10-K 1 v214490_10k.htm Unassociated Document


SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

FORM 10-K
 
(mark one)
 
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Fiscal Year Ended December 31, 2010
 
or
 
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File No. 000-30066
 
Sanders Morris Harris Group Inc.
(Exact name of registrant as specified in its charter)
 
Texas
 
76-0583569
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
     
600 Travis, Suite 5800
   
Houston, Texas
 
77002
(Address of principal executive offices)
 
(Zip code)
(713) 224-3100
(Registrant's telephone number, including area code)
 
Securities Registered Pursuant to Section 12(b) of the Act:
None
 
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $0.01 Par Value
(Title of each class)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
¨ Yes  x No
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
¨ Yes  x No
 
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. x Yes  ¨ No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ¨ Yes  ¨ No
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  ¨
 
Accelerated filer x
     
Non-accelerated filer  ¨
 
Smaller reporting company ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ¨ Yes  x No
 
As of June 30, 2010, the aggregate market value of the shares of Common Stock held by nonaffiliates of the registrant was $88.6 million.  For purposes of this computation, all executive officers, directors and 10% beneficial owners of the registrant were deemed to be affiliates. Such determination is not an admission that such officers, directors, and beneficial owners are, in fact, affiliates of the registrant.
 
As of March 1, 2011, the registrant had 29,283,419 outstanding shares of Common Stock, par value $0.01 per share.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Information in the Registrant's definitive Proxy Statement pertaining to the 2011 Annual Meeting of Shareholders (the "Proxy Statement") to be filed with the SEC is incorporated herein by reference into Part III of this Report.
 


 
 

 
 
SANDERS MORRIS HARRIS GROUP INC. AND SUBSIDIARIES
INDEX
 
PART I
     
Item 1.
Business
1
     
Item1A.
Risk Factors
8
     
Item 1B.
Unresolved Staff Comments
18
     
Item 2.
Properties
18
     
Item 3.
Legal Proceedings
19
     
Item 4.
Reserved
19
     
PART II
     
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
20
     
Item 6.
Selected Financial Data
23
     
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations
24
     
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk.
36
     
Item 8.
Financial Statements and Supplementary Data
39
     
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
74
     
Item 9A.
Controls and Procedures
74
     
Item 9B.
Other Information
76
     
PART III
     
Item 10.
Directors, Executive Officers and Corporate Governance
77
     
Item 11.
Executive Compensation
77
     
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
77
     
Item 13.
Certain Relationships and Related Transactions, and Director Independence
77
     
Item 14.
Principal Accountant Fees and Services
77
     
PART IV
     
Item 15.
Exhibits, Financial Statement Schedules
78

 
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PART I
Item 1.  Business
 
Sanders Morris Harris Group Inc. (“SMHG” or the “the Company”) is a wealth management company.  Through our subsidiaries and affiliates, we provide wealth management services to a wide range of investors.  Our businesses include asset wealth management activities, programs, and products to support our wealth managers.  In addition, we offer a variety of trading, sales, and research services for institutional investors.

Our company was formed through the merger in January 2000 of Sanders Morris Mundy Inc., a Houston-based full-service investment bank, and Harris, Webb & Garrison, Inc., a Houston securities firm.  In 2009 and 2010, we made substantial progress in the execution of our strategy to move away from capital markets operations and focus on wealth management.  We believe we have in place the people, infrastructure, and brand recognition at each of our businesses, which combined with sufficient working capital, will enable us to leverage our operating platform to further increase our profitability and market share.
 
In December 2009, we completed a transaction pursuant to which we contributed our investment banking and certain of our institutional equity and fixed income trading operations (excluding The Juda Group and the Concept Capital division) to Madison Williams and Company, LLC, a new entity formed by a number of the managing directors of the investment banking group and two financial partners. We received a cash payment of $2.7 million and a note for $8.0 million as part of this transaction and retained a 17.5% interest in Madison Williams Capital LLC, subject to a purchase option in favor of the two financial partners for $4.0 million.  We received notices of intent to exercise the options in December 2010.  On February 11, 2011, one option was exercised for 30% of our 17.5% ownership in Madison Williams Capital, LLC in the amount of $1.2 million reducing our interest to 12.25%.  The second option remains pending.

In March 2010, we entered into an agreement with the principals of the Concept Capital division (“Concept”) of Sanders Morris Harris, Inc. (“SMH”) pursuant to which we agreed to contribute certain of the assets, properties, and other rights pertaining to Concept, including the prime brokerage, research and capital markets, fund accounting and administration, and research library businesses, to Concept Capital Markets, LLC (“CCM”) and Concept Capital Administration, LLC (“CCAdmin”), two new entities formed by the principals of Concept.   The Washington Research Group of Concept was sold during the fourth quarter of 2010 prior to the spin-off of Concept.  After the spin-off, SMH retains a 24% capital interest and a 43.48% profit interest in Concept Capital Holdings, LLC (the parent of CCM)(“CCH”) and a 43.48% member interest in CCAdmin.  Current members of management of Concept hold the remaining interests in the new entities.

The Concept spin-off was substantially completed on December 31, 2010. In addition to the capital and profits interests in CCM and CCAdmin, SMH on (a) March 1, 2010, purchased from CCH, at its face value a note in the principal amount of $1.2 million and (b) on December 31, 2010, purchased from CCH a second note in a principal amount generally equal to 50% of the sum of cash and cash equivalents and net security positions of Concept at December 31, 2010.
 
As part of our business expansion strategy, on December 31, 2010, Sanders Morris Harris Group Inc. (“SMHG”) acquired a 48.7% capital interest and a 50.1% profits interest in Global Financial Services, LLC (“GFS BD”) and a 50.1% capital and profits interest in GFS Advisors, LLC, (“GFS IA”) wealth management firms (collectively “Global”), based in Houston, Texas, pursuant to the terms of a Purchase Agreement dated as of November 26, 2010, among the Company and the prior owners of Global.  The acquisition increases our assets under management by $4.1 billion, and complements the growth of SMHG’s high net worth businesses, as Global’s clients are largely international executives, their families and corporations.
 
Our Products and Services
 
Our firm is organized in three major client sectors.

Mass Affluent

The Edelman Financial Center, LLC (“Edelman”), which owns Edelman Financial Services, LLC (“EFS”), is our largest subsidiary.  SMHG owns 76% of Edelman. It is managed by our President, Ric Edelman. Although, more than 1,000 clients have invested more than $1 million with EFS, the business is centered on serving the mass affluent household; which we define as households with $50,000 to $1 million in investable assets.  The average household account at EFS has client assets of $418,000. The core of the Edelman experience is personal financial planning and advice.  Most investments are managed in the Edelman Managed Asset Program (“EMAP”). Through EMAP, investors get a professionally designed investment portfolio that provides a broad array of asset classes and market sectors — far greater diversification than they could normally obtain on their own.  EMAP also offers dynamic security selection, strategic rebalancing, and an array of state-of-the-art client services, all for a single, fully disclosed annual fee, calculated as a percentage of client assets under management.  Nearly 12,000 investors have placed $5.5 billion in EMAP, making it one of the largest and fastest-growing investment management programs in the nation.
 
 
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The Ric Edelman Show provides listeners with comprehensive, educational financial advice — how to buy a home, pay for college, prepare for retirement, care for elders, get out of debt, and invest appropriately for their situation. The show is heard on more than three dozen radio stations, potentially reaching more than 90 million households.
 
In 2009 and 2010, Ric Edelman was recognized by Barron’s as the No. 1 Independent Advisor in the country. Through his best-selling books, nationally syndicated radio program, monthly newsletter, seminars, media appearances and websites, he has positively impacted the lives of millions of Americans.

Ric Edelman is also a #1 New York Times bestselling author. His books on personal finance include Ordinary People, Extraordinary Wealth; The New Rules of Money; Discover the Wealth Within You; What You Need To Do Now; The Lies About Money, Rescue Your Money; and his newest book,  the fourth edition of the  personal finance classic, The Truth About Money. Collectively, more than 1 million copies of Ric’s books are in print and have been translated into several languages. Ric also publishes a monthly newsletter and offers a comprehensive free financial education website at RicEdelman.com.

In all, EFS manages approximately $6.0 billion in client assets for more than 14,000 families. Its legacy business is in the Washington, D.C. metropolitan area, with 24 financial planners in three offices, predominantly in its Fairfax, Virginia headquarters. These offices have approximately 10,000 clients with $4.5 billion in client assets, and recorded revenue of $55.5 million in 2010, up 127% since 2005.  It earned $15.8 million in 2010.

EFS opened its first six offices outside the Washington D.C. area in September, 2009,  located in the New York City metropolitan area. Each office is designed to accommodate one to three financial planners plus support staff. A new office has an expected cash cost of approximately $250,000 and cash burn of approximately $500,000 before becoming cash flow positive, which is estimated to occur between the 12th and 18th month of operation.  In 2010, EFS opened an additional office in New York City, plus four offices in Washington D.C. Metro, two offices in Chicago and one office in South Florida.

EFS also has small direct response and outside advisor departments. Between them, they handle more than 3,000 clients who have nearly $1.0 billion invested with the firm and recorded revenue of $13.6 million in 2010.

High Net Worth
 
Our high net worth business provides investment advisory, wealth and investment management, asset management and financial planning to high net worth and mass affluent individuals and institutions.  We define high net worth clients as individuals who have in excess of $1 million in investable assets.
 
Each of our high net worth units generally focuses on a different portion of the wealth management business in terms of client type and location, asset and product type, and distribution channel. These business units are generally operated as individual businesses that market their products under our or their own brand name, with certain products offered through multiple external and internal distribution channels. Administrative and back office functions for most of these units are provided by the parent company. In addition, one or more of our executive officers serve on the board of directors or management committee of each of these business units.
 
Our high net worth business primarily earns revenue by charging fees for managing the investment assets of clients. Fees are typically calculated as a percentage of the value of assets under management and vary with the type of account managed, the asset manager, and the account size. We believe an asset-based fee structure helps align our interests with those of our clients, particularly as compared to a commission-based fee structure, which is based on the number and value of securities trades executed. Our wealth management business may also earn performance fees if the investment performance of the assets in the account meets or exceeds a specified benchmark during a measurement period.  We also generate a substantial portion of revenue from a traditional, commission-based structure where we earn commissions on client purchase and sale transactions.
 
 
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At December 31, 2010, our high net worth subsidiaries and affiliates managed approximately $11.2 billion in client assets. Our high net worth revenue in 2010 was $52.2 million and pre-tax income from continuing operations was $18.4 million.
 
We have a number of consolidated affiliates in which we own an interest ranging from 48.7% to 100%.  The larger of these are:
 
Sanders Morris Harris Inc.  Sanders Morris Harris Inc. (“SMH”), member Financial Industry Regulatory Authority (“FINRA”)/Securities Investor Protection Corporation (“SIPC”), headquartered in Houston, Texas, provides wealth management services directly through its private client business and its affiliation with independent contractors who are members of the SMH Partners program. Its financial advisors (both internal and affiliated through SMH Partners) serve high net worth clients, many of whom have long-standing relationships with SMH. As a full service firm, SMH offers its clients wealth management financial advice relating to equity securities, bonds, private placements, mutual funds, defined contribution plans, wrap-fee programs, money market funds, insurance products, and tax, trust, and estate advice. At December 31, 2010, SMH managed $3.7 billion in client assets in those channels.  We own 100% of SMH.
 
Kissinger Financial Services.  Kissinger Financial Services (“Kissinger”), a division of SMH based in Hunt Valley, Maryland, provides financial planning and investment management services to high net worth and mass affluent individuals. Kissinger derives revenue from fees charged to clients for the preparation of financial plans and for monitoring services and earns commissions and fees from investment and insurance products sold to clients. At December 31, 2010, Kissinger managed approximately $365.9 million in client assets.  SMH owns 100% of Kissinger.
 
The Rikoon Group, LLC.  The Rikoon Group, LLC (“Rikoon”), based in Santa Fe, New Mexico, provides wealth management services to high net worth individuals including financial and estate planning, investment management services, wealth education, and family retreats.  Rikoon operates nationally with fee only investment counsel and also offers comprehensive family office services.  At December 31, 2010, Rikoon managed approximately $417.4 million in client assets.  We own 75% of Rikoon.
 
Leonetti & Associates, LLC.  Leonetti & Associates, LLC (“Leonetti”), a registered investment advisor based in Buffalo Grove, Illinois, provides fee-based investment advice for individuals and small businesses.  Leonetti provides investment management and financial planning services to enhance client portfolios and help them reach their financial goals.  At December 31, 2010, Leonetti managed approximately $449.0 million in client assets.  We own 50.1% of Leonetti.
 
Miller-Green Financial Services, Inc.  Miller-Green Financial Services, Inc. (“Miller-Green”), a registered investment advisor based in The Woodlands, Texas, provides financial, investment, retirement, and/or estate planning services to individuals and families.  It does extensive pre-retirement planning for a variety of clients.  At December 31, 2010, Miller-Green managed approximately $292.7 million in client assets.  We own 100% of Miller-Green.
 
Investor Financial Solutions, LLC.  Investor Financial Solutions, LLC (“IFS”) doing business as Investor Solutions Group of California, a registered investment advisor located in Huntington Beach, California, provides financial, investment, retirement, and/or estate planning services to individuals and families and was acquired January 1, 2010.  It does extensive pre-retirement planning for a variety of clients.  At December 31, 2010, IFS managed approximately $111.4 million in client assets.  We own 51% of IFS.
 
Global Financial Services, LLC and GFS Advisors, LLC.  Global Financial Services, LLC, a registered broker-dealer located in Houston, Texas, (“GFS BD”) and GFS Advisors, LLC, a registered investment advisor also located in Houston, Texas (“GFS IA”), (collectively, “Global”) serve high net worth clients residing in Mexico, Central and South America, many of whom have long-standing relationships with Global and was acquired December 31, 2010. As a full service firm, Global offers its clients wealth management financial advice relating to equity securities and options, bonds, currencies, mutual funds, money market funds and other securities. At December 31, 2010, Global managed $4.1 billion in client assets in those channels.   We have a 48.7% equity interest and a 50.1% profits interests in GFS BD and a 50.1% equity and profits interest in GFS IA.
 
The Dickenson Group, LLC.  The Dickenson Group, LLC (“Dickenson”), based in Solon, Ohio, has extensive expertise in insurance planning for individuals, families, and businesses as well as employee benefits communications and estate planning.  It serves a number of corporations, practices, and individuals.  We own 50.1% of Dickenson.
 
 
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SMH Capital Advisors, Inc.  SMH Capital Advisors, Inc. (“SMH Capital Advisors”), a registered investment advisor located in Fort Worth, Texas, provides investment management services primarily related to high-yield fixed income securities. This business is also known by its previous name of Cummer/Moyers.  At December 31, 2010, SMH Capital Advisors managed approximately $1.7 billion in client assets.  We own 100% of SMH Capital Advisors.
 
Select Sports Group Holdings, LLC.  Select Sports Group Holdings, LLC, (“SSG”) and its affiliates, based in Houston, Texas, provide sports representation and management services to professional athletes, principally professional football players, in contract negotiation, marketing and endorsements, public relations, legal counseling, and related areas. SSG receives fees from its athlete clients for the representation and management services provided. Our SSG clients have access to our investment programs in the areas of stocks, bonds, private equity, and specialized investment vehicles. Additionally, we provide a deal-screening program that reviews the numerous investment opportunities offered to professional athletes. We own 50.5% of SSG.
 
Additionally, SMH has organized 20 proprietary funds for the purpose of investing primarily in equity or equity-linked securities, interest-bearing debt securities, and debt securities convertible into common stock. These funds invest primarily in small to mid-capitalization companies, both public and private, that we believe are either significantly undervalued relative to their growth potential or that have substantial prospects for capital appreciation. Companies in which the funds invest represent a number of industries, including life sciences, energy, technology, and industrial services. We account for our interests in the management companies of these funds using the equity method, which approximates fair value. Our direct investments in the proprietary funds are accounted for at fair value.  At December 31, 2010, the 17 remaining proprietary funds and their related investment companies that have not been liquidated managed approximately $384.0 million in assets under management and committed capital.

Institutional Services

Our institutional businesses provide institutional brokerage, fixed income brokerage, and prime brokerage services to institutional customers.
 
Institutional Equity.  Our institutional clients include a broad array of institutions throughout North America, Europe, and Asia, including banks, retirement funds, mutual funds, endowments, investment advisors, and insurance companies. Our institutional equity strategy is to provide broad based sales and trading services, together with equity research coverage focused on companies concentrated on technology. We provide our institutional clients with execution and trading services in both exchange-listed equity securities and equity securities quoted on Nasdaq. Commissions are charged on all institutional securities transactions based on rates formulated by us. We also distribute securities which we underwrite to those institutional clients.  We have institutional equity operations in Los Angeles and New York.
 
Concept Capital.  The Concept Capital division of SMH (“Concept”), based in New York, provides prime brokerage services, research and capital markets trading, fund accounting and administration. We earned commission income on the securities transactions that we processed, interest income from arranging financing for hedge funds on the platform, and fees for providing various administrative services.
 
Concept has asset management agreements with a number of individual third party asset managers to manage a portion of the Company’s assets. The Company shares in the profits or losses of these accounts and receives the commissions generated in them. The accounts are designed to diversify the aggregate risks, thus limiting potential losses or gains. Most of the accounts have escrow deposits held with a related clearing broker to insulate the Company from trading losses. We have procedures in place to monitor trading volume to ensure that in the event that any escrow deposits are depleted by a manager, activity is suspended.
 
In 2010, revenue from our institutional services business was $34.9 million and the pre-tax loss from continuing operations was $2.4 million.  As noted above, we spun-off Concept into a stand-alone operation in which we will retain a noncontrolling interest as of December 31, 2010.
 
 
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Industry Trends
 
We believe that we are well positioned to capitalize on a number of trends in the financial services industry, including:
  
 
consolidation among firms offering financial products and services;
 
 
continued and substantial growth in the high net worth and mass affluent markets;
 
 
increasing acceptance of alternative investments by many high net worth, mass affluent, and institutional investors; and
 
 
increased demand by investors for unbiased advice.
 
Our Strengths
 
The ongoing consolidation trend in the financial services industry has provided us access to many highly skilled professionals who have chosen to be part of a smaller yet sophisticated firm that has flexibility and preserves an entrepreneurial environment when providing financial services to clients. We attribute our success and distinctiveness not only to our highly skilled professionals but also to the following strengths:
 
 
Focus on Growing High Net Worth and Mass Affluent Markets.  We offer financial products and services designed to benefit both high net worth and mass affluent individuals. We believe that there is a particularly significant opportunity in providing products and services to the large and growing mass affluent market.
 
 
Highly Regarded Distribution Network and Investment Managers.  Our wealth management business includes SMH, EFS, SMH Capital Advisors, Global, Kissinger, Rikoon, Dickenson, Leonetti, and Miller-Green, each of which benefits from a sound regional reputation. Moreover, our wealth advisors and asset managers include Ric Edelman, the founder of EFS and our largest shareholder, named to Barron’s 100 Top Financial Advisors seven times (2004 - 2010), SMH Capital Advisors, a No. 1 ranked firm in 2005 and 2006 by Nelson’s World’s Best Money Managers, and Don Sanders, our Vice Chairman, who has more than 45 years of investment experience and is well-known and regarded in the Southwest.
 
 
Regional and Industry Focus.  We are a full-service regional financial services company based in Texas with 62 offices in 25 states and the District of Columbia and have achieved a strong brand recognition and sound reputation in the Southwest. Our presence in Texas allows us to focus our investment and financial advisory efforts on industries that have established markets in Texas and the Southwest, including energy, health care, technology, financial and business services, retail and consumer products, and media and communications. We believe that our focus on these industries has allowed us to develop a level of industry expertise that distinguishes us from many of our competitors.
 
 
Alignment of Interests.  Where suitable and permissible, we and members of our executive management frequently invest in the same investment opportunities as our clients, which creates a financial identity of interest and trust among our senior management, our clients, and us. We believe that by creating these wealth partnerships with our clients, we and our executives solidify our client relationships by validating the quality of the products and services that we offer. We also believe that our unbiased offering of a broad range of both proprietary and external investment products and our increasing use of an asset-based fee structure further align our interests with those of our wealth management clients.
 
 
Proven Management Team.  Our executive management averages more than 30 years of experience in the financial services industry and provides senior level management to every aspect of our business. Our executive management is supported by a core team of professionals who also have significant experience in the financial services industry. Their collective experience has resulted in a large network of both leaders of corporations and institutions and affluent investors with whom our executive management has developed extensive relationships. We strengthen these relationships further by providing our clients personalized service, senior level attention, and access to other areas of our business.
 
 
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Our Strategy
 
We believe there is an uncommon opportunity for a high quality wealth management firm that can tailor its product and service offerings to fit the needs of its individual, corporate, and institutional clients. Further, we believe we have put in place the people, infrastructure, and brand recognition at each of our businesses, which, combined with sufficient working capital, will enable us to leverage our operating platform to further increase our profitability and market share. Specifically, we intend to:
 
 
Capitalize on Growth of Our Target Markets by Expanding Our Wealth Management Business.  We intend to take advantage of favorable demographic trends to continue to expand our wealth management business by:
 
 
continuing to gather client assets through internal growth, expansion of external distribution channels, and acquisitions;
 
 
continuing to add additional experienced and productive wealth managers and wealth advisors;
 
 
marketing the skills of our wealth management professionals to our other business areas; and
 
 
continuing to develop, market, and invest in our proprietary funds.
 
We have increased our client assets and expanded our product offerings through the acquisitions of Edelman in 2005 and 2009, Rikoon in 2007, Leonetti and Miller-Green in 2008, and IFS and Global in 2010. At December 31, 2010, EFS’s client assets were $6.0 billion, Rikoon’s client assets were $417.4 million, Leonetti’s client assets were $449.0 million, Miller-Green’s client assets were $292.7 million, IFS’ client assets were $111.4 million and Global’s client assets were $4.1 billion.
 
 
Supplement Internal Growth with Strategic Acquisitions.  We plan to actively pursue opportunities to acquire all or a significant portion of other complementary wealth management businesses to gain access to additional proprietary products to offer our high net worth, mass affluent, and institutional clients, to gain access to new clients, to increase our assets under management or advisement, and to expand our geographic base. We believe that attractive acquisition opportunities exist, particularly among smaller, specialized regional financial services firms that want to affiliate with a larger company while still retaining their identity and entrepreneurial culture. Since 2000, we have acquired or gained control of 15 significant firms with products and services that we believe complement or expand our client base and the services and products that we provide. In addition, we believe that the ongoing consolidation trend in the financial services industry will allow us to continue to hire proven financial professionals who prefer the culture and opportunities inherent in an innovative regional firm such as ours.

Marketing
 
While we believe cross-selling opportunities exist among our various businesses based on the relationships developed by the individual companies, each major subsidiary has its own branding identity subject to an overall Sanders Morris Harris Group umbrella.
 
SMH markets through its 41 offices and through 43 offices of independent registered representatives who are affiliated with SMH through SMH Partners. SMH targets its client groups through financial advisor relationships, mailings, telephone calls, in-person presentations, and firm-sponsored workshops. Due to the nature of its business, its regional name recognition, and the reputation of its management, business is obtained through referrals from existing clients, corporate relationships, investment bankers, or initiated directly by the client, as well as through senior level calling programs.
 
EFS conducts its marketing efforts through media channels designed to educate individuals on the subject of personal finance. Ric Edelman hosts a nationally syndicated weekly radio program in the Washington, D.C. area and in 36 other markets.  Ric Edelman also publishes a monthly newsletter, and is the author of seven books plus video and audio educational programs designed to help people achieve their financial goals.
 
SMH Capital Advisors focuses its marketing and business development efforts on specific client groups through consultants, mailings, telephone calls, and multi-media client presentations. Kissinger conducts its marketing and business development primarily through referrals from existing clients and other professionals (i.e., accountants and attorneys) and sponsored or co-sponsored workshops and seminars. The seminars are sponsored by Kissinger, local employers, government agencies, and local colleges and universities.
 
 
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Existing and potential clients can also gain a variety of information about our firm and the services we provide through the Internet websites for our various businesses. The information on those websites is not a part of this Annual Report on Form 10-K.
 
Competition
 
The wealth management and institutional services businesses are highly competitive. The principal competitive factors influencing our businesses are:
 
 
expertise and quality of the professional staff;
 
 
reputation in the marketplace;
 
 
existing client relationships;
 
 
ability to commit capital to client transactions;
 
 
mix of market capabilities; and
 
 
quality and price of our products and services.
 
We compete directly with many other national and regional full service financial services firms and, to a lesser extent, with discount brokers, investment banking firms, investment advisors, broker-dealer subsidiaries of major commercial bank holding companies, and other companies offering financial services in the U.S., globally, and through the Internet. We also compete for wealth management services with commercial banks, private trust companies, sponsors of mutual funds, insurance companies, financial planning firms, venture capital, private equity and hedge funds, and other wealth and asset managers. We believe that our principal competitive advantages include our regional and industry focus, focus on the growing high net worth and mass affluent markets, highly regarded distribution network and investment managers, ability to cross-sell our products, creating wealth partnerships with our clients, and proven management team.
 
The financial services industry has become considerably more concentrated as many securities firms have either ceased operations or been acquired by or merged into other firms. Many of these larger firms have significantly greater financial and other resources than we do and can offer their customers more product offerings, lower pricing, broader research capabilities, access to international markets, and other products and services we do not offer, which may give these firms a competitive advantage over us.
 
During 2008 and 2009, many of our largest competitors were materially negatively affected by the global financial crisis. Certain of our larger competitors ceased to do business, while others merged, obtained substantial government assistance, and changed their business models and regulatory status, including becoming bank holding companies.  It is likely that the companies that survive will remain competitors and that they will continue to have resources and product offerings that will continue to have a competitive impact on us. The markets were not as volatile in 2010.
 
As we seek to expand our wealth management business, we face competition in the pursuit of clients interested in our services, the recruitment and retention of wealth management professionals, and the identification and acquisition of other wealth management firms that can be integrated into our group.
 
Government Regulation

The securities industry is one of the nation's most extensively regulated industries.  The U.S. Securities and Exchange Commission (“SEC”) is responsible for the administration of the federal securities laws and serves as a supervisory body over all national securities exchanges and associations.  The regulation of broker-dealers has to a large extent been delegated by the federal securities laws to Self Regulatory Organizations (“SROs”).  These SROs include, among others, all the national securities and commodities exchanges and the FINRA.  Subject to approval by the SEC and certain other regulatory authorities, SROs adopt rules that govern the industry and conduct periodic examinations of the operations of our broker-dealer subsidiary.  SMH, one of our broker-dealer subsidiaries is registered in all 50 states, Puerto Rico and is also subject to regulation under the laws of these jurisdictions. GFS BD is registered in 16 states.
 
 
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As registered broker-dealers, SMH and GFS BD, our brokerage subsidiaries, are subject to certain net capital requirements of Rule 15c3-1 under the Exchange Act.  The net capital rules, which specify minimum net capital requirements for registered broker-dealers, are designed to measure the financial soundness and liquidity of broker-dealers.  Failure to maintain the required net capital may subject a firm to suspension or revocation of registration by the SEC and suspension or expulsion by other regulatory bodies, and ultimately may require its liquidation.  Further, a decline in a broker-dealer's net capital below certain “early warning levels”, even though above minimum capital requirements, could cause material adverse consequences to the broker-dealer.
 
As registered investment advisors under the Investment Advisers Act of 1940, SMH, SMH Capital Advisors, EFS, Rikoon, Leonetti, Miller-Green, Global IA, and certain other subsidiaries are subject to the requirements of regulations under both the Investment Advisers Act and certain state securities laws and regulations.  Such requirements relate to, among other things, (1) limitations on the ability of investment advisors to charge performance-based or non-refundable fees to clients, (2) record-keeping and reporting requirements, (3) disclosure requirements, (4) limitations on principal transactions between an advisor or its affiliates and advisory clients, and (5) general anti-fraud prohibitions.
 
Additional legislation, changes in rules promulgated by the SEC and SROs, or changes in the interpretation or enforcement of existing laws and rules may directly effect the mode of our operation and profitability.
 
Employees

At December 31, 2010, we had 529 employees.  Of these, 21 are in institutional sales and trading, 11 are in securities analysis and research, 409 are in investment management, 32 are in systems development, 9 are in sports representation and management, and 47 are in accounting, administration, legal, compliance, and support operations.  None of our employees are subject to collective bargaining agreements.  We believe our relations with our employees generally are good.
 
Available Information
 
Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as well as proxy statements, are made available free of charge on our internet website, www.smhgroup.com, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
 
Additionally, we make available on our website and in print upon request of any shareholder to our Chief Financial Officer, a number of our corporate governance documents. These include: the Audit Committee charter, the Nominating and Corporate Governance Committee charter, and the Business Ethics Policy for Employees. Within the time period required by the SEC and the Nasdaq Stock Market, we will post on our website any modifications to any of the available documents. The information on our website is not incorporated by reference into this report.
 
Our Chief Financial Officer can be contacted at Sanders Morris Harris Group Inc., 600 Travis, Suite 5800, Houston, Texas 77002, telephone: (713) 224-3100.
 
Item 1A.  Risk Factors
 
We face a variety of risks that are substantial and inherent in our businesses, including market, liquidity, credit, operational, legal, and regulatory risks.  In addition to the other information included in this Form 10-K, the following risk factors should be considered in evaluating our business and future prospects.  The risk factors described below represent what we believe are the most significant risk factors with respect to us and our business.  In assessing the risks relating to our business, investors should also read the other information included in this Form 10-K, including the Consolidated Financial Statements and Notes thereto and “Item 7. – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Special Cautionary Notice Regarding Forward-Looking Statements.”
 
 
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Risks Relating to the Nature of Our Business

Recent new legislation and new and pending regulation may significantly affect our business.
 
Recent market and economic conditions have led to new legislation and regulation affecting the financial services industry, both in the United States and abroad. These new measures include limitations on the types of activities in which certain financial institutions may engage as well as more comprehensive regulation of the over-the-counter derivatives market.

These legislative and regulatory initiatives will affect not only us, but also our competitors and certain of our customers. These changes could eventually have an effect on our revenue, limit our ability to pursue certain business opportunities, impact the value of assets that we hold, require us to change certain business practices, impose additional costs on us, and otherwise adversely affect our business. Accordingly, we cannot provide assurance that the new legislation and regulation will not eventually have an adverse effect on our business, results of operations, cash flows and financial conditions.

If we do not comply with the new, or existing, legislation and regulations that apply to our operations, we may be subject to fines, penalties or material restrictions on our business in the jurisdiction where any violations occur. In recent years, regulatory oversight and enforcement have increased substantially, imposing additional costs and taxes and increasing the potential risks associated with our operations. As this regulatory trend continues, it could adversely affect our operations and, in turn, our financial results.

Difficult market conditions have adversely affected the global financial markets and the financial services industry and could adversely affect us.

The financial services industry experienced unprecedented change and volatility in 2008 and 2009. Since 2008, several large securities, insurance, and financial firms in the U. S. and elsewhere failed outright or were acquired by other financial institutions, often in distressed sales. Others received substantial government assistance and in certain cases continue to operate with substantial government assistance and oversight. Concern about the stability of financial markets and the strength of counterparties caused many traditional sources of credit, such as banks, securities firms, and insurers, as well as institutional and private investors, to reduce or cease providing funding to borrowers. Although financial markets stabilized during 2009 and improved in 2010, reflecting substantial efforts by the U.S. and other governments to restore confidence and recapitalize major financial institutions, but there can be no assurance that these conditions will continue in the near or long term. If they do not, our results of operations may be adversely affected.

The economic uncertainties and changes affecting the financial industry may cause us to face some or all of the following risks:

      We may experience losses in securities trading activities or as a result of write-downs in the value of securities that we own as a result of deteriorations in the businesses or creditworthiness of the issuers of such securities.

      Declines in stock prices and trading volumes could result in declines in commission income, margin interest revenue, asset management and service fees that could adversely affect our profitability.
 
      Our plans for expansion of our client base or the services we provide may be delayed or impaired.
 
      As an introducing broker to clearing firms, we are responsible to the clearing firms and could be held liable for the defaults of our customers, including losses incurred as the result of a customer’s failure to meet a margin call. Although we review credit exposure to specific customers, default risk may arise from events or circumstances that are difficult to detect or foresee. When we allow customers to purchase securities on margin, we are subject to risks inherent in extending credit. This risk increases when a market is rapidly declining and the value of the collateral held falls below the amount of a customer’s indebtedness. If a customer’s account is liquidated as the result of a margin call, we are liable to our clearing firm for any deficiency.

      Competition in our sales and trading businesses could intensify as a result of the increasing pressures on financial services companies and larger firms competing for transactions and business that historically would have been too small for them to consider.
 
      Our industry could face increased regulation as a result of legislative or regulatory initiatives, and the responsibilities of the SEC and other federal agencies may be reallocated. Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities.
 
 
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      New or increased taxes on compensation payments such as bonuses or on balance sheet items may adversely affect our profits.

If one or more of the foregoing risks occurs, we could experience an adverse effect, which may be material, on our business, financial condition, and results of operations.

Lack of sufficient liquidity or access to capital could impair our business and financial condition.

Historically, we have satisfied our need for funding from internally generated funds, sales of shares of our common stock to our employees and to the public, and a credit facility with a financial institution. As a result of the low level of leverage that we have traditionally employed in our business model, we have not been forced to significantly curtail our business activities as a result of lack of credit sources and we believe that our capital resources are currently sufficient to continue to support our current business activities.  In the event existing financial resources did not satisfy our needs, we might have to seek additional outside financing. The availability of outside financing will depend on a variety of factors, such as our financial condition and results of operations, the availability of acceptable collateral, market conditions, the general availability of credit, the volume of trading activities, and the overall availability of credit to the financial services industry.

The soundness of other financial institutions could adversely affect us.

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different counterparties and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, could lead to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the receivable due us. Any such losses could be material and could materially and adversely affect our business, financial condition, and results of operations.

The wealth management and institutional services industries are highly competitive. If we are not able to compete successfully against current and future competitors, our business, financial condition, and results of operations will be adversely affected.
 
The financial services business is highly competitive, and we expect it to remain so. The principal competitive factors influencing our wealth management and institutional services businesses are:
 
 
the experience and quality of the professional staff;
 
 
reputation in the marketplace;
 
 
investment performance;
 
 
existing client relationships; and
 
 
mix of market capabilities.
 
We compete directly with many other national and regional full service financial services firms and, to a lesser extent, with discount brokers, investment banking firms, investment advisors, broker-dealer subsidiaries of major commercial bank holding companies, and other companies offering financial services in the U.S., globally, and through the Internet. We also compete for wealth management services with commercial banks, private trust companies, sponsors of mutual funds, insurance companies, financial planning firms, venture capital, private equity and hedge funds, and other wealth managers.
 
 
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We are a relatively small firm with 529 employees as of December 31, 2010, and total revenue of $168.8 million in 2010. Many of our competitors have more personnel and financial resources than we do. Larger competitors are able to advertise their products and services on a national or regional basis and may have a greater number and variety of products and distribution outlets for their products, larger customer bases, and greater name recognition. These larger and better capitalized competitors may be better able to respond to changes in the wealth management and institutional services industries, to finance acquisitions, to fund internal growth, and to compete for market share generally. In addition to competition from firms currently in the securities business, there has been increasing competition from other firms offering financial services, including automated trading and other services based on technological innovations.
 
Increased pressure created by current or future competitors, individually or collectively, could materially and adversely affect our business and results of operations. Increased competition may result in reduced revenue and loss of market share. Further, as a strategic response to changes in the competitive environment, we may from time to time make certain pricing, service, or marketing decisions or acquisitions that also could materially and adversely affect our business and results of operations. In addition, new technologies and the expansion of existing technologies may increase competitive pressures on us. We may not be able to compete successfully against current and future competitors.
 
Competition also extends to the hiring and retention of highly skilled employees. A competitor may be successful in hiring away an employee or group of employees, which may result in our losing business formerly serviced by them. Such competition can also raise our costs of hiring and retaining the key employees we need to effectively execute our business plan.
 
If we are unable to compete effectively, our business, financial condition, and results of operations will be adversely affected.
 
We may experience reduced revenue due to downturns or disruptions in the securities markets that reduce market volumes, securities prices, and liquidity, which can also cause counterparties to fail to perform.
 
The securities business is, by its nature, subject to significant risks, particularly in volatile or illiquid markets, including:
 
 
the risk of trading losses;
 
 
losses resulting from the ownership or underwriting of securities;
 
 
counterparty failure to meet commitments;
 
 
customer, employee, or issuer fraud;
 
 
errors and misconduct;
 
 
failure in connection with the processing of securities transactions; and
 
 
customer litigation.
 
We are a wealth management and institutional services firm and changes in the financial markets or economic conditions in the U.S. and elsewhere in the world could adversely affect our business in many ways. The securities business is directly affected by many factors, including market, economic, and political conditions; broad trends in business and finance; investor sentiment and confidence in the financial markets; legislation and regulation affecting the national and international business and financial communities; currency values; inflation; the availability and cost of short-term and long-term funding and capital; the credit capacity or perceived creditworthiness of the securities industry in the marketplace; the level and volatility of equity prices and interest rates; and technological changes. These and other factors can contribute to lower price levels for securities and illiquid markets.
 
A market downturn could result in lower prices for securities, which may result in reduced management fees calculated as a percentage of assets managed. A market downturn could also lead to a decline in the volume of transactions that we execute for our customers and, therefore, to a decline in the revenue we receive from commissions and spreads. Fluctuations in market activity could impact the flow of investment capital into or from assets under management and advisement and the way customers allocate capital among money market, equity, fixed income, or other investment alternatives, which could negatively impact our wealth management business. In periods of low volume or price levels, profitability is further adversely affected because certain of our expenses remain relatively fixed.
 
 
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Sudden sharp declines in market values of securities can result in illiquid markets and the failure of counterparties to perform their obligations, which could make it difficult for us to sell securities, hedge securities positions, and invest funds under management. Market declines could also increase claims and litigation, including arbitration claims from customers.
 
We are also subject to risks inherent in extending credit to the extent our clearing brokers permit our customers to purchase securities on margin. The margin risk increases during rapidly declining markets when collateral values may fall below the amount our customer owes us. Any resulting losses could adversely affect our business, financial condition, and results of operations.
 
There are market, credit and counterparty, and liquidity risks associated with our market making, principal trading, merchant banking, and arbitrage activities. We may experience significant losses if the value of our marketable security positions deteriorates.
 
We conduct principal trading, market making, merchant banking, and arbitrage activities for our own account, which subjects our capital to significant risks. These activities often involve the purchase, sale, or short sale of securities as principal in markets that are characterized as relatively illiquid or that may be susceptible to rapid fluctuations in liquidity and price. Current unfavorable market conditions could limit our resale of purchased securities or the repurchase of securities sold short. These risks involve market, credit and counterparty, and liquidity risks, which could result in losses for us. Market risk relates to the risk of fluctuating values and the ability of third parties to whom we have extended credit to repay us. Credit and counterparty risks represent the potential loss due to a client or counterparty failing to perform its contractual obligations, such as delivery of securities or payment of funds. Liquidity risk relates to our inability to liquidate assets or redirect illiquid investments. In any period, we may experience losses as a result of price declines, lack of trading volume, or lack of liquidity.
 
In our merchant banking, wealth management, and other activities, we may have large concentrations in securities of, or commitments to, a single issuer or issuers engaged in a specific industry. These concentrations increase our exposure to market risks.
 
Our business depends on the services of our executive officers, senior management, and many other skilled professionals and may suffer if we lose the services of our executive officers, senior management, or other skilled professionals.
 
We depend on the continuing efforts of our executive officers and senior management. That dependence may be intensified by our decentralized operating strategy. If executive officers or members of senior management leave us, our business or prospects could be adversely affected until we attract and retain qualified replacements.
 
We derive a substantial portion of our revenue from the efforts of our financial services professionals. Therefore, our future success depends, in large part, on our ability to attract, recruit, and retain qualified financial services professionals. Demand for these professionals is high and their qualifications make them particularly mobile. These circumstances have led to escalating compensation packages in the industry. Up front payments, increased payouts, and guaranteed contracts have made recruiting these professionals more difficult and can lead to departures by current professionals. From time to time we have experienced, and we may in the future experience, losses of wealth management, sales and trading, and research professionals. Departures can also cause client defections due to close relationships between clients and the professionals. If we are unable to retain our key employees or attract, recruit, integrate, or retain other skilled professionals in the future, our business could suffer.
 
We have a number of investment advisor affiliates, including EFS, Rikoon, SMH Capital Advisors, Kissinger, Dickenson, Leonetti, Miller-Green, Global, and IFS which were founded by and are identified with specific individuals.  The departure, death, or disability of any one of these individuals could result in the loss of clients and assets under management.
 
We generally do not have employment agreements with our senior executive officers or other professionals. We attempt to retain our employees with incentives such as the issuance of our stock subject to continued employment. These incentives, however, may be insufficient in light of increasing competition for experienced professionals in the securities industry, particularly if our stock price declines or fails to appreciate sufficiently to be a competitive source of a portion of a professional’s compensation.
 
 
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Litigation and potential securities laws liabilities may adversely affect our business.
 
Many aspects of our business involve substantial risks of liability, litigation, and arbitration, which could adversely affect us. As a normal part of our business, we are from time to time named as a defendant or co-defendant in civil litigation and arbitration proceedings and as a subject of regulatory investigations arising from our business activities as a financial services firm. Some of these proceedings involve claims for substantial amounts of damages, based on allegations such as misconduct by us or our failure to properly supervise our wealth management advisors, bad investment advice, unsuitable investment recommendations or excessive trading in a client’s account by our wealth management advisors, materially false or misleading statements made in connection with securities offerings and other transactions, the advice we provide to participants in corporate transactions, and disputes over the terms and conditions of complex trading arrangements. The risks of liability, litigation, and arbitration often may be difficult to assess or quantify, and their existence and magnitude often remain unknown for substantial periods of time. In view of the inherent difficulty of predicting the outcome of legal and regulatory proceedings, particularly where the plaintiffs or regulatory authorities seek substantial or indeterminate damages or fines or where novel legal theories or a large number of parties are involved, we cannot state with confidence what the eventual outcome of currently pending matters will be or what the timing of the ultimate resolution of these matters will be. Depending on our results for a particular period, an adverse determination could have a material effect on quarterly or annual operating results in the period in which it is resolved. See “Item 3. – Legal Proceedings.”
 
Poor investment performance, in either relative or absolute terms, may reduce the profitability of our wealth management business.
 
In 2010, our wealth management revenue was $125.3 million, accounting for 74.2% of our total revenue. We derive our revenue from this business primarily from management fees that are based on committed capital, assets under management or advisement, and incentive fees, which are earned if the return of our proprietary funds exceeds certain threshold returns. Our ability to maintain or increase assets under management or advisement is subject to a number of factors, including investors’ perception of our past performance, in either relative or absolute terms, market or economic conditions, and competition from other fund managers.
 
Investment performance is one of the most important factors in retaining existing clients and competing for new wealth management business. Poor investment performance could reduce our revenue and impair our growth in a number of ways:
 
 
existing clients may withdraw funds from our wealth management business in favor of better performing products;
 
 
our incentive fees could decline or be eliminated entirely;
 
 
asset-based advisory fees could decline as a result of a decrease in assets under management;
 
 
our ability to attract funds from existing and new clients might diminish;
 
 
firms with which we have business relationships may terminate their relationships with us; and
 
 
our wealth managers and investment advisors may depart, whether to join a competitor or otherwise.
 
Even when market conditions are generally favorable, our investment performance may be adversely affected by the investment style of our wealth management and investment advisors and the particular investments that they make. To the extent our future investment performance is perceived to be poor in either relative or absolute terms, the revenue and profitability of our wealth management business will likely be reduced and our ability to attract new clients and funds will likely be impaired.
 
Our wealth management clients can terminate their relationships with us, reduce the aggregate assets under management or advisement, or shift their funds to other types of accounts with different rate structures for any number of reasons, including investment performance, changes in prevailing interest rates, inflation, changes in investment preferences of clients, changes in our reputation in the marketplace, changes in management or control of clients or third party distributors with whom we have relationships, loss of key investment management personnel or wealth advisors, and financial market performance.
 
 
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We may experience substantial fluctuations in our operating results from period to period due to the nature of our business and therefore fail to meet profitability expectations.
 
Our operating results may fluctuate from quarter to quarter and from year to year due to a combination of factors. These factors include:
 
 
levels of assets under our management;
 
 
the number of institutional and retail brokerage transactions and the commissions we receive from those transactions;
 
 
changes in the market valuations of investments held by proprietary investment funds that we organize and manage and of companies in which we have invested as a principal;
 
 
the timing of recording of wealth management fees and special allocations of income, if any;
 
 
the realization of profits and losses on principal investments;
 
 
variations in expenditures for personnel, consulting, accounting, and legal expenses;
 
 
expenses of establishing any new business units, including marketing and technology expenses; and
 
 
changes in accounting principles.
 
We depend on proprietary and third party systems, so a systems failure could significantly disrupt our business.  These and other operational risks may disrupt our business, result in regulatory action against us, or limit our growth.
 
Our business depends highly on our ability to process, on a daily basis, a large number of transactions across numerous and diverse markets, and the transactions we process have become increasingly complex. Consequently, we rely heavily on our communications and financial, accounting, and other data processing systems, including systems provided by our clearing brokers and service providers. We face operational risk arising from mistakes made in the confirmation or settlement of transactions or from transactions not being properly recorded, evaluated, or accounted.
 
If any of these systems do not operate properly or are disabled, we could suffer financial loss, a disruption of our business, liability to clients, regulatory intervention, or reputational damage. Any failure or interruption of our systems, the systems of our clearing brokers, or third party trading systems could cause delays or other problems in our securities trading activities, which could have a material adverse effect on our operating results. In addition, our clearing brokers provide our principal disaster recovery system. We cannot assure you that we or our clearing brokers will not suffer any systems failures or interruption, including ones caused by earthquake, fire, other natural disasters, power or telecommunications failure, act of God, act of war, terrorism, or otherwise, or that our or our clearing brokers’ back-up procedures and capabilities in the event of any such failure or interruption will be adequate. The inability of our or our clearing brokers’ systems to accommodate an increasing volume of transactions could also constrain our ability to expand our business.
 
Strategic investments or acquisitions may result in additional risks and uncertainties in our business.
 
We intend to grow our core businesses through both internal expansion and through strategic investments and acquisitions. To the extent we make strategic investments or acquisitions, we face numerous risks and uncertainties combining or integrating the relevant businesses and systems, including the need to combine accounting and data processing systems and management controls, and to integrate relationships with clients, vendors, and business partners. Acquisitions pose the risk that any business we acquire may lose clients or employees or could under-perform relative to expectations.
 
Our acquisition of Global expands are client base into Mexico and Central and South America. A political, economic, or financial disruption in these countries could adversely impact Global’s business. In addition, Global is subject to U.S. laws relating to money laundering and doing business with certain individuals, groups, and countries, such as the USA PATRIOT Act, which place substantial responsibilities on us with respect to knowing our customers. While we have invested and continue to invest resources in training and compliance monitoring, the expended geographical diversity of our clients and customers, as well as the vendors and other third parties that we deal with, increases the risk that we may be found in violation of such rules and regulations and any such violation could subject us to significant penalties and adversely affect our reputation.
 
 
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Growth of our business could result in increased costs.

We may incur significant expenses in connection with any expansion of our existing businesses or in connection with any strategic acquisitions and investments, if and to the extent they arise from time to time. Our overall profitability would be negatively affected if investments and expenses associated with such growth are not matched or exceeded by the revenue that is derived from such growth.
 
In the wealth management business, opening new offices involves recruiting and hiring the personnel necessary to staff the offices. Such personnel may be employed by competitors, and the retention of such individuals may require us to enter into guaranteed compensation contracts for a period following commencement of employment. The compensation terms provided for in such contracts may be fixed in whole or in part. Any guaranteed compensation expenses that cannot be adjusted based on the success or profitability of the offices could reduce our operating margins.
 
During 2009, we began to implement our plan to expand the EFS offices throughout the U.S. with the opening of six new offices in the New York City metropolitan area.  The plan called for us to open an additional 12 new EFS offices during 2010, of which eight were opened, with an additional eleven offices to be opened in 2011. These expansion efforts have required and will continue to require increased investment in management personnel, facilities, and financial and management systems and controls, all of which, in the absence of sufficient corresponding revenue growth, would cause our operating margins to decline from current levels.  In addition, we estimate that the cost of opening each new office requires expenditures of approximately $250,000.
 
Expansion also creates a need for additional compliance, documentation, risk management and internal control procedures, and often involves the hiring of additional personnel to monitor such procedures. To the extent such procedures are not adequate to appropriately monitor any new or expanded business, we could be exposed to a material loss or regulatory sanction.
 
We are a holding company and depend on our subsidiaries for dividends, distributions and other payments.
 
As a holding company, we may require dividends, distributions and other payments from our subsidiaries to fund payments on our obligations, including debt obligations. As a result, regulatory actions could impede access to funds that we need to make payments on obligations or dividend payments. In addition, because we hold equity interests in our subsidiaries, our rights as an equity holder to the assets of these subsidiaries are subordinated to any claims of the creditors of these subsidiaries. At December 31, 2010, none of our subsidiaries had any long term indebtedness to any third party.
 
Risks Related to Our Business
 
Our securities broker-dealer and investment advisor subsidiaries are subject to substantial regulation. If we fail to comply with applicable requirements, our business will be adversely affected.
 
Our businesses are subject to extensive regulation under both federal and state laws. SMH and GFS BD are registered as broker-dealers with the SEC and FINRA; SMH Capital Advisors, EFS, Rikoon, Leonetti, Miller-Green, and GFS IA are registered with the SEC as investment advisors. All of the professional agents employed by SSG are registered as certified contract advisors with the National Football League Players Association.
 
The SEC is the federal agency responsible for the administration of federal securities laws. In addition, self-regulatory organizations, principally FINRA and the securities exchanges, are actively involved in the regulation of broker-dealers. We are also subject to regulation by state securities commissions in those states in which we do business. The principal purpose of regulation and discipline of broker-dealers is the protection of clients and the securities markets rather than protection of creditors and shareholders of broker-dealers. Broker-dealers are subject to regulations that cover all aspects of the securities business, including sales methods, trade practices among broker-dealers, use and safekeeping of customers’ funds and securities, capital structure of securities firms, record-keeping, and the conduct of directors, officers, and employees.
 
 
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The SEC, FINRA, and state securities commissions may conduct administrative proceedings that can result in:
 
 
censure, fines, or civil penalties;
 
 
issuance of cease-and-desist orders;
 
 
deregistration, suspension, or expulsion of a broker-dealer or investment advisor;
 
 
suspension or disqualification of the broker-dealer’s officers or employees;
 
 
prohibition against engaging in certain lines of business; and
 
 
other adverse consequences.
 
The imposition of any penalties or orders on us could have a material adverse effect on our business, financial condition, and results of operations. The investment banking and brokerage industries have recently come under scrutiny at both the state and federal levels, and the cost of compliance and the potential liability for non-compliance has increased as a result.
 
The regulatory environment in which we operate is also subject to change. Our business may be adversely affected as a result of new or revised legislation, or changes in rules promulgated by the SEC, FINRA, and other SRO’s. We may also be adversely affected by changes in the interpretation or enforcement of existing laws and rules by the SEC and FINRA.
 
Our financial services businesses may be materially affected not only by regulations applicable to our subsidiaries as financial market intermediaries but also by regulations of general application. For example, the volume of our merchant banking and principal investment business in a given period could be affected by existing and proposed tax legislation, antitrust policy, and other governmental regulations and policies, (including the monetary policies of the Federal Reserve Board), as well as changes in interpretation or enforcement of existing laws and rules that affect the business and financial communities.
 
Our ability to comply with laws and regulations relating to our financial services businesses depends in large part upon maintaining a system to monitor compliance and our ability to attract and retain qualified compliance personnel. Although we believe we are in material compliance with all applicable laws and regulations, we may not be able to comply in the future. Any noncompliance could have a material adverse effect on our business, financial condition, and results of operations.
 
The business operations of SMH and GFS BD  may face limitations due to net capital requirements.
 
As registered broker-dealers, SMH and GFS BD are subject to the net capital rules administered by the SEC and FINRA. These rules, which specify minimum net capital requirements for registered broker-dealers and FINRA members, are designed to assure that broker-dealers maintain adequate net capital in relation to their liabilities and the size of their customers’ business. These requirements have the effect of requiring that a substantial portion of a broker-dealer’s assets be kept in cash or highly liquid investments. Failure to maintain the required net capital may subject a firm to suspension or revocation of its registration by the SEC and suspension or expulsion by FINRA and other regulatory bodies. Compliance with these net capital rules could limit operations that require extensive capital, such as underwriting or trading activities.
 
These net capital rules could also restrict our ability to withdraw capital in situations where either SMH or GFS BD has more than the minimum required capital. We may be limited in our ability to pay dividends, implement our strategies, pay interest or repay principal on our debt, and redeem or repurchase our outstanding shares. In addition, a change in these net capital rules or new rules affecting the scope, coverage, calculation, or amount of the net capital requirements, or a significant operating loss or significant charge against net capital, could have similar effects.
 
 
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Our exposure to legal liability is significant, and damages that we may be required to pay and the reputational harm that could result from legal or regulatory action against us could materially adversely affect our businesses.

We face significant legal risks in our businesses and, in recent years, the volume of claims and amount of damages sought in litigation and regulatory proceedings against financial institutions have been increasing. These risks include potential liability under securities or other laws for materially false or misleading statements made in connection with securities offerings and other transactions.  We are also potentially subject to claims arising from disputes with employees. These risks often may be difficult to assess or quantify and their existence and magnitude often remain unknown for substantial periods of time. See Item 3 — “Legal Proceedings” for a further discussion of certain legal matters applicable to us.

We depend to a large extent on our reputation for integrity and high-caliber professional services to attract and retain clients and customers. As a result, if a client or customer is not satisfied with our services, it may be more damaging in our business than in other businesses. Our activities may subject us to the risk of significant legal liabilities to our clients and aggrieved third parties. As a result, we may incur significant legal and other expenses in defending against litigation and may be required to pay substantial damages for settlements and adverse judgments. Substantial legal liability or significant regulatory action against us could have a material adverse effect on our results of operations or cause significant reputational harm to us, which could seriously harm our business and prospects.
 
Regulatory inquiries and subpoenas or other requests for information or testimony in connection with litigation may require incurrence of significant expenses, including fees for legal representation and fees associated with document production. These costs may be incurred even if we are not a target of the inquiry or a party to litigation.

There have been a number of highly publicized cases involving fraud or other misconduct by employees in the financial services industry in recent years, and we run the risk that employee misconduct could occur at our company. For example, misconduct by employees could involve the improper use or disclosure of confidential information, which could result in regulatory sanctions and serious reputational or financial harm. It is not always possible to deter employee misconduct and the precautions we take to detect and prevent this activity may not be effective in all cases, and we may suffer significant reputational harm for any misconduct by our employees.
 
Risks Relating to Owning Our Common Stock
 
The market price of our common stock may be volatile, which could adversely affect the value of your shares. Our common stock may trade at prices below your purchase price.
 
The market price of our common stock may be subject to significant fluctuations in response to many factors, including:
 
 
our perceived prospects;
 
 
the perceived prospects of the securities and financial services industries in general;
 
 
differences between our actual financial results and those expected by investors and analysts;
 
 
changes in securities analysts’ recommendations or projections;
 
 
our announcements of significant contracts, milestones, or acquisitions;
 
 
sales of substantial amounts of our common stock;
 
 
changes in general economic or market conditions, including conditions in the securities brokerage and investment banking markets;
 
 
changing conditions in the industry of one of our major client groups; and
 
 
fluctuations in stock market price and volume unrelated to us or our operating performance.
 
Many of these factors are beyond our control. Any one of the factors noted herein could have an adverse effect on the value of our common stock.  Our common stock may trade at prices below your purchase price.
 
 
17

 
 
Because our board of directors can issue common stock without shareholder approval, you could experience substantial dilution.
 
Our board of directors has the authority to issue up to 100,000,000 shares of common stock, to issue options and warrants to purchase shares of our common stock, and to issue debt convertible into common stock without shareholder approval in certain circumstances. Future issuances of additional shares of our common stock could be at values substantially below the price at which you may purchase our stock and, therefore, could represent substantial dilution. In addition, our board of directors could issue large blocks of our common stock to fend off unwanted tender offers or hostile takeovers without shareholder approval.
 
Our ability to issue “blank check” preferred stock without approval by the holders of our common stock could adversely affect your rights as a common shareholder and could be used as an anti-takeover device.
 
Our charter allows our board of directors to issue preferred stock and to determine its rights, powers, and preferences without shareholder approval (“blank check preferred stock”). Future preferred stock issued under the board’s authority could contain preferences over our common stock as to dividends, distributions, and voting power. Holders of preferred stock could, for example, be given the right to separately elect some number of our directors in all or specified events or an independent veto right over certain transactions, and redemption rights and liquidation preferences assigned to preferred shareholders could affect the residual value of your common stock. We could also use the preferred stock to deter or delay a change in control that may be opposed by management even if the transaction might be favorable to you as a common shareholder.
 
Our officers and directors own a substantial amount of our common stock and, therefore, exercise significant control over our corporate governance and affairs, which may result in their taking actions with which you do not agree.
 
Our executive officers, directors, and affiliates, and entities affiliated with them, control approximately 30% of our outstanding common stock (including exercisable stock options held by them). These shareholders, if they act together, may be able to exercise substantial influence over the outcome of all corporate actions requiring approval of our shareholders, including the election of directors and approval of significant corporate transactions, which may result in corporate action with which you do not agree. This concentration of ownership may also have the effect of delaying or preventing a change in control and might affect the market price of our common stock.
 
An impairment in the carrying value of our goodwill could adversely affect our financial condition and results of operations and share price.

Goodwill represents the difference between the purchase price of acquired companies and the related fair values of net assets acquired. Under generally accepted accounting principles, we review our goodwill and other intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is required to be tested for impairment at least annually. Factors that may be considered a change in circumstances indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable include a decline in our stock price and market capitalization, future cash flows, and slower growth rates in our industry. A significant amount of judgment is involved in determining if an indication of impairment exists. We may be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill or other intangible assets is determined, resulting in an impact on our results of operations. For example, in March 2009, we announced a loss of $58.3 million for the fourth quarter of 2008, which included non-cash goodwill and other intangible assets impairment charges of $56.7 million, due to the decline in our stock price causing our market capitalization to fall below the net book value of our assets.
 
Item 1B.  Unresolved Staff Comments
 
None.
 
Item 2.  Properties

Our principal executive office together with certain brokerage and wealth management operations of SMH are located at 600 Travis, Houston, Texas, and comprise approximately 44,000 square feet of leased office space pursuant to lease arrangements expiring in 2020.  The Company has 29 other office locations including two in California, one in Colorado, two in Illinois, four in Maryland, one in Mississippi, two in New Jersey, one in New Mexico, seven in New York, one in Ohio, one in Oklahoma, four in Texas, and three in Virginia.  We lease all of our office space which management believes, at the present time, is adequate for our business.
 
 
18

 
 
Item 3.  Legal Proceedings

Many aspects of our business involve substantial risks of liability. In the normal course of business, we have been and in the future may be named as defendant or co-defendant in lawsuits and arbitration proceedings involving primarily claims for damages. We are also involved in a number of regulatory matters arising out of the conduct of our business. There can be no assurance that these matters will not have a material adverse effect on our results of operations in any future period and a significant judgment could have a material adverse impact on our consolidated financial position, results of operations, and cash flows. In addition to claims for damages and monetary sanctions that may be made against us, we incur substantial costs in investigating and defending claims and regulatory matters.

As previously reported, in March 2009, a purchaser of Ronco Corp. (“Ronco”) convertible preferred stock filed a complaint against SMH, Palisades Master Fund, L.P. and PEF Advisors, LLC vs. Sanders Morris Harris Inc., in the 11th Judicial District Court of Harris County, Texas,  alleging common law fraud, statutory fraud in a stock transaction, violations of the Texas Securities Act, and negligent misrepresentation in connection with their purchase of $1.9 million in Ronco convertible preferred stock. In September 2010, following mediation, SMH agreed to pay the plaintiffs the sum of $225,000 to settle this matter. The settlement was finalized on October 21, 2010, and the case has been dismissed with prejudice.

Also as previously reported, in July 2009, the Bankruptcy Trustee for Ronco Corp. (“Ronco”) filed a derivative action on behalf of the shareholders of Ronco against two former directors of Ronco (who were employees of SMH) for negligently authorizing the closing of the purchase of the assets of Ronco Marketing Corp. in breach of their fiduciary duties of care and loyalty and against SMH for negligent misrepresentation, breach of fiduciary duties, breach of contract, and violation of the Texas Fraudulent Transfer Act, Diane Weil, Solely in Her Capacity as Trustee of Ronco Corporation and Ronco Marketing Corporation vs. A. Emerson Martin II, Gregg Mockenhaupt, and Sanders Morris Harris Inc., in the 190th Judicial District Court of Harris County, Texas. Following mediation, the parties to this matter agreed in principle to a settlement and dismissal, which was approved by the U.S. Bankruptcy Court that has jurisdiction over the Ronco bankruptcy proceeding on December 13, 2010. SMH contributed $50,000 to the settlement, which bars any future actions against SMH with respect to the Ronco offering.

In addition, as previously reported, in July 2008, the Dallas regional office of the Financial Industry Regulatory Authority (FINRA) conducted a routine examination of SMH’s broker-dealer activities.  SMH received an examination report on December 31, 2008, which identified a number of deficiencies in SMH’s operations.  In April 2009, SMH resolved half of the deficiencies noted through a compliance conference procedure. On October 5, 2010, SMH received a “Wells letter” notification from FINRA, which stated that the staff of FINRA had made a preliminary determination to recommend that disciplinary action be brought against SMH and two former employees based on alleged violations of certain federal securities laws and FINRA rules based on the deficiencies identified in the 2008 examination. Counsel for SMH and the former employees have reached an agreement in principle with the Dallas regional office of FINRA to resolve the matter. While the agreement must be finalized, we do not believe its impact on SMH and the Company will be material.

In view of the inherent difficulty of predicting the outcome of legal proceedings, particularly where the plaintiffs seek substantial or indeterminate damages or where novel legal theories or a large number of parties are involved, we cannot state with confidence what the eventual outcome of currently pending matters will be, what the timing of the ultimate resolution of these matters will be, or what the eventual result in each pending matter will be.  Based on currently available information, we have established reserves for certain litigation matters and our management does not believe that resolution of any matter will have a material adverse effect on our liquidity or financial position although, depending on our results for a particular period, an adverse determination could have a material effect on quarterly or annual operating results in the period in which it is resolved.

Item 4.  Reserved
 
None.
 
 
19

 
 
PART II

Item 5.  Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock trades on the Global Market Security tier of The NASDAQ Stock Market under the symbol “SMHG.”  The following table sets forth the quarterly high and low sales prices for our common stock during 2010 and 2009 for the calendar quarters indicated, each as reported on the NASDAQ National Market, and cash dividends declared per share of common stock:

 
               
Cash
 
Calendar Period
 
High
   
Low
   
Dividend
 
                   
2010:
                 
First Quarter
  $ 6.40     $ 4.50     $ 0.045  
Second Quarter
  $ 6.49     $ 5.10     $ 0.045  
Third Quarter
  $ 5.89     $ 4.89     $ 0.045  
Fourth Quarter
  $ 7.74     $ 5.48     $ 0.050  
                         
2009:
                       
First Quarter
  $ 6.45     $ 3.51     $ 0.045  
Second Quarter
  $ 6.38     $ 3.80     $ 0.045  
Third Quarter
  $ 6.21     $ 5.05     $ 0.045  
Fourth Quarter
  $ 6.25     $ 4.74     $ 0.045  

At March 7, 2011, there were 275 holders of record of our common stock.
 
Dividend Policy
 
In 2002, our board of directors instituted a policy of paying regular quarterly dividends on our common stock.  During 2005, we increased the declared quarterly dividend payment to $0.045 per share (an annual amount of $0.18 per share).  We further increased the declared quarterly dividend payment to $0.050 per share in the fourth quarter of 2010.  In March 2011, the board of directors declared an additional dividend for the first quarter of 2011 in the amount of $0.050 per share. Our declaration and payment of future dividends is subject to the discretion of our board of directors.  In exercising this discretion, the board of directors will take into account various factors, including general economic and business conditions, our strategic plans, our financial results and condition, our expansion plans, any contractual, legal and regulatory restrictions on the payment of dividends, and such other factors the board considers relevant.
 
 
20

 
 
Securities Authorized for Issuance Under Equity Compensation Plans
 
For our equity compensation plans, the following table shows, at the end of fiscal year 2010, (a) the number of securities to be issued upon the exercise of outstanding options, warrants and rights, (b) the weighted-average exercise price of such options, warrants and rights, and (c) the number of securities remaining available for future issuance under the plans, excluding those issuable upon exercise of outstanding options, warrants and rights.
 
               
Number of securities
 
               
remaining available for
 
   
Number of securities
         
future issuance under
 
   
to be issued
   
Weighted-average
   
equity compensation
 
   
upon exercise of
   
exercise price of
   
plans
 
   
outstanding options,
   
outstanding options,
   
(excluding securities
 
Plan category
 
warrants and rights
   
warrants and rights
   
reflected in column(a))
 
   
(a)
   
(b)
   
(c)
 
                   
Equity compensation plans approved by security holders
    360,000     $ 12.40       2,577,063 (1)
                         
Equity compensation plans not approved by security holders
    -       -       -  
                         
Total
    360,000     $ 12.40       2,577,063  
 

(1)
The number of shares of our common stock available for incentive awards under our 1998 Incentive Plan is the greater of 4.0 million shares or 25% of the total number of shares of our common stock from time to time outstanding.
 
The following table provides information about the Company’s share repurchase activity for the twelve months ended December 31, 2010:
 
               
Total number of
       
   
Total
         
shares purchased
   
Maximum number of
 
   
number of
   
Average
   
as part of publicly
   
shares that may yet
 
   
shares
   
price paid
   
announced plans
   
be purchased under
 
Period
 
purchased
   
per share
   
or programs (1)
   
the plans or programs
 
Janaury 1 to January 31, 2010
    92,160     $ 5.29       -       -  
February 1 to February 28, 2010
    284,700       4.73       5,685       677,832  
March 1 to March 31, 2010
    639,052       5.84       362,113       315,719  
April 1 to April 30, 2010
    110,462       6.22       -       239,444  
May 1 to May 31, 2010
    219,075       5.59       76,275       1,239,444  
June 1 to June 30, 2010
    367,558       5.69       235,113       1,004,331  
July 1 to July 31, 2010
    178,058       5.58       223,367       780,964  
August 1 to August 31, 2010
    130,547       5.33       3,617       777,347  
September 1 to September 30, 2010
    185,940       5.65       160,342       617,005  
October 1 to October 31, 2010
    159,847       5.81       97,468       519,537  
November 1 to November 30, 2010
    77,279       6.29       7,728       511,809  
December 1 to December 31, 2010
    157,072       7.39       35,485       476,324  
                                 
Total
    2,601,750     $ 5.72       1,207,193       476,324  
 

 
(1)
The Company announced a share repurchase program on November 7, 2007, to purchase up to 1.0 million shares of  the Company's shares of common stock.  On May 27, 2010, the board of directors approved the repurchase of up to an additional 1.0 million shares of common stock, subject to maximum expenditure of $2.5 million under our credit agreement.
 
 
21

 
 
Corporate Performance
 
The following chart shows a comparison of the cumulative total shareholder return on our common stock for the five-year period ended December 31, 2010, as compared to the cumulative total return of the Nasdaq Stock Market Index and the Nasdaq Financial Stocks Index, a peer group, assuming $100 was invested at market close on December 31, 2005 in our common stock and the two indices and dividends were reinvested.
 
 
 
   
Dec-05
   
Dec-06
   
Dec-07
   
Dec-08
   
Dec-09
   
Dec-10
 
Sanders Morris Harris Group Inc
  $ 100.00     $ 78.91     $ 64.45     $ 38.60     $ 36.73     $ 49.56  
Nasdaq Stock Market Index (U.S. & Foreign)
    100.00       110.31       121.92       58.44       84.91       126.86  
Nasdaq Financial Stocks Index (1)
    100.00       114.98       103.36       72.06       75.45       87.38  
 

 
(1)
The NASDAQ Financial Stocks Index is composed of all Nasdaq companies with Standard Industrial Classification codes ranging from 6000 through 6799.
 
The foregoing performance graph is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C, other than as provided in Item 201 of Regulation S-K, or to the liabilities of Section 18 of the Securities Exchange Act of 1934, and will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or Securities Exchange Act of 1934, except to the extent that we specifically incorporate it by reference.
 
 
22

 
 
Item 6.    Selected Financial Data

The following data should be read together with the Consolidated Financial Statements and their related notes and “Management's Discussion and Analysis of Financial Condition and Results of Operations” included later in this report.
 
   
Year Ended December 31,
 
   
2010
   
2009
   
2008
   
2007
   
2006
 
   
(in thousands except per share amounts)
 
Statements of Operations:
                             
Total revenue
  $ 168,843     $ 164,240     $ 171,941     $ 155,071     $ 134,297  
                                         
Income (loss) from continuing operations
  $ 16,232     $ 1,148     $ (13,423 )   $ 20,431     $ 15,815  
Income (loss) from discontinued operations, net of income taxes
     (697 )      (1,518 )      (4,974 )      499        (5,701 )
Net income (loss)
    15,535       (370 )     (18,397 )     20,930       10,114  
Less:  Net income attributable to the noncontrolling interest
     (5,839 )      (5,112 )      (6,896 )      (15,837 )      (6,708 )
Net income (loss) atttributable to Sanders Morris Harris Group Inc.
  $ 9,696     $ (5,482 )   $ (25,293 )   $ 5,093     $ 3,406  
                                         
Diluted earnings (loss) per common share:
                                       
Continuing operations
  $ 0.35     $ (0.14 )   $ (0.75 )   $ 0.18     $ 0.43  
Discontinued operations
    (0.02 )     (0.05 )     (0.19 )     0.02       (0.27 )
Net earnings (loss)
  $ 0.33     $ (0.19 )   $ (0.94 )   $ 0.20     $ 0.16  
                                         
Weighted average common shares outstanding - diluted
     29,370        28,402        26,972        25,086        20,915  
 
   
As of December 31,
 
   
2010
   
2009
   
2008
   
2007
   
2006
 
   
(in thousands except per share amounts)
 
Balance Sheet Data:
 
 
   
 
   
 
   
 
       
Cash and cash equivalents
  $ 44,521     $ 40,455     $ 28,971     $ 46,503     $ 68,861  
Securities owned
    41,691       39,380       54,559       85,567       83,929  
Total assets
    365,892       320,038       297,470       291,548       282,042  
Total liabilities
    101,534       79,411       66,111       48,265       49,982  
Sanders Morris Harris Group Inc. shareholders' equity
     226,621        224,194        222,554        223,178       219,936  
Noncontrolling interest
    37,737       16,433       8,805       20,105       12,124  
Total equity
    264,358       240,627       231,359       243,283       232,060  
Cash dividends declared per common share
  $ 0.185     $ 0.180     $ 0.180     $ 0.180     $ 0.180  
 
Refer to Note 2 – “Acquisitions and Dispositions” and Note 1 – “Principles of Consolidation” for additional information on significant transactions that impact the Balance Sheets for 2010 and 2009 for the following significant transactions:

 
·
Global acquisition
 
·
Concept disposition
 
·
Adoption of ASC Topic 810, Consolidation
 
 
23

 
 
Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations

Special Cautionary Notice Regarding Forward-Looking Statements

This Annual Report on Form 10-K includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements may relate to such matters as anticipated financial performance, future revenue or earnings, business prospects, projected ventures, new products, anticipated market performance, and similar matters.  We caution you that a variety of factors could cause our actual results to differ materially from the anticipated results or other expectations expressed in our forward-looking statements. These risks and uncertainties, many of which are beyond our control, include, but are not limited to (1) trading volume in the securities markets; (2) volatility of the securities markets and interest rates; (3) changes in regulatory requirements that could affect the demand for our services or the cost of doing business; (4) general economic conditions, both domestic and foreign, especially in the regions where we do business; (5) changes in the rate of inflation and related impact on securities markets; (6) competition from existing financial institutions and other new participants in the securities markets; (7) legal developments affecting the litigation experience of the securities industry; (8) successful implementation of technology solutions; (9) changes in valuations of our trading and warrant portfolios resulting from mark-to-market adjustments; (10) dependence on key personnel; (11) demand for our services; and (12) litigation and securities law liabilities.  See “Item 1A. – Risk Factors.”  The Company does not undertake any obligation to publicly update or revise any forward-looking statements.
 
The following discussion should be read in conjunction with the Consolidated Financial Statements and their related notes and other detailed information appearing elsewhere in this Annual Report.
 
Overview

The Company is a holding company that, through its subsidiaries and affiliates, provides wealth management and institutional services to a large and diversified group of clients and customers, including individuals, corporations, and financial institutions. A summary of these services follows:

Our Wealth Management segment provides investment advisory, wealth and investment management, and financial planning services to high net worth and mass affluent individuals and institutions, including investment strategies and alternatives, tax efficient estate and financial planning, trusts, and agent/fiduciary investment management services, throughout their financial life cycle, as well as private client brokerage services. In addition, we provide specialized wealth management products and services in specific investment styles to individuals, corporations, and institutions both through internal marketing efforts and externally through formal sub-advisory relationships and other distribution arrangements with third parties.
 
Our Institutional Services segment provides institutional equity brokerage and prime brokerage services to institutional clients, and third party management of a portion of our assets.
 
Institutional Brokerage provides institutional equity brokerage and hedge funds research to a broad array of institutions, including banks, retirement funds, mutual funds, endowments, investment advisors, and insurance companies.
 
Prime Brokerage Services provides trade execution, clearing, bookkeeping, reporting, custodial, securities borrowing, financing, research, and fund raising to hedge fund clients.  The Company maintains a small number of asset management accounts on behalf of individual asset managers through this division.
 
 
24

 
 
We are exposed to volatility and trends in the general securities market and the economy.  Due to the downturn in the market and the economic recession that began during the second half of 2008 and in the first quarter of 2009, client assets declined during the last half of 2008 and into the first quarter of 2009.  However, during the second quarter of 2009, the market began to improve and client assets have recovered resulting in, among other things, higher fee and commission revenue.  While many economists believe the recession ended some time during the first quarter of fiscal 2010, unemployment and tight credit markets continue to create an unstable economic environment, and there is no guarantee that conditions will not worsen again.  Client assets under management or advisement were as follows:

   
Client Assets(1)
 
   
(in millions)
 
       
December 31, 2007
  $ 11,344  
March 31, 2008
    11,342  
June 30, 2008
    10,979  
September 30, 2008
    10,290  
December 31, 2008
    8,627  
March 31, 2009
    8,501  
June 30, 2009
    9,534  
September 30, 2009
    10,595  
December 31, 2009
    11,273  
March 31, 2010
    11,904  
June 30, 2010
    11,085  
September 30, 2010
    12,072  
December 31, 2010
    17,106  
(1) Client assets include the gross value of assets under management directly or via outside managers and assets held in brokerage accounts for clients by outside clearing firms.
 
Fiscal year 2008 and the first quarter of 2009 was a very challenging environment for the capital markets given the unprecedented events on Wall Street that led to increased uncertainty and turmoil in the U.S. economy and global financial markets.  We made the necessary adjustments to our business and adapted to the current environment.  We focused on the following items:

 
·
preserving capital and retaining key people in order to emerge as a strong player once market stability returns;

 
·
reducing compensation and non-compensation expenses in order to operate on a positive cash basis;

 
·
closing offices that were unprofitable;

 
·
exiting business lines that are subject to greater than normal revenue and profit volatility; and

 
·
acquiring wealth management businesses that enhance or complement our existing franchise value.

Client assets increased by $5.8 billion during 2010, of which $1.5 billion was due to market appreciation and net inflows of $4.3 billion.  The acquisition of Global in December 2011 represents $4.1 billion of the total $4.3 billion of net inflows.  The Company’s 11.85% market-related increase in client assets compares with a 15.06% increase in the S&P 500 and a 12.13% increase in a 60/40 portfolio.
 
 
25

 
 
   
Twelve Months Ended December 31,
 
   
2010
   
2009
 
   
(in millions)
 
             
Client assets at January 1
  $ 11,273     $ 8,627  
Inflows (Outflows):
               
Asset Inflows
    6,661       2,307  
                  
Asset Outflows
    (2,331 )     (1,322 )
                 
Net Inflows
    4,330       985  
                 
Market Appreciation
    1,503       1,661  
Net Change
    5,833       2,646  
Client Assets at December 31
  $ 17,106     $ 11,273  
 
Growth Strategy

Our expansion of Edelman offices continues on plan.  Eight new branches have been added in 2010 in metropolitan New York, greater Washington, D.C., Chicago and South Florida.  Additional expansion offices are slated for the Richmond, Boston, San Francisco and Detroit areas in 2011.  Although the expansion costs will impact earnings over the short term, we believe this investment will add enormously to the Company’s future results of operations.

In addition, the Company plans to further build on this expansion success by seeking to acquire other high-caliber practices and has established reserves to fund this mission.  The Company added $4.1 billion in assets under management from the acquisition of Global.  Global is a registered investment advisor and broker-dealer that serves high net worth clients in international markets in Mexico, in Central and South America.  Initiatives to attract new broker-dealers and advisors who we feel add to the success and profitability of the Company are also underway.  The Company is also working to attract new clients and assets to existing businesses and is preparing a significant marketing initiative for 2011.

The prior years’ economic turmoil and upheaval in the credit markets resulted in significant dislocation in our industry.  We believe this continues to present a time of opportunity for us.  The considerable changes and challenges that many larger national firms are experiencing give us an advantage in hiring highly qualified and experienced financial advisors who have either become dislocated or disheartened with their current employer.  Financial advisors at these firms are faced with the challenge of convincing customers that their parent firm is strong and financially stable despite negative media coverage.  These financial professionals now consider regional firms like ours as serious alternatives for their business.  Our pipeline of new recruits and the quality of new recruits has increased significantly over the past two years.

We are well aligned for expansion having divested the Company of the primary capital markets units that do not complement our concentration on wealth management. We substantially completed the sale of Concept on December 31, 2010.  We continue to own an interest in CCH, the parent of the newly formed broker-dealer, CCM. Concept it is no longer an operating unit of the Company.  The Company is well capitalized and poised for growth.
 
 
26

 
 
Business Environment

Our business is sensitive to financial market conditions, which have been very volatile over the past twenty-four months.  As of December 31, 2010, equity market indices reflected an average increase from a year ago with the Dow Jones Industrial Average, the Standard & Poor’s 500 Index and the NASDAQ Composite Index up.  In contrast, the average daily volume on the New York Stock Exchange declined during 2010.  Despite the rally in the markets in the first quarter of 2010, the economic environment is challenging with the national unemployment rate at approximately 9.8% at December 31, 2010, a decrease from the high of 10% at the end of December 2009.  The Federal Reserve Board reduced the federal funds target rate to 0 – 0.25% on December 16, 2008, and has not yet begun increasing rates.  Most economists do not expect the federal funds rate will increase significantly during the first quarter of 2011.

Investors initially responded to the volatile markets with a flight to quality which, in turn, reduced yields on short-term U.S. treasury securities and produced a dramatic reduction in commercial paper issuance.  Investors are slowly moving back to high yielding investments, but this has been a slow progression.

The disruptions and developments in the general economy and the credit markets over the past twenty-four months have resulted in a range of actions by the U.S. and foreign governments to attempt to bring liquidity and order to the financial markets and to prevent a long recession in the world economy.  The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) was passed by Congress on July 15, 2010, and was signed into law on July 21, 2010.  The Act, among other things, established a Financial Stability Oversight Council and a Consumer Financial Protection Bureau whose duties will include the monitoring of domestic and international financial regulatory proposals and developments, as well as the protection of consumers.  Many regulations will be issued to implement the Act over the next twelve to twenty-four months.  We have reviewed the Act but are unable to determine the final impact that the Act will have on our operations until all of the regulations have been issued.

Components of Revenue and Expenses

Revenue. Our revenue is comprised primarily of (1) fees from asset-based advisory services, wealth management, and financial planning services; (2) commission revenue from wealth advisory, prime and institutional brokerage transactions; and (3) principal transactions.  We also earn interest on cash held and receive dividends from the equity and fixed income securities held in our corporate capital accounts, receive sales credits from third party placement agreements, earn fees through the sale of insurance products, and have realized and unrealized gains (or losses) on securities in our inventory account.

Expenses. Our expenses consist of (1) compensation and benefits; (2) floor brokerage, exchange, and clearance fees; and (3) other expenses. Compensation and benefits have both a variable component, based on revenue production, and a fixed component. The variable component includes institutional and retail sales commissions, bonuses, overrides, and other incentives. Wealth advisory and institutional commissions are based on competitive commission schedules. The fixed component includes administrative and executive salaries, payroll taxes, employee benefits, and temporary employee costs. Compensation and benefits is our largest expense item and includes wages, salaries, and benefits. During 2010, compensation and benefits represented 63.2% of total expenses and 59.3% of total revenue, compared to 58.8% of total expenses and 59.6% of total revenue during 2009.  The increase in compensation and benefits as a percentage of expenses is principally due to a $14.6 million goodwill and other intangible assets impairment charge recognized in 2009, partially offset by increased communications and data processing costs, occupancy, and other general and administrative expenses.
 
Floor brokerage, exchange, and clearance fees include clearing and trade execution costs associated with the retail, prime, and institutional brokerage business at SMH. SMH clears its transactions through several clearing firms, including Pershing, an affiliate of The Bank of New York Mellon, Goldman Sachs Execution & Clearing, L.P., First Clearing Corporation, J.P. Morgan Clearing Corp and T.D. Ameritrade.

Other expenses include (1) communications and data processing expenses, such as third-party systems, data, and software providers; (2) occupancy expenses, such as rent and utility charges for facilities; (3) interest expense; (4) goodwill and other intangible assets impairment charges; (5) amortization of intangible assets; and (6) other general and administrative expenses.
 
 
27

 
 
Results of Operations
 
Year Ended December 31, 2010 Compared to Year Ended December 31, 2009

Total revenue increased $4.6 million to $168.8 million in 2010 from $164.2 million in 2009, while total expenses decreased $8.0 million to $158.3 million in 2010 from $166.3 million in 2009.  The Company recognized goodwill and other intangible assets impairment charges of $14.6 million in 2009.  There were no such impairment charges recorded in 2010. Equity in income (loss) of limited partnerships increased to income of $12.9 million in 2010 from a loss of $1.3 million in 2009, reflecting an increase in the fair value of our investment in PTC Houston Management, Madison Williams, and in the value of fund partnership investments.  The Company recognized a $3.0 million gain on step acquisition in 2009 related to the Company’s previously-held noncontrolling interest in Edelman Financial Advisors, LLC (“EFA”).  Income from continuing operations, net of income taxes attributable to SMHG common shareholders was $10.4 million, or $0.35 per diluted common share, in 2010 compared to a loss of $4.0 million, or $0.14 per diluted common share, in 2009.

Revenue from investment advisory and related services increased from $72.0 million during 2009 to $96.7 million in 2010 as a result of an increase in average client assets.  Commission revenue decreased to $33.3 million in 2010 from $36.6 million during 2009 as a result of a decrease in trading volume in the Wealth Management segment.  Investment banking revenue increased to $4.0 million in 2010 from $2.5 million in 2009 due to an increase in selling concessions earned, partially offset by a decrease in sales credits received in investment banking transactions.  Principal transactions revenue decreased from $35.1 million in 2009 to $18.2 million in 2010 as the result of a decrease in the sale of fixed income products.  Interest and dividend income decreased from $10.7 million in 2009 to $10.3 million in 2010 as a result of decreased interest earned on notes receivable received in connection with the sale of our interests in Salient Partners, L.P. and Endowment Advisors, L.P. in 2008, as the principal balance was paid down during 2010.
 
Employee compensation and benefits increased to $101.0 million in 2010 from $97.8 million in 2009 due to higher employee commission expense related to higher revenue and to additional personnel related to the EFA acquisition and the Edelman expansion.  Floor brokerage, exchange, and clearance fees decreased to $3.8 million in 2010 from $5.2 million in 2009 due to a decrease in clearance fees in the institutional brokerage services division reflecting lower trading volume.  Communications and data processing increased to $11.4 million in 2010 from $9.7 million in 2009 due to higher clearing firm service fees resulting from the increase in trading volume in the Wealth Management segment and additional customer accounts related to the EFA acquisition and the Edelman expansion. Occupancy costs increased to $13.0 million in 2010 from $11.2 million in 2009 due to the Edelman expansion.  Interest expense decreased to $1.8 million in 2010 from $2.7 million in 2009 due to a decrease in the weighted average balance of our funded debt from 2009 to 2010.   Amortization of intangible assets increased to $1.8 million in 2010 from $1.6 million in 2009 due to the acquisition of an additional 66% membership interest in EFA on April 1, 2009 and to the acquisition of IFS in 2010.  Other general and administrative expenses increased to $26.5 million in 2010 from $23.6 million in 2009 due to an increase in advertising and other expenses related to the acquisition of EFA and to the Edelman expansion.
 
Our effective tax rate from continuing operations was 40.8% in 2010 compared to 28.5% in 2009.  The effective tax rate for 2009 was impacted by nondeductible goodwill impairment charges and state income taxes recognized for book purposes.

During the first quarter of 2009, the Company closed three retail offices.  The decision was made due to the offices’ inability to achieve sufficient revenue to offset their costs.  During the fourth quarter of 2009, the Company completed its sale of the Capital Markets Business.  The Company recorded a net loss from discontinued operations, net of income taxes of $697,000 in 2010 compared to $1.5 million in 2009 related to the closed offices, sale of the Capital Markets Business in 2009, and the sale of the Washington Research Group in 2010.  The Company recognized a gain on the sale of the Capital Markets Business of $5.9 million in 2009, and a gain on the sale of the Washington Research Group of $1.4 million in 2010,  net of income taxes, that is included in net loss from discontinued operations.
 
 
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Results by Segment

Wealth Management
 
   
Year Ended December 31,
 
   
2010
   
2009
 
    (in thousands)  
             
Revenue
  $ 125,299     $ 100,943  
                 
Income from continuing operations before income taxes
  $ 35,200     $ 25,787  
 
Revenue from wealth management increased to $125.3 million from $100.9 million and income from continuing operations before income taxes increased to $35.2 million from $25.8 million.  On April 1, 2009, the Company increased its ownership of EFA from 10% to 76%, which required a change in our method of accounting for EFA’s results to consolidation from the cost method.  Edelman opened six new offices in September 2009 and an additional eight new offices during the twelve months ended December 31, 2010.  Investment advisory and related services fees increased to $93.8 million from $71.9 million reflecting an increase in the size of our client portfolios primarily due to improvement in the general securities market and the economy.  Sales credits from syndicate transactions increased $1.8 million as a result of an increase in syndicate transactions.  Total expenses increased to $92.5 million from $74.3 million due to higher employee compensation and occupancy costs associated with the EFA acquisition, the Edelman expansion, and the increase in revenue.  Equity in income (loss) of limited partnerships increased to $2.4 million from a loss of $898,000. The increase in equity in income (loss) of limited partnerships is attributable to an increase in the value of the limited partnerships we manage.
 
Institutional Services
 
Institutional Brokerage

   
Year Ended December 31,
 
   
2010
   
2009
 
    (in thousands)  
             
Revenue
  $ 4,523     $ 4,814  
                 
Loss from continuing operations before income taxes
  $ (454 )   $ (638 )
 
Revenue from institutional services decreased to $4.5 million from $4.8 million. Commission revenue decreased as a result of a decline in the number of shares traded.  Total expenses decreased to $5.0 million from $5.5 million due to decreased employee compensation related to the lower revenue.  Loss from continuing operations before income taxes decreased to $454,000 from $638,000.

Prime Brokerage Services
 
   
Year Ended December 31,
 
   
2010
   
2009
 
    (in thousands)  
             
Revenue
  $ 30,390     $ 49,837  
                 
Income (loss) from continuing operations before income taxes
  $ (1,950 )   $ 2,311  
 
 
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Revenue from prime brokerage services decreased to $30.4 million from $49.8 million and income (loss) from continuing operations before income taxes decreased to a loss of $2.0 million from income of $2.3 million.  Principal transactions revenue decreased to $13.6 million from $27.7 million reflecting a decrease in proprietary trading revenue and a decrease in revenue earned from the sale of fixed income products.  Total expenses decreased to $31.2 million from $47.5 million due to the revenue decline.

Corporate Support and Other
 
   
Year Ended December 31,
 
   
2010
   
2009
 
   
(in thousands)
 
             
Revenue
  $ 8,631     $ 8,646  
                 
Loss from continuing operations before income taxes
  $ (9,391 )   $ (27,890 )
 
Revenue from corporate support and other remained flat at $8.6 million, and loss from continuing operations before income taxes decreased to $9.4 million from $27.9 million.  Total expenses decreased to $28.5 million from $39.1 million due primarily to $14.6 million of goodwill and other intangible assets impairment charges recognized in 2009.  This decrease was partially offset by an increase in the provision for bad debts of $1.4 million due to the write off of a note receivable made in conjunction with the Company’s investment in iProOne, Inc.  The deconsolidation of one of the limited partnerships, due to the adoption of the new accounting guidance for variable interest entities and the fair value measurement of that investment, and the increase in the fair value of our investment in Madison Williams resulted in equity in income of limited partnerships of $10.5 million for the twelve months ended December 31, 2010.  The Company recognized a $3.0 million gain on step acquisition in 2009 related to its previously-held noncontrolling interest in EFA.
 
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

Total revenue decreased $7.7 million to $164.2 million in 2009 from $171.9 million in 2008, while total expenses decreased $46.0 million to $166.3 million in 2009 from $212.3 million in 2008.  The Company recognized goodwill and other intangible assets impairment charges of $14.6 million in 2009 and $56.7 million in 2008.  Equity in income (loss) of limited partnerships decreased to a loss of $1.3 million in 2009 from income of $38.6 million in 2008, primarily due to the sale of our interests in Salient Partners, L.P. and Endowment Advisers, L.P. in 2008.  The Company recognized a $3.0 million gain on step acquisition in 2009 related to the Company’s previously-held noncontrolling interest in EFA.  Loss from continuing operations, net of income taxes attributable to SMHG common shareholders was $4.0 million, or $0.14 per diluted common share, in 2009 compared to $20.3 million, or $0.75 per diluted common share, in 2008.

Revenue from investment advisory and related services decreased from $73.8 million during 2008 to $72.0 million in 2009 as a result of a decrease in average client assets.  Commission revenue decreased to $36.6 million in 2009 from $48.9 million during 2008 as a result of a decrease in trading volume in the Wealth Management segment.  Investment banking revenue increased to $2.5 million in 2009 from $2.3 million in 2008 due to an increase in selling concessions earned, partially offset by a decrease in fees received in investment banking transactions.  Principal transactions revenue increased from $29.0 million in 2008 to $35.1 million in 2009 as the result of an increase in the sale of fixed income products.  Interest and dividend income increased from $6.7 million in 2008 to $10.7 million in 2009 as a result of interest earned on notes receivable received in connection with the sale of our interests in Salient Partners, L.P. and Endowment Advisors, L.P.
 
 
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Employee compensation and benefits decreased to $97.8 million in 2009 from $105.0 million in 2008 due to the lower employee commission costs in the prime brokerage services division.  Floor brokerage, exchange, and clearance fees decreased to $5.2 million in 2009 from $6.5 million in 2008 due to a decrease in clearance fees in the prime brokerage services division reflecting lower trading volume.  Communications and data processing decreased to $9.7 million in 2009 from $10.0 million in 2008 due to a decrease in clearing firm service fees in the prime brokerage services division. Occupancy costs increased to $11.2 million in 2009 from $10.0 million in 2008 due to the acquisition of an additional 66% membership interest in EFA on April 1, 2009 and the acquisitions of Leonetti and Miller-Green in 2008.  Interest expense increased to $2.7 million in 2009 from $147,000 in 2008 due to (1) $1.1 million of imputed interest associated with an incentive compensation payable resulting from the sale of our interests in Salient Partners, L.P. and Endowment Advisers, L.P.; (2) $717,000 of interest related to the credit facility funded in 2009; and (3) $786,000 of interest associated with the acquisition of an additional 66% membership interest in EFA on April 1, 2009.  The Company recognized goodwill and other intangible assets impairment charges of $14.6 million in 2009 and $56.7 million in 2008.  Amortization of intangible assets increased to $1.6 million in 2009 from $777,000 in 2008 due to the acquisition of additional interest in EFA.  Other general and administrative expenses increased to $23.6 million in 2009 from $23.1 million in 2008 due to increases of advertising expense at Edelman and $2.4 million in the provision for uncollectible accounts partially offset by a decrease in outside sales commissions.
 

Our effective tax rate from continuing operations was 28.5% in 2009 compared to (135.7)% in 2008.  The effective tax rate for 2008 was impacted by nondeductible goodwill impairment charges and state income taxes recognized for book purposes.

During the first quarter of 2009, the Company closed three retail offices.  The decision was made due to the offices’ inability to achieve sufficient revenue to offset their costs.  During the fourth quarter of 2009, the Company completed its sale of the Capital Markets Business.  The Company recorded a net loss from discontinued operations of $1.5 million in 2009 compared to $5.0 million in 2008 related to the closed offices and sold Capital Markets Business.  The Company recognized a gain on the sale of the Capital Markets Business of $5.9 million, net of income taxes, that is included in net loss from discontinued operations in 2009.

Results by Segment

Wealth Management
 
   
Year Ended December 31,
 
   
2009
   
2008
 
   
(in thousands)
 
             
Revenue
  $ 100,943     $ 101,950  
                 
Income from continuing operations before income taxes
  $ 25,787     $ 87,177  
 
Revenue from wealth management decreased to $100.9 million in 2009 from $102.0 million in 2008 and income from continuing operations before income taxes decreased to $25.8 million in 2009 from $87.2 million in 2008.  Investment advisory and related services revenue decreased to $71.9 million from $73.6 million as a result of a decrease in assets under management or advisement.  Commission revenue decreased to $11.6 million from $16.6 million reflecting a decline in shares traded by the firm’s wealth advisor clients due to uncertainty in the financial markets.  Interest income increased to $8.2 million from $3.4 million as a result of interest earned on notes receivable received in connection with the sale of our interests in Salient Partners, L.P. and Endowment Advisers, L.P. on August 29, 2008.  Total expenses increased to $74.3 million in 2009 from $66.7 million in 2008 primarily due to increases of $2.3 million in advertising expense and $1.6 million in occupancy expense at Edelman resulting from the Company’s acquisition of 66% of EFA on April 1, 2009.  Equity in income (loss) of limited partnerships decreased to $(898,000) from $51.9 million. The decrease in equity in income (loss) of limited partnerships is attributable to the sale of our interests in Salient Partners, L.P. and Endowment Advisers, L.P. in 2008.
 
 
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Institutional Services
 
Institutional Brokerage

   
Year Ended December 31,
 
   
2009
   
2008
 
   
(in thousands)
 
             
Revenue
  $ 4,814     $ 6,574  
                 
Loss from continuing operations before income taxes
  $ (638 )   $ (1,823 )

Revenue from institutional brokerage decreased to $4.8 million in 2009 from $6.6 million in 2008 and loss from continuing operations before income taxes decreased to $638,000 in 2009 from $1.8 million in 2008.  Commission revenue decreased by $3.1 million to $4.6 million in 2009 from $7.7 million in 2008 reflecting a decline in the number of shares traded in our institutional brokerage division.  Principal transactions revenue increased $1.6 million in 2009 compared to 2008 reflecting a decline in losses from market making activities.  Total expenses decreased to $5.5 million in 2009 from $8.4 million in 2008 due to decreased employee compensation related to the lower commission revenue.

Prime Brokerage Services

   
Year Ended December 31,
 
   
2009
   
2008
 
   
(in thousands)
 
             
Revenue
  $ 49,837     $ 61,658  
                 
Income from continuing operations before income taxes
  $ 2,311     $ 2,851  

Revenue from prime brokerage services decreased to $49.8 million in 2009 from $61.7 million in 2008 and income from continuing operations before income taxes decreased to $2.3 million in 2009 from $2.9 million in 2008.  Commission revenue and third-party marketing fees decreased to $20.3 million in 2009 from $29.6 million in 2008 reflecting a decline in hedge fund servicing revenue.  Principal transactions revenue decreased to $27.7 million in 2009 from $30.6 million in 2008 reflecting a decline in proprietary trading revenue.  Total expenses decreased to $47.5 million during 2009 from $58.8 million during 2008 reflecting a decrease in employee commission expense.

Corporate Support and Other
 
   
Year Ended December 31,
 
   
2009
   
2008
 
   
(in thousands)
 
             
Revenue
  $ 8,646     $ 1,759  
                 
Loss from continuing operations before income taxes
  $ (27,890 )   $ (89,929 )

Revenue from corporate support and other increased to $8.6 million in 2009 from $1.8 million in 2008 and the loss from continuing operations before income taxes decreased to $27.9 million in 2009 from $89.9 million in 2008.  Revenue from principal transactions, which consists principally of changes in the values of our investment portfolios, increased to income of $5.7 million from a loss of $1.7 million.  Total expenses decreased to $39.1 million in 2009 from $78.4 million in 2008.  This decrease is due to a decline in goodwill and other intangible assets impairment charges to $14.6 million in 2009 compared to $56.7 million in 2008.  Equity in loss of limited partnerships decreased to a loss of $450,000 in 2009 from a loss of $13.3 million in 2008.  The 2008 loss was primarily due to the decrease in the value of our direct investment in one limited partnership.  The Company recognized a $3.0 million gain on step acquisition in 2009 related to the Company’s previously-held noncontrolling interest in EFA.

 
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Liquidity and Capital Resources
 
Cash Requirements

The Company’s funding needs consist of (1) funds necessary to maintain current operations; (2) capital expenditure requirements, including funds needed for the Edelman expansion; (3) debt repayment; and (4) funds used for acquisitions.

We intend to satisfy our funding needs with our own capital resources, consisting largely of internally generated earnings and liquid assets, and with borrowings from outside parties.  At December 31, 2010, we had $44.5 million in cash and cash equivalents, which together with receivables from broker-dealers and clearing organizations, deposits with clearing organizations, and marketable securities owned represented 16.9% of our total assets at December 31, 2010.
 
Payments due by period for the Company’s contractual obligations at December 31, 2010 are as described in the following table:
 
   
Payment due by period
 
               
After 1 but
   
After 3 but
       
         
Within
   
within
   
within
   
After
 
   
Total
   
1 year
   
3 years
   
5 years
   
5 years
 
   
(in thousands)
 
                               
Operating lease obligations
  $ 46,162     $ 10,694     $ 18,298     $ 9,013     $ 8,157  
Repayment of borrowings, principal and interest
    27,578       6,973       13,055       7,550       -  
Earnout & CAGR cash payments for Global
    8,614       888       6,012       1,714       -  
Consideration for additional interest in Rikoon
    3,000       3,000       -       -       -  
Total
  $ 85,354     $ 21,555     $ 37,365     $ 18,277     $ 8,157  
 
Operating expenses consist of compensation and benefits, floor brokerage, exchange, and clearance fees, and other expenses. These expenses are primarily dependent on revenue and, with the exception of obligations for office rentals, should require a limited amount of capital in addition to that provided by revenue during 2011.  Currently, obligations for non-cancelable office leases total $10.7 million during 2011.  Funds required for other working capital items such as receivables, securities owned, and accounts payable, along with expenditures to repurchase stock, are expected to total between $2.0 million and $4.0 million during 2011.  Capital expenditure requirements are expected to total between $4.0 million and $6.0 million during 2011, mainly consisting of leasehold improvements, furniture, and computer equipment and software. Funds needed for acquisitions will depend on the completion of transactions that may not be identifiable until such time as the acquisition is completed.
 
Receivables turnover, calculated as annualized revenue divided by average receivables, was 1.4 for the twelve months ended December 31, 2010 and 2009.  The allowance for doubtful accounts as a percentage of receivables was 1.8% at December 31, 2010, compared to 2.2% at December 31, 2009, reflecting an improvement in the credit quality of the Company’s receivables.

For the twelve months ended December 31, 2010, net cash provided by operations was $28.8 million versus $20.9 million during the same period in 2010.  Marketable securities owned decreased by $8.9 million during  2010, securities sold, not yet purchased increased by $1.9 million and payables to broker-dealers and clearing organizations decreased by $22,000. The Company’s portfolio includes both long and short equity positions.  Our asset managers generally seek to generate profits based on trading spreads, rather than through speculation on the direction of the market and employ hedging strategies designed to insulate the net value of our portfolios from fluctuations in the general level of interest rates and equity price variances.  We finance a portion of our positions through our clearing broker-dealers.

Not readily marketable securities owned, primarily investments in limited partnerships, were $27.9 million at December 31, 2010, compared to $22.8 million at December 31, 2009.  This increase is the result of changes in the values of our investment portfolios. The Company does not intend to exit the private investment limited partnerships until dissolution. The company expects to receive its interests in the private investment limited partnerships over the remaining one to ten year life of the private investment limited partnerships.
 
 
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Capital expenditures during 2010 were $3.0 million, mainly for the purchase of leasehold improvements, furniture, and computer equipment and software necessary for the Edelman expansion.

SMH and GFS BD are subject to the Securities and Exchange Commission Uniform Net Capital Rule (SEC rule 15c3-1), which requires the maintenance of minimum net capital and requires that the ratio of aggregate indebtedness to net capital, both as defined, shall not exceed 15 to 1 (and the rule of the “applicable” exchange also provides that equity capital may not be withdrawn or cash dividends paid if the resulting net capital ratio would exceed 10 to 1).  At December 31, 2010, SMH had net capital, as defined, of $11.1 million, which was $10.3 million in excess of its required net capital of $843,000.  At December 31, 2010, GFS BD had net capital, as defined, of $727,000, which was $627,000 in excess of its required net capital of $100,000.

In view of the inherent difficulty of predicting the outcome of legal proceedings, particularly where the plaintiffs seek substantial or indeterminate damages or where novel legal theories or a large number of parties are involved, we cannot state with confidence what the eventual outcome of currently pending matters will be, what the timing of the ultimate resolution of these matters will be, or what the eventual result in each pending matter will be.  Based on currently available information, we have established reserves for certain litigation matters and our management does not believe that resolution of any matter will have a material adverse effect on our liquidity or financial position although, depending on our results for a particular period, an adverse determination could have a material effect on quarterly or annual operating results in the period in which it is resolved.
 
Critical Accounting Policies/Estimates
 
Investment – Valuation of Not Readily Marketable Securities.  Securities not readily marketable consist primarily of investments in private companies, limited partnerships, equities, options, warrants, and a bond.  Investments in private investment limited partnerships are carried at fair value and based on quarterly valuations prepared by the general partner of such partnerships, and reviewed by their valuation committee.  Investments in other limited partnerships are valued at fair value based on either internal valuation models or management’s estimate of amounts that could be realized under current market conditions assuming an orderly liquidation over a reasonable period of time.
 
Investments in not readily marketable securities, marketable securities with insufficient trading volumes, and restricted securities are carried at their estimated fair value by the Company in the absence of readily ascertainable market values.  These estimated values may differ significantly from the values that would have been used had a readily available market existed for these investments.  Such differences could be material to the financial statements.   At December 31, 2010, the investment portfolio included investments totaling $27.9 million and $22.8 million as of December 31, 2009,  whose values had been estimated by the Company in the absence of readily ascertainable market values.
  
The Company estimates the fair value of the not readily marketable securities using various valuation techniques.  The transaction price is typically its best estimate of fair value at inception.  When evidence supports a change in the carrying value, adjustments are made to reflect fair values at each measurement date.  Ongoing reviews by the Company are based on an assessment of each underlying investment, incorporating valuations that consider one or more different valuation techniques (e.g., the market approach, the income approach, or the cost approach) for which sufficient and reliable information is available.  Within Level 3, the use of market approach generally considers comparable transactions and trading multiples of comparable companies, while the use of the income approach generally consists of the net present value of the estimated future cash flows, adjusted as appropriate for liquidity, credit, market and/or other risk factors.
  
The selection of appropriate valuation techniques may be affected by the availability of relevant inputs as well as the relative reliability of the inputs.  In some cases, one valuation technique may provide the best indication of fair value while in other circumstances, multiple valuation techniques may be appropriate.  The results of the application of the various techniques may not be equally representative of fair value, due to factors such as assumptions made in the valuation.  In some situations, the Company may determine it appropriate to evaluate and weigh the results, as appropriate, to develop a range of possible values, with the fair value based on the Company’s assessment of the most representative point within the range.
  
The inputs used by the Company in estimating the value of level 3 investments include estimated capital expenditures, estimated operating costs, and risk-adjusted discount factors.  Other relevant information considered by the Company may include the following factors: original transaction price, recent public or private transactions in the same or similar assets, restrictions on transfer, including the Company’s right, if any, to require registration by the issuer of the offering and sale of securities held by the Company under the securities laws; significant recent events affecting the issuer, including significant changes in financial condition and pending mergers and acquisitions; and all other reasonable and customary factors affecting value.  The fair value measurement of level 3 investments does not include transaction costs that may have been capitalized as part of the investment’s cost basis.  Assumptions used by the Company due to the lack of observable inputs may significantly impact the resulting fair value and therefore the Company’s results of operations.
  
Goodwill and Other Intangible Assets.  Goodwill represents the excess of the aggregate purchase price over the fair value of the net assets acquired in a business combination.  Goodwill is reviewed for impairment at least annually in accordance with the provisions of FASB ASC Topic 350, Intangibles – Goodwill and Other.  ASC Topic 350 requires that goodwill be tested for impairment between annual test dates if an event or changing circumstances indicate that it is more likely than not that the fair value of the reporting unit is below its carrying amount.  The goodwill impairment test is a two-step test.  Under the first step, the fair value of the reporting unit is compared with its carrying value (including goodwill and other intangible assets).  If the fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit and the enterprise must perform step two of the impairment test (measurement).  Under step two, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill.  The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with FASB ASC Topic 805, Business Combinations.  The residual fair value after this allocation is the implied fair value of the reporting unit goodwill.

Factors considered in determining fair value include, among other things, the Company’s market capitalization as determined by quoted market prices for its common stock and the value of the Company’s reporting units.  The Company uses several methods to value its reporting units, including discounted cash flows, comparisons with valuations of public companies in the same industry, and multiples of assets under management.  If the fair value of the reporting unit exceeds its carrying value, step two does not need to be performed.
 
 
34

 
 
In performing the first step of the goodwill impairment test, the estimated fair values of the reporting units were developed using the methods listed above.  When performing the discounted cash flow analysis, the Company utilized observable market data to the extent available.  Future cash flow projections are based primarily on actual results and, at April 30, 2009, included negative future cash flows for one reporting unit.  This reporting unit has no recorded goodwill.  For the February 28, 2009 and April 30, 2009, goodwill analysis, the cash flow estimates reflect zero growth for all projected future periods.

The Company performed an update of its April 30, 2008 review for goodwill impairment as of February 28, 2009, due to deterioration in overall macroeconomic conditions and the extended decline in the Company’s stock price.  This review was performed using the methodology described above.  Future cash flow projections were based primarily on actual results with budgeted cash flow projections used for one reporting unit.  When performing the February 28, 2009 discounted cash flow analysis, no future negative cash flows were projected.  This assessment resulted in the recognition of a goodwill impairment charge of $13.8 million at two reporting units:  Edelman - $13.0 million and Kissinger - $837,000.

For the April 30, 2010 goodwill analysis, the cash flow estimates reflect 6% revenue growth and 3% expense growth for all entities, other than Edelman entities, which were based on historical growth rates and future forecasts.  Edelman reflected higher growth rates of 10% based on the Edelman expansion plan to continue expansion by opening new offices throughout the country.  The discount rates utilized in the April 30, 2010 analysis ranged from 13% to 15%.  The Company also calculates estimated fair values of the reporting units utilizing multiples of earnings, book value, and assets under management of the reporting unit.  The estimated fair value using these techniques is compared with the carrying value of the reporting unit to determine if there is an indication of impairment.  A sensitivity analysis was also performed, which did not impact management’s conclusion that there is no indication of goodwill impairment.

Management also analyzed the estimated fair values of the reporting units in relation to our market capitalization.  The sum of the estimated fair values of the Company’s reporting units was greater than the market value of the Company’s common stock.  Based upon an analysis of historical acquisitions of financial services companies similar to ours, we believe the excess of approximately 40% represents a reasonable control premium in a hypothetical acquisition of the Company.

Remaining amounts of goodwill at December 31, 2010 were as follows:  Edelman - $67.2 million, Kissinger - $2.4 million, Dickenson - $2.1 million, SMH Colorado - $1.5 million, Leonetti - $225,000, IFS $409,000, and Global - $10.8 million.  Future goodwill impairment tests may result in a future charge to earnings.

Other intangible assets consist primarily of customer relationships and trade names acquired in business combinations.  Other intangible assets acquired that have indefinite lives (trade names) are not amortized but are tested for impairment annually, or if certain circumstances indicate a possible impairment may exist.  Certain other intangible assets acquired (customer relationships and covenants not to compete) are amortized on a straight line basis over their estimated useful lives and tested for impairment if certain circumstances indicate an impairment may exist.  Other intangible assets are tested for impairment by comparing expected future cash flows to the carrying amount of the intangible assets.  The Company recognized a trade name impairment of $1.1 million during the quarter ended March 31, 2009. Indefinite lived intangible assets were tested for impairment as of April 30, 2010.  Based on the analysis performed as of April 30, 2010, there was no indication of impairment of other intangible assets.
 
Variable interest entities.
 
We have adopted accounting changes described in ASC Topic 810, Consolidation as of January 1, 2010, which require that the party who has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and who has an obligation to absorb losses of the entity or a right to receive benefits from the entity that could potentially be significant to the entity consolidate the variable interest entity. The changes to ASC 810, effective as of January 1, 2010, eliminate the quantitative approach previously applied to assessing whether to consolidate a variable interest entity and require ongoing reassessments for consolidation.
 
Effects of Inflation

Historically, inflation has not had a material effect on our consolidated financial position, results of operations or cash flows; however, the rate of inflation can be expected to affect our expenses, such as employee compensation, occupancy, and equipment. Increases in these expenses may not be readily recoverable in the prices that we charge for our services. Inflation can have significant effects on interest rates that in turn can affect prices and activities in the financial services market. These fluctuations could have an adverse impact on our financial services operations.
 
 
35

 
 
Recent Accounting Pronouncements
 
See “Note 1 — Nature of Operations and Summary of Significant Accounting Policies” in the accompanying notes to consolidated financial statements included elsewhere in this Annual Report on Form 10-K for details of recent accounting pronouncements and their expected impact on the Company’s financial statements.
 
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
 
Market Risk

The following discussion relates to our market risk sensitive instruments as of December 31, 2010.
 
Our trading equity and debt securities are marked to market on a daily basis.  At December 31, 2010, our marketable securities owned were recorded at fair value of $13.8 million.  Additionally, securities sold, not yet purchased were recorded at fair value of $10.2 million.  These trading equity and debt securities are subject to equity price risk.

Our market making and investing activities often involve the purchase, sale, or short sale of securities and expose our capital to significant risks, including market risk, equity price risk, and credit risk.  Market risk represents the potential loss we may incur as a result of absolute and relative price movements, price volatility, and changes in liquidity in financial instruments due to many factors over which we have no control. Our primary market risk arises from the fact that we own a variety of investments that are subject to changes in value and could result in material gains or losses.  We also engage in proprietary trading and make dealer markets in equity securities. In doing this, we are required to maintain certain amounts of inventories in order to facilitate customer order flow.  We are exposed to equity price risk due to changes in the level and volatility of equity prices primarily in NASDAQ and over-the-counter markets. Changes in market conditions could limit our ability to resell securities purchased or to purchase securities sold short. Direct market risk exposure to changes in foreign exchange rates is not material.  We do not use derivatives for speculative purposes.

We seek to cover our exposure to market and equity price risk by limiting our net long and short positions and by selling or buying similar instruments. In addition, trading and inventory accounts are monitored on an ongoing basis, and we have established position limits. Position and exposure reports are prepared at the end of each trading day and are reviewed by traders, trading managers, and management personnel. These reports show the amount of capital committed to various issuers and industry segments. Securities held in our investment portfolio are guided by an investment policy and are reviewed on a regular basis.

Credit risk represents the potential loss due to a client or counterparty failing to perform its contractual obligations, such as delivery of securities or payment of funds, or the value of collateral held to secure obligations proving to be inadequate as related to our margin lending activities.  This risk depends primarily on the creditworthiness of the counterparty.  We seek to control credit risk by following an established credit approval process, monitoring credit limits, and requiring collateral where appropriate.

We monitor our market and counterparty risk on a daily basis through a number of control procedures designed to identify and evaluate the various risks to which we are exposed.  We have established various committees to assess and to manage risk associated with our activities. The committees review, among other things, business and transactional risks associated with potential clients and products to be sold.

Our financial services business is affected by general economic conditions.  Our revenue relating to asset-based advisory services and managed accounts is typically from fees based on the market value of assets under management or advisement.  Due to the improvement in the overall stock market, assets under management increased, which resulted in higher management fees recorded in “Investment advisory and related services” revenue.
 
At December 31, 2010, securities owned by the Company were recorded at a fair value of $41.7 million, including $13.8 million in marketable securities, $24.5 million representing our investments in limited partnerships, and $3.4 million representing other not readily marketable securities.
 
We do not act as dealer, trader, or end-user of complex derivative contracts such as swaps, collars, and caps.  However, SMH does act as a dealer and trader of mortgage-derivative securities, called collateralized mortgage obligations (CMOs or REMICs).  Mortgage-derivative securities redistribute the risks associated with their underlying mortgage collateral by redirecting cash flows according to specific formulas or algorithms to various tranches or classes designed to meet specific investor objectives.
 
 
36

 
 
Operational Risk
 
Operational risk generally refers to the risk of loss resulting from our operations, including, but not limited to, improper or unauthorized execution and processing of transactions, deficiencies in our operating systems, business disruptions, and inadequacies or breaches in our internal control processes. Our businesses are highly dependent on our and our third party providers’ ability to process, on a daily basis, a large number of transactions across numerous and diverse markets. In addition, the transactions we process have become increasingly complex. If any of our or our third party providers’ financial, accounting, or other data processing systems do not operate properly or are disabled or if there are other shortcomings or failures in our internal processes, people, or systems, we could suffer an impairment to our liquidity, financial loss, a disruption of our businesses, liability to clients, regulatory intervention, or reputational damage. These systems may fail to operate properly or become disabled as a result of events that are wholly or partially beyond our control, including a disruption of electrical or communications services or our inability to occupy one or more of our buildings. The inability of our systems to accommodate an increasing volume of transactions could also constrain our ability to expand our businesses.
 
We also face the risk of operational failure or termination of any of the clearing agents, exchanges, clearing houses, or other financial intermediaries we use to facilitate our securities transactions. Any such failure or termination could adversely affect our ability to effect transactions and manage our exposure to risk.

In addition, despite the contingency plans we have in place, our ability to conduct business may be adversely impacted by a disruption in the infrastructure that supports our businesses and the communities in which they are located. This may include a disruption involving electrical, communications, transportation, or other services used by us or third parties with which we conduct business.

Our operations rely on the secure processing, storage, and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify them as circumstances warrant, our computer systems, software, and networks may be vulnerable to unauthorized access, computer viruses, or other malicious code, and other events that could have a security impact. If one or more of such events occur, this potentially could jeopardize our or our clients’ or counterparties’ confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our, our clients’, our counterparties’ or third parties’ operations. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured or not fully covered through any insurance maintained by us.
 
Legal and Compliance Risk

Legal and compliance risk includes the risk of non-compliance with applicable legal and regulatory requirements. We are subject to extensive regulation in the different jurisdictions in which we conduct our business. We have various procedures addressing issues such as regulatory capital requirements, sales and trading practices, use of and safekeeping of customer funds, credit granting, collection activities, anti-money laundering, and record keeping.
 
 
37

 
 
New Business Risk

New business risk refers to the risk of entering into a new line of business or offering a new product. By entering a new line of business or offering a new product, we may face risks that we are unaccustomed to dealing with and may increase the magnitude of the risks we currently face. We review proposals for new businesses and new products to determine if we are prepared to handle the additional or increased risks associated with entering into such activities.

Other Risks

Other risks encountered by us include political, regulatory, and tax risks. These risks reflect the potential impact that changes in national, state, and local laws and tax statutes have on the economics and viability of current or future transactions. In an effort to mitigate these risks, we continuously review new and pending regulations and legislation and participate in various industry interest groups.
 
 
38

 
 
Item 8.    Financial Statements and Supplementary Data

SANDERS MORRIS HARRIS GROUP INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 
Page
   
   
   
Report of Independent Registered Public Accounting Firm
40
   
Report of Independent Registered Public Accounting Firm
41
   
Consolidated Balance Sheets as of December 31, 2010 and 2009
42
   
Consolidated Statements of Operations for each of the years in the three-year period ended December 31, 2010
43
   
Consolidated Statements of Changes in Equity for each of the years in the three-year period ended December 31, 2010
44
   
Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2010
45
   
Notes to Consolidated Financial Statements
46
 
 
39

 
 
Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders
Sanders Morris Harris Group Inc.

We have audited the accompanying consolidated balance sheets of Sanders Morris Harris Group Inc. (a Texas Corporation) and subsidiaries (collectively, the Company) as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in equity, and cash flows for each of the two years in the period ended December 31, 2010.  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 the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sanders Morris Harris Group Inc. and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 1 to the consolidated financial statements, the Company adopted new accounting guidance on January 1, 2010 related to the evaluation of variable interest entities and consolidation. In addition, the Company adopted new accounting guidance on January 1, 2009 related to the accounting and reporting of noncontrolling interest in the consolidated financial statements.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Sanders Morris Harris Group Inc.’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 16, 2011 expressed an unqualified opinion and exclusion of Global Financial Services, LLC and GFS Advisors, LLC.

/s/  GRANT THORNTON LLP

 
Houston, Texas
March 16, 2011
 
 
40

 
 
Report of Independent Registered Public Accounting Firm
 
The Board of Directors and Shareholders
Sanders Morris Harris Group Inc.
  
We have audited the accompanying consolidated statements of operations, changes in equity, and cash flows of Sanders Morris Harris Group Inc. and subsidiaries (the Company) for the year ended December 31, 2008. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
  
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Sanders Morris Harris Group Inc. and subsidiaries for the year ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.
 
/s/ KPMG  LLP
 
Houston, Texas
March 16, 2009, except as to note 1, which is as of December 10, 2009, and note 23, which is as of March 16, 2010.
 
 
41

 
 
SANDERS MORRIS HARRIS GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
 
         
 
December 31,
 
         
 
2010
   
2009
 
         
           
ASSETS
 
 
   
    
 
Cash and cash equivalents
  $ 44,521     $ 40,455  
Restricted cash  
    769       1,471  
Receivables, net
    112,768       113,072  
Deposits with clearing organizations
    2,963       2,527  
Securities owned
    41,691       39,380  
Furniture, equipment, and leasehold improvements, net
    11,877       14,617  
Other assets and prepaid expenses
    2,886       2,863  
Goodwill
    84,713       73,455  
Other intangible assets, net
    63,704       32,198  
    Total assets
  $ 365,892     $ 320,038  
         
               
LIABILITIES AND EQUITY
               
Liabilities:  
               
    Accounts payable and accrued liabilities
  $ 43,447     $ 35,357  
    Borrowings  
    24,995       20,238  
    Deferred tax liability, net
    22,850       15,455  
    Securities sold, not yet purchased
    10,242       8,339  
    Payable to broker-dealers and clearing organizations
    -       22  
    Total liabilities
    101,534       79,411  
         
               
Commitments and contingencies
               
         
               
Equity:  
               
    Preferred stock, $0.10 par value; 10,000,000 shares
               
      authorized;  no shares issued and outstanding
    -       -  
    Common stock, $0.01 par value; 100,000,000 shares
               
      authorized; 30,544,092 and 29,882,238 shares issued,
               
      respectively  
    305       299  
    Additional paid-in capital
    244,674       240,450  
    Accumulated deficit
    (11,803 )     (16,555 )
    Treasury stock, at cost, 1,207,193 shares and 0 shares,
               
      respectively  
    (6,555 )     -  
    Total Sanders Morris Harris Group Inc. shareholders' equity
    226,621       224,194  
    Noncontrolling interest
    37,737       16,433  
    Total equity
    264,358       240,627  
    Total liabilities and equity
  $ 365,892     $ 320,038  
 
The accompanying notes are an integral part of these consolidated financial statements.

 
 
42

 
 
SANDERS MORRIS HARRIS GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
 
       
 
Year Ended December 31,
 
       
 
2010
   
2009
   
2008
 
Revenue:
                 
    Investment advisory and related services
  $ 96,729     $ 72,006     $ 73,759  
    Commissions
    33,298       36,590       48,876  
    Investment banking
    3,978       2,455       2,251  
    Principal transactions
    18,196       35,094       28,958  
    Interest and dividends
    10,257       10,702       6,726  
    Other income
    6,385       7,393       11,371  
    Total revenue
    168,843       164,240       171,941  
       
                       
Expenses:
                       
    Employee compensation and benefits
    100,962       97,805       104,995  
    Floor brokerage, exchange, and clearance fees
    3,832       5,183       6,469  
    Communications and data processing
    11,396       9,743       10,027  
    Occupancy
    13,019       11,166       10,041  
    Interest
    1,753       2,691       147  
    Goodwill and other intangible assets impairment charges
    -       14,575       56,698  
    Amortization of intangible assets
    1,780       1,563       777  
    Other general and administrative
    25,590       23,596       23,142  
    Total expenses
    158,332       166,322       212,296  
       
                       
Income (loss) from continuing operations before equity in income (loss)
                       
  of limited partnerships and income taxes
    10,511       (2,082 )     (40,355 )
Equity in income (loss) of limited partnerships
    12,894       (1,348 )     38,631  
Gain on step acquisition
    -       3,000       -  
Income (loss) from continuing operations before income taxes
    23,405       (430 )     (1,724 )
Provision (benefit) for income taxes
    7,173       (1,578 )     11,699  
Income (loss) from continuing operations, net of income taxes
    16,232       1,148       (13,423 )
Loss from discontinued operations, net of income taxes of
                       
  ($446), ($1,082), and ($3,007), respectively
    (697 )     (1,518 )     (4,974 )
Net income (loss)
    15,535       (370 )     (18,397 )
  Less:  Net income attributable to the noncontrolling interest
    (5,839 )     (5,112 )     (6,896 )
Net income (loss) attributable to Sanders Morris Harris Group Inc.
  $ 9,696     $ (5,482 )   $ (25,293 )
       
                       
Basic earnings (loss) per common share:
                       
      Continuing operations
  $ 0.35     $ (0.14 )   $ (0.75 )
      Discontinued operations
    (0.02 )     (0.05 )     (0.19 )
      Net earnings (loss)
  $ 0.33     $ (0.19 )   $ (0.94 )
Diluted earnings (loss) per common share:
                       
      Continuing operations
  $ 0.35     $ (0.14 )   $ (0.75 )
      Discontinued operations
    (0.02 )     (0.05 )     (0.19 )
      Net earnings (loss)
  $ 0.33     $ (0.19 )   $ (0.94 )
       
                       
Weighted average common shares outstanding:
                       
      Basic
    29,203       28,402       26,972  
      Diluted
    29,370       28,402       26,972  
       
                       
Amounts attributable to Sanders Morris Harris Group Inc. common
                       
  shareholders:
                       
      Income (loss) from continuing operations, net of income taxes
  $ 10,393     $ (3,964 )   $ (20,319 )
      Discontinued operations, net of income taxes
    (697 )     (1,518 )     (4,974 )
      Net income (loss)
  $ 9,696     $ (5,482 )   $ (25,293 )
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
43

 
 
SANDERS MORRIS HARRIS GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(in thousands, except shares and per share amounts)

   
Amounts
         
Shares
 
   
Year Ended December 31,
         
Year Ended December 31,
 
   
2010
         
2009
         
2008
         
2010
   
2009
   
2008
 
Common stock
                                                     
Balance, beginning of year
  $ 299           $ 292           $ 258             29,882,238       29,207,962       25,765,806  
Sale of stock and warrants
    -             3             -             -       277,715       -  
Stock issued for acquisition
    5             1             28             476,871       52,901       2,859,996  
Stock issued pursuant to stock-based compensation plan
    1             3             6             184,983       343,660       582,160  
Balance, end of year
    305             299             292             30,544,092       29,882,238       29,207,962  
Additional paid-in capital
                                                                 
Balance, beginning of year
    240,450             234,578             204,596                                
Sale of stock and warrants
    -             2,649             -                                
Cash settlement of stock options
    (140 )           -             -                                
Stock issued for acquisition
    2,394             (96 )           23,905                                
Unearned stock-based compensation
    152             336             -                                
Stock issued pursuant to stock-based compensation plan; including tax benefit
    239             239             3,171                                
Tax adjustment related to stock-based compensation plan
    (285 )           (999 )           -                                
Stock-based compensation expense
    1,870             3,743