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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
/X/ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1993
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-6817
LEHMAN BROTHERS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 13-2518466
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) (IDENTIFICATION NO.)
3 WORLD FINANCIAL CENTER
NEW YORK, NEW YORK 10285
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 298-2000
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
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NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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10 3/4% Senior Subordinated New York Stock Exchange
Notes Due 1996
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SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NONE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (sec.229.405 of this chapter) 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 /X/.
As the registrant is a wholly owned subsidiary of Lehman Brothers Holdings
Inc. none of the registrant's outstanding voting stock is held by non-affiliates
of the registrant. As of the date hereof, 1,005 shares of the registrant's
Common Stock, $.10 par value per share were issued and outstanding.
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION
J(1)(A) AND (B) OF FORM 10-K AND THEREFORE IS FILING THIS FORM WITH A PORTION OF
THE REDUCED DISCLOSURE CONTEMPLATED THEREBY.
DOCUMENTS INCORPORATED BY REFERENCE:
NONE.
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PART I
ITEM 1. BUSINESS
GENERAL
As used herein, "LBI" or the "Registrant" means Lehman Brothers Inc., a
Delaware corporation incorporated on January 21, 1965. LBI and its subsidiaries
are collectively referred to as "Lehman Brothers" or the "Company." LBI is a
wholly owned subsidiary of Lehman Brothers Holdings Inc., a Delaware
corporation, which (together with its subsidiaries, where appropriate) is
referred to herein as "Holdings." American Express Company, a New York
corporation ("American Express") owns 100 percent of the outstanding common
stock of Holdings, par value $.10 per share (the "Holdings Common Stock"), which
represents approximately 93% of Holdings' issued and outstanding voting stock.
The remainder of Holdings' voting stock, the 5% Cumulative Convertible Voting
Preferred Stock, Series A (the "Series A Preferred Stock") is owned by Nippon
Life Insurance Company ("Nippon Life"). Assuming the exercise by Nippon Life of
a warrant to purchase shares of Holdings Common Stock (the "Warrant"), American
Express' ownership percentage of Holdings' voting stock would be 88 percent.
The Company is one of the leading global investment banks serving
institutional, corporate, government and high net worth individual clients and
customers. The Company's executive offices are located at 3 World Financial
Center, New York, New York 10285 and its telephone number is (212) 298-2000.
Distribution of Holdings Common Stock
On January 24, 1994, American Express announced plans to issue a special
dividend to its common shareholders consisting of all of Holdings Common Stock
(the "Distribution"). Prior to the Distribution, which is subject to certain
conditions, an additional equity investment of approximately $1.25 billion will
be made in Holdings, most significantly by American Express. Holdings currently
expects to file a Registration Statement on Form S-1 (the "Registration
Statement") with the Securities and Exchange Commission (the "Commission") with
respect to the Distribution during the second quarter of 1994.
Change of Fiscal Year
On March 28, 1994, the Board of Directors of Holdings approved, subject to
the Distribution, a change in the Company's fiscal year end from December 31 to
November 30. Such a change to a non-calendar cycle will shift certain year-end
administrative activities to a time period that conflicts less with the business
needs of the Company's institutional customers.
Reduction in Personnel
During the first quarter of 1994, the Company completed a review of
personnel needs, which will result in the termination of certain personnel. The
Company anticipates that it will record a severance charge of approximately $25
million pre-tax in the first quarter of 1994 as a result of these terminations.
The Primerica Transaction
On July 31, 1993, pursuant to an asset purchase agreement (the "Primerica
Agreement"), the Company completed the sale (the "Primerica Transaction") of its
domestic retail brokerage business (except for such business conducted under the
Lehman Brothers name) and substantially all of its asset management business
(collectively, "Shearson") to Primerica Corporation (now known as Travelers
Corporation) ("Travelers") and its subsidiary Smith Barney, Harris Upham & Co.
Incorporated ("Smith Barney"). Also included in the Primerica Transaction were
the operations and data processing functions that support these businesses, as
well as certain of the assets and liabilities related to these operations.
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LBI received approximately $1.2 billion in cash and a $586 million interest
bearing note from Smith Barney which was repaid in January 1994 (the "Smith
Barney Note"). The Smith Barney Note was issued as partial payment for certain
Shearson assets in excess of $600 million which were sold to Smith Barney. The
proceeds received at July 31, 1993, were based on the estimated net assets of
Shearson, which exceeded the minimum net assets of $600 million prescribed in
the Primerica Agreement. As further consideration for the sale of Shearson,
Smith Barney agreed to pay future contingent amounts based upon the combined
performance of Smith Barney and Shearson, consisting of up to $50 million per
year for three years based on revenues, plus 10% of after-tax profits in excess
of $250 million per year over a five-year period (the "Participation Rights").
In contemplation of the Distribution, American Express received the first
Participation Right payment in the first quarter of 1994. It is anticipated that
all of the Participation Rights will be assigned to American Express prior to
the Distribution. As further consideration for the sale of Shearson, LBI
received 2,500,000 shares of 5.50% Convertible Preferred Stock, Series B, of
Travelers and a warrant to purchase 3,749,466 shares of common stock of
Travelers at an exercise price of $39.00 per share. In August 1993, American
Express purchased such preferred stock and warrant from LBI for aggregate
consideration of $150 million.
The Company recognized a 1993 first quarter loss related to the Primerica
Transaction of approximately $630 million after-tax ($535 million pre-tax),
which amount includes a reduction in goodwill of $750 million and
transaction-related costs such as relocation, systems and operations
modifications and severance.
The Mellon Transaction
On May 21, 1993, pursuant to a stock purchase agreement (the "Mellon
Agreement") between LBI and Mellon Bank Corporation ("Mellon Bank"), LBI sold to
Mellon Bank (the "Mellon Transaction"), The Boston Company, Inc. ("The Boston
Company") which through subsidiaries is engaged in the private banking, trust
and custody, institutional investment management and mutual fund administration
businesses. Under the terms of the Mellon Agreement, LBI received approximately
$1.3 billion in cash, 2,500,000 shares of Mellon Bank common stock and ten year
warrants to purchase an additional 3,000,000 shares of Mellon Bank's common
stock at an exercise price of $50.00 per share. In June 1993, such shares and
warrants were sold by LBI to American Express for an aggregate purchase price of
$169 million. After accounting for transaction costs for the Mellon Transaction
and certain adjustments, the Company recognized a 1993 first quarter after-tax
gain of $165 million.
Shearson Lehman Hutton Mortgage Corporation Transaction
LBI completed the sale of its wholly owned subsidiary, Shearson Lehman
Hutton Mortgage Corporation ("SLHMC"), to GE Capital Corporation on August 31,
1993. The sales price, net of proceeds used to retire indebtedness of SLHMC, was
approximately $70 million. During the first quarter of 1993, the Company
provided $120 million of pre-tax reserves in anticipation of the sale of SLHMC.
After accounting for these reserves, the sale did not have a material effect on
the Company's results of operations.
Lehman Brothers is one of the leading global investment banks serving
institutional, corporate, government and high net worth individual clients and
customers. The Company's worldwide headquarters in New York are complemented by
offices in 19 additional locations in the United States, 11 in Europe and the
Middle East, four in Latin and South America and three in the Asia Pacific
region. Lehman Brothers also operates a commodities trading and sales operation
in London. Holdings provides investment banking and capital markets services in
Europe and Asia. The Company is engaged primarily in providing financial
services. Other businesses in which the Company is engaged represent less than
10 percent of consolidated assets, revenues or pre-tax income.
The Company's business includes capital raising for clients through
securities underwriting and direct placements; corporate finance and strategic
advisory services; merchant banking; securities sales and trading; asset
management; research; and the trading of foreign exchange, derivative products
and certain commodities. The Company acts as a market maker in all major equity
and fixed income products in both the domestic and certain international
markets. Lehman Brothers is a member of all principal securities and commodities
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exchanges in the United States, as well as the National Association of
Securities Dealers, Inc. ("NASD"). Holdings holds memberships or associate
memberships on several principal international securities and commodities
exchanges, including the London, Tokyo, Hong Kong, Frankfurt and Milan stock
exchanges.
Since 1990, Lehman Brothers has followed a "client/customer-driven"
strategy. Under this strategy, Lehman Brothers concentrates on serving the needs
of major issuing and advisory clients and investing customers worldwide to build
an increasing "flow" of business that leverages the Company's capabilities and
generates a majority of the Company's revenues and profits. Developing lead
relationships with issuing clients and investing customers is a central premise
of the Company's client/customer-driven strategy. Based on management's belief
that each client and customer directs a majority of its financial transactions
to a limited number of investment banks, Lehman Brothers' investment banking and
sales professionals work together with global products and services
professionals to identify and develop lead relationships with priority clients
and customers worldwide. The Company believes that such relationships position
Lehman Brothers to receive a substantial portion of its clients' and customers'
financial business and lessen the volatility of revenues generally associated
with the securities industry.
Holdings' strategy, of which Lehman Brothers is an integral part, consists
of the following four key elements:
(1) Focused coverage of major issuing clients and institutional and high
net worth individual investing customers. The Company's Investment Banking and
Sales areas develop and maintain relationships with clients and customers to
understand and meet their financial needs. Business volume generated through
these relationships accounts for the majority of Lehman Brothers' business.
(2) Comprehensive product and service capabilities. Lehman Brothers has
built capabilities in major product and service categories to enable the Company
to develop lead relationships with its clients and customers, meet their diverse
needs and increase the Company's overall volume of business. Each of these
product and service capabilities is provided to clients and customers by
Investment Banking and Sales.
(3) Global scope of business activities. Lehman Brothers pursues a global
strategy in order to: (i) enhance the Company's product and service
capabilities; (ii) position the Company to increase its flow of business as the
international markets continue to expand; (iii) leverage the Company's
infrastructure to benefit from economies of scale; and (iv) geographically
diversify the Company's revenues.
(4) Organizational structure that enables and encourages the Company's
business units to act in a coordinated fashion as "One Firm." The Company is
organized to provide the delivery of products and services through teams
comprised of professionals with specialized expertise focused on meeting the
financial objectives of the Company's clients and customers.
Lehman Brothers also engages in activities such as arbitrage and
proprietary trading that leverage the Company's expertise and infrastructure and
provide attractive profit opportunities, but generally entail a higher degree of
risk as the Company makes investments for its own account.
FOCUSED CLIENT AND CUSTOMER COVERAGE
Investment Banking
Lehman Brothers is a leading underwriter of equity and equity-related
securities in the equity capital markets and of taxable and tax-exempt fixed
income securities denominated in U.S. dollars. The Company also engages in
project and real estate financings around the world. According to Securities
Data Company, Inc., Lehman Brothers was the third ranked underwriter of debt and
equity securities in the United States in 1993. During 1993, Lehman Brothers
lead managed 667 offerings of debt and equity securities in the United States
with a total volume of $114.9 billion.
Investment Banking professionals are responsible for developing and
maintaining relationships with issuing clients, gaining a thorough understanding
of their specific needs and bringing together the full resources of Lehman
Brothers and Holdings to accomplish their financial objectives. Investment
Banking is organized into industry and geographic coverage groups, enabling
individual bankers to develop specific
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expertise in particular industries and markets. Industry coverage groups include
consumer products, financial institutions, health care, industrial, media,
merchandising, natural resources, real estate, technology, telecommunications,
transportation and utilities. Where appropriate, professionals with specialized
expertise in Strategic Advisory, Equities, Fixed Income, Foreign Exchange,
Commodities, Derivatives and Project Finance are integrated into the client
coverage teams.
Lehman Brothers has a long history of providing strategic advisory services
to corporate, institutional and government clients around the world on a wide
range of financial matters, including mergers and acquisitions, divestitures,
leveraged transactions, takeover defenses, spin-offs, corporate reorganizations
and recapitalizations, tender and exchange offers, privatizations, opinion
letters and valuations. The Company's Strategic Advisory Group works closely
with industry and geographic coverage investment bankers and product specialists
around the world. As mergers and acquisitions activity has become increasingly
global, Lehman Brothers has maintained its position as a leader in cross-border
transactions. In 1993, Lehman Brothers was ranked third in terms of mergers and
acquisitions transactions in the United States according to Securities Data
Company, Inc. In 1993, the Company advised clients in the United States on
transactions totaling $20.8 billion.
Institutional Sales
Institutional Sales serves the investing and liquidity needs of major
institutional investors worldwide and provides the distribution mechanism for
new issues and secondary market securities. Lehman Brothers maintains a network
of sales professionals around the world. Institutional Sales focuses on the
major institutional investors that constitute the major share of global buying
power in the financial markets. Lehman Brothers' goal is to be considered one of
the top three investment banks by such institutional investors. By serving the
needs of these customers, the Company also gains insight into investor sentiment
worldwide regarding new issues and secondary products and markets, which in turn
benefits the Company's issuing clients.
Institutional Sales is organized into four distinct sales forces
specialized by the following product types: Equities, Fixed Income, Foreign
Exchange/Commodities and Asset Management. Institutional Sales professionals
work together to coordinate coverage of major institutional investors through
customer teams. Depending on the size and investment objectives of the
institutional investor, a customer team can be comprised of from two to five
sales professionals, each specializing in a specific product. This approach
positions Lehman Brothers to understand and to deliver the full resources of the
Company to its customer base.
High Net Worth and Middle Market Sales
The Company's Financial Services Division serves the investment needs of
high net worth individual investors and small and mid-sized institutions. This
division has one of the largest sales forces of its kind among major investment
banks, with over 500 investment representatives located in seven offices in the
major financial centers of the United States and offices in major financial
centers worldwide. The Company's investment representatives provide investing
customers with ready access to Lehman Brothers' equity and fixed income
research, execution capabilities and global product offerings. The Financial
Services Division also enables the Company's issuing clients to access a diverse
investor base throughout the world.
The global network of investment representatives is supported by the
Investor Services Group located in New York, London and Hong Kong. This group
provides an integrated, global approach to transaction execution, marketing
support, asset allocation strategies, and product development. The Investor
Services Group also works closely with Lehman Brothers Global Asset Management
to develop proprietary product offerings for investing customers.
Through Lehman Brothers Bank (Switzerland) S.A. (the "Bank"), an affiliate
of LBI, the Financial Services Division provides high net worth investors the
traditional personalized services of a Swiss bank, combined with the global
resources of a leading securities company. The Bank's services include deposit
facilities, international investment products, multi-currency secured lending
and global custodial services.
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COMPREHENSIVE PRODUCT AND SERVICE CAPABILITIES
Lehman Brothers provides equity, fixed income, foreign exchange,
commodities, asset management and merchant banking products and services to
clients and customers. Each area is organized to meet more effectively the needs
of clients and customers, and professionals are integrated into teams, supported
by a dedicated administrative and operations staff, to provide the highest
quality products and services.
Equities
Lehman Brothers combines professionals from the sales, trading, financing,
derivatives and research areas of Equities, together with investment bankers,
into teams to serve the financial needs of the Company's equity clients and
customers. The integrated nature of the Company's operations and the equity
expertise delivered through the Company's client and customer teams enable
Lehman Brothers to structure and execute global equity transactions for clients
worldwide. The Company is a leading underwriter of initial public and secondary
offerings of equity and equity-related securities. Lehman Brothers also makes
markets in these and other securities, and executes block trades on behalf of
clients and customers. The Company also actively participates in assisting
governments around the world in raising equity capital as part of their
privatization programs. According to Securities Data Company, Inc., Lehman
Brothers ranked third in lead managed equity and equity-related securities
offerings in the United States in 1993. During 1993, the Company lead managed 87
equity offerings in the United States totaling $8.6 billion.
The Equities product group is responsible for the Company's equity
operations and dollar and non-dollar equity and equity-related products. These
products include listed and over-the-counter ("OTC") securities, American
Depository Receipts, convertibles, options, warrants and derivatives. During
1993, Lehman Brothers made markets in the top 300 NASDAQ stocks as measured by
volume. The Company also makes markets in major European large capitalization
stocks. In addition, the Company's convertible securities trading professionals
make markets in convertible debenture issues and convertible preferred stock
issues.
Derivative Products. Lehman Brothers, in conjunction with its affiliates,
offers equity derivative capabilities across a wide spectrum of products and
currencies, including listed options and futures, portfolio trading and similar
products. In 1993, Lehman Brothers developed and marketed several innovative
products designed to help investors establish or hedge positions in global
markets and currencies. These included products such as certain call and put
warrants that use major stock indices as a benchmark. In addition, Lehman
Brothers lead managed the largest ever stand-alone U.S. corporate warrant issue
in 1993.
Equities Research. The Equities research department is integrated with and
supports the Company's investment banking, sales and trading activities. An
important objective of Equities research is to have in place high quality
research analysts covering industry and geographic sectors that support the
activities of the Company's clients and customers. The Equities research
department is comprised of regional teams staffed by industry specialists,
covering industry sectors and companies worldwide. During 1993, the Company
expanded its global economics coverage and technical market analysis
capabilities.
Equity Finance. Lehman Brothers operates a comprehensive equity finance
business to support the funding, sales and trading activities of the Company and
its clients and customers. Margin lending for the purchase of equities and
equity derivatives, securities lending and short sale facilitation are among the
main functions of the equity finance group. This group also engages in a conduit
business, whereby the Company seeks to earn a positive net spread on matched
security borrowing and lending activities.
Fixed Income
Lehman Brothers actively participates in all major fixed income product
areas. The Company combines professionals from the sales, trading, financing,
derivatives and research areas of Fixed Income, together with investment
bankers, into teams to serve the financial needs of the Company's clients and
customers. The Company is a leading underwriter of new issues, and also makes
markets in these and other fixed income securities. The Company's global
presence facilitates client and customer transactions and provides liquidity in
marketable fixed and floating rate debt securities. According to Securities Data
Company, Inc., Lehman
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Brothers ranked third in lead managed fixed income securities offerings in the
United States in 1993. During 1993, the Company lead managed 580 offerings in
the United States for a total of $106.3 billion of fixed income securities.
Fixed Income products consist of government, sovereign and supranational
agency obligations; money market products; corporate debt securities; mortgage
and asset-backed securities; emerging market securities; municipal and
tax-exempt securities; derivative products and research. In addition, the
Company's central funding operation provides access to cost efficient debt
financing sources, including repurchase agreements, for the Company and its
clients and customers.
Government and Agency Obligations. Lehman Brothers is one of the leading
39 primary dealers in U.S. Government securities, as designated by the Federal
Reserve Bank of New York, and participates in the underwriting of, and maintains
positions in, U.S. Treasury bills, notes and bonds, and securities of federal
agencies.
Money Market Products. Lehman Brothers is a global market leader in the
origination and distribution of short-term debt obligations, including
commercial paper, short-term notes, preferred stock and Money Market Preferred
Stock(R). The Company is an appointed dealer for approximately 480 commercial
paper programs on behalf of companies and government agencies.
Corporate Debt Securities. Lehman Brothers is a leader in the underwriting
and market making of fixed and floating dollar investment grade debt and trades
approximately $1.5 billion of these securities on a daily basis. According to
Securities Data Company, Inc., during 1993, Lehman Brothers ranked third in new
issue domestic investment grade debt. The Company also underwrites and makes
markets in non-investment grade debt securities and bank loans. Lehman Brothers
trades in excess of $2.0 billion of high yield securities on a monthly basis.
Mortgage and Asset-Backed Securities. The Company is a leading underwriter
of and market maker in mortgage and asset-backed securities. The Company's
trading activity in the secondary mortgage market exceeds $3.0 billion on a
daily basis.
Municipal and Tax-Exempt Securities. Lehman Brothers is a leading dealer
in municipal and tax-exempt securities, including general obligation and revenue
bonds, notes issued by states, counties, cities, and state and local
governmental agencies, municipal leases, tax-exempt commercial paper and put
bonds. Lehman Brothers is also a leader in the structuring, underwriting and
sale of tax-exempt and taxable securities and derivative products for city,
state, not-for-profit and other public sector clients. The Company's Public
Finance group advises state and local governments on the issuance of municipal
securities, and works closely with the municipal sales and trading area to
underwrite both negotiated and competitive short-and long-term offerings.
According to Securities Data Company, Inc., Lehman Brothers ranked third in lead
managed municipal securities offerings in 1993 with a total volume of $29.3
billion.
Derivative Products. The Company offers a broad range of derivative
product services. Derivatives professionals are integrated into all of the
Company's major fixed income product areas. In 1993, Lehman Brothers assisted
over 1,000 clients and customers worldwide, in the execution of over 3,900
transactions aggregating approximately $265 billion (notional amount).
In 1993, the Company introduced several new derivative products to meet the
needs of both issuers and investors, including Step-Up Recovery Floating Rate
Notes and Range Floaters. These innovative products are designed to offer
issuers and investors the opportunity to diversify their investment and
liability portfolios. In late 1993, Lehman Brothers incorporated Lehman Brothers
Financial Products Inc. ("LBFP"), a separately capitalized triple-A rated
derivatives subsidiary. Lehman Brothers established LBFP to increase the volume
of its derivatives business and capture additional underwriting and trading
business. It is expected that LBFP will commence its derivatives activities in
the third quarter of 1994.
Central Funding. The central funding unit engages in two major activities,
matched book funding and secured financing. Matched book funding involves
lending cash on a short-term basis to institutional customers collateralized by
marketable securities, typically government or government agency securities.
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These arrangements are classified on the Company's balance sheet as "securities
purchased under agreements to resell." The Company may also enter into
short-term contractual agreements, referred to as "securities sold under
agreements to repurchase," whereby securities are pledged as collateral in
exchange for cash. The Company enters into these agreements in various
currencies and seeks to generate profits from the difference between interest
earned and interest paid.
Central funding works with the Company's institutional sales force to
identify customers that have cash to invest and/or securities to pledge to meet
the financing and investment objectives of the Company and its customers.
Central funding also coordinates with the Company's treasury area to provide
collateralized financing for a large portion of the Company's securities and
other financial instruments owned.
Fixed Income Research. Fixed Income research at Lehman Brothers
encompasses a broad range of research disciplines: quantitative, economic,
strategic, credit, portfolio and market-specific analysis. Fixed Income research
is integrated with and supports the Company's investment banking, sales and
trading activities. An important objective of Fixed Income research is to have
in place high quality research analysts covering industry, geographic and
economic sectors that support the activities of the Company's clients and
customers. Their expertise includes U.S. government and agency securities,
corporate securities, high yield, asset and mortgage-backed securities and
emerging market debt. Fixed Income research expanded its quantitative
capabilities and its coverage of the commercial real estate market during 1993.
Foreign Exchange
According to a leading market research firm, Lehman Brothers is one of the
top two global investment banks that trade foreign exchange for clients and
customers. Through its foreign exchange operations, Lehman Brothers seeks to
provide its clients and customers with superior trading execution, price
protection and hedging strategies to manage volatility. The Company and its
affiliates, through operations in New York, London, and Hong Kong, engage in
trading activities in all major currencies and maintain a 24-hour foreign
exchange market making capability for clients and customers worldwide. In 1993,
Lehman Brothers enhanced its foreign exchange capabilities by becoming the first
U.S. investment bank to join the Electronic Broking Service in Europe. In
addition to the Company's traditional client/customer-driven foreign exchange
activities, Lehman Brothers also trades foreign exchange for its own account.
Commodities and Futures
Lehman Brothers engages in commodities and futures trading in three
business lines: market making in metals, exchange futures execution services,
and managed futures. The Company seeks to provide clients and customers with
innovative investment and hedging strategies to satisfy their investing and risk
management objectives. In 1993, professionals from Commodities, Investment
Banking and Equities worked together to structure and issue gold-denominated
preferred stock, which was the first commodity-linked equity security to be
listed on the New York Stock Exchange.
Asset Management
Lehman Brothers Global Asset Management ("LBGAM") provides discretionary
and non-discretionary investment management services to institutional and high
net worth investors worldwide. LBGAM's asset management philosophy combines
fundamental research with quantitative techniques to identify investment
opportunities that span the global equity, fixed income and currency markets.
During 1993, LBGAM launched the Lehman Brothers Institutional Funds, a family of
funds directed toward U.S. institutional investors, and expanded its managed
futures funds for investors throughout the world.
Merchant Banking Fund Management
Since 1989, Holdings' principal method of making merchant banking
investments has been through a series of partnerships (the "1989 Partnerships"),
for which subsidiaries of Holdings act as general partner, and in some cases as
a limited partner. Merchant banking activities have consisted principally of
making equity and certain other investments in merger, acquisition,
restructuring and leveraged capital transactions,
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including leveraged buyouts, either independently or in partnership with the
Company's clients. Current merchant banking investments include both publicly
traded and privately held companies diversified on a geographic and industry
basis.
The 1989 Partnerships have a 10-year life with capital available for
investment for only the first five years, which period ended in March 1994.
Accordingly, during the remaining life of the Partnerships, Holdings' merchant
banking activities, with respect to investments made by the 1989 Partnerships,
will be directed toward selling or otherwise monetizing such investments.
Holdings is currently considering the establishment of a new merchant banking
fund and participation in other merchant banking opportunities.
Other Business Activities
While Lehman Brothers concentrates on its client/customer-driven strategy,
the Company also participates in business opportunities such as arbitrage and
proprietary trading that leverage the Company's expertise, infrastructure and
resources. These businesses may generate substantial revenues but generally
entail a higher degree of risk as the Company trades for its own account.
Arbitrage. Lehman Brothers engages in a variety of arbitrage activities.
In traditional or "riskless" arbitrage, the Company seeks to benefit from
temporary price discrepancies that occur when a security is traded in two or
more markets, or when a convertible or derivative security is trading at a price
disparate from its underlying security. The Company's "risk" arbitrage
activities involve the purchase of securities at discounts from the expected
values that would be realized if certain proposed or anticipated corporate
transactions (such as mergers, acquisitions, recapitalizations, exchange offers,
reorganizations, bankruptcies, liquidations or spin-offs) were to occur. To the
extent that these anticipated transactions do not materialize in a manner
consistent with the Company's expectations, the Company is subject to the risk
that the value of these investments will decline in value. Lehman Brothers'
arbitrage activities benefit from the Company's presence in the global capital
markets, access to advanced information technology, in-depth market research,
proprietary risk management tools and general experience in assessing rapidly
changing market conditions.
Proprietary Trading. Lehman Brothers engages in the trading of various
securities, derivatives, currencies and commodities for its own account. The
Company's proprietary trading activities bring together various research and
trading disciplines allowing it to take market positions, which at times may be
significant, consistent with the Company's expectations of future events (such
as movements in the level of interest rates, changes in the shape of yield
curves and changes in the value of currencies). The Company is subject to the
risk that actual market events will be different from the Company's
expectations, which may result in significant losses associated with such
proprietary positions. The Company's proprietary trading activities are
generally carried out in consultation with personnel from the relevant major
product area (e.g., mortgages, derivatives and foreign exchange).
ADMINISTRATION AND OPERATIONS
The Company's administration and operations staff supports its businesses
through the processing of certain securities and commodities transactions;
receipt, identification and delivery of funds and securities; internal financial
controls; safeguarding of customers' securities; and compliance with regulatory
and legal requirements. In addition, this staff is responsible for information
systems, communications, facilities, legal, internal audit, treasury, tax,
accounting and other support functions.
In response to the needs of certain of its domestic and international
businesses, the Company has acquired sophisticated data processing and
telecommunications equipment. The Company believes such acquisition was
necessary to provide the high level of technological and analytical support
required to process, settle and account for transactions in a worldwide
marketplace. Automated systems also provide sophisticated decision support which
enhances trading capability and the management of the Company's cash and
collateral resources. There is considerable fluctuation within each year and
from year to year in the volume of business that the Company must process, clear
and settle.
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GLOBAL SCOPE OF BUSINESS ACTIVITIES
Through its network of offices around the world, Lehman Brothers pursues a
global strategy to meet more effectively the needs of clients and customers and
to generate increased business volume for the Company. The Company's
headquarters in New York provides support for and is closely linked to its
regional offices. Because Lehman Brothers' global strategy is based on a unified
team approach to serving the financial needs of its clients and customers, the
Company's regional offices enable Investment Banking and Sales to develop more
effectively relationships and deliver products and services to clients and
customers whose businesses are located in a given area or who predominantly
transact business in that region. Based on the growth in international business
activities over the past several years and the continued development of a more
integrated global financial economy, Lehman Brothers expects international
business activities to continue to grow in the future. The Company believes that
its global presence and operating strategy position it to continue to increase
the Company's flow of business, and thereby continue to realize greater benefits
from economies of scale.
ORGANIZATION
The organization and culture of Lehman Brothers represent the fourth
element of the Company's overall strategy. This strategy requires close
integration of investment bankers and sales professionals and product and
service professionals to maximize the Company's effectiveness in developing
client and customer relationships. To effect this strategy, Lehman Brothers is
managed as an integrated global operation. Business planning and execution is
coordinated between regional locations and product heads. The Company's
18-member Operating Committee is the principal governing body of Lehman
Brothers, and is comprised of representatives from every major area of the
organization, including the senior managers from the European and Asia Pacific
regions. This structure promotes communication and cooperation, enabling Lehman
Brothers to identify and address rapidly opportunities and issues on a global,
firm-wide level. The Operating Committee facilitates management's ability to run
the business as a whole, as opposed to managing the business units separately.
This structure is reinforced with a culture and operating practices that
promote integration through the implementation and communication of
organizational values and principles consistent with the Company's "One Firm"
philosophy. An example of one of these operating practices is the Company's
approach to compensation, whereby employees are compensated to a significant
extent on the overall performance of the Company and to a lesser extent on the
performance of any individual business area.
RISK MANAGEMENT
Risk is an inherent part of all of Lehman Brothers' businesses and
activities. The extent to which Lehman Brothers properly and effectively
identifies, assesses, monitors and manages each of the various types of risks
involved in its trading, brokerage and investment banking activities is critical
to the success and profitability of the Company. The principal types of risk
involved in Lehman Brothers' activities are market risks, credit or counterparty
risks and transaction risks. Lehman Brothers has developed a control
infrastructure to monitor and manage each type of risk on a global basis
throughout the Company.
Market Risk
In its trading, market making and underwriting activities, Lehman Brothers
is subject to risks relating to fluctuations in market prices and liquidity of
specific securities, instruments and derivative products, as well as volatility
in market conditions in general. The markets for these securities and products
are affected by many factors, including the financial performance and prospects
of specific companies and industries, domestic and international economic
conditions (including inflation, interest and currency exchange rates and
volatility), the availability of capital and credit, political events (including
proposed and enacted legislation) and the perceptions of participants in these
markets.
Lehman Brothers has developed a multi-level approach for monitoring and
managing its market risk. The base level control is at the trading desks where
various risk management functions are performed, including daily mark to market
by traders and on-going monitoring of inventory aging and pricing by trading
desk managers, product area management and the independent risk managers for
each product area. The next level
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of management of market risk occurs in the Trade Analysis department, which
independently reviews the prices of the Company's trading positions and
regularly monitors the aging of inventory positions.
The final level of the risk management process is the Senior Risk
Management Committee, which is composed of senior management from the various
product areas and from credit, trade analysis and risk management. In addition,
when appropriate, Lehman Brothers employs hedging strategies to reduce its
exposure to fluctuations in market prices of securities and volatility in
interest or foreign exchange rates.
Credit or Counterparty Risks
Lehman Brothers is exposed to credit risks in its trading activities from
the possibility that a counterparty to a transaction could fail to perform under
its contractual commitment, resulting in Lehman Brothers incurring losses in
liquidating or covering its position in the open market. The responsibility for
managing these credit risks rests with the Corporate Credit department. The
department, which is organized along both industry and geographic lines, is
independent from any of Lehman Brothers' product areas. Corporate Credit manages
the Company's credit risks by establishing and monitoring counterparty limits,
structuring and approving specific transactions, actively managing credit
exposures and participating in the new product review process. In addition,
Lehman Brothers, when appropriate, may require collateral from the counterparty
to secure its obligations to the Company or seek some other form of credit
enhancement (such as financial covenants, guarantees or letters of credit) to
support the counterparty's contractual commitment.
Transaction Risk
In connection with its investment banking and product origination
activities, Lehman Brothers is exposed to risks relating to the merits of
proposed transactions. These risks involve not only the market and credit risks
associated with underwriting securities and developing derivative products, but
also potential liabilities under applicable securities and other laws which may
result from Lehman Brothers' role in the transaction.
Each proposed transaction involving the underwriting or placement of
securities by Lehman Brothers is reviewed by the Company's Commitment Committee.
The Commitment Committee is staffed by senior members of the Company with
extensive experience in the securities industry. The principal function of the
Commitment Committee is to determine whether Lehman Brothers should participate
in a transaction in which the Company's capital and reputation will be at risk.
Fairness opinions and valuation letters to be delivered by Lehman Brothers
must be reviewed and approved by the Company's Fairness Opinion Committee, which
is composed of senior investment bankers who provide an independent evaluation
of the opinions and conclusions to be rendered to the Company's clients.
In connection with its investment banking or merchant banking activities,
the Company may from time to time make proprietary investments in securities
that are not readily marketable. These investments primarily result from the
Company's efforts to help clients achieve their financial and strategic
objectives. Any such proposed investment which falls within established criteria
with respect to the amount of capital invested, the anticipated holding period
and the degree of liquidity of the securities must be reviewed and approved by
the Company's Investment Committee, which is composed of senior investment
bankers. The Investment Committee reviews in detail the proposed investment and
applies relevant valuation methodologies to evaluate the risk of loss of capital
compared to the anticipated returns from the investment and determine whether to
proceed with the transaction.
Lehman Brothers recently established a New Products and Business Committee
(the "NPBC") for new products developed by Lehman Brothers or new businesses to
be entered into by the Company. The NPBC will work in cooperation with the
originators or sponsors of a new product or business to evaluate its
feasibility, assess its potential risks and liabilities and analyze its costs
and benefits.
NON-CORE ASSETS
Prior to 1990, the Company participated in a number of activities that are
not central to its current business as an institutional investment banking firm.
As a result of these activities, the Company carries on its balance sheet a
number of relatively illiquid assets (the "Non-Core Assets"), including a number
of individual
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real estate assets, limited partnership interests and a number of smaller
investments. Subsequent to their purchase, the values of certain of these
Non-Core Assets declined below the recorded values on the Company's balance
sheet, which necessitated the write-down of the carrying values of these assets
and corresponding charges to the Company's income statement. Certain of these
activities have resulted in various legal proceedings.
Since 1990, management has devoted substantial resources to reducing the
Company's Non-Core Assets. Between December 31, 1990 and December 31, 1993, the
Company's Non-Core Assets decreased from $1.1 billion in 1990 to approximately
$79 million in 1993, with Non-Core Assets defined as carrying value plus
contingent exposures net of reserves. Management's intention with regard to
these Non-Core Assets is the prudent liquidation of these investments as and
when possible.
RELATIONSHIP WITH SMITH BARNEY
On July 31, 1993, the Company completed the sale of Shearson which
consisted of LBI's domestic retail brokerage business (except for such business
conducted under the Lehman Brothers name), substantially all of its asset
management business, the operations and data processing functions that supported
those business and certain related assets and liabilities.
Securities Clearing, Data Services and General Services Agreements
Pursuant to a clearing agreement (the "Clearing Agreement"), Smith Barney
carries and clears, on a fully disclosed basis, all accounts introduced to it by
Lehman Brothers, and performs all clearing and settlement functions for
equities, municipal securities and corporate debt which were previously
performed by Shearson. Lehman Brothers also conducts certain securities lending
activities as agent for Smith Barney under the Clearing Agreement. Pursuant to
Data Services and General Services Agreements, Smith Barney provides to the
Company all of the same data processing and related services that it previously
received from Shearson. Charges for services under these three agreements are
generally calculated using the intercompany transfer pricing methodology in
effect prior to the Primerica Transaction. These agreements expire on December
31, 1994, but may be extended for up to an additional six months upon payment by
the Company of up to $5 million. The Company has been reviewing alternative
clearing, data processing and other servicing arrangements to take effect after
the expiration of its arrangements with Smith Barney.
Certain Arrangements
Revolving Cash Subordination Agreement. Holdings has agreed to lend to
Smith Barney up to $150 million to cover capital charges in excess of $50
million incurred by Smith Barney as a result of carrying LBI's customer and
proprietary positions (the "Lehman Capital Charges"). Holdings will lend
additional amounts to Smith Barney in the event that the Lehman Capital Charges
increase above $200 million. As of March 28, 1994, $150 million was outstanding.
Under certain circumstances, Travelers is required to purchase all or part of
Smith Barney's indebtedness to Holdings under the facility up to $250 million.
Holdings is only required to fund in excess of $250 million under this facility
if Travelers agrees to a corresponding increase in its purchase obligation;
provided that, without such agreement, the Company may not engage in any
activity which results in the Lehman Capital Charges exceeding $300 million.
Revolving Credit Agreements. Pursuant to a Revolving Credit Agreement,
Smith Barney may borrow funds from LBI secured by securities having a market
value equal to not less than 130% of the aggregate unpaid principal amount
borrowed for the purpose of funding customer margin debits carried by Smith
Barney. As of March 28, 1994, there were no amounts outstanding under this
facility. Pursuant to an Unsecured Revolving Credit Agreement, Holdings has
agreed to advance funds to Smith Barney in order to finance, in part, certain of
the cash demands of the securities lending activities conducted under the
Clearing Agreement. As of March 28, 1994, $756 million was outstanding under
this facility. These facilities will terminate upon the termination of the
Clearing Agreement.
Non-Solicitation. In connection with the Primerica Transaction, both LBI
and Smith Barney agreed that they would refrain from soliciting each other's
employees and certain customers for varying periods of time after July 31, 1993.
The majority of the customer-related non-solicitation provisions have expired.
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Shearson Related Litigation. LBI and Smith Barney agreed to a division of
litigation relating to Shearson pursuant to which, subject to certain
exceptions, Smith Barney is liable for such litigations arising after April 11,
1993. With respect to matters arising on or before April 11, 1993, LBI
transferred to Smith Barney a $50 million reserve. If such reserve is exhausted,
the parties have agreed to share liability on the matters arising on or before
April 11, 1993. LBI retained liability for regulatory matters.
COMPETITION
All aspects of the Company's business are highly competitive. The Company
competes in domestic and international markets directly with numerous other
brokers and dealers in securities and commodities, investment banking firms,
investment advisors and certain commercial banks and, indirectly for investment
funds, with insurance companies and others.
The financial services industry has become considerably more concentrated
as numerous securities firms have either ceased operations or have been acquired
by or merged into other firms. In addition, several small and specialized
securities firms have been successful in raising significant amounts of capital
for their merger and acquisition activities and merchant banking investment
vehicles and for their own accounts. These developments have increased
competition from firms, many of whom have significantly greater equity capital
than the Company.
REGULATION
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. LBI and certain other subsidiaries
of Holdings are registered as broker-dealers and investment advisers with the
Commission and as such are subject to regulation by the Commission and by
self-regulatory organizations, principally the NASD and national securities
exchanges such as the NYSE, which has been designated by the Commission as LBI's
primary regulator, and the Municipal Securities Rulemaking Board. Securities
firms are also subject to regulation by state securities administrators in those
states in which they conduct business. LBI is a registered broker-dealer in all
50 states, the District of Columbia and the Commonwealth of Puerto Rico. The
Commission, self-regulatory organizations and state securities commissions may
conduct administrative proceedings, which may result in censure, fine, the
issuance of cease-and-desist orders or suspension or expulsion of a
broker-dealer or an investment adviser, its officers or employees.
LBI is registered with the CFTC as a futures commission merchant and is
subject to regulation as such by the CFTC and various domestic boards of trade
and other commodity exchanges. The Company's U.S. commodity futures and options
business is also regulated by the National Futures Association, a not-for-profit
membership corporation which has been designated as a registered futures
association by the CFTC.
Holdings and the Company do business in the international fixed income,
equity and commodity markets and undertakes investment banking activities
through Holdings' subsidiaries. The U.K. Financial Services Act of 1986 (the
"Financial Services Act") governs all aspects of the United Kingdom investment
business, including regulatory capital, sales and trading practices, use and
safekeeping of customer funds and securities, record keeping, margin practices
and procedures, registration standards for individuals, periodic reporting and
settlement procedures. Pursuant to the Financial Services Act, Holdings and the
Company are subject to regulations administered by The Securities and Futures
Authority Limited, a self regulatory organization of financial services
companies (which regulates their equity, fixed income, commodities and
investment banking activities) and the Bank of England (which regulates their
wholesale money market, bullion and foreign exchange businesses).
The Company anticipates regulation of the securities and commodities
industries to increase at all levels and for compliance therewith to become more
difficult. Monetary penalties and restrictions on business activities by
regulators resulting from compliance deficiencies are also expected to become
more severe.
The Company believes that it is in material compliance with regulations
described herein.
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CAPITAL REQUIREMENTS
As registered broker-dealers LBI and Lehman Government Securities Inc.
("LGSI"), a wholly owned subsidiary of LBI, are subject to the Commission's net
capital rule (Rule 15c3-1, the "Net Capital Rule") promulgated under the
Exchange Act. The NYSE and the NASD monitor the application of the Net Capital
Rule by LBI and LGSI, respectively. LBI and LGSI compute net capital under the
alternative method of the Net Capital Rule which requires the maintenance of
minimum net capital, as defined. A broker-dealer may be required to reduce its
business if its net capital is less than 4% of aggregate debit balances and may
also be prohibited from expanding its business or paying cash dividends if
resulting net capital would be less than 5% of aggregate debit balances. In
addition, the Net Capital Rule does not allow withdrawal of subordinated capital
if net capital would be less than 5% of such debit balances.
The Net Capital Rule also limits the ability of broker-dealers to transfer
large amounts of capital to parent companies and other affiliates. Under the Net
Capital Rule, equity capital cannot be withdrawn from a broker-dealer without
the prior approval of the Commission when net capital after the withdrawal would
be less than 25% of its securities position haircuts (which are deductions from
capital of certain specified percentages of the market value of securities to
reflect the possibility of a market decline prior to disposition). In addition,
the Net Capital Rule requires broker-dealers to notify the Commission and the
appropriate self-regulatory organization two business days before a withdrawal
of excess net capital if the withdrawal would exceed the greater of $500,000, or
30% of the broker-dealer's excess net capital, and two business days after a
withdrawal that exceeds the greater of $500,000, or 20% of excess net capital.
Finally, the Net Capital Rule authorizes the Commission to order a freeze on the
transfer of capital if a broker-dealer plans a withdrawal of more than 30% of
its excess net capital and the Commission believes that such a withdrawal would
be detrimental to the financial integrity of the Company or would jeopardize the
broker-dealer's ability to pay its customers. Certain of LBI's other
subsidiaries are also subject to the Net Capital Rule.
Compliance with the Net Capital Rule could limit those operations of LBI
that require the intensive use of capital, such as underwriting and trading
activities and the financing of customer account balances, and also could
restrict the ability of Holdings to withdraw capital from LBI, which in turn
could limit the ability of Holdings to pay dividends, repay debt and redeem or
purchase shares of its outstanding capital stock. See Footnote 16 of Notes to
Consolidated Financial Statements.
EMPLOYEES
As of December 31, 1993, the Company employed approximately 7,500 persons.
The Company considers its relationship with its employees to be good.
ITEM 2. PROPERTIES
The Company's headquarters occupy approximately 915,000 square feet of
space at 3 World Financial Center in New York, New York, which is owned by the
Company as tenants-in-common with American Express and various other American
Express subsidiaries. Holdings expects to relocate on or about August 1994,
certain administrative personnel from 388 and 390 Greenwich Street to five
floors in the World Financial Center which are currently occupied by
subsidiaries of American Express. These five floors will result in total
occupancy of approximately 1,147,000 square feet by Holdings and the Company.
Holdings entered into a lease for approximately 392,000 square feet for
offices located at 101 Hudson Street in Jersey City, New Jersey (the "Operations
Center"). The Operations Center will be used by systems, operations, and certain
administrative personnel and contains certain back-up trading facilities. The
lease term is approximately 16 years and is expected to commence in August 1994.
Holdings and the Company occupy 14 floors at 388 and 390 Greenwich Street
which they expect to vacate by July 31, 1994 and will relocate the personnel to
the Operations Center and the World Financial Center.
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Most of the Company's other offices are located in leased premises, the
leases for which expire at various dates through the year 2007. Facilities owned
or occupied by the Company and its subsidiaries are believed to be adequate for
the purposes for which they are currently used and are well maintained.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in a number of judicial, regulatory and arbitration
proceedings concerning matters arising in connection with the conduct of its
business. Such proceedings include actions brought against the Company and
others with respect to transactions in which the Company acted as an underwriter
or financial advisor, actions arising out of the Company's activities as a
broker or dealer in securities and commodities and actions brought on behalf of
various classes of claimants against many securities and commodities firms of
which the Company is one.
Although there can be no assurance as to the ultimate outcome, the Company
has denied, or believes it has a meritorious defense and will deny, liability in
all significant cases pending against it including the matters described below,
and intends to defend vigorously each such case. Although there can be no
assurance as to the ultimate outcome, based on information currently available
and established reserves, the Company believes that the eventual outcome of the
actions against it, including the matters described below, will not, in the
aggregate, have a material adverse effect on the business or consolidated
financial condition of the Company.
GENERAL ACQUISITION, INC. ET AL. V. GENCORP, INC. ET AL. V. WAGNER & BROWN, ET
AL. AND
SHEARSON LEHMAN BROTHERS INC. AND SHEARSON LEHMAN BROTHERS HOLDINGS INC.
This litigation in the United States District Court for the Southern
District of Ohio (the "Ohio Court") arose out of the Company's representation of
Wagner & Brown and AFG Industries, Inc. ("AFG") in connection with their effort
to acquire GenCorp, Inc. ("GenCorp") in March 1986. In response to the tender
offer and the litigation commenced by Wagner & Brown and AFG on March 17, 1986,
GenCorp amended its answer and counterclaims on April 2, 1986 to assert claims
against LBI and Holdings. Only GenCorp's counterclaims against LBI remain
pending. GenCorp asserted common law claims for breach of fiduciary duty, fraud,
negligence and unjust enrichment against Lehman Brothers. The claims are based
on prior contacts between LBI and GenCorp and LBI's subsequent role in advising
and assisting Wagner & Brown and AFG with respect to the tender offer. GenCorp
seeks $258 million in damages and the imposition of a constructive trust on the
fees and profits the Company earned in the transaction. On or about October 2,
1992, the Ohio Court granted LBI's motion for summary judgment and dismissed
GenCorp's claim for compensatory damages. GenCorp has appealed this decision to
the United States Court of Appeals for the Sixth Circuit. No decision has been
rendered. GenCorp's claim for disgorgement of the fees that LBI received has
been stayed pending the appeal.
BAMAODAH V. E.F. HUTTON & COMPANY INC.
In April 1986, Ahmed and Saleh Bamaodah commenced an action against E.F.
Hutton & Company Inc. ("EFH"), a subsidiary of The E.F. Hutton Group Inc.
("Hutton"), to recover all losses the Bamaodahs had incurred since May 1981 in
the trading of commodity futures contracts in a nondiscretionary EFH trading
account. The Dubai Civil Court ruled that the trading of commodity futures
contracts constituted illegal gambling under Islamic law and that therefore the
brokerage contract was void. In January 1987, a judgment was rendered against
EFH in the amount of $48,656,000. On January 5, 1991, the Dubai Court of Appeals
affirmed the judgment. On March 22, 1992, the Court of Cassation, Dubai's
highest court, revoked and quashed the decision of the Court of Appeals and
ordered that the case be remanded to the Court of Appeals for a further review.
FDIC V. CHENG, ET AL.
On or about February 16, 1990, the Federal Deposit Insurance Corporation
(the "FDIC"), as manager of the Federal Savings and Loan Insurance Corporation
("FSLIC") Resolution Fund (the "FSLIC Resolution
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Fund"), which is the receiver of Guaranty Federal Savings and Loan Association
("Guaranty Federal"), filed a complaint in the U.S. District Court for the
Northern District of Texas (the "Texas District Court") in an action entitled
Federal Deposit Insurance Corporation v. Paul Sau-Ki Cheng, et al. On or about
February 2, 1993, the FDIC served a Third Amended Complaint naming EFH,
Holdings, LBI, four former EFH brokers, Drexel Burnham Lambert Inc. and a
subsidiary of it (collectively "Drexel"), a former Drexel broker, Paul Sau-Ki
Cheng and Simon Edward Heath, both former directors and co-chairmen of the board
of directors of Guaranty Federal and certain other parties not affiliated with
Lehman Brothers as defendants. On or about February 11, 1993, the Company filed
its answer to the Third Amended Complaint, denying all material allegations and
asserting several affirmative defenses. The FDIC's claims related to trading
losses and other alleged damages suffered by Guaranty Federal, its creditors,
stockholders and depositors, the FSLIC and the FSLIC Resolution Fund as a result
of U.S. government bond trading by Cheng and Heath through EFH and Drexel, as
well as alleged violations of the Commodities Exchange Act. As a result, the
FDIC sought $129,980,000 in alleged actual damages against all defendants and
$387.6 million in punitive damages against all defendants except EFH, Holdings
and LBI. On October 25, 1993, the Company and the FDIC entered into a settlement
agreement, and on November 16, 1993, the Texas District Court entered an order
and dismissed all claims with prejudice.
PAUL WILLIAMS AND BEVERLY KENNEDY, ET AL. V. BALCOR PENSION INVESTORS ET AL.
In February 1990, a purported class action complaint was filed in the
United States District Court for the Northern District of Illinois. The
complaint names eight separate limited partnerships originated by The Balcor
Company ("Balcor"), which was then a wholly owned subsidiary of LBI, known as
the Balcor Pension Investors series. Also named as defendants were the general
partner of each named limited partnership, Balcor, and Balcor Securities Co.,
LBI and American Express. The complaint which was amended on October 10, 1990
alleges that the named entities violated certain federal securities laws with
regard to the adequacy and accuracy of disclosure of information in connection
with the offering of limited partnership interests. The complaint also alleges
breach of fiduciary duty, fraud, negligence and violations of the Racketeer
Influenced and Corrupt Organizations Act ("RICO"). The complaint seeks
compensatory damages and punitive damages. Defendants' Amended Counterclaim
filed on September 19, 1990, asserts common law claims of fraud and breach of
warranty against plaintiffs. Defendants seek to recover for the alleged damage
to their reputation and business as well as their costs and attorneys fees in
defending against the claims brought by plaintiffs. On November 29, 1990, W.B.
Copeland, Trustee, Ploof Truck Lines, Inc. Profit Sharing Plan and Allan
Hirschfield filed a class action counterclaim against defendants which is
identical to the Amended Complaint seeking, among other things, leave to join
this action as named plaintiffs.
On September 8, 1993, the plaintiffs filed a Third Amended Complaint adding
additional named plaintiffs and an amended motion for class certification which
motions had previously been denied. No plaintiff class has yet been certified
and no judicial determination has been made. No merits discovery has been
conducted.
RALPH MAJESKI, ET AL. V. BALCOR ENTERTAINMENT COMPANY, LTD. ET AL.;
ROBERT ECKSTEIN, ET AL. V. BALCOR FILM INVESTORS, ET AL.
These two actions were filed in United States District Court for the
Eastern District of Wisconsin (the "Wisconsin District Court"). LBI is a
defendant only in the Majeski case. Plaintiffs allege that the named defendants
in the lawsuits violated certain federal securities laws with regard to the
adequacy and accuracy of disclosure of information in respect of the offering of
limited partnership interests in Balcor Film Investors, a partnership of which a
Balcor subsidiary is the general partner. The Majeski complaint also alleges, in
general, breach of fiduciary duty, common law fraud, misrepresentation, breach
of contract and a cause of action in the nature of a derivative action. On
January 18, 1991, the Wisconsin District Court entered an order certifying a
plaintiffs class of all persons who purchased or currently own interests in the
Partnership which were purchased from January 8, 1985 through December 31, 1985.
The Wisconsin District Court also consolidated the Eckstein and Majeski actions
for the remainder of the pretrial proceedings and trial, but did not merge
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such actions. On March 11, 1992, the Wisconsin District Court granted
defendants' motions to dismiss on statute of limitations grounds in both
actions.
In August 1993, the U.S. Court of Appeals for the Seventh Circuit (the
"Court of Appeals") issued an opinion which reversed the order of the Wisconsin
District Court and remanded the cases to such court for further proceedings. The
defendants sought a writ of certiorari in the U.S. Supreme Court which was
denied in January 1994. Upon remand to the Wisconsin District Court, plaintiffs
filed a motion to amend the complaint to assert a RICO claim; defendants opposed
this amendment, and the motion is pending. In addition, defendants have renewed
their motions to dismiss. These motions are pending before the Wisconsin
District Court.
On or about March 8, 1993, the Majeski plaintiffs filed an action in the
Circuit Court for Milwaukee County, Wisconsin. The allegations, including
damages, in this complaint are essentially the same as in their federal court
action, described above. Plaintiff's counsel has represented that this state
court action will be dismissed.
GLYNWILL INVESTMENT, LTD. V. SHEARSON LEHMAN BROTHERS INC.
Glynwill Investment, Ltd. ("Glynwill"), a corporation chartered in Curacao,
N.A., commenced an action against LBI "as successor in interest to E.F. Hutton &
Co., Inc." in May of 1990 in the Supreme Court of the State of New York (the
"New York Court"), alleging fraud and breach of contract on the part of E.F.
Hutton & Co. Inc. in overcharging Glynwill for foreign exchange transactions
executed for Glynwill. The New York Court, on LBI's motion to dismiss, held that
the release signed by Glynwill after Glynwill's repayment of approximately one
half of the $10 million unsecured debit created in Glynwill's account was not a
general release encompassing the claims raised by Glynwill in this action and
denied LBI's motion. Discovery is ongoing.
SANFORD F. KAPLAN V. THE E.F. HUTTON GROUP INC., ET AL; CHRISTOPHER J. HARRIS V.
THE E.F. HUTTON GROUP INC., ET AL.
On or about December 30, 1987 and January 11, 1988, the Kaplan and Harris
complaints were filed as purported class actions. The complaints in these two
actions, brought in New York State Supreme Court (the "State Court") and the
United States District Court for the Southern District of New York (the
"District Court"), respectively, name as defendants Hutton, LBI and SLBP
Acquisition Corp., and purport to be brought on behalf of classes of certain
holders of nonvested employee stock options or equity grants awarded under
Hutton's Equity Ownership Plan (the "Plan"). Plaintiffs alleged, among other
things, that as a result of the execution of the Agreement and Plan of Merger
between Hutton, SLBP Acquisition Corp. and LBI and the acquisition by LBI of a
majority of the shares of Hutton, their stock options and equity grams vested.
They sought compensatory damages, declaratory relief and, in the case of Kaplan,
injunctive relief. Classes were certified in each action.
On December 29, 1993, the District Court issued a final judgment and order
approving a settlement and dismissing the Harris action. On January 13, 1993,
the State Court issued a final judgment and order approving the settlement and
dismissing the Kaplan case.
ACTIONS RELATING TO FIRST CAPITAL HOLDINGS INC.
FCH Derivative Actions. On or about March 29, 1991, two identical
purported shareholder derivative actions were filed, entitled Mentch v.
Weingarten, et al. and Isaacs v. Weingarten, et al. The complaints in these two
actions, pending in the Superior Court of the State of California, County of Los
Angeles, are filed allegedly on behalf of and naming as a nominal defendant FCH.
Other defendants include Holdings, two former officers and directors of FCH,
Robert Weingarten and Gerry Ginsberg, the four outside directors of FCH, Peter
Cohen, Richard DeScherer, William L. Mack and Jerome H. Miller (collectively,
the "Outside Directors"), and Michael Milken. The complaints allege generally
breaches of fiduciary duty, gross corporate mismanagement and waste of assets in
connection with FCH's purchase of non-rated bonds underwritten by
16
<PAGE> 18
Drexel Burnham Lambert Inc. and seek damages for losses suffered by FCH,
punitive damages and attorneys' fees. The actions have been stayed pursuant to
the bankruptcy of FCH.
Concurrent with the bankruptcy filing of FCH and the conservatorship and
receivership of its two life insurance subsidiaries, First Capital Life
Insurance Company ("First Capital Life") and Fidelity Bankers Life Insurance
Company ("Fidelity Bankers Life") (First Capital Life and Fidelity Bankers Life
collectively, the "Insurance Subsidiaries"), a number of additional actions were
instituted, naming one or more of Holdings, LBI and American Express as
defendants (individually or collectively, as the case may be, the "American
Express Defendants").
FCH Shareholder and Agent Actions. Three actions were commenced in the
United States District Courts for the Southern District of New York and the
Central District of California allegedly as class actions on behalf of the
purchasers of FCH securities during certain specified periods, commencing no
earlier than May 4, 1988 and ending no later than May 31, 1991 (the "Shareholder
Class"). The complaints are captioned Larkin, et al. v. First Capital Holdings
Corp., et al., amended on May 15, 1991 to add American Express as a defendant,
Zachary v. American Express Company, et al., filed on May 20, 1991, and Morse v.
Weingarten, et al., filed on June 13, 1991 (the "Shareholder Class Actions").
The complaints raise claims under the federal securities laws and allege that
the defendants concealed adverse material information regarding the finances,
financial condition and future prospects of FCH and made material misstatements
regarding these matters.
On July 1, 1991 an action was filed in the United States District Court for
the Southern District of Ohio entitled Benndorf v. American Express Company, et
al. The action is brought purportedly on behalf of three classes. The first
class is similar to the Shareholder Class; the second consists of managing
general agents and general agents who marketed various First Capital Life
products from April 2, 1990 to the filing of the suit and to whom it is alleged
misrepresentations were made concerning FCH (the "Agent Class"); and the third
class consists of Agents who purchased common stock of FCH through the First
Capital Life Non Qualified Stock Purchase Plan ("FSPP") and who have an interest
in the Stock Purchase Account under the FSPP (the "FSPP Class"). The complaint
raises claims similar to those asserted in the other Shareholder Class Actions,
along with additional claims relating to the FSPP Class and the Agent Class
alleging damages in marketing the products. In addition, on August 15, 1991,
Kruthoffer v. American Express Company, et al. was filed in the United States
District Court for the Eastern District of Kentucky, whose complaint is nearly
identical to the Benndorf complaint (collectively the "Agent Class Actions").
On November 14, 1991, the Judicial Panel on Multidistrict Litigation issued
an order transferring and coordinating for all pretrial purposes all related
actions concerning the sale of FCH securities, including the Shareholder Class
Action and Agent Class Actions, and any future filed "tag-along" actions, to
Judge John G. Davies of the United States District Court for the Central
District of California (the "California District Court"). The cases are
captioned In Re: First Capital Holdings Corporation Financial Products
Securities Litigation, MDL Docket No.-901 (the "MDL Action").
On January 18, 1993, an amended consolidated complaint (the "Third Amended
Complaint") was filed on behalf of the Shareholder Class and the Agent Class.
The Third Complaint names as defendants the American Express Defendants,
Weingarten and his wife, Palomba Weingarten, Ginsberg, Philip A. Fitzpatrick
(FCH's Chief Financial Officer), the Outside Directors and former FCH outside
directors Jeffrey B. Lane and Robert Druskin (the "Former Outside Directors"),
Fred Buck (President of First Capital Life) and Peat Marwick. The complaint
raises claims under the federal securities law and the common law of fraud and
negligence. On March 10, 1993, the American Express defendants answered the
Third Amended Complaint, denying its material allegations.
On March 11, 1993, the California District Court entered an order granting
class certification to the Shareholder Class. The class consists of all persons,
except defendants, who purchased FCH common stock, preferred stock and
debentures during the period May 4, 1988 to and including May 10, 1991. It also
issued an order denying class certification to the Agent Class. The FSPP Class
action had been previously dropped by the plaintiffs.
17
<PAGE> 19
The American Express Shareholder Action. On or about May 20, 1991, a
purported class action was filed on behalf of all shareholders of American
Express who purchased American Express common shares during the period beginning
August 16, 1990 to and including May 10, 1991. The case is captioned Steiner v.
American Express Company, et al. and was commenced in the United States District
Court for the Eastern District of New York. The defendants are Holdings,
American Express, James D. Robinson, III, Howard L. Clark, Jr., Harvey Golub and
Aldo Papone. The complaint alleges generally that the defendants failed to
disclose material information in their possession with respect to FCH which
artificially inflated the price of the common shares of American Express from
August 16, 1990 to and including May 10, 1991 and that such nondisclosure
allegedly caused damages to the purported shareholder class. The action has been
transferred to California and is now part of the MDL Action. The defendants have
answered the complaint, denying its material allegations.
The Bankruptcy Court Action. In the FCH bankruptcy, pending in the United
States Bankruptcy Court for the Central District of California (the "Bankruptcy
Court"), on February 11, 1992, the Official Committee of Creditors Holding
Unsecured Claims (the "Creditors' Committee") obtained permission from the
Bankruptcy Court to file an action for and on behalf of FCH and the parent
corporations of the Insurance Subsidiaries. On March 3, 1992, the Creditors'
Committee initiated an adversary proceeding in the Bankruptcy Court, Case No. AD
92-01723, in which they assert claims for breach of fiduciary duty and waste of
corporate assets against Holdings; fraudulent transfer against both Holdings and
LBI; and breach of contract against LBI. Also named as defendants are the
Outside Directors, the Former Outside Directors, Weingarten and Ginsberg.
Holdings and LBI have answered this complaint, denying the material allegations.
Fact discovery has been completed and the contract claim has been dropped by
plaintiffs. No trial date has been set.
The Virginia Commissioner of Insurance Action. On December 9, 1992, a
complaint was filed in federal court in the Eastern District of Virginia by
Steven Foster, the Virginia Commissioner of Insurance as Deputy Receiver of
Fidelity Bankers Life. The Complaint names Holdings and Weingarten, Ginsberg and
Leonard Gubar, a former director of FCH and Fidelity Bankers Life, as
defendants. The action was subsequently transferred to California to be part of
the MDL Action. The Complaint alleges that Holdings acquiesced in and approved
the continued mismanagement of Fidelity Bankers Life and that it participated in
directing the investment of Fidelity Bankers Life assets. The complaint asserts
claims under the federal securities laws and asserts common law claims including
fraud, negligence and breach of fiduciary duty and alleges violations of the
Virginia Securities laws by Holdings. It allegedly seeks no less than $220
million in damages to Fidelity Bankers Life and its present and former
policyholders and creditors and punitive damages. Holdings has answered the
complaint, denying its material allegations.
IN RE COMPUTERVISION CORPORATION SECURITIES LITIGATION
In connection with public offerings of notes and common stock of
Computervision, actions were commenced in federal district court in
Massachusetts against Computervision, certain of its executive officers, the
directors of Computervision, LBI, Donaldson, Lufkin & Jenrette Securities
Corporation, The First Boston Corporation and Hambrecht & Quist Incorporated,
Holdings and J.H. Whitney & Co. in the United States District Court for the
District of Massachusetts (collectively the "Massachusetts Case"). These actions
have been consolidated in a consolidated amended class action complaint which
alleges in substance that the registration statement and prospectus used in
connection with the offerings contained materially false and misleading
statements and material omissions related to Computervision's anticipated
operating results for 1992 and 1993. The plaintiffs purport to represent a class
of individuals who purchased in the public offering or in the aftermarket. The
complaint seeks damages for negligent misrepresentation and under Sections 11,
12 and 15 of the Securities Act.
In addition, three suits were filed in the United States District Court for
the Southern District of New York. The suits raise claims similar to those in
the Massachusetts Case against the same defendants. The Judicial Panel on
Multidistrict Litigation has ordered these cases consolidated with the
Massachusetts Case.
18
<PAGE> 20
State Court Action. LBI was named as the sole defendant in a putative
class action, Greenwald v. Lehman Brothers Inc., brought in New York State
Supreme Court (the "State Court"). The complaint alleges in substance that LBI
breached a fiduciary duty owed to its customers in selling them the common
stock, senior notes and senior subordinated notes of Computervision during the
class period, as defined in the complaint. The State Court dismissed the
complaint.
SIMS V. SHEARSON LEHMAN BROTHERS HUTTON INC.
In March 1990, LBI was sued in the United States District Court for the
Northern District of Texas (the "Texas District Court") on behalf of a purported
class of all purchasers of limited partnership interests in a limited
partnership offering called Kanland Associates. The partnership was sold by EFH
in 1982 and raised approximately $20 million. In 1987, the partnership's
property was lost in a foreclosure. On May 29, 1992, a second Amended Complaint
was filed against LBI alleging claims under Section 10(b) of the Exchange Act,
common law fraud, breach of fiduciary duty and RICO relating to disclosures made
in connection with the sale of the partnership and alleged breaches of fiduciary
duty subsequent to the foreclosure. On August 10, 1992, the Texas District Court
issued an order certifying a class of all persons who purchased limited
partnership interests in Kanland pursuant to the offering materials distributed
by EFH. On November 29, 1993, the Texas District Court signed a final judgment
and order approving the class action settlement agreed to by the parties, and
dismissed the action with prejudice.
CC&F MEDFORD III INVESTMENT COMPANY V. THE BOSTON COMPANY, INC. AND
WELLINGTON-MEDFORD III PROPERTIES, INC.
In September 1992, Wellington-Medford Properties, Inc. ("W-M III"), then a
subsidiary of The Boston Company, Inc. and now a subsidiary of LBI, and The
Boston Company, then a subsidiary of LBI, were sued in Superior Court of the
Commonwealth of Massachusetts by a limited partner in a partnership (the
"Partnership") of which W-M III is the general partner. The Partnership's
principal asset is an office building which is leased to The Boston Company.
Financing in the amount of $74 million provided to the Partnership by The Sanwa
Bank, Ltd. ("Sanwa") is secured by the office building and the lease with The
Boston Company. The financing matured in December 1992 and Sanwa has initiated a
foreclosure process.
The complaint alleges that W-M III has breached its obligation to secure
successor financing in order to prevent The Boston Company from being required
to pay increased rental pursuant to a rental formula in its lease. The complaint
seeks damages in an unspecified amount and a declaration regarding The Boston
Company's lease obligations and W-M III's obligations to secure successor
financing. W-M III and The Boston Company have answered, denying the material
allegations of the complaint.
In April 1993, The Boston Company filed a third-party complaint against
Sanwa seeking a declaration as to The Boston Company's obligations pursuant to
its lease of the office building. Sanwa answered and asserted claims against The
Boston Company and W-M III, including claims for treble damages based on alleged
breaches of the construction loan agreement.
In December 1993, the parties entered into a stay of proceedings for
purposes of facilitating negotiations of a possible settlement. Those
negotiations are ongoing but have not resulted in agreement. The stay has been
extended and now expires on April 15, 1994, with trial scheduled to commence on
or after May 16, 1994.
EASTON & CO. V. MUTUAL BENEFIT LIFE INSURANCE CO., ET AL.; EASTON & CO. V.
LEHMAN BROTHERS INC.
LBI has been named as a defendant in two consolidated class action
complaints pending in the United States District Court for the District of New
Jersey (the "N.J. District Court"). Easton & Co. v. Mutual Benefit Life
Insurance Co., et al. ("Easton I"), and Easton & Co. v. Lehman Brothers Inc.
("Easton II"). The plaintiff in both of these actions is Easton & Co., which is
a broker-dealer located in Fort Lee, New Jersey. Both of these actions allege
federal securities law claims and pendent common law claims in connection with
the sale of certain municipal bonds as to which Mutual Benefit Life Insurance
Company ("MBLI") has guaranteed the payment of principal and interest. MBLI is
an insurance company which was placed in rehabilitation proceedings under the
supervision of the New Jersey Insurance Department on or about July 16,
19
<PAGE> 21
1991. In the Matter of the Rehabilitation of Mutual Benefit Life Insurance
Company, (Sup. Ct. N.J. Mercer County.)
Easton I was commenced on or about September 17, 1991. In addition to LBI,
the defendants named in this complaint are MBLI, Henry E. Kates (MBLI's former
Chief Executive Officer) and Ernst & Young (MBLI's accountants). The litigation
is purportedly brought on behalf of a class consisting of all persons and
entities who purchased DeKalb, Georgia Housing Authority Multi-Family Housing
Revenue Refunding Bonds (North Hill Ltd. Project), Series 1991, due November 30,
1994 (the "DeKalb Bonds") during the period from May 3, 1991 (when the DeKalb
bonds were issued) through July 16, 1991. LBI acted as underwriter for this bond
issue, which was in the aggregate principal amount of $18.7 million. The
complaint alleges that LBI violated Section 10(b) of the Exchange Act and Rule
10b-5 promulgated thereunder, and seeks damages in an unspecified amount or
rescission. The complaint also alleges a common law negligent misrepresentation
claim against LBI and the other defendants.
Easton II was commenced on or about May 18, 1992, and names LBI as the only
defendant. Plaintiff purports to bring this second lawsuit on behalf of a class
composed of all persons who purchased "MBLI-backed Bonds" from LBI during the
period April 19, 1991 through July 16, 1991. The complaint alleges that LBI
violated Section 10(b) and Rule 10b-5, and seeks monetary damages in an
unspecified amount, or rescission pursuant to Section 29(b) of the Exchange Act.
The complaint also contains a common law claim of alleged breach of duty and
negligence.
On or about February 9, 1993, the New Jersey District Court granted
plaintiffs' motion for class certification in Easton I. The parties have agreed
to certification of a class in Easton II for purchases of certain fixed-rate
MBLI-backed bonds during the class period.
MAXWELL RELATED LITIGATION
Certain of Holdings' subsidiaries are defendants in several lawsuits
arising out of transactions entered into with the late Robert Maxwell or
entities controlled by Maxwell interests. These actions are described below.
Berlitz International Inc. v. Macmillan Inc. et al. This interpleader
action was commenced in Supreme Court, New York County (the "Court") on or about
January 2, 1992, by Berlitz International Inc. ("Berlitz") against Macmillan
Inc. ("Macmillan"), Lehman Brothers Holdings PLC ("PLC"), Lehman Brothers
International Limited (now known as Lehman Brothers International (Europe),
"LBIE") and seven other named defendants. The interpleader complaint seeks a
declaration of the rightful ownership of approximately 10.6 million shares of
Berlitz common stock, including 1.9 million shares then registered in PLC's
name, alleging that Macmillan claimed to be the beneficial owner of all 10.6
million shares, while the defendants did or might claim ownership to some or all
of the shares. As a result of its bankruptcy filing, Macmillan sought to remove
this case to the Bankruptcy Court for the Southern District of New York. LBIE
and PLC have moved to remand the case back to the Court.
MGN Pension Trustees Limited v. Invesco MIM Management Limited, Capel-Cure
Myers Capital Management Limited and Lehman Brothers International
Limited. This action was commenced by issuance of a writ in the High Court of
Justice, London, England on or about June 5, 1992. It was alleged that LBIE knew
or should have known that certain securities received by it as collateral on a
stock loan account held by Bishopsgate Investment Management were in fact
beneficially owned by the Mirror Group Pension Scheme ("MGPS") or by MGN Pension
Trustees Limited (the trustee of MGPS). On this basis, the plaintiff sought a
declaration that LBIE holds or held a portfolio of securities in constructive
trust for plaintiff. According to the writ, LBIE sold certain of these
securities for L32,024,918, and that LBIE still holds certain of these
securities, allegedly worth approximately L1,604,240. The plaintiff sought
return of the securities still held and the value of the securities liquidated
in connection with the stock loan account. On January 31, 1994, the Company,
along with the other defendants, settled the case.
Macmillan, Inc. v. Bishopsgate Investment Trust, Shearson Lehman Brothers
Holdings PLC et al. This action was commenced by issuance of a writ in the High
Court of Justice in London, England on or about December 9, 1991. In this
action, Macmillan sought a declaration that it is the legal and beneficial owner
of
20
<PAGE> 22
approximately 10.6 million shares of Berlitz International Inc. common stock,
including 1.9 million shares then registered. (The same shares that are at issue
in the Berlitz case in New York discussed above.) After a trial, on December 10,
1993, the High Court of Justice handed down a judgment finding for the Company
on all aspects of its defense and dismissing Macmillan's claims.
Bishopsgate Investment Management Limited (in liquidation) v. Lehman
Brothers International (Europe) and Lehman Brothers Holdings PLC. In August
1993, Bishopsgate Investment Management Limited ("BIM") served a Writ and
Statement of Claim against Lehman Brothers International (Europe) ("LBIE") and
PLC. The Statement of Claim alleges that LBIE and PLC knew or should have known
that certain securities received by them, either for sale or as collateral in
connection with BIM's stock loan activities, were in fact, beneficially owned by
various pension funds associated with the Maxwell Group entities. BIM seeks
recovery of any securities still held by LBIE and PLC or recovery of any
proceeds from securities sold by them. The total value of the securities is
alleged to be L100 million. BIM also commenced certain proceedings for summary
disposition of its claims relating to certain of the securities with a value of
approximately L30 million. On January 11, 1994, the parties agreed to a
settlement of that portion of the claim relating to BIM's request for summary
disposition with respect to certain securities. Under this agreement, two
securities holdings were delivered to BIM. The Company continues to defend the
balance of BIM's claim for recovery of other assets alleged to be worth
approximately L70 million. The case is scheduled for trial in April 1995.
MELLON BANK CORPORATION V. LEHMAN BROTHERS INC., ET AL.
In September 1993, Mellon Bank filed a complaint in the U.S. District Court
for the Western District of Pennsylvania against LBI and American Express. The
complaint alleges that LBI, through the conduct of Smith Barney and Primerica,
breached certain covenants contained in the Mellon Agreement. The covenants,
which relate to the provision of custodial and administrative services to
certain mutual funds, were assumed by Smith Barney in connection with the
Primerica Transaction. In a separate action, Smith Barney and Primerica were
also sued by Mellon Bank in connection therewith. By order dated January 26,
1994, the action against LBI and American Express was dismissed.
WARREN D. CHISUM, ET AL. V. LEHMAN BROTHERS INC. ET AL.
On February 28, 1994 a purported class action was filed in the United
States District Court for the Northern District of Texas. The complaint names
LBI and two former E. F. Hutton & Company Inc. employees as defendants. The
complaint alleges that defendants violated Section 10b of the Exchange Act and
RICO, breached their fiduciary duties and the limited partners' contract and
committed fraud in connection with the origination, sale and operation of four
EFH net lease real estate limited partnerships. Plaintiffs seek: (i) to certify
a class of all persons who purchased limited partnership interests in the four
partnerships at issue, (ii) damages in excess of $140 million plus interest or
rescission, (iii) punitive damages and (iv) accounting and attorneys' fees. The
Company believes it has several meritorious defenses and intends to vigorously
defend this case.
OTHER MATTERS
In connection with the regulatory attention focused on the U.S. treasury
market, LGSI received from the Commission and the U.S. Department of Justice,
Antitrust Division, subpoenas and letters requesting information and testimony
in connection with a review of the activities of various participants in the
government securities market. LGSI has responded to the subpoenas and letters.
The Company continues to cooperate and supply documents and testimony requested.
As of the date hereof, the Company does not believe that the investigations will
have a material adverse effect on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Pursuant to General Instruction J of Form 10-K, the information required by
Item 4 is omitted.
21
<PAGE> 23
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
All of the outstanding common stock of the Company is owned by Holdings.
American Express owns 100 percent of the common stock of Holdings, representing
approximately 93% of the issued and outstanding voting stock of Holdings.
ITEM 6. SELECTED FINANCIAL DATA
Pursuant to General Instruction J of Form 10-K, the information required by
Item 6 is omitted.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Pursuant to General Instruction J of Form 10-K, the information required by
Item 7 is omitted.
Set forth on the following pages is Management's Discussion and Analysis of
Financial Condition and Results of Operations for the year ended December 31,
1993.
22
<PAGE> 24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
BUSINESS ENVIRONMENT
The Company's principal business activities, investment banking and
securities trading and sales are, by their nature, subject to volatility,
primarily due to changes in interest and foreign exchange rates, global economic
and political trends and industry competition. As a result, revenues and
earnings may vary significantly from quarter to quarter and from year to year.
In 1993, the Company's operating results were achieved in an environment of
declining interest rates in the United States, mixed economic trends around the
world and continued globalization of the capital markets.
The general decline in interest rates in the United States, which began in
1990, continued in 1993 with interest rates declining to their lowest levels in
more than 10 years. Investors, seeking higher returns, reduced their holdings of
short-term fixed income securities in favor of longer term debt and equity
securities in U.S. and non-U.S. markets. Corporate issuers took advantage of
this environment and the pools of capital available for investment to
restructure their balance sheets through the issuance of equity, repayment of
debt and refinancing of debt at lower interest rates. These factors resulted in
record levels of debt and equity issuances in 1993.
RESULTS OF OPERATIONS
During 1993, the Company completed the sales of three businesses: The
Boston Company on May 21; Shearson on July 31; and SLHMC on August 31. In the
Company's audited historical consolidated financial statements, the operating
results of The Boston Company are accounted for as a discontinued operation
while the operating results of Shearson and SLHMC are included in the Company's
results from continuing operations through their respective sale dates.
Because of the significant sale transactions completed during 1993, the
Company's historical financial statements are not fully comparable for all years
presented. To facilitate an understanding of the Company's results, the
following discussion is segregated into three sections and provides financial
tables that serve as the basis for the review of results. These sections are as
follows:
- Historical Results: the results of the Company's ongoing businesses; the
results of Shearson and SLHMC through their respective sale dates; the
loss on the sale of Shearson; the reserves for non-core businesses; the
results of The Boston Company (accounted for as a discontinued
operation); and the cumulative effect of changes in accounting
principles.
- The Lehman Businesses: the results of the ongoing businesses of the
Company.
- The Businesses Sold: the results of Shearson and SLHMC; the loss on the
sale of Shearson; and the reserves for non-core businesses related to the
sale of SLHMC.
23
<PAGE> 25
HISTORICAL RESULTS (CONTINUING, SOLD AND DISCONTINUED BUSINESSES)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1993 1992 1991
------ ------ ------
(in millions)
<S> <C> <C> <C>
Net revenues............................................. $4,346 $4,947 $4,457
Total non-interest expenses.............................. 4,492 4,628 4,174
------ ------ ------
Income (loss) from continuing operations before taxes.... (146) 319 283
Provision for income taxes............................... 234 147 65
------ ------ ------
Income (loss) from continuing operations................. (380) 172 218
Income from discontinued operations, net of taxes........ 189 77 10
------ ------ ------
Income (loss) before cumulative effect of changes in
accounting principles.................................. (191) 249 228
Cumulative effect of changes in accounting principles.... (8)
Preferred dividend of subsidiary......................... 68 68 68
------ ------ ------
Net income (loss)........................................ $ (259) $ 173 $ 160
------ ------ ------
------ ------ ------
</TABLE>
HISTORICAL RESULTS (CONTINUING, SOLD AND DISCONTINUED BUSINESSES)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991
Net revenues decreased 12% to $4,346 million in 1993 from $4,947 million in
1992 due to the sale of Shearson and SLHMC, offset in part by a 13% increase in
net revenues of the Lehman Businesses. Net revenues of $4,947 million in 1992
increased 11% over 1991 net revenues of $4,457 million with net revenues of the
Lehman Businesses and the Businesses Sold increasing by 12% and 10%,
respectively.
Non-interest expenses decreased 3% to $4,492 million in 1993 from $4,628
million in 1992 due to the sale of Shearson and SLHMC. Non-interest expenses of
$4,628 million in 1992 increased 11% over 1991 non-interest expenses of $4,174
million due primarily to a 13% increase in compensation and benefits expense,
(including a 15% increase in compensation and benefits expenses related to the
Businesses Sold) and higher levels of provisions for legal settlements and bad
debts.
The Company reported a net loss of $259 million for the year ended December
31, 1993, compared to net income of $173 million in 1992 and net income of $160
million in 1991. Included in the 1993 net loss of $259 million was an after-tax
loss on the sale of Shearson of $630 million ($535 million pre-tax) and an
after-tax charge of $92 million ($141 million pre-tax) related to certain
non-core businesses, including a $79 million ($120 million pre-tax) charge
related to the sale of SLHMC and a $13 million ($21 million pre-tax) charge
related to certain partnership syndication activities in which the Company is no
longer actively engaged. The 1993 net loss also included income from
discontinued operations of The Boston Company of $189 million, which included an
after-tax gain of $165 million on the sale and after-tax operating earnings of
$24 million. The 1992 net income of $173 million included a $22 million ($33
million pre-tax) write-down in the carrying value of certain real estate
investments, income from discontinued operations of $77 million and a charge of
$8 million related to the cumulative effect of the changes in accounting for
non-pension postretirement benefits and income taxes. Net income of $160 million
in 1991 included income from discontinued operations of $10 million and a $71
million tax benefit on previously reported losses for which no financial
statement benefit had been permitted.
Included in the table below are the specific revenue and expense categories
comprising the historical results as segregated between the Lehman Businesses
and the Businesses Sold. The historical amounts for the Lehman Businesses do not
include pro forma adjustments for the effects of the Distribution.
24
<PAGE> 26
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------------------------
1993 1992 1991
---------------------------------- ---------------------------------- ----------------------------------
LEHMAN BUSINESSES LEHMAN BUSINESSES LEHMAN BUSINESSES
(IN MILLIONS) BUSINESSES SOLD HISTORICAL BUSINESSES SOLD HISTORICAL BUSINESSES SOLD HISTORICAL
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Market making and
principal
transactions.... $1,053 $ 323 $ 934 $ 575 $ 846 $ 550
Investment
banking......... 624 170 502 218 354 206
Commissions....... 437 828 410 1,231 458 1,154
Interest and
dividends....... 4,868 161 4,717 257 4,283 330
Other............. 55 412 57 619 53 522
---------- ---------- ---------- ---------- ---------- ----------
Total
revenues...... 7,037 1,894 6,620 2,900 5,994 2,762
Interest
expense......... 4,442 143 4,316 257 3,943 356
---------- ---------- ---------- ---------- ---------- ----------
Net revenues.... 2,595 1,751 $4,346 2,304 2,643 $4,947 2,051 2,406 $4,457
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Non-interest
expenses:
Compensation and
benefits...... 1,400 1,164 1,223 1,759 1,114 1,529
Other
expenses...... 782 470 869 777 719 812
Loss on sale of
Shearson...... 535
Reserves and
other
charges....... 21 120
---------- ---------- ---------- ---------- ---------- ----------
Total
non-interest
expenses.... 2,203 2,289 4,492 2,092 2,536 4,628 1,833 2,341 4,174
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Income (loss) from
continuing
operations
before taxes and
cumulative
effect of
changes in
accounting
principles...... 392 (538) (146) 212 107 319 218 65 283
Provision for
(benefit from)
income taxes.... 126 108 234 92 55 147 28 37 65
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Income (loss) from
continuing
operations
before
cumulative
effect of
changes in
accounting
principles...... $ 266 $ (646) $ (380) $ 120 $ 52 $ 172 $ 190 $ 28 $ 218
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
</TABLE>
THE LEHMAN BUSINESSES
FOR THE YEARS ENDED DECEMBER 31, 1993 AND 1992
Summary. For the Lehman Businesses, income from continuing operations
increased 122% to $266 million in 1993 from $120 million in 1992. The 1993
results consisted of $279 million of income from the continuing businesses
decreased by a $14 million reserve ($21 million pre-tax) for certain non-core
partnership syndication activities in which the Company is no longer actively
engaged. The 1992 results include a $22 million after-tax ($33 million pre-tax)
write-down in the carrying value of certain real estate investments.
Net Revenues. Net revenues increased 13% to $2,595 million in 1993 from
$2,304 million in 1992. Revenues related to market making and principal
transactions and investment banking were the primary sources of the increase.
Market Making and Principal Transactions. Market making and principal
transactions include the results of the Company's market making and trading
related to customer activities, as well as proprietary trading for the Company's
own account. Revenues from these activities encompass net realized and mark-to-
market gains and (losses) on securities and other financial instruments owned as
well as securities and other financial instruments sold but not yet purchased.
The Company utilizes various hedging strategies as it deems appropriate to
minimize its exposure to significant movements in interest and foreign exchange
rates and the equity markets. Market making and principal transactions revenues
increased 13% to $1,053 million in 1993 from $934 million in 1992, reflecting
greater activity and strong customer order flow across all business lines. The
following discussion provides an analysis of the Company's market making and
principal transactions revenues based upon the various product groups which
generated these revenues.
25
<PAGE> 27
Market Making & Principal Transactions Revenues (in millions):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1993 1992 1991
------ ------ ------
<S> <C> <C> <C>
Fixed income................................... $ 462 $ 580 $ 427
Equity......................................... 288 225 318
Derivative products............................ 222 71 40
Foreign exchange and commodities............... 81 58 61
------ ------ ------
$1,053 $ 934 $ 846
------ ------ ------
------ ------ ------
</TABLE>
Fixed income revenues decreased 20% to $462 million in 1993 from $580
million in 1992. This decrease was due principally to decreased revenues from
mortgage-related securities and money market instruments.
Equity revenues include net gains on market making and trading in listed
and over-the-counter equity securities. Equity revenues increased 28% to $288
million from $225 million in 1992, primarily as a result of higher revenues from
the Company's proprietary trading activities.
Derivative products revenues include net revenues primarily from the
trading and market making activities of the Company's fixed income derivative
products group. These products include interest rate and currency swaps, caps,
collars, floors and similar instruments. Derivative products revenues increased
213% to $222 million in 1993 from $71 million in 1992. The increased revenues
were primarily a result of increased Company activity in these markets and
increased usage of these products by the Company's clients and customers. At
December 31, 1993, the notional value of the Company's fixed income derivatives
contracts increased to over $270 billion from approximately $110 billion at
December 31, 1992. Notional amounts do not represent a quantification of the
market or credit risk of the positions; rather, notional amounts represent the
amounts used to calculate contractual cash flows to be exchanged and are
generally not actually paid or received. During 1994, the Company will commence
derivative trading and market making activities through Lehman Brothers
Financial Products Inc., a separately capitalized triple-A rated derivatives
subsidiary. This subsidiary is expected to increase the Company's customer base
and the volume of activity in its fixed income derivatives business and capture
additional underwriting business.
Foreign exchange and commodities revenues include revenues derived from
market making and trading in spot and forward foreign currency contracts,
foreign currency futures contracts and other commodity futures contracts.
Revenues from these sources increased 40% to $81 million in 1993 from $58
million in 1992. Included in these results were foreign exchange revenues of $70
million and $56 million for 1993 and 1992, respectively, reflecting an increase
of 25%. This increase was due primarily to increased customer-related and
proprietary trading activities throughout 1993. Revenues from commodity trading
activities increased to $11 million in 1993 from approximately $2 million in
1992, due primarily to increased customer-related trading activities throughout
1993. Foreign exchange contracts outstanding, including forward commitments to
purchase and forward commitments to sell, at December 31, 1993 and 1992 were
$234 billion and $97 billion, respectively.
Investment Banking. Investment banking revenues increased 24% to $624
million in 1993 from $502 million in 1992. The 1993 results were driven
primarily by a 39% increase in underwriting revenues to $477 million in 1993
from $343 million in 1992. Underwriting revenues increased as a result of
significantly higher underwriting volumes in both equity and fixed income
products, with the increase in equity underwriting the primary component.
Commissions. Commission revenues increased 7% to $437 million in 1993 from
$410 million in 1992, primarily as a result of higher volumes of customer
trading of securities and commodities on exchanges. Commission revenues are
generated from the Company's agency activities on behalf of corporations,
institutions and high net worth individuals.
26
<PAGE> 28
Interest and Dividends. Interest and dividend revenues increased 3% to
$4,868 million in 1993 from $4,717 million in 1992. Net interest and dividend
income increased 6% to $426 million in 1993 from $401 million in 1992. Net
interest and dividend revenue amounts are closely related to the Company's
trading activities. A significant portion of net interest revenue is due to
trading decisions and strategies, the results of which are reflected in market
making and principal transactions. The Company evaluates these strategies on a
total return basis. Therefore, changes in net interest revenue from period to
period should not be viewed in isolation but should be viewed in conjunction
with revenues from market making and principal transactions.
Other Revenues. Other revenues decreased 4% to $55 million in 1993 from
$57 million in 1992. Asset management and related advisory fees increased 15% to
$23 million in 1993 from $20 million in 1992, offset by a decrease in certain
other revenue sources.
Non-interest Expense. Compensation and benefits expense increased 14% to
$1,400 million in 1993 from $1,223 million in 1992, reflecting higher
compensation due to increases in revenues and profitability. However,
compensation and benefits expense as a percentage of net revenues increased only
moderately to 54.0% in 1993 from 53.1% in 1992.
Excluding compensation and benefits expense, non-interest expenses
decreased 8% to $803 million in 1993 from $869 million in 1992. Included in the
1993 amount was a charge of $21 million ($14 million after-tax) related to
certain non-core partnership syndication activities in which the Company is no
longer actively engaged. The 1992 results included a $33 million write down ($22
million after-tax) in the carrying value of certain real estate investments.
Excluding these charges, as well as compensation and benefits, non-interest
expenses declined 6% to $782 million in 1993 from $836 million in 1992. This
decrease was due primarily to lower levels of provisions for legal settlements
and bad debts and reduced operating expenses.
Cost Reduction Effort. In August 1993, the Company announced an expense
reduction program with the objective of reducing costs by $170 million on an
annualized basis by the end of the first quarter of 1994. The Company's expense
structure for the first half of 1993, adjusted for changes in the volume and mix
of revenues as well as for additional costs due to external factors such as
inflation or new legislation, is the basis against which these goals are being
measured. As of March 31, 1994, the Company had taken the following actions
which it believes will result in $170 million of cost reductions on an
annualized basis: (i) reduced certain purchased costs by lowering the volume of
goods and services purchased, renegotiating rates with vendors and strengthening
internal compliance with established policies and procedures; (ii) consolidated
certain administrative and support functions; (iii) strengthened compliance and
control functions; and (iv) completed its annual review of personnel, the
objective of which is to upgrade personnel and eliminate positions to improve
the Company's overall productivity.
During the first quarter of 1994, the Company completed a review of
personnel needs, which will result in the termination of certain personnel. The
Company anticipates that it will record a severance charge of approximately $25
million pre-tax in the first quarter of 1994 as a result of these terminations.
In addition to these actions, the Company has identified a variety of
actions that are expected to reduce expenses further, such as (i) additional
reductions in certain purchased expenses and (ii) the relocation in the summer
of 1994 of certain administrative, operations and other support personnel to
newly leased facilities in New Jersey. See "Properties."
Distribution of Holdings Common Stock
On January 24, 1994, American Express announced the Distribution. Prior to
the Distribution, which is subject to certain conditions, an additional equity
investment of approximately $1.25 billion will be made in Holdings, most
significantly by American Express. Holdings currently expects to file the
Registration Statement with the Commission with respect to the Distribution
during the second quarter of 1994.
27
<PAGE> 29
THE LEHMAN BUSINESSES
FOR THE YEARS ENDED DECEMBER 31, 1992 AND 1991
Summary. For the Lehman Businesses, income from continuing operations
decreased 37% to $120 million in 1992 from $190 million in 1991, primarily as a
result of a higher effective tax rate in 1992 as compared to 1991, due to the
recognition in 1991 of $71 million of tax benefits under Statement of Financial
Accounting Standards ("SFAS") No. 96. The 1992 results reflect higher revenues
in virtually all of the Company's major revenue categories and improved net
interest margins resulting in a 12% increase in net revenues. Also contributing
to the 1992 results was a 14% increase in non-interest expense primarily due to
a 10% increase in compensation and benefits expense in line with the improved
net revenues and a $22 million after-tax ($33 million pre-tax) write-down in the
carrying value of certain real estate investments.
Net Revenues. Net revenues increased 12% to $2,304 million in 1992 from
$2,051 million in 1991. Investment banking revenues were the primary source of
the improvement, increasing 42% to $502 million in 1992 from $354 million in
1991.
Market Making and Principal Transactions. Market making and principal
transactions include the results of the Company's market making and trading
related to customer activities and proprietary trading for the Company's own
account. Revenues from these activities encompass net realized and
mark-to-market gains and (losses) on securities and other financial instruments
owned as well as securities and other financial instruments sold but not yet
purchased. The Company uses various hedging strategies to minimize its exposure
to significant movements in interest and foreign exchange rates and the equity
markets as it deems appropriate. Market making and principal transactions
revenues increased 10% in 1992 to $934 million from $846 million in 1991. The
following discussion provides an analysis of the Company's market making and
principal transactions revenues based upon the various product groups which
generated these revenues.
Revenues from fixed income products increased 36% to $580 million in 1992
from $427 million in 1991, with mortgage-related securities and money market
instruments contributing most of the increase.
Equity revenues include net gains on market making and trading in listed
and over-the-counter equity securities. Equity revenues decreased 29% to $225
million in 1992 from $318 million in 1991, primarily as a result of lower
revenues from the Company's proprietary trading activities.
Derivative products revenues include net revenues primarily from the
trading and market making activities of the Company's fixed income derivatives
group. These products include interest rate and currency swaps, caps, collars,
floors and similar instruments. Derivative products revenues increased 78% to
$71 million in 1992 from $40 million in 1991, primarily as a result of increased
Company activity in these markets and increased usage of these products by the
Company's clients and customers. At December 31, 1992, the notional value of the
Company's fixed income derivatives contracts increased to approximately $110
billion from approximately $45 billion at December 31, 1991.
Foreign exchange and commodities revenues include revenues derived from
market making and trading in spot and forward foreign currency contracts,
foreign currency futures contracts and other commodity futures contracts.
Revenues from these sources decreased 5% to $58 million in 1992 from $61 million
in 1991. Foreign exchange revenues increased 19% to $56 million in 1992 from $47
million in 1991, primarily due to an expansion of the Company's proprietary
trading activities during 1992. Commodity trading revenues decreased to
approximately $2 million in 1992 from approximately $14 million in 1991. Foreign
exchange contracts outstanding, including forward commitments to purchase and
forward commitments to sell, at December 31, 1992 and 1991 were $97 billion and
$53 billion, respectively.
Investment Banking. Investment banking revenues increased 42% to $502
million in 1992 from $354 million in 1991. This increase was due to a 61%
increase in underwriting revenues to $343 million in 1992 from $213 million in
1991.
Commissions. Commission revenues decreased 10% to $410 million in 1992
from $458 million in 1991. This decrease was due primarily to the strategic
deemphasis of the Company's institutional futures sales
28
<PAGE> 30
activities in 1992. Commission revenues are generated from the Company's agency
activities on behalf of corporations, institutions and high net worth
individuals.
Interest and Dividends. Interest and dividend revenues increased 10% to
$4,717 million in 1992 from $4,283 million in 1991. Net interest and dividend
income increased 18% to $401 million in 1992 from $340 million in 1991. Net
interest and dividend revenue amounts are closely related to the Company's
trading activities. A significant portion of net interest revenue results from
trading decisions and strategies, the results of which are reflected in market
making and principal transactions. The Company evaluates these strategies on a
total return basis. Therefore, changes in net interest revenue from period to
period should not be viewed in isolation but should be viewed in conjunction
with revenues from market making and principal transactions.
Other Revenues. Other revenues increased 8% to $57 million in 1992 from
$53 million in 1991. The growth in asset management fees was the primary source
of this increase. Asset management and related advisory fees increased 33% to
$20 million in 1992 from $15 million in 1991.
Non-interest Expense. Compensation and benefits expense increased 10% to
$1,223 million in 1992 from $1,114 million in 1991. Compensation and benefits
expense as a percent of net revenues decreased to 53.1% in 1992 from 54.3% in
1991, due to improvements in productivity.
Excluding compensation and benefits, non-interest expenses increased 21% to
$869 million in 1992 from $719 million in 1991. As previously discussed, 1992
results included a $33 million write-down in the carrying value of certain real
estate investments. Excluding this charge, as well as compensation and benefits
expense, other non-interest expenses increased 16% to $836 million in 1992 from
$719 million in 1991. The increase in expenses was due primarily to higher
provisions for legal settlements and bad debts as well as increased operating
expenses related to the Company's investments in the expansion of its foreign
exchange and derivatives businesses.
THE LEHMAN BUSINESSES
INCOME TAXES -- FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991
In 1993, the Lehman Businesses had an income tax provision of $126 million
which consisted of a provision of $133 million for continuing businesses and a
tax benefit of $7 million related to non-core business reserves. The effective
tax rate for the continuing businesses was 32%, which is less than the statutory
U.S. federal income tax rate principally due to benefits attributable to income
subject to preferential tax treatment partially offset by state and local income
taxes. During the third quarter of 1993, the statutory U.S. federal income tax
rate was increased to 35% from 34%, effective January 1, 1993. The Company's
1993 tax provision includes a one-time benefit of approximately $8 million from
the impact of the federal rate change on the Company's net deferred tax assets.
The Company's effective tax rate for continuing businesses is expected to
increase slightly in 1994, subject to changes in the level and geographic mix of
the Company's profits.
The Company had a net deferred tax liability of $36 million in 1992 as
compared to a net deferred tax asset of $148 million in 1991. The elimination of
the net deferred tax asset was primarily related to the utilization of net
operating loss carryforwards ("NOLs") which resulted in cash savings to the
Company.
In addition, the Company had, as of December 31, 1993, approximately $145
million of tax NOLs available to offset future taxable income, the benefits of
which have not yet been reflected in the financial statements. Although the
benefit related to these NOLs does not currently meet the recognition criteria
of SFAS No. 109, strategies are being implemented to increase the likelihood of
realization. It is anticipated that approximately $15 million of these NOLs will
be transferred to American Express in connection with the Distribution.
In 1992, the Lehman Businesses had an income tax provision of $92 million
which consisted of a provision of $103 million from continuing businesses and a
tax benefit of $11 million related to the $33 million write-down in certain real
estate investments previously discussed. Excluding this tax benefit, the
effective tax rate for the continuing businesses was 42%, which was higher than
the statutory U.S. federal income tax rate primarily due to state and local
taxes.
29
<PAGE> 31
Effective January 1, 1992, the Company adopted SFAS No. 109, "Accounting
for Income Taxes." Previously, the Company accounted for income taxes in
accordance with SFAS No. 96. As a result of the adoption, the Company recorded a
$68 million increase in consolidated net income from the cumulative effect of
this change in accounting principles, $64 million of which related to
discontinued operations. In addition, the Company reduced goodwill by $258
million related to the recognition of deferred tax benefits attributable to the
Company's 1988 acquisition of The E. F. Hutton Group Inc. The Company
established a deferred tax asset of $326 million in the first quarter of 1992
related to tax benefits previously unrecorded under SFAS No. 96.
The 1991 tax provision of $28 million includes $71 million for the
recognition of benefits on previously reported losses for which no financial
statement benefit had been permitted. Excluding the recognition of these
benefits, the 1991 effective tax rate was 46%, which was higher than the
statutory U.S. federal income tax rate due primarily to state and local income
taxes and the non-deductibility of goodwill amortization.
THE BUSINESSES SOLD
FOR THE YEARS ENDED DECEMBER 31, 1993 AND 1992
This discussion is provided to analyze the operating results of the
Businesses Sold. For purposes of this discussion, the amounts described as the
Businesses Sold include the results of operations of Shearson and SLHMC, the
loss on sale of Shearson and the reserve for non-core businesses related to the
sale of SLHMC. All 1993 amounts for the Businesses Sold include results through
their dates of sale and therefore reported results for 1993 are not fully
comparable with prior years' results.
Net revenues related to the Businesses Sold were $1,751 million in 1993 and
$2,643 in 1992. Excluding the loss on the sale of Shearson and the reserve for
non-core businesses related to SLHMC, non-interest expenses of the Businesses
Sold were $1,634 million in 1993 and $2,536 million in 1992. Compensation and
benefits expense were $1,164 million in 1993 and $1,759 million in 1992.
The Businesses Sold recorded a net loss of $646 million in 1993 compared to
net income of $52 million in 1992. The 1993 results include a loss on sale of
Shearson of $630 million and a $79 million charge recorded in the first quarter
as a reserve for non-core businesses in anticipation of the sale of SLHMC. The
loss on the sale of Shearson included a reduction in goodwill of $750 million
and transaction-related costs such as relocation, systems and operations
modifications and severance. Excluding the $630 million after-tax loss on sale,
Shearson's net income was $63 million in 1993 compared to $55 million in 1992.
Excluding the $79 million after-tax charge discussed above, SLHMC operations
were break-even in 1993 compared to a net loss of $3 million in 1992.
THE BUSINESSES SOLD
FOR THE YEARS ENDED DECEMBER 31, 1992 AND 1991
Net revenues related to the Businesses Sold increased 10% to $2,643 million
in 1992 from $2,406 million in 1991, due primarily to increases in other
revenues and commissions. The growth in other revenues was due to increases in
investment advisory and custodial fees, reflecting growth in the Company's
managed asset products. An increase in the volume of customer directed trading
activity was the primary source of the increased level of commission revenues.
Non-interest expenses of the Businesses Sold increased 8% to $2,536 million in
1992 from $2,341 million in 1991. Compensation and benefits increased 15% to
$1,759 million in 1992 from $1,529 million in 1991, reflecting higher
compensation due to increased revenues.
Net income for the Businesses Sold increased 86% to $52 million in 1992
from $28 million in 1991. Shearson net income was $55 million in 1992 and $29
million in 1991.
THE BUSINESSES SOLD
INCOME TAXES -- FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991
The 1993 tax provision of $108 million for Businesses Sold included (i)
expenses of $54 million related to the operating results of Shearson; (ii) an
expense of $95 million from the sale of Shearson and (iii) a tax
30
<PAGE> 32
benefit of $41 million related to the $120 million reserve for non-core
businesses recorded in anticipation of the sale of SLHMC. The provision related
to the sale of Shearson primarily resulted from the write-off of $750 million of
goodwill which was not deductible for tax purposes. For 1992 and 1991 the tax
expense related principally to the Shearson operations. The effective tax rate
for the Businesses Sold was 51% in 1992 and 57% in 1991, with the excess over
the statutory U.S. federal income tax rate primarily resulting from state and
local taxes and the non-deductibility of goodwill amortization.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1993, total assets were $57.8 billion, compared to $74.0
billion at December 31, 1992. The composition of the Company's assets changed
significantly during 1993 due to the sales of The Boston Company, Shearson and
SLHMC. The Company's asset base now consists primarily of cash and cash
equivalents, and assets which can be sold within one year, including securities
and other financial instruments owned, collateralized short-term agreements and
receivables. At December 31, 1993, these assets comprised approximately 97% of
the Company's balance sheet. Long-term assets consist primarily of other
receivables, property, equipment and leasehold improvements, deferred expenses
and other assets, and excess of cost over fair value of net assets acquired.
Daily Funding Activities. The Company finances its short-term assets
primarily on a secured basis through the use of securities sold under agreements
to repurchase, securities and other financial instruments sold but not yet
purchased, advances from Holdings and other affiliates, securities loaned and
other collateralized liability structures. Repurchase agreements and other types
of collateralized borrowings historically have been a more stable financing
source under all market conditions. Because of their secured nature, these
collateralized financing sources are less credit sensitive and also provide the
Company access to lower cost funding.
The Company uses short-term unsecured borrowing sources to fund short-term
assets not financed on a secured basis. The Company's primary sources of
short-term, unsecured general purpose funding include commercial paper and
short-term debt, including master notes and bank borrowings under uncommitted
lines of credit. Commercial paper and short-term debt outstanding totalled $2.6
billion at December 31, 1993, compared to $6.6 billion at December 31, 1992. Of
these amounts, commercial paper outstanding totalled $0.4 billion at December
31, 1993, with an average maturity of 14 days, compared to $3.2 billion at
December 31, 1992, with an average maturity of 11 days. The 1993 year-end
balances reflected the repayment of commercial paper and short-term debt
obligations with the proceeds from the sales of The Boston Company, Shearson and
SLHMC.
To reduce liquidity risk, the Company carefully manages its commercial
paper and master note maturities to avoid large refinancings on any given day.
In addition, the Company limits its exposure to any single commercial paper
investor to avoid concentration risk. LBI's access to short-term and long-term
debt financing is highly dependent on its debt ratings. LBI's current long-term
senior subordinated/short-term debt ratings are as follows: S&P A/A-1; Moody's
A3/P-1 and IBCA -- /A1. As of the Distribution Date, LBI expects to receive a
long-term senior debt rating of A and a short-term debt rating of F-1 from Fitch
Investor Services.
The Company's uncommitted lines of credit provide an additional source of
short-term financing. As of December 31, 1993, the Company had $5.7 billion in
uncommitted lines of credit, provided by 51 banks, consisting of facilities that
the Company has been advised are available but for which no contractual lending
obligation exists.
Long-term assets are financed with a combination of long-term debt and
equity. The Company issues subordinated indebtedness as an integral component of
its regulatory capital base. The Company maintains long-term debt in excess of
its long-term assets to provide additional liquidity, which the Company uses to
meet its short-term funding requirements and reduce its reliance on commercial
paper and short-term debt.
During 1993, the Company issued $722 million in long-term debt, compared to
$239 million in 1992. In addition to refinancing long-term debt, these issuances
strengthened the Company's capital base, which consists of long-term debt plus
equity. The Company staggers the maturities of its long-term debt to minimize
refunding risk. At December 31, 1993, the Company had long-term debt outstanding
of $3.7 billion with an
31
<PAGE> 33
average life of 2.6 years, compared to $4.4 billion outstanding at December 31,
1992, with an average life of 3.1 years. For long-term debt with a maturity of
greater than one year, the Company had $2.4 billion outstanding with an average
life of 3.7 years at December 31, 1993, compared to $3.5 billion outstanding
with an average life of 3.7 years at December 31, 1992. The Company anticipates
that 1994 long-term debt issuances will exceed those of 1993. The proceeds of
these issuances primarily will be used to refinance long-term debt maturing in
1994 and to meet regulatory capital objectives.
The Company enters into a variety of financial and derivative products
agreements as an end user to hedge and/or modify its exposure to foreign
exchange and interest rate risk of certain assets and liabilities. These
agreements are not part of the Company's trading portfolio of derivative
products. The Company primarily enters into interest rate swaps and caps to
modify the interest characteristics of its long-term debt obligations. The
Company recognizes the net interest expense or income related to these
agreements on an accrual basis, including the amortization of premiums, over the
life of the contracts.
At December 31, 1993 and 1992, the Company had outstanding interest rate
swap and cap agreements for the above purposes of approximately $2.7 billion and
$2.9 billion, respectively. Included in these amounts were approximately $2.3
billion of interest rate swaps and caps, maturing in 1995 and 1997, which serve
to reduce the Company's overall fixed rate debt to a lower fixed rate. Of the
remaining interest rate swaps, the most significant serve to convert a portion
of the Company's fixed rate debt to a floating rate. The Company has matched
substantially all of the maturities of its remaining interest rate swaps to the
terms of its underlying borrowings.
The $2.7 billion of notional amount of interest rate swap and cap
agreements mature as follows:
<TABLE>
<CAPTION>
(IN MILLIONS)
<S> <C>
1994..................................................... $ 200
1995..................................................... 1,390
1996..................................................... 0
1997..................................................... 910
1998..................................................... 200
1999 and thereafter...................................... 25
-------------
$ 2,725
-------------
-------------
</TABLE>
The effect of interest rate swap and cap agreements was to decrease
interest expense by approximately $54 million, $53 million and $15 million in
1993, 1992 and 1991, respectively. At December 31, 1993 and 1992, the unrecorded
net gain on these agreements was approximately $55 million and $84 million,
respectively. The Company has no deferred gains or losses related to terminated
agreements.
The Company expects to continue using interest rate swap and cap agreements
to modify the effective interest cost associated with its long-term
indebtedness. The $2.3 billion of interest rate swaps and caps described above,
which reduce the Company's rate on its fixed rate debt to a lower fixed rate,
will lower 1994 and 1995 interest expense by approximately $25 million and $15
million, respectively. The effect of the remaining interest rate swaps is
dependent on the level of interest rates in the future.
Liquidity Management. The maintenance of the liability structure and
balance sheet liquidity as discussed above is achieved through the daily
execution of the following financing policies: (i) match funding the Company's
assets and liabilities; (ii) maximizing the use of collateralized borrowing
sources; and (iii) diversifying and expanding borrowing sources.
(i) The Company's first financing policy focuses on funding the
Company's assets with liabilities which have maturities similar to the
anticipated holding period of the assets to minimize refunding risk. The
anticipated holding period of assets financed on an unsecured basis is
determined by the expected time it would take to obtain financing for these
assets on a collateralized basis.
(ii) The Company's second financing policy is to maximize that portion
of its balance sheet that is funded through collateralized borrowing
sources, which include repurchase agreements, securities loaned,
32
<PAGE> 34
securities sold but not yet purchased and other collateralized liability
structures. The Company currently funds over 68% of its assets on a
collateralized basis. As discussed above, repurchase agreements and other
types of collateralized borrowings historically have been a more reliable
financing source under all market conditions.
(iii) The Company's third financing policy is to diversify and expand
its borrowing sources in an effort to maximize liquidity and reduce
concentration risk. Through its institutional sales force, the Company
seeks financing from a global investor base with the goal of broadening the
availability of its funding sources.
The Company incorporates these policies in its liquidity contingency
planning process, which is designed to enhance the availability of alternative
sources of funding in a period of financial stress. Financial stress is defined
as any event which severely constrains the Company's access to unsecured funding
sources. The Company's liquidity contingency plan is based on an estimate of its
ability to meet its funding requirements with collateralized financing. To help
achieve this objective, the Company would rely on the additional liquidity
created by its policy of issuing long-term debt in excess of long-term assets
and its ability to pledge its unencumbered marketable securities as collateral
to obtain financing rather than on a sale of these securities.
The Company's liquidity contingency plan is continually reviewed and
updated as the Company's asset/liability mix and liquidity requirements change.
The Company believes that these policies, combined with the maintenance of
sufficient capital levels, position the Company to meet its liquidity
requirements in periods of financial stress.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS AND DERIVATIVES
In addition to financial instruments recorded on the consolidated balance
sheet, the Company enters into off-balance sheet financial instruments primarily
consisting of derivative contracts and credit-related arrangements. Derivative
products include futures, forwards, swaps, options, caps, collars, floors,
swaptions, forward rate agreements, foreign exchange contracts and similar
instruments.
Derivative products are generally based on notional amounts, while
credit-related arrangements are based upon contractual amounts. The notional
values of these instruments are generally not recorded on the balance sheet.
Off-balance-sheet treatment is generally considered appropriate when the
exchange of the underlying asset or liability has not occurred or is not
assured, or where the notional amounts are utilized solely as a basis for
determining cash flows to be exchanged. Therefore, the notional amounts of these
instruments do not reflect the Company's market or credit risk amount.
The Company conducts its derivative activities through wholly owned
subsidiaries. In late 1993, the Company established a new subsidiary, Lehman
Brothers Financial Products Inc., a separately capitalized triple-A rated
derivatives subsidiary. This subsidiary, which is expected to commence
activities during the third quarter of 1994, was established to increase the
volume of the Company's derivatives business related to customer-driven
derivative activities.
The Company records derivatives from dealer-related and proprietary trading
activities at market or fair value, with unrealized gains and losses, recognized
in the consolidated statement of operations as market making and principal
transactions revenue. While the notional value of these instruments is not
reflected in the consolidated balance sheet, the mark to market value of
trading-related derivatives is reflected on a net basis in the December 31, 1993
and 1992 balance sheets as securities and other financial instruments owned or
securities and other financial instruments sold not yet purchased, as
applicable.
Derivative products, like all financial instruments, include various
elements of risk which must be actively managed. General types of risk from
derivative products include market risk, liquidity risk and credit risk.
Market risk from derivatives results from the potential for changes in
interest and foreign exchange rates and fluctuations in commodity or equity
prices. The market risk for derivatives is similar to that of cash instruments.
The Company may employ hedging strategies to reduce its exposure to fluctuations
in market prices of securities and volatility in interest or foreign exchange
rates.
33
<PAGE> 35
Liquidity risk from derivatives represents the cost to the Company of
adjusting its positions in times of high volatility and financial stress. The
liquidity of derivative products is highly related to the liquidity of the
underlying cash instruments. As with on-balance sheet financial instruments, the
Company's valuation policies for derivatives include consideration of liquidity
factors.
The Company incorporates these policies in its liquidity contingency
planning process, which is designed to enhance the availability of alternative
sources of funding in a period of financial stress. Financial stress is defined
as any event which severely constrains the Company's access to unsecured funding
sources. The Company's liquidity contingency plan is based on an estimate of its
ability to meet its funding requirements with collateralized financing. To help
achieve this objective, the Company would rely on the additional liquidity
created by its policy of issuing long-term debt in excess of long-term assets
and its ability to pledge its unencumbered marketable securities as collateral
to obtain financing rather than on a sale of these securities.
The Company's liquidity contingency plan is continually reviewed and
updated as the Company's asset/liability mix and liquidity requirements change.
The Company believes that these policies, combined with the maintenance of
sufficient capital levels, position the Company to meet its liquidity
requirements in periods of financial stress.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS AND DERIVATIVES
In addition to financial instruments recorded on the consolidated balance
sheet, the Company enters into off-balance sheet financial instruments primarily
consisting of derivative contracts and credit-related arrangements. Derivative
products include futures, forwards, swaps, options, caps, collars, floors,
swaptions, forward rate agreements, foreign exchange contracts and similar
instruments.
Derivative products are generally based on notional amounts, while
credit-related arrangements are based upon contractual amounts. The notional
values of these instruments are generally not recorded on the balance sheet.
Off-balance-sheet treatment is generally considered appropriate when the
exchange of the underlying asset or liability has not occurred or is not
assured, or where the notional amounts are utilized solely as a basis for
determining cash flows to be exchanged. Therefore, the notional amounts of these
instruments do not reflect the Company's market or credit risk amount.
The Company conducts its derivative activities through wholly owned
subsidiaries. In late 1993, the Company established a new subsidiary, Lehman
Brothers Financial Products Inc., a separately capitalized triple-A rated
derivatives subsidiary. This subsidiary, which is expected to commence
activities during the third quarter of 1994, was established to increase the
volume of the Company's derivatives business related to customer-driven
derivative activities.
The Company records derivatives from dealer-related and proprietary trading
activities at market or fair value, with unrealized gains and losses, recognized
in the consolidated statement of operations as market making and principal
transactions revenue. While the notional value of these instruments is not
reflected in the consolidated balance sheet, the mark to market value of
trading-related derivatives is reflected on a net basis in the December 31, 1993
and 1992 balance sheets as securities and other financial instruments owned or
securities and other financial instruments sold not yet purchased, as
applicable.
Derivative products, like all financial instruments, include various
elements of risk which must be actively managed. General types of risk from
derivative products include market risk, liquidity risk and credit risk.
Market risk from derivatives results from the potential for changes in
interest and foreign exchange rates and fluctuations in commodity or equity
prices. The market risk for derivatives is similar to that of cash instruments.
The Company may employ hedging strategies to reduce its exposure to fluctuations
in market prices of securities and volatility in interest or foreign exchange
rates.
Liquidity risk from derivatives represents the cost to the Company of
adjusting its positions in times of high volatility and financial stress. The
liquidity of derivative products is highly related to the liquidity of the
underlying cash instruments. As with on-balance sheet financial instruments, the
Company's valuation policies for derivatives include consideration of liquidity
factors.
34
<PAGE> 36
Credit risk from derivatives relates to the potential for a counterparty
defaulting on its contractual agreement. The Company manages its counterparty
credit risk through a process similar to its other trading-related activities.
This process includes an evaluation of the counterparty's credit worthiness at
the inception of the transaction, periodic review of credit standing and various
credit enhancements in certain circumstances. In addition, the Company attempts
to execute master netting agreements which provide for net settlement of
contracts with the same counterparty in the event of cancellation or default
when appropriate or when allowable under relevant law.
For a discussion of the Company's policies and procedures regarding risk,
see "Business -- Risk Management."
Cash Flows. Cash and cash equivalents increased $21 million in 1993 to
$316 million, as the net cash provided by operating and investing activities
exceeded the net cash used in financing activities. In addition, cash and cash
equivalents for discontinued operations increased $42 million in 1993. Net cash
provided by operating activities of $1,312 million included the loss from
continuing operations adjusted for non-cash items of approximately $464 million
for the year ended December 31, 1993. Net cash used in financing activities was
$3,784 million in 1993. Net cash provided by investing activities of $2,535
million in 1993 included cash proceeds from the sales of The Boston Company,
Shearson and SLHMC of $2,570 million.
Cash and cash equivalents decreased $120 million in 1992 to $295 million,
as the net cash used in operating and investing activities exceeded the net cash
provided by financing activities. In addition, cash and cash equivalents for
discontinued operations decreased $1,082 million. Net cash used in operating
activities of $5,194 million included income from continuing operations adjusted
for non-cash items of approximately $564 million for the year ended December 31,
1992. Net cash used in investing activities was $25 million in 1993. Net cash
provided by financing activities was $4,017 million.
Cash and cash equivalents decreased $388 million in 1991 to $415 million as
the net cash provided by financing and investing activities was exceeded by net
cash used and operating activities. In addition, cash and cash equivalents for
discontinued operations increased $706 million. Net cash used in operating
activities of $3,365 million included income from continuing operations adjusted
for non-cash items of approximately $538 million for the year ended December 31,
1991. Net cash provided by financing and investing activities was $879 million
and $2,804 million, respectively.
SPECIFIC BUSINESS ACTIVITIES AND TRANSACTIONS
The following sections include information on specific business activities
of the Company which affect overall liquidity and capital resources:
Westinghouse. In May 1993, the Company and Westinghouse Electric
Corporation ("Westinghouse") entered into a partnership to facilitate the
disposition of Westinghouse's commercial real estate portfolio valued at
approximately $1.1 billion, which will be accomplished substantially by
securitizations and asset sales. The Company invested approximately $154 million
in the partnership, and also made collateralized loans to the partnership of
$752 million. During the third quarter of 1993, Lennar Inc. was appointed
portfolio servicer and purchased a 10% limited partnership interest from the
Company and Westinghouse.
At December 31, 1993, the carrying value of the Company's investment in the
partnership was $154 million and the outstanding balance of the collateralized
loan, including accrued interest, was $539 million. The remaining loan balance
is expected to be repaid in 1994 through a combination of mortgage remittances,
securitizations, asset sales and refinancings by third parties.
High Yield Securities. The Company underwrites, trades, invests and makes
markets in high yield corporate debt securities. The Company also syndicates,
trades and invests in loans to below investment grade companies. For purposes of
this discussion, high yield debt securities are defined as securities of or
loans to companies rated below BBB- by S&P and below Baa3 by Moody's, as well as
non-rated securities or loans which, in the opinion of management, are
non-investment grade. High yield debt securities are carried at market value and
unrealized gains or losses for these securities are reflected in the Company's
Consolidated Statement of Operations. The Company's portfolio of such securities
at December 31, 1993 and 1992 included
35
<PAGE> 37
long positions with an aggregate market value of approximately $661 million and
$895 million, respectively, and short positions with an aggregate market value
of approximately $75 million and $47 million, respectively. The portfolio may
from time to time contain concentrated holdings of selected issues. The
Company's two largest high yield positions were $61 million and $56 million at
December 31, 1993 and $128 million and $123 million at December 31, 1992.
Change in Facilities. In 1993, Holdings agreed to lease approximately
392,000 square feet of office space located at 101 Hudson Street in Jersey City,
New Jersey (the "Operations Center"). The lease term will commence in August
1994 and provides for minimum rental payments of approximately $87 million over
its 16-year term. Concurrently, Holdings announced it would relocate certain
administrative employees to five additional floors at 3 World Financial Center
in New York, New York. These floors will be purchased by Holdings from American
Express for approximately $44 million by Holdings. In connection with the
relocation to the Operations Center and the additional space at the World
Financial Center, Holdings anticipates incremental fixed asset additions of
approximately $112 million. Upon commencement of the relocation, a substantial
portion of the lease and depreciation charges will be allocated to the Company
based upon the Parent's method of allocating certain intercompany charges.
Non-Core Activities and Investments. In March 1990, the Company
discontinued the origination of partnerships (whose assets are primarily real
estate) and investments in real estate. Currently, the Company acts as a general
partner for approximately $4.2 billion of partnership investment capital and
manages a real estate investment portfolio with an aggregate investment basis of
approximately $108 million. The Company provided additional reserves for these
activities of $21 million and $33 million in 1993 and 1992, respectively. At
December 31, 1993 and 1992, the Company had remaining net exposure to these
investments (defined as the remaining unreserved investment balance plus
outstanding commitments and contingent liabilities under guarantees and credit
enhancements) of $71 million and $201 million, respectively. In certain
circumstances, the Company provides financial and other support and assistance
to such investments to maintain investment values. Except as described above,
there is no contractual requirement that the Company continue to provide this
support. Although a decline in the real estate market or the economy in general
or a change in the Company's disposition strategy could result in additional
real estate reserves, the Company believes that it is adequately reserved.
CHANGE OF FISCAL YEAR
On March 28, 1994, the Board of Directors of Holdings approved, subject to
the Distribution, a change in the Company's fiscal year-end from December 31 to
November 30. Such a change to a non-calendar cycle will shift certain year-end
administrative activities to a time period that conflicts less with the business
needs of the Company's institutional customers.
EFFECTS OF INFLATION
Because the Company's assets are, to a large extent, liquid in nature, they
are not significantly affected by inflation. However, the rate of inflation
affects the Company's expenses, such as employee compensation, office space
leasing costs and communications charges, which may not be readily recoverable
in the price of services offered by the Company. To the extent inflation results
in rising interest rates and has other adverse effects upon the securities
markets, it may adversely affect the Company's financial position and results of
operations in certain businesses.
NEW ACCOUNTING PRONOUNCEMENTS
Financial Accounting Standards Board Interpretation No. 39, "Offsetting of
Amounts related to Certain Contracts" ("FIN No. 39"), was issued in March 1992.
Effective for balance sheets after January 1, 1994, FIN No. 39 restricts the
current industry practice of offsetting certain receivables and payables.
Although the implementation of this standard is expected to substantially
increase gross assets and liabilities, the Company believes that its results of
operations and overall financial condition will not be affected. The FASB has
instructed its staff to explore modifying FIN No. 39 to create certain
exceptions, which, if enacted, would substantially mitigate the increase in the
Company's gross assets and liabilities expected to initially result from the
implementation of FIN No. 39.
36
<PAGE> 38
In November 1992, the FASB issued Statement of Financial Standards ("SFAS")
No. 112, "Employers Accounting for Postemployment Benefits." This statement
requires the accrual of obligations associated with services rendered to date
for employee benefits accumulated or vested for which payment is probable and
can be reasonably estimated. The Company will record a charge to reflect a
cumulative effect of a change in accounting principle of approximately $13
million after-tax in the first quarter of 1994.
In May 1993, the FASB issued SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." The Company records substantially
all its securities at market value. No adjustment is anticipated to be recorded
as a result of this accounting pronouncement.
RISK MANAGEMENT
Risk management is an integral part of the Company's business. The Company
has established extensive policies and procedures to identify, monitor, assess
and manage risk effectively. For a discussion of these policies and procedures,
see "Business -- Risk Management."
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary financial information required
by this Item and included in this Report are listed in the Index to Financial
Statements and Schedules appearing on page F-1 and are incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
37
<PAGE> 39
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Pursuant to General Instruction J of Form 10-K, the information required by
Item 10 is omitted.
ITEM 11. EXECUTIVE COMPENSATION
Pursuant to General Instruction J of Form 10-K, the information required by
Item 11 is omitted.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Pursuant to General Instruction J of Form 10-K, the information required by
Item 12 is omitted.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Pursuant to General Instruction J of Form 10-K, the information required by
Item 13 is omitted.
PART IV
ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements:
See Index to Consolidated Financial Statements and Schedules appearing
on Page F-1.
2. Financial Statement Schedules:
See Index to Consolidated Financial Statements and Schedules appearing
on Page F-1.
3. Exhibits
<TABLE>
<S> <C>
EXHIBIT 3.1 Restated Certificate of Incorporation of the Registrant dated September 3,
1981 (incorporated by reference to Exhibit 3.1 of the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1987).
EXHIBIT 3.2 Certificate of Amendment to Restated Certificate of Incorporation of the
Registrant dated May 11, 1984 (incorporated by reference to Exhibit 3.2 of
the Registrant's Annual Report on Form 10-K for the year ended December 31,
1988).
EXHIBIT 3.3 Certificate of Amendment to Restated Certificate of Incorporation of the
Registrant, dated March 6, 1985 (incorporated by reference to Exhibit 3.3 of
the Registrant's Annual Report on Form 10-K for the year ended December 31,
1985).
EXHIBIT 3.4 Certificate of Amendment to Restated Certificate of Incorporation of the
Registrant, dated August 31, 1987 (incorporated by reference to Exhibit 3.4
of the Registrant's Annual Report on Form 10-K for the year ended December
31, 1987).
EXHIBIT 3.5 Certificate of Amendment to Restated Certificate of Incorporation of the
Registrant, dated January 28, 1988 (incorporated by reference to Exhibit 3.5
of the Registrant's Annual Report on Form 10-K for the year ended December
31, 1987).
EXHIBIT 3.6 Certificate of Amendment to Restated Certificate of Incorporation of the
Registrant dated July 19, 1990 (incorporated by reference to Exhibit 3.6 of
the Registrant's Annual Report on Form 10-K for the year ended December 31,
1990).
</TABLE>
38
<PAGE> 40
<TABLE>
<S> <C>
EXHIBIT 3.7 By-Laws of the Registrant, amended as of July 1, 1991 (incorporated by
reference to Exhibit 3.7 to the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1992).
EXHIBIT 4.1 The instruments defining the rights of holders of the long-term debt
securities of the Registrant and its subsidiaries are omitted pursuant to
section (b)(4)(iii)(A) of Item 601 of Regulation S-K. The Registrant hereby
agrees to furnish copies of these instruments to the Securities and Exchange
Commission upon request.
EXHIBIT 10.1 Lease and Land Disposition Agreement, dated as of September 14, 1984, between
Shearson Lehman Construction Inc. and The City of New York (incorporated by
reference to Exhibit 10.16 of the Registrant's Registration Statement on Form
S-1 (Reg. No. 33-12976)).
EXHIBIT 10.2 Form of Agreement of Tenants-In-Common by and among American Express Company,
American Express Bank Ltd., American Express Travel Related Services Company,
Inc., Shearson Lehman Brothers Inc., Shearson Lehman Government Securities,
Inc. and Shearson Lehman Commercial Paper Incorporated (incorporated by
reference to Exhibit 10.17 of the Registrant's Registration Statement on Form
S-1 (Reg. No. 33-12976)).
EXHIBIT 10.3 Stock Purchase Agreement, dated as of June 28, 1991, by and among National
Express Company, Inc., The Balcor Company, Shearson Lehman Brothers Holdings
Inc. and Shearson Lehman Brothers Inc. (incorporated by reference to Exhibit
10.4 of the Registrant's Annual Report on Form 10-K for the year ended
December 31, 1991).
EXHIBIT 10.4 Stock Purchase Agreement, dated as of September 14, 1992, by and between
Mellon Bank Corporation and Shearson Lehman Brothers Inc. (incorporated by
reference to Exhibit 10.15 of Shearson Lehman Brothers Holdings Inc. Annual
Report on Form 10-K for the year ended December 31, 1992).
EXHIBIT 10.5 Asset Purchase Agreement, dated as of March 12, 1993, by and among Primerica
Corporation, Smith Barney, Harris Upham & Co. Incorporated and Shearson
Lehman Brothers Inc. (incorporated by reference to Exhibit 10.16 of Shearson
Lehman Brothers Holdings Inc. Annual Report on Form 10-K for the year ended
December 31, 1992).
EXHIBIT 12 Computation in support of ratio of earnings to fixed charges.*
EXHIBIT 21 Pursuant to General Instruction J of Form 10-K, the list of the Registrant's
subsidiaries is omitted.
EXHIBIT 23 Consent of Ernst & Young.*
EXHIBIT 24 Powers of Attorney.*
(b) Reports on Form 8-K:
1. Form 8-K, dated February 22, 1993, Items 5 and 7.
2. Form 8-K, dated May 7, 1993, Items 5 and 7.
3. Form 8-K, dated June 7, 1993, Items 2 and 7.
4. Form 8-K, dated November 5, 1993, Items 5 and 7.
5. Form 8-K, dated February 24, 1994, Items 5 and 7.
</TABLE>
- ---------------
* Filed herewith.
39
<PAGE> 41
SIGNATURES
Pursuant to the Requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report to be
signed on its behalf by the undersigned, thereunto duly authorized.
LEHMAN BROTHERS INC.
(Registrant)
March 31, 1994
By: /s/ THOMAS A. RUSSO
------------------------------------
Title: Managing Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
NAME TITLE DATE
- ------------------------------------------ --------------------------------- ---------------
<C> <S> <C>
* President, Chief Executive March 31, 1994
- ------------------------------------------ Officer and Director (Principal
Richard S. Fuld, Jr. Executive Officer)
* Chief Financial Officer and March 31, 1994
- ------------------------------------------ Director (Principal Financial
Robert Matza Officer)
* (Principal Accounting Officer) March 31, 1994
- ------------------------------------------
Stephen J. Bier
* Director March 31, 1994
- ------------------------------------------
Roger S. Berlind
* Director March 31, 1994
- ------------------------------------------
Philip Caldwell
* Director March 31, 1994
- ------------------------------------------
Harvey Golub
* Director March 31, 1994
- ------------------------------------------
John R. Laird
* Director March 31, 1994
- ------------------------------------------
Sherman R. Lewis, Jr.
* Director March 31, 1994
- ------------------------------------------
David Marcus
* Director March 31, 1994
- ------------------------------------------
Malcolm Wilson
*By: /s/ THOMAS A. RUSSO
- ------------------------------------------
(Attorney-in-Fact)
March 31, 1994
</TABLE>
40
<PAGE> 42
LEHMAN BROTHERS INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors........................................................ F-2
Consolidated Balance Sheet as of December 31, 1993 and 1992........................... F-3
Consolidated Statement of Operations for the Three Years Ended December 31, 1993...... F-5
Consolidated Statement of Stockholder's Equity for the Three Years Ended December 31,
1993................................................................................ F-6
Consolidated Statement of Cash Flows for the Three Years Ended December 31, 1993...... F-7
Notes to Consolidated Financial Statements............................................ F-9
SCHEDULES
Schedule II -- Amounts Receivable from Related Parties and Underwriters, Promoters,
and Employees Other than Related Parties............................................ F-28
Schedule IX -- Short Term Borrowings.................................................. F-32
</TABLE>
Schedules other than those listed above are omitted since they are not
required or are not applicable or the information is furnished elsewhere in the
consolidated financial statements or the notes thereto.
F-1
<PAGE> 43
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholder of
Lehman Brothers Inc.
We have audited the accompanying consolidated balance sheet of Lehman
Brothers Inc. and Subsidiaries as of December 31, 1993 and 1992, and the related
consolidated statements of operations, stockholder's equity, and cash flows for
each of the three years in the period ended December 31, 1993. Our audits also
included the financial statement schedules listed in the index at item 14(a).
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Lehman Brothers
Inc. and Subsidiaries at December 31, 1993 and 1992, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1993 in conformity with generally accepted
accounting principles. Also, in our opinion the related financial statement
schedules, when considered in relation to the basic financial statements taken
as a whole, present fairly in all material respects the information set forth
therein.
As discussed in Note 11 to the consolidated financial statements, in 1992
the Company changed its methods of accounting for postretirement benefits and
income taxes.
ERNST & YOUNG
New York, New York
February 3, 1994
except for Note 2, as to which the date is
March 28, 1994
F-2
<PAGE> 44
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(IN MILLIONS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1993 1992
------- -------
<S> <C> <C>
Cash and cash equivalents................................................ $ 316 $ 295
Cash and securities segregated and on deposit for regulatory and other
purposes............................................................... 867 1,175
Securities and other financial instruments owned......................... 20,557 21,562
Collateralized short-term agreements:
Securities purchased under agreements to resell........................ 23,175 29,366
Securities borrowed.................................................... 4,276 7,575
Receivables:
Brokers and dealers.................................................... 4,102 2,808
Customers.............................................................. 1,391 5,599
Other.................................................................. 2,138 1,418
Property, equipment and leasehold improvements (net of accumulated
depreciation and amortization of $361 in 1993 and $690 in 1992)........ 426 1,029
Deferred expenses and other assets....................................... 299 1,099
Net assets of discontinued operations.................................... 1,004
Excess of cost over fair value of net assets acquired (net of accumulated
amortization of $99 in 1993 and $264 in 1992).......................... 267 1,049
------- -------
$57,814 $73,979
------- -------
------- -------
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE> 45
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET -- (CONTINUED)
(IN MILLIONS, EXCEPT SHARE DATA)
LIABILITIES AND STOCKHOLDER'S EQUITY
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1993 1992
------- -------
<S> <C> <C>
Commercial paper and short-term debt..................................... $ 2,635 $ 6,567
Securities and other financial instruments sold but not yet purchased.... 5,223 9,837
Advances from Holdings and other affiliates.............................. 5,063 4,523
Securities sold under agreements to repurchase........................... 30,798 33,743
Securities loaned........................................................ 772 3,280
Payables:
Brokers and dealers................................................. 2,021 1,767
Customers........................................................... 2,322 4,789
Accrued liabilities and other payables................................... 2,590 2,321
Senior notes............................................................. 653 1,277
Subordinated indebtedness................................................ 3,053 3,095
------- -------
Total liabilities.............................................. 55,130 71,199
------- -------
Preferred stock of subsidiary, $1 par value; 5,000 shares authorized;
1,000 shares
9% Cumulative Preferred, Series A, issued and outstanding.............. 750 750
Less: Note receivable, Series A Preferred stock..................... (750) (750)
Stockholder's equity:
Preferred stock, $.10 par value; 10,000 shares authorized; none
outstanding
Common stock, $.10 par value; 10,000 shares authorized; 1,005 and
1,002 shares issued and outstanding in 1993 and 1992, respectively
Additional paid-in capital.......................................... 2,738 2,588
Net unrealized securities losses.................................... (13)
Foreign currency translation adjustment............................. 2 2
(Accumulated deficit)/Retained earnings............................. (56) 203
------- -------
Total stockholder's equity..................................... 2,684 2,780
------- -------
$57,814 $73,979
------- -------
------- -------
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE> 46
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(IN MILLIONS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1993 1992 1991
------ ------ ------
<S> <C> <C> <C>
REVENUES
Market making and principal transactions....................... $1,376 $1,509 $1,396
Investment banking............................................. 794 720 560
Commissions.................................................... 1,265 1,641 1,612
Interest and dividends......................................... 5,029 4,974 4,613
Other.......................................................... 467 676 575
------ ------ ------
Total revenues......................................... 8,931.. 9,520 8,756
Interest expense............................................... 4,585 4,573 4,299
------ ------ ------
Net revenues........................................... 4,346 4,947 4,457
------ ------ ------
NON-INTEREST EXPENSES
Compensation and benefits...................................... 2,564 2,982 2,643
Communications................................................. 271 332 317
Occupancy and equipment........................................ 186 266 252
Professional services.......................................... 154 163 140
Advertising and market development............................. 131 176 143
Depreciation and amortization.................................. 135 167 179
Brokerage, commissions and clearance fees...................... 112 92 89
Other.......................................................... 263 450 411
Loss on sale of Shearson....................................... 535
Reserves for non-core businesses............................... 141
------ ------ ------
Total non-interest expenses............................ 4,492 4,628 4,174
------ ------ ------
Income (loss) from continuing operations before taxes, cumulative
effect of changes in accounting principles and preferred
dividend of subsidiary......................................... (146) 319 283
Provision for income taxes..................................... 234 147 65
------ ------ ------
Income (loss) from continuing operations before cumulative
effect of changes in accounting principles and preferred
dividend of subsidiary......................................... (380) 172 218
Income from discontinued operations, net of taxes
Income from operations......................................... 24 77 10
Gain on disposal............................................... 165
------ ------ ------
189 77 10
------ ------ ------
Income (loss) before cumulative effect of changes in accounting
principles and preferred dividend of subsidiary................ (191) 249 228
Cumulative effect of changes in accounting principles.......... (8)
Preferred dividend of subsidiary............................... 68 68 68
------ ------ ------
Net income (loss)................................................ $ (259) $ 173 $ 160
------ ------ ------
------ ------ ------
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE> 47
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
THREE YEAR PERIOD ENDED DECEMBER 31, 1993
(IN MILLIONS)
<TABLE>
<CAPTION>
NET FOREIGN (ACCUMULATED
ADDITIONAL UNREALIZED CURRENCY DEFICIT)/
PAID-IN SECURITIES TRANSLATION RETAINED
TOTAL CAPITAL LOSSES ADJUSTMENT EARNINGS
------ ---------- ---------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1991.................. $1,884 $2,221 $ (171) $(36) $ (130)
Net income.................................. 160 160
Capital contributions....................... 214 214
Capital distributions....................... (12) (12)
Net change in unrealized securities
losses.................................... 116 116
Foreign currency translation adjustment..... 38 38
------ ---------- ---------- ---------- ------------
Balance at December 31, 1991................ 2,400 2,423 (55) 2 30
Net income.................................. 173 173
Capital contributions....................... 67 67
Issuance of common stock.................... 100 100
Capital distributions....................... (2) (2)
Net change in unrealized securities
losses.................................... 42 42
------ ---------- ---------- ---------- ------------
Balance at December 31, 1992................ 2,780 2,588 (13) 2 203
Net loss.................................... (259) (259)
Capital contributions....................... 20 20
Issuance of common stock.................... 430 430
Dividends................................... (300) (300)
Net change in unrealized securities
losses.................................... 13 13
------ ---------- ---------- ---------- ------------
Balance at December 31, 1993................ $2,684 $2,738 $ $ 2 $ (56)
------ ---------- ---------- ---------- ------------
------ ---------- ---------- ---------- ------------
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE> 48
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN MILLIONS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1993 1992 1991
------- ------- -------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
(Loss) income from continuing operations before cumulative
effect of changes in accounting principles and preferred
dividend of subsidiary...................................... $ (380) $ 172 $ 218
Adjustments to reconcile (loss) income to net cash provided by
(used in) operating activities:
Depreciation and amortization............................... 135 167 179
Provisions for losses and other reserves.................... 75 215 156
Loss on sale of Shearson.................................... 535
Non-core business reserves.................................. 141
Deferred tax benefit........................................ (106) (27) (26)
Other adjustments........................................... 64 37 11
Net change in:
Cash and securities segregated.............................. 308 (133) 371
Receivables from brokers and dealers........................ (677) (458) (1,085)
Receivables from customers.................................. 508 (1,088) (663)
Securities purchased under agreements to resell............. 6,191 (9,382) (4,374)
Securities borrowed......................................... 3,217 (4,854) 1,176
Loans originated or purchased for resale.................... (62) (26) (126)
Securities and other financial instruments owned at
market................................................... 899 (7,831) (916)
Payables to brokers and dealers............................. 579 470 596
Payables to customers....................................... (984) 674 25
Accrued liabilities and other payables...................... 408 (243) 306
Securities sold under agreements to repurchase.............. (2,945) 11,645 (633)
Securities loaned........................................... (1,728) 177 691
Securities and other financial instruments sold but not
yet purchased............................................ (4,578) 5,345 1,371
Other receivables and other assets.......................... (716) (63) (45)
------- ------- -------
884 (5,203) (2,768)
Net cash flows provided by (used in) operating activities of
discontinued operations..................................... 428 9 (597)
------- ------- -------
Net cash provided by (used in) operating activities...... 1,312 (5,194) (3,365)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of senior notes........................ 151 6
Principal payments of senior notes............................ (636) (469) (160)
Proceeds from issuance of subordinated indebtedness........... 722 88 114
Principal payments of subordinated indebtedness............... (702) (13) (517)
Proceeds from issuance of other indebtedness.................. 1,291 701 170
Principal payments of other indebtedness...................... (1,072) (923) (101)
Increase (decrease) in commercial paper and short-term debt,
net......................................................... (3,236) 4,970 2,696
Capital contributions......................................... 20 67 214
Proceeds from issuance of common stock........................ 430 100
Dividends and capital distributions paid...................... (300) (2) (12)
Net cash flows used in financing activities of discontinued
operations.................................................. (301) (653) (1,531)
------- ------- -------
Net cash (used in) provided by financing activities...... $(3,784) $ 4,017 $ 879
------- ------- -------
</TABLE>
See notes to consolidated financial statements.
F-7
<PAGE> 49
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS -- (CONTINUED)
(IN MILLIONS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1993 1992 1991
------ ------- ------
<S> <C> <C> <C>
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and leasehold improvements...... $ (101) $ (86) $ (63)
Proceeds from the sale of The Boston Company..................... 1,300
Proceeds from the sale of Shearson............................... 1,200
Proceeds from the sale of SLHMC.................................. 70
Proceeds from sale of other assets............................... 607
Other............................................................ 151 (108) 33
Net cash flows (used in) provided by investing activities of
discontinued operations........................................ (85) (438) 2,834
------ ------- ------
Net cash provided by (used in) investing activities......... 2,535 (25) 2,804
------ ------- ------
Net change in cash and cash equivalents of discontinued
operations..................................................... 42 (1,082) 706
------ ------- ------
Net change in cash and cash equivalents..................... 21 (120) (388)
------ ------- ------
Cash and cash equivalents, beginning of year..................... 295 415 803
------ ------- ------
Cash and cash equivalents, end of year...................... $ 316 $ 295 $ 415
------ ------- ------
------ ------- ------
</TABLE>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (IN MILLIONS)
(INCLUDING THE BOSTON COMPANY)
Interest paid (net of amount capitalized) totaled $4,796 in 1993, $5,047 in
1992 and $5,029 in 1991. Income taxes paid totaled $265 in 1993, $20 in 1992 and
$13 in 1991.
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITY
The Company completed three sale transactions during the current year, the
sale of The Boston Company, Shearson and SLHMC. The cash proceeds related to
these sales have been separately reported in the above statement. Excluded from
the statement are the individual balance sheet changes related to the net assets
sold as well as the noncash proceeds received related to these sales. See Notes
3, 4 and 5.
See notes to consolidated financial statements.
F-8
<PAGE> 50
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Basis of Presentation
The consolidated financial statements include the accounts of Lehman
Brothers Inc., a registered broker-dealer (formerly Shearson Lehman Brothers
Inc., "LBI") and subsidiaries (LBI together with its subsidiaries, the "Company"
unless the context otherwise requires). LBI is a wholly owned subsidiary of
Lehman Brothers Holdings Inc. (formerly Shearson Lehman Brothers Holdings Inc.,
"Holdings"). American Express Company ("American Express") owns 100% of
Holdings' common stock, which represents approximately 93% of Holdings' voting
stock. The remainder of Holdings' voting stock is owned by Nippon Life Insurance
Company ("Nippon Life"). See Note 2. All material intercompany transactions and
accounts have been eliminated.
The Consolidated Statement of Operations includes the results of operations
of Shearson and SLHMC, which were sold on July 31, 1993 and August 31, 1993,
respectively. See Notes 4 and 5.
The balance sheet accounts of the Company's foreign subsidiaries are
translated using the exchange rates at the balance sheet date. Revenues and
expenses are translated at average exchange rates during the year. The resulting
translation adjustments, net of hedging gains or losses are included in
stockholder's equity. Gains or losses resulting from foreign currency
transactions are included in the Consolidated Statement of Operations.
The Company uses the trade date basis of accounting for recording principal
transactions. Customer accounts reflect transactions on a settlement date basis.
Certain amounts reflect reclassifications to conform to the current
period's presentation.
Discontinued Operations
As described in Note 3, the Company completed the sale of The Boston
Company, Inc. ("The Boston Company"), on May 21, 1993. The accompanying
consolidated financial statements and notes to consolidated financial statements
reflect The Boston Company as a discontinued operation.
Securities and Other Financial Instruments
Securities and other financial instruments owned and Securities and other
financial instruments sold but not yet purchased, including interest rate and
currency swaps, caps, collars, floors, swaptions, forwards, options and similar
instruments are valued at market or fair value, as appropriate, with unrealized
gains and losses reflected in market making and principal transactions in the
Consolidated Statement of Operations. Market value is generally based on listed
market prices. If listed market prices are not available, market value is
determined based on other relevant factors, including broker or dealer price
quotations, and valuation pricing models which take into account time value and
volatility factors underlying the financial instruments.
In addition to trading and market making activities, the Company enters
into a variety of financial instruments and derivative products as an end user
to hedge and/or modify its exposure to foreign exchange and interest rate risk
of certain assets and liabilities. As an end user, the Company primarily enters
into interest rate swaps and caps to modify the interest characteristics of its
long-term debt obligations. The Company recognizes the net interest
expense/revenue related to these instruments on an accrual basis, including the
amortization of premiums, over the life of the contracts. Other than in
connection with its debt related hedging programs, the Company's other hedging
activities are immaterial.
F-9
<PAGE> 51
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Repurchase and Resale Agreements
Securities purchased under agreements to resell and Securities sold under
agreements to repurchase, which are treated as financing transactions for
financial reporting purposes, are collateralized primarily by government and
government agency securities and are carried at the amounts at which the
securities will be subsequently resold or repurchased plus accrued interest. It
is the policy of the Company to take possession of securities purchased under
agreements to resell and to value the securities on a daily basis to protect the
Company in the event of default by the counterparty. In addition, provisions are
made to obtain additional collateral if the market value of the underlying
assets is not sufficient to protect the Company. Securities and other financial
instruments owned which are sold under repurchase agreements are carried at
market value with changes in market value reflected in the Consolidated
Statement of Operations.
Securities purchased under agreements to resell and Securities sold under
agreements to repurchase for which the resale/repurchase date corresponds to the
maturity date of the underlying securities are accounted for as purchases and
sales, respectively. At December 31, 1993, such resale and repurchase agreements
aggregated $5.5 billion and $5.2 billion.
Securities Borrowed and Loaned
Securities borrowed and Securities loaned are carried at the amount of cash
collateral advanced or received plus accrued interest. It is the Company's
policy to value the securities borrowed and loaned on a daily basis, and to
obtain additional cash as necessary to ensure such transactions are adequately
collateralized.
Income Taxes
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes".
Prior to January 1, 1992, the Company accounted for income taxes under the
provisions of SFAS No. 96.
Fixed Assets and Intangibles
Property and equipment is depreciated on a straight-line basis over the
estimated useful lives of the related assets. Leasehold improvements are
amortized over the lesser of their economic useful lives or the terms of the
underlying leases. The Company capitalizes interest costs during construction
and amortizes the interest costs based on the useful lives of the assets.
Excess of cost over fair value of net assets acquired is amortized using
the straight-line method over a period of 35 years.
Statement of Cash Flows
The Company defines cash equivalents as highly liquid investments with
original maturities of three months or less, other than those held for sale in
the ordinary course of business.
2. SUBSEQUENT EVENTS:
The Distribution
On January 24, 1994, American Express announced plans to issue a special
dividend to its common shareholders consisting of all the Holdings Common Stock
(the "Distribution"). Prior to the Distribution, which is subject to certain
conditions, an additional equity investment of approximately $1.25 billion will
be made in Holdings, most significantly by American Express. Holdings currently
expects to file a Registration
F-10
<PAGE> 52
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Statement on Form S-1 (the "Registration Statement") with the Securities and
Exchange Commission (the "Commission") with respect to the Distribution during
the second quarter of 1994.
Change of Fiscal Year-End
On March 28, 1994, the Board of Directors of Holdings approved, subject to
the Distribution, a change in the Company's fiscal year-end from December 31 to
November 30. Such a change to a non-calendar cycle will shift certain year-end
administrative activities to a time period that conflicts less with the business
needs of the Company's institutional customers.
Reduction in Personnel
During the first quarter of 1994, the Company completed a review of
personnel needs, which will result in the termination of certain personnel. The
Company anticipates that it will record a severance charge of approximately $25
million pre-tax in the first quarter of 1994 as a result of these terminations.
3. SALE OF THE BOSTON COMPANY:
On May 21, 1993, pursuant to a stock purchase agreement (the "Mellon
Agreement") between the Company and Mellon Bank Corporation ("Mellon Bank"), LBI
sold to Mellon Bank (the "Mellon Transaction") The Boston Company, which through
subsidiaries is engaged in the private banking, trust and custody, institutional
investment management and mutual fund administration businesses. Under the terms
of the Mellon Agreement, LBI received approximately $1.3 billion in cash,
2,500,000 shares of Mellon Bank common stock and ten-year warrants to purchase
an additional 3,000,000 shares of Mellon Bank's common stock at an exercise
price of $50 per share. In June 1993, such shares and warrants were sold by LBI
to American Express for an aggregate purchase price of $169 million. After
accounting for transaction costs and certain adjustments, the Company recognized
a 1993 first quarter after-tax gain of $165 million for the Mellon Transaction.
In connection with the completion of the Mellon Transaction, the Company paid a
$300 million dividend to Holdings.
As a result of the Mellon Transaction, the Company has treated The Boston
Company as a discontinued operation. Accordingly, the Company's financial
statements segregate the net assets of The Boston Company, as of December 31,
1992, and operating results of The Boston Company for the three years ended
December 31, 1993.
Presented below are the results of operations and the gain on disposal of
The Boston Company included in Income from discontinued operations (in
millions):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1993 1992 1991
---- ---- ------
<S> <C> <C> <C>
Discontinued Operations:
Revenues.................................................. $201 $909 $1,157
Expenses.................................................. 159 758 1,145
---- ---- ------
Income before taxes....................................... 42 151 12
Provision for income taxes............................. 18 74 2
---- ---- ------
Income from operations.................................... 24 77 10
Gain on disposal, net of taxes of $37 million............. 165
---- ---- ------
Income from discontinued operations, net of taxes......... $189 $ 77 $ 10
---- ---- ------
---- ---- ------
</TABLE>
F-11
<PAGE> 53
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. SALE OF SHEARSON:
On July 31, 1993, pursuant to an asset purchase agreement (the "Primerica
Agreement"), the Company completed the sale (the "Primerica Transaction") of
LBI's domestic retail brokerage business (except for such business conducted
under the Lehman Brothers name) and substantially all of its asset management
business (collectively, "Shearson") to Primerica Corporation (now known as
Travelers Corporation) ("Travelers") and its subsidiary Smith Barney, Harris
Upham & Co. Incorporated ("Smith Barney"). Also included in the Primerica
Transaction were the operations and data processing functions that support these
businesses, as well as certain of the assets and liabilities related to these
operations.
LBI received approximately $1.2 billion in cash and a $586 million interest
bearing note from Smith Barney which was repaid in January 1994 (the "Smith
Barney Note"). The Smith Barney Note was issued as partial payment for certain
Shearson assets in excess of $600 million which were sold to Smith Barney. The
proceeds received at July 31, 1993, were based on the estimated net assets of
Shearson, which exceeded the minimum net assets of $600 million prescribed in
the Primerica Agreement. As further consideration for the sale of Shearson,
Smith Barney agreed to pay future contingent amounts based upon the combined
performance of Smith Barney and Shearson, consisting of up to $50 million per
year for three years based on revenues, plus 10% of after-tax profits in excess
of $250 million per year over a five-year period (the "Participation Rights").
In contemplation of the Distribution, American Express received the first
Participation Right payment in the first quarter of 1994. It is anticipated that
all of the Participation Rights will be assigned to American Express prior to
the Distribution. As further consideration for the sale of Shearson, the Company
received 2,500,000 shares of 5.50% Convertible Preferred Stock, Series B, of
Travelers and a warrant to purchase 3,749,466 shares of common stock of
Travelers at an exercise price of $39 per share. In August 1993, American
Express purchased such preferred stock and warrant from LBI for aggregate
consideration of $150 million.
The Company recognized a 1993 first quarter loss related to the Primerica
Transaction of approximately $630 million after-tax ($535 million pre-tax),
which amount includes a reduction in goodwill of $750 million and
transaction-related costs such as relocation, systems and operations
modifications and severance.
Presented below are the results of operations and the loss on the sale of
Shearson (in millions):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1993 1992 1991
------ ------ ------
<S> <C> <C> <C>
Revenues................................................. $1,825 $2,781 $2,601
Expenses................................................. 1,708 2,669 2,535
Loss on sale of Shearson................................. 535
------ ------ ------
Income (loss) before taxes............................... (418) 112 66
Provision for income taxes............................... 149 57 37
------ ------ ------
Net income (loss)........................................ $ (567) $ 55 $ 29
------ ------ ------
------ ------ ------
</TABLE>
Shearson operating results reflect allocated interest expense of $72
million, $102 million, and $112 million for the years ended December 31, 1993,
1992 and 1991, respectively.
5. SALE OF SHEARSON LEHMAN HUTTON MORTGAGE CORPORATION:
The Company completed the sale of its wholly owned subsidiary, Shearson
Lehman Hutton Mortgage Corporation ("SLHMC") to GE Capital Corporation on August
31, 1993. The sales price, net of proceeds used to retire debt of SLHMC, was
approximately $70 million. During the first quarter of 1993, the Company
provided $120 million of pre-tax reserves in anticipation of the sale of SLHMC,
which are included in the
F-12
<PAGE> 54
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$141 million of pre-tax reserves for non-core businesses on the Consolidated
Statement of Operations. After accounting for these reserves, the sale did not
have a material effect on the Company's results of operations.
6. SECURITIES AND OTHER FINANCIAL INSTRUMENTS:
Securities and other financial instruments owned and Securities and other
financial instruments sold but not yet purchased are summarized as follows (in
millions):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1993 1992
------- -------
<S> <C> <C>
Securities and other financial instruments owned:
Government obligations......................................... $12,579 $13,578
Certificates of deposit and other money market instruments..... 1,849 3,225
Mortgage-backed................................................ 1,071 571
Corporate obligations and other contractual commitments........ 3,780 3,500
Corporate stocks and options................................... 1,247 677
Spot commodities............................................... 31 11
------- -------
$20,557 $21,562
------- -------
------- -------
Securities and other financial instruments sold but not yet
purchased:
Government obligations......................................... $ 3,898 $ 8,569
Corporate obligations and other contractual commitments........ 433 549
Corporate stocks and options................................... 694 502
Spot commodities............................................... 198 217
------- -------
$ 5,223 $ 9,837
------- -------
------- -------
</TABLE>
7. CASH AND SECURITIES SEGREGATED AND ON DEPOSIT FOR REGULATORY AND OTHER
PURPOSES:
In addition to amounts presented in the accompanying Consolidated Balance
Sheet as Cash and securities segregated and on deposit for regulatory and other
purposes, securities with a market value of approximately $890 million and $341
million at December 31, 1993 and 1992, respectively, primarily collateralizing
resale agreements, have been segregated in a special reserve bank account for
the exclusive benefit of customers pursuant to the Reserve Formula requirements
of Commission Rule 15c3-3.
8. COMMERCIAL PAPER AND SHORT-TERM DEBT:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1993 1992
------ ------
(IN MILLIONS)
<S> <C> <C>
Commercial paper................................................... $ 359 $3,185
Short-term debt.................................................... 2,276 3,382
------ ------
$2,635 $6,567
------ ------
------ ------
</TABLE>
Short-term debt consists primarily of bank loans, master notes and payables
to banks.
F-13
<PAGE> 55
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. SENIOR NOTES:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------------
CONTRACTUAL CONTRACTUAL 1993 1992
MATURING IN FIXED RATE FLOATING RATE TOTAL TOTAL
------------------------------------------- ----------- ------------- ----- ------
(IN MILLIONS)
<S> <C> <C> <C> <C>
1993....................................... $ 152
1994....................................... $ 13 $ 99 $ 112 128
1995....................................... 98 64 162 98
1996....................................... 186 186 698
1997....................................... 19 19 19
1998....................................... 22 22 22
1999 and thereafter........................ 152 152 160
----------- ------ ----- ------
Total............................ $ 490 $ 163 $ 653 $1,277
----------- ------ ----- ------
----------- ------ ----- ------
</TABLE>
As of December 31, 1993 the Company had $490 million of fixed rate senior
notes outstanding. Contractual interest rates on these notes ranged from 7.86%
to 12.20% as of December 31, 1993, with a contractual weighted average interest
rate of 10.60%. The Company utilized a series of fixed rate basis swaps
totalling $341 million to lower this fixed rate to an effective weighted average
interest rate of 9.61%.
As of December 31, 1993 the Company had $163 million of floating rate
senior notes outstanding. Contractual interest rates on these notes ranged from
3.87% to 4.43% as of December 31, 1993, with a contractual weighted average
interest rate of 4.38%. Included in floating rate senior notes outstanding were
$148 million of borrowings from a subsidiary of Holdings, the recourse of which
is limited to certain fixed assets. Interest rates on these related party
borrowings are based on the subsidiary's cost of funds. As of December 31, 1993,
the effective weighted average interest rate on these related party borrowings
was 4.43%.
The Company's interest in 3 World Financial Center is financed with fixed
rate senior notes totalling $384 million as of December 31, 1993. Of this
amount, $301 million is guaranteed by American Express with a portion of these
notes being collateralized by certain mortgage obligations. The remaining $83
million of debt supporting the Company's interest in 3 World Financial Center
was loaned to the Company by American Express, the recourse of which is limited
to certain fixed assets.
During 1993, the Company utilized proceeds from the sale of Shearson to
repay $570 million of sole recourse notes from a subsidiary of Holdings, which
supported buildings and certain fixed assets sold to Travelers.
Of the fixed rate senior notes maturing in 1996, $102 million are an
obligation of a subsidiary of LBI and are guaranteed by Holdings.
As of December 31, 1993, the fair value of the Company's senior notes was
approximately $678 million ($1,335 million in 1992) which exceeded the aggregate
carrying value of the notes outstanding by approximately $25 million ($58
million in 1992). For purposes of this fair value calculation, the carrying
value of variable rate debt that reprices within a year and fixed rate debt
which matures in less than six months approximates fair value. For the remaining
portfolio, fair value was estimated using either quoted market prices or
discounted cash flow analyses based on the Company's current borrowing rates for
similar types of borrowing arrangements. Unrecognized gains on interest rate
swaps and other transactions used by the Company to manage its interest rate
risk within the senior notes portfolio were $6 million and $7 million as of
December 31, 1993 and 1992, respectively. The unrecognized gains on these
transactions reflect the estimated amounts the Company would receive if the
agreements were terminated as calculated based upon market rates as of December
31, 1993 and 1992, respectively.
F-14
<PAGE> 56
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. SUBORDINATED INDEBTEDNESS:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------
CONTRACTUAL CONTRACTUAL 1993 1992
MATURING IN FIXED RATE FLOATING RATE TOTAL TOTAL
----------------------------------------------- ----------- ------------- ------ ------
(IN MILLIONS)
<S> <C> <C> <C> <C>
1993........................................... $ 750
1994........................................... $ 986 $ 194 $1,180 1,252
1995........................................... 405 49 454
1996........................................... 256 150 406 296
1997........................................... 341 341 191
1998........................................... 200 200
1999 and thereafter............................ 472 472 606
----------- ------ ------ ------
Total................................ $ 2,660 $ 393 $3,053 $3,095
----------- ------ ------ ------
----------- ------ ------ ------
</TABLE>
As of December 31, 1993, the Company had $2,660 million of fixed rate
subordinated indebtedness outstanding. Contractual interest rates on this
indebtedness ranged from 5.75% to 13.13% as of December 31, 1993, with an
effective weighted average rate of 8.52%. The Company entered into interest rate
swap contracts which effectively converted $425 million of this debt to floating
rates based on the London Interbank Offered Rate "LIBOR". Exclusive of this $425
million, the Company utilized a series of fixed rate basis swaps totalling
$1,949 million to lower the fixed rate of this portfolio to an effective
weighted average interest rate of 7.45% as of December 31, 1993.
As of December 31, 1993, the Company had $393 million of floating rate
subordinated indebtedness outstanding. Contractual interest rates on this
indebtedness are primarily based on LIBOR and ranged from 2.91% to 4.13% as of
December 31, 1993, with an effective weighted average rate of 3.75%. Including
the effect of the $425 million of fixed rate indebtedness swapped to floating
rates at an effective weighted average rate of 3.58%, the effective weighted
average rate of the Company's floating rate subordinated indebtedness was 3.66%.
Of the Company's subordinated indebtedness outstanding as of December 31,
1993, $160 million is repayable prior to maturity at the option of the holder.
This obligation is reflected in the above table as maturing in 1996, the year in
which the holder has the option to redeem the debt at par value, rather than its
contractual maturity of 2003.
Subordinated borrowings from Holdings and subsidiaries of Holdings were
$1,183 million as of December 31, 1993, all of which were at a fixed rate.
Interest rates on these related party borrowings are based on Holdings', and
subsidiaries of Holdings' cost of funds and ranged from 6.12% to 13.13% as of
December 31, 1993, with an effective weighted average rate of 7.57%. Of this
amount, $100 million (which is included in the $425 million swapped indebtedness
discussed previously) was swapped to floating rates based on LIBOR, with an
effective weighted average rate of 3.09%. Excluding this $100 million, the
effective weighted average rate of related party borrowings was 7.07%.
As of December 31, 1993, $2,211 million of the total subordinated
indebtedness outstanding was senior subordinated indebtedness.
As of December 31, 1993 the fair value of the Company's subordinated
indebtedness was approximately $3,198 million ($3,212 million in 1992) which
exceeded the aggregate carrying value of the notes outstanding by approximately
$145 million ($117 million in 1992). Unrecognized gains on interest rate swaps
and other transactions used by the Company to manage its interest rate risk on
the debt was $49 million and $77 million at December 31, 1993 and 1992,
respectively.
F-15
<PAGE> 57
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. CHANGE IN ACCOUNTING PRINCIPLES:
Accounting for Postretirement Benefits
Effective January 1, 1992, the Company adopted SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions," for the Company's
retiree health and other welfare benefit plans. This accounting pronouncement
requires the current recognition of these benefits as expenses based upon
actuarially determined projections of the benefits provided. The cumulative
effect of adopting SFAS No. 106 reduced 1992 net income by $76 million (net of
taxes of $52 million). Of this amount, $5 million (net of taxes of $3 million)
related to discontinued operations. Prior to the adoption of this accounting
principle, the Company recorded these benefits as they were paid.
Accounting for Income Taxes
The Financial Accounting Standards Board ("FASB") issued SFAS No. 109,
"Accounting for Income Taxes," which superseded SFAS No. 96, the accounting
standard that the Company had followed since 1987. The primary difference
between this accounting standard and SFAS No. 96, lies in the manner in which
income tax expense is determined. SFAS No. 96 provided for significantly more
restrictive criteria prior to the recognition of deferred tax assets. Under the
provisions of SFAS No. 109, deferred tax assets are recognized for temporary
differences that will result in deductible amounts in future years and for tax
loss carryforwards, if, in the opinion of management, it is more likely than not
that the tax benefit will be realized. A valuation allowance is recognized, as a
reduction of the deferred tax asset, for that component of the net deferred tax
asset which does not meet the more likely than not criterion for realization.
The Company adopted SFAS No. 109 as of January 1, 1992 and recorded a $68
million increase in consolidated net income from the Cumulative effect of a
change in accounting principle, $64 million of which related to discontinued
operations. In addition, the Company reduced goodwill by $258 million related to
the recognition of deferred tax benefits attributable to the Company's 1988
acquisition of The E.F. Hutton Group Inc. (now known as LB I Group Inc.,
"Hutton").
12. PENSION PLANS:
The Company participates in several noncontributory defined benefit pension
plans sponsored by Holdings. The cost of pension benefits for eligible
employees, measured by length of service, compensation and other factors, is
currently being funded through trusts established under the plans. Funding of
retirement costs for the applicable plans complies with the minimum funding
requirements specified by the Employee Retirement Income Security Act of 1974,
as amended. Plan assets consist principally of equities and bonds.
Total expense related to pension benefits amounted to $16 million, $23
million and $27 million for the years ended December 31, 1993, 1992 and 1991,
respectively, and consisted of the following components (in millions):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1993 1992 1991
----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Service cost -- benefits earned during the
period.................................... $ 24 $ 29 $ 24
Interest cost on projected benefit
obligation................................ 36 42 37
Actual return on plan assets................ $(59) $(47) $(70)
Net amortization and deferral............... 15 (44) (1) (48) 36 (34)
---- ---- ---- ---- ---- ----
$ 16 $ 23 $ 27
---- ---- ----
---- ---- ----
</TABLE>
F-16
<PAGE> 58
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets forth the funded status of the Company's defined
benefit plans (in millions):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1993 1992
----- -----
<S> <C> <C>
Actuarial present value of benefit obligations:
Vested benefit obligation......................................... $(317) $(459)
----- -----
----- -----
Accumulated benefit obligation.................................... $(322) $(476)
----- -----
----- -----
Projected benefit obligation........................................ $(338) $(533)
Plan assets at fair value........................................... 367 556
----- -----
Plan assets in excess of projected benefit obligation............... 29 23
Unrecognized net loss (gain)........................................ 94 (13)
Unrecognized net asset.............................................. (9) (1)
----- -----
Pension asset recognized in the Consolidated Balance Sheet.......... $ 114 $ 9
----- -----
----- -----
</TABLE>
The weighted average discount rate used in determining the actuarial
present value of the projected benefit obligation for the Company's plans was
7.25% for 1993 and 8.25% for 1992. The rate of increase in future compensation
levels used was 5.5% and 6.0% for 1993 and 1992, respectively. The expected
long-term rate of return on assets was 9.75% for 1993 and 1992.
During 1993, the Company incurred a settlement and curtailment in relation
to the Primerica Transaction. The net gain of approximately $26 million
(pre-tax) is included in the loss on sale of Shearson.
13. POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS:
The Company participates in several defined benefit health care plans
sponsored by Holdings that provide health care, life insurance and other
postretirement benefits to retired employees. The health care plans include
participant contributions, deductibles, co-insurance provisions and
service-related eligibility requirements. The Company funds the cost of these
benefits as they are incurred.
Net periodic postretirement benefit cost for the years ending December 31,
1993 and 1992 consisted of the following components (in millions):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-------------
1993 1992
---- ----
<S> <C> <C>
Service cost........................................................... $ 2 $ 3
Interest cost.......................................................... 8 10
---- ----
Net periodic postretirement benefit cost............................... $10 $13
---- ----
---- ----
</TABLE>
The Company previously accounted for the cost of these benefits by
expensing the amount the Company paid. For the year ending December 31, 1991,
$2.5 million was paid for such benefits.
During 1993, the Company incurred a curtailment in relation to the
Primerica Transaction. The net gain of approximately $56 million (pre-tax) is
included in the loss on sale of Shearson.
F-17
<PAGE> 59
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets forth the amount recognized in the Consolidated
Balance Sheet for the Company's postretirement benefit plans (other than pension
plans) at December 31, 1993 and 1992 (in millions):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------
1993 1992
---- ----
<S> <C> <C>
Accumulated postretirement benefit obligation
Retirees............................................................ $48 $ 43
Fully eligible active plan participants............................. 7 40
Other active plan participants...................................... 7 32
---- ----
62 115
Unrecognized net gain................................................. 12 10
---- ----
Accrued postretirement benefit cost................................... $74 $125
---- ----
---- ----
</TABLE>
The weighted average discount rate used in determining the accumulated
postretirement benefit obligation was 7.25% in 1993 and 8.5% in 1992.
The weighted average annual assumed health care cost trend rate is 13% in
1994 and is assumed to decrease at the rate of 1% per year to 7% in 2000 and
remain at that level thereafter. An increase in the assumed health care cost
trend rate by one percentage point in each year would increase the accumulated
postretirement benefit obligation as of December 31, 1993 by approximately $1.4
million.
In November 1992, the FASB issued SFAS No. 112, "Employers' Accounting for
Postemployment Benefits." This statement requires the accrual of obligations
associated with services rendered to date for employee benefits accumulated or
vested for which payment is probable and can be reasonably estimated. The
Company will record a charge to reflect a cumulative effect of a change in
accounting principle of approximately $13 million after-tax in the first quarter
of 1994.
14. INCOME TAXES:
The Company's taxable income is included in the consolidated U.S. federal
income tax return of American Express and in combined state and local tax
returns with other affiliates of American Express. The income tax provision is
computed in accordance with the income tax allocation agreement among Holdings,
the Company and American Express. Under the agreement, the Company receives
income tax benefits for net operating losses ("NOLs"), future tax deductions and
foreign tax credits that are recognizable on a stand-alone basis, or a share,
derived by formula, of such losses, deductions and credits that are recognizable
on American Express' consolidated income tax return. Intercompany taxes are
remitted to or from American Express when they are otherwise due to or from the
relevant taxing authority. The balances due to Holdings at December 31, 1993 and
1992 were $180 million and $54 million, respectively, and are included in
Accrued liabilities and other payables in the accompanying Consolidated Balance
Sheet.
F-18
<PAGE> 60
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The provision (benefit) for income taxes from continuing operations
consists of the following (in millions):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1993 1992 1991
----- ---- ----
<S> <C> <C> <C>
Current
Federal.................................................... $ 218 $127 $ 50
State...................................................... 115 44 38
Foreign.................................................... 7 3 3
----- ---- ----
340 174 91
----- ---- ----
Deferred
Federal.................................................... (75) (24) (26)
State...................................................... (31) (3)
----- ---- ----
(106) (27) (26)
$ 234 $147 $ 65
----- ---- ----
----- ---- ----
</TABLE>
During the third quarter of 1993, the U.S. federal income tax rate was
increased to 35% from 34%, effective January 1, 1993. The Company's 1993 tax
provision includes a one-time benefit of approximately $8 million from the
impact of the rate change on the Company's net deferred tax assets as of January
1, 1993.
Income from continuing operations before taxes included $41 million, $1
million and $11 million that is subject to income taxes of foreign jurisdictions
for 1993, 1992 and 1991, respectively.
The income tax provision differs from that computed by using the statutory
federal income tax rate for the reasons shown below (in millions):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
----------------------
1993 1992 1991
---- ---- ----
<S> <C> <C> <C>
Federal income tax (benefit) provision at statutory rate..... $(51) $108 $ 96
State and local taxes........................................ 54 29 25
Tax-exempt interest and dividends............................ (24) (4) (2)
Write-off of goodwill related to the sale of Shearson........ 263
Amortization of goodwill..................................... 9 14 17
Decrease in unrecognized deferred tax benefits............... (71)
U.S. federal rate change..................................... (8)
Other........................................................ (9)
---- ---- ----
$234 $147 $ 65
---- ---- ----
---- ---- ----
</TABLE>
Deferred income tax assets and liabilities result from the recognition of
temporary differences. Temporary differences are differences between the tax
bases of assets and liabilities and their reported amounts in the consolidated
financial statements that will result in differences between income for tax
purposes and income for consolidated financial statement purposes in future
years.
F-19
<PAGE> 61
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1993 and 1992, the Company's net deferred tax (liabilities)
assets from continuing operations consisted of the following (in millions):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------
1993 1992
---- ----
<S> <C> <C>
Deferred tax assets................................................... $119 $374
Less: Valuation allowance............................................. 116 174
---- ----
Deferred tax assets net of valuation allowance........................ 3 200
Deferred tax liabilities.............................................. (39) (52)
---- ----
Net deferred tax (liabilities) assets from continuing operations.... $(36) $148
---- ----
---- ----
</TABLE>
At December 31, 1993 and 1992, deferred tax assets consisted primarily of
reserves not yet deducted for tax purposes of $78 million and $144 million,
respectively, and tax return NOLs of $38 million and $220 million, respectively.
At December 31, 1993 and 1992, deferred tax liabilities consist primarily of
unrealized trading and investment gains of $33 million and $44 million,
respectively.
During 1993, the Company increased deferred tax assets by approximately $65
million related to transactions arising from the sale of The Boston Company. In
addition, in accordance with the tax sharing agreement with Holdings, the
Company was reimbursed for $169 million and $99 million of net deferred tax
assets in 1993 and 1992, respectively.
The net deferred tax (liability) asset is included in Deferred expenses and
other assets in the accompanying Consolidated Balance Sheet. At December 31,
1993, the valuation allowance recorded against deferred tax assets from
continuing operations was $116 million as compared to $174 million at December
31, 1992. The reduction in the valuation allowance was primarily attributable to
1993 utilization of tax return NOLs for which a valuation allowance was
previously established. Of the $116 million valuation allowance at December 31,
1993, approximately $100 million will reduce goodwill if future circumstances
permit recognition.
For tax return purposes, the Company has approximately $145 million of NOL
carryforwards, all of which are attributable to the 1988 acquisition of Hutton.
Substantially all of the NOLs are scheduled to expire in the years 1999 through
2007. A portion of the valuation allowance discussed above relates to these
NOLs. It is anticipated that approximately $15 million of these NOLs will be
transferred to American Express in connection with the Distribution discussed in
Note 2, the benefit of which had not been reflected in the financial statements.
15. EMPLOYEE STOCK OWNERSHIP PLAN
During 1993, Lehman Brothers established the Lehman Brothers Inc. Employee
Ownership Plan (the "Employee Ownership Plan") pursuant to which certain key
employees of Holdings deferred a percentage of their 1993 salary and bonus for
the purchase of certain Phantom Units of Holdings. Each Phantom Unit is
comprised of a phantom equity interest representing a notional interest in a
share of common stock, $.10 par value per share ("Common Stock"), of Holdings
("Phantom Share") and the right to receive a certain amount in cash with respect
to a Phantom Share ("Cash Right"). Phantom Shares were available for "purchase"
through voluntary and mandatory deferrals of 1993 compensation. In accordance
with the terms of the Plan, Phantom Units will be converted to the Common Stock
contemporaneously with the effectiveness of the Distribution. See Note 2.
The Company will recognize compensation expense in 1994 equal to (i) the
increase in book value attributable to the Phantom Shares and (ii) the excess,
if any, of the market value of the Common Stock on
F-20
<PAGE> 62
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the Distribution Date issued pursuant to the Phantom Share conversion over the
price paid by employees for the Phantom Shares.
16. CAPITAL REQUIREMENTS:
As registered broker-dealers, LBI and certain of its subsidiaries are
subject to the Net Capital Rule (Rule 15c3-1, the "Rule") promulgated under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). The New York
Stock Exchange, Inc. and the National Association of Securities Dealers, Inc.
monitor the application of the Rule by LBI and such subsidiaries, as the case
may be. LBI and such subsidiaries compute net capital under the alternative
method of the Rule which requires the maintenance of minimum net capital, as
defined. A broker-dealer may be required to reduce its business if net capital
is less than 4% of aggregate debit balances or 6% of the funds required to be
segregated pursuant to the Commodity Exchange Act (the "Commodity Act") and the
regulations thereunder, if greater. A broker-dealer may also be prohibited from
expanding its business or paying cash dividends if resulting net capital would
be less than 5% of aggregate debit balances or 7% of the funds required to be
segregated pursuant to the Commodity Act and the regulations thereunder, if
greater. In addition, the Rule does not allow withdrawal of subordinated capital
if net capital would be less than 5% of such debit balances or 7% of the funds
required to be segregated pursuant to the Commodity Act and the regulations,
thereunder, if greater.
The Rule also limits the ability of broker-dealers to transfer large
amounts of capital to parent companies and other affiliates. Under the Rule,
equity capital cannot be withdrawn from a broker-dealer without the prior
approval of the Commission when net capital after the withdrawal would be less
than 25% of its securities positions haircuts (which are deductions from capital
of certain specified percentages of the market value of securities to reflect
the possibility of a market decline prior to disposition). In addition, the Rule
requires broker-dealers to notify the Commission and the appropriate
self-regulatory organization two business days before the withdrawal of excess
net capital if the withdrawal would exceed the greater of $500,000 or 30% of the
broker-dealer's excess net capital, and two business days after a withdrawal
that exceeds the greater of $500,000 or 20% of excess net capital.
Finally, the Rule authorizes the Commission to order a freeze on the
transfer of capital if a broker-dealer plans a withdrawal of more than 30% of
its excess net capital and the Commission believes that such a withdrawal would
be detrimental to the financial integrity of the firm or would jeopardize the
broker-dealer's ability to pay its customers. At December 31, 1993, LBI's net
capital aggregated $1,339 million and was $1,293 million in excess of minimum
requirement. Also at December 31, 1993, Lehman Government Securities Inc., a
wholly owned subsidiary of LBI, had net capital which aggregated $184 million
and was $161 million in excess of minimum requirement.
The Company is subject to other domestic and international regulatory
requirements. As of December 31, 1993, the Company believes it is in material
compliance with all such requirements.
F-21
<PAGE> 63
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
17. COMMITMENTS AND CONTINGENCIES:
The Company leases office space and equipment and has entered into ground
leases with the City of New York or its agencies. For each of the years ended
December 31, 1993, 1992 and 1991, total rent expense was $163 million, $248
million and $246 million, respectively. Minimum future rental commitments under
noncancellable operating leases (net of subleases of $660 million) are as
follows (in millions):
<TABLE>
<CAPTION>
YEAR AMOUNT
-------------------------------------------------------------------- ------
<S> <C>
1994................................................................ $ 30
1995................................................................ 29
1996................................................................ 25
1997................................................................ 19
1998................................................................ 14
1999 and thereafter................................................. 81
------
$198
------
------
</TABLE>
Certain leases on office space contain escalation clauses providing for
additional rentals based upon maintenance, utility and tax increases.
On October 13, 1993, Holdings executed a 16 year lease at 101 Hudson Street
in Jersey City, New Jersey. The lease, which commences in August 1994, obligates
Holdings to make minimum lease payments of approximately $87 million over its
term. Upon commencement, a substantial portion of these lease payments will be
allocated to the Company based upon Holdings' method for allocating certain
intercompany charges. The lease commitment amounts presented above do not
reflect these allocations which have yet to be finalized.
In the normal course of its business, the Company has been named a
defendant in a number of lawsuits and other legal proceedings. After considering
all relevant facts, available insurance coverage and the opinions of outside
counsel, in the opinion of the Company such litigation will not, in the
aggregate, have a material adverse effect on the Company's consolidated
financial statements.
Financial Instruments with Off-Balance-Sheet Risk
In the normal course of business, the Company enters into financial
instrument transactions to conduct its trading activities, to satisfy the
financial needs of its clients and to manage its own exposure to credit and
market risks. Many of these financial instruments typically have
off-balance-sheet risk resulting from their nature including the terms of
settlement. These instruments can be broadly categorized as interest rate and
currency swaps, caps, collars, floors, swaptions and similar instruments
(collectively "Swap Products"), foreign currency products, equity related
products, commitments and guarantees and certain other instruments.
Market risk arises from the possibility that market changes, including
interest and foreign exchange rate movements, may make financial instruments
less valuable. Credit risk results from the possibility that a loss may occur
from the failure of another party to perform according to the terms of a
contract. The Company has extensive control procedures regarding the extent of
the Company's transactions with specific counterparties, the manner in which
transactions are settled and the ongoing assessment of counterparty
creditworthiness.
The notional or contract amounts disclosed below provide a measure of the
Company's involvement in such instruments but are not indicative of potential
loss. Management does not anticipate any material adverse effect to its
financial position or results of operations as a result of its involvement in
these instruments. In many cases, these financial instruments serve to reduce,
rather than increase, market risk.
F-22
<PAGE> 64
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company enters into interest rate contracts as principal in its trading
operations or as an integral part of its interest rate risk management. These
contracts include Swap Products, financial future contracts and forward security
contracts.
The notional or contractual amounts of these instruments are set forth
below (in millions):
<TABLE>
<CAPTION>
NOTIONAL/CONTRACT
AMOUNT
---------------------
1993 1992
-------- --------
<S> <C> <C>
Swap Products.................................................. $274,018 $112,897
Financial futures:
To purchase.................................................. 89,055 27,320
To sell...................................................... 51,234 21,203
Forward contracts:
Securities:
To purchase............................................... 51,789 20,936
To sell................................................... 46,535 21,758
Foreign exchange:
To purchase............................................... 116,484 47,377
To sell................................................... 117,832 49,404
Options written:
Securities................................................... 65,856 4,059
Foreign exchange............................................. 58 84
-------- --------
$812,861 $305,038
-------- --------
-------- --------
</TABLE>
The majority of the Company's off-balance-sheet transactions are short-term
in duration with a weighted average maturity of approximately 1.83 years as of
December 31, 1993 and 1.69 years as of December 31, 1992. Presented below is a
maturity schedule for the notional/contractual amounts outstanding for Swap
Products and other off-balance-sheet instruments (in millions):
<TABLE>
<S> <C>
1994.............................................................. $566,417
1995.............................................................. 70,818
1996.............................................................. 42,599
1997.............................................................. 15,809
1998.............................................................. 82,288
1999 and thereafter............................................... 34,930
--------
$812,861
--------
--------
</TABLE>
At December 31, 1993, the replacement cost of contracts in a gain position
not recorded on the Company's Consolidated Balance Sheet is as follows (in
millions):
<TABLE>
<S> <C>
Swap Products...................................................... $ 1,962
Forward and other contracts........................................ 1,004
-------
2,966
Less: Amounts recorded on the Consolidated Balance Sheet......... (1,278)
-------
Credit exposure not recorded on the Consolidated Balance Sheet..... $ 1,688
-------
-------
</TABLE>
As of December 31, 1993 and 1992, the Company was contingently liable for
$463 million and $822 million, respectively, of letters of credit primarily used
to provide collateral for securities and commodities borrowed and to satisfy
margin deposits at option and commodity exchanges and other financial
guarantees.
As of December 31, 1993 and 1992, the Company had pledged or otherwise
transferred securities, primarily fixed income, having a market value of $21.3
billion and $14.5 billion, respectively, as collateral for securities borrowed
or otherwise received having a market value of $21.1 billion and $14.2 billion,
respectively.
F-23
<PAGE> 65
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Securities sold but not yet purchased represent obligations of the Company
to purchase the securities at prevailing market prices. Therefore, the future
satisfaction of such obligations may be for an amount greater or less than the
amount recorded.
The Company's customer activities may expose it to off-balance-sheet credit
risk. The Company may be required to purchase or sell financial instruments at
prevailing market prices in the event of the failure of a customer to settle
trades on their original terms, or in the event cash and securities in customer
accounts are not sufficient to fully cover customer losses. The Company seeks to
control the risks associated with customer activities through the use of systems
and procedures for financial instruments with off-balance-sheet risk.
Subsidiaries of the Company, as general partner, are contingently liable
for the obligations of certain public and private limited partnerships organized
as pooled investment funds or engaged primarily in real estate activities. In
the opinion of the Company, contingent liabilities, if any, for the obligations
of such partnerships will not in the aggregate have a material adverse effect on
the Company's consolidated financial position or results of operations.
Concentrations of Credit Risk
As a major securities firm, the Company is actively involved in securities
underwriting, distribution and trading. These and other related services are
provided on a worldwide basis to a large and diversified group of clients and
customers, including multinational corporations, governments, emerging growth
companies, financial institutions and individual investors.
A substantial portion of the Company's securities and commodities
transactions is collateralized and is executed with and on behalf of commercial
banks and other institutional investors, including other brokers and dealers.
The Company's exposure to credit risk associated with the non-performance of
these customers and counterparties in fulfilling their contractual obligations
pursuant to securities transactions can be directly impacted by volatile or
illiquid trading markets which may impair the ability of customers and
counterparties to satisfy their obligations to the Company.
Securities and other financial instruments owned by the Company include
U.S. government and agency securities and securities issued by U.S. governments
which, in the aggregate, represented 18.9% of the Company's total assets at
December 31, 1993. In addition, substantially all of the collateral held by the
Company for resale agreements or bonds borrowed, which together represented
47.5% of total assets at December 31, 1993, consisted of securities issued by
the U.S. government and federal agencies. In addition to these specific
exposures, the Company's most significant concentration is financial
institutions, which include other brokers and dealers, commercial banks and
institutional clients. This concentration arises in the normal course of the
Company's business.
Financial Accounting Standards Board Interpretation No. 39, "Offsetting of
Amounts related to Certain Contracts" ("FIN No. 39"), was issued in March 1992.
Effective for balance sheets after January 1, 1994, FIN No. 39 restricts the
current industry practice of offsetting certain receivables and payables.
Although the implementation of this standard is expected to substantially
increase gross assets and liabilities, the Company believes that its results of
operations and overall financial condition will not be affected. The FASB has
instructed its staff to explore modifying FIN No. 39 to create certain
exceptions, which, if enacted, would substantially mitigate the increase in the
Company's gross assets and liabilities expected to initially result from the
implementation of FIN No. 39.
18. FAIR VALUE OF FINANCIAL INSTRUMENTS:
In 1992, the Company adopted SFAS No. 107, "Disclosures about Fair Value of
Financial Instruments," which requires disclosure of the fair values of most on-
and off-balance-sheet financial instruments for which it is practicable to
estimate that value. The scope of SFAS No. 107 excludes certain financial
instruments, such
F-24
<PAGE> 66
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
as trade receivables and payables when the carrying value approximates the fair
value, employee benefit obligations and all non-financial instruments, such as
land, buildings and equipment and goodwill. The fair values of the financial
instruments are estimates based upon current market conditions and perceived
risks and require varying degrees of management judgment.
For the majority of the Company's assets and liabilities which fall under
the scope of SFAS No. 107, book value approximates fair value, with the
exception of senior notes and subordinated indebtedness. See Notes 9 and 10.
19. RELATED PARTY TRANSACTIONS:
In the normal course of business, the Company engages in various securities
trading, investment banking and financing activities with Holdings, American
Express and many of their affiliates (the "Related Parties"). In addition,
various charges, such as occupancy, administration and computer processing are
allocated between the Related Parties, based upon specific identification and
allocation methods.
In addition, Holdings and other subsidiaries of Holdings raise money
through short and long term funding in the capital markets, which it uses to
fund the operations of certain of the Company's wholly owned subsidiaries.
Advances from Holdings and other affiliates were $5,063 million and $4,523
million at December 31, 1993 and 1992, respectively.
In connection therewith, advances from Holdings aggregating approximately
$3.6 billion and $4.1 billion at December 31, 1993 and 1992, respectively, are
generally payable on demand, and the average rate of interest charged, which is
computed primarily based on Holdings' average daily cost of funds, was 3.6% and
4.1% for the years ended December 31, 1993 and 1992, respectively. Interest
charges incurred during 1993, 1992 and 1991 from Holdings, including interest
charges on subordinated and senior debt issued to Holdings, amounted to $227
million, $214 million and $273 million, respectively. In addition, the Company
has advances from other affiliates of Holdings aggregating approximately $1.5
billion and $442 million, at December 31, 1993 and 1992, respectively, with
various repayment terms. The Company also has notes and other receivables due
from Holdings and other subsidiaries of Holdings aggregating approximately $1.6
billion and $1.1 billion at December 31, 1993 and 1992, respectively, with
various repayment terms.
In 1992, the Company issued one share of its common stock to Holdings for
$100 million. During 1993, the Company issued an additional three shares of its
common stock to Holdings for $430 million.
A wholly owned subsidiary of the Company has outstanding 1,000 shares of
its 9% Cumulative Preferred Stock, Series A (the "Preferred Stock"), which it
issued for an aggregate purchase price of $750,000,000 to a wholly owned
subsidiary of Holdings for $1,000 in cash and a promissory note of $749,999,000
bearing interest at a rate equal to the holder's cost of funds (the "Note").
Interest income for the years ended December 31, 1993, 1992 and 1991 includes
$28 million, $36 million and $50 million, respectively, from the Note. The
dividend requirement on the Preferred Stock, as reflected on the Company's
Consolidated Statement of Operations was $68 million for each of the years ended
December 31, 1993, 1992 and 1991.
The Company believes that amounts arising through related party
transactions, including those allocated expenses referred to above, are
reasonable and approximate the amounts that would have been recorded if the
Company operated as an unaffiliated entity.
20. OTHER CHARGES:
During the first quarter of 1993, the Company provided $141 million pre-tax
($93 million after-tax) of non-core business reserves. Of this amount, $21
million pre-tax ($14 million after-tax) relates to certain non-core partnership
syndication activities in which the Company is no longer actively engaged. The
remaining
F-25
<PAGE> 67
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$120 million pre-tax ($79 million after-tax) relates to reserves recorded in
anticipation of the sale of SLHMC. Such sale was completed during the third
quarter of 1993.
21. QUARTERLY INFORMATION (UNAUDITED):
Selected quarterly results for year ended December 31, 1993 were as follows
(in millions):
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
--------- -------- ------------- ------------
<S> <C> <C> <C> <C>
Net revenues.................................. $ 1,372 $1,394 $ 901 $679
Expenses...................................... 1,919 1,242 785 546
--------- -------- ------ ------
Income (loss) from continuing operations
before taxes and preferred dividend of
subsidiary............................... (547) 152 116 133
Provision for income taxes.................... 102 62 37 33
Income (loss) from continuing operations and
preferred dividend of subsidiary......... (649) 90 79 100
Income from discontinued operations, net of
taxes Income from operations................ 24
Gain on disposal............................ 165
--------- -------- ------ ------
189
--------- -------- ------ ------
Income (loss) before preferred dividend of
subsidiary............................... (460) 90 79 100
Preferred dividend of subsidiary.............. 17 17 17 17
--------- -------- ------ ------
Net income (loss)........................... $ (477) $ 73 $ 62 $ 83
--------- -------- ------ ------
--------- -------- ------ ------
</TABLE>
The results for the first quarter of 1993 reflect a loss on the Primerica
Transaction of $630 million ($535 million pre-tax) and reserves for non-core
businesses of $93 million ($141 million pre-tax).
F-26
<PAGE> 68
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Quarterly results for year ended December 31, 1992 were as follows (in
millions):
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
--------- -------- ------------- ------------
<S> <C> <C> <C> <C>
Net revenues.................................. $ 1,328 $1,308 $ 1,149 $1,162
Expenses...................................... 1,178 1,174 1,109 1,167
--------- -------- ------------- ------------
Income (loss) from continuing operations
before taxes, cumulative effect of
changes in accounting principles and
preferred dividend of subsidiary......... 150 134 40 (5)
Provision for (benefit from) income taxes..... 66 64 21 (4)
--------- -------- ------------- ------------
Income (loss) from continuing operations
before cumulative effect of changes in
accounting principles and preferred
dividend of subsidiary................... 84 70 19 (1)
Income from discontinued operations, net of
taxes....................................... 19 20 17 21
--------- -------- ------------- ------------
Income before cumulative effect of changes
in accounting principles and preferred
dividend of subsidiary................... 103 90 36 20
Cumulative effect of changes in accounting
principles.................................. (8)
Preferred dividend of subsidiary.............. 17 17 17 17
--------- -------- ------------- ------------
Net income.................................. $ 78 $ 73 $ 19 $ 3
--------- -------- ------------- ------------
--------- -------- ------------- ------------
</TABLE>
The results for the fourth quarter reflect a $22 million after-tax ($33
million pre-tax) write-down in the carrying value of certain real estate
investments, and $19 million after-tax ($29 million pre-tax) net revenues
primarily from asset management fees, the basis for the calculation of which was
revised during the quarter retroactive to January 1, 1992.
F-27
<PAGE> 69
SCHEDULE II
LEHMAN BROTHERS INC. AND SUBSIDIARIES
AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS,
PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES
FOR THE THREE YEARS ENDED DECEMBER 31, 1993
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1993
------------------------------------------------------
BALANCE AT
BEGINNING OF AMOUNT BALANCE AT
NAME OF DEBTOR PERIOD ADDITIONS COLLECTED END OF PERIOD
- -------------------------------------------- ------------ ---------- ---------- -------------
<S> <C> <C> <C> <C>
Edward Bruksch.............................. $ 120,000 $ 30,000 $ 90,000(1)
Fred Farina................................. 100,000 $ 160,000 260,000(2)
Peter Hunt.................................. 100,000 100,000(3)
Todd C. Jorn................................ 105,000 105,000(4)
Adam Shafiroff.............................. 72,582 22,582 50,000(5)
David Sitzer................................ 60,000 60,000
Kim Sullivan................................ 125,000 125,000
John Tuosto................................. 150,000 93,500 56,500(6)
Helen Van Eeden............................. 73,474 15,341 58,133(2)
Miriam Willard.............................. 100,000 100,000(3)
Jacob Worenklein............................ 600,000 600,000(7)
Others...................................... 6,723,077 52,160 4,623,368 2,151,869(8)
------------ ---------- ---------- -------------
$7,424,133 $1,117,160 $4,969,791 $ 3,571,502
------------ ---------- ---------- -------------
------------ ---------- ---------- -------------
</TABLE>
See notes to Schedule II on page F-31
F-28
<PAGE> 70
SCHEDULE II
LEHMAN BROTHERS INC. AND SUBSIDIARIES
AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS,
PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES, CONTINUED
FOR THE THREE YEARS ENDED DECEMBER 31, 1993
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1992
------------------------------------------------------
BALANCE AT
BEGINNING OF AMOUNT BALANCE AT
NAME OF DEBTOR PERIOD ADDITIONS COLLECTED END OF PERIOD
- -------------------------------------------- ------------ ---------- ---------- -------------
<S> <C> <C> <C> <C>
Edward Bruksch.............................. $ 150,000 $ 30,000 $ 120,000
James Carbone............................... 200,000 200,000
Brian Edmonds............................... 103,000 $ 150,000 253,000
Fred Farina................................. 100,000 100,000
Joseph Gregory.............................. 225,000 225,000
La Brena Martin............................. 270,000 270,000
Gordon Paris................................ 250,000 250,000
Martin Randall.............................. 44,444 44,444
Craig Schiffer.............................. 150,000 150,000
Adam Shafiroff.............................. 145,000 72,418 72,582
David Sitzer................................ 180,000 120,000 60,000
Mark Stevenson.............................. 200,000 200,000
Kim Sullivan................................ 125,000 125,000
John Tuosto................................. 150,000 150,000
Helen Van Eeden............................. 115,000 16,267 57,793 73,474
Samuel Wasserman............................ 225,000 225,000
Richard Zielong............................. 90,000 90,000
Others...................................... 7,536,888 2,734,760 3,548,571 6,723,077
------------ ---------- ---------- -------------
$9,534,332 $3,626,027 $5,736,226 $ 7,424,133
------------ ---------- ---------- -------------
------------ ---------- ---------- -------------
</TABLE>
F-29
<PAGE> 71
SCHEDULE II
LEHMAN BROTHERS INC. AND SUBSIDIARIES
AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS,
PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES, CONTINUED
FOR THE THREE YEARS ENDED DECEMBER 31, 1993
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1991
------------------------------------------------------------
BALANCE AT
BEGINNING OF AMOUNT BALANCE AT
NAME OF DEBTOR PERIOD ADDITIONS COLLECTED END OF PERIOD
- ------------------------------------------ ------------ ---------- ---------- -------------
<S> <C> <C> <C> <C>
Edward Bruksch............................ $ 150,000 $ 150,000
James Carbone............................. 200,000 200,000
Brian Edmonds............................. 103,000 103,000
Joseph Gregory............................ 225,000 225,000
La Brena Martin........................... 270,000 270,000
Gordon Paris.............................. 250,000 250,000
Martin Randall............................ $ 100,000 $ 55,556 44,444
Adam Shafiroff............................ 175,818 145,000 175,818 145,000
David Sitzer.............................. 180,000 180,000
Helen Van Eeden........................... 120,000 15,000 20,000 115,000
Samuel Wasserman.......................... 125,000 100,000 225,000
Richard Zielong........................... 120,000 30,000 90,000
Others.................................... 8,684,769 2,219,762 3,367,643 7,536,888
------------ ---------- ---------- -------------
$ 9,205,587 $3,977,762 $3,649,017 $ 9,534,332
------------ ---------- ---------- -------------
------------ ---------- ---------- -------------
</TABLE>
F-30
<PAGE> 72
SCHEDULE II
LEHMAN BROTHERS INC. AND SUBSIDIARIES
AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS,
PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES, CONTINUED
FOR THE THREE YEARS ENDED DECEMBER 31, 1993
NOTES TO PAGE F-28 OF SCHEDULE II
(1) Note is payable by March 1994. Interest accrues at the Company's margin
rate.
(2) Notes are payable February 1994 vs. bonus. Interest accrues at the Company's
margin rate.
(3) Note is payable February 1994 vs. bonus. Interest accrues at the Company's
margin rate.
(4) Notes are payable February 1995 vs. bonus. Interest accrues at the Company's
margin rate.
(5) Note is payable by payroll deductions of 10% of gross commissions up to
$50,000 and all net commissions over $50,000, plus deferred compensation and
investment banking fees. Interest accrues at the Company's margin rate.
(6) Note is payable by monthly payments of $1,000 plus 50% of any net bonus
payable February 1994. Interest accrues at the Company's margin rate.
(7) Note is payable February 1994 vs. bonus. Note is noninterest bearing.
(8) Other includes employees who transferred to Smith Barney on July 31, 1993.
In connection with this transfer Smith Barney paid the Company $2,263,202
for loans related to these individuals. The balance in other also represents
loans to individuals who terminated employment and are outstanding at
December 31, 1993.
F-31
<PAGE> 73
SCHEDULE IX
LEHMAN BROTHERS INC. AND SUBSIDIARIES
SHORT-TERM BORROWINGS
Information pertaining to aggregate short-term borrowings during each of
the three years in the period ended December 31, 1993 was as follows (dollars in
billions):
<TABLE>
<CAPTION>
WEIGHTED MAXIMUM AVERAGE WEIGHTED
AVERAGE AMOUNT AMOUNT AVERAGE
INTEREST OUTSTANDING OUTSTANDING INTEREST
CATEGORY OF AGGREGATE RATE AT DURING THE DURING THE RATE DURING
SHORT-TERM BORROWINGS YEAR-END YEAR(1) YEAR(2) THE YEAR(3)
- ---------------------------------------------------- -------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Commercial Paper
1993.............................................. 3.5% $ 3.2 $ 1.7 3.4%
1992.............................................. 4.0% $ 3.2 $ 2.5 3.9%
1991.............................................. 5.5% $ 1.9 $ .7 5.7%
Short-term Debt
1993.............................................. 3.7% $ 4.2 $ 3.1 3.5%
1992.............................................. 3.8% $ 4.0 $ 3.3 4.1%
1991.............................................. 5.4% $ 4.6 $ 3.5 6.2%
Securities Sold Under Agreements to Repurchase
1993.............................................. 3.4% $43.6 $38.1 3.3%
1992.............................................. 3.4% $36.5 $31.0 3.8%
1991.............................................. 4.8% $30.1 $24.6 6.0%
</TABLE>
- ---------------
(1) The maximum amount outstanding was based on month end balances.
(2) The average borrowings were computed using the monthly amounts outstanding.
(3) Interest rates were determined by dividing the actual interest expense for
the year by the average monthly amounts outstanding.
F-32
<PAGE> 74
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
<S> <C>
EXHIBIT 3.1 Restated Certificate of Incorporation of the Registrant dated September 3,
1981 (incorporated by reference to Exhibit 3.1 of the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1987).
EXHIBIT 3.2 Certificate of Amendment to Restated Certificate of Incorporation of the
Registrant dated May 11, 1984 (incorporated by reference to Exhibit 3.2 of
the Registrant's Annual Report on Form 10-K for the year ended December 31,
1988).
EXHIBIT 3.3 Certificate of Amendment to Restated Certificate of Incorporation of the
Registrant, dated March 6, 1985 (incorporated by reference to Exhibit 3.3 of
the Registrant's Annual Report on Form 10-K for the year ended December 31,
1985).
EXHIBIT 3.4 Certificate of Amendment to Restated Certificate of Incorporation of the
Registrant, dated August 31, 1987 (incorporated by reference to Exhibit 3.4
of the Registrant's Annual Report on Form 10-K for the year ended December
31, 1987).
EXHIBIT 3.5 Certificate of Amendment to Restated Certificate of Incorporation of the
Registrant, dated January 28, 1988 (incorporated by reference to Exhibit 3.5
of the Registrant's Annual Report on Form 10-K for the year ended December
31, 1987).
EXHIBIT 3.6 Certificate of Amendment to Restated Certificate of Incorporation of the
Registrant dated July 19, 1990 (incorporated by reference to Exhibit 3.6 of
the Registrant's Annual Report on Form 10-K for the year ended December 31,
1990).
EXHIBIT 3.7 By-Laws of the Registrant, amended as of July 1, 1991 (incorporated by
reference to Exhibit 3.7 to the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1992).
EXHIBIT 4.1 The instruments defining the rights of holders of the long-term debt
securities of the Registrant and its subsidiaries are omitted pursuant to
section (b)(4)(iii)(A) of Item 601 of Regulation S-K. The Registrant hereby
agrees to furnish copies of these instruments to the Securities and Exchange
Commission upon request.
EXHIBIT 10.1 Lease and Land Disposition Agreement, dated as of September 14, 1984, between
Shearson Lehman Construction Inc. and The City of New York (incorporated by
reference to Exhibit 10.16 of the Registrant's Registration Statement on Form
S-1 (Reg. No. 33-12976)).
EXHIBIT 10.2 Form of Agreement of Tenants-In-Common by and among American Express Company,
American Express Bank Ltd., American Express Travel Related Services Company,
Inc., Shearson Lehman Brothers Inc., Shearson Lehman Government Securities,
Inc. and Shearson Lehman Commercial Paper Incorporated (incorporated by
reference to Exhibit 10.17 of the Registrant's Registration Statement on Form
S-1 (Reg. No. 33-12976)).
EXHIBIT 10.3 Stock Purchase Agreement, dated as of June 28, 1991, by and among National
Express Company, Inc., The Balcor Company, Shearson Lehman Brothers Holdings
Inc. and Shearson Lehman Brothers Inc. (incorporated by reference to Exhibit
10.4 of the Registrant's Annual Report on Form 10-K for the year ended
December 31, 1991).
EXHIBIT 10.4 Stock Purchase Agreement, dated as of September 14, 1992, by and between
Mellon Bank Corporation and Shearson Lehman Brothers Inc. (incorporated by
reference to Exhibit 10.15 of Shearson Lehman Brothers Holdings Inc. Annual
Report on Form 10-K for the year ended December 31, 1992).
EXHIBIT 10.5 Asset Purchase Agreement, dated as of March 12, 1993, by and among Primerica
Corporation, Smith Barney, Harris Upham & Co. Incorporated and Shearson
Lehman Brothers Inc. (incorporated by reference to Exhibit 10.16 of Shearson
Lehman Brothers Holdings Inc. Annual Report on Form 10-K for the year ended
December 31, 1992).
EXHIBIT 12 Computation in support of ratio of earnings to fixed charges.*
EXHIBIT 21 Pursuant to General Instruction J of Form 10-K, the list of the Registrant's
subsidiaries is omitted.
EXHIBIT 23 Consent of Ernst & Young.*
EXHIBIT 24 Powers of Attorney.*
</TABLE>
- ---------------
* Filed herewith.
<PAGE> 1
EXHIBIT XII
LEHMAN BROTHERS INC. AND SUBSIDIARIES
COMPUTATION IN SUPPORT OF RATIO OF EARNINGS TO FIXED CHARGES
(DOLLARS IN MILLIONS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------
1989 1990 1991 1992 1993
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Fixed charges:
Interest Expense:
Subordinated indebtedness................ $ 341 $ 277 $ 231 $ 210 $ 192
Bank loans and other borrowings*......... 4,325 3,753 4,068 4,363 4,393
Interest component of rentals of office
and equipment.......................... 63 57 64 64 62
Other adjustments**......................... 152 73 88 127 101
------ ------ ------ ------ ------
Total(A)............................ $4,881 $4,160 $4,451 $4,764 $4,748
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Earnings:
Pretax (loss) income from continuing
operations............................... $ 202 $ (501) $ 283 $ 319 $ (146)
Fixed charges............................... 4,881 4,160 4,451 4,764 4,748
Other adjustments***........................ (95) (68) (69) (68) (68)
------ ------ ------ ------ ------
Total(B)............................ $4,988 $3,591 $4,665 $5,015 $4,534
------ ------ ------ ------ ------
------ ------ ------ ------ ------
(B/A)......................................... 1.02 **** 1.05 1.05 ****
</TABLE>
- ---------------
* Includes amortization of long-term debt discount.
** Other adjustments include capitalized interest costs and amortization of
capitalized interest and preferred stock dividends of a wholly owned
subsidiary.
*** Other adjustments include adding the net loss of affiliates accounted for
at equity whose debt is not guaranteed by the Company and subtracting
capitalized interest costs and undistributed net income of affiliates
accounted for at equity and preferred stock dividends of wholly owned
subsidiary.
**** Earnings were inadequate to cover fixed charges and would have had to
increase approximately $569 million in 1990 and $214 million in 1993 in
order to cover the deficiency.
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
and Post-Effective Amendments on Form S-3 (File Nos. 33-51837, 33-2881, 33-9541,
33-4694, 2-95523 and 2-83903) of Lehman Brothers Inc. of our report dated
February 3, 1994, except for Note 2, as to which the date is March 28, 1994,
with respect to the consolidated financial statements and financial statement
schedules of Lehman Brothers Inc. and Subsidiaries included in this Annual
Report (Form 10-K) for the year ended December 31, 1993.
Ernst & Young
New York, New York
March 31, 1994
<PAGE> 1
EXHIBIT 24
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Thomas A. Russo, Michael R. Milversted and Karen
M. Muller and each of them, his true and lawful attorneys-in-fact and agents,
with full power of substitution and resubstitution, for him and in his name,
place and stead, in any and all capacities, to sign the Annual Report on Form
10-K of Lehman Brothers Inc., for the fiscal year ended December 31, 1993 and
any and all amendments thereto, and to file the same, with all exhibits thereto,
and other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, and each of them,
full power and authority to do and perform each and every act and thing
requisite and necessary to be done, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, or their substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Dated: As of March 31, 1994
<TABLE>
<S> <C>
/s/ ROGER S. BERLIND /s/ STEPHEN BIER
- ---------------------------------------- ----------------------------------------
Roger S. Berlind Stephen Bier
Director Principal Accounting Officer
/s/ PHILIP CALDWELL /s/ RICHARD S. FULD, JR.
- ---------------------------------------- ----------------------------------------
Philip Caldwell Richard S. Fuld, Jr.
Director Chief Executive Officer,
President and Director
/s/ HARVEY GOLUB /s/ JOHN R. LAIRD
- ---------------------------------------- ----------------------------------------
Harvey Golub John R. Laird
Director Director
/s/ SHERMAN R. LEWIS, JR. /s/ DAVID MARCUS
- ---------------------------------------- ----------------------------------------
Sherman R. Lewis, Jr. David Marcus
Director Director
/s/ ROBERT MATZA /s/ MALCOLM WILSON
- ---------------------------------------- ----------------------------------------
Robert Matza Malcolm Wilson
Chief Financial Officer Director
Director
</TABLE>
