limit our exposure to credit risk. Securities owned, with the exception of the ARS, are mainly comprised of actively trading, readily marketable securities. We advanced $22.1 million in forgivable notes (which are inherently illiquid) to employees for the year ended December 31, 2021 ($14.8 million for the year ended December 31, 2020) as upfront or backend inducements to commence or continue employment as the case may be. The amount of funds allocated to such inducements will vary with hiring activity.
We satisfy our need for short-term liquidity from internally generated funds, collateralized and uncollateralized bank borrowings, stock loans and repurchase agreements and warehouse facilities. Bank borrowings are, in most cases, collateralized by firm and customer securities.
We obtain short-term borrowings primarily through bank call loans. Bank call loans are generally payable on demand and bear interest at various rates. At December 31, 2021, bank call loans were $69.5 million ($82.0 million at December 31, 2020). The average daily bank loan outstanding for the year ended December 31, 2021 was $76.4 million ($82.8 million for the year ended December 31, 2020). The largest daily bank loan outstanding for the year ended December 31, 2021 was $227.7 million ($324.3 million for the year ended December 31, 2020).
At December 31, 2021, securities loan balances totaled $244.2 million ($249.5 million at December 31, 2020). The average daily securities loan balance for the year ended December 31, 2021 was $285.2 million ($238.3 million for the year ended December 31, 2020). The largest daily stock loan balance for the year ended December 31, 2021 was $322.2 million ($317.8 million for the year ended December 31, 2020).
We finance our government trading operations through the use of securities purchased under agreements to resell ("reverse repurchase agreements") and repurchase agreements. Except as described below, repurchase and reverse repurchase agreements, principally involving government and agency securities, are carried at amounts at which securities subsequently will be resold or reacquired as specified in the respective agreements and include accrued interest.
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Repurchase and reverse repurchase agreements are presented on a net-by-counterparty basis, when the repurchase and reverse repurchase agreements are executed with the same counterparty, have the same explicit settlement date, are executed in accordance with a master netting arrangement, the securities underlying the repurchase and reverse repurchase agreements exist in "book entry" form and certain other requirements are met.
Certain of our repurchase agreements and reverse repurchase agreements are carried at fair value as a result of the Company's fair value option election. We elected the fair value option for those repurchase agreements and reverse repurchase agreements that do not settle overnight or have an open settlement date in order for these instruments to more accurately reflect market and economic events in our earnings and to mitigate a potential imbalance in earnings caused by using different measurement attributes (i.e. fair value versus carrying value) for certain assets and liabilities. At December 31, 2021, we did not have any repurchase agreements and reverse repurchase agreements that did not settle overnight or have an open settlement date.
At December 31, 2021, the gross balances of reverse repurchase agreements and repurchase agreements were $30.4 million and $306.8 million, respectively. The average daily balance of reverse repurchase agreements and repurchase agreements on a gross basis for the year ended December 31, 2021 was $120.3 million and $352.8 million, respectively ($170.7 million and $374.3 million, respectively, for the year ended December 31, 2020). The largest amount of reverse repurchase agreements and repurchase agreements outstanding on a gross basis during the year ended December 31, 2021 was $424.2 million and $636.7 million, respectively ($714.2 million and $803.0 million, respectively, for the year ended December 31, 2020).
Liquidity Management
We manage our need for liquidity on a daily basis to ensure compliance with regulatory requirements. Our liquidity needs may be affected by market conditions, increased inventory positions, business expansion and other unanticipated occurrences. In the event that existing financial resources do not satisfy our liquidity needs, we may have to seek additional external financing. The availability of such additional external financing may depend on market factors outside our control.
We have Company-owned life insurance policies which are utilized to fund certain non-qualified deferred compensation plans. Certain policies which could provide additional liquidity if needed had a cash surrender value of $95.3 million as of December 31, 2021.
We regularly review our sources of liquidity and financing and conduct internal stress analysis to determine the impact on the Company of events that could remove sources of liquidity or financing and to plan actions the Company could take in the case of such an eventuality. Our reviews have resulted in plans that we believe would result in a reduction of assets through liquidation that would significantly reduce the Company's need for external financing.
Our primary long-term cash requirements include $124.0 million principal outstanding as of December 31, 2021 under our Senior Secured Notes (due in 2025) and $192.0 million of operating lease obligations. The total cash requirement for interest expense related to the Notes and operating lease obligations is estimated to be approximately $48.6 million for the upcoming year.
Funding Risk
(Expressed in thousands)
For the Years Ended December 31,
2021 2020
Cash provided by/(used in) operating activities $ 227,786 $ (54,059)
Cash used in investing activities (6,267) (3,941)
Cash provided by/(used in) financing activities 84,581 13,874
Net increase/(decrease) in cash and cash equivalents and restricted cash $ 306,100 $ (44,126)
Management believes that funds from operations, combined with our capital base and available credit facilities, are sufficient for our liquidity needs in the foreseeable future. Under some circumstances, banks including those on whom we rely may back away from providing funding to the securities industry. Such a development might impact our ability to finance our day-to-day activities or increase the costs to acquire funding. We may or may not be able to pass such increased funding costs on to our clients.
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During the recent period of high volatility, we have seen increased calls for deposits of collateral to offset perceived risk between the Company's settlement liability to industry utilities such as the Options Clearing Corporation (“OCC”) and National Securities Clearing Corp. (“NSCC”) as well as more stringent collateral arrangements with our bank lenders. All such requirements have been met in the ordinary course with available collateral.
CYBERSECURITY
For many years, we have sought to maintain the security of our clients' data, limit access to our data processing environment, and protect our data processing facilities. See "Risk Factors — Cybersecurity – Security breaches of our technology systems, or those of our clients or other third-party vendors we rely on, could subject us to significant liability and harm our reputation" in Item 1A. Recent examples of vulnerabilities by other companies and the government that have resulted in loss of client data and fraudulent activities by both domestic and foreign actors have caused us to continuously review our security policies and procedures and to take additional actions to protect our network and our information.
Given the importance of the protection of client data, regulators have developed increased oversight of cybersecurity planning and protections that broker-dealers and other financial service providers have implemented. Such planning and protection are subject to the SEC's and FINRA's oversight and examination on a periodic or targeted basis. We expect that regulatory oversight will intensify, as a result of publicly announced data breaches by other organizations involving tens of millions of items of personally identifiable information. We continue to implement protections and adopt procedures to address the risks posed by the current information technology environment. The Company has significantly increased the resources dedicated to this effort and believes that further increases may be required in the future, in anticipation of increases in the sophistication and persistency of such attacks. There can be no guarantee that our cybersecurity efforts will be successful in discovering or preventing a security breach.
REGULATORY MATTERS AND DEVELOPMENTS
Regulation Best Interest (U.S.)
On June 5, 2019, the SEC adopted Regulation Best Interest (“Reg BI”) as Rule 15l-1 under the Exchange Act. Reg BI imposes a federal standard of conduct on registered broker-dealers and their associated persons when dealing with retail clients and requires that a broker-dealer and its representatives act in the best interest of clients and not place its own interests ahead of the customer’s interests. Reg BI does not define the term “best interest” but instead sets forth four distinct obligations, disclosure, care, conflict of interest and compliance that a broker-dealer must satisfy in each transaction. Compliance with Reg BI became effective on June 30, 2020. In addition to adopting Reg BI, the SEC also adopted rules (i) requiring broker-dealers and investment advisers to provide a written relationship summary to each client, and (ii) clarifying certain interpretations under the Investment Advisers Act of 1940 including but not limited to when a broker-dealer's activity is considered “solely incidental” to its broker-dealer business and is, therefore, not considered investment advisory activity (collectively, the “Reg BI Rules”).
Reg BI requires enhanced documentation for recommendations of securities transactions to broker-dealer retail clients as well as the cessation of certain practices and limitations on certain kinds of transactions previously conducted in the normal course of business. The new rules and processes related thereto may limit revenue and most likely will involve increased costs, including, but not limited to, compliance costs associated with new or enhanced technology as well as increased litigation costs. The Company made significant structural, technological and operational changes to our business practices to comply with the requirements of the Reg BI Rules and it is likely that additional changes may be necessary to continue to comply as more experience with the Reg BI Rules is gained. Regulators have commenced reviews of the industry’s compliance with the requirements of Reg BI, including that of the Company.
See “Business – Regulation – Fiduciary Standard – Rulemaking by the U.S. Department of Labor and SEC” in Part I, Item 1.
On December 18, 2020, the DOL published its final prohibited transaction exemption (“PTE”) addressing investment advice fiduciaries to ERISA plans and IRAs. Similar to the proposal the DOL released in June of 2020 the final exemption takes a principles-based (rather than a prescriptive) approach to resolving conflicts that arise under ERISA when an investment advice fiduciary, its affiliate or a related party is paid certain types of compensation (such as commissions, trailing fees or revenue-sharing) or engages in certain principal transactions. The final exemption should provide a new and more flexible approach to ERISA compliance for certain types of transactions, which financial institutions may choose to utilize in place of other existing exemptions. Like the proposal (but in contrast to the precursor rule the DOL finalized in April 2016 that the U.S. Court of Appeals for the Fifth Circuit later vacated in June 2018), the final exemption does not materially change the scope of fiduciary activities under ERISA, with the exception of including certain rollover-related advice as fiduciary advice. The effective date for compliance with the PTE was February 1, 2022. The Company believes many of steps taken by the Company to achieve
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compliance with the Reg BI Rules will enable the Company to comply with the PTE. The Company implemented certain additional processes above the actions taken to comply with the Reg BI Rules in order to ensure full compliance with the PTE.
Regulatory Environment
See the discussion of the regulatory environment in which we operate and the impact on our operations of certain rules and regulations in Item 1 “Business - Regulation” herein for additional information.
Oppenheimer and many of its affiliates are each subject to various regulatory capital requirements. As of December 31, 2021, all of our active regulated domestic and international subsidiaries had net capital in excess of minimum requirements. See “Business – Regulatory - Regulatory Capital Requirements” in Part I, Item 1 and note 18 of the Notes to Consolidated Financial Statements in Item 8 for further information on regulatory capital requirements.
Other Regulatory Matters
Oppenheimer has been responding to information requests from the SEC’s Division of Enforcement relating to a former Oppenheimer financial advisor and his relationship with registered investment adviser Southport Capital and its affiliates. See Item 3 “Legal Proceedings” for further information.
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FACTORS AFFECTING "FORWARD-LOOKING STATEMENTS"
From time to time, the Company may publish or make oral statements that constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995 which provides a safe harbor for forward-looking statements. These forward-looking statements may relate to such matters as anticipated financial performance, future revenues, earnings, liabilities or expenses, business prospects, projected ventures, new products, anticipated market performance, and similar matters. The Company cautions readers that a variety of factors could cause the Company’s actual results to differ materially from the anticipated results or other expectations expressed in the Company’s forward-looking statements. These risks and uncertainties, many of which are beyond the Company’s control, include, but are not limited to: (i) transaction volume in the securities markets, (ii) the volatility of the securities markets, (iii) fluctuations in interest rates, (iv) changes in regulatory requirements that could affect the cost and method of doing business, (v) general economic conditions, both domestic and international, (vi) competition from existing financial institutions, new entrants and other participants in the securities markets and financial services industry, (vii) potential cybersecurity threats, (viii) legal developments affecting the litigation experience of the securities industry and the Company, (ix) changes in foreign, federal and state tax laws that could affect the popularity of products sold by the Company or impose taxes on securities transactions, (x) the adoption and implementation of the SEC’s “Regulation Best Interest” and other regulations adopted in recent years, (xi) war, terrorist acts and nuclear confrontation as well as political unrest, (xii) the Company’s ability to achieve its business plan, (xiii) the effects of the economy on the Company’s ability to find and maintain financing options and liquidity, (xiv) credit, operational, legal and regulatory risks, (xv) risks related to foreign operations, including those in the United Kingdom which may be affected by Britain’s January 2020 exit from the EU(“Brexit”), (xvi) the effect of technological innovation on the financial services industry and securities business, (xvii) risks related to election results, Congressional gridlock, political and social unrest, government shutdowns and investigations, trade wars, changes in or uncertainty surrounding regulation, and the potential for default by the U.S. government on the nation's debt, (xviii) risks related to changes in capital requirements under international standards that may cause banks to back away from providing funding to the securities industry, and (xviv) risks related to the severity and duration of the COVID-19 Pandemic; the COVID-19 Pandemic’s impact on the U.S. and global economies; and federal, state and local governmental responses to the COVID-19 Pandemic. There can be no assurance that the Company has correctly or completely identified and assessed all of the factors affecting the Company's business. See “Risk Factors” in Part I, Item 1A.
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