SIEBERT FINANCIAL CORP 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion provides a narrative of our financial performance and condition that should be read in conjunction with the accompanying financial statements and related notes included under Part I, Item 1 of this Report. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in our 2022 Form 10-K, particularly in Part I, Item 1A - Risk Factors. Overview We are a financial services company and provide a wide variety of financial services to our clients. We operate in business lines such as retail brokerage, investment advisory, insurance, and technology development through our wholly-owned and majority-owned subsidiaries. Results in the businesses in which we operate are highly correlated to general economic conditions and, more specifically, to the direction of the U.S. equity and fixed-income markets. Market volatility, overall market conditions, interest rates, economic, political, and regulatory trends, and industry competition are among the factors which could affect us and which are unpredictable and beyond our control. These factors affect the financial decisions made by market participants who include investors and competitors, impacting their level of participation in the financial markets. In addition, in periods of reduced financial market activity, profitability is likely to be adversely affected because certain expenses remain relatively fixed, including salaries and related costs, as well as portions of communications costs and occupancy expenses. Accordingly, earnings for any period should not be considered representative of earnings to be expected for any other period. Transaction with Kakaopay On April 27, 2023, Siebert entered into an agreement to raise new capital into Siebert by issuing new shares of Siebert’s common stock to Kakaopay, a company established under the Laws of the Republic of Korea and a fintech subsidiary of Korean-based conglomerate Kakao Corp. Kakaopay offers a diverse array of financial services and has approximately 40 million registered users according to Kakaopay. Siebert entered into stock purchase agreements and ancillary agreements regarding this transaction. The transaction will occur in two tranches, and in the first tranche, Kakaopay will purchase a 19.9% stake of Siebert of 8,075,607 newly issued shares for approximately $17.4 million. In the second tranche, subject to shareholder and regulatory approval, Kakaopay will acquire an additional 31.1% of Siebert of 25,756,470 of newly issued shares for approximately $60.5 million. After the close of the second tranche, Kakaopay will become the largest shareholder of Siebert with a total of 51% ownership of Siebert. We cannot make any assurances that any of the shareholder approvals, regulatory approvals, or any other closing conditions to the second tranche will be satisfied. The Gebbia Family will continue to hold significant ownership of Siebert, and Siebert’s current management team, led by the Gebbia Family, will continue to manage Siebert’s operations and branch locations. Siebert intends to utilize the additional capital from the first tranche primarily to expand its securities lending business, corporate services, and order flow opportunities, as well as launch correspondent clearing, among other initiatives. Refer to Siebert’s Current Report on Form 8-K filed on May 3, 2023 for further detail regarding this transaction. RISE RISE was an institutional brokerage for which all its revenue producing customers transitioned to other prime service providers by the first quarter of 2022. The expenses associated with the transition resulted in a loss of $0.4 million for the three months ended March 31, 2022. During 2022, there were various transactions involving the ownership of RISE. Refer to Note 3 – Transactions with Tigress and Hedge Connection and Note 4 – RISE for additional detail. As part of this transition, Siebert had an agreement with JonesTrading Institutional Service, LLC (“JonesTrading”) hereby JonesTrading pays RISE a percentage of the net revenue produced by certain historical clients of RISE less any related expenses. For the three months ended March 2023 and 2022, this agreement resulted in pre-tax income of $54,000 and $39,000, respectively. We do not anticipate the pre-tax income related to this agreement will offset the reduction in pre-tax income from customers that have transitioned to other prime service providers. Management is assessing the future strategic direction of RISE, taking into consideration current market conditions, demand trends, and resources. While we believe our expertise and industry relationships will enable us to execute a new strategic direction, our business plan for RISE is untested, and it is uncertain whether our efforts will attract the customers and revenue necessary to compete in the market. - 20 - Transactions with Tigress and Hedge Connection Siebert and RISE engaged in certain transactions with Tigress and Hedge Connection to exchange equity, cash, and respective leadership positions. Based upon the strategic direction of these ventures, management of the respective businesses decided to unwind the original transactions with Siebert, RISE, Hedge Connection and Tigress. As of March 31, 2023 and the date of this Report, Siebert owned 17% of Tigress. See Note 3 – Transactions with Tigress and Hedge Connection for further detail on these transactions. Interest Rates We are exposed to market risk from changes in interest rates. Such changes in interest rates primarily impact revenue from interest, marketing, and distribution fees. The Company primarily earns interest, marketing and distribution fees from margin interest charged on clients’ margin balances, interest on cash and securities segregated for regulatory purposes, and distribution fees from money market mutual funds in clients’ accounts. Securities segregated for regulatory purposes consist solely of U.S. government securities. If prices of U.S. government securities within our portfolio decline, we anticipate the impact to be temporary as we intend to hold these securities to maturity. We seek to mitigate this risk by managing the average maturities of our U.S. government securities portfolio and setting risk parameters for securities owned, at fair value. Technology Partner In third quarter of 2022, we entered into a software license agreement with a new technology provider for the development of a new retail trading platform which will replace our current platforms and resulted in the termination of our original technology relationship. We believe this new technology provider will be key to creating a platform for the next generation of retail customers and the termination of our original technology relationship had minimal impact on our current operations. We plan to launch a new retail trading platform in the second quarter of 2023. Client Account and Activity Metrics The following tables set forth metrics we use in analyzing our client account and activity trends for the periods indicated. For the periods presented, there were no institutional client accounts or client activity metrics. Client Account Metrics As of March 31, 2023 December 31, 2022 Retail customer net worth (in billions) $ 14.4 $ 13.5 Retail customer margin debit balances (in billions) $ 0.4 $ 0.4 Retail customer credit balances (in billions) $ 0.6 $ 0.6 Retail customer money market fund value (in billions) $ 0.6 $ 0.6 Retail customer accounts 124,170 122,394 ● Retail customer net worth represents the total value of securities and cash in the retail customer accounts after deducting margin debits ● Retail customer margin debit balances represents credit extended to our customers to finance their purchases against current positions ● Retail customer credit balances represents client cash held in brokerage accounts ● Retail customer money market fund value represents all retail customers accounts invested in money market funds ● Retail customer accounts represents the number of retail customers Client Activity M etrics Three Months Ended March 31, 2023 2022 Total retail trades 82,221 109,952 ● Total retail trades represents retail trades that generate commissions - 21 - Statements of Operations and Financial Condition Statements of Operations for the Three Months Ended March 31, 2023 and 2022 Revenue Commissions and fees for the three months ended March 31, 2023 were $1,901,000 and decreased by $439,000 from the corresponding period in the prior year, primarily due to market conditions. Interest, marketing and distribution fees for the three months ended March 31, 2023 were $6,973,000 and increased by $4,611,000 from the corresponding period in the prior year primarily due to an increase in rising interest rates that resulted in an increase in margin interest, 12b-1fees, as well as interest on U.S. treasuries and cash deposits within MSCO. Principal transactions and proprietary trading for the three months ended March 31, 2023 were $2,800,000 and increased by $3,067,000 from the corresponding period in the prior year, primarily due to the factors discussed below. The decrease in realized and unrealized gain on primarily riskless principal transactions was primarily due to market conditions. The increase in unrealized gain on our portfolio of U.S. government securities was due to the following. Siebert invested in 1-year treasury bills and 2-year treasury notes in order to enhance its yield on its excess 15c3-3 deposits. During 2022, there was an increase in U.S. government securities yields, which created an unrealized loss on our government securities portfolio. In 2023, we began to see the reversal of the unrealized loss resulting in an unrealized gain due to the securities coming closer to maturity. We intend to hold these securities to maturity and as such, the aggregate unrealized loss will be returned over the duration of the government securities, at a point no later than the maturity of the securities, the latest maturity being August 2024. If the value of our portfolio of government securities declines further, we will incur further unrealized losses; however, we anticipate this loss to be temporary as we intend to hold these securities to maturity. We believe that the level invested reduces the risk of having to liquidate the securities prior to maturity. Below is a summary of the change in the principal transactions and proprietary trading line item for the periods presented. Three Months Ended March 31, 2023 2022 Increase (Decrease) Principal transactions and proprietary trading Realized and unrealized gain on primarily riskless principal transactions $ 1,799,000 $ 1,919,000 $ (120,000 ) Unrealized gain (loss) on portfolio of U.S. government securities 1,001,000 (2,186,000 ) 3,187,000 Total Principal transactions and proprietary trading $ 2,800,000 $ (267,000 ) $ 3,067,000 Market making for the three months ended March 31, 2023 was $345,000 and decreased by $419,000 from the corresponding period in the prior year, primarily due to market conditions. Stock borrow / stock loan for the three months ended March 31, 2023 was $3,442,000 and decreased by $136,000 from the corresponding period in the prior year. Advisory fees for the three months ended March 31, 2023 were $444,000 and decreased by $63,000 from the corresponding period in the prior year, primarily due to market conditions. Other income for the three months ended March 31, 2023 was $265,000 and decreased by $795,000 from the corresponding period in the prior year, primarily due to the termination of consulting fee income from a technology partner as well as a decrease in various customer account fees. Operating Expenses Employee compensation and benefits for the three months ended March 31, 2023 were $6,967,000 and decreased by $127,000 from the corresponding period in the prior year, primarily due to a decrease in commissions paid to revenue producers, partially offset by timing of certain compensation expenses. Clearing fees, including execution costs for the three months ended March 31, 2023 were $355,000 and decreased by $139,000 from the corresponding period in the prior year, primarily due the timing of certain fees and a decrease in our clearing costs related to RISE. - 22 - Technology and communications expenses for the three months ended March 31, 2023 were $789,000 and decreased by $393,000 from the corresponding period in the prior year, primarily due to a decrease in technology costs related to RISE as well as a decrease in costs related to a technology partner. Other general and administrative expenses for the three months ended March 31, 2023 were $1,093,000 and increased by $161,000 from the corresponding period in the prior year, primarily due to an increase in travel and entertainment expenses. Data processing expenses for the three months ended March 31, 2023 were $851,000 and increased by $335,000 from the corresponding period in the prior year, primarily due to timing of service charges and overall increase in processing fees. Rent and occupancy expenses for the three months ended March 31, 2023 were $478,000 and increased by $5,000 from the corresponding period in the prior year. Professional fees for the three months ended March 31, 2023 were $1,074,000 and increased by $378,000 from the corresponding period in the prior year, primarily due to an increase in consulting fees related to certain transactions and timing of other consulting vendor charges. Depreciation and amortization expenses for the three months ended March 31, 2023 were $190,000 and decreased by $69,000 from the corresponding period in the prior year, primarily due to the completion of useful lives of certain software assets in 2022. Interest expense for the three months ended March 31, 2023 was $88,000 and decreased by $36,000 from the corresponding period in the prior year, primarily due to a decrease in notes payable offset by an increase in interest rates related to the mortgage and the loan with East West Bank in 2023. Advertising and promotion expense for the three months ended March 31, 2023 was a credit of $28,000 and decreased by $141,000 from the corresponding period in the prior year, primarily due to a reversal related to advertising expenses. Earnings of (Loss from) Equity Method Investment in Related Party The earnings of equity method investment in related party for the three months ended March 31, 2023 was $38,000 and decreased by $127,000 from the corresponding period in the prior year, primarily due to a decrease in our proportional income from our investment in Tigress. Provision For (Benefit From) Income Taxes The provision from income taxes for the three months ended March 31, 2023 was $1,136,000 and increased from the benefit for income taxes by $1,418,000 from the corresponding period in the prior year. The change from the corresponding period in the prior year is primarily due to increased pre-tax earnings in the first quarter of 2023. Refer to Note 17 – Income Taxes for additional detail. Net Income (Loss) Attributable to Noncontrolling Interests As further discussed in Note 1 – Organization and Basis of Presentation, we consolidate RISE’s financial results into our financial statements and reflect the portion of RISE not held by Siebert as a noncontrolling interests in our financial statements. The net income attributable to noncontrolling interests for the three months ended March 31, 2023 was $19,000, and increased by $138,000 from the corresponding period in the prior year, due to more expenses in RISE in 2022 associated with the exiting of the prime brokerage business. Statements of Financial Condition as of March 31, 2023 and December 31, 2022 Assets Assets as of March 31, 2023 were $772,689,000 and increased by $44,641,000 from December 31, 2022, primarily due to an increase in securities borrowed partially offset by a decrease in cash and cash equivalents and cash and securities segregated for regulatory purposes. Liabilities Liabilities as of March 31, 2023 were $719,554,000 and increased by $41,426,000 from December 31, 2022, primarily due to an increase in securities loaned partially offset by a decrease in payables to customers and payables to non-customers. - 23 - Liquidity and Capital Resources Overview We expect to use our available cash, cash equivalents, and potential future borrowings under our debt agreements and potential issuance of new debt or equity, to support and invest in our core business, including investing in new ways to serve our customers, potentially seeking strategic acquisitions to leverage existing capabilities, and for general capital needs (including capital, deposit, and collateral requirements imposed by regulators and SROs). Based on our current level of operations, we believe our available cash, available lines of credit, overall access to capital markets, and cash provided by operations will be adequate to meet our current liquidity needs for the foreseeable future. As of the date of this Report, there are no known or material events that would require us to use large amounts of our liquid assets to cover expenses. Cash and Cash Equivalents Our cash and cash equivalents were $3.9 million and $23.7 million as of March 31, 2023 and December 31, 2022, respectively. Cash Requirements The following table summarizes our short- and long-term material cash requirements as of March 31, 2023. Payments Due By Period 2023 2024 2025 2026 Thereafter Total Operating lease commitments $ 920,000 $ 588,000 $ 450,000 $ 234,000 $ 48,000 $ 2,240,000 Mortgage with East West Bank 61,000 84,000 88,000 91,000 4,048,000 4,372,000 Loan with East West Bank 749,000 1,661,000 — — — 2,410,000 Technology vendor* 850,000 350,000 — — — 1,200,000 Total $ 2,580,000 $ 2,683,000 $ 538,000 $ 325,000 $ 4,096,000 $ 10,222,000 * On March 31, 2023, we entered into an agreement with a technology vendor for certain development projects for a total of approximately $1.2 million over a term of 2 years. On December 30, 2021, we purchased the Miami office building and are building out this space to be one of our primary operating centers. As of March 31, 2023, we have incurred approximately $1.6 million out of the total estimated $1.7 million build out costs. In the fourth quarter of 2022, we partnered with a technology partner to develop a new retail trading platform for our customers and integrate the retail trading platform into our operations. As of March 31, 2023, we have incurred approximately $0.6 million out of the total estimated $0.8 million development costs. Debt Agreements We have a $4.4 million mortgage and a $2.4 million loan outstanding with East West Bank, and an unutilized loan for short term overnight demand borrowing of up to $25 million with BMO Harris as of March 31, 2023. As of March 31, 2023, we were in compliance with all covenants related to our debt agreements. Shelf Registration Statement On February 18, 2022, we filed a shelf registration statement on Form S-3 that was declared effective on March 2, 2022 by the SEC for the potential offering, issuance and sale by us of up to $100.0 million of our common stock, preferred stock, warrants to purchase our common stock and/or preferred stock, units consisting of all or some of these securities and subscription rights to purchase all or some of these securities. The registration statement was filed in reliance on General Instruction I.B.6 of Form S-3, which imposes a limitation on the maximum amount of securities that we may sell pursuant to the registration statement during any twelve-month period. Assuming we remain subject to General Instruction I.B.6, at the time we sell securities pursuant to the registration statement, the amount of securities to be sold plus the amount of any securities we have sold during the prior twelve months in reliance on Instruction I.B.6 may not exceed one-third of the aggregate market value of our outstanding common stock held by non-affiliates as of a day during the 60 days immediately preceding such sale as computed in accordance with Instruction I.B.6. Whether we sell securities under the registration statement will depend on a number of factors, including the market conditions at that time, our cash position at that time and the availability and terms of alternative sources of capital. - 24 - At the Market Offering On May 27, 2022, we entered into a Capital on Demand TM Sales Agreement with JonesTrading as agent, pursuant to which we may offer and sell, from time to time through JonesTrading, shares of our common stock having an aggregate offering amount of up to $9.6 million under our shelf registration statement on Form S-3. For the three months ended March 31, 2023 and 2022, we did not sell any shares pursuant to this Sales Agreement. Refer to Note 20 – Commitments, Contingencies, and Other for additional detail. Net Capital, Reserve Accounts, Segregation of Funds, and Other Regulatory Requirements MSCO is subject to the Uniform Net Capital Rules of the SEC (Rule 15c3-1) and the Customer Protection Rule (15c3-3) of the Exchange Act and maintains capital and segregated cash reserves in excess of regulatory requirements. Requirements under these regulations may vary; however, MSCO has adequate reserves and contingency funding plans in place to sufficiently meet any regulatory requirements. In addition to net capital requirements, as a self-clearing broker-dealer, MSCO is subject to cash deposit and collateral requirements with clearing houses, such as the DTCC and OCC, which may fluctuate significantly from time to time based upon the nature and size of clients’ trading activity and market volatility. RISE, as a member of FINRA, is subject to the SEC Uniform Net Capital Rule 15c3-1 and the corresponding regulatory capital requirements. MSCO can transfer funds to Siebert as long as MSCO maintains its liquidity and regulatory capital requirements. RISE can transfer funds to its shareholders, of which Siebert is entitled to its proportional ownership interest, as long as RISE maintains its liquidity and regulatory capital requirements. For the three months ended March 31, 2023 and 2022, MSCO and RISE had sufficient net capital to meet their respective liquidity and regulatory capital requirements. Refer to Note 18 – Capital Requirements for more detail about our capital requirements. Cash Flows Cash provided by and used in operating activities consisted of net income (loss) adjusted for certain non-cash items. Net operating assets and liabilities at any specific point in time are subject to many variables, including variability in customer activity, the timing of cash receipts and payments, and vendor payment terms. The total changes in our statements of cash flows, especially our operating cash flow, are not necessarily indicative of the ongoing results of our business as we have customer assets and liabilities on our statements of financial condition. For the three months ended March 31, 2023, we had negative operating cash flow primarily due to the change in payables to customers and payables to non-customers. We had investing cash outflows primarily from the build out of the Miami office building and development work related to our new retail trading platform and other technology initiatives. We had financing cash outflows due to the repayment of our loan with East West Bank. For the three months ended March 31, 2022, we had negative operating cash flow primarily due to the change in payables to customers and payables to non-customers, partially offset by the net effect of the change in securities borrowed and securities loaned. We had investing cash outflows primarily from the build out of the Miami office building and repayment of note payable - related party. We had financing cash inflows related to the issuance and transfers of RISE membership interests, partially offset by repayment of a note payable - related party and long term debt. Long Term Contracts Contract with NFS Effective August 1, 2021, MSCO entered into an amendment to its clearing agreement with NFS that, among other things, extends the term of their arrangement for an additional four-year period commencing on August 1, 2021 and ending July 31, 2025. As part of this agreement, we received a one-time business development credit of $3 million, and NFS will pay us four annual credits of $100,000 over the term of the agreement. The amendment also provides for an early termination fee; however, as of March 31, 2023, we do not expect to terminate the contract with NFS before the end of the contract term. Refer to Note 15 – Deferred Contract Incentive and Note 20 – Commitments, Contingencies and Other for additional detail. Off-Balance Sheet Arrangements We enter into various transactions to meet the needs of customers, conduct trading activities, and manage market risks and are, therefore, subject to varying degrees of market and credit risk. In the normal course of business, our customer activities involve the execution, settlement, and financing of various customer securities transactions. These activities may expose us to off-balance sheet risk in the event the customer or other broker is unable to fulfill its contracted obligations and we are forced to purchase or sell the financial instrument underlying the contract at a loss. There were no material losses for unsettled customer transactions for the three months ended March 31, 2023 and 2022. Refer to Note 19 – Financial Instruments with Off-Balance Sheet Risk for additional detail. - 25 - Uncertain Tax Positions We account for uncertain tax positions in accordance with the authoritative guidance issued under ASC 740-10, which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. We may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. The tax benefits recognized in the financial statements from such position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. ASC 740-10 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure requirements. We recognize interest and penalties related to unrecognized tax benefits on the provision for income taxes line on the statements of operations. Accrued interest and penalties would be included on the related tax liability line on the statements of financial condition. As of both March 31, 2023 and December 31, 2022, the Company recorded an uncertain tax position of $1,596,000 related to various tax matters, which is included in the line item “Taxes payable” in the statements of financial condition. Critical Accounting Policies Certain of our accounting policies that involve a higher degree of judgment and complexity are discussed in Part I, Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2022 Form 10-K. As of March 31, 2023, there have been no changes to our critical accounting policies or estimates. New Accounting Standards Refer to Note 2 - Summary of Significant Accounting Policies for additional information regarding new Accounting Standards Updates (“ASU”s) issued by the Financial Accounting Standards Board (“FASB”). - 26 -