10-K 1 itg-20161231x10k.htm 10-K itg_Current_Folio_10K

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10‑K

(Mark One)

 

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

For the fiscal year ended December 31, 2016

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 001‑32722


INVESTMENT TECHNOLOGY GROUP, INC.

(Exact name of registrant as specified in its charter)

DELAWARE

(State of incorporation)

95‑2848406

(IRS Employer Identification No.)

165 Broadway, New York, New York

(Address of principal executive offices)

10006

(Zip Code)

(212) 588‑4000

(Registrant’s telephone number, including area code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:

Common Stock, $0.01 par value

(Title of class)

New York Stock Exchange

(Name of exchange on which registered)

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None


Indicate by check mark if the registrant is a well‑known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐  No ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐  No ☒

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S‑T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒  No ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S‑K (§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 ☐

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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b‑2 of the Exchange Act.

Large accelerated filer ☒

Accelerated filer ☐

Non‑accelerated filer ☐

(Do not check if a smaller

reporting company)

Smaller reporting company ☐

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b‑2 of the Act)

Yes ☐  No ☒

Aggregate market value of the voting stock

held by non‑affiliates of the

Registrant at June 30, 2016:

$539,965,254

Number of shares outstanding of the

Registrant’s Class of common stock

at February 13, 2017:

33,238,842

DOCUMENTS INCORPORATED BY REFERENCE:

Proxy Statement relating to the 2017 Annual Meeting of Stockholders (incorporated, in part, in Form 10‑K Part III)

 

 

 


 

2016 FORM 10‑K ANNUAL REPORT

TABLE OF CONTENTS

 

 

Page

 

Forward Looking Statements

ii

 

PART I

 

Item 1. 

Business

Item 1A. 

Risk Factors

Item 1B. 

Unresolved Staff Comments

19 

Item 2. 

Properties

20 

Item 3. 

Legal Proceedings

20 

Item 4 

Mine Safety Disclosures

20 

 

PART II

 

Item 5. 

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

21 

Item 6. 

Selected Financial Data

23 

Item 7. 

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

24 

Item 7A. 

Quantitative and Qualitative Disclosures About Market Risk

45 

Item 8. 

Financial Statements and Supplementary Data

47 

Item 9. 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

87 

Item 9A. 

Controls and Procedures

87 

Item 9B. 

Other Information

89 

 

PART III

 

Item 10. 

Directors, Executive Officers and Corporate Governance

90 

Item 11. 

Executive Compensation

90 

Item 12.

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

90 

Item 13. 

Certain Relationships and Related Transactions, and Director Independence

90 

Item 14. 

Principal Accountant Fees and Services

90 

 

PART IV

 

Item 15. 

Exhibits and Financial Statement Schedules

91 

Item 16. 

Form 10-K Summary

94 

Investment Technology Group, ITG, the ITG logo, AlterNet, ITG List‑Based Algorithms, ITG Net, ITG Single‑Stock Algorithms, POSIT, POSIT Alert, POSIT Marketplace, RFQ‑hub, Triton,  TriAct, and MATCHNow are registered trademarks or service marks of the Investment Technology Group, Inc. companies. ITG Derivatives, ITG Opt, Single Ticket Clearing and Trade Ops are trademarks or service marks of the Investment Technology Group, Inc. companies.

i


 

PRELIMINARY NOTES

When we use the terms “ITG,” the “Company,” “we,” “us” and “our,” we mean Investment Technology Group, Inc. and its consolidated subsidiaries.

FORWARD‑LOOKING STATEMENTS

In addition to the historical information contained throughout this Annual Report on Form 10‑K, there are forward‑looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and the Private Securities Litigation Reform Act of 1995. All statements regarding our expectations related to our future financial position, results of operations, revenues, cash flows, dividends, financing plans, business and product strategies, competitive positions, as well as the plans and objectives of management for future operations, and all expectations concerning securities markets, client trading and economic trends are forward‑looking statements. In some cases, you can identify these statements by forward‑looking words such as “may,” “might,” “will,” “could,” “should,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “trend,” “potential” or “continue” and the negative of these terms and other comparable terminology.

Although we believe our expectations reflected in such forward‑looking statements are based on reasonable assumptions and beliefs, and on information currently available to our management, there can be no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the expectations reflected in the forward‑looking statements herein include, among others, general economic, business, credit, political and financial market conditions, both internationally and domestically, financial market volatility, fluctuations in market trading volumes, effects of inflation, adverse changes or volatility in interest rates, fluctuations in foreign exchange rates, evolving industry regulations and increased regulatory scrutiny, customer or shareholder reaction to the Company’s settlement of the SEC’s inquiry regarding pre-released ADRs or further proceedings or sanctions based on the Company’s discontinued ADR activity, the outcome of other contingencies such as legal proceedings or governmental or regulatory investigations, the volatility of our stock price, changes in tax policy or accounting rules, the ability of the Company to recognize its deferred tax assets, the actions of both current and potential new competitors, changes in commission pricing, rapid changes in technology, errors or malfunctions in our systems or technology, operational risks related to misconduct or errors by our employees or entities with which we do business, cash flows into or redemptions from equity mutual funds, ability to meet liquidity requirements related to the clearing of our customers’ trades, customer trading patterns, the success of our products and service offerings, our ability to continue to innovate and meet the demands of our customers for new or enhanced products, our ability to protect our intellectual property, our ability to execute on strategic initiatives or transactions, our ability to attract and retain talented employees, and our ability to pay dividends or repurchase our common stock in the future.

Certain of these factors, and other factors, are more fully discussed in Item 1A, Risk Factors, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 7A, Quantitative and Qualitative Disclosures about Market Risk, in this Annual Report which you are encouraged to read.

We disclaim any duty to update any of these forward‑looking statements after the filing of this report to conform our prior statements to actual results or revised expectations and we do not intend to do so. These forward‑looking statements should not be relied upon as representing our views as of any date subsequent to the filing of this report.

 

 

ii


 

Item 1.  Business

Investment Technology Group, Inc. was formed as a Delaware corporation on July 22, 1983. Its principal subsidiaries include: (1) ITG Inc., AlterNet Securities, Inc. (“AlterNet”) and ITG Derivatives LLC (“ITG Derivatives”), institutional broker‑dealers in the United States (“U.S.”), (2) ITG Canada Corp. (“ITG Canada”), an institutional broker‑dealer in Canada, (3) Investment Technology Group Limited (“ITG Europe”), an institutional broker‑dealer in Europe, (4) ITG Australia Limited (“ITG Australia”), an institutional broker‑dealer in Australia, (5) ITG Hong Kong Limited (“ITG Hong Kong”), an institutional broker‑dealer in Hong Kong, (6) ITG Software Solutions, Inc., our intangible property, software development and maintenance subsidiary in the U.S., and (7) ITG Solutions Network, Inc., a holding company for ITG Analytics, Inc., a provider of pre‑ and post‑trade analysis, fair value and trade optimization services, and ITG Platforms Inc., a provider of workflow technology solutions and network connectivity services for the financial community.

ITG is a global financial technology company that helps leading brokers and asset managers improve returns for investors around the world. We empower traders to reduce the end-to-end cost of implementing investments via technology-enabled liquidity, execution, analytics and workflow solutions. The firm is headquartered in New York with offices in North America, Europe, and the Asia Pacific region.

ITG’s business is organized into four reportable operating segments: U.S. Operations, Canadian Operations, European Operations and Asia Pacific Operations (see Note 22,  Segment Reporting, to the consolidated financial statements). These four operating segments provide the following categories of products and services:

 

·

Execution Services — includes (a) self-directed trading using algorithms, smart routing and matching through POSIT in cash equities (including single stocks and portfolio lists), futures and options trading and (b) portfolio trading and high-touch trading desks providing execution expertise

 

·

Workflow Technology — includes trade order and execution management software applications in addition to network connectivity

 

·

Analytics — includes (a) tools enabling portfolio managers and traders to improve pre-trade, real-time and post-trade execution performance, (b) portfolio construction and optimization decisions and (c) securities valuation

 

Regional segment results exclude the impact of corporate activity, which is presented separately and includes investment income and other gains as well as costs not associated with operating the businesses within the Company’s regional segments. These costs include, among others, (a) the costs of being a public company, such as certain staff costs, a portion of external audit fees, and reporting, filing and listing costs, (b) intangible asset amortization, (c) interest expense, (d) professional fees associated with our global transfer pricing structure, (e) foreign exchange gains or losses and (f) certain non‑operating revenues and expenses.

Execution Services

ITG execution services includes self‑directed trading by clients using algorithms and smart routing for cash equities, futures and options as well as matching in cash equities through POSIT, our Alternative Trading System (“ATS”). ITG execution services also provides execution expertise through portfolio trading and single stock trading desks.

ITG’s Algorithms and Smart Order Router

ITG’s algorithms and Smart Order Router offer portfolio managers and traders a way to trade orders quickly, comprehensively and cost‑efficiently from our Execution Management Systems (“EMS”) or our Order Management System (“OMS”) and most third‑party trading platforms. The algorithms execute orders anonymously and discreetly, thereby potentially lowering market impact costs and improving overall performance. ITG’s algorithms help users pursue best execution through two suites: ITG Single‑Stock Algorithms and ITG List‑Based Algorithms.

1


 

Smart Order Router offers a solution for routing trades that can help capture liquidity with a combination of speed and confidentiality. These routers continuously scan markets for liquidity with an emphasis on trading without displaying the order. Smart Order Router uses proprietary techniques to quickly execute at the best available prices.

POSIT

POSIT was launched in 1987 as a point‑in‑time electronic crossing network. Today, POSIT provides anonymous continuous and scheduled crossing of non‑displayed (or dark) equity orders and price improvement opportunities within the National Best Bid and Offer (“NBBO”). ITG has also developed versions of POSIT for trading U.S. corporate bonds (POSIT FI) and foreign exchange (POSIT FX).

POSIT Alert is a block crossing mechanism within POSIT. POSIT Alert scans uncommitted shares from participating clients. When a crossing opportunity is detected, POSIT Alert notifies the relevant buy‑side users that a matching opportunity exists.

POSIT Marketplace provides access to POSIT liquidity, the dark pools of other ATSs, and certain exchange dark order types. POSIT Marketplace is a dark pool aggregator that provides clients with access to a large range of non‑displayed liquidity destinations. POSIT Marketplace uses advanced quantitative techniques in an effort to interact with quality liquidity while protecting clients from gaming.

ITG Derivatives

ITG Derivatives provides electronic listed futures and options trading, including algorithmic trading and direct market access. ITG Derivatives offers advanced options features for traders employing volatility‑neutral or delta‑neutral strategies and also provides low‑latency application programming interfaces.

High‑Touch Trading

ITG provides single-stock and option sales trading as well as portfolio trading for institutional clients. ITG’s trading desks are staffed with experienced trading professionals who provide ITG clients with execution through advanced electronic tools.

Commission Management Services

ITG offers administration and consolidation of client commission arrangements across a wide range of our clients’ preferred brokerage and research providers through Commission Manager, a robust, multi‑asset, web‑based commission management portal.

Workflow Technology

Execution Management and Order Management

Our EMSs are designed to meet the needs of a broad range of trading styles. Triton is ITG’s award‑winning, multi‑asset and broker‑neutral EMS, which brings a complete set of integrated execution and analytical tools to the user’s desktop for global list‑based and single‑stock trading, as well as futures and options capabilities and a fully integrated and supported financial services communications network (ITG Net). Triton Derivatives is a broker‑neutral, direct‑access EMS that provides traders with access to scalable, low‑latency, multi‑asset trading opportunities.

Our OMS combines portfolio management, compliance functionality (ITG’s Compliance Monitoring System), and a fully integrated and supported financial services communications network (ITG Net) with a consolidated, outsourced service for global trade matching and settlement (Trade Ops) that provides connectivity to the industry’s post‑trade utilities, as well as support for multiple, flexible settlement communication methods and a real‑time process monitor.

ITG Net

ITG Net is a global financial communications network that provides secure, reliable and fully supported

2


 

connectivity between buy‑side and sell‑side firms for multi‑asset order routing and indication‑of‑interest messages with ITG and third‑party trading platforms. ITG Net supports approximately 9,000 billable connections to more than 580 unique brokerage firms worldwide. ITG Net also integrates the trading products of third‑party brokers and ATSs into our OMS and EMS platforms.

RFQ‑hub

In July 2014, ITG acquired ID’S, a Paris‑based company that operated RFQ‑hub, a multi‑asset platform for global‑listed and over‑the‑counter (“OTC”) financial instruments. RFQ‑hub connects buy‑side trading desks and portfolio managers with a large network of sell‑side market makers in Europe, North America and the Asia Pacific region, allowing these trading desks to place requests‑for‑quotes (“RFQ”) in negotiated equities, futures, options, swaps, convertible bonds, structured products and commodities. RFQ‑hub is available as a stand‑alone platform and is also integrated with Triton.

Single Ticket Clearing

ITG’s commitment to best execution platforms also extends to broker‑neutral operational services to help ensure that trades clear and settle efficiently, and to significantly lower the transaction costs associated with trade tickets. Single Ticket Clearing is a broker‑neutral service that aggregates executions across multiple destinations for settlement purposes. Single Ticket Clearing helps reduce the number of trade tickets and resulting charges imposed by custodians, reducing the costs of trade processing due to market fragmentation.

Analytics

Trading Analytics

The ITG Smart Trading Analytics suite enables portfolio managers and traders to improve execution performance before the trade happens (pre‑trade) and during trading (real‑time) by providing reliable trading analytics and risk models that help them perform predictive analyses, manage risk, change strategy and reduce trading costs. Trading costs are affected by multiple factors, such as execution strategies, time horizon, volatility, spread, volume and order size. ITG Smart Trading Analytics gauges the effects of these factors and aids in the understanding of the trade‑off between market impact and opportunity cost.

ITG’s Transaction Cost Analysis (“TCA”) offers unique measurement and reporting capabilities to analyze costs and performance across the trading continuum. TCA assesses trading performance and implicit costs under various market conditions so users can adjust strategies and potentially reduce costs and boost investment performance. TCA is also available for foreign exchange transactions (TCA for FX).

Alpha Capture Reporting measures cost at every point of the investment process and provides portfolio managers with quarterly analytical reviews, written interpretations and on‑site consultative recommendations to enhance performance.

Portfolio Analytics

ITG provides market‑leading tools to assist asset managers with portfolio decision‑making tasks from portfolio construction and optimization to the enterprise challenge of global, real‑time portfolio performance monitoring.

Fair Value helps mutual fund managers meet their obligations to investors and regulators to fairly price the securities within their funds, and helps minimize the impact of market timing.

ITG Opt allows portfolio managers to develop new portfolio construction strategies and solve complex optimization problems. ITG Opt allows users to accurately model tax liability, transaction costs and long/short objectives, while adhering to diverse portfolio‑specific constraints.

3


 

Non‑U.S. Operations

ITG has established a strong and growing presence in key financial centers around the world to serve the needs of global institutional investors. In addition to its New York headquarters, ITG has North American offices in Boston, Chicago, Los Angeles, San Francisco and Toronto. In Europe, ITG has offices in London, Dublin and Paris. In the Asia Pacific region, ITG has offices in Hong Kong, Singapore, Sydney and Melbourne. Local representation in regional markets provides an important competitive advantage for ITG. ITG also provides electronic and high‑touch trading for Latin American equities from its New York headquarters, including algorithms for Brazil, Mexico and Chile, and POSIT Alert on-exchange block crossing in Brazil and Mexico, as well as high‑touch trading access into Colombia and Peru.

Canadian Operations

ITG Canada was founded in 2000 and ranks in the Top 10 investment dealers in Canada. ITG Canada provides electronic brokerage services, including ITG’s algorithms and Smart Order Router, as well as high‑touch agency execution, portfolio trading services and commission management services. In addition, ITG Canada provides Triton, Triton Derivatives, connectivity services, Single Ticket Clearing, ITG Opt, ITG Smart Trading Analytics, TCA, and Fair Value. ITG Canada also engages in foreign exchange trading to facilitate equity trades by clients in different currencies as well as other client foreign exchange trades unrelated to equity trades.

In July 2007, ITG Canada launched MATCHNow, an ATS for Canadian‑listed equities, operated by ITG’s wholly‑owned subsidiary, TriAct Canada Marketplace LP (“TriAct”). MATCHNow is a leading dark pool ATS in Canada, offering a call auction marketplace with a confidential non‑displayed book with trades executed at or within the Canadian NBBO.

European Operations

ITG Europe was established as a broker‑dealer in 1998. Today, ITG Europe focuses on trading European, Middle Eastern and African equities as well as providing ITG’s technologies to its clients. ITG Europe provides electronic brokerage services including ITG’s algorithms and Smart Order Router, and the POSIT suite, as well as high‑touch agency execution services, portfolio trading services and commission management services. In Europe, ITG provides Triton, OMS, connectivity services, Single Ticket Clearing, RFQ‑hub, TCA, Alpha Capture Reporting, ITG Smart Trading Analytics and Fair Value.

Asia Pacific Operations

Australia

In 1997, ITG launched ITG Australia, an institutional brokerage firm specializing in execution and analytics for Australian‑listed equities. ITG provides clients with a range of products and services including trade execution, trade execution management through Triton, connectivity services and pre‑ and post‑trade analysis through TCA and ITG Smart Trading Analytics. Trade execution services include electronic brokerage products such as ITG’s algorithms and the POSIT suite, as well as high‑touch agency trading.

Hong Kong

In 2001, ITG formed ITG Hong Kong, an institutional broker‑dealer focused on developing and applying ITG’s technologies across the Asian markets. Execution services are provided through electronic brokerage products such as ITG’s algorithms and the POSIT suite and through an experienced high‑touch agency trading services team. Other trading and analytical tools provided by ITG Hong Kong include Triton, connectivity services, TCA and ITG Smart Trading Analytics.

Singapore

In 2010, ITG Singapore Pte Limited (“ITG Singapore”) obtained a Capital Markets Services License from the Monetary Authority of Singapore (“MAS”). ITG Singapore provides clients in Singapore with a range of ITG’s products and services including trade execution management through Triton and trading analysis through TCA and ITG Smart Trading Analytics.

4


 

Competition

The financial services industry generally, and the institutional securities brokerage business in which we operate, are extremely competitive, and we expect them to remain so for the foreseeable future. Our full suite of products does not directly compete with a particular firm; however, individual products compete with various firms and consortia:

·

Our trading and portfolio analytics compete with offerings from several sell‑side‑affiliated and independent companies.

·

POSIT and MATCHNow compete with various national and regional securities exchanges, ATSs, Electronic Communication Networks, Multilateral Trading Facilities (“MTFs”), and systematic internalizers for trade execution services. These venues have proliferated in recent years.

·

Our EMSs, OMS, connectivity and RFQ services compete with offerings from independent vendors, agency‑only firms and other sell‑side firms.

·

Our algorithmic and smart routing products, as well as our high‑touch agency execution and portfolio trading services, compete with agency‑only and other sell‑side firms.

In many cases we face competitors that are larger than we are and have greater financial resources than we have and may have more flexibility to offer a broader set of products and services than we can. Competition is also intense for the recruitment and retention of qualified professionals. The performance of our business is in large part dependent on the skills, expertise and performance of our employees. Our ability to continue to compete effectively in our businesses will depend upon our continued ability to attract new professionals and retain and motivate our existing professionals.

Regulation

Certain of our subsidiaries are subject to various securities regulations and capital adequacy requirements promulgated by the regulatory and exchange authorities of the countries in which they operate. In the U.S., the Securities and Exchange Commission (“SEC”) is the federal agency responsible for the administration of the federal securities laws, with the regulation of broker‑dealers primarily delegated to self‑regulatory organizations (“SROs”), principally the Financial Industry Regulatory Authority (“FINRA”) as well as other national securities exchanges. In addition to federal and SRO oversight, securities firms are also subject to regulation by state securities administrators in those states in which they conduct business. Furthermore, our non‑U.S. subsidiaries are subject to regulation by central banks and regulatory bodies in those jurisdictions where each subsidiary is authorized to do business, as further discussed below. The SROs, central banks and regulatory bodies conduct periodic examinations of our broker‑dealer subsidiaries in accordance with the rules they have adopted and amended from time to time.

ITG’s principal regulated subsidiaries are listed below. The principal self‑regulator of all our U.S. broker‑dealers is FINRA.

·

ITG Inc. is a U.S. broker‑dealer registered with the SEC, FINRA, The NASDAQ Stock Market (“NASDAQ”), New York Stock Exchange, NYSE Arca, Inc. (“ARCA”), NYSE MKT LLC (“NYSE MKT”), BATS Y‑Exchange, Inc. (“BYX”), BATS Z‑Exchange, Inc. (“BZX”), Chicago Stock Exchange Inc., EDGA Exchange, Inc. (“EDGA”), EDGX Exchange, Inc. (“EDGX”), NASDAQ OMX BX, Inc. (“NASDAQ BX”), NASDAQ OMX PHLX, Inc. (“NASDAQ OMX PHLX”), Investors Exchange LLC, National Futures Association (“NFA”), all 50 states, Puerto Rico and the District of Columbia.

·

ITG Derivatives is a U.S. broker‑dealer registered with the SEC, FINRA, NYSE MKT, ARCA, BYX, BZX, BOX Options Exchange LLC, Chicago Board Options Exchange LLC, C2 Options Exchange Incorporated, International Securities Exchange, ISE Gemini, LLC, ISE Mercury, LLC, NASDAQ, NASDAQ BX, NASDAQ OMX PHLX, EDGX, Commodities and Futures Trading Commission (“CFTC”), Miami International Stock Exchange, the NFA and 28 states.

·

AlterNet is a U.S. broker‑dealer registered with the SEC, FINRA, NASDAQ, EDGA, EDGX and 14 states.

5


 

·

ITG Canada is a Canadian broker‑dealer registered as an investment dealer with the Investment Industry Regulatory Organization of Canada (“IIROC”), Ontario Securities Commission (“OSC”), the Autorité Des Marchés Financiers in Quebec, Alberta Securities Commission (“ASC”), British Columbia Securities Commission, Manitoba Securities Commission, New Brunswick Securities Commission, Nova Scotia Securities Commission and Saskatchewan Financial Services Commission. ITG Canada is also registered as a Futures Commission Merchant in Ontario and Manitoba and Derivatives Dealer in Quebec. ITG Canada is a member of the Toronto Stock Exchange (“TSX”), TSX Venture Exchange, Bourse de Montreal, TriAct (which is registered with the OSC and ASC), NASDAQ Canada,  CX2, CXD, Omega, Lynx, Canadian Securities Exchange, TSX Alpha Exchange, Instinet Canada Cross Limited and Aequitas NEO Exchange (of which ITG Canada is a minority owner and has a board seat).

·

ITG Europe is authorized and regulated by the Central Bank of Ireland under the European Communities (Markets in Financial Instruments) Regulations 2007. ITG Europe is a member of the main national European exchanges, including the London Stock Exchange, Deutsche Börse and Euronext, as well as most of the European‑domiciled MTFs. It also operates the POSIT crossing system in Europe as a MTF under the Markets in Financial Instruments Directive (“MiFID”). ITG Europe’s London Branch is registered with the UK Financial Conduct Authority (“FCA”) and ITG Europe’s Paris branch is registered with the Banque de France. AlterNet (UK) Limited, a U.K. broker, is registered with the FCA.

·

ITG Australia is a market participant of the Australian Securities Exchange (“ASX”) and Chi‑X Australia Limited. It is also a holder of an Australian Financial Services License issued by the Australian Securities and Investments Commission (“ASIC”). ITG Australia’s principal regulators are the ASX and ASIC.

·

ITG Hong Kong is a participating organization of the Hong Kong Stock Exchange and a holder of a securities dealer’s license issued by the Securities and Futures Commission of Hong Kong (“SFC”), with the SFC acting as its principal regulator.

·

ITG Singapore is a holder of a Capital Markets Services License from the MAS, with the MAS acting as its principal regulator.

Broker‑dealers are subject to regulations covering all aspects of the securities trading business, including sales methods, trade practices, investment research distribution, use and safekeeping of clients’ funds and securities, capital structure, record keeping and conduct of directors, officers and employees. Additional legislation or changes in the interpretation or enforcement of existing laws and rules may directly affect the mode of operation and profitability of broker‑dealers. The SEC, SROs, state securities commissions and foreign regulatory authorities may conduct administrative proceedings or commence judicial actions, which can result in censure, fines, the issuance of cease‑and‑desist orders or the suspension or expulsion of a broker‑dealer, its directors, officers or employees.

ITG Inc., AlterNet, and ITG Derivatives are required by law to belong to the Securities Investor Protection Corporation (“SIPC”). In the event of a U.S. broker‑dealer’s insolvency, the SIPC fund provides protection for client accounts up to $500,000 per customer, with a limitation of $250,000 on claims for cash balances. ITG Canada and TriAct are required by Canadian law to belong to the Canadian Investors Protection Fund (“CIPF”). In the event of a Canadian broker‑dealer’s insolvency, CIPF provides protection for client accounts up to CAD $1 million per customer. ITG Europe is required to be a member of the Investor Compensation Protection Schemes which provides compensation to retail investors in the event of certain stated defaults by an investment firm. ITG Hong Kong is regulated by the SFC. The SFC operates the Investor Compensation Fund which provides compensation to retail investors in the event of a default by a regulated financial institution. ITG Australia is obligated to contribute to the ACH Clearing Fund and/or the National Guarantee Fund if and when requested by ASIC. In the past twelve months, no such requests have been made of ITG Australia.

Regulation ATS

Regulation ATS permits U.S. “alternative trading systems” such as POSIT to match orders submitted by buyers and sellers without having to register as a national securities exchange. Accordingly, POSIT is not registered with the SEC as an exchange. We continue to review and monitor POSIT’s systems and procedures to ensure compliance with Regulation ATS. The Form ATS describing the operations of POSIT in the U.S. is publicly available at http://www.itg.com/about/transparency/.

6


 

Net Capital Requirement

ITG Inc., AlterNet and ITG Derivatives are subject to the Uniform Net Capital Rule (Rule 15c3‑1) under the Exchange Act, which requires the maintenance of minimum net capital.

ITG Inc. has elected to use the alternative method permitted by Rule 15c3‑1, which requires that ITG Inc. maintain minimum net capital equal to the greater of $1.0 million or 2% of aggregate debit balances arising from customer transactions, as defined. AlterNet and ITG Derivatives have elected to use the basic method permitted by Rule 15c3‑1, which requires that they maintain minimum net capital equal to the greater of 62/3% of aggregate indebtedness or $100,000. On August 2, 2016, ITG Derivatives was approved as an introducing broker, resulting in a reduction of its minimum net capital requirement from $1.0 million to $100,000. Dividends or withdrawals of capital cannot be made if capital is needed to comply with regulatory requirements.  In addition, our Canadian, European and Asia Pacific Operations have subsidiaries with regulatory capital requirements.

For further information on our net capital position, see Note 16, Net Capital Requirement, to the consolidated financial statements.

Research and Product Development

We devote a significant portion of our resources to the development and improvement of technology‑based services. Important aspects of our research and development efforts include enhancements of existing software, the ongoing development of new software and services and investment in technology to enhance our efficiency.

The amounts expensed for research and development costs, excluding routine maintenance, for the years ended December 31, 2016, 2015 and 2014 are estimated at $31.8 million, $29.2 million and $35.8 million, respectively.

Intellectual Property

Patents and other proprietary rights are important to our business. We also rely upon trade secrets, know‑how, continuing technological innovations, and licensing opportunities to maintain and improve our competitive position.

We own a portfolio of patents and patent applications, in the U.S. and abroad, that principally relate to financial services, information technology and software. Patents for individual products extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. We also own and maintain a portfolio of trademarks. The extent and duration of trademark rights are dependent upon national laws and use of the trademarks.

While we consider our patents and trademarks to be valued assets, we do not believe that our competitive position is heavily dependent on patent or trademark protection or that our operations are dependent upon any single patent or group of related patents.

It is our practice to enter into confidentiality and intellectual property ownership agreements with our clients, employees, independent contractors and business partners, and to control access to, and distribution of, our intellectual property.

Clients

For the years ended December 31, 2016, 2015 and 2014, no single client accounted for more than 5% of our consolidated revenue.

Employees

On December 31, 2016, the Company employed 956 staff globally, of whom 610, 91, 146, and 109 staff were employed by the U.S., Canadian, European and Asia Pacific Operations, respectively.

7


 

Website and Availability of Public Reports

Our website can be found at http://www.itg.com. From time to time, we may use our website as a channel of distribution of material company information. Financial and other material information is routinely posted and accessible on the investor relations section of our corporate website, http://investor.itg.com. We are not including the information contained on our website as part of, or incorporating it by reference into, this Annual Report on Form 10‑K.

We are required to file reports and other information with the SEC. Our Annual Reports on Form 10‑K, Quarterly Reports on Form 10‑Q and Current Reports on Form 8‑K, together with any amendments to those reports are available without charge on our website at http://investor.itg.com. We make this information available on our website as soon as reasonably practicable after we electronically file such information with, or furnish it to, the SEC. A copy of these filings is also available at the SEC’s website (www.sec.gov). Additionally, you may read and copy any documents filed by us at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1‑800‑SEC‑0330 for further information on the Public Reference Room.

Item 1A.  Risk Factors

Certain Factors That May Affect Our Financial Condition and Results of Operations

We face risks and uncertainties that may affect our financial condition and results of operations. The following risk factors should be considered in evaluating our business and growth outlook and may be important to understanding any statement in this Annual Report on Form 10‑K. These risk factors should be read in conjunction with Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and the consolidated financial statements and related notes in Part II, Item 8, Financial Statements and Supplementary Data, of this Form 10‑K.

Decreases in equity trading activity by active fund managers and declining securities prices could harm our business and profitability.

Declines in the trading activity of active fund managers generally result in lower revenues from our trading solutions, which generate the majority of our revenues globally. In addition, securities’ price declines adversely affect our trading commissions outside North America, which are based on the value of transactions. The demand for our trading solutions is directly affected by factors such as economic, regulatory and political conditions that may lead to decreased trading activity and prices in the securities markets in the U.S. and in all of the foreign markets we serve. Significant flows of investments out of actively‑managed equity funds has curtailed their trading activity, which has weighed on our buy‑side trading volumes and the use of some of our higher value services. Volatility levels also impact the amount of trading activity. Sustained periods of low volatility can result in lower levels of trading activity. In addition, trading activity tends to decline in periods following extreme levels of volatility.

Decreases in our commission rates and other transactional revenues could adversely affect our operating results.

Commission rates on institutional trading activity have declined historically and we anticipate a continuation of the competitive pricing environment for the foreseeable future. In addition, we have seen a shift in the mix of our business to include an increased portion from higher‑turnover lower‑rate clients, particularly sell‑side firms. A decline in commission rates or revenue capture from future mix shifts or from rate reductions within client segments could materially reduce our margins and harm our financial condition and operating results.

Our fixed costs may result in reduced profitability or losses.

We incur significant operating and capital expenditures to support our business that do not vary directly, at least in the short term, with fluctuations in executed transaction volumes or revenues. In addition, changes in market practices have required us, and may require us in the future, to invest in additional infrastructure to increase capacity levels without a corresponding increase in revenues. To ensure that we have the capacity to process projected increases in trade orders and executed transaction volumes, we have historically made substantial infrastructure investments in advance of such projected increases, including during periods of low revenues. In the event of reductions in trade executions and/or revenues, we may not be able to reduce such expenses quickly and, as a result, we could experience reduced profitability or losses. If the growth in our executed volumes does not occur or we are not able to successfully implement and monetize our investments, including by failing to accurately forecast the demand for new products, effectively deploy

8


 

new products or decommission legacy products, the expenses related to such investments could cause reduced profitability or losses.

We may not have sufficient cash flows from operating activities, cash on hand and the ability to obtain borrowing capacity to finance required capital expenditures, fund strategic initiatives and meet our other cash needs. These obligations require a significant amount of cash, and we may need additional funds, which may not be readily available.

We depend on the availability of adequate capital to maintain and develop our business and meet our regulatory capital requirements. Although we believe that we can meet our ongoing operating cash and regulatory capital needs from our cash flow from operations, our existing cash balances and our available credit facilities, if cash on hand and cash flow from operations are not sufficient to meet our needs, our ability to borrow additional funds may be impacted by financial lending institutions’ ability or willingness to lend to us on commercially acceptable terms and we may become subject to covenants even more restrictive than those contained in our current credit facilities. During 2016, the net cash provided by operating activities was less than the amount needed to fund capital expenditures, capitalized software and certain financing activities, which were funded by excess cash on hand from the sale of our energy research operations in December 2015. Continued low levels of operating cash flow together with limited access to capital or credit in the future could have an impact on our ability to, among others, meet our regulatory capital requirements, invest in our software and infrastructure, engage in strategic initiatives, make acquisitions or strategic investments in other companies, react to changing economic and business conditions, repay our outstanding debt, make dividend payments or repurchase shares of our common stock. If we are unable to generate sufficient cash flow from operations or borrow additional funds to fund our capital or credit requirements, it could have an adverse effect on our business, financial condition and operating results.

We will need to continue to invest in our operations for the foreseeable future to fund our strategic initiatives including the ongoing investment program under the Strategic Operating Plan we announced in July 2016. If we do not achieve the expected operating results, we may need to seek additional financing in the debt or equity markets or sell selected assets or reduce or delay planned capital, research or development expenditures.  These measures may not be successful and may harm our business and prospects. In addition, any financing, or sale of assets might not be available, or available on economically favorable terms.

A failure in the design, operation or configuration of our technology could adversely affect our profitability and reputation.

A technological failure or error of one or more of our products or systems, including but not limited to POSIT, our algorithms, smart routers, and order and execution management systems, could result in lost revenues and/or significant market losses. We operate complex trading systems, algorithms and analytical products that may fail to correctly model interacting or conflicting trading objectives, unusual market conditions, available trading venues and other factors, which may cause unintended results. Similarly, the operation and configuration of our systems can be quite complex and departure from standard procedures can result in adverse trading outcomes. Such problems could cause us to incur trading losses, lose clients or experience other reputational harm resulting in lost revenues and profits. Our quality assurance testing cannot test for all potential scenarios or ensure that the technology will function as designed and intended in all cases.

Failure to keep up with rapid changes in technology while continuing to seek to provide leading products and services to our customers could negatively impact our results of operations.

The institutional brokerage industry is subject to rapid technological change and evolving industry standards. Our customers’ demands become greater and more sophisticated as the dissemination of products and information to customers increases. If we are unable to anticipate and respond to the demand for new services, products and technologies, innovate in a timely and cost‑effective manner and adapt to technological advancements and changing standards, we may be unable to compete effectively, which could have a material adverse effect on our business. Many of our competitors have significantly greater resources than we do to fund such technological advances. Moreover, the development of technology‑based services is a complex and time‑consuming process. New products and enhancements to existing products can require long development and testing periods. Significant delays in new product releases, failure to meet key deadlines, or significant problems in creating new products could negatively impact our revenues and profits.

9


 

Insufficient system capacity, system operating failures, or disasters could materially harm our reputation, financial position and profitability.

The success of our business is dependent on the computer and communications systems supporting our operations, which must monitor, process and support a large volume of transactions across numerous execution venues in many countries and multiple currencies. As our business continues to expand, we will need to continue to expand our systems to accommodate an increasing volume of transactions across a larger client base and more geographical locations. In addition, certain changes in market practices may require us to invest in infrastructure to increase capacity levels. Unexpectedly high volumes or times of unusual market volatility could cause our systems to operate slowly, decrease output or even fail for periods of time, as could general power or telecommunications failures, hardware failures, software errors, data center outages, human error, computer viruses, acts of vandalism, natural disasters, terrorist activities, cybersecurity breaches or other business disruptions. System failure or degradation could adversely affect our ability to effectuate transactions and lead our customers to file formal complaints with industry regulatory organizations, initiate regulatory inquiries or proceedings, file lawsuits against us, trade less frequently through us or cease doing business with us. In turn, we could incur financial loss, liability to clients, regulatory intervention or reputational damage.

Our corporate headquarters and largest concentration of employees and technology is in the New York metropolitan area. Our other offices are also located in major cities around the globe. If a business system disruption were to occur, especially in New York, for any reason, including widespread health emergencies, natural disasters or terrorist activities, and we were unable to execute our disaster recovery plan, or our disaster recovery plan proves insufficient, it could have a material effect on our business. Moreover, we have varying levels of disaster recovery plan coverage among our non‑U.S. subsidiaries.

Any system capacity or operational failure or business system disruption could result in regulatory or legal claims. We could incur significant costs in defending such regulatory or legal claims, even those without merit. Moreover, such failures could result in the need to remediate issues and repair or expand our networks and systems. Any obligation to expend significant resources to defend claims or repair and expand infrastructure could have an adverse effect on our financial condition and results of operations.

Our systems and those of our third‑party service providers may be vulnerable to cybersecurity risks.

Our business relies on the secure collection, storage, processing and transmission of proprietary information, including our clients’ confidential data, in our internal systems and through our vendor networks and communications infrastructure. Increased cybersecurity threats pose a risk to this information, in addition to our and our third party service providers’ systems and networks. While we have not been the victim of cyber‑attacks that have had a material impact on our operations or financial condition, we have experienced cyber security incidents such as denial of service attempts, malware infections, phishing attempts, and other attempts at compromising our information technology that are typical for a company of our size that operates in the global financial marketplace. Our systems also may be vulnerable to unauthorized access, computer viruses, acts of vandalism, or other malicious code, cyber-attack and other adverse events that could have a negative impact, including loss or destruction of data (including confidential client information) and unavailability or disruption of service. Despite our efforts to implement industry‑standard security measures, we face the risk that our security measures may prove insufficient as attacks have resulted in material breaches against other financial services companies with significant security controls and the nature of cyber threats continues to evolve. These threats may come from external factors such as governments, organized crime, hackers, and other third parties such as outsource or infrastructure-support providers and application developers, or may originate internally from within us. System errors that result from these acts may be repeated or compounded before they are discovered and rectified. Successful security breaches of our systems or the systems of certain of our vendors could expose us to a risk of misappropriation of our or our clients’ confidential information, the corruption or deletion of data, and the disruption of our services to our clients. These outcomes could result in reputational damage, loss of clients, lower trading volumes, a negative impact on our competitive position, significant expense in implementing future security measures, litigation, and regulatory inquiries or proceedings, all of which could adversely impact our financial results.

Financial services regulators in recent years have increased their examination and enforcement focus on matters relating to cybersecurity threats, including the assessment of firms’ vulnerability to cyber-attacks. In particular, regulatory concerns have been raised about firms establishing effective cybersecurity governance and risk management policies, practices and procedures; protecting firm networks and information; identifying and addressing risk associated

10


 

with remote access to client information; identifying and addressing risks associated with client business partners, counterparties, vendors, and other third parties, including exchanges and clearing organizations; preventing and detecting unauthorized activities; adopting effective mitigation and business continuity plans to address the impact of cybersecurity breaches; and establishing protocols for reporting cybersecurity incidents. Although we maintain insurance coverage that, subject to policy terms and conditions, covers certain aspects of cyber risks, such insurance coverage may be insufficient to cover all losses and would not protect us from the effects of adverse regulatory actions that may result from the incident or a finding that we had inadequate cybersecurity controls, or any follow-on litigation, including the reputational harm that could result from such regulatory actions, findings or litigation.

 

We are dependent on certain third party vendors for key services.

We depend on a number of third parties to supply elements of our trading systems, computers, market data, data centers, access to trading in certain markets, FIX connectivity, communication network infrastructure, other equipment and related support and maintenance. We cannot be certain that any of these providers will be willing or able to continue to provide these services in an efficient and cost‑effective manner or to meet our evolving needs. Moreover, we are dependent on our communications network providers for interconnectivity with our clients, markets and clearing agents to service our customers and operate effectively. We have also made substantial investments in our infrastructure to provide improved business recovery capabilities in the event of potential outages at our third-party service providers. If our vendors fail to meet their obligations, provide poor, inaccurate or untimely service, we are unable to make alternative arrangements for the supply of these services, we are unable to execute our business recovery plan, or our business recovery plan proves insufficient, we may fail, in turn, to provide our services or to meet our obligations to our customers, and our business, financial condition and our operating results could be materially harmed.

Our securities business and related clearing operations expose us to material liquidity risk.

We self‑clear equity transactions in the U.S. and Australia. In those markets, we may be required to provide considerable additional funds with clearing and settlement organizations, such as the National Securities Clearing Corporation or Depository Trust and Clearing Corporation in the U.S., especially during periods of high market volatility. In addition, regulatory agencies have recently required these clearing and settlement organizations to increase the level of margin deposit requirements and they may continue to do so in the future. We rely on our excess cash, certain established credit facilities and the use of outsourced clearing arrangements to meet or reduce those demands. While we have historically met requests for additional margin deposits, there is no guarantee that our excess cash and our established credit facilities and clearing arrangements will be sufficient for future needs, particularly if there is an increase in requirements. There is also no guarantee that these established credit facilities will be extended beyond their expiration.

In addition, each of our broker‑dealer subsidiaries worldwide is subject to regulatory capital requirements promulgated by the applicable regulatory and exchange authorities of the countries in which they operate. Growth in trading activity in certain jurisdictions outside the U.S. has led, and could continue to lead to, higher regulatory capital requirements. The failure by any of these subsidiaries to maintain its required regulatory capital may lead to suspension or revocation of its broker‑dealer registration and its suspension or expulsion by its regulatory body. Historically, all regulatory capital needs of our broker‑dealers have been provided by existing cash and cash from operations. However, if existing cash together with cash from operations are not sufficient, we may need to reject orders from clients and we may ultimately breach regulatory capital requirements. 

Furthermore, if our broker-dealer subsidiaries are subject to new or modified regulatory capital rules or requirements, or fines, penalties or sanctions due to increased or more stringent enforcement, it could materially limit or reduce the liquidity we may need to expand or even maintain our then-present levels of business, which could have a material adverse effect on our business, results of operations and financial condition.

As a clearing member firm in certain jurisdictions we are subject to significant default risk.

We are required to finance our clients’ unsettled positions from time to time and we could be held responsible for the defaults of our clients. Default by our clients may also give rise to our incurring penalties imposed by execution venues, regulatory authorities and clearing and settlement organizations. Although we regularly review our credit exposure, default risk may arise from events or circumstances that may be difficult to detect or foresee. In addition, concerns about, or a default by, one institution could lead to significant liquidity problems, losses or defaults by other

11


 

institutions that could in turn adversely affect us.

In certain jurisdictions we are dependent on third-party clearing agents and any failures by such clearing agents could materially impact our business and operating results.

In certain jurisdictions we are dependent on agents for the clearing and settlement of securities transactions. If our agents fail to properly facilitate the clearing and settlement of our customer trades, we could be subject to financial, legal and regulatory risks and costs that may impact our business and operating results. In addition, it could cause our clients to reduce or cease their trading with us, which would adversely affect our revenues and financial results.

Moreover, certain of our agreements with clearing agents may be terminated upon short notice. There is no guarantee that we could obtain alternative services in a timely manner and any interruption of the normal course of our trading and clearing operations could have a material impact on our business and results of operations.

Our business exposes us to credit risk that could affect our operating results and profitability.

We are exposed to credit risk from third parties that owe us money, securities or other obligations, including our customers and trading counterparties. These parties may default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other reasons, and we could be held responsible for such defaults. In addition, client trading errors which they are unable or unwilling to cover may cause us to incur financial losses. Volatile securities markets, credit markets and regulatory changes may increase our exposure to our customers’ credit profiles, which could adversely affect our financial condition and operating results. Our review of the credit risk of trading counterparties may not be adequate to provide sufficient protection from this risk.

We may incur material losses on foreign exchange transactions entered into on behalf of clients and be exposed to material liquidity risk due to counterparty defaults or errors.

We enable clients to settle cross‑border equity transactions in their local currency through the use of foreign exchange contracts. These arrangements typically involve the delivery of securities or cash to a counterparty that is not processed through a central clearing facility in exchange for a simultaneous receipt of cash or securities. We may operate as either a principal or agent in these transactions. As a result, a default by one of our counterparties prior to the settlement of their obligation could materially impact our liquidity and have a material adverse effect on our financial condition and results of operations.

In addition, we are exposed to operational risk. Employee and technological errors in executing, recording or reporting foreign exchange transactions may result in material losses due to the large size of such transactions and the underlying market risk in correcting such errors.

Our limited principal trading exposes us to risk of loss.

We engage in a limited amount of principal trading, which exposes us to risk of loss due to market fluctuations and volatility.   For example, in our Canadian Operations, a limited portion of our revenues is derived from principal trading activities including the net spread on foreign exchange contracts executed to facilitate equity trades by clients in different currencies and trading exchange traded funds (“ETFs”) to facilitate the creation or redemption of an ETF.  In addition, in limited circumstances, we may transact on a principal basis in the normal course of agency trading by taking temporary positions in securities (including trade errors and client trade accommodations). Although we attempt to close out all of our positions by the end of the day, we bear the risk of market fluctuations and we may incur losses due to changes in the prices of such securities and currencies. Any principal gains or losses resulting from these positions could have a disproportionate effect, positive or negative, on our revenues and profits, and could also result in reputational damage.

Our Canadian Operations also derive a limited portion of its revenues from the principal trading of spot and short‑dated forward foreign exchange contracts with clients that may not be related to equity trades. Although we seek to execute offsetting foreign exchange contracts concurrently with any client trades, earning a net spread, there can be no assurances that the trades are in fact concurrent (and therefore we bear the risk of market fluctuations). In addition, foreign exchange contracts are not centrally cleared and therefore we bear counterparty and settlement risk on such trades.

12


 

Our risk management policies and procedures may not be effective and may leave us exposed to unidentified or unexpected risks.

We seek to monitor and control our risk exposure through a risk and control framework encompassing a variety of separate but complementary financial, credit, operational, technological, compliance and legal reporting systems, internal controls, management review processes and other mechanisms that rely on a combination of technical and human controls and supervision, including our global risk committee. These policies, procedures and practices used to identify, monitor and control a variety of risks may fail to be effective. As a result, we face the risk of losses, including, for example, losses resulting from trading errors, customer defaults, fraud and money laundering.

Internal control over financial reporting, no matter how well designed, has inherent limitations. Therefore, internal control over financial reporting determined to be effective can provide only reasonable assurance with respect to financial statement preparation and may not prevent or detect all misstatements. Moreover, 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. As such, we could lose investor confidence in the accuracy and completeness of our financial reports, which may have a material adverse effect on our stock price.

The business in which we operate is extremely competitive worldwide.

Many of our competitors have substantially greater financial, technical, marketing and other resources than we do, which, among other things, enable them to compete with the services we provide on the basis of price, including lowering prices for certain of our key services to gain business in their higher margin areas, and a willingness to commit their firms’ capital to service their clients’ trading needs on a principal, rather than on an agency basis. In addition, many of our competitors offer a wider range of bundled services, have broader name recognition, and have larger customer bases than we do. Some of our competitors have long‑standing, well‑established relationships with their clients, and also hold dominant positions in their trading markets. Moreover, new entrants may enter the market with alternative methods of providing trade execution and related services, and existing competitors often launch new initiatives. Many of our competitors have undertaken measures to link various electronic trading systems and platforms in an effort to attract order flow to off‑exchange venues and increase internal executions.

Although we believe that our products and services have established certain competitive advantages, our ability to maintain these advantages will require continued enhancements to our products, investment in the development of our services, additional marketing activities and enhanced customer support services. In addition, there can be no assurance that we will have sufficient resources to continue to make investments in development of our services, that our competitors will not devote significantly more resources to competing services or that we will otherwise be successful in maintaining our market position. If competitors offer superior services, our market share would be affected and this would adversely impact our business and results of operations.

We face certain challenges and risks to our international business that may adversely affect our strategy.

Global client coverage is a key component of our business plan. We have invested significant resources in our foreign operations and the globalization of our products and services. However, there are certain risks inherent in the operation of our business outside of the U.S., including, but not limited to, additional regulatory capital requirements, less developed technology and infrastructure, and higher costs for infrastructure. These risks may limit our ability to provide services to clients in certain markets. There also may be difficult processes for obtaining regulatory approvals. This could result in delays in our global business plans, difficulties in staffing foreign operations and adapting our products to foreign markets, practices and languages, exchange rate risks and the need to meet foreign regulatory requirements. Each of these could force us to alter our operational plans and this may adversely impact our strategy.

Political and economic uncertainty arising from the outcome of the June 2016 referendum in which the people of the United Kingdom voted in favor of an exit from the European Union could adversely impact our business, results of operations and financial condition.

 

There is substantial political and economic uncertainty surrounding the referendum held on June 23, 2016 in which the citizens of the United Kingdom voted in favor of an exit from the European Union (often referred to as Brexit). The referendum is non-binding; however, if passed into law, negotiations would then commence to determine

13


 

the terms of the United Kingdom’s future relationship with the European Union, including the terms of trade between the United Kingdom and the European Union. It is unclear how the United Kingdom’s access to the European Union single market, and the wider trading, legal and regulatory environment in which we and our clients operate, will be impacted and how this will affect our and their businesses. The announcement of Brexit caused, and further developments may continue to cause, significant volatility in global stock markets and currency exchange rate fluctuations. The uncertainty surrounding the terms of the United Kingdom’s exit and its consequences could adversely impact client and investor confidence, result in additional market volatility and adversely affect our businesses, including our revenues from trading activities in Europe, and our results of operations and financial condition.

 

We incur risks related to our international business due to currency exchange rate fluctuations that could impact our financial results and financial position.

We have significant operations outside of the U.S. generating approximately 50% of our revenues in 2016. We currently operate and continue to expand globally, principally through our operations in Canada, Europe and Asia Pacific as well as through the development of specially tailored versions of our services to meet the needs of our clients who trade in international markets. We therefore have significant exposure to currency exchange rate fluctuations primarily between the U.S. Dollar and the British Pound Sterling, Euro, Swiss Franc, Scandinavian currencies, Australian Dollar, Canadian Dollar and Hong Kong Dollar. When the U.S. Dollar strengthens against these currencies, the U.S. Dollar value of non‑U.S. Dollar‑based revenue and profit decreases. These fluctuations may materially impact the translation of our non‑U.S. results of operations and financial condition into U.S. dollars as part of the preparation of our consolidated financial statements.

We are dependent on certain major customers and a decline in their use of our services could materially impact our revenues.

Our customers may discontinue their use of our trading services at any time. The loss of any significant customer could have a material adverse effect on our results of operations.

The chart below sets forth our dependence on our three largest clients individually, as well as on our ten largest clients in the aggregate, expressed as a percentage of total revenues:

 

 

 

 

 

 

 

 

 

 

% of Total Consolidated Revenue

 

 

    

2016

    

2015

    

2014

 

Largest customer

 

3.0

%  

2.2

%  

2.7

%

Second largest customer

 

2.2

%  

2.2

%  

2.0

%

Third largest customer

 

2.1

%  

2.1

%  

1.7

%

Ten largest customers

 

17.8

%  

17.0

%  

16.9

%

The securities markets and the brokerage industry in which we operate globally are subject to extensive, evolving regulation that could materially impact our business.

We currently operate POSIT in the U.S. under Regulation ATS, our European operations are subject to MiFID and we must comply with the requirements of the U.S. PATRIOT Act and its foreign equivalents for monitoring our customers and suspicious transactions. Moreover, most aspects of our broker‑dealer operations are highly regulated, such as sales and reporting practices, operational compliance, capital requirements and licensing of employees. Accordingly, we face the risk of significant intervention by regulatory authorities in all jurisdictions in which we conduct business, such as the SEC and FINRA in the U.S. and their equivalents in other countries. As we expand our business, we may be exposed to increased and different types of regulatory requirements.

We are subject to, and in the future, we may become subject to new regulations or changes in the interpretation or enforcement of existing regulations, which may adversely affect our business. Also, regulatory changes that impact how our customers conduct their business may impact our business and results of operations. The new U.S. administration and other members of the U.S. federal government and other governments outside of the United States may implement new or revised regulatory requirements for the financial services industry. Any changes to the regulatory rules could cause us to expend more significant compliance, business and technology resources, incur additional operational costs and create additional regulatory exposure.

14


 

On June 24, 2014, the SEC issued an order mandating the U.S. exchanges to implement the National Market System Plan to Implement a Tick Size Pilot Program (the “Pilot”). The Pilot was implemented on October 3, 2016. The Pilot will last for two years and it has changed the minimum ‘tick sizes’ (quoting and trading increments) for 1,200 Regulation NMS common stocks with small market capitalizations. The plan also includes a ‘trade‑at’ prohibition for 400 of the Regulation NMS stocks covered by the Pilot that would prevent price matching by a trading center, such as a dark pool, that is not displaying a protected bid or protected offer, subject to certain exceptions. The Pilot is intended to allow the SEC, SROs, and the public to evaluate and assess the impact of increment conventions on the liquidity and trading of stocks of small capitalization companies. If the Pilot (specifically the trade‑at prohibition) is expanded to more securities, the program could reduce our U.S. trading volumes. Moreover, the SEC adopted the Consolidated Audit Trail rule (“CAT”) in July 2012, which requires SROs to establish an order trail reporting system that would enable regulators to track, within 24 hours of the trade date, information related to trading orders received and executed across the securities markets. The SEC approved a national market system plan for implementation of the CAT that had been submitted by the exchanges and FINRA on November 15, 2016. By November 2017, each exchange will start reporting CAT data to the established central repository. As a non‑small industry member, we will be required to start reporting CAT data by November 2018, which will result in significant implementation costs and increased ongoing administrative expenses and burdens.

On November 19, 2014, the SEC unanimously adopted Regulation Systems Compliance and Integrity (“Regulation SCI”). The regulation became effective on February 3, 2015 and the compliance date was November 3, 2015. The rule requires SCI entities (i.e., exchanges, SROs, clearing and settlement agencies, and certain ATSs) to establish extensive policies, procedures, and/or controls to ensure the capacity, stability, integrity, and resiliency of their trading and regulatory reporting systems. Regulation SCI, among other things, also requires the reporting of certain systems issues, testing of business continuity and disaster recovery plans with mandatory participation by customers and members, the establishment of geographically diverse backup capabilities, the completion of an objective annual review of systems, and the maintenance and preservation of certain books and records concerning matters covered by the rule. To the extent Regulation SCI is applicable to us (as a result of POSIT or otherwise), we could experience significant implementation costs as well as increased ongoing administrative expenses and burdens.

On November 18, 2015, the SEC proposed amendments (the “ATS Proposal”) to Regulation ATS and related rules under the Exchange Act to enhance transparency requirements on, and increase the SEC’s oversight of, ATSs that facilitate transactions in National Market System stocks (generally, exchange-listed equities) (“NMS Stock ATSs”).  This would require, among other things, a publicly-available Form ATS-N containing disclosures about the operation of the ATS and the interactions between the ATS, its affiliates, and other firm products (e.g. smart routers and algorithms). The level of disclosure that would be required under the ATS Proposal and the SEC’s ongoing involvement in approving or reviewing the design and operations of NMS Stock ATSs would bring the regulation of NMS Stock ATSs closer to the way in which national securities exchanges are currently regulated.  To the extent that the ATS Proposal results in a significant increase in regulatory requirements associated with operating an NMS Stock ATS and the need to disclose sensitive business information, it could have adverse consequences on ATSs, including POSIT, such as increased administrative expenses and burdens.

In addition, new regulatory obligations have been proposed, adopted or implemented pertaining to markets outside of the United States, which may also have a material impact upon our business model.

 

·

In Europe, these include MiFID II for which the rulemaking process is complete but with additional regulatory guidance still underway in anticipation of implementation taking place in January 2018. In particular, under MiFID II, MTFs—the European equivalent to an SEC‑registered ATS—that trade in dark cash equity orders would be required to cross such orders at the midpoint, open, or closing prices of the primary venue (where displayed orders in those securities are traded) and adhere to volume limits on dark trading. These limits would be set at 4% of all the displayed and dark regulated venue trading volume for any individual dark venue and 8% of such volume for all dark trading venues in the aggregate. The calculations would be performed at an individual stock level over a 12‑month rolling period. In the event that the relevant limit is breached, the crossing of that particular stock in the individual dark trading venue or in all such venues (as applicable depending on whether the 4% or 8% threshold is breached) would cease for the following 6 months. MiFID II provides an exception from these requirements for large sized orders, which may be crossed at any price point and without regard to the above‑mentioned volume limits.

In addition, a financial transaction tax (the “European FTT”) is being considered which would include at

15


 

least ten of the twenty‑eight members of the European Union. In addition to the impact that such tax would have on the affected securities and signatory countries, certain alternative versions of the proposals could include an extra‑territorial scope that may impact the trading activities of entities which are, and trade entirely outside, the European FTT zone.

Compliance with certain of these adopted laws, rules or regulations of the various jurisdictions in which we operate could result in the loss of revenue and has caused us, and could cause us, to incur significant costs. In addition, if any new regulatory obligations are implemented, ITG could incur significant costs to establish the appropriate processes, systems, and/or controls. Last, if we fail to comply adequately with any of these laws, rules or regulations, we may be subject to censure, fines, cease‑and‑desist orders, suspension of our business, suspensions of personnel, or other sanctions, including revocation of our exchange or self‑regulatory organization memberships or our broker‑dealer registrations.

Increased regulatory scrutiny has led to, and will continue to lead to, increased costs associated with responding to investigations and inquiries and the potential for penalties and necessary remediation, which we expect to negatively impact our profitability and could harm our reputation.

In recent years, there has been increased regulatory scrutiny of our industry by regulators and other governmental authorities, including a focus on, among other areas, trading risk management controls, market abuse, undisclosed trading practices and dark pool operations, resulting in an increase in regulatory investigations, inquiries and reviews. Our broker-dealer subsidiaries are subject to, or involved in, investigations and other proceedings by government agencies and self-regulatory organizations, with respect to which we are cooperating. Our broker-dealer subsidiaries have been the subject of claims alleging the violation of securities laws, rules and regulations, some of which have resulted in the payment of disgorgement, penalties, fines, awards, judgments and settlements. Such enhanced scrutiny has caused, and we expect it to continue to cause, ITG to incur significant costs in light of the legal and compliance resources needed to respond to such investigations and proceedings, in addition to monetary penalties and increased compliance costs, that could arise from such investigations and proceedings. Such regulatory or other actions may also be directed at certain of our past and present executives, employees or directors and we may be required to indemnify these individuals in regard to these matters. The risks associated with such matters are often difficult to assess or quantify, and their existence and magnitude often remain unknown or uncertain for substantial periods of time. A settlement of, or judgment related to, any such matters could result in civil or criminal liability, disgorgement, penalties, fines, restrictions or limitations on our operations and activities and other sanctions, could lead to related private litigation and could otherwise have a material adverse effect on our businesses, results of operations, financial condition and prospects. Any such investigation, inquiry or action could also cause us significant reputational harm. In addition, regardless of the outcome of such matters, we have incurred and will continue to incur significant legal and other costs, including substantial management time, dealing with such matters.

Our business has been and may continue to be adversely affected by our customers’ reaction to our SEC Settlements.

In August 2015, we paid $20.3 million to settle the SEC’s investigation into a proprietary trading pilot operated in 2010 and 2011 (the “2015 SEC Settlement”), which had a significant negative impact on our business and we continue our work to restore our business to pre-2015 SEC Settlement levels. In January 2017, we paid $24.5 million to settle the SEC’s investigation into our activity with respect to pre-released American Depositary Receipts (the “2017 SEC Settlement” and together with the 2015 SEC Settlement, the “SEC Settlements”).  Our customers’ reaction to the SEC Settlements may continue to result in reputational and financial harm, which could have a material adverse effect on the Company.

The circumstances relating to the SEC Settlements could subject us to additional actions, including purported class action litigation.

In connection with the 2015 SEC Settlement, two putative class action lawsuits were filed and have since been consolidated into a single action in the U.S. District Court for the Southern District of New York against the Company and certain of its current and former executives. In addition, a purported shareholder of the Company filed a shareholder derivative action against eleven current or former officers and directors of the Company in the Supreme Court for the State of New York relating to the 2015 SEC Settlement. The Company is named as a nominal defendant, and the plaintiff purports to seek recovery on its behalf. The complaint generally alleges that the individual defendants breached their fiduciary duties to the Company in connection with the matters that were the subject of the 2015 SEC Settlement.

16


 

Any further actions or threatened actions based on the circumstances relating to the SEC Settlements, including any governmental investigations or private litigation, and the defense and any related settlement thereof, could have a material adverse effect on the Company’s consolidated financial position or on the results of operations for any particular period, and may result in significant ongoing expenses.

We could be subject to challenges by U.S. and foreign tax authorities that could result in additional taxes and penalties.

We are subject to income and other taxes in each jurisdiction in which we operate. We are also subject to reviews and audits by U.S. and foreign tax authorities. Our determination of our tax obligations in each jurisdiction requires us and our advisers to make judgment calls and estimations. Our determination may differ, even materially, from the judgment of the tax authorities and therefore cause us to incur additional taxes and related interest and penalties, which could impact our financial results.

We may not be able to realize the value of our deferred tax assets.

 

At December 31, 2016, we have significant deferred tax assets that we have recognized based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities.  We have recognized deferred tax assets because management believes, based on earnings and financial projections, that it is more likely than not that we will have sufficient future earnings to utilize these assets to offset future income tax liabilities.  We regularly review our deferred tax assets for recoverability based on our history of earnings, expectations for future earnings and expected timing of reversals of temporary differences.   Realization of deferred tax assets requires us to apply significant judgment and is inherently speculative because it requires the future occurrence of circumstances that cannot be predicted with certainty and ultimately depends on the existence of sufficient taxable income, including taxable income in prior carry-back years, as well as future taxable income.  There can be no assurance that we will achieve sufficient future taxable income as the basis for the ultimate realization of our deferred tax assets.  A period of sustained losses or other changes in facts and circumstances could require us to establish or increase a valuation allowance at some point in the future.  This would result in an increase in our effective tax rate and may have a material adverse effect on our future operating results and financial condition. In addition, changes in statutory tax rates may change our deferred tax asset or liability balances, with either favorable or unfavorable impacts on our effective tax rate. Our deferred tax assets may also be impacted by new legislation or regulation.

 

Inability to protect our intellectual property may result in increased competition, loss of business or other negative results on our business and financial condition.

Our success is dependent, in part, upon our intellectual property. We generally rely upon patents, copyrights, trademarks and trade secrets to establish and protect our rights in our proprietary technology, methods, products and services. We cannot assure that any of the rights granted under any patent, copyright or trademark that we may obtain will protect our competitive advantages. A third party may still try to challenge, invalidate or circumvent the protective mechanisms that we select. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as the laws of the U.S., so we cannot predict our ability to properly protect our intellectual property in those jurisdictions. Third parties operating in jurisdictions in which we have not filed for protection may be able to obtain rights in intellectual property that we have protected in the U.S. and other jurisdictions or may be able to misappropriate our intellectual property with impunity.

Additionally, we might not detect the unauthorized use of our intellectual property. If we do detect unauthorized use, enforcing our infringed or misappropriated intellectual property rights may require significant resources. Accordingly, we might choose not to enforce our infringed or misappropriated intellectual property rights, depending on factors like the best use of our limited resources, the value of our infringed or misappropriated intellectual property rights and other outcomes peripherally related to our attempted enforcement.

There can be no assurance that we will be able to protect our intellectual property from improper disclosure or use, or that others will not develop technologies that are similar or superior to our technology without violating our intellectual property. Violations of our intellectual property by third parties could have an adverse effect on our competitiveness and business. In addition, the cost of seeking to enforce our intellectual property rights could have an adverse effect on our financial results.

17


 

If we were to unknowingly infringe third party intellectual property or be accused of doing so without merit, we would bear significant costs of defense and litigation, which could impact our financial results.

Under current law, U.S. patent applications remain secret for 18 months and may, depending on how they are prosecuted, remain secret until the issuance of a patent. In light of these factors, it is not always possible to determine in advance whether any of our products or services may infringe the present or future patent rights of others. There can be no guarantee that we will be aware of all patents and trademarks that might pose a risk of infringement by our services. From time to time, we may receive notices from others of claims or potential claims of intellectual property infringement or we may be called upon to defend our products, customers or licensees against such third-party claims. Responding to these kinds of claims, regardless of merit, could consume valuable time and result in costly litigation that could have a material adverse effect on us. Such claims could also result in our entering into royalty or licensing agreements with the third parties claiming infringement on terms that could have a material impact on our profitability.

If we cannot successfully execute on our strategic initiatives, our business and financial results may be adversely impacted.

 

We may not be able to implement important strategic initiatives in accordance with our expectations, including that the strategic initiatives could result in additional unanticipated costs, which may result in an adverse impact on our business and financial results. In July 2016, we completed an end-to-end review of our business, clients, people and processes initiated by our Chief Executive Officer.  In connection with these findings, we announced our Strategic Operating Plan to increasingly focus our resources on our core capabilities in execution, liquidity, analytics and workflow solutions, which are our four key service offerings that revolve around the trade implementation cycle. As part of our Strategic Operating Plan, we began pursuing significant investments in technology and people in the second half of 2016 to enhance these key service offerings and sharpen our brand with the expectation that we will meaningfully grow market share, revenues and profitability on a global basis. We expect to continue these investments through the end of 2018.  If we are unable to execute or realize the benefits of these or other strategic initiatives, the strategic initiatives may not result in improvements in future financial performance and could have a material adverse effect on our business, financial condition, cash flows, or results of operations.

Our strategic transactions, including acquisitions and dispositions, may not result in anticipated benefits and may present risks not originally contemplated, which may adversely affect our results of operations and financial condition.

Over the last several years, we have undertaken several strategic transactions, including the acquisition of RFQ‑hub, a multi‑asset platform for global‑listed and OTC financial instruments, as well as the dispositions of our investment research operations. We may elect to pursue additional potential strategic transactions in the future, including acquisitions, dispositions, strategic partnerships, joint ventures, restructurings, business combinations and investments.    These transactions entail numerous operational and financial risks, including but not limited to difficulties in valuing acquired businesses, combining personnel and firm cultures, integrating acquired products, services and operations, achieving anticipated synergies that were inherent in our valuation assumptions, exposure to unknown material liabilities, the potential loss of key vendors, clients or employees of acquired companies, incurrence of substantial debt or dilutive issuance of equity securities to pay for acquisitions, higher-than expected acquisition or integration costs, write-downs of assets or impairment charges, increased amortization expenses and decreased earnings, revenue or cash flow from dispositions.  Accordingly, there can be no assurance that we will undertake or successfully complete any transactions of the nature described above, and our failure to execute on any strategic transaction in a satisfactory manner could adversely affect our future results of operations and financial condition.

Our business could be adversely affected by our inability to attract and retain talented employees, including sales, technology and development professionals.

Our business operations require highly specialized knowledge of the financial industry and of technological innovation as it applies to the financial industry. If we are unable to hire or retain the services of talented employees, including executive officers, other key management and sales, technology and development professionals, we would be at a competitive disadvantage. In addition, recruitment and retention of qualified staff could result in substantial additional costs. The loss of the services of one or more of our executive officers or other key professionals or our inability to attract, retain and motivate qualified personnel, could have a material adverse effect on our ability to operate our business.

18


 

Operational risks, such as misconduct and errors of our employees or entities with which we do business, could cause us reputational and financial harm.

Employee errors in recording or executing transactions for customers can cause us to enter into transactions that customers may disavow and refuse to settle. Such operational risks expose us to risk of loss, which can be material, until we detect the errors in question and halt, or where possible, unwind or reverse the transactions. As with any unsettled transaction, adverse movements in the prices of the securities involved in these transactions before we unwind or reverse them can increase this risk. We may incur losses as a result of these transactions that could materially impact our financial results.

In addition to trading errors by our employees, other errors or misconduct by our employees or entities with which we do business could subject us to financial losses or regulatory sanctions and seriously harm our reputation. It is not always possible to prevent employee errors or misconduct and the precautions we take to prevent and detect this activity may not be effective in all cases. Our ability to detect and prevent errors or misconduct by entities with which we do business may be even more limited. Errors could include inadvertently sharing confidential information with unauthorized parties or operational errors from the potential misuse of our products or services.  Misconduct could include, among other things, hiding unauthorized activities from us, improper or unauthorized activities such as activities prohibited by rule or law or improper use of confidential information. Misconduct by our employees or entities with which we do business could result in losses, litigation, regulatory sanctions or other material adverse effects on the Company.

Our business exposes us to litigation risks.

Many aspects of our business involve substantial risks of liability and we are involved in a number of investigations and inquiries that could result in liability. These risks of liability arise from, and could result in claims regarding, among other things, potential delays or failures of trade executions, trade settlement terms and the conduct of other aspects of our business. The defense of claims, even those without merit, could involve significant legal expenses and substantial management time. An adverse resolution of any lawsuit or claim against us could have a material adverse effect on our business, financial condition and results of operations.

The market price of our common stock could be volatile.

The market price of our common stock may be volatile and could be significantly affected by any number of factors like volatility in the broader stock market, changes in analyst earnings estimates, quarterly variations in our results of operations, shifting investor perceptions, a large purchase or sale by a significant stockholder, the announcement of new products or the occurrence of events described in the other risk factors in this Annual Report on Form 10‑K.

There can be no assurance that we will continue to declare cash dividends or repurchase our common stock.

During 2016, we repurchased shares of our common stock under a Board‑authorized repurchase program and the Board also authorized payment of quarterly cash dividends on our common stock. Any Board determinations to continue to repurchase our common stock or to continue to pay cash dividends on the common stock, in each case at levels consistent with recent practice or at all, will be based on a variety of factors including, among others, market conditions, our financial condition, results of operations, business and capital requirements, price of our common stock in the case of the repurchase programs, competing needs for the use of our capital and the Board’s continuing determination that the repurchase programs and the declaration of dividends are in the best interests of our stockholders and are in compliance with all laws and agreements applicable to the repurchase and dividend programs. In the event we do not declare a quarterly dividend, or discontinue our share repurchases, our stock price could be adversely affected.

Item 1B.  Unresolved Staff Comments

None

19


 

Item 2.  Properties

U.S.

Our principal offices are located at One Liberty Plaza, in New York, New York, where we occupy approximately 132,000 square feet of office space pursuant to a lease agreement expiring in January 2029.

We maintain a facility in El Segundo, California where we occupy approximately 36,200 square feet of office space pursuant to a lease agreement expiring in June 2027. This facility is used primarily for technology research and development and support services.

We have a regional office in Boston, Massachusetts where we occupy approximately 36,000 square feet of office space pursuant to a lease expiring in November 2030.

We also have additional regional offices in Chicago, Illinois where we occupy approximately 10,300 square feet pursuant to a lease agreement expiring in October 2017, and in San Francisco, California where we occupy approximately 3,900 square feet pursuant to a lease agreement expiring in October 2018.

Canada

We have an office in Toronto where we occupy approximately 19,900 square feet of office space pursuant to a lease expiring in December 2019.

Europe

In Europe, we have offices in Dublin, London and Paris where we occupy approximately 6,200, 12,200 and 5,000 square feet of office space, respectively. The Dublin space is leased pursuant to an agreement that expires in November 2017, the London space is leased pursuant to an agreement that expires in July 2023 (with a termination option in August 2018), and the space in Paris is leased pursuant to an agreement that expires in May 2024 (with a termination option in May 2019).

Asia Pacific

In Australia we have offices in Melbourne and Sydney, where we occupy approximately 5,700 and 3,400 square feet of office space, respectively, pursuant to leases expiring in May 2020 and June 2017, respectively.

In Hong Kong we occupy approximately 7,500 square feet of office space pursuant to a lease that expires in September 2018. We also lease approximately 1,500 square feet of space for our regional office in Singapore pursuant to a lease that expires in February 2018.

Item 3.  Legal Proceedings

Information pertaining to legal proceedings can be found in “Item 8. Financial Statements—Note 21. Commitments and Contingencies—Legal Matters” and is incorporated herein by reference.

Item 4.  Mine Safety Disclosures

Not applicable

20


 

PART II

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

Common Stock Data

Our common stock trades on the NYSE under the symbol “ITG.”

The following table sets forth, for the periods indicated, the range of the intra‑day high and low sales prices of our common stock as reported on the NYSE.

 

 

 

 

 

 

 

 

  High  

    

Low  

 

2016:

 

 

 

 

 

 

First Quarter

$

22.39

 

$

14.95

 

Second Quarter

$

22.92

 

$

15.29

 

Third Quarter

$

18.47

 

$

15.06

 

Fourth Quarter

$

21.11

 

$

15.04

 

2015:

 

 

 

 

 

 

First Quarter

$

30.85

 

$

19.24

 

Second Quarter

$

32.07

 

$

24.55

 

Third Quarter

$

27.13

 

$

12.63

 

Fourth Quarter

$

21.44

 

$

12.75

 

On February 13, 2017, the closing price per share for our common stock as reported on the NYSE was $20.34. On February 13, 2017, we believe that our common stock was held by approximately 6,294 stockholders of record or through nominees in street name accounts with brokers.

Dividends

In April 2015, our Board of Directors initiated a dividend program under which we began to pay quarterly dividends, subject to quarterly declarations by the Board of Directors. During 2016 and 2015, our Board of Directors declared and we paid quarterly cash dividends as follows:

 

 

 

 

 

 

 

 

 

    

2016

 

2015

 

First Quarter

 

$

0.07

 

$

N/A

 

Second Quarter

 

 

0.07

 

 

0.07

 

Third Quarter

 

 

0.07

 

 

0.07

 

Fourth Quarter

 

 

0.07

 

 

0.07

 

Total

 

$

0.28

 

$

0.21

 

In February 2017, our Board of Directors declared a quarterly dividend of $0.07 per share on our common stock, payable on March 15, 2017 to shareholders of record as of February 27, 2017.

21


 

Stock Repurchases

ISSUER PURCHASES OF EQUITY SECURITIES

 

 

 

 

 

 

 

 

 

 

 

 

    

 

    

 

 

    

 

    

Maximum Number

 

 

 

 

 

 

 

 

Total Number of

 

of Shares (or Units)

 

 

 

 

 

 

 

 

Shares (or Units)

 

that May Yet

 

 

 

Total Number of

 

Average

 

Purchased as Part of

 

Be Purchased

 

 

 

Shares (or Units)

 

Price Paid per

 

Publicly Announced

 

Under the Plans or

 

Period

 

Purchased (a)

 

Share (or Unit) (a)

 

Plans or Programs (b)

 

Programs (b)

 

From: January 1, 2016

 

 

 

 

 

 

 

 

 

 

To: January 31, 2016

 

462,742

 

$

16.23

 

437,906

 

2,345,066

 

From: February 1, 2016

 

 

 

 

 

 

 

 

 

 

To: February 29, 2016

 

482,503

 

 

17.16

 

150,005

 

2,195,061

 

From: March 1, 2016

 

 

 

 

 

 

 

 

 

 

To: March 31, 2016

 

5,841

 

 

19.95

 

 —

 

2,195,061

 

From: April 1, 2016

 

 

 

 

 

 

 

 

 

 

To: April 30, 2016

 

2,933

 

 

21.73

 

 —

 

2,195,061

 

From: May 1, 2016

 

 

 

 

 

 

 

 

 

 

To: May 31, 2016

 

29,335

 

 

18.16

 

23,998

 

2,171,063

 

From: June 1, 2016

 

 

 

 

 

 

 

 

 

 

To: June 30, 2016

 

301,652

 

 

16.48

 

297,773

 

1,873,290

 

From: July 1, 2016

 

 

 

 

 

 

 

 

 

 

To: July 31, 2016

 

184,827

 

 

17.45

 

179,879

 

1,693,411

 

From: August 1, 2016

 

 

 

 

 

 

 

 

 

 

To: August 31, 2016

 

246,571

 

 

16.34

 

246,571

 

1,446,840

 

From: September 1, 2016

 

 

 

 

 

 

 

 

 

 

To: September 30, 2016

 

 —

 

 

 —

 

 —

 

1,446,840

 

From: October 1, 2016

 

 

 

 

 

 

 

 

 

 

To: October 31, 2016

 

10,756

 

 

16.27

 

 —

 

1,446,840

 

From: November 1, 2016

 

 

 

 

 

 

 

 

 

 

To: November 30, 2016

 

 —

 

 

 —

 

 —

 

1,446,840

 

From: December 1, 2016

 

 

 

 

 

 

 

 

 

 

To: December 31, 2016

 

167

 

 

17.47

 

 —

 

1,446,840

 

Total

 

1,727,327

 

$

16.73

 

1,336,132

 

 

 


(a)

This column includes the acquisition of 391,195 shares of common stock from employees in order to satisfy minimum statutory withholding tax requirements upon settlement of equity awards.

 

(b)

In October 2014, our Board of Directors authorized the repurchase of 4.0 million shares. This authorization has no expiration date. As of December 31, 2016, there were 1.5 million shares remaining available for repurchase under ITG’s stock repurchase program. The specific timing and amount of repurchases will vary depending on various factors including, among others, market conditions and competing needs for the use of our capital.

During 2016, we repurchased 1.7 million shares of our common stock at a cost of $28.9 million, which was funded from our available cash. Of these shares, 1.3 million were purchased under our Board of Directors’ authorization for a total cost of $22.1 million (average cost of $16.55 per share). An additional 0.4 million shares repurchased for $6.8 million pertained to the satisfaction of minimum statutory withholding tax upon the net settlement of equity awards and the net settlement of director option exercises. As of December 31, 2016, the total remaining number of shares currently available for repurchase under ITG’s stock repurchase program was 1.5 million.

22


 

Performance Graph

The following line graph compares the total cumulative stockholder return on our common stock against the cumulative total return of the Russell 2000 Index and the mean of the NASDAQ Other Finance Index and the NYSE Arca Securities Broker/Dealer Index, for the five‑year period ended December 31, 2016.

Picture 2

Item 6.  Selected Financial Data

The selected Consolidated Statements of Operations data and the Consolidated Statements of Financial Condition data presented below for each of the years in the five‑year period ended December 31, 2016, are derived from our consolidated financial statements. Such selected financial data should be read in connection with the consolidated financial statements contained in this report.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31, 

 

 

    

2016

    

2015

    

2014

    

2013

    

2012

 

Consolidated Statements of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

($ in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

469,052

 

$

634,803

 

$

559,814

 

$

530,801

 

$

504,436

 

Total expenses

 

 

512,292

 

 

513,577

 

 

494,827

 

 

487,746

 

 

774,891

 

(Loss) income before income tax (benefit) expense

 

 

(43,240)

 

 

121,226

 

 

64,987

 

 

43,055

 

 

(270,455)

 

Income tax (benefit) expense

 

 

(17,322)

 

 

29,656

 

 

14,095

 

 

11,970

 

 

(22,596)

 

Net (loss) income

 

$

(25,918)

 

$

91,570

 

$

50,892

 

$

31,085

 

$

(247,859)

 

Basic (loss) income per share

 

$

(0.79)

 

$

2.70

 

$

1.44

 

$

0.84

 

$

(6.45)

 

Diluted (loss) income per share

 

$

(0.79)

 

$

2.63

 

$

1.40

 

$

0.82

 

$

(6.45)

 

Dividends per share

 

$

0.28

 

$

0.21

 

$

 —

 

$

 —

 

$

 —

 

Basic weighted average number of common shares outstanding (in millions)

 

 

32.9

 

 

33.9

 

 

35.3

 

 

36.8

 

 

38.4

 

Diluted weighted average number of common shares outstanding (in millions)

 

 

32.9

 

 

34.8

 

 

36.4

 

 

38.1

 

 

38.4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated Statements of Financial Condition Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

($ in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

775,285

 

$

1,709,022

 

$

1,350,849

 

$

1,539,472

 

$

1,492,976

 

Cash and cash equivalents

 

$

277,977

 

$

330,653

 

$

275,210

 

$

261,897

 

$

245,875

 

Short-term bank loans

 

$

72,150

 

$

81,934

 

$

78,360

 

$

73,539

 

$

22,154

 

Term debt

 

$

6,367

 

$

12,567

 

$

17,781

 

$

30,332

 

$

19,272

 

Total stockholders’ equity

 

$

405,164

 

$

454,821

 

$

415,596

 

$

417,432

 

$

409,770

 

 

23


 

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

The following discussion and analysis should be read in conjunction with our consolidated financial statements, including the notes thereto.

Overview

ITG is a global financial technology company that helps leading brokers and asset managers improve returns for investors. ITG empowers traders to reduce the end-to-end cost of implementing investments via technology-enabled liquidity, execution, analytics and workflow solutions. ITG has offices in Asia Pacific, Europe and North America and offers execution services in more than 50 countries.

Our business is organized into four reportable operating segments: U.S. Operations, Canadian Operations, European Operations and Asia Pacific Operations (see Note 22, Segment Reporting, to the consolidated financial statements). These four operating segments provide the following categories of products and services:

·

Execution Services — includes (a) self-directed trading using algorithms, smart routing and matching through POSIT in cash equities (including single stocks and portfolio lists), futures and options trading and (b) portfolio trading and high-touch trading desks providing execution expertise

 

·

Workflow Technology  — includes trade order and execution management software applications in addition to network connectivity

 

·

Analytics — includes (a) tools enabling portfolio managers and traders to improve pre-trade, real-time and post-trade execution performance, (b) portfolio construction and optimization decisions and (c) securities valuation.

 

In December 2015 we sold our energy research operations and in May 2016 sold our remaining investment research operations, both of which were within the former product group, Research, Sales & Trading (“RS&T”). Beginning in the third quarter 2016, the remaining portfolio trading and high-touch execution offerings, previously grouped within RS&T, were combined with the electronic execution and liquidity solutions, previously grouped within the Electronic Brokerage (“EB”) product group, to form the new Execution Services product group to create an optimal alignment for cross-selling synergies. The entire historic activity of EB and RS&T, including the divested research operations, has been reclassified to the Execution Services product group to conform to the current presentation. For more information on the sale of the remaining investment research operations, see Note 4, Divestitures and Acquisitions, to the consolidated financial statements.  Also, in July 2016 we changed the name of our Platforms product group to Workflow Technology.

 

Regional segment results exclude the impact of Corporate activity, which is presented separately and includes investment income from treasury activity, certain non-operating revenues and other gains as well as costs not associated with operating the businesses within the Company’s regional segments.  These costs include, among others, (a) the costs of being a public company, such as certain staff costs, a portion of external audit fees, and reporting, filing and listing costs, (b) intangible asset amortization, (c) interest expense, (d) professional fees associated with our global transfer pricing structure, (e) foreign exchange gains or losses and (f) certain non-operating expenses.

 

Sources of Revenues

Revenues from our products and services are generated from commissions and fees, recurring (subscriptions) and other sources.

Commissions and fees are derived primarily from (i) commissions charged for trade execution services, (ii) income generated on net executions, whereby equity orders are filled at different prices within or at the NBBO and (iii) commission sharing arrangements between ITG Net (our private value‑added FIX‑based financial electronic communications network) and third‑party brokers and alternative trading systems whose trading products are made available to our clients on our OMS and EMS applications in addition to commission sharing arrangements for our Single Ticket Clearing service and our RFQ‑hub request‑for‑quote service. Because commissions are earned on a per‑transaction basis, such revenues fluctuate from period to period depending on (a) the volume of securities traded

24


 

through our services in the U.S. and Canada, (b) the contract value of securities traded in Europe and the Asia Pacific region and (c) our commission rates. Certain factors that affect our volumes and contract values traded include: (i) macro trends in the global equities markets that affect overall institutional equity trading activity, (ii) competitive pressure, including pricing, created by a proliferation of electronic execution competitors and (iii) potential changes in market structure in the U.S. and other regions. In addition to share volume, revenues from net executions are also impacted by the width of spreads within the NBBO. Trade orders are delivered to us from our OMS and EMS products and other vendors’ products, direct computer‑to‑computer links to customers through ITG Net and third‑party networks and phone orders from our customers.

Recurring revenues are derived from the following primary sources: (i) connectivity fees generated through ITG Net for the ability of the sell‑side to receive orders from, and send indications of interest to, the buy‑side and for the sell‑side to receive requests‑for‑quotes through RFQ‑hub, (ii) software and analytical products and services and (iii) maintenance and customer technical support for our OMS. Prior to the divestitures of our investment research operations in May 2016 and December 2015, recurring revenues included subscriptions from these operations.

Other revenues include: (1) income from principal trading in Canada, including within our recently closed arbitrage trading desk (for historical and year-to-date periods up until April 2016), (2) the net spread on foreign exchange transactions executed on a principal basis to facilitate equity trades by clients in different currencies, as well as on other foreign exchange transactions unrelated to equity trades, (3) the net interest spread earned on securities borrowed and loaned on transactions in our recently closed U.S. matched-book securities lending operations (for historical and year-to-date periods up until June 2016), (4) non-recurring consulting services, such as one-time implementation and customer training related activities, (5) investment income from treasury activity, (6) interest income on securities borrowed in connection with customers’ settlement activities, (7) market gains/losses resulting from temporary positions in securities assumed in the normal course of agency trading (including trade errors and client trade accommodations) and (8) non‑recurring gains and losses such as divestitures.

Expenses

Compensation and employee benefits, our largest expense, consist of salaries and wages, incentive compensation, employee benefits and taxes. Incentive compensation fluctuates based on revenues, profitability and other measures, taking into account the landscape for key talent. Incentive compensation includes a combination of cash and deferred share‑based awards. Only the cash portion of incentive compensation is a variable expense in the current period. As a result, our ratio of compensation expense to revenues may fluctuate from period‑to‑period based on revenue levels.

Transaction processing expense consists of costs to access various third‑party execution destinations and to process, clear and settle transactions. These costs tend to fluctuate with share and trade volumes, the mix of trade execution services used by clients and the rates charged by third parties.

Occupancy and equipment expense consists primarily of rent and utilities related to leased premises, office equipment and depreciation and amortization of fixed assets and leasehold improvements.

Telecommunications and data processing expenses primarily consist of costs for obtaining market data, data associated with investment research, telecommunications services and systems maintenance.

Other general and administrative expenses primarily include software amortization, professional (including legal) fees, consulting, business development and intangible asset amortization.

Interest expense consists primarily of costs associated with outstanding debt and credit facilities.

Non‑GAAP Financial Measures

To supplement our financial information presented in accordance with accounting principles generally accepted in the U.S. (“U.S. GAAP”), management uses certain “non‑GAAP financial measures” as such term is defined in Regulation G promulgated by the SEC. Generally, a non‑GAAP financial measure is a numerical measure of a company’s operating performance, financial position or cash flows that excludes or includes amounts that are included in, or excluded from, the most directly comparable measure calculated and presented in accordance with U.S. GAAP. Management believes the presentation of these measures provides investors with greater transparency and supplemental

25


 

data relating to our financial condition and results of operations, and therefore a more complete understanding of factors affecting our business than U.S. GAAP measures alone. In addition, management believes the presentation of these measures is useful to investors for period‑to‑period comparison of results as the items described below reflect certain unique and/or non‑operating items such as acquisitions, divestitures, restructuring charges, write‑offs and impairments, charges associated with litigation or regulatory matters together with related expenses or items outside of management’s control.

Adjusted revenues, adjusted expenses, adjusted pretax income (loss), adjusted income tax expense (benefit) and adjusted net income (loss), together with related per share amounts, are non‑GAAP performance measures that we believe are useful to assist investors in gaining an understanding of the trends and operating results for our core business. These measures should be viewed in addition to, and not in lieu of, results reported under U.S. GAAP.

Reconciliations of adjusted revenues, adjusted expenses, adjusted pre-tax income (loss), adjusted income tax expense (benefit) and adjusted net income (loss) to revenues, expenses, income (loss) before income tax expense (benefit), income tax expense (benefit) and net income (loss) and related per share amounts as determined in accordance with U.S. GAAP for the years ended December 31, 2016 and 2015 are provided below, as applicable (dollars in

26


 

thousands, except per share amounts). There were no adjustments for unique and/or non-operating items during the year ended December 31, 2014.

 

 

 

 

 

 

 

 

 

 

Year Ended December 31,

 

 

 

2016

 

2015

 

 

 

 

 

 

 

 

 

Total revenues

 

$

469,052

 

$

634,803

 

Less:

 

 

 

 

 

 

 

Other revenues - gains (1)

 

 

(2,438)

 

 

 —

 

Gain on the sale of energy research operations (2)

 

 

 —

 

 

(107,699)

 

Adjusted revenues

 

$

466,614

 

$

527,104

 

 

 

 

 

 

 

 

 

Total expenses

 

$

512,292

 

$

513,577

 

Less:

 

 

 

 

 

 

 

ADR settlement and associated costs (3)

 

 

(27,371)

 

 

 —

 

Restructuring (4)

 

 

(9,620)

 

 

 —

 

Compensation awards for current CEO (5)

 

 

(4,415)

 

 

 —

 

Arbitration case with former CEO and associated costs (6)

 

 

(6,580)

 

 

 —

 

Trading pilot settlement and associated costs (7)

 

 

 —

 

 

(25,198)

 

Gain from currency translation adjustment (8)

 

 

1,066

 

 

 —

 

Adjusted expenses

 

$

465,372

 

$

488,379

 

 

 

 

 

 

 

 

 

(Loss) income before income tax (benefit) expense

 

$

(43,240)

 

$

121,226

 

Effect of adjustments

 

 

44,482

 

 

(82,501)

 

Adjusted pre-tax income

 

$

1,242

 

$

38,725

 

 

 

 

 

 

 

 

 

Income tax (benefit) expense

 

$

(17,322)

 

$

29,656

 

Tax effect of adjustments (1) – (7)

 

 

7,618

 

 

(14,201)

 

Adjustment to tax reserves from resolving a multi-year contingency in the U.S. (9)

 

 

7,320

 

 

 —

 

Tax incurred to amend capital structure outside North America (10)

 

 

 —

 

 

(6,526)

 

Adjusted income tax (benefit) expense

 

$

(2,384)

 

$

8,929

 

 

 

 

 

 

 

 

 

Net (loss) income

 

$

(25,918)

 

$

91,570

 

Net effect of adjustments

 

 

29,544

 

 

(61,774)

 

Adjusted net income

 

$

3,626

 

$

29,796

 

 

 

 

 

 

 

 

 

Diluted (loss) income per share

 

$

(0.79)

 

$

2.63

 

Net effect of adjustments

 

 

0.90

 

 

(1.77)

 

Adjusted diluted income per share

 

$

0.11

 

$

0.86

 

 

27


 


Notes:

 

(1)

In the second quarter of 2016, we received insurance proceeds of $2.4 million from our corporate insurance carrier to settle a claim for lost profits arising from an August 2015 outage in our outsourced primary data center in the U.S. Additionally, we generated a nominal gain on the completion of the sale of our investment research operations in May 2016.

 

(2)

In December 2015, we completed the sale of the subsidiaries conducting our energy research operations to an affiliate of Warburg Pincus, a global private equity firm, for $120.5 million. The pre‑tax gain of $107.7 million is net of a working capital adjustment on the closing balance sheet, direct costs related to the sale, including share‑based compensation costs, and the carrying value of the net assets disposed.

 

(3)

In the second half of 2016, we incurred $24.5 million for a settlement with the SEC with respect to an inquiry involving pre-released ADRs and incurred legal and other related costs associated with this matter of $2.9 million.

 

(4)

During the second quarter of 2016, we incurred restructuring charges of $4.3 million related to (a) the reduction in our high-touch trading and sales organizations and (b) the closing of our U.S. matched-book securities lending operations and our Canadian arbitrage trading desk. In the fourth quarter of 2016, we incurred additional restructuring charges of $5.3 million related to management delayering and the elimination of certain positions.

 

(5)

Our current Chief Executive Officer was granted cash and stock awards upon the commencement of his employment in January 2016, a significant portion of which replaced awards he forfeited at his former employer. Due to U.S. tax regulations, only a small portion of the amount expensed for these awards was eligible for a tax deduction.

 

(6)

In the first half of 2016, we incurred a charge of $4.8 million, net of an insurance recovery of $0.5 million, to settle an arbitration case with our former CEO and incurred legal fees of $2.7 million. In the third quarter of 2016, we recorded a reimbursement of $0.9 million of these legal fees from our insurance carrier.

 

(7)

In August 2015, we reached a final settlement with the SEC to pay an aggregate amount of $20.3 million in connection with the SEC’s investigation into a proprietary trading pilot operated in 2010 and 2011. During 2015, we incurred $4.9 million in legal and related costs associated with this matter.

 

(8)

In the third quarter of 2016, we substantially completed the liquidation of our investment in our Israel entity that ceased operations in December 2013. During our period of ownership and through December 2013, we had accumulated foreign exchange translation gains as a component of equity, which have been reclassified as a gain that reduced other general and administrative expenses in the Consolidated Statement of Operations.

 

(9)

In the fourth quarter of 2016, we resolved a multi-year tax contingency in the U.S. and reduced tax reserves by $7.3 million.

 

(10)

In December 2015, we amended the capital structure of our principal holding company outside North America to provide continued flexibility for the movement of global capital. This amendment accelerated the U.S. taxation of amounts earned outside of North America resulting in a tax charge of $6.5 million.

 

Executive Summary for the Year Ended December 31, 2016

Consolidated Overview

Our 2016 results reflect the progress we have made in restoring our business following the fallout from the 2015 SEC Settlement as well as the impact of active global markets. In the fourth quarter, each of our international operations achieved their best quarterly profitability of 2016, with Asia Pacific posting its second highest quarterly profit ever, and the U.S. regaining significant market share. 

 

We are focused on building upon this momentum through the continued execution of our Strategic Operating Plan, which is enhancing ITG’s global capabilities in liquidity, execution, analytics and workflow solutions. We have sharpened our focus around these four key service offerings and have divested our remaining investment research operations and closed our Canadian arbitrage trading desk and our U.S. matched-book securities lending operations. As part of this plan we are pursuing significant investments in technology and people to enhance these key service offerings and sharpen our brand with the expectation that we will meaningfully grow market share, revenues and profitability on a global basis.

 

On a U.S. GAAP basis, we generated revenues of $469.1 million and incurred a net loss of $25.9 million, or $0.79 per diluted share in 2016 compared to revenues of $634.8 million and net income of $91.6 million, or $2.63 per diluted share in 2015.  

 

During 2016 we worked towards resolving legacy matters and focused on improving our organizational structure to better position ourselves for long-term growth under our Strategic Operating Plan. These efforts resulted in non-operating charges during 2016 for (i) settling an inquiry by the SEC related to our activity with pre-released ADRs, (ii) settling an arbitration case with our former CEO, (iii) restructuring our organization to delayer our management structure, eliminate certain positions, reduce headcount within the high-touch trading and sales organization and close peripheral businesses and (iv) expensing the upfront awards given to our current CEO, a significant portion of which

28


 

replaced awards he forfeited at his former employer. These efforts also resulted in non-operating gains associated with recognizing historical translation gains into earnings following the substantial liquidation of our Israel entity, insurance proceeds from the settlement of a claim related to a 2015 outage at our outsourced primary data center in the U.S. and reducing tax reserves following the resolution of a multi-year contingency in the U.S. Each of these items is more fully described above in the Non-GAAP Financial Measures discussion and reduced our reported results on a net basis by $29.5 million, or $0.90 per diluted share.

 

Excluding the non-operating items noted above, we generated adjusted net income of $3.6 million, or $0.11 per diluted share compared with adjusted net income of $29.8 million or $0.86 per diluted share in 2015 (see Non-GAAP Financial Measures). Expenses of $512.3 million in 2016 were slightly lower than 2015 despite the inclusion of the above-mentioned non-operating costs. On an adjusted basis, expenses of $465.4 million were down 5% from 2015 reflecting the impacts of the sale of energy research in December 2015 and the sale of our remaining investment research operations in May 2016 (collectively, the “Research Divestitures”), lower transaction processing costs and lower compensation from cost reduction measures.

 

Segment Discussions

 

Our U.S. average daily volume (“ADV”) was 138.1 million shares, down 15% from 2015, while market-wide volumes increased 6%. Most of the ADV decrease came from sell-side clients as ADV from buy-side clients was down just 1% reflecting the progress we have made since the 2015 SEC Settlement.

 

In Canada, commissions and fees grew 5%, below the 16% growth in market-wide volumes due to a 4% decline in currency and the fact that a greater proportion of our volume in 2016 was from lower priced sell-side clients, including our MATCHNow dark pool where we set a new quarterly revenue record in the fourth quarter. 

 

Our European Operations had another strong year in 2016. While European commissions and fees fell 3%, this was attributable to the impact of currency translation on trading in the U.K. Daily market-wide trading was up 2% over 2015 reflecting peak activity following the Brexit vote and the U.S. presidential election. Buy-side activity was strong towards the end of the year, including the fourth quarter when we set a new record in the region for market share.

 

Our Asia Pacific results in 2016 were nearly flat with 2015 despite a 13% decline in daily market-wide trading, demonstrating the steady progress we have made since the 2015 SEC Settlement. We have experienced five consecutive quarters in the region of growth in both value traded and market share, with the fourth quarter being our highest on record. Revenues in POSIT Alert were up 79% over 2015 with consecutive record levels of value traded and commissions during each of the last three quarters of 2016.

 

Corporate activity reduced pre-tax income by $70.7 million, including the impact of the items noted above for the SEC ADR settlement and related legal costs, the settlement of the arbitration case with our former CEO together with related legal fees, the restructuring charges, the expensing of upfront awards to our current CEO and the gains related to the insurance recovery as well as the Israel entity liquidation.

 

Capital Resource Allocation

 

During 2016, we repurchased 1.3 million shares under our authorized stock repurchase program for $22.1 million, or $16.55 per share, and we maintained our $0.07 quarterly dividend program, paying out $9.1 million in cash.

 

We suspended share repurchases under our program in the fourth quarter pending the final resolution of the ADR matter with the SEC. Going forward we expect to use our share repurchase program to offset dilution from the issuance of stock under employee compensation plans. We may repurchase additional shares opportunistically depending on various factors including, among others, market conditions and competing needs for the use of our capital.

 

29


 

Results of Operations—Year Ended December 31, 2016 Compared to Year Ended December 31, 2015

U.S. Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

 

 

 

 

December 31, 

 

 

 

 

 

 

$ in thousands

2016

    

2015

    

Change

    

% Change

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

Commissions and fees

$

171,995

 

$

200,325

 

$

(28,330)

 

(14)

%

Recurring

 

54,799

 

 

79,296

 

 

(24,497)

 

(31)

%

Other

 

2,861

 

 

5,609

 

 

(2,748)

 

(49)

%

Total revenues

 

229,655

 

 

285,230

 

 

(55,575)

 

(19)

%

Expenses:

 

 

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

106,464

 

 

128,715

 

 

(22,251)

 

(17)

%

Transaction processing

 

39,131

 

 

42,524

 

 

(3,393)

 

(8)

%

Other expenses

 

95,193

 

 

97,991

 

 

(2,798)

 

(3)

%

Total expenses

 

240,788

 

 

269,230

 

 

(28,442)

 

(11)

%

(Loss) income before income tax (benefit) expense

$

(11,133)

 

$

16,000

 

$

(27,133)

 

(170)

%

 

The 14% decline in commissions and fees compared to the prior year period resulted from a 15% reduction in our ADV as compared to a 6% increase in total daily U.S. market volumes. This decline in ADV was largely from a 24% reduction from sell-side clients. Activity from buy-side clients was down negligibly due to a strong finish to the year following the roll-out of the Strategic Operating Plan in late July and the implementation of changes to certain client facing roles. These steps helped grow our market share of consolidated U.S. trading volumes to 2.05% in the fourth quarter from 1.75% in the third quarter. 

Commissions and fees were further affected by an overall 2% decline in rates from $0.0043 to $0.0042 which was driven by a lower average sell-side rate per share and the impact of reduced high-touch trading for equities due to the reduction in our high-touch trading organization following the sale of our remaining investment research operations in May 2016.  The declines in commissions and fees noted above were partially offset by the growth in commissions from the high-touch trading of derivatives.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

 

 

 

 

December 31, 

 

 

 

 

 

 

U.S. Operations: Key Indicators*

2016

    

2015

    

Change

    

% Change

 

Total trading volume (in billions of shares)

 

34.8

 

 

40.9

 

 

(6.1)

 

(15)

%

Average trading volume per day (in millions of shares)

 

138.1

 

 

162.2

 

 

(24.1)

 

(15)

%

Average revenue per share

$

0.0042

 

$

0.0043

 

$

(0.0001)

 

(2)

%

U.S. market trading days

 

252

 

 

252

 

 

 —

 

 —

 


*

Excludes activity from the trading of derivatives and Latin American equities as well as commission share arrangements.

Recurring revenues decreased 31% from 2015 primarily from the loss of billed investment research revenue following the Research Divestitures. We also experienced lower subscription revenue for our OMS product due to client attrition and a reduction in billed revenue for analytics products.

 

Other revenues decreased 49% compared to 2015 due to the impact of transaction advisory services revenue earned in 2015 by our former energy research team and client trade accommodations, which reduced other revenues by $1.2 million during 2016 compared to a reduction of $0.7 million during 2015. The closing of our matched-book securities lending operations in the second quarter 2016, and lower market data tape rebate revenue also contributed to the decline. These reductions were partially offset by clearing ticket revenue earned. 

 

Compensation and employee benefits decreased 17% from the prior year in large part due to the Research Divestitures, which represented approximately 71% of the total decrease. We also incurred a lower cost for current year incentive-based compensation due in part to a greater proportion of 2016 incentive compensation awarded in deferred

30


 

stock to better align employees with the long-term outcome of the Strategic Operating Plan and we benefitted from cost savings measures implemented during the second half of 2016.

 

Transaction processing costs decreased 8% as compared to 2015, which was lower than the 15% decline in our ADV due to additional costs to outsource select clearing accounts to a third party and the impact that fixed clearing and settlement costs have on reduced volumes. These factors led to an increase in transaction processing costs as a percentage of commission and fees to 22.8% in 2016 from 21.2% in 2015.

 

Other expenses decreased 3% from the prior year period due to lower travel and entertainment, marketing, recruiting and bad debt costs, as well as the impact of the Research Divestitures, which impact was offset in part by an agreement to purchase energy research for distribution to bundled trading clients. The cost relating to energy research is expected to decline by more than $6 million in 2017 following the amendment to terminate the initial energy research distribution agreement. 

 

Canadian Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

 

 

 

 

December 31, 

 

 

 

 

 

 

$ in thousands

2016

    

2015

    

Change

    

% Change

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

Commissions and fees

$

51,723

 

$

49,169

 

$

2,554

 

5

%

Recurring

 

5,113

 

 

5,563

 

 

(450)

 

(8)

%

Other

 

4,986

 

 

8,296

 

 

(3,310)

 

(40)

%

Total revenues

 

61,822

 

 

63,028

 

 

(1,206)

 

(2)

%

Expenses:

 

 

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

18,232

 

 

20,078

 

 

(1,846)

 

(9)

%

Transaction processing

 

9,384

 

 

8,783

 

 

601

 

7

%

Other expenses

 

22,642

 

 

23,524

 

 

(882)

 

(4)

%

Total expenses

 

50,258

 

 

52,385

 

 

(2,127)

 

(4)

%

Income before income tax expense

$

11,564

 

$

10,643

 

$

921

 

9

%

 

Currency translation from a weaker Canadian Dollar decreased total Canadian revenues and expenses by $1.8 million and $1.3 million, respectively, resulting in a decrease of $0.5 million to pre-tax income.

 

The 5% growth in commissions and fees from 2015 trailed the 16% growth in daily market-wide volumes due to the impact of unfavorable currency translation as well as a greater proportion of our volume in 2016 coming from lower-priced sell-side clients. MATCHNow volumes grew by more than 50% for a second consecutive year.

 

Recurring revenues decreased 8% from the prior year primarily from the sale of energy research at the end of 2015.

 

Other revenues decreased 40% from 2015 due to the impact of closing the arbitrage trading desk in April 2016. 

 

Compensation and employee benefits costs decreased 9% from the prior year due to lower incentive-based compensation due in part to a greater proportion of 2016 incentive compensation awarded in deferred stock to better align employees with the long-term outcome of the Strategic Operating Plan and the favorable impact of foreign currency.

 

Transaction processing costs grew at a slightly higher pace than commissions and fees due to the impact of processing increased volumes from lower-rate sell-side clients, offset in part by reductions related to closing the arbitrage trading desk and currency translation. 

 

Other expenses decreased 4% from the prior year period due to lower consulting, travel and entertainment and marketing costs as well as lower research distribution fees paid to the U.S. Operations.

 

31


 

European Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

 

 

 

 

December 31, 

 

 

 

 

 

 

$ in thousands

2016

    

2015

    

Change

    

% Change

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

Commissions and fees

$

110,554

 

$

113,633

 

$

(3,079)

 

(3)

%

Recurring

 

16,029

 

 

16,272

 

 

(243)

 

(1)

%

Other

 

(638)

 

 

(176)

 

 

(462)

 

(263)

%

Total revenues

 

125,945

 

 

129,729

 

 

(3,784)

 

(3)

%

Expenses:

 

 

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

35,964

 

 

38,924

 

 

(2,960)

 

(8)

%

Transaction processing

 

31,104

 

 

29,887

 

 

1,217

 

4

%

Other expenses

 

33,407

 

 

32,674

 

 

733

 

2

%

Total expenses

 

100,475

 

 

101,485

 

 

(1,010)

 

(1)

%

Income before income tax expense

$

25,470

 

$

28,244

 

$

(2,774)

 

(10)

%

 

The British Pound is the functional currency for our European Operations, however, we did not see a decline in profitability in the region from the significant reduction in the translation rate for that currency since we have transactions that originate in other currencies in the region including the Euro, Swiss Franc and Scandinavian currencies. Revenues and expenses on transactions that originate in the U.K largely offset each other and, as a result, the weaker British Pound lowered both revenues and expenses by approximately $5.0 million. There were no material changes to the translation rate of other currencies in the region. 

 

Commissions and fees declined 3% compared to 2015 due to the impact of currency translation on U.K.-based trading and the reduced use of POSIT crossing by certain sell-side clients. This impact was offset in part by increases from buy-side clients using our POSIT Alert block crossing system and high-touch trading services.

 

Recurring revenues decreased 1% from the prior year due primarily to lower billed revenue for analytics products and currency translation, while the change in other revenues primarily reflected higher client trade accommodations and the impact of losses in the first half of 2016 to provide price improvement for ETFs in order to generate higher levels of commissions and fees on such trades.  

 

Compensation and employee benefits decreased 8% from 2015 primarily due to the impact of currency translation on costs for employees based in the U.K., and lower current year incentive-based cash compensation due largely to a greater proportion of 2016 incentive compensation awarded in deferred stock to better align employees with the long-term outcome of the Strategic Operating Plan. These decreases were offset in part by an increase in stock-based compensation associated with awards granted in 2013 through 2015.

 

Transaction processing costs increased 4% over the prior year despite favorable currency translation due to a lower concentration of business transacted through POSIT, transaction costs for executions in ETFs in the second half of 2016 and higher financing costs associated with delivery failures. Transaction processing costs increased as a percentage of commissions and fees to 28.1%, compared to 26.3% in 2015. 

 

Other expenses were 2% higher than 2015 due to investments in lower latency market data feeds and compliance monitoring tools, increased costs for connecting clients and costs relating to our new Paris office. These increases were offset in part by the impact of currency translation on U.K.-based expenses, lower professional fees, bank charges and travel and entertainment costs.

 

32


 

Asia Pacific Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

 

 

 

 

December 31, 

 

 

 

 

 

 

$ in thousands

2016

    

2015

    

Change

    

% Change

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

Commissions and fees

$

42,191

 

$

42,552

 

$

(361)

 

(1)

%

Recurring

 

5,975

 

 

6,053

 

 

(78)

 

(1)

%

Other

 

(247)

 

 

(426)

 

 

179

 

42

%

Total revenues

 

47,919

 

 

48,179

 

 

(260)

 

(1)

%

Expenses:

 

 

 

 

 

 

 

 

 

 

 

Compensation and employee benefits

 

17,692

 

 

18,165

 

 

(473)

 

(3)

%

Transaction processing

 

10,652

 

 

10,298

 

 

354

 

3

%

Other expenses

 

18,022

 

 

18,096

 

 

(74)

 

(0)

%

Total expenses

 

46,366

 

 

46,559

 

 

(193)

 

(0)

%

Income (loss) before income tax expense (benefit)

$

1,553

 

$

1,620

 

$

(67)

 

(4)

%

 

Currency translation from a weaker Australian Dollar decreased total Asia Pacific revenues and expenses by $0.3 million and $0.2 million, respectively, resulting in a decrease of $0.1 million to pre-tax income.

 

Asia Pacific commissions and fees were virtually unchanged from 2015 as the strong growth in block crossing in POSIT Alert offset the decline in commissions on algorithm trading from buy-side clients, which began to decline shortly after the announcement of the 2015 SEC Settlement. We saw record activity in POSIT Alert in terms of both value traded and commissions during the last three quarters of 2016. Our average daily value executed in the region increased by 3% as compared to the prior year despite a decline in market-wide trading of 13%. A greater proportion of our current year activity was from lower-priced sell-side accounts, which pushed our average commission rate on the increased executed value lower.  

 

Recurring revenues were comparable to the prior year period, while other revenues improved due to a reduced impact of client trade accommodations.

 

Compensation and employee benefits decreased 3% from 2015 due to lower incentive-based compensation, including the impact of a greater proportion of 2016 incentive compensation awarded in deferred stock to better align employees with the long-term outcome of the Strategic Operating Plan.

 

Transaction processing costs increased 3% from the prior year, less than the 11% growth in value executed, due to a higher proportion of our trading in markets where costs are lower and the impact of increased block crossing. As a percentage of commissions and fees, transaction processing costs increased slightly to 25.2% from 24.2% for the year due to the impact of a higher proportion of value executed for lower-rate, sell-side clients.

 

Other expenses decreased slightly as compared to the prior year period primarily due to lower travel and entertainment costs, recruiting fees and allocated software development expenses partially offset by higher software amortization and marketing costs.

 

Corporate

Corporate activity includes investment income from treasury activity, certain non-operating revenues and other gains as well as costs not associated with operating the businesses within our regional segments. These costs include, among others, (a) the costs of being a public company, such as certain staff costs, a portion of external audit fees, and reporting, filing and listing costs, (b) intangible asset amortization, (c) interest expense, (d) professional fees associated with our global transfer pricing structure, (e) foreign exchange gains or losses and (f) certain non‑operating expenses.

33


 

For 2016, we incurred a pre-tax loss from Corporate activities of $70.7 million, reflecting $2.4 million of insurance proceeds related to the August 2015 outage at our outsourced primary data center, $1.3 million of investment income and $74.4 million of costs.  For 2015, we reported pre-tax income of $64.7 million reflecting the $107.7 million gain on the sale of energy research, $0.9 million of investment income and $43.9 million of costs.  Costs in 2016 included a $27.4 million charge for a settlement with the SEC related to an inquiry involving pre-released ADRs and related professional fees. These costs also included $4.4 million for the expensing of upfront awards to our current CEO, a significant portion of which replaced awards he forfeited at his former employer, $4.8 million for the settlement of the arbitration claim by our former CEO, together with related professional fees of $1.8 million, net of a $0.9 million insurance recovery in the third quarter, and $9.6 million of restructuring costs related to (a) the headcount reduction within the high-touch trading and sales organization, including headcount that was previously focused on our research products, (b) the closing of our U.S. matched-book securities lending operations and our Canadian arbitrage trading desk and (c) additional cost savings related to management delayering and elimination of certain positions. Costs during the 2016 period were reduced by $1.1 million for the reclassification of an accumulated foreign translation gain now that we have substantially liquidated our Israel entity. Costs in the 2015 period included $25.2 million for the 2015 SEC Settlement and related legal and other fees. Excluding the items noted above for 2016 and 2015, Corporate costs increased by $7.9 million compared to the prior year reflecting the impact of a $2.1 million reversal in 2015 of compensation associated with the executive changes announced in August 2015 and additional professional fees in the current year period related to litigation, regulatory and other matters. These increases were offset in part by lower intangible amortization expense as a result of the Research Divestitures. Corporate costs can vary from period-to-period as we work through litigation, regulatory and other corporate matters.

Consolidated income tax expense

Our effective tax rate was a benefit of 40.1% for 2016 compared to an expense of 24.5% for 2015. The high benefit rate in 2016 reflects the positive impact of tax reserve reversals of $7.3 million as a result of the resolution of a multi-year tax contingency in the U.S., the strong earnings from our European Operations, where we are taxed at a lower rate and the benefit of pre-tax income in our Asia Pacific Operations, where we do not incur tax expense due to loss carryforwards. These benefits were partially offset by the negative impact in the U.S. of a substantial portion of the $24.5 million settlement cost for the ADR matter being non-deductible. The low rate in 2015 primarily reflected the impact of a low tax rate on the gain from the sale of energy research due to the availability of a deductible basis that was mostly written-off for book purposes in 2012, significant income generated by our European Operations where we are taxed at a lower rate and profitability generated by our Asia Pacific Operations where we are not incurring a tax cost due to the availability of loss carryforwards. These impacts were partially offset by the non-deductibility of a substantial portion of the cost for the 2015 SEC Settlement and a tax expense of $6.5 million on a deemed dividend associated with an amendment to the capital structure of our operations outside North America. Our consolidated effective tax rate can vary from period to period depending on, among other factors, the geographic and business mix of our earnings. 

Results of Operation—Year Ended December 31, 2015 Compared to Year Ended December 31, 2014

U.S. Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended

 

 

 

 

 

 

 

December 31, 

 

 

 

 

 

 

$ in thousands

2015

    

2014

    

Change

    

% Change

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

Commissions and fees

$

200,325

 

$

220,567

 

$

(20,242)

 

(9)

%

Recurring

 

79,296

 

 

73,808

 

 

5,488

 

7

%

Other

 

5,609

 

 

12,165

 

 

(6,556)

 

(54)

%

Total revenues

 

285,230

 

 

306,540