10-K 1 d658682d10k.htm 10-K 10-K
Table of Contents

 

 

UNITED STATES

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, 2013

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 0-16633

 

 

THE JONES FINANCIAL COMPANIES, L.L.L.P.

(Exact name of registrant as specified in its charter)

 

 

 

MISSOURI   43-1450818

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

 

12555 Manchester Road

Des Peres, Missouri

  63131
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code (314) 515-2000

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

NONE   NONE

Securities registered pursuant to Section 12(g) of the Act:

Limited Partnership Interests

(Title of Class)

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  ¨    NO  x

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  ¨    NO  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

Indicate by check mark 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  x    NO  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicated by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

As of February 28, 2014, 639,232 units of limited partnership interest (“Interests”) are outstanding, each representing $1,000 of limited partner capital. There is no public or private market for such Interests.

DOCUMENTS INCORPORATED BY REFERENCE

None

 

 

 


Table of Contents

THE JONES FINANCIAL COMPANIES, L.L.L.P.

TABLE OF CONTENTS

 

         Page  
PART I     
Item 1  

Business

     3   
Item 1A  

Risk Factors

     15   
Item 1B  

Unresolved Staff Comments

     32   
Item 2  

Properties

     32   
Item 3  

Legal Proceedings

     33   
Item 4  

Mine Safety Disclosures

     35   
PART II     
Item 5  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     36   
Item 6  

Selected Financial Data

     36   
Item 7  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     38   
Item 7A  

Quantitative and Qualitative Disclosures about Market Risk

     59   
Item 8  

Financial Statements and Supplementary Data

     60   
Item 9  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     89   
Item 9A  

Controls and Procedures

     89   
Item 9B  

Other Information

     89   
PART III     
Item 10  

Directors, Executive Officers and Corporate Governance

     90   
Item 11  

Executive Compensation

     97   
Item 12  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     99   
Item 13  

Certain Relationships and Related Transactions, and Director Independence

     100   
Item 14  

Principal Accounting Fees and Services

     102   
PART IV     
Item 15  

Exhibits and Financial Statement Schedules

     103   
  Signatures      104   

 

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PART I

 

ITEM 1. BUSINESS

The Jones Financial Companies, L.L.L.P. (“JFC”) is a registered limited liability limited partnership organized under the Uniform Limited Partnership Law of the State of Missouri Revised Statutes. Unless expressly stated, or the context otherwise requires, the terms “Registrant” and “Partnership” refer to JFC and all of its consolidated subsidiaries. The Partnership’s principal operating subsidiary, Edward D. Jones & Co., L.P. (“Edward Jones”), was organized on February 20, 1941 and reorganized as a limited partnership on May 23, 1969. JFC was organized on June 5, 1987 and, along with Edward Jones, was reorganized on August 28, 1987.

As of December 31, 2013, the Partnership operates in two geographic segments, the United States (“U.S.”) and Canada. Edward Jones is comprised of two registered broker-dealers primarily serving individual investors in the U.S. and, through a subsidiary, Canada. As the ultimate parent company of Edward Jones, JFC is a holding company. Edward Jones primarily derives its revenue from the retail brokerage business through the sale of listed and unlisted securities and insurance products, investment banking, principal transactions, distribution of mutual fund shares, and through fees related to assets held by and account services provided to its clients. Edward Jones conducts business in the U.S. and Canada with its clients, various brokers, dealers, clearing organizations, depositories and banks. For financial information related to segments for the years ended December 31, 2013, 2012 and 2011, see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 16 to the Consolidated Financial Statements.

 

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Item 1. Business, continued

 

ORGANIZATIONAL STRUCTURE

At December 31, 2013, the Partnership was organized as follows:

 

LOGO

For additional information about the Partnership’s other subsidiaries and affiliates, see Exhibit 21.

Branch Office Network. The Partnership primarily serves individual long-term investors through its extensive network of branch offices. The Partnership operated 11,647 branch offices as of December 31, 2013, primarily staffed by a single financial advisor and a branch office administrator. Of this total, the Partnership operated 11,083 offices in the U.S. (located in all 50 states) and 564 offices in Canada.

 

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Item 1. Business, continued

 

Governance. Unlike a corporation, the Partnership is not governed by a board of directors and has no individuals who are designated as directors. Moreover, none of its securities are listed on a securities exchange and therefore the governance requirements that apply to many U.S. Securities and Exchange Commission (“SEC”) reporting companies do not apply to it. Under the terms of the Partnership’s Eighteenth Amended and Restated Partnership Agreement (“the Partnership Agreement”), the Managing Partner has primary responsibility for administering the Partnership’s business, determining its policies and controlling the management and conduct of the Partnership’s business, and has the power to admit and dismiss general partners of JFC and to adjust the proportion of their respective interests in JFC. As of December 31, 2013, JFC was composed of 371 general partners, 13,760 limited partners and 297 subordinated limited partners. See Item 10 – Directors, Executive Officers and Corporate Governance for a description of the governance structure of the Partnership.

Revenues by Source. The following table sets forth the sources of the Partnership’s revenues for the past three years. Due to the interdependence of the activities and departments of the Partnership’s investment business and the arbitrary assumptions required to allocate overhead, it is impractical to identify and specify expenses applicable to each aspect of the Partnership’s operations. Further information on revenue related to the Partnership’s segments is provided in Note 16 to the Consolidated Financial Statements and Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

($ thousands)

   2013     2012     2011  

Asset-based fees

   $ 2,522,719         44   $ 2,042,392         41   $ 1,776,883         39

Commissions

               

Mutual funds

     1,166,677         21     1,050,948         21     866,005         19

Listed and unlisted securities

     594,676         10     539,189         11     447,498         10

Insurance

     373,043         7     388,889         7     385,184         8
  

 

 

   

 

 

   

 

 

 

Total commissions

     2,134,396         38     1,979,026         39     1,698,687         37

Account and activity fees

     567,617         10     573,949         11     522,898         11

Principal transactions

     182,547         3     155,895         3     284,231         6

Interest and dividends

     133,726         2     133,469         3     130,150         3

Investment banking

     122,365         2     111,539         2     153,100         3

Other revenue

     52,281         1     31,148         1     11,553         1
  

 

 

   

 

 

   

 

 

 

Total revenue

   $ 5,715,651         100   $ 5,027,418         100   $ 4,577,502         100
  

 

 

   

 

 

   

 

 

 

Asset-based Fees

The Partnership earns fees from investment advisory services offered through Edward Jones Advisory Solutions (“Advisory Solutions”), Edward Jones Managed Account Program (“MAP”) and, in Canada, Edward Jones Portfolio Program (“Portfolio Program”) and Guided Portfolios Program. Advisory Solutions and MAP are both registered as investment advisory programs with the SEC under the Investment Advisers Act of 1940. Portfolio Program and Guided Portfolios Program are not required to be registered under this Act as services from these programs are only offered in Canada.

 

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Item 1. Business, continued

 

Advisory Solutions provides investment advisory services to its clients for a monthly fee based upon the average value of their assets in the program, and consists of a managed account invested in mutual funds, exchange-traded funds (ETFs) and money market funds, or Unified Managed Account models, which also include separately managed allocations (SMAs). For this program, the client must elect either a research or a custom account model. If the client elects a research type model, the Partnership assumes full investment discretion on the account, which will be one of numerous different research models developed and managed by Edward Jones’ Mutual Fund Research department. If the client elects to build a custom model, the Partnership assumes limited investment discretion on the account developed by the client and his or her financial advisor.

In order to accommodate the current size and expected growth in Advisory Solutions, in 2013 the Partnership launched a new sub-advised mutual fund, Bridge Builder Trust (the “Trust”), for clients of Advisory Solutions. Olive Street Investment Advisers, L.L.C. (“OLV”), a wholly-owned subsidiary of JFC and a Missouri limited liability company, was formed in December 2012 to be the investment adviser to the Bridge Builder fund. In 2013, the Trust hired OLV as the overall investment adviser to the Trust’s sub-advised mutual fund. OLV has primary responsibility for allocation of funds, setting the mutual fund’s overall investment strategies, the selection and management of subadvisors, and supervisory responsibility for the general management of the trust, subject to the review and approval by its board of trustees. As of December 31, 2013, the Trust had client assets under management of $5.9 billion.

MAP and Portfolio Program offer investment advisory services to clients, for a monthly fee based upon the average value of assets in the program, by using independent investment managers and proprietary asset allocation models. Guided Portfolios Program is a non-discretionary, fee-based program with structured investment guidelines.

In addition to the advisory programs mentioned above, the Partnership earns asset-based fees from the trust and investment management services offered to its clients through Edward Jones Trust Company (“EJTC”), a wholly-owned subsidiary of JFC.

The Partnership also earns revenue on most of its clients’ assets through service fees and other revenues received under agreements with mutual fund and insurance companies. The fees generally range from 15 to 25 basis points (0.15% to 0.25%) of the value of the client assets held.

In addition, the Partnership earns revenue sharing from certain mutual fund and insurance companies. In most cases, this is additional compensation paid by investment advisers, insurance companies or distributors based on a percentage of average assets held by the Partnership’s clients.

The Partnership is a 49.5% limited partner of Passport Research, Ltd., the investment adviser to certain money market funds made available to the Partnership’s clients. Revenue from this source is primarily based on client assets in the funds. However, due to the low interest rate environment, the investment adviser voluntarily chose (beginning in March 2009) to reduce certain fees charged to the funds to a level that will maintain a positive client yield on funds. For further information on this reduction of fees, see Item 7A – Quantitative and Qualitative Disclosures About Market Risk.

 

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Commissions

Commissions revenue consists of charges to clients for the purchase or sale of mutual fund shares, equities and insurance products. The following briefly describes the Partnership’s sources of commissions revenue.

Mutual Funds. The Partnership distributes mutual fund shares in continuous offerings and new underwritings. As a dealer in mutual fund shares, the Partnership receives a dealer’s discount which generally ranges from 1% to 5% of the purchase price of the shares, depending on the terms of each fund’s prospectus and the amount of the purchase.

Listed and Unlisted Securities. The Partnership receives a commission when it acts as an agent for a client in the purchase or sale of listed and unlisted (over-the-counter) securities. These securities include common and preferred stocks and debt securities traded on and off the securities exchanges. The commission is based on the value of the securities purchased or sold.

Insurance. The Partnership sells life insurance, long-term care insurance, disability insurance, fixed and variable annuities and other types of insurance products of unaffiliated insurance companies to its clients through its financial advisors who hold insurance sales licenses. As an agent for the insurance companies, the Partnership receives commissions on the premiums paid for the policies.

Account and Activity Fees

Revenue sources include sub-transfer agent accounting services fees, Individual Retirement Account (“IRA”) custodial services fees, and other product/service fees.

The Partnership charges fees to certain mutual fund companies for sub-transfer agent accounting services, including maintaining client account information and providing other administrative services for the mutual funds. Also, the Partnership acts as the custodian for clients’ IRA accounts and the clients are charged an annual fee for this service. Account and activity fees also include sales-based revenue sharing fees pursuant to arrangements with certain mutual fund and insurance companies where the companies pay additional compensation to the Partnership based on a percentage of current year sales by the Partnership of products supplied by these companies. The Partnership earns revenue through a co-branded credit card with a major credit card company. Previously, the Partnership earned revenue from offering mortgage loans to its clients through a joint venture. However, the joint venture partner elected to terminate the arrangement in April 2013 and the joint venture discontinued offering mortgage loans to the Partnership’s clients at that time.

Principal Transactions

The Partnership makes a market in municipal obligations, over-the-counter corporate obligations, government obligations, unit investment trusts, mortgage-backed securities and certificates of deposit. The Partnership’s market-making activities are conducted with other dealers in the “wholesale” and “retail” markets where the Partnership acts as a dealer buying from and selling to its clients. In making markets in securities, the Partnership exposes its capital to the risk of fluctuation in the fair value of its security positions. The Partnership maintains securities positions in inventory solely to support its business of buying securities from and selling securities to its retail clients and does not seek to profit by engaging in proprietary trading for its own account.

 

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Interest and Dividends

Interest and dividends revenue is earned on client margin (loan) account balances, cash and cash equivalents, cash and investments segregated under federal regulations, securities purchased under agreements to resell, partnership loans, inventory securities and investment securities. Loans secured by securities held in client margin accounts provide a source of income to the Partnership. The Partnership is permitted to use securities owned by margin clients having an aggregate market value of generally up to 140% of the debit balance in margin accounts as collateral for the borrowings. The Partnership may also use funds provided by free credit balances in client accounts to finance client margin account borrowings.

The Partnership’s interest income is impacted by the level of client margin account balances, cash and cash equivalents, cash and investments segregated under federal regulations, securities purchased under agreements to resell, partnership loans, inventory securities and investment securities and the interest rates earned on each.

Investment Banking

Investment banking revenue is primarily derived from the Partnership’s distribution of unit investment trusts, corporate and municipal obligations, and government sponsored enterprise obligations. Investment banking revenue also includes underwriting fee revenue related to underwriting and management fees as well as gross acquisition profit / loss and volume concession revenue, which is earned and collected from the issuer.

The Partnership’s investment banking activities are performed primarily by its Syndicate, Investment Banking and Unit Investment Trust departments. The principal service which the Partnership renders as an investment banker is the underwriting and distribution of securities, either in a primary distribution on behalf of the issuer of such securities or in a secondary distribution on behalf of a holder of such securities. The roles the Partnership may play include senior manager, co-manager, syndicate member, selling group member, dealer or distributor and encompass both negotiated and competitively bid offerings.

The Partnership historically has not, and does not presently engage in other investment banking activities, such as assisting in mergers and acquisitions, arranging private placement of securities issues with institutions, or providing consulting and financial advisory services to entities.

In the case of an underwritten offering managed by the Partnership, the Syndicate, Investment Banking and Unit Investment Trust departments may form underwriting syndicates and work with the branch office network for sales of the Partnership’s own participation and with other members of the syndicate in the pricing and negotiation of other terms. In offerings managed by others in which the Partnership participates as a syndicate, selling group member, dealer or distributor, these departments serve as active coordinators between the managing underwriter and the Partnership’s branch office network.

 

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The underwriting activity of the Partnership involves substantial risks. An underwriter may incur losses if it is unable to resell the securities it is committed to purchase or if it is forced to liquidate all or part of its commitment at less than the agreed upon purchase price. Furthermore, the commitment of capital to an underwriting may adversely affect the Partnership’s capital position and, as such, its participation in an underwriting may be limited by the requirement that it must at all times be in compliance with the SEC’s uniform net capital requirements (the “Uniform Net Capital Rule”).

Significant Revenue Source

As of December 31, 2013, the Partnership distributed mutual funds for approximately 75 mutual fund companies, including American Funds Distributors, Inc. which represented 19% of the Partnership’s total revenue for the year ended December 31, 2013. This revenue consisted of commissions, asset-based fees and account and activity fees, which are described above. The revenue generated from this company relates to business conducted with the Partnership’s U.S. segment.

BUSINESS OPERATIONS

Research Department. The Partnership maintains a Research department to provide specific investment recommendations and market information for clients. The department supplements its own research with the services of an independent research service. In addition, the Research department provides recommendations for asset allocation, portfolio rebalancing and investment selections for Advisory Solutions client accounts.

Client Account Administration and Operations. Employees in the Operations division are responsible for activities relating to client securities and the processing of transactions with other broker-dealers, exchanges and clearing organizations. These activities include receipt, identification, and delivery of funds and securities, internal financial controls, accounting and personnel functions, office services, custody of client securities and the handling of margin accounts. The Partnership processes substantially all of its own transactions.

To expedite the processing of orders, the Partnership’s branch office system is linked to the home office through an extensive communications network. Orders for securities are generally captured at the branch electronically, routed to the home office and forwarded to the appropriate market for execution. The Partnership’s processing of paperwork following the execution of a security transaction is generally automated.

There is considerable fluctuation during any one year and from year to year in the volume of transactions the Partnership processes. The Partnership records transactions and posts its books on a daily basis. The Partnership has a computerized branch office communication system which is principally utilized for entry of security orders, quotations, messages between offices, research of various client account information, and cash and security receipts functions. Home office personnel, including operations and compliance personnel, monitor day-to-day operations to determine compliance with applicable laws, rules and regulations. Failure to keep current and accurate books and records can render the Partnership liable to disciplinary action by governmental and self-regulatory organizations (“SROs”).

 

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The Partnership clears and settles virtually all of its listed and over-the-counter equities, municipal bond, corporate bond, mutual fund and annuity transactions for its U.S. broker-dealer through the National Securities Clearing Corporation (“NSCC”), Fixed Income Clearing Corporation (“FICC”) and Depository Trust Company (“DTC”), which are all subsidiaries of the Depository Trust and Clearing Corporation located in New York, New York.

In conjunction with clearing and settling transactions with NSCC, the Partnership holds client securities on deposit with DTC in lieu of maintaining physical custody of the certificates. The Partnership also uses a major bank for custody and settlement of treasury securities and Government National Mortgage Association (“GNMA”), Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation (“FHLMC”) issues.

The Partnership is substantially dependent upon the operational capacity and ability of NSCC, DTC, FICC, and Canadian Depository of Securities (“CDS”). Any serious delays in the processing of securities transactions encountered by these clearing and depository companies may result in delays of delivery of cash or securities to the Partnership’s clients.

Broadridge Financial Solutions, Inc. (“Broadridge”), along with its U.S. business, Securities Processing Solutions, U.S., and its international business, Securities Processing Solutions, International, provide automated data processing services for client account activity and related records for the Partnership in the U.S. and Canada, respectively. The Partnership does not employ its own floor brokers for transactions on exchanges. The Partnership has arrangements with other brokers to execute the Partnership’s transactions in return for a commission based on the size and type of trade. If, for any reason, any of the Partnership’s clearing, settling or executing agents were to fail, the Partnership and its clients would be subject to possible loss. To the extent that the Partnership would not be able to meet the obligations to the clients, such clients might experience delays in obtaining the protections afforded them.

The Canada broker-dealer has an agreement with Broadridge to provide the securities processing systems, as well as an agreement with Computershare Trust Company of Canada to act as trustee for cash balances held by clients in their retirement accounts. The Canada broker-dealer is the custodian for client securities and manages all related securities and cash processing, such as trades, dividends, corporate actions, client cash receipts and disbursements, client tax reporting and statements.

The Canada broker-dealer handles the routing and settlement of client transactions. In addition, the Canada broker-dealer is a member of CDS and FundServ for clearing and settlement of transactions. CDS effects clearing of securities on the Canadian National Stock Exchange (“CNQ”), Toronto Stock Exchange (“TSX”) and TSX Venture Exchange (“CDNX”). Client securities on deposit are also held with CDS and National Bank Correspondent Network (“NBCN”).

Employees. The Partnership’s financial advisors are employees (or general partners of the Partnership) and are not independent contractors. As of December 31, 2013, the Partnership had approximately 39,000 full and part-time employees, including its 13,158 financial advisors. The Partnership’s financial advisors are generally compensated on a commission basis and may be entitled to bonus compensation based on their respective branch office profitability and the profitability of the Partnership. The Partnership pays bonuses to its non-financial advisor employees pursuant to a discretionary formula established by management.

 

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Employees of the Partnership in the U.S. are bonded under a blanket policy as required by Financial Industry Regulation Authority, Inc. (“FINRA”) rules. The Partnership has a per occurrence coverage limit in the U.S. of $5,000,000, subject to a $500,000 deductible provision. In addition, there is excess coverage with an annual aggregate amount of $45,000,000. Employees of the Partnership in Canada are bonded under a blanket policy as required by the Investment Industry Regulation Organization of Canada (“IIROC”). The Partnership has an annual aggregate amount of coverage in Canada of C$50,000,000 with a per occurrence limit of C$25,000,000, subject to a C$50,000 deductible provision per occurrence.

The Partnership maintains an initial training program for prospective financial advisors that spans nearly four months and includes preparation for regulatory exams, concentrated instruction in the classroom and on-the-job training in a branch office. During the first phase, U.S. trainees spend nearly two months studying Series 7 and Series 66 examination materials and taking the examinations. In Canada, financial advisors have the requisite examinations completed prior to being hired. After passing the requisite examinations, trainees spend one week in a comprehensive training program in one of the Partnership’s home office training facilities, followed by seven weeks of on-the-job training in their market and in a nearby branch location. This training includes reviewing investments, compliance requirements, office procedures, and understanding client needs, as well as establishing a base of potential clients. One final week is spent in a home office training facility to complete the initial training program. Five months later, the financial advisor attends an additional training class in a home office location. The Partnership also offers periodic continuing training to its experienced financial advisors for the entirety of their career. Training programs for the more experienced financial advisors focus on meeting client needs and effective management of the branch office.

The Partnership considers its employee relations to be good and believes that its compensation and employee benefits, which include medical, life and disability insurance plans and profit sharing and deferred compensation retirement plans, are competitive with those offered by other firms principally engaged in the securities business.

Competition. The Partnership is subject to intense competition in all phases of its business from other securities firms, many of which are substantially larger than the Partnership in terms of capital, brokerage volume and underwriting activities. In addition, the Partnership encounters competition from other organizations such as banks, insurance companies, and others offering financial services and advice. The Partnership also competes with a number of firms offering discount brokerage services, usually with lower levels of personalized service to individual clients. Clients are free to transfer their business to competing organizations at any time, although a fee may be charged to do so. There is intense competition among firms for financial advisors. The Partnership experiences continued efforts by competing firms to hire away its financial advisors, although the Partnership believes its rate of turnover of financial advisors is in line with other comparable firms.

REGULATION

Broker-Dealer and Investment Adviser Regulation

Broker-dealers are subject to regulations which cover all aspects of the securities business, including sales methods, trade practices among broker-dealers, use and safekeeping of client funds and securities, client payment and margin requirements, capital structure of securities firms, record-keeping, and the conduct of directors, officers and employees.

 

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The SEC is the federal agency responsible for the administration of the U.S. securities laws. Its mission is to protect investors, maintain fair, orderly and efficient markets and facilitate capital formation. Edward Jones is registered as a broker-dealer and investment adviser with the SEC. Much of the regulation of broker-dealers has been delegated to SROs, principally FINRA. FINRA adopts rules (which are subject to approval by the SEC) that govern the broker-dealer industry and conducts periodic examinations of Edward Jones’ operations.

Securities firms are also subject to regulation by state securities commissions in those states in which they conduct business. Edward Jones is registered as a broker-dealer in all 50 states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands.

The SEC, SROs and state securities commissions may conduct administrative proceedings which can result in censure, fine, suspension or expulsion of a broker-dealer, its officers or employees. Edward Jones has in the past been, and may in the future be, the subject of regulatory actions by various agencies that have the authority to regulate its activities (see Item 3 – Legal Proceedings for more information).

As an investment dealer in all provinces and territories of Canada, the Canada broker-dealer is subject to provincial, territorial and federal laws. All provinces and territorial jurisdictions have established securities administrators to fulfill the administration of securities laws. The Canada broker-dealer is also subject to the regulation of the Canada SRO, IIROC, which oversees the business conduct and financial affairs of its member firms, as well as all trading activity on debt and equity marketplaces in Canada. IIROC fulfills its regulatory obligations by implementing and enforcing rules regarding the proficiency, business and financial conduct of member firms and their registered employees, and marketplace integrity rules regarding trading activity on Canada debt and equity marketplaces.

Pursuant to U.S. federal law, Edward Jones belongs to the Securities Investors Protection Corporation (“SIPC”). For clients in the U.S., SIPC provides $500,000 of coverage for missing cash and securities, with a maximum of $250,000 for cash claims. Pursuant to IIROC requirements, the Canada broker-dealer belongs to the Canadian Investor Protection Fund (“CIPF”), a non-profit organization that provides investor protection for investment dealer insolvency. For clients in Canada, CIPF limits coverage to C$1,000,00 in total, which can be any combination of securities and cash.

The Partnership currently maintains additional protection for U.S. clients provided by Underwriters at Lloyd’s. The additional protection contract provided by Underwriters at Lloyd’s protects clients’ accounts in excess of the SIPC coverage subject to specified limits. This policy covers theft, misplacement, destruction, burglary, embezzlement or abstraction of cash and client securities up to an aggregate limit of $900 million (with maximum cash coverage limited to $1,900,000 per client calculated on a pro rata basis) for covered claims of all U.S. clients of Edward Jones. Market losses are not covered by SIPC or the additional protection.

In addition, Edward Jones and OLV are subject to the rules and regulations of the Investment Advisers Act of 1940 which require investment advisers to register with the SEC. The rules and regulations of the Investment Advisers Act govern all aspects of the investment advisory business, including registration, trading practices, custody of client funds and securities, record-keeping, advertising and business conduct. Edward Jones and OLV are subject to examination by the SEC who is authorized to institute proceedings and impose sanctions for violations of the Investment Advisers Act.

 

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Additional legislation, changes in rules promulgated by the SEC, the Department of Labor and SROs, and/or changes in the interpretation or enforcement of existing laws and rules, may directly affect the operations and profitability of broker-dealers and investment advisers. With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), the SEC has been directed to study existing practices in the industry and granted discretionary rulemaking authority to establish, among other things, comparable standards of conduct for broker-dealers and investment advisers when providing personalized investment advice about securities to retail clients and such other clients as the SEC provides by rule. The SEC may engage in rulemaking or issue interpretive guidance concerning the standard of conduct for broker-dealers and investment advisers. FINRA or other regulatory authorities may also issue rules related to the Dodd–Frank Act, but it is unclear at this time what impact such rulemaking activities will have on the Partnership or its operations.

Trust Regulation of EJTC and Regulation of JFC as EJTC’s Parent

EJTC is a federally chartered savings and loan association and, effective October 31, 2012, operates under a limited purpose “trust-only” charter which generally restricts EJTC to acting solely in a trust or fiduciary capacity. EJTC is subject to supervision and regulation by the Office of the Comptroller of the Currency (“OCC”). EJTC’s limited purpose charter allowed JFC to deregister as a savings and loan holding company subject to regulation by the Federal Reserve. JFC is currently subject to supervision and regulation by the OCC.

Uniform Net Capital Rule

As a result of its activities as a broker-dealer and a member firm of FINRA, Edward Jones is subject to the Uniform Net Capital Rule which is designed to measure the general financial integrity and liquidity of a broker-dealer and the minimum net capital deemed necessary to meet the broker-dealer’s continuing commitments to its clients. The Uniform Net Capital Rule provides for two methods of computing net capital and Edward Jones has adopted what is generally referred to as the alternative method. Minimum required net capital under the alternative method is equal to the greater of $250,000 or 2% of the aggregate debit items, as defined. The Uniform Net Capital Rule prohibits withdrawal of equity capital whether by payment of dividends, repurchase of stock or other means, if net capital would thereafter be less than minimum requirements. Additionally, certain withdrawals require the approval of the SEC to the extent they exceed defined levels even though such withdrawals would not cause net capital to be less than 5% of aggregate debit items. In computing net capital, various adjustments are made to exclude assets which are not readily convertible into cash and to provide a conservative valuation of other assets, such as securities owned. Failure to maintain the required net capital may subject Edward Jones to suspension or expulsion by FINRA, the SEC and other regulatory bodies and/or exchanges and may ultimately require liquidation. Edward Jones has, at all times, been in compliance with the Uniform Net Capital Rule.

The Canada broker-dealer and EJTC are also required to maintain specified levels of regulatory capital. Each subsidiary has, at all times, been in compliance with the applicable capital requirements in the jurisdictions in which it operates.

 

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FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K, and in particular Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements within the meaning of U.S. securities laws. You can identify forward-looking statements by the use of the words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “will,” “should,” and other expressions which predict or indicate future events and trends and which do not relate to historical matters. You should not rely on forward-looking statements, because they involve known and unknown risks, uncertainties and other factors, some of which are beyond the control of the Partnership. These risks, uncertainties and other factors may cause the actual results, performance or achievements of the Partnership to be materially different from the anticipated future results, performance or achievements expressed or implied by the forward-looking statements.

Some of the factors that might cause differences between forward-looking statements and actual events include, but are not limited to, the following: (1) general economic conditions; (2) regulatory actions; (3) changes in legislation or regulation, including new regulations under the Dodd-Frank Act; (4) actions of competitors; (5) litigation; (6) the ability of clients, other broker-dealers, banks, depositories and clearing organizations to fulfill contractual obligations; (7) changes in interest rates; (8) changes in technology; (9) a fluctuation or decline in the fair value of securities; and (10) the risks discussed under Item 1A – Risk Factors. These forward-looking statements were based on information, plans, and estimates at the date of this report, and the Partnership does not undertake to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes.

AVAILABLE INFORMATION

The Partnership files annual, quarterly, and current reports and other information with the SEC. The Partnership’s SEC filings are available to the public on the SEC’s website at www.sec.gov.

 

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ITEM 1A. RISK FACTORS

The Partnership is subject to a number of risks potentially impacting its business, financial condition, results of operations and cash flows. In addition to the risks and uncertainties discussed elsewhere in this Annual Report on Form 10-K, or in the Partnership’s other filings with the SEC, the following are some important factors that could cause the Partnership’s actual results to differ materially from results experienced in the past or those projected in any forward-looking statement. The risks and uncertainties described below are not the only ones facing the Partnership. Additional risks and uncertainties not presently known to the Partnership or that the Partnership currently deems immaterial could also have a material adverse effect on the Partnership’s business and operations. If any of the matters included in the following risks were to occur, the Partnership’s business, financial condition, results of operations and cash flows could be materially adversely affected.

RISK RELATED TO THE PARTNERSHIP’S BUSINESS

MARKET CONDITIONS — As a part of the securities industry, a downturn in the U.S. and/or global securities markets historically has, and in the future could have, a significant negative effect on revenues and could significantly reduce or eliminate profitability of the Partnership.

General political and economic conditions and events such as U.S. fiscal policy, economic recession, natural disasters, terrorist attacks, war, changes in local economic and political conditions, regulatory changes or changes in the law, or interest rate or currency rate fluctuations could create a downturn in the U.S and/or global securities markets. The securities industry, and therefore the Partnership, is highly dependent upon market prices and volumes which are highly unpredictable and volatile in nature. Events such as global recession, frozen credit markets, and institutional failures, as well as debt ceiling debates and sovereign credit downgrades, could make the capital markets increasingly volatile. Weakened global economic conditions and unsettled financial markets, among other things, could cause significant declines in the Partnership’s net revenues which would adversely impact its overall financial results.

As the Partnership’s composition of net revenue becomes more heavily weighted towards asset-based fee revenue, a decrease in the market value of assets can have a greater negative impact on the Partnership’s financial results than experienced in prior years, due to the fact that asset-based fees are earned on the value of the underlying client assets. Conversely, in times of improved market conditions the Partnership’s asset-based fee revenue would be positively impacted due to the increase in the market value of assets on which fees are earned.

In addition, the Partnership could experience a material reduction in volume and lower securities prices in times of unfavorable economic conditions, which would result in lower commission revenue, decreased margins and losses in dealer inventory accounts and syndicate positions. This would have a material adverse impact on the profitability of the Partnership’s operations.

 

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Financial markets continue to experience volatility and the risks to sustained global economic growth remain. Furthermore, the Partnership would be subject to increased risk of its clients being unable to meet their commitments, such as margin obligations, if the market were to experience a downturn or the economy were to enter into a recession. If clients are unable to meet their margin obligations, the Partnership has an increased risk of losing money on margin transactions and incurring additional expenses defending or pursuing claims. Developments such as lower revenues and declining profit margins could reduce or eliminate the Partnership’s profitability.

LEGISLATIVE AND REGULATORY INITIATIVES — Newly adopted federal legislation and pending regulatory proposals intended to reform the financial services industry could significantly impact the regulation and operation of the Partnership and its subsidiaries. In addition, such laws and regulations may significantly alter or restrict the Partnership’s historic business practices, which could negatively affect its operating results.

The Partnership is subject to extensive regulation by federal and state regulatory agencies and by SROs, within the industry. The Partnership operates in a regulatory environment that is subject to ongoing change and has seen significantly increased regulation in recent years. The Partnership may be adversely affected as a result of new or revised legislation or regulations, changes in federal, state or foreign tax laws and regulations, or by changes in the interpretation or enforcement of existing laws and regulations. The Partnership continues to monitor several regulatory initiatives and proposed or potential rules (“Regulatory Initiatives”), including, but not limited to:

The Dodd-Frank Act. The Dodd-Frank Act, passed by the U.S. Congress and signed by the President on July 21, 2010, includes provisions that could potentially impact the Partnership’s operations. Since the passage of the Dodd-Frank Act, the Partnership has not been required to enact material changes to its operations. However, the Partnership continues to review and evaluate the provisions of the Dodd-Frank Act and the impending rules to determine what impact or potential impact it may have on the financial services industry, the Partnership and its operations. Among the numerous potentially impactful provisions in the Dodd-Frank Act are: (i) pursuant to Section 913 of the Dodd-Frank Act, the SEC staff issued a study recommending a universal fiduciary standard of care applicable to both broker-dealers and investment advisers when providing personalized investment advice about securities to retail clients, and such other clients as the SEC provides by rule; and (ii) pursuant to Section 914 of the Dodd-Frank Act, a new SRO to regulate investment advisers could be proposed. In addition, the Dodd-Frank Act contains new or enhanced regulations that could impact specific securities products offered by the Partnership to investors and specific securities transactions. Proposed rules related to all of these provisions have not yet been adopted by regulators. It is unclear what impact any such rules, if adopted, would have on the Partnership.

Department of Labor. In 2010, the Department of Labor (the “DOL”) proposed a modification to a rule that would have impacted the Employee Retirement Income Security Act’s definition of “fiduciary” and potentially limited certain of Edward Jones’ business practices. In September 2011, the DOL announced that it was withdrawing the proposed rule and stated its intention to re-propose the rule in the future. The DOL has not yet re-proposed the rule, but the Partnership expects such re-proposal to occur in the near future. The DOL has indicated that the re-proposed rule will impact IRAs and has indicated an intention to address what has been generally described as “third party payments,” such as revenue sharing. The Partnership cannot predict what the re-proposed rule will say, what its scope will be, when it will be re-proposed or adopted, or what the impact will be on the Partnership. However, any such rule could impact the operations of Edward Jones and the profitability of the Partnership.

 

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Rule 12b-1 Fees. The Partnership receives various payments in connection with the purchase, sale and on-going servicing of mutual fund shares by its clients. Those payments include Rule 12b-1 fees (i.e., service fees) and expense reimbursements. Rule 12b-1, under the Investment Company Act of 1940, allows a mutual fund to pay distribution and marketing expenses out of the fund’s assets. The SEC currently does not limit the size of Rule 12b-1 fees that funds may pay. FINRA does impose such limitations. However, in July, 2010 the SEC proposed reform of Rule 12b-1. The proposal called for the rescission of Rule 12b-1 and a proposed new Rule 12b-2 which would allow funds to deduct a fee on an annual basis of up to 25 basis points to pay for distribution expenses without a cumulative cap on this fee. Additionally, the proposal includes other amendments that would permit funds to deduct an asset-based distribution fee in which the fund may deduct ongoing sales charges with no annual limit, but cumulatively the asset-based distribution fee could not exceed the amount of the highest front-end load for a particular fund. The proposed rule also allows funds to create and distribute a class of shares at net asset value and dealers could establish their own fee schedule. The proposal includes additional requirements for disclosure on trade confirmations and in fund documents. These proposed rules have not been enacted and the Partnership cannot predict with any certainty whether or which of these proposals will be enacted in their current form, revised form or not enacted at all. In addition, the Partnership is not yet able to determine the potential financial impact on its operating results related to this proposed reform of Rule 12b-1. For further information on the amount of Rule 12b-1 fees earned by the Partnership, see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Health Care Reform. The Patient Protection and Affordable Care Act (“PPACA”) was signed into law in March, 2010, amended and revised by the Health Care and Education and Reconciliation Act of 2010 (“collectively referred to as “Affordable Care Act”). The Affordable Care Act requires employers to provide affordable coverage with minimum value to full-time employees or pay a financial penalty and pay other fees for providing coverage. The Affordable Care Act contains provisions that go into effect over the next several years that expand employee eligibility for the Partnership’s medical plan and place certain requirements on plan design. Regulatory guidance required to fully assess the impact of this law is still forthcoming. The impact on 2014 is expected to be immaterial. The Partnership is not yet able to determine the full potential financial impact on its operating results for fiscal 2015 and beyond.

Federal “Do Not Call” Regulations. The Partnership is also subject to federal and state regulations like other businesses and must evaluate and adapt to new regulations as they are adopted. In particular, the Partnership believes the federal “do not call” regulations enacted in recent years have affected the manner in which many of its financial advisors conduct their businesses. While the Partnership believes it is in compliance with these regulations, these regulations could impact the Partnership’s future revenues or results of operations.

Money Market Mutual Funds. On June 5, 2013, the SEC proposed rules to reform money market mutual funds. The proposal includes two alternative reforms, which could be adopted separately or in combination. The first alternative would require institutional prime funds to move to a floating net asset value (“NAV”). Alternative one would maintain the stable NAV for all government money market funds and other retail money market funds, defined by the proposal as any money market funds that limit shareholder redemptions to no more than $1 million per business day. Alternative two would permit money market funds to maintain a stable NAV, but provide for liquidity fees and redemption gates as a mechanism to counter shareholder redemptions in times of market stress.

 

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This alternative would require a non-government money market fund’s board to impose a two percent liquidity fee if a fund’s level of liquid assets falls below 15% of the fund’s total assets, unless the board determines this is not in the shareholder’s best interest. The fund board could also postpone or gate shareholder redemptions for up to 30 days should a fund fall below the 15% threshold. The SEC’s proposal also includes additional diversification and disclosure requirements that would apply under either alternative. The Partnership cannot predict with any certainty whether the SEC will adopt one of these alternatives, a hybrid approach combining the two alternatives, or decide to take a completely different approach to money market reform based on the written comments received from interested parties to this proposal. SEC adoption of any money market reform could have a financial impact on the Partnership’s operating results, but the Partnership has not yet been able to determine what that impact may be.

The Regulatory Initiatives may impact the manner in which the Partnership markets its products and services, manages its business and operations, and interacts with clients and regulators, any or all of which could materially impact the Partnership’s results of operations, financial condition, and liquidity. However, the Partnership cannot presently predict when or if any Regulatory Initiatives will be enacted or the impact that any Regulatory Initiatives will have on the Partnership.

COMPETITIONThe Partnership is subject to intense competition for clients and personnel, and many of its competitors have greater resources.

All aspects of the Partnership’s business are highly competitive. The Partnership competes for clients and personnel directly with other securities firms and increasingly with other types of organizations and other businesses offering financial services, such as banks and insurance companies. Many of these organizations have substantially greater capital and additional resources, and some entities offer a wider range of financial services. Over the past several years, there has been significant consolidation of firms in the financial services industry, forcing the Partnership to compete with larger firms with greater capital and resources, brokerage volume and underwriting activities, and more competitive pricing. Also, the Partnership continues to compete with a number of firms offering discount brokerage services, usually with lower levels of personalized service to individual clients. Clients are free to transfer their business to competing organizations at any time, although there may be a fee to do so.

Competition among financial services firms also exists for financial advisors and other personnel. The Partnership’s continued ability to expand its business and to compete effectively depends on the Partnership’s ability to attract qualified employees and to retain and motivate current employees. If the Partnership’s profitability decreases, then bonuses paid to financial advisors and other personnel, along with profit-sharing contributions, may be decreased or eliminated, increasing the risk that personnel could be hired away by competitors. In addition, the Partnership has recently faced increased competition from larger firms in its non-urban markets, and from a broad range of firms in the urban and suburban markets in which the Partnership competes.

The competitive pressure the Partnership experiences could have an adverse effect on its business, results of operations, financial condition and cash flow. For additional information, see Item 1 - Business Operations - Competition.

 

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BRANCH OFFICE SYSTEM — The Partnership’s system of maintaining branch offices primarily staffed by one financial advisor may expose the Partnership to risk of loss or liability from the activities of the financial advisors and to increases in rent related to increased real property values.

Most of the Partnership’s branch offices are staffed by a single financial advisor and a branch office administrator without an onsite supervisor as would be found at broker-dealers with multi-broker branches. The Partnership’s primary supervisory activity is conducted from its home offices. Although this method of supervision is designed to comply with all applicable industry and regulatory requirements, it is possible that the Partnership is exposed to a risk of loss arising from alleged imprudent or illegal actions of its financial advisors. Furthermore, the Partnership may be exposed to further losses if additional time elapses before its supervisory personnel detect problem activity.

The Partnership maintains personal financial and account information and other documents and instruments for its clients at its branch offices, both physically and in electronic format. Despite reasonable precautions, because the branch offices are relatively small and some are in remote locations, the security systems at these branch offices may not prevent theft of such information. If security of a branch is breached and personal financial and account information is stolen, the Partnership’s clients may suffer financial harm and the Partnership could suffer financial harm, reputational damage and regulatory issues.

In addition, the Partnership leases its branch office spaces and a material increase in the value of real property may increase the amount of rent paid, which will negatively impact the Partnership’s profitability.

INABILITY TO ACHIEVE GROWTH RATE — If the Partnership is unable to fully achieve its goals for hiring financial advisors or the attrition rate of its financial advisors is higher than its expectations, the Partnership may not be able to meet its planned growth rates or maintain its current number of financial advisors.

Historically, during market downturns, it is more difficult for the Partnership to attract qualified applicants for financial advisor positions. In addition, the Partnership relies heavily on referrals from its current financial advisors in recruiting new financial advisors. During an economic downturn, current financial advisors can be less effective in recruiting potential new financial advisors through referrals.

Regardless of the presence of a market downturn, the Partnership has not historically been able to consistently meet its growth objectives. For 2013, the Partnership grew by 695 financial advisors, slightly less than its annual growth objective. There can be no assurance that the Partnership will be able to grow at desired rates in future periods or maintain its current number of financial advisors.

 

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A significant number of the Partnership’s financial advisors have been licensed as brokers for less than three years. As a result of their relative inexperience, many of these financial advisors have encountered or may encounter difficulties developing or expanding their businesses. Consequently, the Partnership has periodically experienced higher rates of attrition, particularly with respect to the less experienced financial advisors and especially during market downturns. The Partnership generally loses more than half of its financial advisors who have been licensed for less than three years. The Partnership may experience increased financial advisor attrition due to increased competition from other financial services companies and efforts by those firms to recruit its financial advisors. There can be no assurance that the attrition rates the Partnership has experienced in the past will not increase in the future.

Either the failure to achieve hiring goals or an attrition rate higher than anticipated may result in a decline in the revenue the Partnership receives from commissions and other securities related revenues. As a result, the Partnership may not be able to either maintain its current number of financial advisors or achieve the level of net growth upon which its business model is based and its revenues and results of operations may be adversely impacted.

INCREASED FINANCIAL ADVISOR COMPENSATIONThe Partnership has recently increased the compensation it pays to new financial advisors and implemented a retirement transition plan for current financial advisors, both of which could negatively impact its profitability and capital.

In order to attract candidates to become financial advisors, the Partnership has recently increased the compensation paid to new financial advisors during the first three years as a financial advisor. The intent is to attract a greater number of high quality recruits with an enhanced level of guaranteed compensation in order to meet the Partnership’s growth objectives and ability to serve more clients. If this increase in new financial advisor compensation does not comparatively increase the level of productivity and retention rate of these financial advisors, then the additional compensation could negatively impact the Partnership’s financial performance in future periods.

Additionally, to better transition clients to a new financial advisor when their current financial advisor retires, as well as to retain quality financial advisors until retirement, a new retirement transition plan has recently been announced that offers increased financial consideration prior to and after retirement for financial advisors who provide client transition services in accordance with a retirement transition agreement. If this increased financial consideration does not increase client asset retention or help to retain quality financial advisors until retirement, the additional financial consideration could negatively impact the Partnership’s profitability and capital in future periods.

LITIGATION AND REGULATORY INVESTIGATIONS AND PROCEEDINGSAs a securities firm, the Partnership is subject to litigation involving civil plaintiffs seeking substantial damages and regulatory investigations and proceedings, which have increased over time and are expected to continue to increase.

Many aspects of the Partnership’s business involve substantial litigation and regulatory risks. The Partnership is, from time to time, subject to examinations and informal inquiries by regulatory and other governmental agencies.

 

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Such matters have in the past, and could in the future, lead to formal actions, which may impact the Partnership’s business. In the ordinary course of business, the Partnership also is subject to arbitration claims, lawsuits and other significant litigation such as class action suits. Over time, there has been increasing litigation involving the securities industry, including class action suits that generally seek substantial damages.

The Partnership has incurred significant expenses to defend and/or settle claims in the past. In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases in which claimants seek substantial or indeterminate damages or in actions which are at very preliminary stages, the Partnership cannot predict with certainty the eventual loss or range of loss related to such matters. Due to the uncertainty related to litigation and regulatory investigations and proceedings, the Partnership cannot determine if future litigation will have a material adverse effect on its consolidated financial condition. Such legal actions may be material to future operating results for a particular period or periods. See Item 3 – Legal Proceedings for more information regarding unresolved claims.

RELIANCE ON THIRD PARTIESThe Partnership’s dependence on third-party organizations exposes the Partnership to disruption if their products and services are no longer offered, supported or develop defects.

The Partnership incurs obligations to its clients which are supported by obligations from firms within the industry, especially those firms with which the Partnership maintains relationships by which securities transactions are executed. The inability of an organization with which the Partnership does a large volume of business to promptly meet its obligations could result in substantial losses to the Partnership.

The Partnership is particularly dependent on Broadridge, which acts as the Partnership’s primary vendor for providing accounting and record-keeping for client accounts in both the U.S. and Canada. The Partnership’s communications and information systems are integrated with the information systems of Broadridge. There are relatively few alternative providers to Broadridge and although the Partnership has analyzed the feasibility of performing Broadridge’s functions internally, the Partnership may not be able to do it in a cost-effective manner or otherwise. Consequently, any new computer systems or software packages implemented by Broadridge which are not compatible with the Partnership’s systems, or any other interruption or the cessation of service by Broadridge as a result of systems limitations or failures, could cause unanticipated disruptions in the Partnership’s business which may result in financial losses and/or disciplinary action by governmental agencies and/or SROs.

CANADA OPERATIONS The Partnership is focusing heavily on efforts, and intends to continue to make substantial investments, to support its Canada operations, which have not yet achieved profitability.

The Partnership commenced operations in Canada in 1994 and plans to continue to expand its branch system in Canada. Canada operations have operated at a substantial deficit from inception. The Partnership intends to make additional investments in its Canada operations to address short-term liquidity, capital, or expansion needs, which could be substantial.

There is no assurance Canada operations will ultimately become profitable. For further information on Canada operations, see Note 16 to the Consolidated Financial Statements.

 

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CAPITAL REQUIREMENTS; UNIFORM NET CAPITAL RULEThe SEC’s Uniform Net Capital Rule imposes minimum net capital requirements and could limit the Partnership’s ability to engage in certain activities which are crucial to its business.

Adequacy of capital is vitally important to broker-dealers, and lack of sufficient capital may limit the Partnership’s ability to compete effectively. In particular, lack of sufficient capital or compliance with the Uniform Net Capital Rule may limit Edward Jones’ ability to commit to certain securities activities such as underwriting and trading, which require significant amounts of capital, its ability to expand margin account balances, as well as its commitment to new activities requiring an investment of capital. FINRA regulations and the Uniform Net Capital Rule may restrict Edward Jones’ ability to expand its business operations, including opening new branch offices or hiring additional financial advisors. Consequently, a significant operating loss or an extraordinary charge against net capital could adversely affect Edward Jones’ ability to expand or even maintain its present levels of business.

In addition to the regulatory requirements applicable to Edward Jones, EJTC and the Canada broker-dealer are subject to regulatory capital requirements in the U.S. and in Canada. Failure by the Partnership to maintain the required net capital for any of its subsidiaries may subject it to disciplinary actions by the SEC, FINRA, IIROC, OCC or other regulatory bodies, which could ultimately require its liquidation. In the U.S., Edward Jones may be unable to expand its business and may be required to restrict its withdrawal of subordinated debt and partnership capital in order to meet its net capital requirements.

LIQUIDITYThe Partnership’s business in the securities industry requires that sufficient liquidity be available to maintain its business activities, and it may not always have access to sufficient funds.

Liquidity, or ready access to funds, is essential to the Partnership’s business. A tight credit market environment could have a negative impact on the Partnership’s ability to maintain sufficient liquidity to meet its working capital needs. Short-term and long-term financing are two sources of liquidity that could be affected by a tight credit market. In a tight credit market, lenders may reduce their lending to borrowers, including the Partnership. There is no assurance that financing will be available at attractive terms, or at all, in the future. A significant decrease in the Partnership’s access to funds could negatively affect its business and financial management in addition to its reputation in the industry.

Many limited partners have financed their initial or subsequent Partnership capital contributions by obtaining personal bank loans. Any such bank loan agreement is and will be between the partner and the bank. The Partnership does not guarantee the bank loans, nor can partners pledge their Partnership interest as collateral for the bank loan. However, partners who finance all or a portion of their Partnership interest with bank financing may be more likely to request the withdrawal of capital to repay such obligations should the Partnership experience a period of reduced earnings. Any withdrawals by limited partners are subject to the terms of the Partnership Agreement and would reduce the Partnership’s available liquidity and capital.

 

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The Partnership makes loans available to those general partners (other than members of the Executive Committee) who require financing for some or all of their Partnership capital contributions. Additionally, in limited circumstances, a general partner may withdraw from the Partnership and become a subordinated limited partner while he or she still has an outstanding Partnership loan. Loans made by the Partnership to general partners are generally for a period of one year, but are expected to be renewed and bear interest at the prime rate, as defined in the loan documents. The Partnership recognizes interest income for the interest earned from general partners in connection with such loans. General partners borrowing from the Partnership will be required to repay such loans by applying their Partnership earnings to such loans, net of amounts retained by the Partnership in accordance with the Partnership Agreement and amounts distributed for income taxes. The Partnership has full recourse against any general partner that defaults on loan obligations. However, there is no assurance that general partners will be able to repay the interest and/or the principal amount of their loans at or prior to maturity.

UPGRADE OF TECHNOLOGICAL SYSTEMSThe Partnership will engage in significant technology initiatives in the future which may be costly and could lead to disruptions.

From time to time, the Partnership has engaged in significant technology initiatives and expects to continue to do so in the future. Such initiatives are not only necessary to better meet the needs of the Partnership’s clients, but also to satisfy new industry standards and practices and better secure the transmission of clients’ information on the Partnership’s systems. With any major system replacement, there will be a period of education and adjustment for the branch and home office employees utilizing the system. Following any upgrade or replacement, if the Partnership’s systems or equipment does not operate properly, is disabled or fails to perform due to increased demand (which might occur during market upswings or downturns), or if a new system or system upgrade contains a major problem, the Partnership could experience unanticipated disruptions in service, including interrupted trading, slower response times, decreased client service and client satisfaction, and delays in the introduction of new products and services, any of which could result in financial losses, liability to clients, regulatory intervention or reputational damage. Further, the inability of the Partnership’s systems to accommodate a significant increase in volume of transactions also could constrain its ability to expand its business.

INTEREST RATE ENVIRONMENTThe Partnership’s profitability is impacted by a low interest rate environment.

A low interest rate environment adversely impacts the interest income the Partnership earns from clients’ margin loans, the investment of excess funds, and securities the Partnership owns, as well as the fees earned by the Partnership through its minority ownership in the investment adviser to the Edward Jones money market funds. While a low interest rate environment positively impacts the Partnership’s expenses related to liabilities that finance certain assets, such as amounts payable to clients and other interest-bearing liabilities, its interest bearing liabilities are less impacted by short-term interest rates compared to its interest earning assets, resulting in interest income being more sensitive to a low interest rate environment than interest expense.

 

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CREDIT RISK The Partnership is subject to credit risk due to the nature of the transactions it processes for its clients.

The Partnership is exposed to the risk that third parties who owe it money, securities or other assets will not meet their obligations. Many of the transactions in which the Partnership engages expose it to credit risk in the event of default by its counterparty or client, such as cash balances held at various major U.S. financial institutions, which typically exceed Federal Deposit Insurance Corporation (“FDIC”) insurance coverage limits. In addition, the Partnership’s credit risk may be increased when the collateral it holds cannot be realized or is liquidated at prices insufficient to recover the full amount of the obligation due to the Partnership. See Item 10 – Director’s, Executive Officers and Corporate Governance, for more information about the Partnership’s credit risk.

LACK OF CAPITAL PERMANENCY Because the Partnership’s capital is subject to mandatory liquidation either upon the death or withdrawal request of a partner, the capital is not permanent and a significant mandatory liquidation could lead to a substantial reduction in the Partnership’s capital, which could, in turn, have a material adverse effect on the Partnership’s business.

Under the terms of the Partnership Agreement, a partner’s capital balance is liquidated upon death. In addition, partners may request withdrawals of their partnership capital, subject to certain limitations on the timing of those withdrawals. Accordingly, the Partnership’s capital is not permanent and is dependent upon current and future partners to both maintain their existing capital and make additional capital contributions in the Partnership. Any withdrawal requests by general partners, subordinated limited partners or limited partners would reduce the Partnership’s available liquidity and capital. In addition, the Managing Partner may decline a withdrawal request if that withdrawal would result in the Partnership violating any agreement, such as a loan agreement, or any applicable regulations.

Under the terms of the Partnership Agreement, limited partners who request the withdrawal of their capital are repaid their capital in three equal annual installments beginning the month after their withdrawal request. The Managing Partner may, in his discretion, allow a limited partner to accelerate the withdrawal of his or her capital. The capital of general partners requesting the withdrawal of capital from the Partnership may be converted to subordinated limited partner capital or, at the discretion of the Managing Partner, redeemed by the Partnership. The withdrawal of subordinated limited partner capital is repaid in six equal annual installments beginning the month after their request for withdrawal. Liquidations upon the death of a partner are generally required to be made within six months of the date of death. Due to the nature of the liquidation requirements of the capital as set forth in the Partnership Agreement, the Partnership accounts for its capital as a liability, in accordance with U.S generally accepted accounting principles (“GAAP”). If the Partnership’s capital declines by a substantial amount due to liquidation or withdrawal, the Partnership may not have sufficient capital to operate or expand its business or to meet withdrawal requests by partners.

 

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Item 1A. Risk Factors, continued

 

INTERRUPTION OF BUSINESS AND OPERATIONSAny substantial disruption to the Partnership’s business and operations could lead to significant financial loss to its business and operations as well as harm relations with its clients.

The Partnership relies heavily on communications and information systems to conduct its business. The Partnership’s home office facilities and its existing computer system and network, including its backup systems, are vulnerable to damage or interruption from human error, natural disasters, power loss, sabotage, computer viruses, intentional acts of vandalism, attempts by others to gain unauthorized access to the Partnership’s information technology system, and similar events. Such an event could substantially disrupt the Partnership’s business by causing physical harm to its home office facilities and its technological systems. In addition, the Partnership’s reputation and business may suffer if clients experience data or financial loss from a significant interruption. The risk of these types of events occurring has grown recently due to increased use of the internet and mobile devices, as well as increased sophistication of external parties who may attempt to cause harm. The Partnership’s primary data center is located in St. Louis, Missouri. The Partnership has a data center in Tempe, Arizona, which currently operates as a secondary data center to its primary data center in St. Louis and is designed to enable the Partnership to maintain service during a system disruption contained in St. Louis. A prolonged interruption of either site might result in a delay in service and substantial additional costs and expenses. While the Partnership has disaster recovery and business continuity planning processes, and interruption and property insurance to mitigate and help protect it against such losses, there can be no assurance that the Partnership is fully protected from such an event. In 2011, the Partnership began re-purposing its secondary data center in Tempe, Arizona in order to be able to operate this facility as a primary data center for processing the most critical systems such that they could run in St. Louis, Missouri or Tempe, Arizona. As of December 31, 2013, it is anticipated that this process will take a few more years to complete.

UNDERWRITING, SYNDICATE AND TRADING POSITION RISKSThe Partnership engages in underwriting activities, which can expose the Partnership to material losses and liability.

Participation as a manager or syndicate member in the underwriting of fixed income and equity securities subjects the Partnership to substantial risk. As an underwriter, the Partnership is subject to risk of substantial liability, expense and adverse publicity resulting from possible claims against it as an underwriter under federal and state securities laws. Such laws and regulations impose substantial potential liabilities on underwriters for material misstatements or omissions in the document used to describe the offered securities. In addition, there exists a potential for possible conflict of interest between an underwriter’s desire to sell its securities and its obligation to its clients not to recommend unsuitable securities. There has been an increasing incidence of litigation in these areas. These lawsuits are frequently brought by large classes of purchasers of underwritten securities. Such lawsuits often name underwriters as defendants and typically seek substantial amounts in damages.

Further, as an underwriter, the Partnership may incur losses if it is unable to resell the securities it is committed to purchase or if it is forced to liquidate all or part of its commitment at less than the agreed upon purchase price. In addition, the commitment of capital to an underwriting may adversely affect the Partnership’s capital position and, as such, the Partnership’s participation in an underwriting may be limited by the requirement that it must at all times be in compliance with the SEC’s Uniform Net Capital Rule. In maintaining inventory in fixed income and equity securities, the Partnership is exposed to a substantial risk of loss, depending upon the nature and extent of fluctuations in market prices.

 

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Item 1A. Risk Factors, continued

 

RISK OF INFLATIONAn increase in inflation could affect securities prices and as a result, the profitability and capital of the Partnership.

Inflation and future expectations of inflation can negatively influence securities prices, as well as activity levels in the securities markets. As a result, the Partnership’s profitability and capital may be adversely affected by inflation and inflationary expectations. Additionally, the impact of inflation on the Partnership’s operating expenses may affect profitability to the extent that additional costs are not recoverable through increased prices of services offered by the Partnership.

TRANSACTION VOLUME VOLATILITYSignificant increases and decreases in the number of transactions by the Partnership’s clients can have a material negative effect on the Partnership’s profitability and its ability to efficiently process and settle these transactions.

Significant volatility in the number of client transactions may result in operational problems such as a higher incidence of failures to deliver and receive securities and errors in processing transactions, and such volatility may also result in increased personnel and related processing costs. In the past, the Partnership has experienced adverse effects on its profitability resulting from significant reductions in securities sales and has encountered operational problems arising from unanticipated high transaction volume. The Partnership is not able to control such decreases and increases, and there is no assurance that it will not encounter such problems and resulting losses in future periods.

In addition, significant transaction volume could result in inaccurate books and records, which would expose the Partnership to disciplinary action by governmental agencies and SROs.

INVESTMENT ADVISORY ACTIVITIESThe Partnership’s investment advisory businesses may be affected by the investment performance of its portfolios.

Poor investment returns, due to either general market conditions or underperformance (relative to the Partnership’s competitors or to benchmarks) of programs constructed by the Partnership may affect its ability to retain existing assets under care and to attract new clients or additional assets from existing clients. Should there be a reduction in assets under care in programs which generate asset-based fees, the Partnership will experience a decrease in net revenue.

MANAGEMENT OF SUB-ADVISERSThe Partnership’s business may be affected by the heightened regulatory requirements it faces as a result of managing sub-advisers.

Serving as an investment adviser to proprietary funds subjects the Partnership, through its ownership of OLV, the investment adviser to the Bridge Builder fund, to additional operational and regulatory requirements, which may result in financial losses and/or disciplinary action by governmental agencies and/or SROs.

 

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Item 1A. Risk Factors, continued

 

RISKS RELATED TO AN INVESTMENT IN LIMITED PARTNERSHIP INTERESTS

HOLDING COMPANY — JFC is a holding company; as a consequence, JFC’s ability to satisfy its obligations under the Partnership Agreement will depend in large part on the ability of its subsidiaries to pay distributions or dividends to JFC, which is restricted by law and contractual obligations.

Since JFC is a holding company, the principal sources of cash available to it are distributions or dividends from its subsidiaries and other payments under intercompany arrangements with its subsidiaries. Accordingly, JFC’s ability to generate the funds necessary to satisfy its obligations with respect to the Interests, including the 7.5% “guaranteed payment” (for tax purposes, within the meaning of the Internal Revenue Code (the “IRC”)) to limited partners pursuant to Section 3.3 of the Partnership Agreement (the “7.5% Payment”), will be dependent on distributions, dividends, and intercompany payments from its subsidiaries, and if those sources are insufficient, JFC may be unable to satisfy such obligations.

JFC’s principal operating subsidiaries, including Edward Jones, are subject to various statutory and regulatory restrictions applicable to broker-dealers generally that limit the amount of cash distributions, dividends, loans and advances that those subsidiaries may pay to JFC. Regulations relating to capital requirements affecting some of JFC’s subsidiaries also restrict their ability to pay distributions or dividends and make loans to JFC. See subheading “Regulation” of Item 1, “Business” of this Annual Report on Form 10-K.

In addition, JFC’s subsidiaries may be restricted under the terms of their financing arrangements from paying distributions or dividends to JFC, or may be required to maintain specified levels of capital. Moreover, JFC or its subsidiaries may enter into financing arrangements in the future which may include additional restrictions or debt covenant requirements further restricting distributions to JFC, which may impact JFC’s ability to make distributions to its limited partners.

SUFFICIENCY OF DISTRIBUTIONS TO REPAY FINANCINGLimited partners may finance their purchase of the Interests with a bank loan. The Partnership does not guarantee those loans and distributions may be insufficient to pay the interest or principal on the loans.

Many limited partners finance the purchases of their Interests by obtaining personal bank loans. Any such bank loan agreement is between the limited partner and the bank. The Partnership does not guarantee the bank loans, nor can limited partners pledge their Partnership Interest as collateral for the bank loan. Limited partners who have chosen to finance a portion of the purchase price of their Interests assume all risks associated with the loan, including the legal obligation to repay the loan.

There is no assurance that distributions from the Partnership will be sufficient to pay the interest on a limited partner’s loan or repay the principal amount of the loan at or prior to its maturity. Furthermore, in the event the Partnership experiences a loss which leads to its liquidation, there is no assurance there will be sufficient capital available to distribute to the limited partners for the repayment of any loans.

 

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Item 1A. Risk Factors, continued

 

STATUS AS PARTNER FOR TAX PURPOSESLimited partners will be subject to income tax liabilities on the Partnership’s income, whether or not income is distributed, and may have an increased chance of being audited.

Limited partners will be required to file tax returns and pay income tax in each jurisdiction in which the Partnership operates, as well as in the limited partner’s state of residence or domicile. Limited partners will be liable for income taxes on their pro rata share of the Partnership’s taxable income. The amount of income the limited partner pays tax on can significantly exceed the net income earned on the Interests and the income distributed to such limited partner, which results in a disproportionate share of income being used to pay taxes. The Partnership’s income tax returns may be audited by government authorities, and such audit may result in the audit of the returns of the limited partners (and, consequently, an amendment of their tax returns). In addition, from time to time, legislative changes to the IRC or state laws may be adopted that could increase the tax rate applicable to the limited partners’ net income earned and/or subject the net income earned to additional taxes currently not applicable.

POSSIBLE TAX LAW CHANGESFederal legislation could significantly impact a limited partner’s taxes by imposing self-employment taxes on such Interest.

Congress may enact legislation that subjects a limited partner’s share of the Partnership’s taxable income to self-employment tax. Such legislation, if ever enacted, may substantially reduce a limited partner’s after-tax return from their Interest. Other tax law changes may substantially impact a limited partner’s Interest and cannot be predicted.

NON-VOTING INTERESTS; NON-TRANSFERABILITY OF INTERESTS; ABSENCE OF MARKET, PRICE FOR INTERESTSThe Interests are non-voting and non-transferable, no market for the Interests exists or is expected to develop, and the price only represents book value.

None of the limited partners in their capacity as limited partners may vote or otherwise participate in the management of the Partnership’s business. The Managing Partner has the authority to amend the Partnership Agreement without the consent of the limited partners or general partners. None of the limited partners may sell, pledge, exchange, transfer or assign their Interests without the express written consent of the Managing Partner (which is not expected to be given).

Because there is no market for the Interests, there is no fair market value for the Interests. The price ($1,000 per Interest) at which the Interests were offered represents the book value of each Interest. Capital could decline to a point where the book value of the Interests could be less than the price paid.

 

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Item 1A. Risk Factors, continued

 

RISK OF DILUTIONThe Interests may be diluted from time to time, which could lead to decreased returns to the limited partners.

The Managing Partner has the ability, in his sole discretion, to issue additional Interests or Partnership capital. The Partnership filed a Registration Statement on Form S-8 with the SEC on January 17, 2014 to register $350 million in securities in preparation for its anticipated 2014 Limited Partnership offering. The Partnership intends to offer approximately $300 million in new Interests to eligible financial advisors, branch office administrators and home office associates. The remaining $50 million may be issued in the discretion of the Executive Committee, which may include issuances to financial advisors who complete a retirement transition plan in future years and who may be considered for additional limited partnership interest. The 2014 Limited Partnership offering is expected to close early next year. The issuance of limited partnership interests will reduce the percentage of participation in net income by general partners, subordinated limited partners and current limited partners. Proceeds from the 2014 Limited Partnership offering are expected to be used toward working capital and general corporate purposes and to ensure there is adequate general liquidity of the Partnership for future needs.

Any addition of new Interests will decrease the Partnership’s net interest income by the 7.5% Payment for any such additional Interests, and holders of existing Interests may suffer decreased returns on their investment because the amount of the Partnership’s net income they participate in may be reduced as a consequence. Accordingly, the issuance of new Interests will reduce the Partnership’s net interest income and profitability beginning in 2015.

In 2013, the Partnership retained approximately 14% of the general partners’ net income as capital which is credited monthly to the general partners’ Adjusted Capital Contributions (as defined in the Partnership Agreement). Retention for 2014 is expected to remain at approximately 14%. Such retention, along with any additional capital contributions by general partners, will reduce the percentage of participation in net income by limited partners. There is no requirement to retain a minimum amount of general partners’ net income, and the percentage of retained net income could change at any time in the future. In accordance with the Partnership Agreement, the percentage of income allocated to limited partners is reset annually and the amount of retained general partner income and any additional issuance of general partnership capital reduces the income allocated to limited partners.

LIMITATION OF LIABILITY; INDEMNIFICATIONThe Partnership Agreement limits the liability of the Managing Partner and general partners by indemnifying them under certain circumstances, which may limit a limited partner’s rights against them and could reduce the accumulated profits distributable to limited partners.

The Partnership Agreement provides that none of the general partners, including the Managing Partner, will be liable to any person for any acts or omissions by such partner on behalf of the Partnership (even if such action, omission or failure constituted negligence) as long as such partner has not (a) committed fraud, (b) acted or failed to act in subjective good faith or in a manner which involved intentional misconduct or a knowing violation of law or which was grossly negligent, or (c) derived improper personal benefit.

 

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Item 1A. Risk Factors, continued

 

The Partnership also must indemnify the general partners, including the Managing Partner, from any claim in connection to acts or omissions performed in connection with the business of the Partnership and from costs or damages stemming from a claim attributable to acts or omissions by such partner unless such act was not in good faith on behalf of the Partnership, in a manner reasonably believed by the partner to be within the scope of his or her authority, nor in the best interests of the Partnership. The Partnership does not have to indemnify any general partner in instances of fraud, acts or omissions not in good faith or which involve intentional misconduct, a knowing violation of the law, or gross negligence, or where such partner derived improper personal benefit.

As a result of these provisions, the limited partners will have more limited rights against such partners than they would have absent the limitations in the Partnership Agreement. Indemnification of the general partners could deplete the Partnership’s assets unless the indemnification obligation is covered by insurance, which the Partnership may or may not obtain, or which insurance may not be available at a reasonable price or at all or in an amount sufficient to cover the indemnification obligation. The Partnership Agreement does not provide for indemnification of limited partners.

RISK OF LOSSThe Interests are equity interests in the Partnership. As a result, and in accordance with the Partnership Agreement, the right of return of a limited partner’s Capital Contribution is subordinate to all existing and future claims of the Partnership’s general creditors, including any of its subordinated creditors.

In the event of a partial or total liquidation of the Partnership or in the event there were insufficient Partnership assets to satisfy the claims of its general creditors, the limited partners may not be entitled to receive their entire Capital Contribution amounts back. Limited partner capital accounts are not guaranteed. However, as a class, the limited partners would be entitled to receive their aggregate Capital Contributions back prior to the return of any capital contributions to the subordinated limited partners or the general partners. If the Partnership suffers losses in any year but liquidation procedures described above are not undertaken and the Partnership continues, the amounts of such losses would be absorbed in the capital accounts of the partners as described in the Partnership Agreement, and each limited partner in any event remains entitled to receive the annual 7.5% Payment on his or her contributed capital. However, as there would be no accumulated profits in such a year, limited partners would not receive any sums representing participation in net income of the Partnership. In addition, although the amount of such annual 7.5% Payments to limited partners are charged as an expense to the Partnership and are payable whether or not the Partnership earns any accumulated profits during any given period, no reserve fund has been set aside to enable the Partnership to make such payments. Therefore, such payments to the limited partners are subject to the Partnership’s ability to service this annual 7.5% Payment, of which there is no assurance.

 

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Item 1A. Risk Factors, continued

 

FOREIGN EXCHANGE RISK FOR CANADIAN RESIDENTS — Each foreign limited partner has the risk that he or she will lose value on his or her investment in the Interests due to fluctuations in the applicable exchange rate; furthermore, foreign limited partners may owe tax on a disposition of the Interests solely as the result of a movement in the applicable exchange rate.

All investors will purchase the Interests using U.S. dollars. As a result, limited partners who reside in Canada may risk having the value of their investment, expressed in Canadian currency, decrease over time due to movements in the applicable currency exchange rates. Accordingly, such limited partner may have a loss upon disposition of his or her investment solely due to a downward fluctuation in the applicable exchange rate.

In addition, changes in exchange rates could have an impact on Canadian federal income tax consequences for a limited partner, if such limited partner is a resident in Canada for purposes of the Income Tax Act (Canada). The disposition by such limited partner of an Interest, including on and as a result of the withdrawal of the limited partner or the Partnership’s dissolution, may result in the realization of a capital gain (or capital loss) by such limited partner. The amount of such capital gain (or capital loss) generally will be the amount, if any, by which the proceeds of disposition of such Interest, less any reasonable costs of disposition, each expressed in Canadian currency using the exchange rate on the date of disposition, exceed (or are exceeded by) the adjusted cost base of such Interest, expressed in Canadian currency using the exchange rate on the date of each transaction that is relevant in determining the adjusted cost base. Accordingly, because the exchange rate for those currencies may fluctuate between the date or dates on which the adjusted cost base of a limited partner’s Interest is determined and the date on which the Interest is disposed of, a Canadian-resident limited partner may realize a capital gain or capital loss on the disposition of his or her Interest solely as a result of fluctuations in exchange rates.

 

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ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2. PROPERTIES

The Partnership primarily conducts its U.S. home office operations from two campus locations in St. Louis, Missouri and one campus location in Tempe, Arizona. As of December 31, 2013, the Partnership’s U.S. home office consisted of 18 separate buildings totaling approximately 2.0 million square feet.

Of the 18 U.S. home office buildings, two buildings are leased through an operating lease and the remaining 16 are owned by the Partnership. In addition, the Partnership leases its Canada home office facility in Mississauga, Ontario through an operating lease. The Partnership also maintains facilities in 11,647 branch locations as of December 31, 2013, which are located in the U.S. and Canada and are predominantly rented under cancelable leases. See Notes 14 and 17 to the Consolidated Financial Statements for information regarding non-cancelable lease commitments and related party transactions, respectively.

 

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ITEM 3. LEGAL PROCEEDINGS

In the normal course of business, the Partnership is named, from time to time, as a defendant in various legal actions, including arbitrations, class actions and other litigation. Certain of these legal actions may include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. The Partnership is involved, from time to time, in investigations and proceedings by governmental organizations and SROs, certain of which may result in adverse judgments, fines or penalties.

Countrywide. There have been four cases filed against Edward Jones (in addition to numerous other issuers and underwriters) asserting claims under the U.S. Securities Act of 1933 (the “Securities Act”) in connection with registration statements and prospectus supplements issued for certain mortgage-backed certificates issued between 2005 and 2007. Three cases are purported class actions (David H. Luther, et al. v. Countrywide Financial Corporation, et al. filed in 2007; Maine State Retirement System, et al. v. Countrywide Financial Corporation, et al. filed in 2010; and Western Conference of Teamsters Pension Trust Fund v. Countrywide Financial Corporation, et al. filed in 2010). All three cases, however, have been settled, and on December 6, 2013, the court granted plaintiffs’ motion for final approval of the settlement. The settlement that was approved by the court (1) establishes a fund to be paid exclusively by Countrywide, (2) contains a complete release for all defendants in all three cases, including Edward Jones, (3) contains proposals for the administration of the settlement fund, and (4) provides for the dismissal of all three cases once the Court enters the final approval of the settlement and enters a final judgment. Because Edward Jones was being indemnified and defended in all three cases, Edward Jones will not be paying and is not required to pay any money into the settlement fund. On December 17, 2013, the Court entered the final judgment and dismissal for all three cases. On January 14, 2014, some objectors to the class action settlement filed their Notice of Appeal of the Court’s final judgment and dismissal. The appeal will be heard by the Ninth Circuit Court of Appeals, but no briefing schedule has been entered.

On August 10, 2012, the FDIC, in its capacity as receiver for Colonial Bank, filed a separate lawsuit (FDIC v. Countrywide Securities Corporation, Inc., et al.) in the U.S. District Court for the Central District of California against numerous issuers and underwriters including Edward Jones. However, plaintiff does not allege that it purchased any tranche of any offering for which Edward Jones acted as dealer. Following defendant’s motion to dismiss, plaintiffs filed their first amended complaint on November 6, 2012. On April 8, 2013, the Court dismissed FDIC v. Countrywide based on statute of limitations grounds. The FDIC filed its notice of appeal of the Court’s dismissal on October 3, 2013. The appeal is pending.

On December 12, 2013, a case was filed in the Superior Court of the State of California, County of Los Angeles, Northwest District styled Triaxx Prime CDO 2006-1 LTD et al. v. Banc of America Securities, LLC et al. The case involves allegations regarding the sale of Countrywide Private Label Mortgage Backed Securities. The complaint alleges that Edward Jones was the underwriter for two tranches of securities sold to the plaintiffs. Edward Jones denies that it was the underwriter for said tranches. The plaintiffs seek damages in an amount to be determined at trial and the consideration paid for the tranches at issue, less any income received on the tranches. The defendants removed the case to federal court on January 10, 2014.

 

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Item 3. Legal Proceedings, continued

 

Daniel Ezersky, individually and on behalf of all others similarly situated. On March 14, 2013, Edward Jones was named as a defendant in a putative class action lawsuit in the Circuit Court of St. Louis County, Missouri. The petition alleges that Edward Jones breached its fiduciary duties and was unjustly enriched through the use of an online life insurance needs calculator that plaintiff claims inflated the amount of insurance he needed. Plaintiff seeks damages on behalf of Missouri residents who purchased certain life insurance products from Edward Jones between March of 2008 and the present, including: actual damages, or alternatively, judgment in an amount equal to profits gained from the sale of term, whole life or universal life insurance to plaintiff/damages class; punitive damages; injunctive relief; costs, including reasonable fees and expert witness expenses; and reasonable attorneys’ fees. The litigation is in the pleading stage and no class has been certified.

Nicholas Maxwell, individually and on behalf of all others similarly situated. Edward Jones was named as a defendant in a putative class action complaint in Alameda Superior Court. The complaint asserted causes of action for unlawful wage deductions (Labor Code sections 221, 223, 400-410, 2800, 2802, Cal. Code Reg. title 8, section 11040(8)); California Unfair Competition Law violations (Business and Professions Code sections 17200-04); and waiting time penalties (Labor Code sections 201-203). Plaintiff alleges that Edward Jones improperly charged its California financial advisors fees, costs, and expenses related to trading errors or “broken” trades, and failed to timely pay wages at termination; however plaintiff does not allege a specific amount of damages. Plaintiff filed the complaint on December 18, 2012 and Edward Jones filed its answer on February 6, 2013. Plaintiff has not yet filed his motion for class certification.

Tribune. In August 2011, retirees of Times Mirror/Tribune Company filed suit in the U.S. District Court for the Southern District of New York (“SDNY”) against numerous brokerage firms and banks, including Edward Jones, claiming that a fraudulent transfer occurred during the 2007 Times Mirror/Tribune Company merger. Plaintiffs allege that payments made to Tribune Company shareholders, of which Edward Jones’ customers received approximately $6.5 million, constituted fraudulent transfers. The case has been consolidated in the U.S. District Court for the SDNY along with a number of similar cases as part of the multi-district litigation process.

Yavapai County Litigation. In September, 2009, three lawsuits were filed in the State of Arizona; all three lawsuits were consolidated and are pending before the U.S. District Court for the District of Arizona. The actions relate to bonds underwritten by Edward Jones and other brokerage firms for the purpose of financing construction of an event center in Prescott Valley, Arizona. Edward Jones sold approximately $2.9 million of the bonds. The plaintiffs allege the underwriters, including Edward Jones, made material misrepresentations and omissions in the preliminary official statement and/or in the official statement. One of the matters was filed as a putative class action in which the plaintiffs seek to represent all purchasers of the issued bonds. Allstate is suing as a purchaser of the bonds and Wells Fargo filed a separate action as indenture trustee on behalf of all bond holders. The Court entered an order in November, 2010 dismissing several of the claims against Edward Jones, including all claims brought on behalf of the class. Plaintiffs are seeking an unspecified amount of damages including attorneys’ fees, costs, expenses, rescission or statutory damages, out-of-pocket damages and prejudgment interest. The Court entered an order on September 13, 2013, granting in part and denying in part various motions for summary judgment filed by Edward Jones. The only remaining claims against Edward Jones stem from allegations that defendants violated the Arizona Securities Act. A one month trial is set for September, 2014.

 

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Item 3. Legal Proceedings, continued

 

FINRA Exchange-Traded Funds Matter. On January 9, 2014, Edward Jones, without admitting or denying the findings, entered into a Letter of Acceptance, Waiver and Consent related to trading in nontraditional exchange traded funds for the period June 2008 to July 2009. Edward Jones, without admitting or denying the findings, was censured, fined $200,000, and ordered to pay restitution of $51,581.25 to clients. The restitution is to be paid on or about May 9, 2014.

In the Matter of Edward D. Jones & Co., L.P. Municipal Bond Pricing. On April 27, 2012, the SEC’s Division of Enforcement informed Edward Jones it had commenced an investigation into Nebraska Public Power District’s (“NPPD”) Taxable Build America Bonds (“BAB”), which formed part of NPPD’s 2009 General Revenue Bonds offering. Edward Jones was a co-manager of that offering. The investigation inquired into whether Edward Jones and others may have engaged in possible violations of the Securities Act, the Securities Exchange Act of 1934 (the “Exchange Act”) (including Section 10(b) and Rule 10b-5 thereunder), and MSRB Rules. In January 2013, the SEC commenced an investigation that subsumed the one just described, relating more generally to municipal bond pricing and inquiring into the same possible violations. In August 2013, the SEC’s Division of Enforcement informed Edward Jones that it was requesting certain additional information growing out of a 2010 examination conducted by the SEC’s Office of Compliance Inspections and Examinations. The SEC has stated to Edward Jones with respect to each of the investigations described above that the “investigation is a non-public, fact-finding, informal inquiry, which should not be construed as an indication that the Commission or its staff have determined that any violations of law have occurred,” and the SEC has not taken any action against Edward Jones or others with respect to this investigation. On October 30, 2013, the Special Inspector General for the Troubled Asset Relief Program issued a subpoena to Edward Jones requesting documents relating to certain BAB transactions and informed Edward Jones that it is in the process of reviewing these issues. Consistent with its practice, Edward Jones is cooperating fully with the SEC and the Special Inspector General with respect to these investigations.

New Hampshire Investigation. In March 2012, Edward Jones received an inquiry from the New Hampshire Bureau of Securities Regulation (“the Bureau”) in connection with its investigation into Edward Jones’ telephone solicitation practices and procedures. On April 11, 2013, the Bureau filed an administrative action against Edward Jones relating to these matters. On February 25, 2014, Edward Jones, without admitting or denying the facts or allegations contained therein, entered into a Consent Order with the Bureau in which Edward Jones agreed to cease and desist from further violations of N.H. RSA 421-B, pay the Bureau’s costs of investigation in the amount of $175,000, make a payment to the New Hampshire Investor Education Fund in the amount of $175,000, and pay an administrative fine in the amount of $400,000. Edward Jones also agreed to certain undertakings with respect to its policies and procedures in this area.

 

ITEM 4. MINE SAFETY DISCLOSURES

None.

 

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ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

There is no established public trading market for the Partnership’s limited partnership and subordinated limited partnership interests and their assignment or transfer is prohibited. As of December 31, 2013, the Partnership was composed of 13,760 limited partners and 297 subordinated limited partners.

 

ITEM 6. SELECTED FINANCIAL DATA

The following information sets forth, for the past five years, selected financial data determined from audited financial statements.

All information included in the Annual Report on Form 10-K is presented on a continuing operations basis unless otherwise noted.

Summary Consolidated Statements of Income Data:

 

($ millions, except per unit information and units outstanding)

   2013      2012      2011      2010      2009(1)  

Total revenue

   $ 5,716       $ 5,027       $ 4,578       $ 4,163       $ 3,548   

Interest expense

     59         62         68         56         58   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net revenue

   $ 5,657       $ 4,965       $ 4,510       $ 4,107       $ 3,490   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income from continuing operations

   $ 674       $ 555       $ 482       $ 393       $ 269   

Loss from discontinued operations

     —           —           —           —           (105
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income before allocations to partners

   $ 674       $ 555       $ 482       $ 393       $ 164   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income allocated to limited partners per weighted average $1,000 equivalent limited partnership unit outstanding

   $ 121.12       $ 109.84       $ 104.66       $ 96.07       $ 41.44   

Weighted average $1,000 equivalent limited partnership units outstanding

     644,856         655,663         668,450         455,949         471,597   

 

(1) Discontinued operations relate to the 2009 sale of Edward Jones Limited, a United Kingdom private limited company engaged in the retail services businesses in the U.K.

In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) No. 480, Distinguishing Liabilities from Equity (“ASC 480”), the Partnership presents net income of $0 on its Consolidated Statements of Income. See Note 1 to the Consolidated Financial Statements for further discussion.

 

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Item 6. Selected Financial Data, continued

 

Summary Consolidated Statements of Financial Condition Data:

 

($ millions)

   2013      2012      2011      2010      2009  

Total assets

   $ 13,795       $ 13,042       $ 9,584       $ 8,241       $ 7,168   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Long-term debt and bank loans

   $ 4       $ 6       $ 7       $ 66       $ 117   

Other liabilities exclusive of subordinated liabilities and partnership capital subject to mandatory redemption

     11,660         10,953         7,521         6,366         5,327   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     11,664         10,959         7,528         6,432         5,444   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Subordinated liabilities

     50         100         150         204         257   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Partnership capital subject to mandatory redemption, net of reserve for anticipated withdrawals

     1,858         1,812         1,758         1,497         1,437   

Reserve for anticipated withdrawals

     223         171         148         108         30   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Partnership capital subject to mandatory redemption

     2,081         1,983         1,906         1,605         1,467   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities and partnership capital

   $ 13,795       $ 13,042       $ 9,584       $ 8,241       $ 7,168   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis is intended to help the reader understand the results of operations and the financial condition of the Partnership. Management’s Discussion and Analysis should be read in conjunction with the Partnership’s Consolidated Financial Statements and accompanying notes included in Item 8, Financial Statements and Supplementary Data of this Annual Report on Form 10-K.

Basis of Presentation

The Partnership broadly categorizes its net revenues into four categories: trade revenue (revenue from client buy or sell transactions of securities), fee revenue, net interest and dividends revenue (net of interest expense) and other revenue. In the Partnership’s Consolidated Statements of Income, trade revenue is composed of commissions, principal transactions and investment banking. Fee revenue is composed of asset-based fees and account and activity fees. These sources of revenue are affected by a number of factors. Trade revenue is impacted by the number of financial advisors, trading volume (client dollars invested), mix of the products in which clients invest, margins earned on the transactions and market volatility. Asset-based fees are generally a percentage of the total value of specific assets in client accounts. These fees are impacted by client dollars invested in and divested from the accounts which generate asset-based fees and change in market values of the assets. Account and activity fees and other revenue are impacted by the number of client accounts and the variety of services provided to those accounts, among other factors. Net interest and dividends revenue is impacted by the amount of cash and investments, receivables from and payables to clients, the variability of interest rates earned and paid on such balances, the number of Interests, and the balances of partnership loans, long-term debt and liabilities subordinated to claims of general creditors.

 

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OVERVIEW

The following table sets forth the change in major categories of the Consolidated Statements of Income as well as several key related metrics for the last three years. Management of the Partnership relies on this financial information and the related metrics to evaluate the Partnership’s operating performance and financial condition. All amounts are presented in millions, except the number of financial advisors and as otherwise noted.

 

     For the years ended December 31,     % Change  
     2013     2012     2011     2013 vs. 2012     2012 vs. 2011  

Revenue:

          

Trade revenue:

          

Commissions

   $ 2,134.4      $ 1,979.0      $ 1,698.7        8     17

Principal transactions

     182.5        155.9        284.2        17     -45

Investment banking

     122.4        111.6        153.1        10     -27
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total trade revenue

     2,439.3        2,246.5        2,136.0        9     5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of net revenue

     43     45     47    

Fee revenue:

          

Asset-based

     2,522.7        2,042.4        1,776.9        24     15

Account and activity

     567.6        573.9        522.9        -1     10
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fee revenue

     3,090.3        2,616.3        2,299.8        18     14
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of net revenue

     55     53     51    

Net interest and dividends

     75.0        71.2        62.5        5     14

Other revenue

     52.3        31.2        11.6        68     169
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net revenue

     5,656.9        4,965.2        4,509.9        14     10

Operating expenses

     4,982.6        4,410.2        4,028.1        13     9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before allocations to partners

   $ 674.3      $ 555.0      $ 481.8        21     15
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Related metrics:

          

Client dollars invested(1):

          

Trade ($ billions)

   $ 107.9      $ 97.4      $ 88.4        11     10

Advisory programs ($ billions)

   $ 18.8      $ 11.9      $ 17.8        58     -33

Client households at year end (millions)

     4.61        4.52        4.48        2     1

Client assets under care:

          

Total:

          

At year end ($ billions)

   $ 787.1      $ 668.7      $ 591.2        18     13

Average ($ billions)

   $ 726.4      $ 636.9      $ 586.1        14     9

Advisory Programs:

          

At year end ($ billions)

   $ 115.6      $ 87.4      $ 68.8        32     27

Average ($ billions)

   $ 101.0      $ 78.8      $ 63.6        28     24

Financial advisors:

          

At year end

     13,158        12,463        12,242        6     2

Average

     12,784        12,273        12,359        4     -1

Attrition %

     9.4     10.7     14.1     n/a        n/a   

Dow Jones Industrial Average:

          

At year end

     16,577        13,104        12,218        27     7

Average for year

     15,010        12,965        11,958        16     8

S&P 500 Index:

          

At year end

     1,848        1,426        1,258        30     13

Average for year

     1,644        1,379        1,268        19     9

 

(1) Client dollars invested related to trade revenue represent the principal amount of clients’ buy and sell transactions resulting in commissions, principal transactions and investment banking revenues. Client dollars invested related to advisory programs revenue represent the net inflows of client dollars into the programs.

 

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2013 versus 2012 Overview

The Partnership experienced very strong financial results during 2013 compared to a strong 2012, including record net revenue, income before allocations to partners and client assets under care. Financial results benefitted from improved market conditions, including increases of 19% in the average S&P 500 Index and 16% in the average Dow Jones Industrial Average.

The Partnership’s key performance measures were strong during 2013 and financial advisors attracted $48.2 billion in net new assets. Average client assets under care grew 14% to $726.4 billion, which included a 28% increase in the advisory programs’ average assets under care to $101.0 billion. In addition, client dollars invested related to trade revenue were up 11% to $107.9 billion.

Net revenue increased 14% to $5.7 billion in 2013. This increase was led by an 18% increase in fee revenue, primarily due to higher levels of asset values on which fees were earned, driven by the continued investment of client dollars into advisory programs and the overall rise in the equity market daily averages. Revenue growth was also driven by a 9% increase in trade revenue.

Operating expenses increased 13% in 2013 compared to 2012, primarily due to higher compensation and benefits expense driven by increased financial advisor productivity. Higher variable compensation due to the increase in the Partnership’s profitability also contributed to the increase.

Overall, the 14% increase in net revenue, partially offset by the 13% increase in operating expenses, generated income before allocations to partners of $674.3 million, a 21% increase over 2012.

2012 versus 2011 Overview

During 2012, global market and economic conditions generally improved compared to 2011 even though concerns about U.S. and global economic growth and an uncertain political environment led investors to remain cautious. Despite these concerns, the Partnership experienced record financial results in 2012 through continued focus on providing solutions to its clients.

The Partnership’s key performance measures were relatively strong in 2012. Average client assets under care grew 9% in 2012 to $636.9 billion, which included a 24% increase in the average advisory programs assets under care to $78.8 billion. In addition, client dollars invested related to trade revenue were up 10% to $97.4 billion.

Net revenue increased 10% to $5.0 billion in 2012 compared to 2011. This significant growth in net revenue was primarily attributable to a 14% increase in fee revenue due to higher levels of asset values on which fees were earned, driven by the continued investment of client dollars into advisory programs and the overall rise in the equity market daily averages, evidenced by the 9% increase in the average S&P 500 Index and the 8% increase in the average Dow Jones Industrial Average.

Operating expenses increased 9% in 2012 compared to 2011, primarily due to an increase in compensation and benefits driven by increased financial advisor productivity as well as higher variable compensation due to the increase in the Partnership’s profitability.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

 

Overall, the 10% increase in net revenue, partially offset by the 9% increase in operating expenses, generated income before allocations to partners of $555.0 million, a 15% increase over the prior year.

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

The discussion below details the significant fluctuations and their drivers for each of the major categories of the Partnership’s Consolidated Statements of Income.

Trade Revenue

Trade revenue, which consists of commissions, principal transactions and investment banking revenue, increased 9% to $2.4 billion during 2013 and 5% to $2.2 billion during 2012. The increase in trade revenue for both 2013 and 2012 was primarily due to the impact of increased client dollars invested, partially offset by a decrease in the margin earned.

Commissions

 

     Years Ended December 31,      % Change  
     2013      2012      2011      2013 vs. 2012     2012 vs. 2011  

Commissions revenue ($ millions):

             

Mutual funds

   $ 1,166.7       $ 1,050.9       $ 866.0         11     21

Equities

     594.7         539.2         447.5         10     20

Insurance

     373.0         388.9         385.2         -4     1
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total commissions revenue

   $ 2,134.4       $ 1,979.0       $ 1,698.7         8     17
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Related metrics:

             

Client dollars invested ($ billions)

   $ 87.3       $ 79.4       $ 65.3         10     22

Margin per $1,000 invested

   $ 24.4       $ 24.9       $ 26.0         -2     -4

U.S. business days

     252         250         252         1     -1

Commissions revenue increased 8% in 2013 to $2.1 billion primarily due to a 10% increase in client dollars invested in commission generating transactions resulting from the continued improvement in market conditions and clients continuing to reinvest their dollars from fixed income products into mutual fund and equity products. This increase was partially offset by a 2% decrease in the margin per $1,000 invested, reflecting a change in product mix due to proportionally less insurance revenue which earns a higher margin. In addition, the average trade size of mutual fund products increased, resulting in lower commission rates and thus a decrease in margin earned.

Commissions revenue increased 17% in 2012 to $2.0 billion primarily due to a 22% increase in client dollars invested in commission generating transactions resulting from improvement in market conditions and the fact that clients reinvested their dollars from maturing fixed income products into mutual fund and equity products. This increase was partially offset by a 4% decrease in the margin per $1,000 invested caused by a shift from higher-margin equity mutual funds to lower-margin debt mutual funds.

 

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Principal Transactions

Principal transactions revenue increased 17% in 2013 to $182.5 million. Overall, principal transactions revenue was positively impacted by relatively higher interest rates during the last half of 2013, which increased demand and led to an increase in client dollars invested. In addition, there was an increase in margin earned per $1,000 invested.

Principal transactions revenue decreased 45% in 2012 to $155.9 million primarily due to the low interest rate environment and the improvement in equity market conditions which decreased demand. In addition, margin decreased 28% in 2012 as client investments shifted during the period towards products with shorter maturities which have lower margins.

Investment Banking

Investment banking revenue increased 10% in 2013 to $122.4 million. The increase in investment banking revenue was primarily due to an increase in client dollars invested resulting from improved market conditions. This increase was partially offset by an 11% decrease in the margin earned per $1,000 invested. Client investments shifted away from higher-margin municipal and corporate unit investment trusts towards lower-margin equity unit investment trusts.

Investment banking revenue decreased 27% in 2012 to $111.6 million. The decrease reflects lower demand in 2012 due to the low interest rate environment and lower supply of state and municipal obligations. The decrease in investment banking revenue was further caused by a decrease in margin which resulted from a shift in client investments to lower-margin equity unit investment trusts.

 

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Fee Revenue

Fee revenue, which consists of asset-based fees and account and activity fees, increased 18% in 2013 to $3.1 billion and 14% in 2012 to $2.6 billion. The increase in fee revenue for both 2013 and 2012 was primarily due to higher asset values and continued investment in advisory programs. A discussion of fee revenue components follows.

Asset-based

 

     Years Ended December 31,      % Change  
     2013      2012      2011      2013 vs. 2012     2012 vs. 2011  

Asset-based fee revenue ($ millions):

             

Advisory programs fees

   $ 1,367.4       $ 1,052.5       $ 849.6         30     24

Service fees

     958.5         808.7         765.0         19     6

Revenue sharing

     155.0         138.6         129.0         12     7

Trust fees

     34.2         28.4         23.9         20     19

Cash solutions

     7.6         14.2         9.4         -46     51
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total asset-based fee revenue

   $ 2,522.7       $ 2,042.4       $ 1,776.9         24     15
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Related metrics ($ billions):

             

Average U.S. client asset values(1):

             

Mutual fund assets held outside of advisory programs

   $ 396.6       $ 329.3       $ 305.3         20     8

Advisory programs

     100.6         78.8         63.6         28     24

Insurance

     62.6         54.6         50.4         15     8

Cash solutions

     19.9         18.4         17.9         8     3
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total client asset values

   $ 579.7       $ 481.1       $ 437.2         20     10
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) Assets on which the partnership earns asset-based fee revenue. The U.S. portion of consolidated asset-based fee revenue was 98%, 97% and 97% for 2013, 2012 and 2011, respectively.

Asset-based fee revenue increased 24% in 2013 to $2.5 billion primarily due to higher advisory programs fees and service fees. Advisory programs fee revenue growth was primarily due to increased investment of client dollars into advisory programs, which includes new client assets and increases in the market value of the underlying assets. Service fees increased in 2013 primarily due to increases in the market value of the underlying assets as well as continued investment of client dollars into mutual fund products, which includes new client assets. A majority of client assets held in advisory programs were converted from other client investments previously held with the Partnership.

Asset-based fee revenue increased 15% in 2012 to $2.0 billion primarily due to increases in advisory programs fees. Advisory programs fee revenue increased 24% primarily due to market appreciation of asset values as well as continued investment of client dollars into advisory programs. A majority of client assets held in advisory programs were converted from other client investments previously held with the Partnership.

 

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Account and Activity

 

     Years Ended December 31,      % Change  
     2013      2012      2011      2013 vs. 2012     2012 vs. 2011  

Account and activity fee revenue ($ millions):

             

Sub-transfer agent services

   $ 350.2       $ 322.2       $ 289.1         9     11

Retirement account fees

     125.8         141.6         136.9         -11     3

Other account and activity fees

     91.6         110.1         96.9         -17     14
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total account and activity fee revenue

   $ 567.6       $ 573.9       $ 522.9         -1     10
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Related metrics (millions):

             

Average client accounts:

             

Sub-transfer agent services(1)

     19.8         18.4         17.1         8     8

Retirement accounts

     4.2         3.9         3.8         8     3

 

(1) Amount represents average number of individual mutual fund holdings serviced on which the Partnership recognizes sub-transfer agent services revenue.

Account and activity fee revenue decreased 1% in 2013 to $567.6 million primarily due to decreases in retirement account fees and other account and activity fees. Retirement account fees decreased as more client accounts reached the asset level at which fees are waived. Effective January 1, 2013, the Partnership reduced the asset level on which retirement account fees and certain other account activity fees are waived. These decreases were partially offset by higher sub-transfer agent services primarily related to an increase in the number of average client mutual fund holdings serviced.

Account and activity fee revenue increased 10% in 2012 to $573.9 million primarily due to increases in revenue from sub-transfer agent services and other account and activity fees. Sub-transfer agent services increased primarily due to an increase in the number of average client holdings serviced as well as a contract rate adjustment effective for 2012. Other account and activity fees increased primarily due to increases in various other types of fees including credit card revenue and other transaction fees.

 

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Net Interest and Dividends

 

     Years Ended December 31,     % Change  
     2013     2012     2011     2013 vs. 2012     2012 vs. 2011  

Net interest and dividends revenue ($ millions):

          

Client loan interest

   $ 108.0      $ 112.9      $ 115.2        -4     -2

Short-term investing interest

     14.2        11.3        7.4        26     53

Other interest and dividends

     11.5        9.2        7.5        25     23

Limited partnership interest expense

     (48.4     (49.2     (50.1     -2     -2

Other interest expense

     (10.3     (13.0     (17.5     -21     -26
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net interest and dividends revenue

   $ 75.0      $ 71.2      $ 62.5        5     14
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Related metrics ($ millions):

          

Average aggregate client loan balance

   $ 2,109.4      $ 2,187.9      $ 2,213.9        -4     -1

Average rate earned

     5.12     5.15     5.20     -1     -1

Average funds invested

   $ 8,764.6      $ 6,560.0      $ 4,815.0        34     36

Average rate earned

     0.16     0.17     0.15     -6     13

Weighted average $1,000 equivalent limited partnership units outstanding

     644,856        655,663        668,450        -2     -2

Net interest and dividends revenue increased 5% in 2013 to $75.0 million. Interest income from cash and cash equivalents, cash and investments segregated under federal regulations and securities purchased under agreements to resell increased 26% in 2013 primarily due to an increase in the average funds invested. Interest expense decreased in 2013 primarily due to lower average debt balances during the current period related to debt repayments in 2012 and 2013. Other interest and dividends revenue increased 25% primarily due to an increase in interest income recognized on general partner partnership loans. See further discussion of these loans in Note 10 to the Consolidated Financial Statements. These favorable increases were partially offset by a 4% decrease in interest income from client loans, a reflection of a lower average aggregate client loan balance and a lower average rate earned.

Net interest and dividends revenue increased 14% in 2012 to $71.2 million. Interest expense decreased in 2012 primarily due to lower average debt balances during the current period related to debt repayments in 2011 and 2012. Interest income from short-term investing increased 53% in 2012 primarily due to an increase in the average funds invested on these types of investments as well as an increase in the rate earned. Other interest and dividends revenue increased 23% primarily due to an increase in interest income recognized on general partner partnership loans.

Other Revenue

Other revenue increased 68% to $52.3 million in 2013 and increased 169% to $31.2 million in 2012. The increase in both years is primarily attributable to increases in the value of investments held related to the Partnership’s nonqualified deferred compensation plan. The Partnership has chosen to hedge the future liability for the plan by purchasing investments in an amount similar to the future expected liability. As the market value of these investments fluctuates, the gains or losses are recorded in other revenue with an offset in compensation and fringe benefits expense, resulting in minimal net impact to the Partnership’s income before allocations to partners.

 

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Operating Expenses

 

     Years Ended December 31,      % Change  
     2013      2012      2011      2013 vs. 2012     2012 vs. 2011  

Operating expenses ($ millions):

             

Compensation and benefits:

             

Financial advisor compensation

   $ 2,003.9       $ 1,738.6       $ 1,597.0         15     9

Home office and branch

     946.8         917.4         855.3         3     7

Variable compensation

     643.1         497.0         378.3         29     31

Financial advisor salary and subsidy

     199.3         132.2         109.5         51     21
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total compensation and benefits

     3,793.1         3,285.2         2,940.1         15     12

Occupancy and equipment

     356.0         353.0         356.6         1     -1

Communications and data processing

     291.5         279.3         289.4         4     -3

Payroll and other taxes

     207.3         186.0         171.1         11     9

Advertising

     58.0         56.3         54.2         3     4

Postage and shipping

     50.9         47.6         48.5         7     -2

Clearance fees

     12.6         12.6         12.6         0     0

Other operating expenses

     213.2         190.2         155.6         12     22
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total operating expenses

   $ 4,982.6       $ 4,410.2       $ 4,028.1         13     9
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Related metrics:

             

Number of branches

             

At period end

     11,647         11,415         11,408         2     0

Average

     11,510         11,396         11,394         1     0

Financial advisors:

             

At period end

     13,158         12,463         12,242         6     2

Average

     12,784         12,273         12,359         4     -1

Branch employees(1):

             

At period end

     13,832         13,619         12,889         2     6

Average

     13,639         13,365         13,130         2     2

Home office employees(1):

             

At period end

     5,174         5,087         4,933         2     3

Average

     5,119         5,008         4,919         2     2

Home office employees(1) per 100 financial advisors (average)

     40.0         40.8         39.8         -2     3

Branch employees(1) per 100 financial advisors (average)

     106.7         108.9         106.2         -2     3

Average operating expenses per financial advisor(2)

   $ 182,697       $ 177,177       $ 166,096         3     7

 

(1) Counted on a full-time equivalent basis.
(2) Operating expenses used in calculation represent total operating expenses less financial advisor and variable compensation.

Operating expenses increased 13% in 2013 to $5.0 billion primarily due to a 15% increase in compensation and benefits (described below). The remaining operating expenses increased 6% ($64.5 million) primarily due to an 11% increase in payroll and other taxes caused by the increases in compensation and a 12% increase in other operating expenses.

Financial advisor compensation increased 15% ($265.3 million) in 2013 primarily due to increases in trade and asset-based fee revenue on which financial advisor commissions are paid. Financial advisor salary and subsidy increased 51% ($67.1 million) primarily due to growth in financial advisors and new compensation initiatives.

 

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Home office and branch salary and fringe benefit expense increased 3% ($29.4 million) in 2013 primarily due to higher wages and more personnel to support increased productivity of the Partnership’s financial advisor network. The average number of both the Partnership’s home office and branch employees increased 2%.

Variable compensation expands and contracts in relation to revenues, income before allocations to partners and the Partnership’s related profit margin. As the Partnership’s financial results and profit margin improve, a significant portion is allocated to variable compensation and paid to employees in the form of increased profit sharing and bonuses. As a result, variable compensation increased 29% ($146.1 million) in 2013 to $643.1 million.

The Partnership uses the ratios of both the number of home office and the number of branch employees per 100 financial advisors and the average operating expenses per financial advisor as key metrics in managing its costs. In 2013, both the average number of home office employees and branch employees per 100 financial advisors decreased 2%, reflecting the Partnership’s longer term cost management strategy to grow its financial advisor network at a faster pace than its home office and branch support staff. The average operating expense per financial advisor increased 3% primarily due to increases in home office employees’ salary and fringe benefit expenses and branch operating expenses to support the Partnership’s financial advisor network, partially offset by the impact of spreading those costs over more financial advisors.

Operating expenses increased 9% in 2012 to $4.4 billion primarily due to a 12% increase in compensation and benefits (described below). The remaining operating expenses increased 3% ($37.0 million) primarily due to a 9% increase in payroll and other taxes caused by the increase in compensation and a 22% increase in other operating expenses.

Financial advisor compensation increased 9% ($141.6 million) in 2012 primarily due to increases in trade and asset-based fee revenue on which financial advisor commissions are paid. Financial advisor salary and subsidy increased 21% ($22.7 million) primarily due to new financial advisor compensation initiatives implemented in July 2012, in addition to more financial advisors participating in the programs.

Home office and branch salary and fringe benefit expense increased 7% ($62.1 million) in 2012 primarily due to salary increases, higher healthcare costs, and increases in personnel to support increased productivity of the Partnership’s financial advisor network. The average number of both the Partnership’s home office and branch employees increased 2%.

As a result of the Partnership’s strong financial results and profit margin, variable compensation increased 31% ($118.7 million) in 2012 to $497.0 million.

In 2012, the average number of home office employees and branch employees per 100 financial advisors both increased 3%. This result is despite the Partnership’s longer term cost management strategy to grow its financial advisor network at a faster pace than its home office support staff. Although the average number of financial advisors in 2012 decreased 1% as compared to 2011, the number of financial advisors at December 31, 2012 increased 2% as compared to December 31, 2011. The average operating expense per financial advisor increased 7% primarily due to increases in home office employees’ salary and fringe benefit expenses and branch operating expenses to support the Partnership’s financial advisor network, in addition to a decrease in the average number of financial advisors.

 

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Segment Information

An operating segment is defined as a component of an entity that has all of the following characteristics: it engages in business activities from which it may earn revenues and incur expenses; the entity’s chief operating decision-maker (or decision-making group) regularly reviews its operating results for resource allocation and to assess performance; and discrete financial information is available. Operating segments may be combined in certain circumstances into reportable segments for financial reporting. The Partnership has determined it has two operating and reportable segments based upon geographic location, the U.S. and Canada.

Each segment, in its own geographic location, primarily derives revenue from the retail brokerage business for the purchase or sale of mutual fund shares, listed and unlisted securities and insurance products, as well as from principal transactions, investment banking, and fees related to assets held by and account services provided to its clients.

The Partnership evaluates segment performance based upon income before allocations to partners, as well as income before variable compensation. Variable compensation is determined at the Partnership level for profit sharing and home office and branch employee bonus amounts, and therefore is allocated to each geographic segment independent of that segment’s individual income (loss) before variable compensation. Financial advisor bonuses are determined by the overall Partnership’s profitability, as well as the performance of the individual financial advisors. Both income (loss) before allocations to partners and income (loss) before variable compensation are considered in evaluating segment performance.

Canada segment information, as reported in the following table, is based upon the Consolidated Financial Statements of the Partnership’s Canada operations without eliminating intercompany items, such as management fees paid to affiliated entities. The U.S. segment information is derived from the Consolidated Financial Statements less the Canada segment information as presented. This is consistent with how management reviews the segments in order to assess performance.

 

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The following table shows financial information for the Partnership’s reportable segments. All amounts are presented in millions, except the number of financial advisors and as otherwise noted.

 

     Years Ended December 31,     % Change  
     2013     2012     2011     2013 vs. 2012     2012 vs. 2011  

Net revenue:

          

U.S.

   $ 5,457.5      $ 4,789.9      $ 4,324.5        14     11

Canada

     199.4        175.3        185.4        14     -5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenue

     5,656.9        4,965.2        4,509.9        14     10

Operating expenses (excluding variable compensation):

          

U.S.

     4,147.2        3,734.4        3,468.6        11     8

Canada

     192.3        178.8        181.2        8     -1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     4,339.5        3,913.2        3,649.8        11     7

Pre-variable income (loss):

          

U.S.

     1,310.3        1,055.5        855.9        24     23

Canada

     7.1        (3.5     4.2        303     -183
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total pre-variable income

     1,317.4        1,052.0        860.1        25     22

Variable compensation:

          

U.S.

     626.0        485.2        366.7        29     32

Canada

     17.1        11.8        11.6        45     2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total variable compensation

     643.1        497.0        378.3        29     31

Income (loss) before allocations to partners:

          

U.S.

     684.3        570.3        489.2        20     17

Canada

     (10.0     (15.3     (7.4     35     -107
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total income before allocations to partners

   $ 674.3      $ 555.0      $ 481.8        21     15
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Client assets under care ($ billions):

          

U.S.

          

At year end

   $ 768.8      $ 651.9      $ 576.4        18     13

Average

   $ 708.9      $ 621.1      $ 570.5        14     9

Canada

          

At year end

   $ 18.3      $ 16.8      $ 14.8        9     14

Average

   $ 17.5      $ 15.9      $ 15.6        10     2

Financial advisors:

          

U.S.

          

At year end

     12,483        11,822        11,622        6     2

Average

     12,131        11,652        11,740        4     -1

Canada

          

At year end

     675        641        620        5     3

Average

     653        621        619        5     0

 

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U.S.

Net revenue increased 14% in 2013 primarily due to increases in asset-based fee revenue and trade revenue. Asset-based fee revenue increased 24% ($471.4 million) primarily due to an increase in advisory programs fee revenue of 30% ($313.7 million) which was the result of continued growth in client assets under care. The increase to trade revenue of 9% ($184.5 million) was primarily due to the impact of increased client dollars invested, partially offset by a decrease in the margin earned in 2013 compared to 2012. Strong market performance also contributed to overall revenue growth.

Operating expenses (excluding variable compensation) increased 11% in 2013 primarily due to higher financial advisor compensation and salary and fringe benefits. The increase in financial advisor compensation was due to increases in trade and asset-based fee revenue on which financial advisor commissions are paid. Salary and fringe benefits expense increased due to more personnel to support increased productivity of the Partnership’s financial advisor network.

Net revenue increased 11% in 2012 primarily due to increases in asset-based fee revenue, trade revenue and account and activity fees. Asset-based fee revenue increased 15% ($263.9 million) primarily due to an increase in advisory programs fee revenue of 24% ($201.4 million) which was the result of continued growth in client assets under care. The increase to trade revenue of 6% ($121.0 million) was primarily due to the impact of increased client dollars invested, partially offset by a decrease in the margin earned in 2012 compared to 2011. The increase in account and activity fees of 10% ($51.6 million) was primarily the result of an increase in revenue from sub-transfer agent services due to an increase in the number of average client holdings serviced.

Operating expenses (excluding variable compensation) increased 8% in 2012 primarily due to increases in financial advisor compensation and salary and fringe benefits. The increase in financial advisor compensation was due to increases in trade and asset-based fee revenue on which financial advisor commissions are paid. Salary and fringe benefits expense increased due to salary increases and increased personnel to support increased productivity of the Partnership’s financial advisor network, as well as an increase in healthcare costs.

Canada

Net revenue increased 14% in 2013 primarily due to increases in asset-based fee revenue and trade revenue. Asset-based fee revenue increased 18% ($8.9 million) primarily due to an increase in service fee revenue of 16% ($7.6 million), reflecting an increase in client assets under care due to the investment of client dollars and higher market values of the underlying assets. Trade revenue increased 8% ($8.3 million) primarily due to an increase in client dollars invested and favorable market conditions, reflected in the 5% increase in the daily average of the TSX.

Operating expenses (excluding variable compensation) increased 8% in 2013 primarily due to higher financial advisor compensation resulting from increases in trade and asset-based fee revenues on which financial advisor commissions are paid.

 

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As a result, pre-variable income (loss) improved from a loss of $3.5 million in 2012 to income of $7.1 million in 2013. Improvement in the Canada segment is due in part to the continued focus to achieve profitability. This includes several initiatives to increase revenue and control expenses. Revenue initiatives include the plan to grow the number of financial advisors, client assets under care and the depth of financial solutions provided to clients, and the roll out of additional advisory programs.

Net revenue decreased 5% in 2012 primarily due to a decrease in trade revenue. Trade revenue decreased 9% ($10.5 million) primarily due to a decrease in client dollars invested. This decrease was consistent with the lower levels of client activity and unfavorable market conditions, reflected in the 8% decrease in the daily average of the TSX. Operating expenses (excluding variable compensation) decreased 1% in 2012 primarily due to lower financial advisor compensation caused by a decrease in trade revenue on which financial advisor commissions are paid. As a result, there was a pre-variable loss of $3.5 million in 2012. Further, the Canada business segment experienced a slight increase in the average number of financial advisors in 2012 and 3% growth year-over-year.

LEGISLATIVE AND REGULATORY REFORM

As discussed more fully in the “Legislative and Regulatory Initiatives” risk factor in Part I, Item 1A – Risk Factors, the Partnership continues to monitor Regulatory Initiatives, including the possibility of a universal fiduciary standard of care applicable to both broker-dealers and investment advisers under the Dodd-Frank Act, limits on fees paid by mutual funds (often called 12b-1 fees), and reforms to the regulation of money market funds. The Regulatory Initiatives may impact the manner in which the Partnership markets its products and services, manages its business and operations, and interacts with clients and regulators, any or all of which could materially impact the Partnership’s results of operations, financial condition, and liquidity. However, the Partnership cannot presently predict when or if any Regulatory Initiatives will be enacted or the impact that any Regulatory Initiatives will have on the Partnership.

MUTUAL FUNDS AND ANNUITIES

The Partnership derived 75%, 74% and 70% of its total revenue from sales and services related to mutual fund and annuity products in 2013, 2012 and 2011, respectively. In addition, the Partnership derived from one mutual fund company 19% of its total revenue in 2013, 2012 and 2011. The revenue generated from this company relates to business conducted with the Partnership’s U.S. segment.

Significant reductions in these revenues due to regulatory reform or other changes to the Partnership’s relationship with mutual fund companies could have a material adverse effect on the Partnership’s results of operations.

 

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LIQUIDITY AND CAPITAL RESOURCES

The Partnership requires liquidity to cover its operating expenses, net capital requirements, capital expenditures, debt repayment obligations and redemptions of partnership interests. The principal sources for meeting the Partnership’s liquidity requirements include existing liquidity and capital resources of the Partnership, discussed further below, and funds generated from operations. The Partnership believes that the liquidity provided by these sources will be sufficient to meet its capital and liquidity requirements for the next twelve months. Depending on conditions in the capital markets and other factors, the Partnership will, from time to time, consider the issuance of debt and additional partnership capital, the proceeds of which could be used to meet growth needs or for other purposes.

Partnership Capital

The Partnership’s growth in capital has historically been through the sale of limited partnership interests to its employees and existing limited partners, the sale of subordinated limited partnership interests to its current or retiring general partners, general partnership interest contributions, and retention of general partner earnings.

The Partnership filed a Registration Statement on Form S-8 with the SEC on January 17, 2014 to register $350 million in securities in preparation for its anticipated 2014 Limited Partnership offering. The Partnership intends to offer approximately $300 million in Interests to eligible financial advisors, branch office administrators and home office associates. The remaining $50 million may be issued in the discretion of the Executive Committee, which may include issuances to financial advisors who complete a retirement transition plan in future years and who may be considered for additional limited partnership interest. The 2014 Limited Partnership offering is expected to close early next year. The issuance of limited partnership interests will reduce the percentage of participation in net income by general partners, subordinated limited partners and current limited partners. Proceeds from the 2014 Limited Partnership offering are expected to be used toward working capital and general corporate purposes and to ensure there is adequate general liquidity of the Partnership for future needs.

Any addition of new Interests will decrease the Partnership’s net interest income by the 7.5% Payment for any such additional Interests, and holders of existing Interests may suffer decreased returns on their investment because the amount of the Partnership’s net income they participate in may be reduced as a consequence. Accordingly, the issuance of LP interests will reduce the Partnership’s net interest income and profitability beginning in 2015.

The Partnership’s capital subject to mandatory redemption at December 31, 2013, net of reserve for anticipated withdrawals, was $1,857.9 million, an increase of $45.7 million from December 31, 2012. This increase in the Partnership’s capital subject to mandatory redemption was primarily due to the retention of general partner earnings ($72.2 million) and additional capital contributions related to subordinated limited partner and general partner interests ($31.5 million and $102.3 million, respectively), partially offset by the redemption of limited partner, subordinated limited partner and general partner interests ($10.5 million, $10.6 million and $94.9 million, respectively) and the increase of partnership loans outstanding ($44.3 million). During the years ended December 31, 2013, 2012 and 2011, the Partnership retained 13.8%, 23.0% and 23.0%, respectively, of income allocated to general partners. Beginning in 2013, the Partnership decreased the amount of retention to 13.8% of net income allocated to general partners due to the increase in individual income tax rates in 2013 and current capital needs. The decrease in the percentage of retention of income allocated to general partners did not have a material impact on the Partnership’s capital or liquidity.

 

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Under the terms of the Partnership Agreement, a partner’s capital is required to be redeemed by the Partnership in the event of the partner’s death or withdrawal from the Partnership, subject to compliance with ongoing regulatory capital requirements. In the event of a partner’s death, the Partnership must generally redeem the partner’s capital within six months. The Partnership has withdrawal restrictions in place limiting the amount of capital that can be withdrawn at the discretion of the partner. Under the terms of the Partnership Agreement, limited partners withdrawing from the Partnership are to be repaid their capital in three equal annual installments beginning the month after their withdrawal. The capital of general partners withdrawing from the Partnership is converted to subordinated limited partnership capital or, at the discretion of the Managing Partner, redeemed by the Partnership. Subordinated limited partners are repaid their capital in six equal annual installments beginning the month after their request for withdrawal of contributed capital. The Partnership’s Managing Partner has discretion to waive or modify these withdrawal restrictions and to accelerate the return of capital.

The Partnership makes loans available to those general partners (other than members of the Executive Committee, which consists of the executive officers of the Partnership) who require financing for some or all of their partnership capital contributions. Additionally, in limited circumstances a general partner may withdraw from the Partnership and become a subordinated limited partner while he or she still has an outstanding partnership loan. Loans made by the Partnership to partners are generally for a period of one year but are expected to be renewed and bear interest at the prime rate, as defined in the loan documents. The Partnership recognizes interest income for the interest received related to these loans. Partners borrowing from the Partnership will be required to repay such loans by applying the earnings received from the Partnership to such loans, net of amounts retained by the Partnership and amounts distributed for income taxes. Prior to 2013, bank loans administered by the Partnership and entered into by general or subordinated limited partners to finance their capital contributions in the Partnership were repaid prior to any application of earnings towards that partner’s partnership loan. On January 18, 2013, the Partnership paid, through earnings on behalf of the general and subordinated limited partners, the $35.4 million outstanding balance on partnership administered bank loans related to capital contributions of general or subordinated limited partners. The maturity date of these loans was February 22, 2013. In connection with this payoff, the Partnership issued $11.2 million of partnership loans. It is anticipated that future general and subordinated limited partnership capital contributions (other than for Executive Committee members) requiring financing will be financed through partnership loans. The Partnership has full recourse against any partner that defaults on loan obligations to the Partnership. The Partnership does not anticipate that partner loans will have an adverse impact on the Partnership’s short-term liquidity or capital resources.

The Partnership has not and will not provide loans to members of the Executive Committee. Executive Committee members who require financing for some or all of their partnership capital contributions will continue to borrow directly from banks willing to provide such financing on an individual basis. Other partners may also choose to have individual banking arrangements for their partnership capital contributions.

Any bank financing of capital contributions is in the form of unsecured bank loan agreements and are between the individual and the bank. The Partnership does not guarantee these bank loans, nor can the partner pledge his or her partnership interest as collateral for the bank loan. The Partnership performs certain administrative functions in connection with its limited partners who have elected to finance a portion of their partnership capital contributions through individual unsecured bank loan agreements from banks with whom the Partnership has other banking relationships.

 

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For all limited partner capital contributions financed through such bank loan agreements, each agreement instructs the Partnership to apply the proceeds from the liquidation of that individual’s capital account to the repayment of their bank loan prior to any funds being released to the partner. In addition, the partner is required to apply partnership earnings, net of any distributions to pay taxes, to service the interest and principal on the bank loan. Should a partner’s individual bank loan not be renewed upon maturity for any reason, the Partnership could experience increased requests for capital liquidations, which could adversely impact the Partnership’s liquidity. In addition, partners who finance all or a portion of their capital contributions with bank financing may be more likely to request the withdrawal of capital to meet bank financing requirements should the partners experience a period of reduced earnings. As a partnership, any withdrawals by general partners, subordinated limited partners or limited partners would reduce the Partnership’s available liquidity and capital.

Many of the same banks that provide financing to limited partners also provide various forms of financing to the Partnership. To the extent these banks increase credit available to the partners, financing available to the Partnership may be reduced.

The Partnership, while not a party to any partner unsecured bank loan agreements, does facilitate making payments of allocated income to certain banks on behalf of the limited partner. The following table represents amounts related to partnership loans as well as bank loans (for which the Partnership facilitates certain administrative functions). Partners may have arranged their own bank loans to finance their partnership capital for which the Partnership does not facilitate certain administrative functions and therefore any such loans are not included in the table.

 

     As of December 31, 2013  

($ millions)

   Limited
Partnership
Interests
    Subordinated
Limited
Partnership
Interests
    General
Partnership
Interests
    Total
Partnership
Capital
 

Partnership capital(1) :

        

Total partnership capital

   $ 640.3      $ 304.5      $ 1,127.6      $ 2,072.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Partnership capital owned by partners with individual loans

   $ 95.2      $ 0.5      $ 583.6      $ 679.3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Partnership capital owned by partners with individual loans as a percent of total partnership capital

     14.9     0.2     51.8     32.8

Partner loans:

        

Bank loans

   $ 22.7      $ —        $ —        $ 22.7   

Partnership loans

   $ —        $ 0.1      $ 214.4      $ 214.5   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

   $ 22.7      $ 0.1      $ 214.4      $ 237.2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Partner loans as a percent of total partnership capital

     3.5     0.0     19.0     11.4

Partner loans as a percent of partnership capital owned by partners with loans

     23.8     20.0     36.7     34.9

 

(1) Partnership capital, as defined for this table, is before the reduction of partnership loans and is net of reserve for anticipated withdrawals.

 

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Historically, neither the amount of partnership capital financed with individual loans as indicated in the table above, nor the amount of partner capital withdrawal requests has had a significant impact on the Partnership’s liquidity or capital resources.

Lines of Credit

The following table shows the composition of the Partnership’s aggregate bank lines of credit in place as of December 31, 2013 and 2012:

 

($ millions)

   2013      2012  

2013 Credit Facility

   $ 400       $ —     

2011 Credit Facility

     —           395   

Uncommitted secured credit facilities

     415         415   
  

 

 

    

 

 

 

Total bank lines of credit

   $ 815       $ 810   
  

 

 

    

 

 

 

In March 2011, the Partnership entered into a three-year $395 million committed unsecured revolving line of credit (“2011 Credit Facility”) with an expiration date of March 18, 2014. In November 2013, the Partnership replaced the 2011 Credit Facility with an agreement with 12 banks for a five-year $400 million committed unsecured revolving line of credit (“2013 Credit Facility”). The 2013 Credit Facility is intended to provide short-term liquidity to the Partnership should the need arise. In addition, the Partnership has uncommitted lines of credit that are subject to change at the discretion of the banks. Based on credit market conditions and the uncommitted nature of these credit facilities, it is possible that these lines of credit could decrease or not be available in the future.

Actual borrowing availability on the uncommitted secured lines is based on client margin securities and partnership securities, which would serve as collateral on loans in the event the Partnership borrowed against these lines. There were no amounts outstanding on the 2013 Credit Facility and the uncommitted lines of credit as of December 31, 2013 and 2012. In addition, the Partnership did not have any draws against these lines of credits during the years ended December 31, 2013 and 2012.

The Partnership is in compliance with all covenants related to its outstanding debt agreements as of December 31, 2013. For further details on covenants, see discussion regarding debt covenants in Notes 7 and 9 to the Consolidated Financial Statements.

Cash Activity

As of December 31, 2013, the Partnership had $0.6 billion in cash and cash equivalents and $1.0 billion in securities purchased under agreements to resell, which have maturities of less than one week. This totals $1.6 billion of Partnership liquidity as of December 31, 2013, a 4% ($67 million) decrease from $1.7 billion at December 31, 2012. This decrease is primarily due to timing of client cash activity and the resulting requirement for segregation. The Partnership had $8.4 billion and $7.7 billion in cash and investments segregated under federal regulations as of December 31, 2013 and 2012, respectively, which was not available for general use.

 

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Capital Expenditures

The Partnership estimates 2014 capital expenditures will approximate $130 million and will be funded by normal operations. Approximately half of the capital expenditures will be for construction at the north campus location in St. Louis where the Partnership is currently renovating two facilities and building a new parking structure.

Regulatory Requirements

As a result of its activities as a U.S. broker-dealer, Edward Jones is subject to the net capital provisions of Rule 15c3-1 of the Exchange Act and capital compliance rules of the FINRA Rule 4110. Under the alternative method permitted by the rules, Edward Jones must maintain minimum net capital, as defined, equal to the greater of $0.25 million or 2% of aggregate debit items arising from client transactions. The net capital rules also provide that Edward Jones’ partnership capital may not be withdrawn if the resulting net capital would be less than minimum requirements. Additionally, certain withdrawals require the approval of the SEC and FINRA to the extent they exceed defined levels, even though such withdrawals would not cause net capital to be less than minimum requirements.

The Partnership’s Canada broker-dealer is a registered securities dealer regulated by IIROC. Under the regulations prescribed by IIROC, the Partnership is required to maintain prescribed/minimum levels of risk-adjusted capital, which are dependent on the nature of the Partnership’s assets and operations.

The following table shows the Partnership’s net capital figures for its U.S. and Canada broker-dealers as of December 31, 2013 and 2012:

 

($ millions)

   2013     2012     % Change  

U.S.:

      

Net capital

   $ 873      $ 712        23

Net capital in excess of the minimum required

   $ 830      $ 670        24

Net capital as a percentage of aggregate debit items

     41.4     34.0     22

Net capital after anticipated capital withdrawals, as a percentage of aggregate debit items

     24.8     18.5     34

Canada:

      

Regulatory risk adjusted capital

   $ 34      $ 38        -11

Regulatory risk adjusted capital in excess of the minimum required to be held by IIROC

   $ 27      $ 28        -4

Net capital and the related capital percentage may fluctuate on a daily basis. In addition, EJTC was in compliance with regulatory capital requirements.

The Partnership and its subsidiaries are subject to examination by the Internal Revenue Service (“IRS”) and by various state and foreign taxing authorities in the jurisdictions in which the Partnership and its subsidiaries conduct business. In 2012, the IRS began an examination of Edward Jones’ income tax returns for the years ended 2009 and 2010. This examination is on-going and is not expected to have a material impact to the Partnership.

 

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OFF BALANCE SHEET ARRANGEMENTS

The Partnership does not have any significant off-balance-sheet arrangements.

CONTRACTUAL COMMITMENTS AND OBLIGATIONS

The following table summarizes the Partnership’s long-term financing commitments and obligations as of December 31, 2013. Subsequent to December 31, 2013, these commitments and obligations may have fluctuated based on the changing business environment. The interest on financing commitments is based upon the stated rates of the underlying instruments, which range from 7.28% to 7.33%. For further disclosure regarding long-term debt, liabilities subordinated to claims of general creditors and rental commitments, see Notes 8, 9 and 14, respectively, to the Consolidated Financial Statements.

 

($ millions)

   Payments Due by Period  
     2014      2015      2016      2017      2018      Thereafter      Total  

Long-term debt

   $ 1.2       $ 1.2       $ 1.3       $ 0.7       $ —         $ —         $ 4.4   

Liabilities subordinated to claims of general creditors

     50.0         —           —           —           —           —           50.0   

Interest on financing commitments(1)

     2.1         0.2         0.1         —           —           —           2.4   

Rental commitments

     132.0         34.2         22.9         16.0         11.8         32.4         249.3   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total financing commitments and obligations

   $ 185.3       $ 35.6       $ 24.3       $ 16.7       $ 11.8       $ 32.4       $ 306.1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Interest paid may vary depending on timing of principal payments in addition to changes in variable interest rates on underlying obligations.

In addition to the above table, the Partnership has a revolving unsecured line of credit outstanding as of December 31, 2013 (see Note 7 to the Consolidated Financial Statements). Additionally, the Partnership would incur termination fees of approximately $146 million in 2014 in the event the Partnership terminated existing contractual commitments with certain vendors providing ongoing services primarily for information technology, operations and marketing. These termination fees will decrease over the related contract periods, which generally expire within the next three years.

CRITICAL ACCOUNTING POLICIES

The Partnership’s financial statements are prepared in accordance with GAAP, which may require judgment and involve estimation processes to determine its assets, liabilities, revenues and expenses which affect its results of operations.

The Partnership believes that of its significant accounting policies, the following critical policies require estimates that involve a higher degree of judgment and complexity.

Asset-Based Fees. Due to the timing of receipt of information, the Partnership must use estimates in recording the accruals related to certain asset-based fees. These accruals are based on historical trends and are adjusted to reflect market conditions for the period covered. Additional adjustments, if needed, are recorded in subsequent periods.

 

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Legal Reserves. The Partnership provides for potential losses that may arise out of litigation, regulatory proceedings and other contingencies to the extent that such losses can be estimated, in accordance with ASC No. 450, Contingencies. See Note 15 to the Consolidated Financial Statements and Part I, Item 3 – Legal Proceedings for further discussion of these items. The Partnership regularly monitors its exposures for potential losses. The Partnership’s total liability with respect to litigation and regulatory proceedings represents the best estimate of probable losses after considering, among other factors, the progress of each case, the Partnership’s experience and discussions with legal counsel.

Included in Part II, Item 7A – Quantitative and Qualitative Disclosures about Market Risk and in Note 1 to the Consolidated Financial Statements, are additional discussions of the Partnership’s accounting policies.

THE EFFECTS OF INFLATION

The Partnership’s net assets are primarily monetary, consisting of cash and cash equivalents, cash and investments segregated under federal regulations, securities owned and receivables, less liabilities. Monetary net assets are primarily liquid in nature and would not be significantly affected by inflation. Inflation and future expectations of inflation influence securities prices, as well as activity levels in the securities markets. As a result, profitability and capital may be impacted by inflation and inflationary expectations. Additionally, inflation’s impact on the Partnership’s operating expenses may affect profitability to the extent that additional costs are not recoverable through increased prices of services offered by the Partnership.

RECENTLY ADOPTED ACCOUNTING STANDARDS

In December 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-11, Disclosures about Offsetting Assets and Liabilities (“ASU 2011-11”), which established requirements for an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. ASU 2011-11 was adopted on January 1, 2013 and adoption did not have a material impact on the Partnership’s Consolidated Financial Statements (see Note 19 to the Consolidated Financial Statements).

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Various levels of management within the Partnership manage the Partnership’s risk exposure. Position limits in trading and inventory accounts are established and monitored on an ongoing basis. Credit risk related to various financing activities is reduced by the industry practice of obtaining and maintaining collateral. The Partnership monitors its exposure to counterparty risk through the use of credit exposure information, the monitoring of collateral values and the establishment of credit limits. For further discussion of monitoring, see the Risk Management discussion in Item 10 – Directors, Executive Officers and Corporate Governance of this Annual Report.

The Partnership is exposed to market risk from changes in interest rates. Such changes in interest rates impact the income from interest earning assets, primarily receivables from clients on margin balances and short-term investments, which averaged $2.1 billion and $8.8 billion for the year ended December 31, 2013, respectively. The changes in interest rates may also have an impact on the expense related to liabilities that finance these assets, such as amounts payable to clients and other interest and non-interest bearing liabilities.

The Partnership performed an analysis of its financial instruments and assessed the related interest rate risk and materiality in accordance with the SEC rules. Under current market conditions and based on current levels of interest earning assets and the liabilities that finance these assets, the Partnership estimates that a 100 basis point (1.00%) increase in short-term interest rates could increase its annual net interest income by approximately $82 million. Conversely, the Partnership estimates that a 100 basis point (1.00%) decrease in short-term interest rates could decrease the Partnership’s annual net interest income by approximately $14 million. A decrease in short-term interest rates currently has a less significant impact on net interest income due to the current low interest rate environment. The Partnership has two distinct types of interest bearing assets: client receivables from margin accounts and short-term, primarily overnight, investments, which are primarily comprised of cash and investments segregated under federal regulations and securities purchased under agreements to resell. These investments have earned interest at an average rate of approximately 16 basis points (0.16%) in 2013, and therefore the financial dollar impact of further decline in rates is minimal. The Partnership has put in place an interest rate floor for the interest charged related to its client margin loans, which helps to limit the negative impact of declining interest rates.

In addition to the interest earning assets and liabilities noted above, the Partnership’s revenue earned related to its minority ownership interest in the adviser to the Edward Jones money market funds is also impacted by changes in interest rates. As discussed in Item 1—Business, as a 49.5% limited partner of Passport Research Ltd., the investment adviser to two of the money market funds made available to Edward Jones clients, the Partnership receives a portion of the income of the investment adviser. Due to the current historically low interest rate environment, the investment adviser voluntarily chose (beginning in March 2009) to reduce certain fees charged to the funds to a level that will maintain a positive client yield on the funds. This reduction of fees reduced the Partnership’s cash solutions revenue by approximately $100 million, $90 million and $90 million for the years ended December 31, 2013, 2012 and 2011, respectively, and is expected to continue at that level in future periods, based upon the current interest rate environment. Alternatively, if the interest rate environment improved such that this reduction in fees was no longer necessary to maintain a positive client yield, the Partnership’s revenue could increase annually by that same level.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Financial Statements Included in this Item

 

 

    Page
No.
 

Management’s Report on Internal Control over Financial Reporting

    61   

Report of Independent Registered Public Accounting Firm

    62   

Consolidated Statements of Financial Condition as of December 31, 2013 and 2012

    64   

Consolidated Statements of Income for the years ended December 31, 2013, 2012 and 2011

    65   

Consolidated Statements of Changes in Partnership Capital Subject to Mandatory Redemption for the years ended December 31, 2013, 2012 and 2011

    66   

Consolidated Statements of Cash Flows for the years ended December 31, 2013, 2012 and 2011

    67   

Notes to Consolidated Financial Statements

    68   

 

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MANAGEMENT’S REPORT ON INTERNAL CONTROL

OVER FINANCIAL REPORTING

Management of The Jones Financial Companies, L.L.L.P. and all wholly-owned subsidiaries (collectively, the “Partnership”), is responsible for establishing and maintaining adequate internal control over financial reporting. The Partnership’s internal control over financial reporting is a process designed under the supervision of the Partnership’s chief executive officer and chief financial officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Partnership’s financial statements for external purposes in accordance with U.S. generally accepted accounting principles.

As of the end of the Partnership’s 2013 fiscal year, management conducted an assessment of the effectiveness of the Partnership’s internal control over financial reporting based on the framework established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992). Based on this assessment, management has determined that the Partnership’s internal control over financial reporting as of December 31, 2013 was effective.

The Partnership’s internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of management of the Partnership; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Partnership’s assets that could have a material effect on its financial statements.

The Partnership’s internal control over financial reporting as of December 31, 2013 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their accompanying report, which expresses an unqualified opinion on the effectiveness of the Partnership’s internal control over financial reporting as of December 31, 2013.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To The Jones Financial Companies, L.L.L.P.

In our opinion, the accompanying Consolidated Statements of Financial Condition and the related Consolidated Statements of Income, of Changes in Partnership Capital Subject To Mandatory Redemption and of Cash Flows present fairly, in all material respects, the consolidated financial position of The Jones Financial Companies, L.L.L.P. and its subsidiaries (the “Partnership”) at December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15(a)(2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related Consolidated Financial Statements. Also in our opinion, the Partnership maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992). The Partnership’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Partnership’s internal control over financial reporting based on our integrated 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

/s/ PricewaterhouseCoopers LLP

St. Louis, Missouri

March 28, 2014

 

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Item 8. Financial Statements and Supplementary Data, continued

 

THE JONES FINANCIAL COMPANIES, L.L.L.P.

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

 

     December 31,
2013
     December 31,
2012
 

(Dollars in thousands)

     

ASSETS:

     

Cash and cash equivalents

   $ 599,705       $ 600,936   

Cash and investments segregated under federal regulations

     8,435,077         7,714,642   

Securities purchased under agreements to resell

     1,026,405         1,092,586   

Receivable from:

     

Clients

     2,300,082         2,266,874   

Mutual funds, insurance companies and other

     405,009         355,507   

Brokers, dealers and clearing organizations

     148,103         189,119   

Securities owned, at fair value:

     

Inventory securities

     101,495         74,552   

Investment securities

     141,094         111,904   

Equipment, property and improvements, at cost, net of accumulated depreciation and amortization

     542,585         537,049   

Other assets

     95,206         99,074   
  

 

 

    

 

 

 

TOTAL ASSETS

   $ 13,794,761       $ 13,042,243   
  

 

 

    

 

 

 

LIABILITIES:

     

Payable to:

     

Clients

   $ 10,596,321       $ 10,075,684   

Brokers, dealers and clearing organizations

     79,243         65,477   

Securities sold, not yet purchased, at fair value

     4,259         22,327   

Accrued compensation and employee benefits

     842,448         665,509   

Accounts payable and accrued expenses

     137,562         124,850   

Long-term debt

     4,430         5,503   
  

 

 

    

 

 

 
     11,664,263         10,959,350   
  

 

 

    

 

 

 

Liabilities subordinated to claims of general creditors

     50,000         100,000   

Commitments and contingencies (Notes 14 and 15)

     

Partnership capital subject to mandatory redemption, net of reserve for anticipated withdrawals

     1,857,915         1,812,247   

Reserve for anticipated withdrawals

     222,583         170,646   
  

 

 

    

 

 

 

Total partnership capital subject to mandatory redemption

     2,080,498         1,982,893   
  

 

 

    

 

 

 

TOTAL LIABILITIES

   $ 13,794,761       $ 13,042,243   
  

 

 

    

 

 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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Item 8. Financial Statements and Supplementary Data, continued

 

THE JONES FINANCIAL COMPANIES, L.L.L.P.

CONSOLIDATED STATEMENTS OF INCOME

 

(Dollars in thousands, except per unit information and units outstanding)

   For the Years Ended December 31,  
   2013      2012      2011  

Revenue:

        

Trade revenue

        

Commissions

   $ 2,134,396       $ 1,979,026       $ 1,698,687   

Principal transactions

     182,547         155,895         284,231   

Investment banking

     122,365         111,539         153,100   
  

 

 

    

 

 

    

 

 

 

Total trade revenue

     2,439,308         2,246,460         2,136,018   

Fee revenue

        

Asset-based

     2,522,719         2,042,392         1,776,883   

Account and activity

     567,617         573,949         522,898   
  

 

 

    

 

 

    

 

 

 

Total fee revenue

     3,090,336         2,616,341         2,299,781   

Interest and dividends

     133,726         133,469         130,150   

Other revenue

     52,281         31,148         11,553   
  

 

 

    

 

 

    

 

 

 

Total revenue

     5,715,651         5,027,418         4,577,502   

Interest expense

     58,745         62,243         67,641   
  

 

 

    

 

 

    

 

 

 

Net revenue

     5,656,906         4,965,175         4,509,861   
  

 

 

    

 

 

    

 

 

 

Operating expenses:

        

Compensation and benefits

     3,793,110         3,285,171         2,940,088   

Occupancy and equipment

     356,018         352,968         356,555   

Communications and data processing

     291,529         279,320         289,358   

Payroll and other taxes

     207,326         185,954         171,125   

Advertising

     57,964         56,255         54,201   

Postage and shipping

     50,904         47,587         48,487   

Clearance fees

     12,588         12,648         12,564   

Other operating expenses

     213,129         190,252         155,700   
  

 

 

    

 

 

    

 

 

 

Total operating expenses

     4,982,568         4,410,155         4,028,078   
  

 

 

    

 

 

    

 

 

 

Income before allocations to partners

     674,338         555,020         481,783   

Allocations to partners:

        

Limited partners

     78,105         72,018         69,960   

Subordinated limited partners

     73,166         60,551         50,292   

General partners

     523,067         422,451         361,531   
  

 

 

    

 

 

    

 

 

 

Net income

   $ —         $ —         $ —     
  

 

 

    

 

 

    

 

 

 

Income before allocations to partners per weighted average $1,000 equivalent limited partnership unit outstanding

   $ 121.12       $ 109.84       $ 104.66   
  

 

 

    

 

 

    

 

 

 

Weighted average $1,000 equivalent limited partnership units outstanding

     644,856         655,663         668,450   
  

 

 

    

 

 

    

 

 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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Item 8. Financial Statements and Supplementary Data, continued

 

THE JONES FINANCIAL COMPANIES, L.L.L.P.

CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERSHIP CAPITAL

SUBJECT TO MANDATORY REDEMPTION

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 and 2011

 

     Limited
Partnership
Capital
    Subordinated
Limited
Partnership
Capital
    General
Partnership
Capital
    Total  
          
          

(Dollars in thousands)

        

TOTAL PARTNERSHIP CAPITAL SUBJECT TO MANDATORY REDEMPTION, DECEMBER 31, 2010

   $ 479,554      $ 237,415      $ 888,004      $ 1,604,973   
  

 

 

   

 

 

   

 

 

   

 

 

 

Reserve for anticipated withdrawals

     (28,205     (15,447     (64,596     (108,248
  

 

 

   

 

 

   

 

 

   

 

 

 

Partnership capital subject to mandatory redemption, net of reserve for anticipated withdrawals, December 31, 2010

   $ 451,349      $ 221,968      $ 823,408      $ 1,496,725   

Issuance of partnership interests

     223,560        35,182        103,790        362,532   

Redemption of partnership interests

     (12,683     (1,736     (82,772     (97,191

Income allocated to partners

     69,960        50,292        361,531        481,783   

Distributions

     (26,482     (34,623     (190,114     (251,219
  

 

 

   

 

 

   

 

 

   

 

 

 

Total partnership capital, including capital financed with partnership loans

     705,704        271,083        1,015,843        1,992,630   

Partnership loans outstanding, December 31, 2011

     —          —          (86,853     (86,853
  

 

 

   

 

 

   

 

 

   

 

 

 

TOTAL PARTNERSHIP CAPITAL SUBJECT TO MANDATORY REDEMPTION, DECEMBER 31, 2011

   $ 705,704      $ 271,083      $ 928,990      $ 1,905,777   
  

 

 

   

 

 

   

 

 

   

 

 

 

Reserve for anticipated withdrawals

     (43,478     (15,669     (88,265     (147,412
  

 

 

   

 

 

   

 

 

   

 

 

 

Partnership capital subject to mandatory redemption, net of reserve for anticipated withdrawals, December 31, 2011

   $ 662,226      $ 255,414      $ 840,725      $ 1,758,365   

Partnership loans outstanding, December 31, 2011

     —          —          86,853        86,853   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total partnership capital, including capital financed with partnership loans, net of reserve for anticipated withdrawals, December 31, 2011

     662,226        255,414        927,578        1,845,218   

Issuance of partnership interests

     —          36,134        103,157        139,291   

Redemption of partnership interests

     (11,491     (7,839     (79,840     (99,170

Income allocated to partners

     72,018        60,551        422,451        555,020   

Distributions

     (27,195     (41,352     (218,655     (287,202
  

 

 

   

 

 

   

 

 

   

 

 

 

Total partnership capital, including capital financed with partnership loans

     695,558        302,908        1,154,691        2,153,157   

Partnership loans outstanding, December 31, 2012

     —          —          (170,264     (170,264
  

 

 

   

 

 

   

 

 

   

 

 

 

TOTAL PARTNERSHIP CAPITAL SUBJECT TO MANDATORY REDEMPTION, DECEMBER 31, 2012

   $ 695,558      $ 302,908      $ 984,427      $ 1,982,893   
  

 

 

   

 

 

   

 

 

   

 

 

 

Reserve for anticipated withdrawals

     (44,823     (19,199     (106,624     (170,646
  

 

 

   

 

 

   

 

 

   

 

 

 

Partnership capital subject to mandatory redemption, net of reserve for anticipated withdrawals, December 31, 2012

   $ 650,735      $ 283,709      $ 877,803      $ 1,812,247   

Partnership loans outstanding, December 31, 2012

     —          —          170,264        170,264   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total partnership capital, including capital financed with partnership loans, net of reserve for anticipated withdrawals, December 31, 2012

     650,735        283,709        1,048,067        1,982,511   

Issuance of partnership interests

     —          31,466        102,280        133,746   

Redemption of partnership interests

     (10,465     (10,617     (94,936     (116,018

Income allocated to partners

     78,105        73,166        523,067        674,338   

Distributions

     (30,595     (49,090     (299,872     (379,557
  

 

 

   

 

 

   

 

 

   

 

 

 

Total partnership capital, including capital financed with partnership loans

     687,780        328,634        1,278,606        2,295,020   

Partnership loans outstanding, December 31, 2013

     —          (126     (214,396     (214,522
  

 

 

   

 

 

   

 

 

   

 

 

 

TOTAL PARTNERSHIP CAPITAL SUBJECT TO MANDATORY REDEMPTION, DECEMBER 31, 2013

   $ 687,780      $ 328,508      $ 1,064,210      $ 2,080,498   
  

 

 

   

 

 

   

 

 

   

 

 

 

Reserve for anticipated withdrawals

     (47,510     (24,076     (150,997     (222,583
  

 

 

   

 

 

   

 

 

   

 

 

 

Partnership capital subject to mandatory redemption, net of reserve for anticipated withdrawals, December 31, 2013

   $ 640,270      $ 304,432      $ 913,213      $ 1,857,915   

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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Item 8. Financial Statements and Supplementary Data, continued

 

THE JONES FINANCIAL COMPANIES, L.L.L.P.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     For the years ended December 31,  

(Dollars in thousands)

   2013     2012     2011  

CASH FLOWS FROM OPERATING ACTIVITIES:

      

Net income

   $ —        $ —        $ —     

Adjustments to reconcile net income to net cash provided by operating activities:

      

Income before allocations to partners

     674,338        555,020        481,783   

Depreciation and amortization

     82,095        80,148        90,609   

Changes in assets and liabilities:

      

Cash and investments segregated under federal regulations

     (720,435     (3,242,116     (858,363

Securities purchased under agreements to resell

     66,181        (416,138     278,761   

Net payable to clients

     487,429        3,435,028        1,085,328   

Net receivable from brokers, dealers and clearing organizations

     54,782        (100,084     8,124   

Receivable from mutual funds, insurance companies and other

     (49,502     (55,500     (8,922

Securities owned, net

     (74,201     7,453        (3,700

Other assets

     3,868        305        (5,113

Accrued compensation and employee benefits

     176,939        125,093        34,195   

Accounts payable and accrued expenses

     9,314        (41,975     (21,974
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     710,808        347,234        1,080,728   
  

 

 

   

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

      

Purchase of equipment, property and improvements, net

     (84,233     (36,903     (54,230
  

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (84,233     (36,903     (54,230
  

 

 

   

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

      

Repayment of long-term debt

     (1,073     (997     (59,897

Repayment of subordinated liabilities

     (50,000     (50,000     (53,700

Issuance of partnership interests (net of partnership loans)

     38,549        45,121        270,839   

Redemption of partnership interests

     (116,018     (99,170     (97,191

Distributions from partnership capital

     (550,203     (434,614     (359,467

Issuance of partnership loans

     (11,203     —          —     

Repayment of partnership loans

     62,142        10,759        4,840   
  

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

     (627,806     (528,901     (294,576
  

 

 

   

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

     (1,231     (218,570     731,922   

CASH AND CASH EQUIVALENTS:

      

Beginning of year

     600,936        819,506        87,584   
  

 

 

   

 

 

   

 

 

 

End of year

   $ 599,705      $ 600,936      $ 819,506   
  

 

 

   

 

 

   

 

 

 

Cash paid for interest

   $ 58,817      $ 62,524      $ 67,904   
  

 

 

   

 

 

   

 

 

 

Cash paid for taxes (Note 12)

   $ 7,460      $ 4,132      $ 5,087   
  

 

 

   

 

 

   

 

 

 

NON-CASH ACTIVITIES:

      

Additions of equipment, property and improvements in accounts payable and accrued expenses

   $ 3,914      $ 516      $ 1,371   
  

 

 

   

 

 

   

 

 

 

Issuance of general partnership interests through partnership loans in current period

   $ 95,197      $ 94,170      $ 91,693   
  

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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Item 8. Financial Statements and Supplementary Data, continued

 

THE JONES FINANCIAL COMPANIES, L.L.L.P.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per unit information and the number of financial advisors)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The Partnership’s Business and Basis of Accounting. The accompanying Consolidated Financial Statements include the accounts of The Jones Financial Companies, L.L.L.P. and all wholly-owned subsidiaries (collectively, the “Partnership”). All material intercompany balances and transactions have been eliminated in consolidation. Non-controlling minority interests are accounted for under the equity method. The results of the Partnership’s subsidiaries in Canada are included in the Partnership’s Consolidated Financial Statements for the twelve month periods ended November 30, 2013, 2012 and 2011 because of the timing of the Partnership’s financial reporting process.

The Partnership’s principal operating subsidiary, Edward D. Jones & Co., L.P. (“Edward Jones”), is comprised of two registered broker-dealers primarily serving individual investors in the United States (“U.S.”) and, through a subsidiary, Canada. Edward Jones primarily derives its revenues from the retail brokerage business through the sale of listed and unlisted securities and insurance products, investment banking, principal transactions, distribution of mutual fund shares, and through fees related to assets held by and account services provided to its clients. The Partnership conducts business throughout the U.S. and Canada with its clients, various brokers, dealers, clearing organizations, depositories and banks. For financial information related to the Partnership’s two operating segments for the years ended December 31, 2013, 2012 and 2011, see Note 16 to the Consolidated Financial Statements. Trust services are offered to Edward Jones’ U.S. clients through Edward Jones Trust Company (“EJTC”), a wholly-owned subsidiary of the Partnership.

The Consolidated Financial Statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the U.S. (“GAAP”) which require the use of certain estimates by management in determining the Partnership’s assets, liabilities, revenues and expenses. Actual results could differ from these estimates.

Under the terms of the Partnership’s Eighteenth Amended and Restated Partnership Agreement (the “Partnership Agreement”), a partner’s capital is required to be redeemed by the Partnership in the event of the partner’s death or withdrawal from the Partnership, subject to compliance with ongoing regulatory capital requirements. In the event of a partner’s death, the Partnership must generally redeem the partner’s capital within six months. The Partnership has withdrawal restrictions in place limiting the amount of capital that can be withdrawn at the discretion of the partner. Under the terms of the Partnership Agreement, limited partners withdrawing from the Partnership are to be repaid their capital in three equal annual installments beginning the month after their withdrawal. The capital of general partners withdrawing from the Partnership is converted to subordinated limited partnership capital or, at the discretion of the Managing Partner, redeemed by the Partnership. Subordinated limited partners are repaid their capital in six equal annual installments beginning the month after their request for withdrawal of contributed capital. The Partnership’s Managing Partner has discretion to waive or modify these withdrawal restrictions and to accelerate the return of capital. All current and future partnership capital is subordinate to all current and future liabilities of the Partnership.

 

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Revenue Recognition. The Partnership’s commissions, principal transactions and investment banking revenues are recorded on a trade date basis. Other forms of revenue are recorded on an accrual basis. Due to the timing of receipt of information, the Partnership must use estimates in recording the accruals related to certain asset-based fees. These accruals are based on historical trends and are adjusted to reflect market conditions for the period covered. The Partnership classifies its revenue into the following categories:

Commissions revenue consists of charges to clients for the purchase or sale of mutual fund shares, listed and unlisted securities and insurance products.

Principal transactions revenue is the result of the Partnership’s participation in market-making activities in municipal obligations, over-the-counter corporate obligations, government obligations, unit investment trusts, mortgage-backed securities and certificates of deposit.

Investment banking revenue is derived from the Partnership’s distribution of unit investment trusts, corporate and municipal obligations, and government sponsored enterprise obligations.

Asset-based fee revenue is derived from fees determined by the underlying value of client assets and includes advisory programs, service fees and revenue sharing. Most asset-based fee revenue is generated from fees for investment advisory services within the Partnership’s advisory programs, including Edward Jones Advisory Solutions (“Advisory Solutions”), Edward Jones Managed Account Program (“MAP”) and, in Canada, Edward Jones Portfolio Program and Guided Portfolios Program. The Partnership also earns asset-based fee revenue through service fees received under agreements with mutual fund and insurance companies, including revenue related to the Partnership’s ownership interest in Passport Research Ltd., the investment adviser to the Edward Jones money market funds. In addition, the Partnership earns revenue sharing from certain mutual fund and insurance companies. In most cases, this is additional compensation paid by investment advisers, insurance companies or distributors based on a percentage of average assets held by the Partnership’s clients.

Account and activity fee revenue includes fees received from mutual fund companies for sub-transfer agent accounting services performed by the Partnership and retirement account fees primarily consisting of self-directed IRA custodian account fees. This revenue category also includes other activity-based fee revenue from clients, mutual fund companies and insurance companies.

Interest and dividends revenue is earned on client margin (loan) account balances, cash and cash equivalents, cash and investments segregated under federal regulations, securities purchased under agreements to resell, partnership loans, inventory securities and investment securities.

The Partnership derived from one mutual fund company 19% of its total revenue for each of the years ended December 31, 2013, 2012 and 2011. The revenue generated from this company related to business conducted with the Partnership’s U.S. segment. Significant reductions in revenue due to regulatory reform or other changes to the Partnership’s relationship with this mutual fund company could have a material impact on the Partnership’s results of operations.

Foreign Exchange. Assets and liabilities denominated in a foreign currency are translated at the exchange rate at the end of the period. Revenue and expenses denominated in a foreign currency are translated using the average exchange rate for each period. Foreign exchange gains and losses are included in other revenue on the Consolidated Statements of Income.

 

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Fair Value. Substantially all of the Partnership’s financial assets and financial liabilities covered under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) No. 820, Fair Value Measurement and Disclosure (“ASC 820”), are carried at fair value or contracted amounts which approximate fair value. Upon the adoption of fair value guidance set forth in FASB ASC No. 825, Financial Instruments, the Partnership elected not to take the fair value option on all debt and liabilities subordinated to the claims of general creditors.

Fair value of a financial instrument is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, also known as the “exit price.” Financial assets are marked to bid prices and financial liabilities are marked to offer prices. The Partnership’s financial assets and financial liabilities recorded at fair value in the Consolidated Statements of Financial Condition are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels, defined by ASC 820 with the related amount of subjectivity associated with the inputs to value these assets and liabilities at fair value for each level, are as follows:

Level I – Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

The types of assets and liabilities categorized as Level I generally are U.S. treasuries, investments in publicly traded mutual funds, equities listed in active markets, government and agency obligations, and unit investment trusts with quoted market prices.

Level II – Inputs (other than quoted prices included in Level I) are either directly or indirectly observable for the asset or liability through correlation with related market data at the measurement date and for the duration of the instrument’s anticipated life. The Partnership uses the market approach valuation technique which incorporates third-party pricing services and other relevant observable information (such as market interest rates, yield curves, prepayment risk and credit risk generated by market transactions involving identical or comparable assets or liabilities) in valuing these types of investments. When third-party pricing services are used, the methods and assumptions used are reviewed by the Partnership.

The types of assets and liabilities categorized as Level II generally are certificates of deposit, state and municipal obligations and corporate bonds and notes.

Level III – Inputs are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the inputs to the model.

The Partnership did not have any assets or liabilities categorized as Level III during the periods ended December 31, 2013 and 2012. In addition, there were no transfers into or out of Levels I, II or III during these periods.

The Partnership estimates the fair value of long-term debt and the liabilities subordinated to claims of general creditors based on the present value of future principal and interest payments associated with the debt, using current interest rates for debt of a similar nature as that of the Partnership (Level II input).

Cash and Cash Equivalents. The Partnership considers all highly liquid investments with original maturities of three months or less to be cash equivalents.

 

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Cash and Investments Segregated under Federal Regulations. Cash of $7,056,047 and $6,607,714 and investments of $1,379,030 and $1,106,928 as of December 31, 2013 and 2012, respectively, were segregated in special reserve bank accounts for the benefit of U.S. clients under Rule 15c3-3 of the Securities and Exchange Commission (“SEC”).

Securities Purchased Under Agreements to Resell. The Partnership participates in short-term resale agreements collateralized by government and agency securities. These transactions are reported as collateralized financing. The fair value of the underlying collateral as determined daily, plus accrued interest, must equal or exceed 102% of the carrying amount of the transaction in U.S. agreements and must equal or exceed 100% in Canada agreements. It is the Partnership’s policy to have such underlying resale agreement collateral delivered to the Partnership or deposited in its accounts at its custodian banks. Resale agreements are carried at the amount at which the securities will be subsequently resold, as specified in the agreements. The Partnership considers these financing receivables to be of good credit quality and, as a result, has not recorded a related allowance for credit loss. In addition, the Partnership considers risk related to these securities to be minimal due to the fact that these securities are fully collateralized.

Securities Borrowing and Lending Activities. Securities borrowed and securities loaned transactions are reported as collateralized financings. Securities borrowed transactions require the Partnership to deposit cash with the lender. In securities loaned transactions, the Partnership receives collateral in the form of cash. Collateral for both securities borrowed and securities loaned is based on 102% of the fair value of the underlying securities loaned in U.S. agreements and 100% in Canada agreements. The Partnership monitors the fair value of securities borrowed and loaned on a daily basis, with additional collateral obtained or refunded as necessary. Securities borrowed and securities loaned are included in receivable from and payable to brokers, dealers and clearing organizations, respectively, in the Consolidated Statements of Financial Condition.

Collateral. The Partnership reports as assets collateral it has pledged in secured borrowings and other arrangements when the secured party cannot sell or repledge the assets or the Partnership can substitute collateral or otherwise redeem it on short notice. The Partnership does not report collateral it has received in secured lending and other arrangements as an asset when the debtor has the right to redeem or substitute the collateral on short notice.

Securities Owned and Sold, Not Yet Purchased. Securities owned and sold, not yet purchased, including inventory securities and investment securities, are recorded at fair value which is determined by using quoted market or dealer prices. The Partnership records the related unrealized gains and losses for inventory securities and certain investment securities in principal transactions revenue in the Consolidated Statements of Income. The unrealized gains and losses for investment securities related to the nonqualified deferred compensation plan are recorded in other revenue in the Consolidated Statements of Income (see below).

Equipment, Property and Improvements. Equipment, including furniture and fixtures, is recorded at cost and depreciated using straight-line and accelerated methods over estimated useful lives of three to seven years. Buildings are depreciated using the straight-line method over their useful lives, which are estimated at thirty years. Leasehold improvements are amortized based on the term of the lease or the economic useful life of the improvement, whichever is less. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation or amortization is removed from the respective category and any related gain or loss is recorded as other revenue in the Consolidated Statements of Income.

 

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The cost of maintenance and repairs is charged against income as incurred, whereas significant enhancements are capitalized. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the book value of the asset may not be fully recoverable. If impairment is indicated, the asset value is written down to its fair value.

Nonqualified Deferred Compensation Plan. The Partnership has a nonqualified deferred compensation plan for certain financial advisors. The Partnership has recorded a liability for the future payments due to financial advisors participating in the nonqualified deferred compensation plan. As the future amounts due to financial advisors change in accordance with plan requirements, the Partnership records the change in future amounts owed to financial advisors as an increase or decrease in accrued compensation in the Consolidated Statements of Financial Condition and compensation and benefits expense in the Consolidated Statements of Income. The Partnership has chosen to hedge this future liability by purchasing securities in an amount similar to the future liability expected to be due in accordance with the plan. These securities are included in investment securities in the Consolidated Statements of Financial Condition and the unrealized gains and losses are recorded in other revenue in the Consolidated Statements of Income. Each period, the net impact of the change in future amounts owed to financial advisors in the nonqualified deferred compensation plan and the change in investment securities are approximately the same, resulting in minimal net impact on the Partnership’s financial results.

Lease Accounting. The Partnership enters into lease agreements for certain home office facilities as well as branch office locations. The associated lease expense is recognized on a straight-line basis over the minimum lease terms.

Income Taxes. Income taxes have not been provided for in the Consolidated Financial Statements in most jurisdictions as the Partnership is organized as a partnership and each partner is liable for its own tax payments. For the jurisdictions in which the Partnership is liable for its own tax payments, the income tax provisions are immaterial (see Note 12).

Reclassification. Certain prior year balances have been reclassified to conform to the current year presentation.

Partnership Capital Subject to Mandatory Redemption. FASB ASC No. 480, Distinguishing Liabilities from Equity (“ASC 480”), established standards for classifying and measuring certain financial instruments with characteristics of both liabilities and equity. Under the provisions of ASC 480, the obligation to redeem a partner’s capital in the event of a partner’s death is one of the criteria requiring capital to be classified as a liability.

Since the Partnership Agreement obligates the Partnership to redeem a partner’s capital after a partner’s death, ASC 480 requires all of the Partnership’s equity capital to be classified as a liability. In accordance with ASC 480, income allocable to limited, subordinated limited and general partners is classified as a reduction of income before allocations to partners, which results in a presentation of $0 net income for the years ended December 31, 2013, 2012 and 2011. The financial statement presentations required to comply with ASC 480 do not alter the Partnership’s treatment of income, income allocations or capital for any other purposes.

 

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Net income, as defined in the Partnership Agreement, is equivalent to income before allocations to partners on the Consolidated Statements of Income. Such income, if any, for each calendar year is allocated to the Partnership’s three classes of capital in accordance with the formulas prescribed in the Partnership Agreement. Income allocations are based upon partner capital contributions including capital contributions financed with loans from the Partnership. First, limited partners are allocated net income (as defined in the Partnership Agreement) in accordance with the prescribed formula for their share of net income. Limited partners do not share in the net loss in any year in which there is a net loss and the Partnership is not dissolved or liquidated. Thereafter, subordinated limited partners and general partners are allocated any remaining net income or net loss based on formulas as defined in the Partnership Agreement.

Recently Adopted Accounting Standards. In December 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-11, Disclosures about Offsetting Assets and Liabilities (“ASU 2011-11”), which established requirements for an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. ASU 2011-11 was adopted on January 1, 2013 and adoption did not have a material impact on the Partnership’s Consolidated Statement of Financial Condition (see Note 19).

NOTE 2 – RECEIVABLE FROM AND PAYABLE TO CLIENTS

Receivable from and payable to clients include margin balances and amounts due on cash transactions. The value of securities owned by clients and held as collateral for these receivables is not reflected in the Consolidated Financial Statements. The Partnership considers these financing receivables to be of good credit quality due to the fact that these receivables are primarily collateralized by the related client investments and, as a result, the Partnership considers risk related to these receivables to be minimal. Substantially all amounts payable to clients are subject to withdrawal upon client request. The Partnership pays interest on certain credit balances in client accounts.

NOTE 3 – RECEIVABLE FROM MUTUAL FUNDS, INSURANCE COMPANIES, AND OTHER

Receivable from mutual funds, insurance companies and other is primarily composed of amounts due to the Partnership for asset-based fees and fees for sub-transfer agent accounting services from the mutual fund companies and insurance companies as well as a receivable from a retirement account trustee. The retirement account trustee receivable represents deposits held with the trustee as required by Canadian regulations for the Partnership’s clients’ retirement account funds held in Canada.

 

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Item 8. Financial Statements and Supplementary Data, continued

 

NOTE 4 – RECEIVABLE FROM AND PAYABLE TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS

The following table shows the components of receivable from and payable to brokers, dealers and clearing organizations as of December 31, 2013 and 2012:

 

     2013      2012  

Receivable from money market funds

   $ 62,317       $ 88,084   

Deposits with clearing organizations

     49,110         49,154   

Receivable from clearing organizations

     26,889         24,208   

Securities failed to deliver

     3,703         2,582   

Other

     6,084         25,091   
  

 

 

    

 

 

 

Total receivable from brokers, dealers and clearing organizations

   $ 148,103       $ 189,119   
  

 

 

    

 

 

 

Payable to clearing organizations

   $ 65,949       $ 53,874   

Securities failed to receive

     10,245         10,723   

Payable to brokers, dealers and carrying brokers

     3,049         880   
  

 

 

    

 

 

 

Total payable to brokers, dealers and clearing organizations

   $ 79,243       $ 65,477   
  

 

 

    

 

 

 

 

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NOTE 5 – FAIR VALUE

The following table shows the Partnership’s financial instruments measured at fair value:

 

     Financial Assets at Fair Value as of  
     December 31, 2013  
     Level I      Level II      Level III      Total  

Investments segregated under federal regulations:

           

U.S. treasuries

   $ 1,154,030       $ —         $ —         $ 1,154,030   

Certificates of deposit

     —           225,000         —           225,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments segregated under federal regulations

   $ 1,154,030       $ 225,000       $ —         $ 1,379,030   
  

 

 

    

 

 

    

 

 

    

 

 

 

Securities owned:

           

Inventory securities:

           

State and municipal obligations

   $ —         $ 66,777       $ —         $ 66,777   

Equities

     27,138         —           —           27,138   

Corporate bonds and notes

     —           2,433         —           2,433   

Certificates of deposit

     —           1,922         —           1,922   

Unit investment trusts

     1,903         —           —           1,903   

Other

     391         931         —           1,322   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total inventory securities

   $ 29,432       $ 72,063       $ —         $ 101,495   
  

 

 

    

 

 

    

 

 

    

 

 

 

Investment securities:

           

Mutual funds

   $ 116,523       $ —         $ —         $ 116,523   

Government and agency obligations

     19,110         —           —           19,110   

Equities

     4,609         —           —           4,609   

Other

     —           852         —           852   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 140,242       $ 852       $ —         $ 141,094   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Financial Liabilities at Fair Value as of  
     December 31, 2013  
     Level I      Level II      Level III      Total  

Securities sold, not yet purchased:

           

Corporate bonds and notes

   $ —         $ 1,871       $ —         $ 1,871   

Equities

     1,023         —           —           1,023   

Other

     301         1,064         —           1,365   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities sold, not yet purchased

   $ 1,324       $ 2,935       $ —         $ 4,259   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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     Financial Assets at Fair Value as of
December 31, 2012
 
    
     Level I      Level II      Level III      Total  

Investments segregated under federal regulations:

           

U.S. treasuries

   $ 1,006,928       $ —         $ —         $ 1,006,928   

Certificates of deposit

     —           100,000         —           100,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments segregated under federal regulations

   $ 1,006,928       $ 100,000       $ —         $ 1,106,928   
  

 

 

    

 

 

    

 

 

    

 

 

 

Securities owned:

           

Inventory securities:

           

State and municipal obligations

   $ —         $ 46,705       $ —         $ 46,705   

Equities

     17,845         —           —           17,845   

Certificates of deposit

     —           4,236         —           4,236   

Corporate bonds and notes

     —           3,183         —           3,183   

Other

     1,166         1,417         —           2,583   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total inventory securities

   $ 19,011       $ 55,541       $ —         $ 74,552   
  

 

 

    

 

 

    

 

 

    

 

 

 

Investment securities:

           

Mutual funds

   $ 89,743       $ —         $ —         $ 89,743   

Government and agency obligations

     14,678         —           —           14,678   

Equities

     6,184         —           —           6,184   

Other

     —           1,299         —           1,299   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 110,605       $ 1,299       $ —         $ 111,904   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Financial Liabilities at Fair Value as of  
     December 31, 2012  
     Level I      Level II      Level III      Total  

Securities sold, not yet purchased:

           

Mutual funds

   $ 12,014       $ —         $ —         $ 12,014   

Equities

     5,133         —           —           5,133   

Certificates of deposit

     —           2,774         —           2,774   

Corporate bonds and notes

     —           1,492         —           1,492   

Other

     314         600         —           914   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities sold, not yet purchased

   $ 17,461       $ 4,866       $ —         $ 22,327   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Partnership attempts to reduce its exposure to market price fluctuations of its inventory securities through the sale of U.S. government securities and, to a limited extent, the sale of fixed income futures contracts. The amount of the securities purchased or sold fluctuates on a daily basis due to changes in inventory securities owned, interest rates and market conditions. Futures contracts are settled daily, and any gain or loss is recognized as a component of net inventory gains, which are included in principal transactions revenue. The notional amounts of futures contracts outstanding were $9,000 and $2,000 at December 31, 2013 and 2012, respectively. The average notional amounts of futures contracts outstanding throughout the years ended December 31, 2013 and 2012 were approximately $6,900 and $4,700, respectively. The underlying assets of these contracts are not reflected in the Partnership’s Consolidated Financial Statements; however, the related mark-to-market adjustment gains of $31 and $7 are included in investment securities in the Consolidated Statements of Financial Condition as of December 31, 2013 and 2012, respectively. The total gains or losses related to these assets, recorded within the Consolidated Statements of Income, were gains of $419 and losses of $410 and $1,129 for the years ended December 31, 2013, 2012 and 2011, respectively.

 

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The following table shows the estimated fair values of long-term debt and liabilities subordinated to claims of general creditors as of December 31, 2013 and 2012:

 

     2013      2012  

Long-term debt

   $ 4,824       $ 6,091   

Liabilities subordinated to claims of general creditors

     50,000         103,396   
  

 

 

    

 

 

 

Total

   $ 54,824       $ 109,487   
  

 

 

    

 

 

 

See Notes 8 and 9 for the carrying values of long-term debt and liabilities subordinated to claims of general creditors, respectively.

NOTE 6 – EQUIPMENT, PROPERTY AND IMPROVEMENTS

The following table shows equipment, property and improvements as of December 31, 2013 and 2012:

 

     2013     2012  

Land

   $ 18,745      $ 18,745   

Buildings and improvements

     812,868        793,655   

Equipment, furniture and fixtures

     611,051        613,568   
  

 

 

   

 

 

 

Equipment, property and improvements, Gross

     1,442,664        1,425,968   

Accumulated depreciation and amortization

     (900,079     (888,919
  

 

 

   

 

 

 

Equipment, property and improvements, Net

   $ 542,585      $ 537,049   
  

 

 

   

 

 

 

Depreciation and amortization expense on equipment, property and improvements of $82,095, $80,148 and $90,609 is included in the Consolidated Statements of Income within the communications and data processing and occupancy and equipment categories for the years ended December 31, 2013, 2012 and 2011, respectively.

The Partnership has recorded $3,914 and $516 of accrued costs which are included in equipment, property and improvements in the Consolidated Financial Statements as of December 31, 2013 and 2012, respectively.

The Partnership has purchased Industrial Revenue Bonds issued by St. Louis County related to certain self-constructed and purchased real and personal property. This provides for potential property tax benefits over the life of the bonds (generally 10 years). The Partnership is therefore both the bondholder and the debtor/lessee for these properties. The Partnership has exercised its right to offset the amounts invested in and the obligations for these bonds and has therefore excluded any bond related balances in the Consolidated Statements of Financial Condition.

 

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Item 8. Financial Statements and Supplementary Data, continued

 

NOTE 7 – LINES OF CREDIT

The following table shows the composition of the Partnership’s aggregate bank lines of credit in place as of December 31, 2013 and 2012:

 

     2013      2012  

2013 Credit Facility

   $ 400,000       $ —     

2011 Credit Facility

     —           395,000   

Uncommitted secured credit facilities

     415,000         415,000   
  

 

 

    

 

 

 

Total lines of credit

   $ 815,000       $ 810,000   
  

 

 

    

 

 

 

In March 2011, the Partnership entered into an agreement with 10 banks for a three-year $395,000 committed unsecured revolving line of credit (“2011 Credit Facility”), with an expiration date of March 18, 2014. In November 2013, the Partnership replaced the 2011 Credit Facility with an agreement with 12 banks for a five-year $400,000 committed unsecured revolving line of credit (“2013 Credit Facility”). The 2013 Credit Facility is intended to provide short-term liquidity to the Partnership should the need arise. The 2013 Credit Facility has a tiered interest rate margin based on the Partnership’s leverage ratio (ratio of total debt to total capitalization). Borrowings made with a three-day advance notice will have a rate of LIBOR plus a margin ranging from 1.25% to 2.00%. Same day borrowings, which are subject to certain borrowing notification cutoff times, will have a rate consisting of a margin ranging from 0.25% to 1.00% plus the greater of the prime rate, the federal funds effective rate plus 1.00% or the one-month LIBOR rate plus 1.00%. In accordance with the terms of the 2013 Credit Facility, the Partnership is required to maintain a leverage ratio of no more than 35% and minimum partnership capital, net of reserve for anticipated withdrawals, of at least $1,381,577 plus 50% of subsequent issuances of partnership capital. As of December 31, 2013, the Partnership was in compliance with all covenants related to the 2013 Credit Facility. As of the date of this filing, the Partnership has not borrowed against the 2013 Credit Facility.

The Partnership’s uncommitted lines of credit are subject to change at the discretion of the banks and, therefore, due to credit market conditions and the uncommitted nature of these credit facilities, it is possible that these lines of credit could decrease or not be available in the future. Actual borrowing availability on the uncommitted lines of credit is based on client margin securities and Partnership securities, which would serve as collateral in the event the Partnership borrowed against these lines.

There were no amounts outstanding on the lines of credit as of December 31, 2013 and 2012. In addition, the Partnership did not have any draws against these lines of credit during the years ended December 31, 2013, 2012 and 2011.

 

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Item 8. Financial Statements and Supplementary Data, continued

 

NOTE 8 – LONG-TERM DEBT

The following table shows the Partnership’s long-term debt as of December 31, 2013 and 2012:

 

     2013      2012  

Note payable, collateralized by real estate, fixed rate of 7.28%, principal and interest due in fluctuating monthly installments, with a final installment on June 1, 2017

   $ 4,430       $ 5,503   
  

 

 

    

 

 

 
   $ 4,430       $ 5,503   
  

 

 

    

 

 

 

Scheduled annual principal payments as of December 31, 2013 are as follows:

 

2014

   $ 1,153   

2015

     1,240   

2016

     1,333   

2017

     704   

2018

     —     

Thereafter

     —     
  

 

 

 

Total

   $ 4,430   
  

 

 

 

In 2002, the Partnership entered into a $13,100 fixed rate mortgage on a home office building located on its Tempe, Arizona campus location. The note payable is collateralized by the building, which has a cost of $15,758 and a carrying value of $9,269 as of December 31, 2013.

NOTE 9 – LIABILITIES SUBORDINATED TO CLAIMS OF GENERAL CREDITORS

Liabilities subordinated to claims of general creditors as of December 31, 2013 and 2012 consist of:

 

     2013      2012  

Capital notes 7.33%, due in annual installments of $50,000 commencing on June 12, 2010 with a final installment on June 12, 2014

   $ 50,000       $ 100,000   
  

 

 

    

 

 

 
   $ 50,000       $ 100,000   
  

 

 

    

 

 

 

The Partnership paid the annual scheduled installments of $50,000 in 2013, 2012 and 2011. The final required annual payment of $50,000 is due on June 12, 2014.

The capital note agreements contain restrictions which, among other things, require Edward Jones to maintain certain financial ratios, restrict encumbrance of assets and creation of indebtedness and limit the withdrawal of its partnership capital. As of December 31, 2013, Edward Jones was required, under the capital note agreements, to maintain minimum partnership capital subject to mandatory redemption of $400,000 and regulatory net capital of $158,016. Edward Jones was in compliance with all restrictions as of and for the years ended December 31, 2013 and 2012.

 

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The liabilities subordinated to claims of general creditors are subject to cash subordination agreements approved by Financial Industry Regulatory Authority (“FINRA”) and, therefore, are included in Edward Jones’ computation of net capital under the SEC’s Uniform Net Capital Rule.

NOTE 10 – PARTNERSHIP CAPITAL SUBJECT TO MANDATORY REDEMPTION

The following table shows the Partnership’s capital subject to mandatory redemption as of December 31, 2013 and 2012:

 

     2013     2012  

Partnership capital outstanding:

    

Limited partnership capital

   $ 640,270      $ 650,735   

Subordinated limited partnership capital

     304,558        283,709   

General partnership capital

     1,127,609        1,048,067   
  

 

 

   

 

 

 

Total partnership capital outstanding

     2,072,437        1,982,511   

Partnership loans outstanding:

    

Partnership loans outstanding at beginning of period

     (170,264     (86,853

Partnership loans issued during the period

     (106,400     (94,170

Repayment of partnership loans during the period

     62,142        10,759   
  

 

 

   

 

 

 

Total partnership loans outstanding

     (214,522     (170,264

Partnership capital subject to mandatory redemption, net of reserve for anticipated withdrawals

     1,857,915        1,812,247   

Reserve for anticipated withdrawals

     222,583        170,646   
  

 

 

   

 

 

 

Partnership capital subject to mandatory redemption

   $ 2,080,498      $ 1,982,893   
  

 

 

   

 

 

 

The Partnership makes loans available to those general partners (other than members of the Executive Committee, which consists of the executive officers of the Partnership) who require financing for some or all of their partnership capital contributions. In limited circumstances a general partner may withdraw from the Partnership and become a subordinated limited partner while he or she still has an outstanding partnership loan. Loans made by the Partnership to partners are generally for a period of one year but are expected to be renewed and bear interest at the prime rate, as defined in the loan documents. The Partnership recognizes interest income for the interest received related to these loans. The outstanding amount of partner loans financed through the Partnership is reflected as a reduction to total partnership capital in the Consolidated Statements of Changes in Partnership Capital Subject to Mandatory Redemption. As of December 31, 2013 and 2012, the outstanding amount of partner loans financed through the Partnership was $214,522 and $170,264, respectively. Interest income from these loans, which is included in interest and dividends in the Consolidated Statements of Income, was $7,604, $5,717 and $2,888 for the years ended December 31, 2013, 2012 and 2011, respectively. Partnership loans issued during the year ended December 31, 2013 consisted of $95,197 of new capital contributions and $11,203 of partnership loans issued in connection with paying off bank loans, as further discussed below.

 

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On January 18, 2013, the Partnership paid, through earnings on behalf of the general and subordinated limited partners, the $35,393 outstanding balance on partnership administered bank loans related to capital contributions of general or subordinated limited partners. The maturity date of these loans was February 22, 2013. In connection with this payoff, the Partnership issued $11,203 of partnership loans. It is anticipated that all future general and subordinated limited partnership capital contributions (other than for Executive Committee members) requiring financing will be financed through partnership loans.

The limited partnership capital subject to mandatory redemption is held by current and former employees and general partners of the Partnership. Limited partners participate in the Partnership’s profits and are paid a minimum 7.5% annual return on the face amount of their capital, in accordance with the Partnership Agreement. The minimum 7.5% annual return totaled $48,380, $49,181 and $50,137 for the years ended December 31, 2013, 2012 and 2011, respectively. These amounts are included as a component of interest expense in the Consolidated Statements of Income.

The subordinated limited partnership capital subject to mandatory redemption is held by current and former general partners of the Partnership. Subordinated limited partners receive a percentage of the Partnership’s net income determined in accordance with the Partnership Agreement. The subordinated limited partnership capital subject to mandatory redemption is subordinated to the limited partnership capital.

The general partnership capital subject to mandatory redemption is held by current general partners of the Partnership. General partners receive a percentage of the Partnership’s net income determined in accordance with the Partnership Agreement. The general partnership capital subject to mandatory redemption is subordinated to the limited partnership capital and the subordinated limited partnership capital.

NOTE 11 – NET CAPITAL REQUIREMENTS

As a result of its activities as a broker-dealer, Edward Jones is subject to the net capital provisions of Rule 15c3-1 of the Securities Exchange Act of 1934 (“Exchange Act”) and capital compliance rules of the FINRA Rule 4110. Under the alternative method permitted by the rules, Edward Jones must maintain minimum net capital equal to the greater of $250 or 2% of aggregate debit items arising from client transactions. The net capital rules also provide that Edward Jones’ partnership capital may not be withdrawn if resulting net capital would be less than minimum requirements. Additionally, certain withdrawals require the approval of the SEC and FINRA to the extent they exceed defined levels, even though such withdrawals would not cause net capital to be less than minimum requirements.

The Partnership’s Canada broker-dealer is a registered securities dealer regulated by the Investment Industry Regulatory Organization of Canada (“IIROC”). Under the regulations prescribed by IIROC, the Partnership is required to maintain prescribed/minimum levels of risk-adjusted capital, which are dependent on the nature of the Partnership’s assets and operations.

 

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The following table shows the Partnership’s net capital figures for its U.S. and Canada broker-dealers as of December 31, 2013 and 2012:

 

     2013     2012  

U.S.:

    

Net capital

   $ 872,592      $ 711,894   

Net capital in excess of the minimum required

   $ 830,455      $ 670,072   

Net capital as a percentage of aggregate debit items

     41.4     34.0

Net capital after anticipated capital withdrawals, as a percentage of aggregate debit items

     24.8     18.5

Canada:

    

Regulatory risk adjusted capital

   $ 34,131      $ 38,488   

Regulatory risk adjusted capital in excess of the minimum required to be held by IIROC

   $ 27,093      $ 27,567   

Net capital and the related capital percentages may fluctuate on a daily basis. In addition, EJTC was in compliance with its regulatory capital requirements.

NOTE 12 – INCOME TAXES

The Partnership is a pass through entity for federal and state income tax purposes and generally does not incur income taxes. Instead, its earnings and losses are included in the income tax returns of the general and limited partners. However, the Partnership structure does include certain subsidiaries which are corporations that are subject to income tax. As of December 31, 2013 and 2012, the Partnership’s tax basis of assets and liabilities exceeds book basis by $102,968 and $82,925, respectively. The primary difference between financial statement basis and tax basis is related to the deferral for tax purposes in deducting accrued expenses until they are paid. Since the Partnership is treated as a pass through entity for federal and state income tax purposes, the difference between the tax basis and the book basis of assets and liabilities will impact the future tax liabilities of the partners. The tax differences will not impact the net income of the Partnership.

ASC No. 740, Income Taxes, requires the Partnership to determine whether a tax position is greater than fifty percent likely of being realized upon settlement with the applicable taxing authority, which could result in the Partnership recording a tax liability that would reduce net partnership capital. The Partnership did not have any significant uncertain tax positions as of December 31, 2013 and 2012 and is not aware of any tax positions that will significantly change during the next twelve months. Edward Jones is subject to examination by the Internal Revenue Service (“IRS”) and by various state and foreign taxing authorities in the jurisdictions in which Edward Jones conducts business. In 2012, the IRS began an examination of Edward Jones’ income tax returns for the years ended 2009 and 2010. This examination is on-going and is not expected to have a material impact to the Partnership. With the exception of the IRS examination noted above, tax years prior to 2010 are generally no longer subject to examination by U.S. federal, state, local or foreign tax authorities.

 

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NOTE 13 – EMPLOYEE BENEFIT PLANS

The Partnership maintains a Profit Sharing and Deferred Compensation plan covering all eligible U.S. employees and a Group Registered Retirement Savings Plan and a Deferred Profit Sharing Plan covering all eligible Canada employees. Contributions to the plans are at the discretion of the Partnership. Additionally, participants may contribute on a voluntary basis. The Partnership contributed approximately $161,500, $133,300 and $115,600 to the plans for the years ended December 31, 2013, 2012 and 2011, respectively.

NOTE 14 – COMMITMENTS, GUARANTEES AND RISKS

The Partnership leases home office and branch office space under numerous operating leases. Branch offices are leased generally for terms of three to five years. Rent expense is recognized on a straight-line basis over the minimum lease term. Rent and other lease-related expenses were approximately $234,000, $229,300, and $227,500 for the years ended December 31, 2013, 2012 and 2011, respectively.

The Partnership’s non-cancelable lease commitments greater than one year as of December 31, 2013, are summarized below:

 

2014

   $ 132,026   

2015

     34,228   

2016

     22,936   

2017

     16,022   

2018

     11,760   

Thereafter

     32,361   
  

 

 

 

Total

   $ 249,333   
  

 

 

 

The Partnership’s annual rent expense is greater than its annual future lease commitments because the annual future lease commitments include only non-cancelable lease payments greater than one year.

In addition to the commitments discussed above, the Partnership has a revolving unsecured line of credit outstanding as of December 31, 2013 (see Note 7), as well as would have incurred termination fees of approximately $146,000 as of December 31, 2013 in the event the Partnership terminated existing contractual commitments with certain vendors providing ongoing services primarily for information technology, operations and marketing. These termination fees will decrease over the related contract periods, which generally expire within the next three years.

The Partnership provides margin loans to its clients in accordance with Regulation T and FINRA, which loans are collateralized by securities in the client’s account. The Partnership could be liable for the margin requirement of its client margin securities transactions. To mitigate this risk, the Partnership monitors required margin levels and requires clients to deposit additional collateral or reduce positions to meet minimum collateral requirements.

The Partnership’s securities activities involve execution, settlement and financing of various securities transactions for clients. The Partnership may be exposed to risk of loss in the event clients, other brokers and dealers, banks, depositories or clearing organizations are unable to fulfill contractual obligations.

 

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For transactions in which it extends credit to clients, the Partnership seeks to control the risks associated with these activities by requiring clients to maintain margin collateral in compliance with various regulatory and internal guidelines. Therefore, the potential to make payments under these client transactions is remote and accordingly, no liability has been recognized for these transactions.

Cash balances held at various major U.S. financial institutions, which typically exceed Federal Deposit Insurance Corporation insurance coverage limits, subject the Partnership to a concentration of credit risk. Additionally, the Partnership’s Canada broker-dealer may also have cash deposits in excess of the applicable insured amounts. The Partnership regularly monitors the credit ratings of these financial institutions in order to help mitigate the credit risk that exists with the deposits in excess of insured amounts. The Partnership has credit exposure to U.S. government and agency securities which are held as collateral for its resell agreements, investment securities and segregated investments. The Partnership’s primary exposure on resell agreements is with the counterparty and the Partnership would only have exposure in the event of the counterparty’s default on the resell agreements.

The Partnership provides guarantees to securities clearing houses and exchanges under their standard membership agreements, which require a member to guarantee the performance of other members. Under these agreements, if a member becomes unable to satisfy its obligations to the clearing houses and exchanges, all other members would be required to meet any shortfall. The Partnership’s liability under these arrangements is not quantifiable and may exceed the cash and securities it has posted as collateral. However, the potential requirement for the Partnership to make payments under these agreements is remote. Accordingly, no liability has been recognized for these transactions.

NOTE 15 – CONTINGENCIES

In the normal course of business, the Partnership has been named as a defendant in various legal actions, including arbitrations, class actions and other litigation. Certain of these legal actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. The Partnership is also involved from time to time in investigations and proceedings by governmental and self-regulatory agencies, certain of which may result in adverse judgments, fines or penalties. In addition, the Partnership provides for potential losses that may arise related to other contingencies.

The Partnership assesses its liabilities and contingencies utilizing available information. For those matters where it is probable the Partnership will incur a potential loss and the amount of the loss is reasonably estimable, in accordance with FASB ASC No. 450, Contingencies, an accrued liability has been established. These reserves represent the Partnership’s aggregate estimate of the potential loss contingency at December 31, 2013 and are believed to be sufficient. Such liability may be adjusted from time to time to reflect any relevant developments.

For such matters where an accrued liability has not been established and the Partnership believes a loss is both reasonably possible and estimable, as well as for matters where an accrued liability has been recorded but for which an exposure to loss in excess of the amount accrued is both reasonably possible and estimable, the current estimated aggregated range of additional possible loss is $5,000 to $45,000. This range of reasonably possible loss does not necessarily represent the Partnership’s maximum loss exposure as the Partnership was not able to estimate a range of reasonably possible loss for all matters.

 

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Further, the matters underlying any disclosed estimated range will change from time to time, and actual results may vary significantly. While the outcome of these matters is inherently uncertain, based on information currently available, the Partnership believes that its established reserves at December 31, 2013 are adequate and the liabilities arising from such proceedings will not have a material adverse effect on the consolidated financial position, results of operations or cash flows of the Partnership. However, based on future developments and the potential unfavorable resolution of these matters, the outcome could be material to the Partnership’s future consolidated operating results for a particular period or periods.

NOTE 16 – SEGMENT INFORMATION

An operating segment is defined as a component of an entity that has all of the following characteristics: it engages in business activities from which it may earn revenues and incur expenses; its operating results are regularly reviewed by the entity’s chief operating decision-maker (or decision-making group) for resource allocation and to assess performance; and discrete financial information is available. Operating segments may be combined in certain circumstances into reportable segments for financial reporting. The Partnership has determined it has two operating and reportable segments based upon geographic location, the U.S. and Canada.

Each segment, in its own geographic location, primarily derives revenue from the retail brokerage business from the purchase or sale of mutual fund shares, listed and unlisted securities and insurance products, as well as from principal transactions, investment banking, and fees related to assets held by and account services provided to its clients.

The Partnership evaluates segment performance based upon income (loss) before allocations to partners, as well as income (loss) before variable compensation. Variable compensation is determined at the Partnership level for profit sharing and home office and branch employee bonus amounts, and therefore is allocated to each geographic segment independent of that segment’s individual income before variable compensation. Financial advisor bonuses are determined by the overall Partnership’s profitability, as well as the performance of the individual financial advisors. Both income (loss) before allocations to partners and income (loss) before variable compensation are considered in evaluating segment performance. Long-lived assets are not disclosed because the balances are not used for evaluating segment performance and deciding how to allocate resources to segments. However, total assets for each segment are provided for informational purposes.

The accounting policies of the segments are the same as those described in Note 1 – Summary of Significant Accounting Policies. For computation of segment information, the Partnership allocates costs incurred by the U.S. entity in support of Canada operations to the Canada segment. Canada segment information is based upon the Consolidated Financial Statements of the Partnership’s Canada operations without eliminating intercompany items, such as management fees paid to affiliated entities. The U.S. segment information is derived from the Consolidated Financial Statements less the Canada segment information as presented. This is consistent with how management reviews the segments in order to assess performance.

 

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Item 8. Financial Statements and Supplementary Data, continued

 

The following table shows financial information for the Partnership’s reportable segments for the years ended December 31, 2013, 2012 and 2011:

 

     2013     2012     2011  

Net revenue:

      

U.S.

   $ 5,457,479      $ 4,789,850      $ 4,324,451   

Canada

     199,427        175,325        185,410   
  

 

 

   

 

 

   

 

 

 

Total net revenue

   $ 5,656,906      $ 4,965,175      $ 4,509,861   
  

 

 

   

 

 

   

 

 

 

Net interest and dividends revenue:

      

U.S.

   $ 70,557      $ 66,912      $ 57,647   

Canada

     4,424        4,314        4,862   
  

 

 

   

 

 

   

 

 

 

Total net interest and dividends revenue

   $ 74,981      $ 71,226      $ 62,509   
  

 

 

   

 

 

   

 

 

 

Pre-variable income (loss):

      

U.S.

   $ 1,310,285      $ 1,055,550      $ 855,862   

Canada

     7,192        (3,482     4,189   
  

 

 

   

 

 

   

 

 

 

Total pre-variable income

   $ 1,317,477      $ 1,052,068      $ 860,051   

Variable compensation:

      

U.S.

   $ 625,979      $ 485,196      $ 366,663   

Canada

     17,160        11,852        11,605   
  

 

 

   

 

 

   

 

 

 

Total variable compensation

   $ 643,139      $ 497,048      $ 378,268   

Income (loss) before allocations to partners:

      

U.S.

   $ 684,306      $ 570,354      $ 489,199   

Canada

     (9,968     (15,334     (7,416
  

 

 

   

 

 

   

 

 

 

Total income before allocations to partners

   $ 674,338      $ 555,020      $ 481,783   
  

 

 

   

 

 

   

 

 

 

Capital expenditures:

      

U.S.

   $ 81,329      $ 35,845      $ 52,437   

Canada

     2,904        1,058        1,793   
  

 

 

   

 

 

   

 

 

 

Total capital expenditures

   $ 84,233      $ 36,903      $ 54,230   
  

 

 

   

 

 

   

 

 

 

Depreciation and amortization:

      

U.S.

   $ 80,026      $ 78,226      $ 88,118   

Canada

     2,069        1,922        2,491   
  

 

 

   

 

 

   

 

 

 

Total depreciation and amortization

   $ 82,095      $ 80,148      $ 90,609   
  

 

 

   

 

 

   

 

 

 

Total assets:

      

U.S.

   $ 13,340,985      $ 12,617,643      $ 9,158,882   

Canada

     453,776        424,600        424,704   
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 13,794,761      $ 13,042,243      $ 9,583,586   
  

 

 

   

 

 

   

 

 

 

Financial advisors at year end:

      

U.S.

     12,483        11,822        11,622   

Canada

     675        641        620   
  

 

 

   

 

 

   

 

 

 

Total financial advisors

     13,158        12,463        12,242   
  

 

 

   

 

 

   

 

 

 

 

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Item 8. Financial Statements and Supplementary Data, continued

 

NOTE 17 – RELATED PARTIES

Edward Jones owns a 49.5% limited partnership interest in the investment adviser to the Edward Jones money market funds. The Partnership does not have management responsibility with regard to the adviser. Approximately 0.1%, 0.2% and 0.2% of the Partnership’s total revenues were derived from this limited partnership interest in the adviser to the Fund during 2013, 2012 and 2011, respectively.

As of December 31, 2013, Edward Jones leases approximately 10% of its branch office space from its financial advisors. Rent expense related to these leases approximated $22,700, $20,000 and $20,000 for the years ended December 31, 2013, 2012 and 2011, respectively. These leases are executed and maintained in a similar manner as those entered into with third parties.

In the normal course of business, partners and employees of the Partnership and its affiliates use the brokerage services and trust services of the Partnership for the same services as unrelated third parties, with certain discounts on commissions and fees for certain services. The Partnership has included balances arising from such transactions in the Consolidated Statements of Financial Condition on the same basis as other clients.

The Partnership recognizes interest income for the interest earned from partners who elect to finance a portion or all of their partnership capital contributions through loans made available from the Partnership (see Note 10).

NOTE 18 – QUARTERLY INFORMATION

(Unaudited)

 

     2013 Quarters Ended  
     Mar 29      Jun 28      Sep 27      Dec 31  

Total revenue

   $ 1,350,661       $ 1,431,733       $ 1,431,720       $ 1,501,537   

Income before allocations to partners

   $ 148,779       $ 172,140       $ 167,757       $ 185,662   

Income before allocations to partners per weighted average $1,000 equivalent limited partnership unit outstanding

   $ 26.72       $ 30.92       $ 30.13       $ 33.35   

 

     2012 Quarters Ended  
     Mar 30      Jun 29      Sep 28      Dec 31  

Total revenue

   $ 1,222,446       $ 1,230,238       $ 1,269,435       $ 1,305,299   

Income before allocations to partners

   $ 138,565       $ 138,962       $ 130,861       $ 146,632   

Income before allocations to partners per weighted average $1,000 equivalent limited partnership unit outstanding

   $ 27.42       $ 27.50       $ 25.90       $ 29.02   

In accordance with FASB ASC 480, the Partnership presents net income of $0 on its Consolidated Statement of Income (see Note 1).

 

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NOTE 19 – OFFSETTING ASSETS AND LIABILITIES

The Partnership does not offset financial instruments in the Consolidated Statements of Financial Condition. However, the Partnership enters into master netting arrangements with counterparties for securities purchased under agreements to resell that are subject to net settlement in the event of default. These agreements create a right of offset for the amounts due to and due from the same counterparty in the event of default or bankruptcy.

The following table shows the Partnership’s securities purchased under agreements to resell as of December 31, 2013 and 2012:

 

    

Gross

amounts of

    

Gross amounts

offset in the

Consolidated

Statements of

    

Net amounts

presented in the

Consolidated

Statements of

     Gross amounts not offset
in the Consolidated
Statements of Financial
Condition
       
     recognized
assets
     Financial
Condition
     Financial
Condition
     Financial
instruments
     Securities
collateral(1)
    Net
amount
 

Dec 31, 2013

   $ 1,026,405         —           1,026,405         —           (1,026,405   $ —     

Dec 31, 2012

   $ 1,092,586         —           1,092,586         —           (1,092,586   $ —     

 

(1) Actual collateral was greater than 102% of the related assets in U.S. agreements and greater than 100% in Canada agreements for all periods presented.

NOTE 20 – SUBSEQUENT EVENT

The Partnership filed a Registration Statement on Form S-8 with the SEC on January 17, 2014 to register $350 million in securities in preparation for its anticipated 2014 Limited Partnership offering. The Partnership intends to offer approximately $300 million in Interests to eligible financial advisors, branch office administrators and home office associates. The remaining $50 million may be issued in the discretion of the Executive Committee, which may include issuances to financial advisors who complete a retirement transition plan in future years and who may be considered for additional limited partnership interest. The 2014 Limited Partnership offering is expected to close early next year. Limited partners participate in the Partnership’s profits and are paid a minimum 7.5% annual return on the face amount of their capital.

 

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ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures. As required by Rule 13a-15e under the Exchange Act, as of the end of the period covered by this Annual Report on Form 10-K, the Partnership’s certifying officers, the Chief Executive Officer and the Chief Financial Officer, carried out an evaluation with the participation of its management of the effectiveness of the design and operation of our disclosure controls and procedures. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and we were required to apply our judgment in evaluating and implementing possible controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the date of completion of the evaluation, our disclosure controls and procedures were effective to ensure that information required to be disclosed by the Partnership in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. We will continue to review and document our disclosure controls and procedures, including our internal controls and procedures for financial reporting, on an ongoing basis, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business.

Management’s report on internal control over financial reporting and the report of independent registered public accounting firm are set forth in Part II, Item 8, of this Annual Report on Form 10-K.

Changes in Internal Control Over Financial Reporting. There was no change in the Partnership’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended December 31, 2013 that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting.

 

ITEM 9B. OTHER INFORMATION

None.

 

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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

JFC does not have a board of directors. As of February 28, 2014, the Partnership was composed of 377 general partners, 13,717 limited partners and 332 subordinated limited partners. Under the terms of the Partnership Agreement, the Managing Partner has primary responsibility for administering the Partnership’s business, determining its policies, controlling the management and conduct of the Partnership’s business and has the power to admit and dismiss general partners and to fix the proportion of their respective interests in the Partnership. The Managing Partner serves for an indefinite term and may be removed by a majority vote of the Executive Committee or a vote of the general partners holding a majority percentage ownership in the Partnership. If at any time the office of the Managing Partner is vacant, a new Managing Partner is elected by a majority of the Executive Committee. The Partnership does not have a formal code of ethics that applies to its Executive Committee members, as it relies on the core values and beliefs of the Partnership, as well as the Partnership Agreement. The Partnership’s operating subsidiaries are managed by JFC, under the leadership of the Managing Partner, pursuant to a services agreement.

Executive Committee. The Executive Committee consists of the Managing Partner and the executive officers of the Partnership, which are five to nine general partners appointed by the Managing Partner, with the specific number determined by the Managing Partner. The purpose of the Executive Committee is to provide counsel and advice to the Managing Partner in discharging his functions, including the consideration of partnership compensation, ensuring the Partnership’s business risks are managed appropriately and helping to establish the strategic direction of the Partnership. In addition, the Executive Committee takes an active role in identifying, measuring and controlling the risks to which the Partnership is subject. Executive Committee members serve for an indefinite term and may be removed by the Managing Partner or a vote of general partners holding a majority percentage ownership in the Partnership. Furthermore, in the event the position of Managing Partner is vacant, the Executive Committee shall succeed to all of the powers and duties of the Managing Partner. Throughout 2013, the Executive Committee was comprised of James D. Weddle, Kevin D. Bastien, Brett A. Campbell, Norman L. Eaker, Daniel J. Timm and James A. Tricarico, Jr.

The following table is a listing as of February 28, 2014 of the members of the Executive Committee, each member’s age, year in which each member became an Executive Committee member, the year in which each member became a general partner and each member’s area of responsibility. Under terms of the Partnership Agreement, all general partners, including the members of the Executive Committee, are required to retire in their capacity as general partners at the age of 65. The members’ biographies are below.

 

Name

   Age    Executive
Committee
   General
Partner
  

Area of Responsibility

           

James D. Weddle

   60    2005    1984    Managing Partner

Kevin D. Bastien

   48    2010    1998    Chief Financial Officer

Brett A. Campbell

   55    2006    1993    Client Strategies Group

Norman L. Eaker

   57    2005    1984    Firm Administration

Daniel J. Timm

   55    2009    1998    Branch Development

James A. Tricarico, Jr.

   61    2007    2006    Legal and Compliance

 

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James D. Weddle, Managing Partner – Mr. Weddle joined the Partnership in 1976, was named a general partner in 1984 and has served as Managing Partner since January 2006. Previously he worked in the Research department and as a financial advisor, and has been responsible for the Mutual Fund Sales department as well as the Marketing and Branch Administration divisions. Mr. Weddle earned his bachelor’s degree from DePauw University and his MBA from Washington University in St. Louis. Mr. Weddle is a member of the FINRA Board of Governors.

Kevin D. Bastien, Chief Financial Officer – Mr. Bastien joined the Partnership in 1996, was named a general partner in 1998 and has served as Chief Financial Officer since January 2009. Previously he has been responsible for various areas of the Finance division including tax, partnership accounting, coordinating overall finance support for international operations and the Sourcing Office, which negotiates all Partnership financial commitments. Mr. Bastien earned his bachelor’s and master’s degrees in accounting from Southern Illinois University at Carbondale and is a certified public accountant.

Brett A. Campbell, Client Strategies Group – Mr. Campbell joined the Partnership in 1984 and was named a general partner in 1993. Mr. Campbell is responsible for the Client Strategies Group, which encompasses all of the Partnership’s advice and guidance, products and services, marketing, and branch support related to helping clients achieve their financial goals, since 2008. Previously he worked as a financial advisor and has been responsible for the Financial Advisor Training department and Branch Development division. Mr. Campbell earned his bachelor’s degree from Ball State University and is a graduate of the Kellogg Management Institute at Northwestern University.

Norman L. Eaker, Chief Administrative Officer – Mr. Eaker joined the Partnership in 1981, was named a general partner in 1984 and has served as the Chief Administrative Officer since 2008. As Chief Administrative Officer, Mr. Eaker is responsible for Firm Administration, which encompasses the Operations, Service, Human Resources and Information Systems divisions. Previously he has been responsible for the Internal Audit division and various areas within the Operations division. Mr. Eaker earned his bachelor’s degree from the University of Missouri–St. Louis. Mr. Eaker is a member of the Operations and Technology Steering Committee of the Securities Industry and Financial Markets Association (SIFMA).

Daniel J. Timm, Branch Development – Mr. Timm joined the Partnership in 1983 and was named a general partner in 1998. Mr. Timm has been responsible for the Branch Development division, which encompasses Financial Advisor and Branch Office Administrator Hiring, Branch Training, Branch and Region Development, Branch Administration and Financial Advisor Leadership Development, since 2007. Previously he worked as a financial advisor and has been responsible for various areas of the Branch Development division, including the Financial Advisor Training, Financial Advisor Development and Branch Administration departments. Mr. Timm earned his bachelor’s degree and MBA from the University of Missouri–Columbia. Mr. Timm is a member of the SIFMA Bulls Roundtable.

James A. Tricarico, Jr., General Counsel – Mr. Tricarico joined the Partnership as general partner and General Counsel in 2006. He is responsible for the Legal and Compliance divisions and Government Relations. Prior to joining the Partnership, he was in private practice and before that he served as general counsel and executive vice president of a large broker-dealer. Mr. Tricarico earned his bachelor’s degree from Fordham University and his law degree from New York Law School. Mr. Tricarico is a member of the Board of Directors and the Executive Committee of the Board of SIFMA and the Executive Committee of the Compliance and Legal Society of SIFMA.

 

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Management Committee. The Management Committee consists of up to 25 general partners appointed by the Managing Partner, with the specific number determined by the Managing Partner, and includes the members of the Executive Committee. As of February 28, 2014, the Management Committee consisted of 20 general partners. The Management Committee is generally comprised of general partners with overall responsibility for a significant or critical functional division or area of the Partnership’s operating subsidiaries. The Management Committee meets weekly, is operational in nature, and is responsible for identifying, developing and accomplishing the Partnership’s objectives through, among other means, sharing information across divisions and identifying and resolving risk management issues for the Partnership. General partners on the Management Committee serve for an indefinite term and may be removed by the Managing Partner.

Audit Committee. The Audit Committee was created by way of the Partnership Agreement. The Audit Committee operates according to its charter adopted by the Executive Committee. Pursuant to its charter and the Partnership Agreement, the Audit Committee is directly responsible for the appointment, compensation, retention and oversight of the work of any independent registered public accounting firm engaged by the Partnership for the purpose of preparing or issuing an audit report. The Audit Committee is responsible for the development and maintenance of an understanding of the Partnership’s financial statements and the financial reporting process, overseeing the Partnership’s efforts to comply with the financial reporting control requirements of the Sarbanes Oxley Act of 2002 (“Sarbanes Oxley”) and providing input to the Partnership’s Internal Audit division regarding audit topics and the resolution of outstanding audit findings. In 2013 the Audit Committee was comprised of James A. Tricarico, Jr., Chairman, James D. Weddle, Kevin D. Bastien, Brett A. Campbell, Norman L. Eaker, Anthony Damico, who is a member of the Management Committee and the general partner responsible for the Internal Audit division, Joseph G. Porter, who is a general partner in the Finance division, and Ed Glotzbach, who is an independent member of the committee. Mr. Bastien meets the requirements adopted by the SEC for qualification as an “audit committee financial expert.” Because Mr. Bastien is a general partner, he would not meet the definition of “independent” under the rules of the NYSE. However, since the Partnership’s securities are not listed on any exchange, it is not subject to the listing requirements of the NYSE or any other securities exchanges. Audit Committee members serve for an indefinite term and may be removed by the Managing Partner.

 

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RISK MANAGEMENT

Overview

The Partnership’s business model and activities expose it to a number of different risks. The most significant risks to which the Partnership is subject include business and operational risk, credit risk, market and liquidity risk, and legal, regulatory and reputational risk. The identification and ongoing management of the Partnership’s risk is critical to its long-term business success and related financial performance. The Partnership is governed by an Executive Committee, which is ultimately responsible for overall risk management. Throughout 2013, the Executive Committee consisted of the Partnership’s Managing Partner and five other general partners, each responsible for broad functional areas of the Partnership. The Executive Committee is responsible for providing advice and counsel to the Managing Partner and helps establish the strategic direction of the Partnership. In addition, the Executive Committee takes an active role in identifying, measuring and controlling the risks to which the Partnership is subject. The Executive Committee communicates regularly, meets monthly and also conducts periodic planning sessions to meet its responsibilities.

The Management Committee assists the Executive Committee in its ongoing risk management responsibilities through its day-to-day operations. The Management Committee is responsible for identifying, developing and accomplishing the Partnership’s objectives. In addition, the Management Committee is responsible for sharing information across divisions and identifying issues and risks with other members of the Committee. The Management Committee meets weekly and provides a forum to both identify and resolve risk management issues for the Partnership.

Several other committees and departments support the Executive Committee’s risk management responsibilities by managing certain components of the risk management process. Some of the more prominent committees and departments and their primary responsibilities, as they relate to risk management, are listed below:

Audit Committee - responsible for the development and maintenance of an understanding of the Partnership’s financial statements and the financial reporting process, overseeing the Partnership’s efforts to comply with the financial reporting control requirements of Sarbanes Oxley, overseeing the independent auditors qualifications and independence, and providing input to the Partnership’s Internal Audit division regarding audit topics and the resolution of outstanding audit findings.

New Products and Services Committee - responsible for ensuring that all new products and services are aligned with clients’ needs, are consistent with the Partnership’s objectives and strategies, and that all areas of the Partnership are sufficiently prepared to support, service, and supervise any new activities. A new product or service has to be approved by the New Products and Services Committee and the Executive Committee before being offered to clients.

Credit Review Committee - establishes policies governing the Partnership’s client margin accounts. The committee discusses and monitors the risks associated with the Partnership’s client margin practices and current trends in the industry. The committee reviews large client margin balances, the quality of the collateral supporting those accounts, and the credit exposure related to those accounts to minimize potential losses. Any margin loan over $2.5 million is subject to approval by the Chief Financial Officer.

 

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Capital Markets Committee - approves new issue equity offerings and primary fixed income inventory commitments above $10.0 million. The approval is based upon Partnership guidelines and credit quality standards administered by the Partnership’s Product Review department. Additionally, a member of the Capital Markets Committee is responsible both for the hedging strategies employed by the Partnership to reduce inventory risk, and for the communication of those strategies to the Capital Markets Committee.

Finance Risk Committee - reviews the Partnership’s financial liquidity, cash investment portfolio and capital adequacy and assesses major exposures to financial institutions. These exposures include banks in which the Partnership has deposits or on which it depends for funding.

Product Review Department - analyzes proposed new investments prior to them being made broadly available to the Partnership’s clients, and performs ongoing due diligence activities on all products broadly marketed by the Partnership.

In addition to the committees and department discussed above, each of the Partnership’s divisions also assists the Executive Committee in its ongoing risk management activities through their day-to-day responsibilities.

As part of the financial services industry, the Partnership’s business is subject to inherent risks. As a result, despite its risk management efforts and activities, there can be no absolute assurance that the Partnership will not experience significant unexpected losses due to the realization of certain operational or other risks to which the Partnership is subject. The following discussion highlights the Partnership’s procedures and policies designed to identify, assess, and manage the primary risks of its operations.

Business and Operational Risk

There is an element of operational risk inherent within the Partnership’s business. The Partnership is exposed to operational risk and its business model is dependent on complex technology systems, and there is a degree of exposure to systems failure. A business continuity planning process has been established to respond to severe business disruptions. The Partnership has established a data center in Tempe, Arizona, that operates as a secondary data center to its primary data center located in St. Louis, Missouri and is designed to enable the Partnership to maintain service during a system disruption contained to St. Louis. A prolonged interruption of either site might result in a delay in service and substantial costs and expenses. In 2011, the Partnership began re-purposing its secondary data center in Tempe, Arizona in order to be able to operate this facility as a primary data center for processing the most critical systems such that they could run in St. Louis, Missouri or Tempe, Arizona. As of December 31, 2013, it is anticipated that the process will take a few more years to complete.

In order to address the Partnership’s risk of identifying fraudulent or inappropriate activity, the Partnership implemented an anonymous ethics hotline for employees to report suspicious activity for review and disciplinary action when necessary. The Partnership’s Internal Audit and Compliance divisions investigate reports as they are received. The Internal Audit and Compliance divisions review other Partnership activity to assist in risk identification and other inappropriate activities. In addition, the Partnership communicates and provides ongoing training regarding the Partnership’s privacy requirements to better protect client information.

 

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The Partnership is also exposed to operational risk as a result of its reliance on third parties to provide technology, processing and other business support services. The Partnership’s Sourcing Office primarily manages that risk by reviewing key vendors through a vendor due diligence process.

Credit Risk

The Partnership is subject to credit risk due to the very nature of the transactions it processes for its clients. In order to manage this risk, the Partnership limits certain client transactions by, in some cases, requiring payment at the time or in advance of a client transaction being accepted. The Partnership manages the credit risk arising out of the client margin loans it offers by limiting the amount and controlling the quality of collateral held in the client’s account against those loans. In accordance with FINRA rules, the Partnership requires, in the event of a decline in the market value of the securities in a margin account, the client to deposit additional securities or cash so that, at all times, the loan to the client is no greater than 75% of the value of the securities in the account (or to sell a sufficient amount of securities in order to maintain this percentage). The Partnership, however, generally imposes a more stringent maintenance requirement, which requires that the loan to the client be no greater than 65% of the value of the securities in the account.

The Partnership purchases and holds securities inventory positions for retail sales to its clients and does not trade those positions for the purpose of generating gains for its own account. To monitor inventory positions, the Partnership has an automated trading system designed to report trading positions and risks. This system requires traders to mark positions to market and to report positions at the trader level, department level and for the Partnership as a whole. There are established trading and inventory limits for each trader and each department, and activity exceeding those limits is subject to supervisory review. By maintaining an inventory hedging strategy, the Partnership has attempted to avoid material inventory losses or gains in the past (see Note 5 to the Consolidated Financial Statements for further details). The objective of the hedging strategy is to mitigate the risks of carrying its inventory positions and not to generate profit for the Partnership. The compensation of the Partnership’s traders is not directly tied to gains or losses incurred by the Partnership on the inventory, which eliminates the incentive to hold inappropriate inventory positions.

The Partnership also has credit exposure with counterparties as a result of its ongoing, routine business activities. This credit exposure can arise from the settlement of client transactions, related failures to receive and deliver, or related to the Partnership’s overnight investing activities with other financial institutions. The Partnership monitors its exposure to such counterparties on a regular basis through the activities of its Finance Risk Committee in order to minimize its risk of loss related to such exposure.

Market and Liquidity Risk

Market risk is the risk of declining revenue or the value of financial instruments held by the Partnership as a result of fluctuations in interest rates, equity prices or overall market conditions. Liquidity risk is the risk of insufficient financial resources to meet the short-term or long-term cash needs of the Partnership. For a discussion of the Partnership’s market and liquidity risk, see “Item 7A – Quantitative and Qualitative Disclosures about Market Risk”.

 

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Legal, Regulatory and Reputational Risk

In the normal course of business, from time to time, the Partnership is named as a defendant in various legal actions, including arbitrations, class actions and other litigation. Certain of these legal actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. Further, the Partnership is involved, from time to time, in investigations and proceedings by governmental and self-regulatory agencies, certain of which may result in adverse judgments, fines or penalties. The number of legal actions and investigations has increased among many firms in the financial services industry, including the Partnership.

The Partnership has established, through its overall compliance program, a variety of policies and procedures (including written supervisory procedures) designed to avoid legal claims or regulatory issues. As a normal course of business, new accounts and client transactions are reviewed on a daily basis, in part, through the Partnership’s field supervision function, to mitigate the risk of non-compliance with regulatory requirements as well as any resulting negative impact on the Partnership’s reputation. To minimize the risk of regulatory non-compliance, each branch office is subject to an annual onsite branch audit, to review the financial advisor’s business and competency. Additionally, certain branches are visited regularly by field supervision directors to assure reasonable compliance. The Partnership’s Compliance division works with other business areas to advise and consult on business activities to help ensure compliance with regulatory requirements and Partnership policies. The Partnership also has a clear awareness of privacy issues, uses client information responsibly, and trains its employees on privacy requirements, all of which come under the responsibility of the Partnership’s Chief Privacy Officer. The Partnership has specific policies related to prevention of fraud and money laundering and providing initial as well as annual training and review of competency to help mitigate regulatory risks.

 

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ITEM 11. EXECUTIVE COMPENSATION

COMPENSATION DISCUSSION AND ANALYSIS

The Partnership’s compensation program allocates profits to general partners, including members of its Executive Committee, primarily based upon their ownership interest in the Partnership. As general partners, Executive Committee members benefit annually from the profits of the Partnership through current cash payments from short-term results and from having an opportunity to co