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Financial Instruments

6 Months Ended

Jun. 30, 2011

8. Financial Instruments

Refer to Note 1 within the footnotes to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 for a detailed discussion of accounting policies related to the Company’s securities transactions and derivative financial instruments. In addition, the Company has elected to apply the FVO to all residential mortgage loans originated by ClearPoint.

The Company’s financial instruments are recorded within the Consolidated Statements of Financial Condition at fair value. ASC 820 defines fair value as the price that would be received upon the sale of an asset or paid upon the transfer of a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date and establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances. The hierarchy is broken down into three levels based on the reliability of inputs as follows:

Level 1: Quoted prices in active markets that the Company has the ability to access at the reporting date, for identical assets or liabilities. Prices are not adjusted for the effects, if any, of the Company holding a large block relative to the overall trading volume (referred to as a “blockage factor”).

Level 2: Directly or indirectly observable prices in active markets for similar assets or liabilities; quoted prices for identical or similar items in markets that are not active; inputs other than quoted prices (e.g., interest rates, yield curves, credit risks, volatilities); or “market corroborated inputs.”

Level 3: Unobservable inputs that reflect management’s own assumptions about the assumptions market participants would make.

The availability of observable inputs can vary from product to product and is affected by a wide variety of factors, including, for example, the type of product, whether the product is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by management in determining fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.

ASC 820 also provides (i) general guidance on determining fair value when markets are inactive including the use of judgment in determining whether a transaction in a dislocated market represents fair value, the inclusion of market participant risk adjustments when an entity significantly adjusts observable market data based on unobservable inputs, and the degree of reliance to be placed on broker quotes or pricing services as well as (ii) additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly declined and guidance on identifying circumstances that indicate a transaction is not orderly.

Fair Valuation Methodology

Cash Equivalents — These financial assets represent cash in banks or cash invested in highly liquid investments with original maturities less than 90 days that are not segregated for regulatory purposes or held for sale in the ordinary course of business. These investments are valued at par, which represent fair value, and are considered Level 1. Refer to Note 3 herein for additional information.

Loans — These financial instruments primarily consist of residential mortgage loans originated by ClearPoint, for which the FVO has been elected, and are classified as Level 2 as there is no quoted market for these loans. Fair value is determined utilizing observable market factors and is principally based upon the fair value of the “to-be-announced” (“TBA”) forward securities market (See “Derivatives” below).

Securities Owned/Securities Sold But Not Yet Purchased — These financial instruments primarily consist of investments in fixed income securities, as well as holdings in equity securities.

Fixed income securities include securities traded in active markets, such as U.S. government and federal agency obligations, agency mortgage-backed securities, corporate debt, preferred stock and certain asset and mortgage-backed securities. The on-the-run treasuries are generally traded in active, quoted and highly liquid markets and therefore are generally classified as Level 1. As there is no quoted market for agency mortgage-backed securities, corporate debt, asset and mortgage-backed securities, and certain preferred stock, the Company utilizes observable market factors in determining fair value. These financial instruments are reported as Level 2. In certain circumstances, the Company may utilize unobservable inputs that reflect management’s own assumptions about the assumptions market participants would make. These financial assets are reported as Level 3.

In determining fair value for Level 2 financial instruments, management utilizes benchmark yields, reported trades for comparable trade sizes, recent purchases or sales of the financial assets, issuer spreads, benchmark securities, bids and offers. These inputs relate either directly to the financial assets being evaluated or indirectly to a similar security (for example, another bond of the same issuer or a bond of a different issuer in the same industry with similar maturity, terms and conditions). Additionally, for certain mortgage-backed securities, management also considers various characteristics such as the issuer, underlying collateral, prepayment speeds, cash flows and credit ratings.

In determining fair value for Level 3 financial instruments, management maximizes the use of market observable inputs when available. Management utilizes factors such as bids that were received, recent purchases or sales of the financial assets, spreads to the yield curve on similar offered financial assets, or comparing spreads to similar financial assets that traded and had been priced through an independent pricing source. Management considers these pricing methodologies consistent with assumptions in how other market participants value certain financial assets. These pricing methodologies involve management judgment and lead to a Level 3 classification.

Unrestricted equity securities traded in active markets are valued at quoted market prices and are reported as Level 1. Equity securities that are subject to legal restrictions on transfer are classified as Level 2. When quoted prices are not available, valuation models are applied to these financial assets. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments’ complexity. Accordingly, these financial assets are reported as Level 3.

Derivatives — These financial instruments primarily consist of TBAs, exchange treasury futures contracts and interest rate lock commitments (“IRLCs”).

TBA and exchange traded treasury futures contracts: In connection with mortgage-backed and U.S. government securities trading, and the mortgage lending activities of ClearPoint, the Company economically hedges certain exposures through the use of TBAs and exchange treasury futures contracts. A TBA is a forward mortgage-backed security whose collateral remains “to-be-announced” until just prior to the trade settlement. TBAs and exchange traded treasury futures contracts are traded in an active quoted market and therefore generally classified as Level 1.

IRLCs: The Company enters into mortgage loan IRLCs in connection with its mortgage lending activities. The fair value of the IRLCs are determined on an individual loan basis and are based on investor pricing tables stratified by product, note rate and term and considers the servicing release premium, expected loan origination fees and costs and loan pricing adjustments specific to each loan. The Company also applies an estimated rate of closure based on historical experience in determining the notional amount of the loans expected to be funded. All of these factors combined results in the classification of the IRLCs as Level 3.

Investments — These financial assets primarily represent the Company’s investment in FA Technology Ventures, L.P. (“FATV” or “the Partnership”), a venture capital limited partnership which provides early stage growth capital to companies in the information and new energy technology sectors. Valuation techniques applied by FATV GP LLC (the “General Partner”) to the underlying portfolio companies predominantly include consideration of comparable market transactions and the use of valuation models to determine the discounted value of estimated future cash flows, adjusted as appropriate for market and/or other risk factors. In addition, certain portfolio companies are valued based upon quoted market prices. This investment is classified as Level 3 as the majority of the valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments’ complexity.

The following tables summarize the categorization of the financial instruments within the fair value hierarchy including those for which the Company accounts for under the FVO, at June 30, 2011:

	Assets at Fair Value
(In thousands of dollars)	Level 1		Level 2		Level 3		Total
Financial instruments owned
Agency mortgage-backed securities	$	—	$	992,103	$	8,013	$	1,000,116
U.S. Government and federal agency obligations	18,123		31,416		—		49,539
Commercial mortgage-backed securities	—		3,650		56,359		60,009
Loans	—		63,993		—		63,993
Residential mortgage-backed securities	—		3,304		27,193		30,497
Corporate debt securities	—		14,225		—		14,225
Preferred stock	—		201		—		201
Other debt obligations	—		—		15,998		15,998
Collateralized debt obligations	—		3,568		1,424		4,992
Equity securities	1,043		—		60		1,103
Derivatives (1)	498		—		574		1,072
Investments	—		—		16,098		16,098
Total financial assets at fair value	$	19,664	$	1,112,460	$	125,719	$	1,257,843

	Liabilities at Fair Value
(In thousands of dollars)	Level 1		Level 2		Level 3		Total
Securities sold but not yet purchased
U.S. Government and federal agency obligations	$	133,409	$	11,834	$	—	$	145,243
Equity securities	101		—		—		101
Corporate debt securities	—		5,498		—		5,498
Preferred stock	—		3,158		—		3,158
Derivatives (1)	189		—		—		189
Total financial liabilities at fair value	$	133,699	$	20,490	$	—	$	154,189

(1) Unrealized gains/(losses) relating to derivatives are reported in Securities owned and Securities sold, but not yet purchased, at fair value in the Consolidated Statements of Financial Condition.

Included below is a discussion of the characteristics of the Company’s Level 2 and Level 3 holdings at June 30, 2011. Unless otherwise stated, fair value of Level 2 assets are determined based upon observable third party information including recent trading activity, broker quotes and other relevant market data as noted above. Fair value for Level 3 assets are based predominantly on management’s own assumptions about the assumptions market participants would make. The Company generally does not utilize internally developed valuation models to determine fair value during the relevant reporting periods for any holdings other than certain underlying portfolio companies comprising the Company’s investment in FATV.

The Company’s agency mortgage-backed securities positions classified as Level 2, of approximately $992.1 million, have a weighted average loan size of approximately $0.2 million paying interest of 5.8%, with a weighted average FICO score of 722. This portfolio has a weighted average coupon remitting payment of 5.3% and has a weighted average annualized constant prepayment rate of approximately 17.1%. Fair value is determined through a combination of matrix pricing as well as the information noted in the preceding paragraph.

The Company’s net Level 2 U.S. Government and federal agency obligations of approximately $19.6 million have a weighted average coupon of 3.6% and a weighted average maturity of 2019.

The Company’s Level 2 commercial mortgage backed securities of approximately $3.7 million are primarily subordinated tranches, have a weighted average credit rating of B and a weighted average issuance year of 2007.

The Company’s Level 2 loans of approximately $64.0 million (unpaid principal of approximately $61.8 million), which are related to the mortgage lending activities of ClearPoint and for which the FVO has been elected, have a weighted average loan size of approximately $0.3 million and have a weighted average coupon remitting payment of 4.6%. Unrealized losses arising from fair value changes of approximately ($0.3) million have been recorded within Principal transactions within the Consolidated Statements of Operations as of June 30, 2011. There are no loans 90 days or more past due and no loans are in non-accrual status. The loans are underwritten using standards prescribed by conventional mortgage lenders and loan buyers such as the Federal National Mortgage Association and Federal Home Loan Mortgage Corporation.

The Company’s Level 2 non-agency residential mortgage backed securities of approximately $3.3 million are primarily senior tranches and have a weighted average credit rating of BB.

The Company’s net holdings of corporate debt securities classified as Level 2 of approximately $8.7 million have a weighted average credit rating of B, have a weighted average issuance year of 2006 and a weighted average maturity of 2024.

The Company’s net preferred stock holdings classified as Level 2 of approximately ($3.0) million have a weighted average coupon of 7.65% and a weighted average credit rating of BBB.

The Company’s Level 2 collateralized debt obligations of $3.6 million is comprised of commercial real estate, with a weighted average vintage of 2007, has a weighted average credit rating of B.

The Company’s Level 3 agency mortgage-backed securities positions of approximately $8.0 million have a weighted average loan size of $0.1 million paying interest of 6.6%, with a weighted average coupon of 14.8% and a weighted average vintage of 2006.

The Company’s portfolio of Level 3 commercial mortgage backed securities of approximately $56.4 million are primarily mezzanine, have a weighted average credit rating of B and a weighted average issuance year of 2006.

The Company’s portfolio of Level 3 non-agency residential mortgage backed securities of approximately $27.2 million are primarily senior tranches, have a weighted average credit rating of A, and have experienced on average, a weighted average default rate of 4.5% and 58.3% severity.

The Company’s other debt obligations reported as Level 3 include holdings of approximately $16.0 million of asset backed securities, paying interest of 4.0%, with a weighted average credit rating of A and a weighted average vintage of 2007.

The Company’s Level 3 collateralized debt obligations of $1.4 million is comprised of commercial real estate, with a weighted average vintage of 2005, has a weighted average credit rating of CCC and have on average 12.3% subordination.

IRLCs are reported as derivatives and are classified as Level 3. Refer to Note 9 herein for additional information.

The Company’s Investments of approximately $16.1 million classified as Level 3, include the Company’s investment in FATV of approximately $14.8 million. FATV invests primarily in equity securities of closely held private companies and also invests in equity securities in public companies which are generally subject to legal restrictions on transfer. FATV is comprised of 24 holdings and fair value is determined based upon the nature of the underlying holdings. The Company has classified its entire investment as Level 3, as FATV is predominantly comprised of private companies.

· Investments in privately held companies: Valuation techniques include consideration of comparable market transactions (market approach) and utilizing the discounted value of estimated future cash flows, as adjusted for market and/or other risk factors. Relevant inputs include the current financial position and current and projected operating results of the issuer, sales prices of recent public or private transactions in the same or similar securities, significant recent events affecting the issuer, the price paid by FATV to acquire the asset, subsequent rounds of financing, completed or pending third-party transactions in the underlying investment or comparable issuers, recapitalizations and other transactions across the capital structure.

· Investments in public companies: Valuation is based on quoted market prices in active markets and adjusted as a result of legal restrictions on transfer, where applicable.

The Company’s Level 3 Investments also include approximately $1.3 million as a result of the consolidation of the Employee Investment Funds (“EIF”). For additional information regarding the Company’s Investments, refer to Note 10 herein.

The following tables summarize the categorization of the financial instruments within the fair value hierarchy at December 31, 2010:

	Assets at Fair Value
(In thousands of dollars)	Level 1		Level 2		Level 3		Total
Financial instruments owned
Agency mortgage-backed securities	$	—	$	1,084,576	$	806	$	1,085,382
Commercial mortgage-backed securities	—		—		46,571		46,571
U.S. Government and federal agency obligations	35		47,546		—		47,581
Other debt obligations	—		8,200		5,843		14,043
Preferred stock	—		12,381		—		12,381
Corporate debt securities	—		4,037		—		4,037
Residential mortgage-backed securities	—		—		33,604		33,604
Collateralized debt obligations	—		—		23,235		23,235
Equity securities	14,212		—		60		14,272
Derivatives (1)	137		—		—		137
Investments	—		—		18,084		18,084
Total financial assets at fair value	$	14,384	$	1,156,740	$	128,203	$	1,299,327

	Liabilities at Fair Value
(In thousands of dollars)	Level 1		Level 2		Level 3		Total
Securities sold but not yet purchased
U.S. Government and federal agency obligations	$	92,971	$	—	$	—	$	92,971
Preferred stock	—		2,469		—		2,469
Corporate debt securities	—		1,004		—		1,004
Equity securities	13,148		—		—		13,148
Derivatives (1)	2,683		—		—		2,683
Total financial liabilities at fair value	$	108,802	$	3,473	$	—	$	112,275

(1) Fair value of derivatives are reported in Securities owned and Securities sold, but not yet purchased, at fair value in the Consolidated Statements of Financial Condition.

The Company reviews its financial instrument classification on a quarterly basis. As the observability and strength of valuation attributes change, reclassifications of certain financial assets or liabilities may occur between levels. The Company’s policy is to utilize an end-of-period convention for determining transfers in or out of Levels 1, 2 and 3. During the three and six months ended June 30, 2011, there were no transfers between Levels 1 and 2.

The following table summarizes the changes in the Company’s Level 3 financial instruments for the three months ended June 30, 2011:

(In thousands)	Balance at March 31, 2011		Total gains or (losses) (realized and unrealized) (1)			Purchases		Sales			Settlements			Transfers in and/or out of Level 3 (2)			Balance at June 30, 2011		Changes in unrealized gains/(losses) on Level 3 assets still held at the reporting date (1)
Commercial mortgage-backed securities	$	68,247	$	(3,726	)	$	62,245	$	(66,737	)	$	(20	)	$	(3,650	)	$	56,359	$	(4,923	)
Residential mortgage-backed securities	32,385		(575		)	10,831		(13,731		)	(1,717		)	—			27,193		101
Other debt obligations	9,555		52			22,857		(16,186		)	(280		)	—			15,998		13
Agency mortgage-backed securities	2,430		(168		)	8,043		(2,292		)	—			—			8,013		(146		)
Collateralized debt obligations	7,135		6,566			3,766		(12,463		)	(12		)	(3,568		)	1,424		(63		)
Equities	60		—			—		—			—			—			60		—
Investments	16,883		(785		)	—		—			—			—			16,098		(149		)
Derivatives	685		574			—		—			(685		)	—			574		574
Total	$	137,380	$	1,938		$	107,742	$	(111,409	)	$	(2,714	)	$	(7,218	)	$	125,719	$	(4,593	)

(1) Realized and unrealized gains/(losses) are reported in Principal transactions in the Consolidated Statements of Operations.

(2) During the three months ended June 30, 2011, the Company transferred approximately $3.7 million of commercial mortgage backed securities and approximately $3.6 million of collateralized debt obligations from Level 3 to Level 2 due to price discovery resulting from Company trading activity occurring in close proximity to June 30, 2011.

The following table summarizes the changes in the Company’s Level 3 financial instruments for the three months ended June 30, 2010:

(In thousands)	Balance at March 31, 2010		Total gains or (losses) (realized and unrealized) (1)			Purchases		Sales			Settlements			Transfers in and/or out of Level 3 (2)		Balance at June 30, 2010		Changes in unrealized gains/(losses) on Level 3 assets still held at the reporting date (1)
Commercial mortgage-backed securities	$	48,859	$	5,078		$	74,331	$	(72,391	)	$	(14	)	$	—	$	55,863	$	(942	)
Other debt obligations	5,612		7			13,742		(3,813		)	(1,715		)	—		13,833		3
Residential mortgage-backed securities	9,081		248			8,241		(7,418		)	(268		)	—		9,884		(295		)
Agency mortgage-backed securities	4,759		1,350			3,377		(5,805		)	(24		)	—		3,657		(154		)
Collateralized debt obligations	1,604		14			4,971		(4,607		)	—			—		1,982		14
Corporate debt securities	1		—			—		—			—			—		1		—
Equities	60		—			—		—			—			—		60		—
Investments	19,756		(1,664		)	155		(609		)	—			—		17,638		(2,118		)
Total	$	89,732	$	5,033		$	104,817	$	(94,643	)	$	(2,021	)	$	—	$	102,918	$	(3,492	)

(1) Realized and unrealized gains/(losses) are reported in Principal transactions in the Consolidated Statements of Operations.

(2) During the three months ended June 30, 2010 there were no transfers in or out of Level 3.

The following table summarizes the changes in the Company’s Level 3 financial instruments for the six months ended June 30, 2011:

(In thousands)	Balance at December 31, 2010		Total gains or (losses) (realized and unrealized) (1)			Purchases		Sales			Settlements			Transfers in and/or out of Level 3 (2)		Balance at June 30, 2011		Changes in unrealized gains/(losses) on Level 3 assets still held at the reporting date (1)
Commercial mortgage-backed securities	$	46,571	$	10,966		$	111,801	$	(112,904	)	$	(75	)	$	—	$	56,359	$	(4,687	)
Residential mortgage-backed securities	33,604		(147		)	11,909		(15,943		)	(2,230		)	—		27,193		92
Other debt obligations	5,843		57			30,698		(20,241		)	(359		)	—		15,998		4
Agency mortgage-backed securities	806		(236		)	8,043		(600		)	—			—		8,013		(180		)
Collateralized debt obligations	23,235		11,471			5,488		(38,244		)	(526		)	—		1,424		(42		)
Equities	60		—			—		—			—			—		60		—
Investments	18,084		(1,471		)	—		—			(515		)	—		16,098		(425		)
Derivatives	—		1,259			—		—			(685		)	—		574		574
Total	$	128,203	$	21,899		$	167,939	$	(187,932	)	$	(4,390	)	$	—	$	125,719	$	(4,664	)

(1) Realized and unrealized gains/(losses) are reported in Principal transactions in the Consolidated Statements of Operations.

(2) During the six months ended June 30, 2011 there were no transfers in or out of Level 3.

The following table summarizes the changes in the Company’s Level 3 financial instruments for the six months ended June 30, 2010:

(In thousands)	Balance at December 31, 2009		Total gains or (losses) (realized and unrealized) (1)			Purchases		Sales			Settlements			Transfers in and/or out of Level 3 (2)		Balance at June 30, 2010		Changes in unrealized gains/(losses) on Level 3 assets still held at the reporting date (1)
Commercial mortgage-backed securities	$	32,585	$	9,730		$	118,755	$	(105,176	)	$	(31	)	$	—	$	55,863	$	110
Other debt obligations	9,775		2,242			19,303		(15,717		)	(1,770		)	—		13,833		1,123
Residential mortgage-backed securities	5,177		635			16,621		(12,148		)	(401		)	—		9,884		(266		)
Agency mortgage-backed securities	5,082		1,222			3,376		(5,852		)	(171		)	—		3,657		(157		)
Collateralized debt obligations	7,371		139			5,020		(10,547		)	(1		)	—		1,982		14
Corporate debt securities	1		—			—		—			—			—		1		32
Equities	60		—			—		—			—			—		60		34
Investments	19,326		(1,511		)	432		—			(609		)	—		17,638		(1,219		)
Total	$	79,377	$	12,457		$	163,507	$	(149,440	)	$	(2,983	)	$	—	$	102,918	$	(329	)

(1) Realized and unrealized gains/(losses) are reported in Principal transactions in the Consolidated Statements of Operations.

(2) During the six months ended June 30, 2010 there were no transfers in or out of Level 3.