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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[_] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM JANUARY 1, 1994 TO NOVEMBER 30, 1994
COMMISSION FILE NUMBER 1-6817
LEHMAN BROTHERS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 13-2518466
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
3 WORLD FINANCIAL CENTER 10285
(ZIP CODE)
NEW YORK, NEW YORK
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 526-7000
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 Notes Due 1996 New York Stock Exchange
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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 ((S)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, 1,006 shares of the
registrant's Common Stock, $.10 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 DEVELOPMENT OF BUSINESS
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 the "Company" or "Lehman
Brothers". 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."
The Company is one of the leading global investment banks serving
institutional, corporate, government and high net worth individual clients and
customers. Its executive offices are located at 3 World Financial Center, New
York, New York 10285 and its telephone number is (212) 526-7000.
Spin-off of Holdings from American Express
Prior to May 31, 1994, the American Express Company ("American Express")
owned 100% of Holdings' common stock (the "Common Stock"), which represented
approximately 93% of Holdings' voting stock. On May 31, 1994, American Express
issued a special dividend to its common shareholders consisting of all of the
Common Stock it then held (the "Distribution") and Holdings became a widely-
held public company with its Common Stock traded on the New York Stock
Exchange. Prior to the Distribution, an additional equity investment of
approximately $1.25 billion was made in Holdings, primarily from American
Express.
Change of Fiscal Year
Effective as of the Distribution, the Company's fiscal year end was changed
from December 31 to November 30. Such a change to a non-calendar cycle shifted
certain year-end administrative activities to a time period that conflicts less
with the business needs of the Company's institutional customers.
Ongoing Cost Reduction Program
The Company is committed to expense reduction efforts and the ongoing review
of its expense structure. Throughout 1994, Holdings and the Company took
actions to reduce both personnel and non-personnel related expenses. Since the
number of employees at the Company directly affects these expenses, reducing
headcount was a major initiative of the cost reduction program. During 1994,
the Company's total number of employees was reduced from approximately 7,500 in
early 1994 to approximately 6,950 at fiscal year-end in November. As part of
this process, the Company recorded a $27 million pre-tax severance charge in
the first quarter of 1994. A separate and comprehensive effort focused on non-
personnel expenses. This process is expected to continue throughout 1995.
LEHMAN BROTHERS
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 additional locations in the United States, Europe, the Middle East,
Latin and South America and 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
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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 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 financial services industry.
Lehman Brothers' strategy 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 which 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.
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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 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.
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 in major locations around the world. Institutional Sales
focuses on the large 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 425 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.
Through Lehman Brothers Bank (Switzerland) S.A. (the "Bank"), 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. 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.
The Equities product group is responsible for the Company's equity operations
and all dollar and non-dollar equity and equity-related products worldwide.
These products include listed and over-the-counter ("OTC") securities, American
Depository Receipts, convertibles, options, warrants and derivatives.
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, warrants
and similar products. In 1994, Lehman Brothers marketed several innovative
products designed to help investors establish or hedge positions in individual
stocks or groups of stocks, including yield enhanced equity linked debt
securities ("YEELDSSM") and stock upside note securities ("SUNSSM").
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 more than 50 industry sectors and 1,000 companies worldwide.
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.
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;
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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 38
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 engages in the underwriting and
market making of fixed and floating dollar investment grade debt. The Company
also underwrites and makes markets in non-investment grade debt securities and
bank loans.
Mortgage and Asset-Backed Securities. The Company is a leading underwriter of
and market maker in mortgage and asset-backed securities.
Emerging Market Securities. The Company is active in the trading, structuring
and underwriting of Latin American, Eastern European, and Asian dollar and
local currency instruments.
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.
Derivative Products. The Company offers a broad range of fixed income
derivative product services. Derivatives professionals are integrated into all
of the Company's major fixed income product areas.
In addition, on December 3, 1993, Lehman Brothers incorporated Lehman
Brothers Financial Products Inc. ("LBFP"), a separately capitalized, triple-A
rated derivatives subsidiary, which commenced trading with counterparties in
July 1994.
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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.
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.
Fixed Income research specialists from the Company and its affiliates are based
in New York, London, Tokyo and Hong Kong. Their expertise includes U.S.
government and agency securities, sovereign and supranational issues, corporate
securities, high yield, asset and mortgage-backed securities and emerging
market debt.
Foreign Exchange
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, Hong Kong and Singapore, engage in
trading activities in all major currencies and maintains a 24-hour foreign
exchange market making capability for clients and customers worldwide. 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.
Asset Management
Lehman Brothers Global Asset Management Inc. ("LBGAM"), a subsidiary of
Holdings, 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.
Merchant Banking Fund Management
Since 1989, Holdings' principal method of making merchant banking investments
had been through a series of partnerships (the "1989 Partnerships"), for which
subsidiaries of Holdings and the Company 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, 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.
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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, 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 several new merchant banking opportunities which will be
targeted towards specific types of investments and specific geographical areas
within the world's emerging markets.
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. 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., fixed income, 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 and its affiliates acquired sophisticated data
processing and telecommunications equipment 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 in major cities 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 other 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 more effectively develop 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 Corporate Management
Committee (the "CMC"), which consists of the Chief Executive Officer, the
President and Chief Operating Officer, the Chief Administrative Officer, the
Chief Financial Officer and the Chief Legal Officer performs broad, policy
making functions. Complementing the CMC is the Operating Committee comprised of
representatives from every major area of the organization, including the senior
managers from the Company's operations in the European and Asia Pacific
regions. This structure promotes communication and cooperation, enabling Lehman
Brothers to rapidly identify and address 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,
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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-tier 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 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' exposure to credit risks in its trading activities arise
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
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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 has 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 works 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 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 November 30, 1994, the
Company's Non-Core Assets decreased from $1.1 billion in 1990 to approximately
$103 million in 1994. The value of the Company's Non-Core Assets includes
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.
TRANSACTION SUPPORT SERVICES AGREEMENTS
Following the sale on July 31, 1993 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) and
its subsidiary Smith Barney, Harris Upham & Co. Incorporated ("Smith Barney"),
the Company entered into a clearing agreement (the "Clearing Agreement"), under
which Smith Barney carried and cleared, on a fully disclosed basis, all
accounts introduced to it by Lehman Brothers, and performed all clearing and
settlement functions for equities, municipal securities and corporate debt
securities. This agreement expired on December 31, 1994, but was extended until
February 17, 1995. On October 12, 1994, the Company and Bear Stearns Securities
Corp. ("BSSC") entered into an agreement pursuant to which BSSC has agreed to
process the transactions currently cleared by Smith Barney (the "BSSC
Agreement"). As a result, the Company will now be self-clearing, and the
accounts currently carried by Smith Barney will be carried on the Company's
books. The BSSC Agreement will take effect On February 17, 1995 and will run
for a term of five years.
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
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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 undertake 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 believes that it is in material compliance with regulations
described herein.
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.
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
Rule 15c3-1 (the "Net Capital Rule") promulgated under the Securities Exchange
Act of 1934, as amended (the "Exchange Act"). The Net Capital Rule requires LBI
and LGSI to maintain net capital of not less than 2% of aggregate debit items
arising from customer transactions, as defined, or 4% of funds required to be
segregated for customers' regulated commodity accounts, as defined.
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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 9 of Notes to
Consolidated Financial Statements.
EMPLOYEES
As of November 30, 1994 the Company employed approximately 6,950 persons. The
Company considers its relationship with its employees to be good.
ITEM 2. PROPERTIES
The Company's headquarters occupy approximately 1,147,000 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 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 is used by systems, operations, and
certain administrative personnel and contains certain back-up trading systems.
The lease term is approximately 16 years and commenced in August 1994.
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 consolidated
financial condition of the Company.
Bamaodah v. E.F. Hutton & Company Inc.
In April 1986, Ahmed and Saleh Bamaodah commenced an action against E.F.
Hutton & Company Inc., ("EFH") to recover all losses the Bamaodahs had incurred
since May 1981 in the trading of commodity
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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. On April 26,
1994, the Dubai Court of Appeals again affirmed the judgment of the Dubai Civil
Court. The Company appealed the judgment to the Court of Cassation, which
reversed the Court of Appeals on November 27, 1994 and ordered that a new
expert be appointed to review the case.
Glynwill Investment, Ltd. v. Shearson Lehman Brothers Inc.
Glynwill Investment, Ltd. ("Glynwill"), a corporation chartered in Curacao,
N.A., commenced an action against Lehman Brothers "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 EFH in overcharging Glynwill for foreign exchange transactions executed
for Glynwill. The New York Court, on Lehman Brothers' 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 Shearson Lehman Brothers' motion. After extensive discovery, Lehman
Brothers' motion for summary judgment was granted on October 26, 1994. Glynwill
has filed an appeal which will be heard during the March, 1995 term of the
Appellate Division, First Department.
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
First Capital Holdings Inc. ("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 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, Lehman Brothers and American
Express as defendants (individually or collectively, as the case may be, the
"American Express Defendants").
Under the terms of an agreement between American Express and Holdings,
Holdings has agreed to indemnify American Express for liabilities which it may
incur in connection with any action (including any derivative action) relating
to FCH. In connection therewith, Holdings' indemnification obligation extends
to the below described actions.
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
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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 present 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
Complaint") was filed on behalf of the Shareholder Class and the Agent Class.
The Third Complaint names as defendants American Express, Holdings, Lehman
Brothers, 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.
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.
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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 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 Lehman Brothers; and breach of contract against Lehman Brothers. Also named
as defendants are the Outside Directors, the Former Outside Directors,
Weingarten and Ginsberg. Holdings and Lehman Brothers have answered this
complaint, denying the material allegations. A trial of limited issues
specified by the court commenced September 22, 1994.
American Express Derivative Action. On June 6, 1991, a purported shareholder
derivative action was filed in the United States District Court for the Eastern
District of New York, entitled Rosenberg v. Robinson, et al., against all of
the then-current directors of American Express. In January 1992, this action
was transferred by stipulation to the United States District Court for the
Central District of California for coordinated or consolidated proceedings with
all other federal actions related to FCH. The complaint alleges that the Board
of Directors of American Express should have required Holdings to divest its
investment in FCH and to write down such investment sooner. In addition, the
complaint alleges that the failure to act constituted a waste of corporate
assets and caused damage to American Express' reputation. The complaint seeks a
judgment declaring that the directors named as defendants breached their
fiduciary duties and duties of loyalty and requiring the defendants to pay
money damages to American Express, and remit their compensation for the period
in which the duties were breached, to pay attorneys' fees and costs and other
relief. The defendants have answered the complaint, denying its material
allegations.
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 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, Lehman Brothers, Donaldson, Lufkin & Jenrette
Securities Corporation, The First Boston Corporation and Hambrecht & Quist
Incorporated, the Company 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. On July 20, 1993 the
defendants filed a motion to dismiss the complaint. On November 22, 1994, the
Court partially granted the defendants' motion, dismissing every factual
allegation underlying plaintiffs' claims for relief with one exception. Thus
there remains one allegation against all defendants under Section 11 of the
Securities Act. The Court also dismissed plaintiffs'
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claim under Section 12 of the Securities Act and for negligent
misrepresentation against Computervision and its officers and directors, but
did not dismiss these claims against the underwriters.
Easton & Co. v. Mutual Benefit Life Insurance Co., et al.; Easton & Co. v.
Lehman Brothers Inc.
Lehman Brothers 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 II"), 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, 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 Lehman
Brothers, 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. Lehman Brothers
acted as underwriter for this bond issue, which was in the aggregate principal
amount of $18.7 million. The complaint alleges that Lehman Brothers 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 Lehman Brothers
and the other defendants.
Easton II was commenced on or about May 18, 1992, and names Lehman Brothers
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 Lehman Brothers during the period April 19, 1991 through July 16, 1991.
The complaint alleges that Lehman Brothers 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 N.J. 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' and the Company's 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.
On LBIE's motion, the case was remanded back to the Court.
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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 relief virtually identical to that sought in the
Berlitz action, described above. Specifically, Macmillan sought a declaration
that it is the legal and beneficial owner of the disputed 10.6 million shares
of Berlitz common stock, including the 1.9 million shares then held by PLC.
After a trial, on December 10, 1993, the High Court of Justice handed down a
judgment finding for the Company on all aspect of its defense and dismissing
Macmillan's claims. On April 12, 1994, Macmillan appealed such judgment.
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 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 (Pounds)100 million. BIM also commenced certain
proceedings for summary disposition of its claims relating to certain of the
securities with a value of approximately (Pounds)30 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. On
February 10, 1995, the parties agreed to settle all remaining claims, subject
to the execution of formal settlement documents.
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. An amended complaint was
filed on December 15, 1994. The amended complaint names LBI and two former EFH
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 nine EFH net lease real estate limited
partnerships. Plaintiffs seek: (i) to certify a class of all persons who
purchased limited partnership interests in the nine partnerships at issue, (ii)
unspecified damages (plaintiffs claim that class members invested approximately
$224 million including interest on installment payments), plus interest or
rescission, (iii) treble damages, (iv) punitive damages and (v) accounting and
attorneys' fees. The Company believes it has several meritorious defenses and
intends to vigorously defend this case.
Lehman Brothers Commercial Corporation and Lehman Brothers Special Financing
Inc. v. China International United Petroleum and Chemical Co., Ltd.
On November 15, 1994, Lehman Brothers Commercial Corporation ("LBCC"), a
Holdings subsidiary, and Lehman Brothers Special Financing Inc. ("LBSF"), an
LBI subsidiary, commenced an action against China International United
Petroleum and Chemicals Company ("Unipec") in the United States District Court
for the Southern District of New York alleging breach of contract. The
litigation arose from the refusal by Unipec to honor its obligations with
respect to certain foreign exchange and swap transactions. LBCC and LBSF seek
to recover approximately $44 million from Unipec. The defendant has not yet
responded to the complaint. LBCC and LBSF intend to vigorously prosecute this
action.
Lehman Brothers Commercial Corporation and Lehman Brothers Special Financing
Inc. v. Minmetals International Non-Ferrous Metals Trading Company
On November 15, 1994, LBCC and LBSF commenced an action against Minmetals
International Non-Ferrous Metals Trading Company ("Minmetals") and China
National Metals and Minerals Import and Export Company ("CNM") in the United
States District Court for the Southern District of New York alleging breach of
contract against Minmetals and breach of guarantee against CNM. The litigation
arose
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from the refusal by Minmetals and CNM to honor their obligations with respect
to certain foreign exchange and swap transactions. LBCC and LBSF seek to
recover approximately $53.5 million from Minmetals and/or CNM. The defendants
have not yet responded to the complaint. LBCC and LBSF intend to vigorously
prosecute this action.
In re Tiphook Securities Litigation
On or about January 25, 1994, LBI was served with an Amended Complaint in an
action captioned In re Tiphook Securities Litigation. The Amended Complaint
purportedly is brought on behalf of all purchasers of American Depository
Receipts of Tiphook, PLC ("Tiphook") and all purchasers of various Tiphook debt
securities issued in offerings on November 2, 1992, March 8, 1993 and April 23,
1993, during the alleged class period of October 8, 1992 through November 15,
1993. The action is pending in the United States District Court for the
District of New Jersey. Also named as defendants are Tiphook, Tiphook Finance
and various officers and directors of Tiphook. The Amended Complaint alleges
violations of Sections 11 and 15 of the Securities Act of 1933, as amended, by
Lehman Brothers and the three other underwriters of the Tiphook note offerings.
Such claims are based on alleged misstatements and omissions in the
prospectuses for such note offerings. The plaintiffs seek an unspecified amount
of damages resulting from the alleged misstatements and omissions. Lehman
Brothers answered the Amended Complaint, denying its material allegations. In
December, 1994, all defendants came to an agreement in principle which must be
embodied in a formal settlement agreement and is subject to the final approval
of the Court.
Actions Relating to National Association of Securities Dealers Automated
Quotations System ("NASDAQ") Market Maker Antitrust and Securities Litigation.
Beginning in May, 1994, several class actions were filed in various state and
federal courts against various broker-dealers making markets in NASDAQ
securities. With respect to a number of those actions LBI was either
specifically named as a defendant or was not specifically named as a defendant
but could be deemed to be a member of the defendant class as defined in the
complaints. Plaintiffs in these cases have alleged violations of the antitrust
laws, securities laws and have pled a variety of other statutory and common law
claims. All of these actions are based on the theory that because odd-eighth
quotes occur less often than quarter quotes, NASDAQ market makers must be
colluding wrongfully to maintain a wider spread.
By Order filed October 14, 1994, the Judicial Panel on Multidistrict
Litigation consolidated these actions in the Southern District of New York and
ordered that all related actions be transferred and coordinated for all
pretrial purposes. The case is captioned In Re NASDAQ Market-Makers Antitrust
Litigation, MDL No. 1023.
On December 16, 1994, plaintiffs served a consolidated Amended Complaint
naming 33 defendants including LBI. Plaintiffs claim violations of the federal
antitrust laws including Section 1 of the Sherman Antitrust Act. Plaintiffs
seek unspecified compensatory damages trebled in accordance with the antitrust
laws, costs including attorneys' fees as well as injunctive relief. The
defendants have not yet responded to the complaint. At this time, it is
premature to express an opinion as to the ultimate outcome of these actions,
although LBI believes that it has meritorious defenses to these claims, which
it intends to pursue vigorously.
State Court Action. On or about May 27, 1994, a class action entitled Abel et
al. v. Merrill Lynch et al. was instituted in the Superior Court of the State
of California, County of San Diego. This complaint was filed on behalf of all
residents of California who, within the last four years, purchased or sold any
security listed on the NASDAQ. The complaint specifically named 13 broker-
dealers as defendants, including LBI. The complaint generally alleges
violations of the California Business and Professions Code--specifically the
Cartwright Act and the Unfair Competition Act--and seeks treble damages, costs
and attorneys' fees, restitution, and injunctive relief. On consent of all
parties and the Court, the response date has been extended to April 3, 1995.
18
<PAGE>
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.
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.
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
Set forth on the following pages is Management's Discussion and Analysis of
Financial Condition and Results of Operations for the eleven months ended
November 30, 1994 and the twelve months ended December 31, 1993 and 1992.
BUSINESS ENVIRONMENT
The principal business activities of Lehman Brothers Inc., a registered
broker-dealer ("LBI") and subsidiaries (collectively, the "Company" or "Lehman
Brothers") are investment banking and securities trading and sales, which by
their nature are subject to volatility and cyclicality, 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 period to period. LBI is a
wholly owned subsidiary of Holdings.
In February of 1994, inflationary concerns prompted the U.S. Federal Reserve
Bank to raise interest rates in the first of six such actions over the course
of the year. These actions resulted in an increase in the absolute level of
interest rates and a general contraction in the differentials between short-
and long-term interest rates in 1994.
Uncertainties over the direction of interest rates and the shape of the yield
curve had a detrimental effect on the volume of debt and equity offerings in
the U.S. markets, with lead-managed domestic underwritings falling a total of
32 percent for the industry as a whole in 1994 when compared to 1993 levels.
Interest rate concerns also had a negative effect on the levels and relative
profitability of customer activity, as investors focused on shorter duration
products that were inherently less profitable. Volatility in the U.S. fixed
income markets extended into other markets, affecting the levels of interest
rates in Europe and decreasing liquidity in the equity market.
Increasing interest rates had a negative impact on the industry's costs to
finance securities inventory positions as well as on the valuations of various
types of fixed income securities, affecting the levels of net interest and
principal transactions revenue.
During 1994, the derivatives business became a focal point of media,
congressional and judicial scrutiny. New legal and regulatory proposals, as
well as several highly publicized court actions created uncertainty in the
derivatives market, which particularly affected end user volumes.
In late 1994, the Mexican government's unexpected devaluation of the peso
caused a rapid decline in the value of that country's currency as well as the
prices on various debt and equity securities. This action provoked a liquidity
crisis in Mexico as certain investors withdrew from that market. A financial
aid package, totaling approximately $50 billion, provided by the U.S., the
International Monetary Fund and the Bank for International Settlement appears
to have stabilized the Mexican markets. However, the circumstances in Mexico
could result in increased volatility and decreased liquidity in emerging
markets over the near term as investors react more cautiously to political and
economic events.
Although market conditions were difficult throughout 1994, the environment
for merger and acquisition activity was extremely positive. Driving this trend
was a wave of consolidations in various industries coupled with multinational
corporations completing strategic acquisitions both domestically and abroad to
strengthen competitive positions worldwide. This trend has continued into 1995.
19
<PAGE>
During 1993, the Company's operating results were achieved in a more
favorable environment which was characterized by declining interest rates,
record levels of debt and equity issuances and significant growth in many
emerging market economies, particularly in Asia and Latin America. The 1993
environment resulted in record operating profits for companies in the
securities industry.
The adverse market conditions experienced during 1994 have continued into
1995. Any further increases in U.S. interest rates could exert pressures on the
Company's business.
RESULTS OF OPERATIONS
HOLDINGS' SPIN-OFF FROM AMERICAN EXPRESS
On May 31, 1994 all of the shares of common stock of Holdings were
distributed (the "Distribution") to American Express common shareholders of
record on May 20, 1994, as a result of a special dividend declared on April 29,
1994 by the Board of Directors of American Express. Prior to the Distribution,
an additional equity investment of approximately $1.25 billion was made in
Holdings, primarily from American Express. As a result of the Distribution,
Holdings became a widely held public corporation with its common stock traded
on the New York Stock Exchange.
CHANGE IN YEAR-END
Effective with the Distribution, the Company and Holdings changed their year-
end from December 31 to November 30, in order to shift certain year-end
administrative activities to a time period that conflicts less with the
business needs of the Company's institutional customers. As a result of the
change in the Company's year-end, it is reporting its 1994 financial statements
on the basis of an eleven month transition period ended November 30, 1994 (the
"1994 Fiscal Year"). Due to the eleven month reporting period for 1994, the
Company's 1994 results of operations are not directly comparable with financial
results of prior years.
BUSINESSES SOLD
The Company completed the sale of three businesses during 1993: The Boston
Company, Shearson, and SLHMC which were completed on May 21, July 31, and
August 31, 1993, respectively. (See Note 17 to the Consolidated Financial
Statements.) The Company's operating results reflect The Boston Company as a
discontinued operation, while the operating results of Shearson and SLHMC are
included in the Company's results from continuing operations for all periods
prior to their sale in 1993. Because of the significant sale transactions
completed during 1993, the Company's historical financial statements are not
fully comparable for all periods presented. To facilitate an understanding of
the Company's results, the following table and discussions segregate the
Company's results into three sections.
. Historical Results: the results of the businesses that now comprise
Lehman Brothers; the results of Shearson and SLHMC through their
respective sale dates; the loss on the sale of Shearson; the reserves for
non-core businesses; and the results of The Boston Company (accounted for
as a discontinued operation).
. The Lehman Businesses: the results of the businesses that now comprise
Lehman Brothers.
. 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.
20
<PAGE>
HISTORICAL RESULTS (CONTINUING, SOLD AND DISCONTINUED BUSINESSES)
FOR THE ELEVEN MONTHS ENDED NOVEMBER 30, 1994 AND EACH OF THE
YEARS ENDED DECEMBER 31, 1993 AND 1992
<TABLE>
<CAPTION>
ELEVEN MONTHS TWELVE MONTHS
ENDED ENDED
NOVEMBER 30, DECEMBER 31,
------------- --------------
1994 1993 1992
------------- ------ ------
<S> <C> <C> <C>
Net revenues..................................... $1,969 $4,425 $5,010
Total non-interest expenses...................... 1,968 4,571 4,691
------ ------ ------
Income (loss) from continuing operations before
taxes........................................... 1 (146) 319
Provision for (benefit from) income taxes........ (33) 234 147
------ ------ ------
Income (loss) from continuing operations......... 34 (380) 172
Income from discontinued operations, net of
taxes........................................... 189 77
------ ------ ------
Income (loss) before cumulative effect of changes
in accounting principles and preferred dividend
of subsidiary................................... 34 (191) 249
Cumulative effect of changes in accounting
principles, net of taxes........................ (13) (8)
Preferred dividend of subsidiary................. (50) (68) (68)
------ ------ ------
Net income (loss)................................ $ (29) $ (259) $ 173
====== ====== ======
</TABLE>
Net revenues were $1,969 million for the 1994 Fiscal Year, $4,425 million and
$5,010 million for the years ended December 31, 1993 and 1992, respectively.
Net revenues in 1994 were reduced from the prior year due to lower levels of
trading and underwriting revenues for the Lehman Businesses in 1994 due to
unfavorable market conditions and the elimination of revenues from Businesses
Sold during 1993. Net revenues decreased 12% to $4,425 million in 1993 from
$5,010 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.
Non-interest expenses were $1,968 million for the 1994 Fiscal Year, $4,571
million and $4,691 million for the years ended December 31, 1993 and 1992,
respectively. Non-interest expenses in 1994 included a $27 million severance
charge. Non-interest expenses decreased 3% to $4,571 million in 1993 from
$4,691 million in 1992, due to the sale of Shearson and SLHMC.
The Company reported a net loss of $29 million and $259 million for the 1994
Fiscal Year and the year ended December 31, 1993, respectively, and net income
of $173 million for the year ended December 31, 1992. The 1994 results included
a $13 million aftertax charge for the cumulative effect of a change in
accounting for postemployment benefits as a result of the adoption of Statement
of Financial Accounting Standards ("SFAS") No. 112, and a $15 million aftertax
severance charge. The 1993 net loss of $259 million was comprised of net income
from the Lehman Businesses of $198 million, net income of $189 million from the
discontinued operations of The Boston Company, including an aftertax gain of
$165 million on the sale and aftertax earnings of $24 million, and a net loss
from the Businesses Sold of $646 million, which included an aftertax loss on
the sale of Shearson of $630 million ($535 million pretax), an aftertax charge
of $79 million ($120 million pretax) related to a reserve for non-core
businesses recognized in anticipation of the sale of SLHMC, and operating
earnings from Shearson of $63 million. The 1992 net income of $173 million
included a $22 million ($33 million pretax) 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.
21
<PAGE>
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.
<TABLE>
<CAPTION>
ELEVEN
MONTHS ENDED TWELVE MONTHS ENDED DECEMBER 31,
NOVEMBER 30, -----------------------------------------------------------------
1994 1993 1992
------------ -------------------------------- --------------------------------
LEHMAN LEHMAN BUSINESSES LEHMAN BUSINESSES
BUSINESSES BUSINESSES SOLD HISTORICAL BUSINESSES SOLD HISTORICAL
------------ ---------- ---------- ---------- ---------- ---------- ----------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Principal transactions.. $ 732 $1,132 $ 323 $ 997 $ 575
Investment banking...... 399 624 170 502 218
Commissions............. 391 437 828 410 1,231
Interest and dividends.. 6,235 4,868 161 4,717 257
Other................... 57 55 412 57 619
------ ------ ------ ------ ------
Total revenues...... 7,814 7,116 1,894 6,683 2,900
Interest expense........ 5,845 4,442 143 4,316 257
------ ------ ------ ------ ------
Net revenues........ 1,969 2,674 1,751 $4,425 2,367 2,643 $5,010
------ ------ ------ ------ ------ ------ ------
Non-interest expenses:
Compensation and
benefits............. 1,004 1,400 1,164 1,223 1,759
Other expenses........ 937 861 470 932 777
Loss on sale of
Shearson............. 535
Reserves and other
charges.............. 27 21 120
------ ------ ------ ------ ------
Total non-interest
expenses........... 1,968 2,282 2,289 4,571 2,155 2,536 4,691
------ ------ ------ ------ ------ ------ ------
Income (loss) from
continuing operations
before taxes,
cumulative effect of
changes in accounting
principles and
preferred dividend of
subsidiary............. 1 392 (538) (146) 212 107 319
Provision for (benefit
from) income taxes..... (33) 126 108 234 92 55 147
------ ------ ------ ------ ------ ------ ------
Income (loss) from
continuing operations
before cumulative
effect of changes in
accounting principles
and preferred dividend
of subsidiary.......... $ 34 $ 266 $ (646) $ (380) $ 120 $ 52 $ 172
====== ====== ====== ====== ====== ====== ======
</TABLE>
22
<PAGE>
THE LEHMAN BUSINESSES
FOR THE ELEVEN MONTHS ENDED NOVEMBER 30, 1994
AND YEAR ENDED DECEMBER 31, 1993
Summary. Net income from continuing operations was $34 million for the 1994
Fiscal Year and $266 million for the year ended December 31, 1993. Included
within the 1994 results was a $15 million ($27 million pretax) severance charge
recorded in the first quarter of 1994 related to the Company's ongoing review
of its personnel needs ("Severance Charge"). The 1993 results consisted of $280
million of income from the continuing businesses decreased by a $14 million
reserve ($21 million pretax) for certain non-core partnership syndication
activities in which the Company is no longer actively engaged. Including the
effect of a $13 million ($23 million pretax) charge for the cumulative effect
of a change in accounting for postemployment benefits and the preferred
dividend of subsidiary, the Lehman Businesses reported a net loss of $29
million for the 1994 Fiscal Year. Including the preferred dividend of a
subsidiary, net income for the Lehman Businesses was $198 million for the year
ended December 31, 1993.
In the fourth quarter of 1994, the $750 million preferred stock of subsidiary
was canceled along with the $750 million note receivable related to the Series
A preferred stock issuance. (See Note 16 to the Consolidated Financial
Statements).
Net Revenues. Net revenues were $1,969 million for the 1994 Fiscal Year and
$2,674 million for the year ended December 31, 1993. Net revenue levels in 1994
were adversely affected by significantly reduced underwriting volumes and a
less favorable mix of investor activity, due to increasing interest rates and
volatile equity markets as compared with the prior year. Principal transaction
revenues declined to $732 million for the 1994 Fiscal Year as improved
profitability from the derivatives product business was insufficient to offset
broad based declines across the fixed income, equity, foreign exchange and
commodities businesses. Investment banking revenues in the 1994 Fiscal Year
decreased to $399 million as significantly reduced underwriting revenues in
both fixed income and equities more than overshadowed strong gains in strategic
advisory activities. Commission revenues in 1994 decreased to $391 million due
to the Company's lower market volumes of customer activity in listed
securities. Net interest and dividend income declined to $390 million for the
1994 Fiscal Year primarily due to reduced spreads in fixed income products and
overall increased funding costs as a result of the higher interest rate
environment.
The economic environment in 1993 resulted in a record year for Lehman
Brothers as well as the United States securities industry, which benefited from
historically low interest rates, record volumes of new stock and bond issues,
and the continued restructuring of corporate balance sheets.
Principal Transactions. Principal transactions revenues include the results
of the Company's market making and trading related to customer flow activities,
as well as proprietary trading for the Company's own account (on a combined
basis, "Trading Activities").
Since 1990, Lehman Brothers has focused on a "client/customer-driven"
strategy. Under this strategy, Lehman Brothers concentrates on serving the
needs of major issuing and advisory clients and investing worldwide to build an
increasing "flow" of business that leverages the Company's research,
underwriting and distribution capabilities. 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. Customer flow continues to be the primary source of the
Company's principal transactions revenues.
In addition to its customer flow activities, the Company also takes
proprietary positions based upon expected movements in interest rate, foreign
exchange, equity and commodity markets in both the short- and long-term. The
Company's success in this area is dependent upon its ability to anticipate
economic and
23
<PAGE>
market trends and to develop trading strategies that capitalize on these
anticipated changes. These activities accounted for approximately 6% of net
revenues in 1994.
As part of its market-making activities, the Company maintains inventory
positions of varying amounts across a broad range of financial instruments
which are marked-to-market on a daily basis, along with the Company's
proprietary trading positions, and give rise to principal transactions
revenues. The Company utilizes various hedging strategies to minimize its
exposure to significant movements in interest and foreign exchange rates and
the equity markets.
The following discussion provides an analysis of the Company's Trading
Activities based upon the various product groups which generated these
revenues.
PRINCIPAL TRANSACTIONS REVENUES
<TABLE>
<CAPTION>
ELEVEN MONTHS TWELVE MONTHS
ENDED ENDED
NOVEMBER 30, DECEMBER 31,
------------- --------------
1994 1993 1992
------------- ------- ------
(IN MILLIONS)
<S> <C> <C> <C>
Fixed income....................................... $224 $ 498 $ 614
Equity............................................. 92 299 232
Derivative products................................ 366 233 80
Foreign exchange and commodities................... 50 102 71
---- ------- -----
$732 $ 1,132 $ 997
==== ======= =====
</TABLE>
Fixed income products consist of government, sovereign and government agency
obligations; money market products; corporate debt securities; mortgage and
asset-backed securities; emerging market securities; municipal and tax-exempt
securities and certain related fixed income derivative products including
options, futures and forwards utilized by the Company in its trading-related
activities, excluding those transactions executed by the Company's fixed income
derivative products business. Lehman Brothers is one of the leading 38 primary
dealers in U.S. government securities. The Company is also a market leader in
market making for a broad range of other fixed income products.
Fixed income revenues were $224 million for the 1994 Fiscal Year and $498
million for the year ended December 31, 1993. Rising interest rates and
inflationary uncertainties had a negative effect on customer activity
throughout 1994 resulting in reduced profitability for most of the fixed income
businesses. In addition, customers concentrated on short-term, high quality
products in the fixed income area which typically provide reduced profit
margins. Broad based declines across certain fixed income businesses were
offset in part by stronger 1994 results in governments.
Equity revenues include net gains on market making and trading in listed and
over-the-counter equity securities, American Depository Receipts, convertibles,
options, warrants and other related equity derivatives utilized by the Company
in its trading-related activities. Equity revenues were $92 million for the
1994 Fiscal Year and $299 million for the year ended December 31, 1993. The
decline in equity trading revenue was broad based as revenues were negatively
impacted by increased volatility in the equity markets, outflows of capital
from the equity markets and reduced customer demand as yields on fixed income
securities increased throughout 1994.
Derivative product revenues include net revenues primarily from the trading
and market making activities of the Company's fixed income derivative products
business. The fixed income derivative products business is conducted by the
Company's special purpose subsidiary Lehman Brothers Special Financing, Inc.
and a separately capitalized triple-A rated subsidiary, Lehman Brothers
Financial Products Inc., whose operations commenced in mid-1994. Fixed income
derivatives include swaps (interest and currency), interest rate option
contracts (caps, collars and floors), swap options and similar instruments.
Derivative product
24
<PAGE>
revenues were $366 million for the 1994 Fiscal Year and $233 million for the
year ended December 31, 1993. This increase was primarily attributable to
increased Company activity in these markets and increased usage of these
products by the Company's clients and customers. The total notional value of
fixed income derivative products increased by 58% to $427 billion at November
30, 1994 from over $270 billion at December 31, 1993. 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.
Foreign exchange and commodities revenues were $50 million for the 1994
Fiscal Year and $102 million for the year ended December 31, 1993. Foreign
exchange revenues of $46 million and $81 million for the 1994 Fiscal Year and
for the year ended December 31, 1993, respectively, include revenues derived
from market making and trading in spot and forward foreign exchange contracts,
foreign currency futures contracts and foreign exchange option contracts.
Reduced customer activity due to volatility in worldwide currencies contributed
to decreased 1994 revenue. As a market maker in foreign exchange products, the
Company engages in foreign exchange trading activities in all major currencies
and maintains a 24-hour foreign exchange market making capability for customers
worldwide. The notional/contract value of foreign exchange products
outstanding, including forward commitments to purchase and forward commitments
to sell at November 30, 1994 and December 31, 1993, were $267 billion and $235
billion, respectively. Commodities revenues include revenues derived from the
purchase and sale of metals and other commodity futures contracts. The
notional/contract value related to commodities was $10 billion and $12 billion
at November 30, 1994 and December 31, 1993, respectively.
Investment Banking. Investment banking revenues were $399 million for the
1994 Fiscal Year and $624 million for the year ended December 31, 1993.
Worldwide debt and equity underwriting volumes decreased to $80.6 billion for
the 1994 Fiscal Year from $129.5 billion for the year ended December 31, 1993.
The Company's 1994 results were adversely affected by lower origination volumes
in both equities and fixed income, resulting in underwriting revenues of $224
million for the 1994 Fiscal Year and $489 million for the year ended December
31, 1993. Partially offsetting this decrease were improved results from
strategic advisory activities which increased to $153 million in Fiscal 1994
from $101 million in 1993 due to the increased number of merger and acquisition
transactions. Merchant banking revenues were $12 million for the 1994 Fiscal
Year and $15 million for the year ended December 31, 1993. The Company expects
that merchant banking revenues will increase in 1995 due to the merger of
certain subsidiaries into the Company (see Note 16 to the Consolidated
Financial Statements).
Commissions. Commission revenues were $391 million for the 1994 Fiscal Year
and $437 million for the year ended December 31, 1993. Commission revenues
declined slightly from prior year levels, primarily as the result of the
Company's restructuring of the high net worth brokerage unit and the
corresponding reduction of approximately 100 salespeople. Commission revenues
are generated from the Company's agency activities on behalf of corporations,
institutions and high net worth individuals. The Company's Investment
Representatives averaged $600 thousand in total revenues on an annualized,
weighted average basis for fiscal 1994.
Interest and Dividends. Interest and dividend revenues were $6,235 million
for the 1994 Fiscal Year and $4,868 million for the year ended December 31,
1993. Net interest and dividend income was $390 million for the 1994 Fiscal
Year and $426 million for the year ended December 31, 1993. Net interest and
dividend revenue amounts are closely related to the Company's Trading
Activities. The Company evaluates its trading strategies on an overall
profitability basis which includes both principal transactions revenues and net
interest. Therefore, changes in net interest and dividend revenue from period
to period should not be viewed in isolation but should be viewed in conjunction
with revenues from principal transactions. Net interest and dividend revenue is
impacted by the balance sheet size and mix of assets, the amount and mix of
short- and long-term funding sources, as well as the prevailing level, term
structure and volatility of interest rates. Net interest and dividend revenues
for the current year were adversely affected by reduced spreads on fixed income
products and increased funding costs to the Company as a result of the higher
interest rate environment.
25
<PAGE>
Other Revenues. Other revenues were $57 million for the 1994 Fiscal Year and
$55 million for the year ended December 31, 1993. Other revenues increased, as
increased revenues from a number of sources were only partially offset by a
decrease in asset management and related advisory fees.
Non-interest Expenses. Non-interest expenses were $1,968 million for the 1994
Fiscal Year and $2,282 million for the year ended December 31, 1993.
Compensation and benefits expense was $1,004 million for the 1994 Fiscal Year
and $1,400 million for the year ended December 31, 1993. Compensation and
benefits expense does not include any portion of management fees, which are
separately categorized on the Company's consolidated statement of operations,
related to employee services provided by Holdings. Non-interest expenses in
1994 included a $27 million Severance Charge. Non-interest expenses in 1993
included a $21 million charge related to certain non-core partnership
syndication activities in which the Company is no longer actively engaged.
Excluding these special charges, non-compensation and benefit expenses were
$937 million for the 1994 Fiscal Year and $861 million for the year ended
December 31, 1993.
Cost Reduction Effort. Significant effort was spent during 1994 on reducing
both personnel and nonpersonnel expenses worldwide across all subsidiaries of
Holdings. During 1994, Holdings took actions to reduce its headcount from a
peak of 9,400 employees reached in the first quarter to 8,512 by November 30,
1994. More than 100% of this net reduction has occurred in the United States,
with growth continuing in the non-U.S. businesses. In addition to headcount
reductions, Holdings initiated a number of other cost reduction efforts during
1994 which resulted in Holdings' nonpersonnel costs decreasing in the third and
fourth quarter of 1994 to $298 million, and $287 million, respectively, from a
peak of $305 million in the second quarter of 1994. This represents an
annualized reduction in Holdings' nonpersonnel costs of approximately $70
million from the second quarter to the fourth quarter.
While significant progress has been made thus far in reducing costs, Holdings
will take several additional actions in fiscal 1995. These actions are expected
to lower Holdings' cost structure by $300 million on an annualized basis
(pretax) compared to Holdings' third quarter 1994 expense run rate. The Company
expects that its overall cost structure will be reduced significantly as a
result of Holdings' cost reduction efforts. However, the Company's cost
structure differs from Holdings in that nonpersonnel related expenses are not
readily determinable from the Company's statement of operations, since a
portion of the Company's management fee expense is comprised of charges related
to employee services provided by Holdings and its subsidiaries. In addition,
the Company's management fees are subject to fluctuation due to changes in the
nature and levels of intercompany services provided. Listed below is a summary
of Holdings' cost reduction targets for 1995, which have been categorized into
three areas: personnel costs; nonpersonnel costs; and interest and tax expense.
Personnel reductions made in the fourth quarter of 1994 will result in over
$50 million of the savings on a run rate basis, with additional reductions to
be made in 1995. Further personnel savings will be achieved by completing the
process begun in 1994 to restructure certain businesses, reduce staffing
levels, reduce capacity in businesses which are continuing to experience lower
volume, and restructure and automate certain functions.
Nonpersonnel costs are targeted to be reduced significantly from the third-
quarter run rate, with major reduction efforts underway on a global basis
against all major cost categories. As stated previously, Holdings' nonpersonnel
costs were reduced from $305 million in the second quarter of 1994 to $298
million in the third quarter and $287 million in the fourth quarter. On an
annualized basis, this represents a savings to Holdings of approximately $70
million in total off the second quarter and $44 million off the third quarter
total that Holdings is using as its benchmark. Additional savings of over $100
million on a run rate basis are expected to come from many individual actions
to be taken throughout fiscal 1995.
Interest and taxes are areas which are also expected to provide substantial
cost reductions. Holdings has restructured its debt portfolio, developed
additional secured financing opportunities on a global basis and has
implemented new tax planning strategies. The interest expense and equivalent
tax savings achieved in the fourth quarter by Holdings total approximately $40
million on an annualized basis.
26
<PAGE>
As these reductions in costs will come from many actions and require changes
in the business, the Company expects that they will not be complete until the
end of fiscal 1995.
THE LEHMAN BUSINESSES
FOR THE YEARS ENDED DECEMBER 31, 1993 AND 1992
Summary. For the Lehman Businesses, income from continuing operations was
$266 million in 1993, consisting of $280 million of income from the continuing
businesses and a $14 million reserve ($21 million pretax) for certain non-core
partnership syndication activities in which the Company is no longer actively
engaged. In 1992 income from continuing operations for the Lehman Businesses
was $120 million. The 1992 results include a $22 million aftertax ($33 million
pretax) write-down in the carrying value of certain real estate investments.
Net Revenues. Net revenues increased 13% to $2,674 million in 1993 from
$2,367 million in 1992. Revenues related to principal transactions and
investment banking were the primary sources of the increase.
Principal Transactions. Principal transactions revenues increased 14% to
$1,132 million in 1993 from $997 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 principal transactions
revenues based upon the various product groups which generated these revenues.
Fixed income revenues decreased 19% to $498 million in 1993 from $614 million
in 1992. This decrease was due principally to decreased revenues from mortgage-
related securities and money market instruments.
Equity revenues increased 29% to $299 million in 1993 from $232 million in
1992, primarily as a result of higher revenues from the Company's proprietary
trading activities.
Derivative product revenues increased 191% to $233 million in 1993 from $80
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 trading-related fixed income derivative contracts increased to
over $270 billion from approximately $110 billion at December 31, 1992.
Foreign exchange and commodities revenues increased 44% to $102 million in
1993 from $71 million in 1992. Included in these results were foreign exchange
revenues of $81 million and $63 million for 1993 and 1992, respectively,
reflecting an increase of 29%. Revenues from commodity trading activities
increased to $21 million in 1993 from $8 million in 1992. This increase was 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
$235 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
35% increase in underwriting revenues to $489 million in 1993, as a result of
significantly higher underwriting volumes in both domestic 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.
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.
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.
27
<PAGE>
Non-interest Expense. Non-interest expenses were $2,282 million and $2,155
million for the years ended December 31, 1993 and 1992, respectively.
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. Compensation and benefits expense as a percentage
of net revenues increased to 52.4% in 1993 from 51.7% in 1992.
Excluding compensation and benefits expense, other noninterest expenses
decreased 5% to $882 million in 1993 from $932 million in 1992. Included in the
1993 amount was a charge of $21 million, 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 in the carrying
value of certain real estate investments. Excluding these charges and
compensation and benefits expense, other noninterest expenses declined 4% to
$861 million in 1993 from $899 million
THE LEHMAN BUSINESSES--INCOME TAXES
FOR THE ELEVEN MONTHS ENDED NOVEMBER 30, 1994 AND THE
YEARS ENDED DECEMBER 31, 1993 AND 1992
For the eleven months ended November 30, 1994, the Lehman Businesses had an
income tax benefit of $33 million as compared to an income tax provision of
$126 million for the year ended December 31, 1993. The 1994 benefit reflects an
increase in benefits attributable to income subject to preferential tax
treatment. The 1993 income tax provision consisted of a provision of $133
million for continuing businesses and a tax benefit of $7 million related to
non-core business reserves. The 1993 effective tax rate for the continuing
businesses was 32%, which is less than the statutory U.S. federal income tax
rate primarily 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 had a net deferred tax asset of $14 million at November 30, 1994
as compared to a net deferred tax liability of $36 million at December 31,
1993. The increase in net deferred tax assets is primarily attributable to the
reversal of certain temporary differences.
As of November 30, 1994, the Company had approximately $50 million of tax net
operating losses available to offset future taxable income, the benefits of
which have not yet been reflected in the financial statements.
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.
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 principle, $64 million of which related to discontinued
operations.
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.
28
<PAGE>
Net revenues related to the Businesses Sold were $1,751 million in 1993 and
$2,643 million 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 the 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 aftertax
loss on the sale, Shearson's net income was $63 million in 1993, compared to
$55 million in 1992. Excluding the $79 million aftertax charge discussed above,
SLHMC operations were break-even in 1993, compared to a net loss of $3 million
in 1992.
The 1993 tax provision of $108 million for the 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 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, the tax expense related
principally to the Shearson operations. The effective tax rate for the
Businesses Sold was 51% in 1992, with the excess over the statutory U.S.
federal income tax rate, primarily resulting from state and local taxes and the
nondeductibility of goodwill amortization.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity Management. Due to the nature of the Company's business and the
size of the Company's asset base, funding and liquidity are critical to the
Company's daily activities. As a consequence, the Company has developed certain
funding principles to guide its global funding strategy and to provide
sufficient liquidity and availability of funding sources throughout all market
environments. These funding principles are:
(i) To maintain an appropriate overall capital structure to support the
business activities in which the Company is engaged.
(ii) To maximize the portion of the Company's balance sheet that is
funded through collateralized borrowing sources, and conversely minimize
the use of short-term unsecured financings. Collateralized borrowing
sources include securities and other financial instruments sold but not yet
purchased, securities sold under agreements to repurchase ("repos") and
securities loaned.
Because of their secured nature, repos and other types of collateralized
borrowings are less credit-sensitive and have historically been a more
stable financing source under adverse market conditions. Secured financings
generally provide the Company access to lower cost funding. The Company has
been able to exceed its goal of maintaining repo funding lines of at least
two times actual balance sheet utilization.
(iii) To minimize refunding risk by funding the Company's assets with
liabilities which have maturities similar to the anticipated holding period
of the assets.
(iv) To diversify and expand the Company's borrowing sources to maximize
liquidity and reduce concentration risk. The Company seeks financing from a
global investor base with the goal of broadening the availability of its
funding sources and maintaining funding availability well in excess of
actual utilization.
To reduce liquidity risk, the Company carefully manages its commercial
paper and master note maturities to avoid large refinancings on any one
given day. In addition, the Company limits its exposure to any single
commercial paper investor to avoid concentration risk.
29
<PAGE>
(v) To maintain sufficient liquidity 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 through a combination of collateralized financing sources,
long-term debt and stockholder's equity. To achieve this objective, the
Company's liquidity policies include maintaining sufficient excess
unencumbered securities to use as collateral to obtain secured financing,
if necessary, to meet maturities of short-term unsecured liabilities as
well as current maturities of long-term debt. Also the Company maintains a
sufficient amount of long-term debt and stockholder's equity to enable the
Company to maintain an excess cash position in the event it becomes
necessary to fund on a fully secured basis.
The Company's liquidity contingency plans are continually reviewed and
updated as the Company's asset/liability mix and liquidity requirements change.
The Company believes that all of these liquidity policies position the Company
to meet its liquidity requirements in all periods including those of financial
stress.
Daily Funding Activities. Total assets increased to $79.1 billion at November
30, 1994 from $57.8 billion at December 31, 1993. A substantial portion of this
increase was due to the adoption of FIN No. 39, which restricts the historical
industry practice of offsetting certain receivables and payables. (See Note 10
to the Consolidated Financial Statements.)
The Company's asset base consists primarily of cash and cash equivalents and
assets which can be converted to cash within one year, including securities and
other financial instruments owned, collateralized short-term agreements, and
receivables. At November 30, 1994, these assets comprised approximately 96% 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.
On a daily basis the Company reviews its mix of long- and short-term
borrowings as it relates to maturity matching and the availability of secured
and unsecured financing. Tracking of collateral is done to ensure sufficient
unencumbered collateral. Lastly, the Company periodically tests its secured and
unsecured credit facilities to ensure availability.
Short-Term Secured Funding. As noted above, the Company finances its short-
term assets primarily on a secured basis. At November 30, 1994, 80% of the
Company's securities and other financial instruments owned, securities
purchased under agreements to resell and securities borrowed are financed by
securities sold but not yet purchased and other short-term secured financings.
Short-Term Unsecured 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 totaled $2.3 billion at November 30, 1994, compared to $2.6
billion at December 31, 1993.
The Company's uncommitted lines of credit provide an additional source of
secured and unsecured short-term financing. At November 30, 1994, the Company
had $5.3 billion in uncommitted lines of credit compared to $5.7 billion at
December 31, 1993. Uncommitted lines consist of facilities that the Company has
been advised are available but for which no contractual lending obligation
exists.
Total Capital. Long-term assets are financed with a combination of long-term
debt and stockholder's equity (collectively, "Total Capital"). The Company's
long-term unsecured funding sources are senior notes and subordinated
indebtedness. 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 to reduce its reliance on commercial paper
and short-term debt.
30
<PAGE>
During the 1994 Fiscal Year, the Company issued $1.6 billion in long-term
debt, compared to $722 million in 1993. The Company staggers the maturities of
its long-term debt to minimize refunding risk. At November 30, 1994, the
Company had long-term debt outstanding of $3.4 billion with an average life of
3.5 years, compared to $3.7 billion outstanding at December 31, 1993, with an
average life of 3.1 years. For long-term debt with a maturity of greater than
one year, the Company had $3.2 billion outstanding with an average life of 3.7
years at November 30, 1994, compared to $2.5 billion outstanding with an
average life of 4.3 years at December 31, 1993.
At November 30, 1994, the Company had approximately $525 million available
for the issuance of indebtedness under its shelf registration.
The Company's stockholder's equity has decreased from $2,684 million at
December 31, 1993 to $2,587 million at November 30, 1994 primarily due to the
payment of $536 million to Holdings by the Company, $300 million as a return of
capital and $236 million as dividends, and the fiscal 1994 net loss, partially
offset by an increase in equity of $467 million due to the merger of certain
subsidiaries. During 1994 the Company canceled the preferred stock and the
related note receivable from an affiliate. These cancellations had no impact on
overall equity of the Company or cash flow. (See Note 16 to the Consolidated
Financial Statements.)
Dependence on Credit Ratings. The Company, like other companies in the
securities industry, relies on external sources to finance a significant
portion of its day-to-day operations. Access to the global capital markets for
unsecured financing, such as commercial paper and short-term debt, senior notes
and subordinated indebtedness, is dependent on the Company's short-term and
long-term debt ratings. The current short-term and long-term debt ratings of
the Company are as follows:
<TABLE>
<CAPTION>
LBI
------------
SHORT- LONG-
TERM TERM*
------ -----
<S> <C> <C>
Duff & Phelps................................................ D-1 A-
Fitch Investor Services...................................... F-1 A-
IBCA......................................................... A1 --
Moody's...................................................... P1 A3
S&P.......................................................... A-1 A
Thomson Bank Watch........................................... TBW-1 A-
</TABLE>
- --------
* Relates to subordinated indebtedness only.
On September 21, 1994, Standard & Poor's affirmed the short- and long-term
ratings of the Company. However, in light of weaker market conditions resulting
from interest rate uncertainties and inflationary concerns, S&P has revised the
long-term debt outlook of the Company from stable to negative. Furthermore, S&P
indicated that weak or volatile earnings over the next few quarters could lead
to a rating downgrade.
On February 16, 1995, Moody's Investors Service confirmed the ratings of LBI,
after placing the ratings on review for possible downgrade. They highlighted
the Company's efforts to lower the overall cost structure and diversify
revenues beyond fixed income businesses, enabling the Company to earn more
stable and robust returns over time. The confirmations also reflected the
Company's strategic focus on customer-flow business rather than on more
volatile proprietary position taking and anticipated continuing improvements in
the Company's financial flexibility through further reductions in illiquid
assets.
Other rating agencies either took no action or affirmed the Company's
existing ratings.
End User Activities. The Company enters into a variety of financial and
derivative product 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. In order to modify the interest characteristics of its
long-term debt obligations, the Company enters into interest
31
<PAGE>
rate swaps, caps and swaptions as an end user. 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
November 30, 1994 and December 31, 1993, the notional values of the Company's
interest rate swaps and caps related to its long term debt obligations were
approximately $3.8 billion and $2.7 billion, respectively. Included in these
amounts were approximately $2.3 billion of interest rate swaps and caps,
maturing in fiscal 1995 and fiscal 1997, which serve to reduce the Company's
subordinated fixed rate indebtedness to a lower fixed rate. The Company has
matched substantially all of the maturities of its remaining interest rate
swaps to the terms of its underlying borrowings.
In addition, the Company had $392 million notional value of swaptions
outstanding at November 30, 1994, which, if exercised, would convert $200
million of the Company's floating rate subordinated indebtedness to a fixed
rate. The remaining swaptions, if exercised, would convert a portion of the
Company's subordinated indebtedness from a fixed rate to a floating rate.
Swaptions of $192 million could be exercised in December 1994, and the
remaining swaptions could be exercised in November 1998.
The $3.8 billion of notional amount of interest rate swaps and caps
outstanding as of November 30, 1994, mature as follows (in millions):
<TABLE>
<S> <C>
Year ended November 30, 1995...................................... $1,384
Year ended November 30, 1996...................................... 198
Year ended November 30, 1997...................................... 1,651
Year ended November 30, 1998...................................... 350
Year ended November 30, 1999...................................... 179
December 1, 1999 and thereafter................................... 84
------
$3,846
======
</TABLE>
The effect of interest rate swap and cap agreements was to decrease interest
expense by approximately $40 million, $54 million and $53 million in 1994, 1993
and 1992, respectively. The unrecorded net loss on these agreements at November
30, 1994 was approximately $24 million compared to a net gain of approximately
$55 million at December 31, 1993.
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 subordinated indebtedness to
a lower fixed rate, will lower fiscal 1995 and fiscal 1996 interest expense by
approximately $15 million and $5 million, respectively. The effect of the
remaining interest rate swaps is dependent on the level of interest rates in
the future.
The Company also enters into interest rate swap and cap agreements as an end
user. The Company, as an end user, utilized derivative financial instruments
with an aggregate notional amount of $32.3 billion at November 30, 1994 to
modify the interest rate characteristics of certain assets and liabilities,
which aggregated approximately $83 billion at November 30, 1994. The Company
had unrecognized net losses of approximately $110 million at November 30, 1994
related to these derivative financial instruments which were offset by
unrecognized net gains arising from these assets and liabilities. The total
notional value of these swap and cap agreements had a weighted average maturity
of 1.2 years as of November 30, 1994. The effect of these interest rate swap
and caps was to decrease interest expense by approximately $6 million in the
1994 Fiscal Year.
Capital Adequacy. At November 30, 1994, LBI's net capital, as defined by
regulatory authorities, aggregated $1,338 million and was $1,281 million in
excess of the minimum regulatory requirements. Lehman Government Securities
Inc., a wholly-owned subsidiary of LBI and the Company's primary dealer in U.S.
government securities, had net capital, as defined, which aggregated $575
million and was $556 million in
32
<PAGE>
excess of the minimum requirement. The Company is subject to certain rules and
regulations which limit the amount of capital which can be withdrawn from
regulated entities. In addition, certain instruments governing the indebtedness
of LBI contractually limit its ability to pay dividends. At November 30, 1994,
$1,406 million of net assets of the Company were restricted as to the payment
of dividends. As of November 30, 1994 the Company believes it is in material
compliance with all such regulatory capital requirements.
Cash Flows. Cash and cash equivalents increased $45 million in 1994 to $361
million, as the net cash provided by financing activities, exceeded the net
cash used in operating and investing activities. Net cash used in operating
activities of $2,422 million included income from continuing operations
adjusted for non-cash items of approximately $159 million for the 1994 Fiscal
Year. Net cash provided by financing activities was $2,518 million and net cash
used in investing activities was $51 million.
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.
Incentive Plans. To broaden and increase the level of employee ownership in
Holdings, the Compensation and Benefits Committee of the Board of Directors of
Holdings approved the 1994 Management Ownership Plan (the "1994 Plan") pursuant
to which it awarded, subject to vesting provisions and transfer restrictions,
approximately 5.2 million Restricted Stock Units ("RSUs") to employees of
Holdings and the Company and determined to award approximately 1 million RSUs
to certain officers of Holdings and the Company based on performance goals
during the period June 1, 1994 through December 31, 1994. The RSUs will
comprise part of the bonuses awarded for the 1994 calendar year.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS AND DERIVATIVES
Derivatives are financial instruments, which include swaps, options, futures
and forwards whose value is based upon an underlying asset (e.g., treasury
bond), index (e.g., S&P 500) or reference rate (e.g., LIBOR). A derivative
contract may be traded on an exchange or negotiated in the over-the-counter
markets. Exchange-traded derivatives are standardized and include futures, and
certain option contracts listed on an exchange. Over-the-counter derivative
contracts are individually negotiated between contracting parties and include
forwards, swaps and certain options including caps, collars and floors. The
origination and trading of derivative financial instruments have expanded
significantly over the past decade. Derivative instruments have been utilized
as highly effective tools that enable users to adjust risk profiles, such as
interest rate, currency, or other market risks, or to take proprietary trading
positions. Derivatives provide a cost-effective alternative to assuming market
risks associated with traditional on-balance sheet financial instruments and
commodities.
Users of derivative products are primarily financial intermediaries (U.S. and
foreign banks), securities firms, corporations, governments and their agencies,
finance companies, insurance companies, investment companies and pension funds.
In the normal course of business, the Company enters into derivative
transactions both as a dealer and as an end user. Acting as a dealer, the
Company enters into derivative transactions to satisfy the financial needs of
its clients and to manage the Company's own exposure to market and credit risks
resulting from its proprietary trading activities (collectively, "Trading-
Related Derivative Activities"). As an end user, the Company primarily enters
into interest rate swap and option contracts to
33
<PAGE>
adjust the interest rate nature of its funding sources from fixed to floating
interest rates and vice versa, and to change the index upon which floating
interest rates are based (i.e., Prime to LIBOR) (collectively, "End User
Derivative Activities").
The Company conducts its derivative activities through wholly owned
subsidiaries. The fixed income derivative products business is conducted by the
Company's special purpose subsidiary, Lehman Brothers Special Financing, Inc.
and a separately capitalized triple-A rated subsidiary, Lehman Brothers
Financial Products, Inc., whose operations commenced in mid-1994.
As derivative products have continued to expand in volume, so has market
participation and competition. As a result, additional liquidity has been added
into the markets for conventional derivative products, such as interest rate
swaps. Competition has also contributed to the development of more complex
products structured for specific clients. It is this rapid growth and
complexity of certain derivative products which has led to the perception, by
some, that derivative products are unduly risky to users and the financial
markets. Derivatives are subject to risks similar to non-derivative financial
instruments including market, credit, liquidity and operational risk. The risks
of derivatives should not be viewed in isolation but they should be considered
on an aggregate basis along with the Company's other trading-related
activities. The Company manages risks associated with derivatives on an
aggregate basis along with the risks associated with its proprietary trading
and market making activities in cash instruments as part of its firm-wide risk
management policies.
In light of the recent publicized losses by certain users of derivative
products, regulators have voiced increased concern regarding the risks of
derivatives to users and the adequacy of disclosures provided to users of
sophisticated derivative products and the readers of financial statements. The
Company supports the efforts of the regulators in striving for enhanced
disclosures and to ensure that users of derivatives are fully aware of the
nature of risks inherent within derivative transactions. As evidence of this
support, the Company is participating, at the request of the Securities and
Exchange Commission, in a select industry task force aimed at developing
additional disclosure standards for derivative financial instruments.
The Company's Trading-Related Derivatives Activities have increased during
the current year to a notional value of $1,028 billion at November 30, 1994
from $833 billion at December 31, 1993, primarily as a result of growth in the
Company's activities as a dealer in derivative products. Notional values are
not recorded on the balance sheet and are not indicative of potential risk,
rather they are utilized as a basis for determining the exchange of future cash
flows and provide a measure of the Company's involvement with such instruments.
The Company's credit risk with respect to derivatives was $4.0 billion at
November 30, 1994 after consideration of master netting agreements and
collateral. Approximately 90% of the Company's net credit risk exposure was
with counterparties rated single-A or better. See Note 14 of Notes to the
Consolidated Financial Statements for a discussion of the Company's activities
in derivatives including trading and end user products, value of off-balance-
sheet financial instruments and the credit exposure of the Company's
derivatives.
SPECIFIC BUSINESS ACTIVITIES AND TRANSACTIONS
The following sections include information on specific business activities of
the Company which affect overall liquidity and capital resources:
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 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 November 30, 1994 and December
34
<PAGE>
31, 1993 included long positions with an aggregate market value of
approximately $624 million and $661 million, respectively, and short positions
with an aggregate market value of approximately $71 million and $75 million,
respectively. The portfolio may, from time to time, contain concentrated
holdings of selected issues. The Company's two largest high yield positions
were $89 million and $70 million at November 30, 1994, and $61 million and $56
million at December 31, 1993.
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, to be accomplished substantially through 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 November 30, 1994, the carrying value of the Company's investment in the
partnership was $193 million and the outstanding balance of the collateralized
loans, including accrued interest, was $155 million. The remaining loan balance
and the related investment is expected to be fully recovered by the second half
of 1995 through a combination of securitizations, asset sales, mortgage
remittances and refinancings by third parties.
Merchant Banking Partnerships. At November 30, 1994, the Company's investment
in merchant banking partnerships was $126 million. The Company has no remaining
commitments to make investments through these partnerships. The Company's
policy is to carry its interests in merchant banking partnerships at fair value
based upon the Company's assessment of the underlying investments. The
Company's merchant banking investments, made primarily through a series of
partnerships are consistent with the terms of those partnerships and are
expected to be sold or otherwise monetized during the remaining term of the
partnerships. In December 1994, these partnerships sold certain investments,
the proceeds of which will reduce the Company's investment in merchant banking
partnerships to approximately $85 million.
Non-core Activities and Investments. In March 1990, the Company discontinued
the origination of partnerships (the assets of which are primarily real estate)
and investments in real estate. Currently, Holdings and the Company act as
general partner for approximately $4.1 billion of partnership investment
capital and manage the remaining real estate investment portfolio. At November
30, 1994, the Company had net exposure to these investments of approximately
$103 million. This amount includes $32 million of investments in these real
estate activities, net of applicable reserves, as well as $71 million of
commitments and contingent liabilities under guarantees and credit
enhancements. The Company believes any exposure under these commitments and
contingent liabilities has been adequately reserved. In certain circumstances,
the Company provides financial and other support and assistance to such
investments to maintain investment values. 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.
CLEARING AGREEMENT
Pursuant to a clearing agreement (the "Clearing Agreement"), Smith Barney
carried and cleared, on a fully disclosed basis, all accounts introduced to it
by Lehman Brothers, and performed all clearing and settlement functions for
equities, municipal securities and corporate debt securities. The Clearing
Agreement expired on December 31, 1994, but was extended until February 17,
1995. On October 12, 1994, the Company and Bear Stearns Securities Corp.
("BSSC") entered into an agreement pursuant to which BSSC has agreed to process
the transactions currently cleared by Smith Barney (the "BSSC Agreement"). As a
result, the Company will now be self clearing and the accounts currently
carried by Smith Barney will be carried on the Company's books. The BSSC
Agreement will take effect on February 17, 1995 and will run for a term of five
years. As a result of this arrangement, the Company estimates that assets will
increase by approximately $10 billion which will be predominantly funded with
offsetting liabilities.
35
<PAGE>
NEW ACCOUNTING PRONOUNCEMENTS
During the first quarter of 1994, the Company adopted Financial Accounting
Standards Board Interpretation No. 39, "Offsetting of Amounts Related to
Certain Contracts" ("FIN No. 39"). FIN No. 39 restricts the historical industry
practice of offsetting certain receivables and payables. A substantial portion
of the increase in the Company's gross assets and liabilities from December 31,
1993 to November 30, 1994 is due to the adoption of FIN No. 39. In January
1995, the Financial Accounting Standards Board issued Interpretation No. 41,
Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase
Agreements ("FIN No. 41"). FIN No. 41 is a modification to FIN No. 39, to
permit certain limited exceptions to the criteria established under FIN No. 39
for offsetting certain repurchase and reverse repurchase agreements with the
same counterparty. The Company will adopt this modification on a prospective
basis which will partially mitigate the increase in the Company's gross assets
and liabilities resulting from the implementation of FIN No. 39.
Effective January 1, 1994, the Company adopted SFAS No. 112, "Employers'
Accounting for Postemployment Benefits." SFAS No. 112 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. These benefits principally include the continuation of salary,
health care and life insurance costs for employees on service disability
leaves. The Company previously expensed the cost of these benefits as they were
incurred. The cumulative effect of adopting SFAS No. 112 reduced net income for
the first quarter of 1994 by $13 million aftertax ($23 million pretax).
Excluding the cumulative effect of this accounting change, the effect of this
change on the 1994 results of operations was not material.
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.
RISK MANAGEMENT
As a leading global investment company, 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 risks involved in Lehman Brothers' activities are market
risk, credit or counterparty risk, and transaction risk. Lehman Brothers has
developed a control infrastructure to monitor and manage each type of risk on a
global basis throughout the Company.
The Company aims to reduce risk through the diversification of its products,
counterparties and activities in geographic regions. The Company accomplishes
this objective through allocating the usage of capital to each of its
businesses, establishing trading limits for individual products and traders,
and the approval of credit limits for individual counterparties including
regional concentrations. In addition, the Company is committed to employing
qualified personnel with expertise in each of its various businesses who are
responsible for the establishment of risk management policies and the continued
review and evaluation of these policies in light of changes in environmental
factors, counterparty credit status, and the long- and short-term goals of the
Company. Senior management plays a critical role in the ongoing evaluation of
risks, including credit, market, operational and liquidity risks and makes
necessary changes in risk management policies in light of these factors.
36
<PAGE>
The Company's risk management strategy is based on a multi-tier approach to
risk which includes many independent groups (i.e., finance, legal, front office
senior management, credit) being included in the risk monitoring process. The
Company's Trade Analysis department performs independent verification of the
prices of trading positions, regularly monitors the aging of inventory, and
performs daily due diligence of the Company's profitability, by business unit.
The Corporate Credit department has the responsibility for establishing and
monitoring counterparty limits, structuring and approving specific
transactions, and establishing collateral requirements or other credit
enhancement features (such as financial covenants, guarantees or letters of
credit), when deemed necessary, to secure the Company's position. The Company's
Commitment Committee has the responsibility for reviewing and approving
proposed transactions involving the underwriting or placement of securities by
Lehman Brothers, while the Investment Committee performs a similar function in
reviewing and approving proposed transactions related to investments of capital
in connection with the Company's investment banking and merchant banking
activities. Additionally, the Company employs an Internal Audit Department that
reports directly to the Company's Audit Committee and the Board of Directors.
This group performs periodic reviews to evaluate compliance with established
control processes. These reviews include performing tests on the accuracy of
inventory prices, compliance with established credit and trading limits, and
compliance with securities and other laws. The Company's control structure and
various control mechanisms are also subject to periodic reviews as a result of
examinations by the Company's external auditors as well as various regulatory
authorities. The final level of risk oversight is performed by the Senior Risk
Management Committee, which is comprised of senior management from the various
product areas and from the Credit, Trade Analysis and Risk Management
departments.
The Company seeks to ensure that it achieves adequate returns from each of
its business units commensurate with the risks assumed. To achieve this
objective, the Company periodically re-allocates capital to each of its
businesses based upon their ability to obtain returns consistent with
established guidelines as well as perceived opportunities in the marketplace
and the Company's long-term strategy.
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.
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.
37
<PAGE>
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 Financial Statements and Schedules appearing on page F-1.
2. Financial Statement Schedules:
Schedules are omitted since they are not required or are not
applicable.
3. Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NO.
-------
<C> <S>
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 Certificate of Amendment to Restated Certificate of Incorporation
of the Registrant, dated August 2, 1993 (incorporated by
reference to Exhibit 3 of the Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1993).
EXHIBIT 3.8 By-Laws of the Registrant, amended as of July 1, 1991
(incorporated by reference to Exhibit 3.7 of the Registrant
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 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 10.1 of Lehman Brothers Holdings Inc.'s Transition Report
on Form 10-K for the eleven months ended November 30, 1994.
</TABLE>
38
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO.
-------
<C> <S>
EXHIBIT 10.3 Amendment No. 1 dated as of July 31, 1993, to Asset Purchase Agreement
dated March 12, 1993, by and among Primerica Corporation, Smith Barney,
Harris Upham & Co. Incorporated and the Registrant (Incorporated by
reference to Exhibit 10.1 of the Registrant's Quarterly Report on Form 10-
Q for the quarter ended June 30, 1993).
EXHIBIT 10.4 Amendment No. 2 dated as of July 31, 1993, to Asset Purchase Agreement
dated March 12, 1993 by and among Primerica Corporation, Smith Barney,
Harris Upham & Co. Incorporated and the Registrant (Incorporated by
reference to Exhibit 10.2 of the Registrant's Quarterly Report on Form 10-
Q for the quarter ended June 30, 1993).
EXHIBIT 10.5 Clearing Agreement dated as of July 31, 1993, by and between Smith Barney,
Harris Upham & Co. Incorporated and the Registrant (Incorporated by
reference to Exhibit 10.3 of the Registrant's Quarterly Report on Form 10-
Q for the quarter ended June 30, 1993).
EXHIBIT 10.6 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 10.7 Transaction Support Services Agreement dated as of September 30, 1994 by
and between Bear, Stearns Securities Corp. and Lehman Brothers Inc.
(incorporated by reference to Exhibit 10.15 of Lehman Brothers Holdings
Inc.'s Transition Report for the eleven months ended November 30, 1994)
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 LLP.*
EXHIBIT 24 Powers of Attorney.*
EXHIBIT 27 Financial Data Schedule.
(b)Reports on Form 8-K.
1. Form 8-K dated September 29, 1994, Items 5 and 7.
2. Form 8-K dated November 15, 1994, Item 5.
3. Form 8-K dated January 13, 1995, Items 5 and 7.
</TABLE>
- --------
*Filed herewith.
**To be filed by amendment.
39
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS TRANSITION REPORT TO
BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
Lehman Brothers Inc.
(Registrant)
February 28, 1995
/s/ Karen M. Muller
By: _________________________________
Title: Attorney-in-Fact
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
---- ----- ----
<S> <C> <C>
* Chief Executive Officer and February 28, 1995
____________________________________ Chairman of the Board of
Richard S. Fuld, Jr. Directors
(principal executive
officer)
* Chief Operating Officer, February 28, 1995
____________________________________ President and Director
T. Christopher Pettit
* Chief Financial Officer February 28, 1995
____________________________________ (principal financial
Robert Matza officer)
* Controller February 28, 1995
____________________________________ (principal accounting
Stephen J. Bier officer)
* Director February 28, 1995
____________________________________
Roger S. Berlind
* Director February 28, 1995
____________________________________
Philip Caldwell
* Director February 28, 1995
____________________________________
Howard L. Clark, Jr.
* Director February 28, 1995
____________________________________
Sherman J. Lewis, Jr.
* Director February 28, 1995
____________________________________
</TABLE> Malcolm Wilson
/s/ Karen M. Muller
*By: __________________________
Karen M. Muller
(Attorney-in-Fact)
February 28, 1995
40
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-------
FINANCIAL STATEMENTS
- --------------------
<S> <C>
Report of Independent Auditors....................................... F-2
Consolidated Statement of Operations for Eleven Months Ended November
30, 1994 and for the Years Ended December 31, 1993 and December 31,
1992................................................................ F-3
Consolidated Statement of Financial Condition at November 30, 1994
and December 31, 1993............................................... F-4
Consolidated Statement of Changes in Stockholder's Equity for the
Eleven Months Ended November 30, 1994 and for the Years Ended
December 31, 1993 and December 31, 1992............................. F-6
Consolidated Statement of Cash Flows for the Eleven Months Ended
November 30, 1994 and for the Years Ended December 31, 1993 and
December 31, 1992................................................... F-7
Notes to Consolidated Financial Statements........................... F-8
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholder of Lehman Brothers Inc. and Subsidiaries
We have audited the accompanying consolidated statement of financial condition
of Lehman Brothers Inc. and Subsidiaries (the "Company") as of November 30,
1994 and December 31, 1993, and the related consolidated statements of
operations, changes in stockholder's equity, and cash flows for the eleven
month period ended November 30, 1994 and for each of the two years in the
period ended December 31, 1993. 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 November 30, 1994 and December 31, 1993, and the
consolidated results of its operations and its cash flows for the eleven month
period ended November 30, 1994 and for each of the two years in the period
ended December 31, 1993 in conformity with generally accepted accounting
principles.
As discussed in Note 10 to the consolidated financial statements, in 1994 the
Company changed its methods of accounting for postemployment benefits and in
1992 the Company changed its methods of accounting for postretirement benefits
and income taxes.
Ernst & Young LLP
New York, New York
January 5, 1995
F-2
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(IN MILLIONS)
<TABLE>
<CAPTION>
ELEVEN MONTHS TWELVE MONTHS
ENDED ENDED
NOVEMBER 30, DECEMBER 31,
------------- --------------
1994 1993 1992
------------- ------ ------
<S> <C> <C> <C>
Revenues
Principal transactions......................... $ 732 $1,455 $1,572
Investment banking............................. 399 794 720
Commissions.................................... 391 1,265 1,641
Interest and dividends......................... 6,235 5,029 4,974
Other.......................................... 57 467 676
------ ------ ------
Total revenues............................... 7,814 9,010 9,583
Interest expense............................... 5,845 4,585 4,573
------ ------ ------
Net revenues................................. 1,969 4,425 5,010
------ ------ ------
Non-interest expenses
Compensation and benefits...................... 1,004 2,564 2,982
Brokerage, commissions and clearance fees...... 190 189 155
Communications................................. 135 271 332
Professional services.......................... 103 153 163
Depreciation and amortization.................. 89 135 167
Business development........................... 86 131 176
Occupancy and equipment........................ 82 189 266
Management fees................................ 102
Other.......................................... 150 263 450
Severance charge............................... 27
Loss on sale of Shearson....................... 535
Reserves for non-core businesses............... 141
------ ------ ------
Total non-interest expenses.................. 1,968 4,571 4,691
------ ------ ------
Income (loss) from continuing operations before
taxes, cumulative effect of changes in
accounting principles and preferred dividend of
subsidiary...................................... 1 (146) 319
Provision for (benefit from) income taxes........ (33) 234 147
------ ------ ------
Income (loss) from continuing operations before
cumulative effect of changes in accounting
principles and preferred dividend of subsidiary. 34 (380) 172
------ ------ ------
Income from discontinued operations, net of
taxes:
Income from operations......................... 24 77
Gain on disposal............................... 165
------ ------ ------
Net income from discontinued operations.......... 189 77
------ ------ ------
Income (loss) before cumulative effect of changes
in accounting principles and preferred dividend
of subsidiary................................... 34 (191) 249
Cumulative effect of changes in accounting
principles, net of taxes........................ (13) (8)
Preferred dividend of subsidiary................. (50) (68) (68)
------ ------ ------
Net income (loss)................................ $ (29) $ (259) $ 173
====== ====== ======
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
NOVEMBER 30, DECEMBER 31,
ASSETS 1994 1993
- ------ ------------ ------------
(IN MILLIONS, EXCEPT
SHARE DATA)
<S> <C> <C>
Cash and cash equivalents........................... $ 361 $ 316
Cash and securities segregated and on deposit for
regulatory and other purposes...................... 1,263 867
Securities and other financial instruments owned:
Governments and agencies.......................... 16,941 12,844
Corporate obligations and other contractual
commitments...................................... 7,094 3,574
Mortgages and mortgage-backed..................... 2,444 1,043
Corporate stocks and options...................... 1,411 1,247
Certificates of deposit and other money market
instruments...................................... 1,239 1,849
------- -------
29,129 20,557
------- -------
Collateralized short-term agreements:
Securities purchased under agreements to resell... 29,392 23,175
Securities borrowed............................... 9,210 4,276
Receivables:
Brokers, dealers and clearing organizations....... 3,868 4,102
Customers......................................... 1,406 1,391
Others............................................ 3,694 2,138
Property, equipment and leasehold improvements (net
of accumulated depreciation and amortization of
$424 in 1994 and $361 in 1993)..................... 409 426
Deferred expenses and other assets.................. 221 299
Excess of cost over fair value of net assets
acquired (net of accumulated amortization of $108
in 1994 and $99 in 1993)........................... 181 267
------- -------
Total assets.................................... $79,134 $57,814
======= =======
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION--(CONTINUED)
<TABLE>
<CAPTION>
NOVEMBER 30, DECEMBER 31,
LIABILITIES AND STOCKHOLDER'S EQUITY 1994 1993
- ------------------------------------ ------------ ------------
(IN MILLIONS, EXCEPT
SHARE DATA)
<S> <C> <C>
Short-term financings:
Securities sold under agreements to repurchase..... $44,174 $30,798
Commercial paper and short-term debt............... 2,272 2,635
Securities loaned.................................. 315 772
Securities and other financial instruments sold but
not yet purchased:
Governments and agencies........................... 5,184 3,967
Corporate obligations and other contractual
commitments....................................... 2,842 562
Corporate stocks and options....................... 1,352 694
------- -------
9,378 5,223
------- -------
Advances from Holdings and other affiliates.......... 8,807 5,063
Payables:
Brokers, dealers and clearing organizations........ 2,730 2,021
Customers.......................................... 2,059 2,322
Accrued liabilities and other payables............... 3,416 2,590
Senior notes......................................... 511 653
Subordinated indebtedness............................ 2,885 3,053
------- -------
Total liabilities................................ 76,547 55,130
------- -------
Commitments and contingencies (Note 14)
Preferred stock of subsidiary, $1 par value; 5,000
shares authorized; 1,000 shares 9% Cumulative
Preferred, Series A, issued and outstanding in 1993. 750
Less: Note receivable, Series A Preferred stock.... (750)
Stockholder's equity:
Preferred stock, $.10 par value; 10,000 shares
authorized; none outstanding
Common stock, $.10 par value; 10,000 shares
authorized; 1,006 shares issued and outstanding in
1994 and 1993
Additional paid-in capital......................... 2,905 2,738
Foreign currency translation adjustment............ 3 2
Accumulated deficit................................ (321) (56)
------- -------
Total stockholder's equity....................... 2,587 2,684
------- -------
Total liabilities and stockholder's equity....... $79,134 $57,814
======= =======
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDER'S EQUITY
<TABLE>
<CAPTION>
ELEVEN MONTHS ENDED TWELVE MONTHS ENDED
NOVEMBER 30, DECEMBER 31,
------------------- --------------------
1994 1993 1992
------------------- --------- ---------
(IN MILLIONS)
<S> <C> <C> <C>
ADDITIONAL PAID-IN CAPITAL
Beginning balance.................. $2,738 $2,588 $2,423
Merger of subsidiaries............. 467
Capital contributions.............. 20 67
Capital distributions.............. (300) (300) (2)
Issuance of common stock........... 430 100
------ --------- ---------
Ending balance..................... 2,905 2,738 2,588
------ --------- ---------
FOREIGN CURRENCY TRANSLATION
ADJUSTMENT
Beginning balance.................. 2 2 2
Translation adjustment............. 1
------ --------- ---------
Ending balance..................... 3 2 2
------ --------- ---------
RETAINED EARNINGS (ACCUMULATED
DEFICIT)
Beginning balance.................. (56) 203 30
Net income (loss).................. (29) (259) 173
Dividends.......................... (236)
------ --------- ---------
Ending balance..................... (321) (56) 203
------ --------- ---------
NET UNREALIZED SECURITIES LOSSES
Beginning balance.................. (13) (55)
Change in unrealized securities
losses, net....................... 13 42
------ --------- ---------
Ending balance..................... (13)
------ --------- ---------
TOTAL STOCKHOLDER'S EQUITY........... $2,587 $2,684 $2,780
====== ========= =========
</TABLE>
See notes to consolidated financial statements
F-6
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
ELEVEN MONTHS ENDED TWELVE MONTHS ENDED
NOVEMBER 30, DECEMBER 31,
------------------- ---------------------
1994 1993 1992
------------------- --------- ----------
(IN MILLIONS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Income (loss) from continuing
operations before cumulative
effect of changes in accounting
principles and preferred dividend
of subsidiary..................... $ 34 $ (380) $ 172
Adjustments to reconcile income
(loss) to net cash (used in)
provided by operating activities:
Depreciation and amortization...... 89 135 167
Provisions for losses and other
reserves.......................... 32 75 215
Loss on sale of Shearson........... 535
Non-core business reserves......... 141
Deferred tax benefit............... (13) (106) (27)
Other adjustments.................. 17 64 37
Net change in:
Cash and securities segregated..... (396) 308 (133)
Receivables from brokers, dealers
and clearing organizations........ 234 (677) (458)
Receivables from customers......... (15) 508 (1,088)
Securities purchased under
agreements to resell.............. (6,217) 6,191 (9,382)
Securities borrowed................ (4,934) 3,217 (4,854)
Loans originated or purchased for
resale............................ (62) (26)
Securities and other financial
instruments owned................. (8,572) 899 (7,831)
Payables to brokers, dealers and
clearing organizations............ 709 579 470
Payables to customers.............. (263) (984) 674
Accrued liabilities and other
payables.......................... 802 408 (243)
Securities sold under agreements
to repurchase..................... 13,376 (2,945) 11,645
Securities loaned.................. (457) (1,728) 177
Securities and other financial
instruments sold but not yet
purchased......................... 4,155 (4,578) 5,345
Other operating assets and
liabilities, net.................. (1,003) (716) (63)
------- --------- ----------
(2,422) 884 (5,203)
Net cash flows provided by
operating activities of
discontinued operations........... 428 9
------- --------- ----------
Net cash (used in) provided by
operating activities............ (2,422) 1,312 (5,194)
------- --------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of senior
notes............................. 151
Principal payments of senior notes. (155) (636) (469)
Proceeds from issuance of
subordinated indebtedness......... 1,560 722 88
Principal payments of subordinated
indebtedness...................... (1,733) (702) (13)
Proceeds from issuance of other
indebtedness...................... 3,795 1,291 701
Principal payments of other
indebtedness...................... (26) (1,072) (923)
Increase (decrease) in commercial
paper and short-term debt, net.... (387) (3,236) 4,970
Capital contributions.............. 20 67
Proceeds from the issuance of
common stock...................... 430 100
Dividends and capital distributions
paid.............................. (536) (300) (2)
Net cash flows used in financing
activities of discontinued
operations........................ (301) (653)
------- --------- ----------
Net cash provided by (used in)
financing activities............ 2,518 (3,784) 4,017
------- --------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, equipment and
leasehold improvements............ (51) (101) (86)
Proceeds from the sale of:
The Boston Company................. 1,300
Shearson........................... 1,200
SLHMC.............................. 70
Other assets....................... 607
Other.............................. 151 (108)
Net cash flows used in investing
activities of discontinued
operations........................ (85) (438)
------- --------- ----------
Net cash (used in) provided by
investing activities............ (51) 2,535 (25)
------- --------- ----------
Net change in cash and cash
equivalents of discontinued
operations........................ 42 (1,082)
------- --------- ----------
Net change in cash and cash
equivalents..................... 45 21 (120)
------- --------- ----------
Cash and cash equivalents, beginning
of period.......................... 316 295 415
------- --------- ----------
Cash and cash equivalents, end of
period.......................... $ 361 $ 316 $ 295
======= ========= ==========
</TABLE>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (IN MILLIONS)
(INCLUDING THE BOSTON COMPANY)
Interest paid totaled $5,818 in 1994, $4,796 in 1993 and $5,047 in 1992.
Income taxes paid totaled $33 in 1994, $265 in 1993 and $20 in 1992.
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITY
During 1993, the Company completed 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
statement of financial condition changes related to the net assets sold as well
as the non-cash proceeds received related to these sales. See Note 17.
See notes to consolidated financial statements.
F-7
<PAGE>
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 ("LBI") and subsidiaries (LBI together with
its subsidiaries, the "Company"). LBI is a wholly owned subsidiary of Lehman
Brothers Holdings Inc. ("Holdings"). All material intercompany accounts and
transactions have been eliminated in consolidation. Prior to May 31, 1994, the
American Express Company ("American Express") owned 100% of Holdings' common
stock, which represented approximately 93% of Holdings' voting stock. Effective
May 31, 1994, Holdings became a widely held public company with its common
stock traded on the New York Stock Exchange, Inc. (See Note 7.)
The Consolidated Statement of Operations includes the results of operations
of Shearson and SLHMC for all periods prior to their sale in 1993. Shearson and
SLHMC were sold on July 31, 1993 and August 31, 1993, respectively. (See Note
17 for definitions and additional information concerning these sales.)
The Company uses the trade date basis of accounting for recording principal
transactions. Customer account balances are reflected on a settlement date
basis.
Certain amounts reflect reclassifications to conform to the current period's
presentation.
Discontinued Operations
As described in Note 17, 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.
Translation of Foreign Currencies
Assets and liabilities of foreign subsidiaries having non-U.S. dollar
functional currencies are translated at exchange rates at the statement of
financial condition date. Revenues and expenses are translated at average
exchange rates during the period. The gains or losses resulting from
translating foreign currency financial statements into U.S. dollars, net of
hedging gains or losses and related tax effects, are included in a separate
component of stockholder's equity, the Foreign currency translation adjustment.
Gains or losses resulting from foreign currency transactions are included in
the Consolidated Statement of Operations.
Securities and Other Financial Instruments
Securities and other financial instruments owned and Securities and other
financial instruments sold but not yet purchased are valued at market or fair
value, as appropriate, with unrealized gains and losses reflected in Principal
transactions in the Consolidated Statement of Operations. These amounts also
include certain instruments with multiple characteristics whose principal
repayment is contingent upon the performance of certain stocks, stock indices
or changes in foreign exchange rates. Market value is generally based on listed
market prices. If listed market prices are not available fair 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.
Derivative Financial Instruments
Derivatives include futures, forwards, swaps and options and other similar
instruments. Derivative transactions entered into for market making or
proprietary position taking or used as hedges of other trading
F-8
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
instruments are recorded at market or fair value with unrealized gains and
losses reflected in Principal transactions in the Consolidated Statement of
Operations.
The market or fair value associated with derivatives utilized for trading
purposes is recorded on a net by counterparty basis where a legal right of set-
off exists in the Consolidated Statement of Financial Condition at November 30,
1994. Prior to the adoption of Financial Accounting Standards Board
Interpretation No. 39, "Offsetting of Amounts related to Certain Contracts"
("FIN No. 39"), the Company reflected the value of all such contracts on a net
basis. Unrealized gains and losses related to swaps and option contracts are
recorded as Securities and other financial instruments owned and Securities and
other financial instruments sold but not yet purchased, as applicable.
Unrealized gains and losses related to securities and foreign exchange forwards
and commodity contracts are recorded as receivables and payables with Brokers,
dealers and clearing organizations and Customers, as applicable.
In addition to trading and market making activities, the Company enters into
various 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.
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.
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. The Company monitors the market value of the underlying
positions on a daily basis as compared to the related receivable including
accrued interest. The Company obtains additional collateral, as necessary.
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 November 30, 1994, such resale and repurchase
agreements which have not yet matured aggregated $4.2 billion and $5.3 billion,
respectively.
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.
F-9
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Fixed Assets and Intangibles
Property, equipment, and leasehold improvements are recorded at historical
cost, net of accumulated depreciation and amortization. Depreciation is
recognized 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 (goodwill) is amortized
using the straight-line method over a period of 35 years. Goodwill is also
reduced upon the recognition of certain acquired net operating loss
carryforward benefits.
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. CHANGE IN YEAR-END
During 1994, the Company changed its year-end from December 31 to November
30. Such a change to a non-calendar cycle shifts certain year-end
administrative activities to a time period that conflicts less with the
business needs of the Company's institutional customers.
The following is selected financial data for the eleven month transition
period ending November 30, 1994 and the comparable prior year period.
<TABLE>
<CAPTION>
(IN MILLIONS) ELEVEN MONTHS ENDED
-------------------------
NOVEMBER 30, NOVEMBER 30,
1994 1993
------------ ------------
(UNAUDITED)
<S> <C> <C>
Total revenues...................................... $7,814 $8,412
Interest expense.................................... 5,845 4,213
------ ------
Net revenues........................................ 1,969 4,199
Non-interest expenses............................... 1,968 4,362
------ ------
Income (loss) from continuing operations before
taxes, cumulative effect of change in accounting
principle and preferred dividend of subsidiary..... 1 (163)
Provision for (benefit from) income taxes........... (33) 234
------ ------
Income (loss) from continuing operations before
cumulative effect of change in accounting principle
and preferred dividend of subsidiary............... 34 (397)
------ ------
Income from discontinued operations, net of taxes:
Income from operations............................ 24
Gain on disposal.................................. 165
------ ------
Net income from discontinued operations............. 189
------ ------
Income (loss) before cumulative effect of change in
accounting principle and preferred dividend of
subsidiary......................................... 34 (208)
Cumulative effect of change in accounting principle,
net of taxes....................................... (13)
Preferred dividend of subsidiary.................... (50) (62)
------ ------
Net loss............................................ $ (29) $ (270)
====== ======
</TABLE>
F-10
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The above selected financial data for 1993 includes the results of operations
of Shearson and SLHMC, which were sold on July 31, 1993 and August 31, 1993,
respectively. The Company completed the sale of The Boston Company on May 21,
1993. The above selected financial data for 1993 reflects The Boston Company as
a discontinued operation. (See Note 17 for definitions and additional
information concerning these sales.)
3. CASH AND SECURITIES SEGREGATED AND ON DEPOSIT FOR REGULATORY AND OTHER
PURPOSES:
In addition to amounts presented in the accompanying Consolidated Statement
of Financial Condition as Cash and securities segregated and on deposit for
regulatory and other purposes, securities with a market value of approximately
$941 million and $890 million at November 30, 1994 and December 31, 1993,
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 the Securities and Exchange
Commission Rule 15c3-3.
4. SHORT-TERM FINANCING:
The Company obtains short-term financing on both a secured and unsecured
basis. The secured financing is obtained through the use of repurchase
agreements and securities loaned agreements, which are primarily collateralized
by government and agency securities. The unsecured financing is generally
obtained through the issuance of commercial paper and short-term debt.
The Company's Commercial paper and short-term debt is comprised of the
following (in millions):
<TABLE>
<CAPTION>
NOVEMBER 30, DECEMBER 31,
1994 1993
------------ ------------
<S> <C> <C>
Short-term debt
Payables to banks............................. $1,053 $ 872
Master notes.................................. 999 1,374
Bank loans.................................... 220 30
Commercial paper................................ 359
------ ------
$2,272 $2,635
====== ======
</TABLE>
The weighted average interest rates at November 30, 1994 and December 31,
1993 were as follows:
<TABLE>
<CAPTION>
NOVEMBER 30, DECEMBER 31,
1994 1993
------------ ------------
<S> <C> <C>
Short-term debt......... 5.9% 3.7%
Commercial paper........ 3.5%
Securities sold under
agreements to
repurchase............. 5.2% 3.4%
</TABLE>
F-11
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. SENIOR NOTES:
The Company's Senior notes are comprised of the following (in millions):
<TABLE>
<CAPTION>
NOVEMBER 30, 1994
-------------------------------
CONTRACTUAL CONTRACTUAL DECEMBER 31,
MATURING IN FIXED RATE FLOATING RATE TOTAL 1993
- ----------- ----------- ------------- ----- ------------
<S> <C> <C> <C> <C>
Eleven months ended November 30,
1994............................. $ 86
Year ended November 30, 1995...... $ 97 $17 $114 181
Year ended November 30, 1996...... 185 185 185
Year ended November 30, 1997...... 18 18 18
Year ended November 30, 1998...... 10 10 10
Year ended November 30, 1999...... 21 21 22
December 1, 1999 and thereafter... 163 163 151
---- --- ---- ----
$494 $17 $511 $653
==== === ==== ====
</TABLE>
As of November 30, 1994, the Company had $494 million of fixed rate senior
notes outstanding. Contractual interest rates on these notes ranged from 7.81%
to 12.20% as of November 30, 1994, with a contractual weighted average interest
rate of 10.58%. The Company entered into an interest rate swap contract which
effectively converted $102 million of these notes to a floating rate based on
the London Interbank Offered Rate ("LIBOR"), resulting in an effective rate of
7.21% as of November 30, 1994. Exclusive of this $102 million, the Company also
utilized a series of fixed rate basis swaps totaling $335 million to lower the
rate on its fixed rate senior notes to an effective weighted average interest
rate of 9.73%.
As of November 30, 1994, the Company had the equivalent of $17 million of yen
denominated floating rate senior notes outstanding with a contractual rate of
2.96%.
The Company's interest in 3 World Financial Center, its Corporate
Headquarters, is financed with fixed rate senior notes totaling $388 million as
of November 30, 1994. Of this amount, $305 million are 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.
Of the fixed rate senior notes maturing in fiscal 1996, $102 million are an
obligation of a subsidiary of LBI and are guaranteed by Holdings.
6. SUBORDINATED INDEBTEDNESS:
The Company's Subordinated indebtedness is comprised of the following (in
millions):
<TABLE>
<CAPTION>
NOVEMBER 30, 1994
--------------------------------
CONTRACTUAL CONTRACTUAL DECEMBER 31,
MATURING IN FIXED RATE FLOATING RATE TOTAL 1993
- ----------- ----------- ------------- ------ ------------
<S> <C> <C> <C> <C>
Eleven months ended November 30,
1994............................ $1,117
Year ended November 30, 1995..... $ 64 $ 64 324
Year ended November 30, 1996..... 96 $ 164 260 260
Year ended November 30, 1997..... 741 820 1,561 501
Year ended November 30, 1998..... 350 350 200
Year ended November 30, 1999..... 179 179 179
December 1, 1999 and thereafter.. 441 30 471 472
------ ------ ------ ------
$1,871 $1,014 $2,885 $3,053
====== ====== ====== ======
</TABLE>
F-12
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
As of November 30, 1994, the Company had $1,871 million of fixed rate
subordinated indebtedness outstanding. Contractual interest rates on this
indebtedness ranged from 5.04% to 11.63% as of November 30, 1994, with a
contractual weighted average interest rate of 8.31%. The Company utilized a
series of fixed rate basis swaps totaling $1,949 million to lower the rate of
its fixed rate subordinated indebtedness, and the Company entered into interest
rate swap contracts which effectively converted $1,460 million of this debt to
floating rates based on LIBOR. Including the effect of both the basis and
interest rate swaps applied to the Company's fixed rate indebtedness, the
effective weighted average interest rate on the remaining fixed rate debt was
7.75%.
As of November 30, 1994, the Company had $1,014 million of floating rate
subordinated indebtedness outstanding. Contractual interest rates on this
indebtedness are primarily based on LIBOR and ranged from 4.80% to 6.77% as of
November 30, 1994, with a contractual weighted average interest rate of 6.64%.
Including the effect of the $1,460 million of fixed rate indebtedness swapped
to a floating interest rate, the effective weighted average interest rate of
the Company's floating rate subordinated indebtedness was 6.57%.
In addition to the interest rate swaps utilized by the Company to convert the
interest rate nature of the Company's subordinated indebtedness, the Company
had $392 million notional value of swaptions outstanding at November 30, 1994.
These swaptions, if exercised, would convert $200 million of the Company's
subordinated indebtedness from a floating rate to a fixed rate. The remaining
swaptions, if exercised, would convert the Company's subordinated fixed rate
debt to a floating rate.
Of the Company's subordinated indebtedness outstanding as of November 30,
1994, $200 million is repayable prior to maturity at the option of the holder.
This obligation is reflected in the table presented as maturing in fiscal 1997,
the year in which the holder has the option to redeem the debt at par value,
rather than at its contractual maturity of 2003.
Subordinated borrowings from subsidiaries of Holdings were $821 million as of
November 30, 1994. Interest rates on these related party borrowings are based
on subsidiaries of Holdings' cost of funds, which are primarily floating rate.
These borrowings had a weighted average interest rate of 6.77% as of November
30, 1994.
As of November 30, 1994, the Company had $525 million available for the
issuance of subordinated indebtedness under its shelf registration.
7. HOLDINGS--EQUITY INVESTMENTS AND DISTRIBUTION OF COMMON STOCK:
On May 31, 1994 all of the shares of common stock of Holdings were
distributed (the "Distribution") to American Express common shareholders of
record on May 20, 1994, as a result of a special dividend declared on April 29,
1994 by the Board of Directors of American Express. Prior to the Distribution,
an additional equity investment of approximately $1.25 billion was made in
Holdings, most significantly by American Express.
8. INCENTIVE PLANS:
The Compensation and Benefits Committee (the "Compensation Committee") of the
Board of Directors of Holdings adopted, effective as of the date of the
Distribution, the Lehman Brothers Holdings Inc. 1994 Management Ownership Plan
(the "1994 Plan") and the Lehman Brothers Holdings Inc. 1994 Management
F-13
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Replacement Plan (the "Replacement Plan"). In addition, the Compensation
Committee adopted, effective June 1, 1994, the Employee Stock Purchase Plan
(the "ESPP"). The Company participates in all of the above mentioned incentive
plans.
The 1994 Plan provides for the Compensation Committee to grant stock options,
stock appreciation rights ("SARs"), restricted stock units ("RSUs"), restricted
stock, performance shares and performance units for a period up to ten years to
eligible employees of Holdings and the Company ("Eligible Employees"). A total
of 16,650,000 shares of Holdings' common stock may be subject to awards under
the 1994 Plan, which number includes 150,000 shares available as RSUs which may
be issued to non-employee Directors of Holdings. All RSUs outstanding at
November 30, 1994 were granted during the current period. Each RSU awarded in
1994 and outstanding on July 1, 1999 will be exchanged for a share of Holdings'
common stock. Holdings will pay a dividend equivalent on each RSU outstanding
based on dividends paid on the Holdings' common stock.
The Replacement Plan allows the Compensation Committee to grant stock options
and restricted stock awards to Eligible Employees. The primary purpose of the
Replacement Plan is to provide awards similar to the American Express common
shares granted to Holdings' and the Company's employees which were canceled as
of the date of the Distribution. At November 30, 1994, virtually all stock
options granted under the Replacement Plan were exercisable.
The ESPP allows employees to purchase Holdings' common stock at a 15%
discount from market value, with a maximum of $15,000 in annual aggregate
purchases by any one individual. The number of shares of Holdings' common stock
authorized for purchase by Eligible Employees is 6,000,000. As of November 30,
1994, 130,827 shares of Holdings' common stock were purchased by Eligible
Employees through the ESPP. The shares were purchased in the open market and
thus did not increase the total shares outstanding.
At November 30, 1994, a total of approximately 4.6 million RSUs were
outstanding. In addition, the Compensation Committee also determined to award
approximately one million RSUs to certain officers of Holdings and the Company
under the 1994 Plan based on performance goals during the period June 1, 1994
through December 31, 1994. All RSUs will vest approximately 75% on July 1,
1995, 5% on July 1, 1997 and 20% on July 1, 1999. Options for approximately
3,750,000 shares of Holdings' common stock are also outstanding at November 30,
1994 under the 1994 Plan and the Replacement Plan. These options expire at
various times from 1995 through 2004, with the exercise price for all options
being $18 per share. Restricted stock awards outstanding under the Replacement
Plan total approximately 62,000 shares at November 30, 1994.
9. CAPITAL REQUIREMENTS:
As registered broker-dealers, LBI and Lehman Government Securities Inc.
("LGSI"), a wholly owned subsidiary of LBI, are subject to United States
Securities and Exchange Commission ("SEC") Rule 15c3-1, the Net Capital Rule,
which requires LBI and LGSI to maintain net capital of not less than 2% of
aggregate debit items arising from customer transactions, as defined, or 4% of
funds required to be segregated for customers' regulated commodity accounts, as
defined. At November 30, 1994, LBI's regulatory net capital, as defined, of
$1,338 million exceeded the minimum requirement by $1,281 million. LGSI's
regulatory net capital, as defined, of $575 million exceeded the minimum
requirement by $556 million at November 30, 1994.
Certain advances and dividend payments by LBI are restricted by the
regulations of the SEC and other regulatory agencies. In addition, certain
instruments governing the indebtedness of LBI contractually limit
F-14
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
its ability to pay dividends. At November 30, 1994, $1,406 million of net
assets of the Company were restricted as to the payment of dividends.
10. CHANGES IN ACCOUNTING PRINCIPLES:
Accounting for Postemployment Benefits. Effective January 1, 1994, the
Company adopted SFAS No. 112, "Employers' Accounting for Postemployment
Benefits". SFAS No. 112 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. These benefits principally
include the continuation of salary, health care and life insurance costs for
employees on service disability leaves. The Company previously expensed the
cost of these benefits as they were incurred.
The cumulative effect of adopting SFAS No. 112 reduced net income for the
first quarter of 1994 by $13 million after-tax ($23 million pre-tax). The
effect of this accounting change on the 1994 results of operations was not
material, excluding the cumulative effect.
Offsetting of Certain Receivables and Payables. During the first quarter of
1994, the Company adopted FIN No. 39. FIN No. 39 restricts the historical
industry practice of offsetting certain receivables and payables. A substantial
portion of the increase in the Company's gross assets and liabilities from
December 31, 1993 to November 30, 1994 is due to the adoption of FIN No. 39. In
January 1995, the Financial Accounting Standards Board issued Interpretation
No. 41, "Offsetting of Amounts Related to Certain Repurchase and Reverse
Repurchase Agreements" ("FIN No. 41"). FIN No. 41 is a modification to FIN No.
39 to permit certain limited exceptions to the criteria established under FIN
No. 39 for offsetting certain repurchase and reverse repurchase agreements with
the same counterparty. The Company will adopt this modification on a
prospective basis which will partially mitigate the increase in the Company's
gross assets and liabilities resulting from the implementation of FIN No. 39.
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 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").
F-15
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
11. 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 $3 million for the
eleven months ended November 30, 1994 and $16 million and $23 million for the
twelve months ended December 31, 1993 and 1992, respectively, and consisted of
the following components (in millions):
<TABLE>
<CAPTION>
ELEVEN MONTHS TWELVE MONTHS
ENDED ENDED
NOVEMBER 30, DECEMBER 31,
------------- --------------
1994 1993 1992
------------- ------ ------
<S> <C> <C> <C>
Service cost-benefits earned during the period.... $ 8 $ 24 $ 29
Interest cost on projected benefit obligation..... 23 36 42
Actual return on plan assets...................... 2 (59) (47)
Net amortization and deferral..................... (30) 15 (1)
---- ------ ------
$ 3 $ 16 $ 23
==== ====== ======
</TABLE>
The following table sets forth the funded status of Holdings' domestic
defined benefit plans (in millions):
<TABLE>
<CAPTION>
NOVEMBER 30, DECEMBER 31,
1994 1993
------------ ------------
<S> <C> <C>
Actuarial present value of benefit obligations:
Vested benefit obligation.......................... $(289) $(317)
===== =====
Accumulated benefit obligation..................... $(296) $(322)
===== =====
Projected benefit obligation......................... $(312) $(338)
Plan assets at fair value............................ 380 367
----- -----
Plan assets in excess of projected benefit
obligation.......................................... 68 29
Unrecognized net loss................................ 74 94
Unrecognized prior service cost...................... (4) (6)
Unrecognized net asset............................... (3) (3)
----- -----
Prepaid pension asset recognized in Holdings'
Consolidated Statement of Financial Condition....... $ 135 $ 114
===== =====
</TABLE>
The assumed discount rates used in determining the actuarial present value of
the projected benefit obligation for the plans were 8.5% and 7.25% in 1994 and
1993, respectively. The rate of increase in future compensation levels used was
5.5% in 1994 and 1993. The expected long-term rate of return on assets was
9.75% in 1994, 1993 and 1992.
During 1993, the Company incurred a settlement and curtailment with respect
to its domestic pension plan in relation to the Primerica Transaction. The net
gain of approximately $26 million (pre-tax) was included in the loss on the
sale of Shearson. (See Note 17 for definitions and additional information
concerning this sale.)
F-16
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
12. POSTRETIREMENT 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 substantially all eligible 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 eleven months ended November
30, 1994 and the twelve months ended December 31, 1993 and 1992 consisted of
the following components (in millions):
<TABLE>
<CAPTION>
ELEVEN MONTHS TWELVE MONTHS
ENDED ENDED
NOVEMBER 30, DECEMBER 31,
------------- --------------
1994 1993 1992
------------- ------ ------
<S> <C> <C> <C>
Service cost....................................... $ 1 $ 2 $ 3
Interest cost...................................... 5 8 10
Amortization of unrecognized prior service cost.... (1)
--- ------ ------
Net periodic postretirement benefit cost........... $ 5 $ 10 $ 13
=== ====== ======
</TABLE>
During 1993, the Company incurred a curtailment with respect to its
postretirement plan, in relation to the Primerica Transaction. The net gain of
approximately $56 million (pre-tax) was included in the loss on the sale of
Shearson. (See Note 17 for definitions and additional information concerning
this sale.)
The following table sets forth the amount recognized in the Consolidated
Statement of Financial Condition for the Company's postretirement benefit plans
(other than pension plans) at November 30, 1994 and December 31, 1993 (in
millions):
<TABLE>
<CAPTION>
NOVEMBER 30, DECEMBER 31,
1994 1993
------------ ------------
<S> <C> <C>
Accumulated postretirement benefit obligation:
Retirees............................................ $45 $48
Fully eligible active plan participants............. 5 7
Other active plan participants...................... 6 7
--- ---
56 62
Unrecognized net gain................................. 12 3
Unrecognized prior service cost....................... 9 9
--- ---
Accrued postretirement benefit cost................... $77 $74
=== ===
</TABLE>
The discount rate used in determining the accumulated postretirement benefit
obligation was 8.5% in 1994 and 7.25% in 1993.
The annual assumed health care cost trend rate is 12% for the year ended
November 30, 1995 and is assumed to decrease at the rate of 1% per year to 7%
in the year ended November 30, 2000 and remain at that level thereafter. An
increase in the assumed health care cost trend rate by one percentage point in
each period would increase the accumulated postretirement benefit obligation as
of November 30, 1994 by approximately $1 million.
13. INCOME TAXES:
Holdings will file a consolidated U.S. federal income tax return for the
period of June 1, 1994 to December 31, 1994 reflecting the income of Holdings
and its subsidiaries. For the period prior to the spin-off from American
Express, the income of Holdings will be included in the American Express
consolidated U.S.
F-17
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
federal income tax return, as it has been since August of 1990. The income tax
provision for the Company is computed in accordance with the income tax
allocation agreement among Holdings, the Company and American Express.
With respect to the period in which the Company was included in the American
Express consolidated U.S. federal 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 from Holdings at November 30,
1994 and December 31, 1993 were $226 million and $180 million, respectively.
The provision for (benefit from) income taxes from continuing operations
consists of the following (in millions):
<TABLE>
<CAPTION>
ELEVEN TWELVE MONTHS
MONTHS ENDED ENDED
NOVEMBER 30, DECEMBER 31,
------------ --------------
1994 1993 1992
------------ ------ ------
<S> <C> <C> <C>
Current:
Federal.................................... $ (1) $218 $127
State...................................... (21) 115 44
Foreign.................................... 2 7 3
---- ------ ------
(20) 340 174
Deferred:
Federal.................................... (16) (75) (24)
State...................................... 3 (31) (3)
---- ------ ------
$(33) $ 234 $ 147
==== ====== ======
</TABLE>
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 rate change on the Company's net deferred tax assets as of
January 1, 1993.
Income from continuing operations before taxes included $79 million, $41
million and $1 million that is subject to income taxes of foreign jurisdictions
for the eleven months ended November 30, 1994 and the twelve months ended
December 31, 1993 and 1992, respectively.
The income tax provision (benefit) differs from that computed by using the
statutory federal income tax rate for the reasons shown below (in millions):
<TABLE>
<CAPTION>
ELEVEN MONTHS ENDED TWELVE MONTHS ENDED
NOVEMBER 30, DECEMBER 31,
------------------- --------------------
1994 1993 1992
------------------- --------- ---------
<S> <C> <C> <C>
Federal income taxes at statutory
rate................................ $ 1 $ (51) $ 108
State and local taxes................ (12) 54 29
Tax-exempt interest and dividends.... (21) (24) (4)
Goodwill reduction related to the
sale of Shearson.................... 263
Amortization of goodwill............. 3 9 14
U.S. federal rate change............. (8)
Other................................ (4) (9)
---- --------- ---------
$(33) $ 234 $ 147
==== ========= =========
</TABLE>
F-18
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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.
At November 30, 1994 and December 31, 1993, the Company's net deferred tax
assets (liabilities) from continuing operations consisted of the following (in
millions):
<TABLE>
<CAPTION>
NOVEMBER 30, DECEMBER 31,
1994 1993
------------ ------------
<S> <C> <C>
Deferred tax assets................................... $115 $119
Less: Valuation allowance............................. 97 116
---- ----
Deferred tax assets net of valuation allowance........ 18 3
Deferred tax liabilities.............................. (4) (39)
---- ----
Net deferred tax assets (liabilities) from
continuing operations............................ $ 14 $(36)
==== ====
</TABLE>
The net deferred tax asset increased by $50 million to $14 million at
November 30, 1994. The net increase is primarily attributable to the reversal
of certain temporary differences. At November 30, 1994 and December 31, 1993,
deferred tax assets consisted primarily of reserves not yet deducted for tax
purposes of $99 million and $78 million, respectively. At December 31, 1993,
deferred tax liabilities consisted primarily of unrealized trading and
investment gains of $33 million. In addition, in accordance with the tax
sharing agreement with Holdings, the Company was reimbursed for $345 million
and $270 million of net deferred tax assets as of November 30, 1994 and
December 31, 1993, respectively.
The net deferred tax asset is included in Deferred expenses and other assets
in the accompanying Consolidated Statement of Financial Condition. At November
30, 1994, the valuation allowance recorded against deferred tax assets from
continuing operations was $97 million as compared to $116 million at December
31, 1993, of which approximately $59 million and $100 million, respectively
will reduce goodwill if future circumstances permit recognition. The net
decrease in the valuation allowance reflects the ability to recognize certain
tax benefits related to the 1988 acquisition of Hutton that were previously
unrecognized. The benefit was reflected as a reduction in the Excess of cost
over fair value of net assets acquired.
For tax return purposes, the Company has approximately $50 million of net
operating loss carryforwards, a portion of which are attributable to the 1988
acquisition of Hutton. Substantially all of the net operating losses are
scheduled to expire in the years 1999 through 2009.
14. COMMITMENTS AND CONTINGENCIES:
Derivative Financial Instruments
Derivatives are financial instruments, which include swaps, options, futures
and forwards, whose value is based upon an underlying asset (e.g., treasury
bond), index (e.g., S&P 500) or reference rate (e.g., LIBOR). A derivative
contract may be traded on an exchange or over-the-counter. Exchange-traded
derivatives are standardized and include futures, and certain option contracts
listed on an exchange. Over-the-counter derivative contracts are individually
negotiated between contracting parties and include forwards, swaps and certain
options including caps, collars and floors.
Derivatives are subject to various risks similar to non-derivative financial
instruments including, market, credit, liquidity, and operational risk. The
risks of derivatives should not be viewed in isolation but rather should be
considered on an aggregate basis along with the Company's other trading-related
activities. The
F-19
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Company manages the risks associated with derivatives on an aggregate basis
along with the risks associated with its proprietary trading and market making
activities in cash instruments as part of its firm-wide risk management
policies.
Market Risk. Market risk is the potential for changes in the value of
derivative financial instruments due to market changes, including interest and
foreign exchange rate movements and fluctuations in commodity or security
prices. Market risk is directly impacted by the volatility and liquidity in the
markets in which the related underlying assets are traded. The Company manages
its exposure to market risk on an aggregate basis combining the effects of cash
instruments and derivative contracts.
Credit Risk. Credit risk is the possibility that a loss may occur from the
failure of a counterparty to perform according to the terms of a contract. At
any point in time, the credit risk for over-the-counter derivative contracts is
limited to the net unrealized gain for each counterparty for which a master
netting agreement exists, net of collateral received. The Company's credit
review process includes an evaluation of the counterparty's credit worthiness
at the inception of the transaction, periodic review of credit standing,
obtaining collateral and various credit enhancements in certain circumstances.
In addition, the Company actively pursues obtaining master netting agreements
for all its derivative counterparties.
Liquidity Risk. Liquidity risk is the possibility that the Company may not be
able to rapidly adjust the size of its derivative positions in times of high
volatility and financial stress at a reasonable cost. The liquidity of
derivative products is highly related to the liquidity of the underlying cash
instrument. As with non-derivative financial instruments, the Company's
valuation policies for derivatives include consideration of liquidity factors.
Operational Risk. Operational risk is the possibility of a deficiency in the
Company's systems for executing derivative transactions. Such risks include the
potential for liabilities resulting from the Company's role in the execution of
a derivative transaction in which there was a breakdown in information transfer
or settlement systems.
In addition to these risks, the Company may also be exposed to legal risks
related to its derivative activities, including the possibility that a
transaction may be unenforceable under applicable law. Such risks are also
present in cash instruments and are controlled through the Company's
established risk management policies.
In the normal course of business, the Company enters into derivative
transactions both as a dealer and as an end user. Acting as a dealer, the
Company enters into derivative transactions to satisfy the needs of its clients
and to manage the Company's own exposure to market and credit risks resulting
from proprietary trading activities (collectively, "Trading-Related Derivative
Activities"). Acting as an end user, the Company primarily enters into interest
rate swap and option contracts to adjust the interest rate nature of its
funding sources from fixed to floating rates and vice versa, and to change the
index upon which floating interest rates are based (i.e., Prime to LIBOR)
(collectively, "End User Derivative Activities.")
At November 30, 1994 the notional value of the Company's End User Derivative
Activities was $36.1 billion. Approximately $3.8 billion of this notional value
was related to the Company's interest rate management activities for the senior
and subordinated debt portfolios, with approximately $32.3 billion of notional
value related to the management of interest rate risk of the Company's secured
financing activities, including Securities purchased under agreement to resell,
Securities borrowed, Securities sold under agreements to repurchase and
Securities loaned. The weighted average maturity of such derivative contracts
was 2.1 years for the senior and subordinated debt related instruments and 1.2
years for the secured financing related derivatives as of November 30, 1994.
F-20
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In addition, the Company had $392 million notional value of swaptions
outstanding at November 30, 1994 which, if exercised, would convert $200
million of the Company's subordinated debt from a floating rate to a fixed
rate. The remaining swaptions, if exercised, would convert the Company's
subordinated debt from a fixed to a floating rate.
Derivatives are generally based upon notional values. Notional values are not
recorded on-balance-sheet, but rather are utilized solely as a basis for
determining future cash flows to be exchanged. Therefore, notional amounts
provide a measure of the Company's involvement with such instruments, but are
not indicative of potential risk. The following table represents the notional
contract amounts of the Company's outstanding derivative contracts:
<TABLE>
<CAPTION>
1994
WEIGHTED
NOTIONAL/CONTRACT VALUE AVERAGE
TRADING-RELATED DERIVATIVE ----------------------------------- MATURITY
FINANCIAL INSTRUMENTS NOVEMBER 30, 1994 DECEMBER 31, 1993 IN YEARS
- -------------------------- ----------------- ----------------- --------
(IN MILLIONS) (IN MILLIONS)
<S> <C> <C> <C>
Swap Products...................... $ 431,607 $271,293 3.76
Financial Futures:
To purchase.................... 130,641 89,055
To sell........................ 105,230 51,234
---------- --------
235,871 140,289 0.90
Forward Contracts:
Securities:
To purchase.................... 17,449 51,789
To sell........................ 16,549 46,535
---------- --------
33,998 98,324 0.07
Foreign Exchange:
To purchase.................... 133,725 116,484
To sell........................ 133,392 117,832
---------- --------
267,117 234,316 0.18
Options Written:
Securities..................... 26,033 65,856
Foreign exchange............... 25 58
---------- --------
26,058 65,914 0.30
Options Purchased:
Securities..................... 23,252 10,234
Foreign exchange............... 27 914
---------- --------
23,279 11,148 0.30
Commodities........................ 9,835 11,508 0.29
Total Notional/Contract Values. $1,027,765 $832,792 1.85
========== ========
</TABLE>
Approximately $590 billion of the notional/contract value of the Company's
Trading-Related Derivative Activities mature within the year ended November 30,
1995, of which approximately 47% have maturities of less than one month.
The Company records its Trading-Related Derivative Activities on a mark-to-
market basis with realized and unrealized gains (losses) recognized currently
in Principal transactions. While the Company may utilize
F-21
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
derivative products in all its businesses, the Company views its derivative
product revenues as the net revenues earned from the trading and market making
activities of its derivative products businesses. Such derivative product
revenues were $366 million for the eleven months ended November 30, 1994 and
$233 million and $80 million for the years ended December 31, 1993 and 1992,
respectively.
The Company currently records unrealized gains and losses on derivative
contracts on a net basis in the Consolidated Statement of Financial Condition
for those transactions with counterparties executed under a legally enforceable
master netting agreement. Prior to the adoption of FIN No. 39 in early 1994,
the Company recorded all such contracts on a net basis. Listed in the table
below is the fair value of the Company's Trading-Related Derivatives as of
November 30, 1994. Average fair values of these instruments are also shown
below. Variances between average values and period-end values are due to
changes in the volume of activities in these instruments and changes in the
valuation of these instruments due to changes in market and credit conditions.
Average fair value was calculated based upon month-end statement of financial
condition values which the Company believes do not vary significantly from the
average fair value calculated on a more frequent basis.
<TABLE>
<CAPTION>
FAIR VALUE OF TRADING-RELATED DERIVATIVE
FINANCIAL INSTRUMENTS
- ----------------------------------------
AVERAGE FAIR
VALUE ELEVEN
FAIR VALUE MONTHS ENDED
NOVEMBER 30, NOVEMBER 30,
1994 1994
---------------- ----------------
ASSET LIABILITY ASSET LIABILITY
------ --------- ------ ---------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Swap Products................................... $3,739 $2,072 $2,981 $1,596
Financial Futures............................... 14 11 9 15
Forward Contracts............................... 925 817 864 886
Options Written................................. 75 54
Options Purchased............................... 79 89
Commodities..................................... 289 2 289 2
------ ------ ------ ------
Total....................................... $5,046 $2,977 $4,232 $2,553
====== ====== ====== ======
</TABLE>
Total credit exposure of the Company's trading-related derivative contracts
at November 30, 1994, net of collateral, is $3,994 million. Collateral held
generally includes cash and U.S. government and federal agency securities.
Presented below is an analysis of the Company's net credit exposure from these
contracts based upon internal designations of counterparty credit quality.
<TABLE>
<CAPTION>
COUNTERPARTY
RISK S&P/MOODY'S NET CREDIT
RATING EQUIVALENT EXPOSURE
------------ ----------- ----------
<S> <C> <C>
1........................................ AAA/Aaa 20%
2........................................ AA-/Aa3 or higher 22%
3........................................ A-/A3 or higher 48%
4........................................ BBB-/Baa3 or higher 5%
5........................................ BB-/B3 or higher 4%
6........................................ B+/B1 or lower 1%
</TABLE>
These designations are based on actual ratings made by external rating
agencies or by equivalent ratings established and utilized by the Company's
Corporate Credit Department.
F-22
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Concentrations of Credit Risk
As a major international securities firm, the Company is actively involved in
securities underwriting, brokerage, 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 non-U.S. governments
which, in the aggregate, represented 21.4% of the Company's total assets at
November 30, 1994. In addition, substantially all of the collateral held by the
Company for resale agreements or securities borrowed, which together
represented 48.8% of total assets at November 30, 1994, consisted of securities
issued by the U.S. government, federal agencies or non-U.S. governments. 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.
OTHER COMMITMENTS AND CONTINGENCIES
As of November 30, 1994 and December 31, 1993, the Company was contingently
liable for $675 million and $463 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
guarantees.
As of November 30, 1994 and December 31, 1993, the Company had pledged or
otherwise transferred securities, primarily fixed income, having a market value
of $15.2 billion and $21.3 billion, respectively, as collateral for securities
borrowed or otherwise received having a market value of $15.1 billion and $21.1
billion respectively.
Securities and other financial instruments 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 ultimate gain or
loss is dependent upon the price at which the underlying financial instrument
is purchased to settle its obligation under the sale commitment.
In addition, the Company's customer activities may expose it to off-balance-
sheet credit and market risk. These risks may arise in the normal course of
business as a result of executing, financing and settling various customer
security and commodity transactions. Off-balance-sheet risk arises from the
potential that customers or counterparties fail to satisfy their obligations
and that the collateral obtained is insufficient. In such instances, the
Company may be required to purchase or sell financial instruments at
unfavorable market prices. The Company seeks to control these risks by
obtaining margin balances and other collateral in accordance with regulatory
and internal guidelines.
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
F-23
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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.
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 advice 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 position or
results of operations.
Lease Commitments
The Company leases office space and equipment and has entered into ground
leases with the City of New York or its agencies. Total rent expense under
these long-term commitments for the eleven months ended November 30, 1994 and
the twelve months ended December 31, 1993 and 1992 was $34 million, $85 million
and $137 million, respectively.
Certain leases on office space contain escalation clauses providing for
additional rentals based upon maintenance, utility and tax increases. Minimum
future rental commitments under noncancellable operating leases (net of
subleases of $608 million) are as follows (in millions):
<TABLE>
<CAPTION>
AMOUNT
------
<S> <C>
Year ended November 30, 1995....................................... $ 27
Year ended November 30, 1996....................................... 25
Year ended November 30, 1997....................................... 21
Year ended November 30, 1998....................................... 18
Year ended November 30, 1999....................................... 14
December 1, 1999 and thereafter.................................... 224
-----
$ 329
=====
</TABLE>
15. FAIR VALUE OF FINANCIAL INSTRUMENTS:
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires the disclosure of the fair value of on- and off-balance-sheet
financial instruments for which it is practicable to estimate fair value,
whether or not such financial instruments are recorded at fair value in the
Consolidated Statement of Financial Condition.
The disclosure requirement of SFAS No. 107 excludes certain financial
instruments, such as trade receivables and payables when the carrying value
approximates the fair value, employee benefit obligations and all non-financial
instruments such as fixed assets and goodwill. The fair values of the financial
instruments are estimates based upon market conditions and perceived risks as
of the statement of financial condition date and require varying degrees of
management judgment. For the majority of the Company's financial instruments,
book value approximates fair value, with the exception of senior notes,
subordinated indebtedness, certain secured financing activities and the related
financial instruments utilized by the Company as an end user to manage the
interest rate risk of these portfolios.
At November 30, 1994, the fair value of the Company's Senior notes and
Subordinated indebtedness was approximately $3,393 million ($3,876 million at
December 31, 1993) as compared to a carrying value of $3,396 million ($3,706
million at December 31, 1993), representing an unrecognized net gain of
approximately $3 million at November 30, 1994 (unrecognized net loss of $170
million at December 31,
F-24
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1993). 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 is considered to approximate 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 net
gains (losses) on financial instruments utilized by the Company as an end user
to convert the interest rate basis from fixed or floating to another basis for
the Senior notes and Subordinated indebtedness were $(24) million and $55
million at November 30, 1994 and December 31, 1993, respectively. The
unrecognized net gains (losses) on these transactions reflect the estimated
amounts the Company would pay if the agreements were terminated based on market
rates as of November 30, 1994 and December 31, 1993, respectively.
At November 30, 1994, the Company had approximately $83 billion of secured
financing activities, including Securities purchased under agreements to
resell, Securities borrowed, Securities sold under agreements to repurchase,
and Securities loaned which are carried at their original contract amount plus
accrued interest. The Company, as an end user, utilized derivative financial
instruments with an aggregate notional amount of $32.3 billion at November 30,
1994 to modify the interest rate characteristics of these secured financings.
The Company has unrecognized net losses of approximately $110 million related
to these derivative financial instruments which are offset by unrecognized net
gains arising from these secured financing activities.
16. RELATED PARTY TRANSACTIONS:
In the normal course of business, the Company engages in various securities
trading, investment banking and financing activities with Holdings and many of
its subsidiaries (the "Related Parties"). 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 subsidiaries of Holdings raise money through short
and long term funding in the capital markets, which is used to fund the
operations of certain of the Company's wholly owned subsidiaries. Advances from
Holdings and other affiliates were $8,807 million and $5,063 million at
November 30, 1994 and December 31, 1993, respectively.
In connection therewith, advances from Holdings aggregating approximately
$7.1 billion and $3.6 billion at November 30, 1994 and December 31, 1993,
respectively, are generally payable on demand. The average interest rate
charged on these advances is primarily based on Holdings' average daily cost of
funds, which was 4.8% for the eleven months ended November 30, 1994 and 3.6%
for the twelve months ended December 31, 1993. In addition, the Company had
borrowings from subsidiaries of Holdings comprised of approximately $821
million in subordinated indebtedness. Interest charges incurred during the
eleven months ended November 30, 1994 and the twelve months ended December 1993
and 1992 from Holdings, including interest charges on subordinated and senior
debt issued to Holdings, amounted to $277 million, $227 million and $214
million, respectively. In addition, the Company has advances from other
affiliates of Holdings aggregating approximately $1.7 billion and $1.5 billion,
at November 30, 1994 and December 31, 1993, respectively, with various
repayment terms. The Company had notes and other receivables due from Holdings
and subsidiaries of Holdings aggregating approximately $3.4 billion and $1.6
billion at November 30, 1994 and December 31, 1993, respectively, with various
repayment terms.
During the third quarter of 1994, Holdings acquired additional space in the
World Financial Center and also began occupying its leased facility at 101
Hudson Street in Jersey City, New Jersey. In addition, certain employees of the
Company who perform administrative and corporate functions were transferred to
Holdings.
F-25
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Accordingly, Holdings has allocated the cost of these new facilities and
services provided by employees transferred to its appropriate subsidiaries.
These charges, which are classified in the Consolidated Statement of Operations
as Management fees, are primarily comprised of compensation, occupancy and
computer processing. The result of these allocations was to reduce expenses
incurred directly by the Company in previous periods with an offsetting
increase in Management fees.
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.
LBI Group ("Group"), a wholly owned subsidiary of the Company had 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 LB
Funding Corp. ("Funding"), 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"). In the fourth quarter of 1994, the
Preferred Stock and Note were canceled. Interest income for the eleven months
ended November 30, 1994 and the twelve months ended December 31, 1993 and 1992
includes $25 million, $28 million and $36 million respectively, from the Note.
The dividend requirement on the Preferred Stock, as reflected on the Company's
Consolidated Statement of Operations was $50 million for the eleven months
ended November 30, 1994 and $68 million for each of the twelve month periods
ended December 31, 1993 and 1992.
Effective June 10, 1994, Lehman Special Securities Inc., a wholly owned
subsidiary of Holdings, was merged into a subsidiary of the Company resulting
in an increase in Stockholder's equity in LBI and LGSI of approximately $149
million. In addition, in the fourth quarter of 1994, Funding and certain other
wholly owned subsidiaries of Holdings were merged into the Company. As a
result, Stockholder's equity increased by $318 million. The effect of these
mergers on the results of operations to this and prior periods was not
material.
During 1994, the Company paid $536 million to Holdings, $300 million as a
return of capital and $236 million as dividends.
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.
17. SALE OF BUSINESS UNITS:
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 The
Travelers Inc., "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
F-26
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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"). All Participation Rights,
including the first payment, were 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 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
------ ------
<S> <C> <C>
Revenues.................................................. $1,825 $2,781
Expenses.................................................. 1,708 2,669
Loss on sale of Shearson.................................. 535
------ ------
Income (loss) before taxes................................ (418) 112
Provision for income taxes................................ 149 57
------ ------
Net income (loss)......................................... $ (567) $ 55
====== ======
</TABLE>
Shearson operating results reflect allocated interest expense of $72 million
and $102 million for the years ended December 31, 1993 and 1992.
The Boston Company
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. 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.
As a result of the Mellon Transaction, the Company treated The Boston Company
as a discontinued operation. Accordingly, the Company's financial statements
segregate the operating results of The Boston Company.
F-27
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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
------ ------
<S> <C> <C>
Discontinued operations:
Revenues................................................. $ 201 $ 909
Expenses................................................. 159 758
------ ------
Income before taxes...................................... 42 151
Provision for income taxes............................... 18 74
------ ------
Income from operations................................... 24 77
Gain on disposal, net of taxes of $37.................... 165
------ ------
Income from discontinued operations, net of taxes........ $ 189 $ 77
====== ======
</TABLE>
Shearson Lehman Hutton Mortgage Corporation
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 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 reserves are included in the $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.
18. OTHER CHARGES:
Reduction in Personnel
During the first quarter of 1994, the Company completed a review of personnel
needs, which resulted in the termination of certain personnel. The Company
recorded a severance charge of $27 million pre-tax ($15 million after-tax) in
the first quarter of 1994.
Reserves for Non-Core Businesses
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 $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.
F-28
<PAGE>
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)
19. QUARTERLY INFORMATION (UNAUDITED): (IN MILLIONS)
The following information represents the Company's unaudited quarterly
results of operations for 1994 and 1993. Certain amounts reflect
reclassifications to conform to the current period's presentation. These
quarterly results reflect all normal recurring adjustments which are, in the
opinion of management, necessary for a fair presentation of the results.
Revenues and earnings of the Company can vary significantly from quarter to
quarter due to the nature of the Company's business activities.
<TABLE>
<CAPTION>
NOV. AUG. JUNE MAR. DEC. SEP. JUNE MAR.
30 31 30 31 31 30 30 31
1994 1994 1994 1994 1993 1993 1993 1993
------ ------ ------ ------ ------ ------ ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Total revenues.......... $2,460 $2,198 $1,958 $1,927 $1,836 $2,092 $2,574 2,508
Interest expense........ 1,956 1,695 1,475 1,254 1,137 1,170 1,161 1,117
------ ------ ------ ------ ------ ------ ------ -----
Net revenues............ 504 503 483 673 699 922 1,413 1,391
Non-interest expenses:
Compensation and
benefits.............. 251 265 256 336 347 502 843 872
Other expenses......... 255 268 256 245 219 304 418 390
Loss on sale of
Shearson.............. 535
Reserves and other
charges............... 27 141
------ ------ ------ ------ ------ ------ ------ -----
Total non-interest
expenses............ 506 533 512 608 566 806 1,261 1,938
------ ------ ------ ------ ------ ------ ------ -----
Income (loss) from
continuing operations
before taxes and
cumulative effect of
change in accounting
principle.............. (2) (30) (29) 65 133 116 152 (547)
Provision for (benefit
from) income taxes..... (9) (28) (22) 24 33 37 62 102
------ ------ ------ ------ ------ ------ ------ -----
Income (loss) from
continuing operations
before cumulative
effect of change in
accounting principle
and preferred dividend
of subsidiary.......... 7 (2) (7) 41 100 79 90 (649)
Income from discontinued
operations, net of
taxes:
Income from operations. 24
Gain on disposal....... 165
------ ------ ------ ------ ------ ------ ------ -----
Net income from
discontinued
operations............. 189
------ ------ ------ ------ ------ ------ ------ -----
Income (loss) before
cumulative effect of
change in accounting
principle.............. 7 (2) (7) 41 100 79 90 (460)
Cumulative effect of
change in accounting
principle, net of
taxes.................. (13)
Preferred dividend of
subsidiary............. (5) (17) (17) (17) (17) (17) (17) (17)
------ ------ ------ ------ ------ ------ ------ -----
Net income (loss)....... $ 2 $ (19) $ (24) $ 11 $ 83 $ 62 $ 73 $(477)
====== ====== ====== ====== ====== ====== ====== =====
</TABLE>
In conjunction with the decision to change its year-end, the Company reported
its third quarter results on the basis of its new fiscal year for the three
months ended August 31, 1994. As such, the results for the month of June 1994
have been reflected in both the second and third quarters of 1994. Thus, the
four quarters of 1994 are not additive.
Net income for the first quarter of 1994 includes a $13 million after-tax
charge for the cumulative effect of a change in accounting for postemployment
benefits as a result of the adoption of SFAS No. 112.
The results for the first quarter of 1993 reflect a loss on the sale of
Shearson of $630 million ($535 million pre-tax), reserves for non-core
businesses of $93 million ($141 million pre-tax) and net income from the
discontinued operation of The Boston Company of $189 million.
F-29
<PAGE>
EXHIBIT 12
LEHMAN BROTHERS INC. AND SUBSIDIARIES
COMPUTATION IN SUPPORT OF RATIO OF EARNINGS TO FIXED CHARGES
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
FOR THE
FOR THE YEAR ENDED DECEMBER 31, ELEVEN MONTHS
---------------------------------- ENDED NOVEMBER 30,
1990 1991 1992 1993 1994
------- ------- ------- ------- ------------------
<S> <C> <C> <C> <C> <C>
Fixed charges:
Interest expense:
Subordinated
indebtedness....... $ 277 $ 231 $ 210 $ 192 $ 184
Bank loans and other
borrowings*........ 3,753 4,068 4,363 4,393 5,661
Interest component
of rentals of
office and
equipment.......... 57 64 64 62 27
Other adjustments**... 73 88 127 101 53
------- ------- ------- ------- ------
Total (A)......... $ 4,160 $ 4,451 $ 4,764 $ 4,748 $5,925
======= ======= ======= ======= ======
Earnings:
Pre-tax income (loss)
from continuing
operations........... $ (501) $ 283 $ 319 $ (146) $ 1
Fixed charges......... 4,160 4,451 4,764 4,748 5,925
Other adjustments***.. (68) (69) (68) (68) (52)
------- ------- ------- ------- ------
Total (B)......... $ 3,591 $ 4,665 $ 5,015 $ 4,534 $5,874
======= ======= ======= ======= ======
(B / A)................. **** 1.05 1.05 **** ****
</TABLE>
- --------
* Includes amortization of long-term debt discount.
** Other adjustments include capitalized interest and debt issuance costs,
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 a wholly owned
subsidiary.
**** Earnings were inadequate to cover fixed charges and would have had to
increase approximately $569 million in 1990, $214 million in 1993 and $51
million in 1994 in order to cover the deficiency.
F-30
<PAGE>
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, 33-28381, 33-
9541, 33-4694, 2-95523 and 2-83903 of Lehman Brothers Inc. and in the related
Prospectuses of our report dated January 5, 1995, with respect to the
consolidated financial statements and financial statement schedules of Lehman
Brothers Inc. included in this 1994 Transition Report on Form 10-K for the
eleven month period ended November 30, 1994.
Ernst & Young LLP
New York, New York
February 28, 1995
<PAGE>
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 November 30, 1994 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 February 28, 1995
/s/ Richard S. Fuld, Jr.
____________________________________ /s/ Philip Caldwell
____________________________________
RICHARD S. FULD, JR. PHILIP CALDWELL
/s/ T. Christopher Pettit
____________________________________ /s/ Howard L. Clark, Jr.
____________________________________
T. CHRISTOPHER PETTIT HOWARD L. CLARK, JR.
/s/ Robert Matza
____________________________________ /s/ Sherman J. Lewis, Jr.
____________________________________
ROBERT MATZA SHERMAN J. LEWIS, JR.
/s/ Stephen J. Bier
____________________________________ /s/ Malcolm Wilson
____________________________________
STEPHEN J. BIER MALCOLM WILSON
/s/ Roger S. Berlind
____________________________________
ROGER S. BERLIND
<TABLE> <S> <C>
<PAGE>
<ARTICLE> BD
<LEGEND> THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE CONSOLIDATED STATEMENT OF FINANCIAL CONDITION AT NOVEMBER 30, 1994
AND THE CONSOLIDATED STATEMENT OF OPERATIONS FOR THE ELEVEN MONTHS
ENDED NOVEMBER 30, 1994 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 11-MOS
<FISCAL-YEAR-END> NOV-30-1994
<PERIOD-START> JAN-01-1994
<PERIOD-END> NOV-30-1994
<CASH> 1,624
<RECEIVABLES> 8,968
<SECURITIES-RESALE> 29,392
<SECURITIES-BORROWED> 9,210
<INSTRUMENTS-OWNED> 29,129
<PP&E> 409
<TOTAL-ASSETS> 79,134
<SHORT-TERM> 2,272
<PAYABLES> 4,789
<REPOS-SOLD> 44,174
<SECURITIES-LOANED> 315
<INSTRUMENTS-SOLD> 9,378
<LONG-TERM> 3,396
<COMMON> 0
0
0
<OTHER-SE> 2,587
<TOTAL-LIABILITY-AND-EQUITY> 79,134
<TRADING-REVENUE> 732
<INTEREST-DIVIDENDS> 6,235
<COMMISSIONS> 391
<INVESTMENT-BANKING-REVENUES> 399
<FEE-REVENUE> 0
<INTEREST-EXPENSE> 5,845
<COMPENSATION> 1,004
<INCOME-PRETAX> 1
<INCOME-PRE-EXTRAORDINARY> 34
<EXTRAORDINARY> 0
<CHANGES> (13)
<NET-INCOME> (29)
<EPS-PRIMARY> 0.00
<EPS-DILUTED> 0.00
</TABLE>
