Table of Contents

 

 

 

**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

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

 

**For the quarterly period ended June 30, 2011**

 

**OR**

 

**o****        ****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: 001-33138**

 

**KBW, INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**

 (State or Other Jurisdiction of   Incorporation or Organization) | ** ** | **13-4055775**

 (I.R.S. Employer Identification No.) |
|--------------------------------------------------------------------------------------|------------|------------------------------------------------------------|

 

**787 Seventh Avenue, New York, New York 10019**

(Address of principal executive offices)

 

Registrant’s telephone number: **(212) 887-7777**

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No  o

 

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. (Check one):

 

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

 

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

 

The number of shares of the Registrant’s common stock, par value $0.01 per share, outstanding as of July 29, 2011 was 34,977,329,which number includes 4,007,254 shares representing unvested restricted stock awards and excludes 907,558 shares underlying vested restricted stock units.

 

 

 

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Table of Contents

 

**TABLE OF CONTENTS**

 
| Available   Information                                                                                          | 1      |
|------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                             |   |
| PART I-FINANCIAL   INFORMATION                                                                              | 2      |
|                                                                                                             |   |
| Item 1.   Financial Statements                                                                                   | 2      |
|                                                                                                             |   |
| Consolidated   Statements of Financial Condition-June 30, 2011 (unaudited) and   December 31, 2010     | 2      |
|                                                                                                             |   |
| Consolidated Statements of Operations-Three and Six   Months ended June 30, 2011 and 2010 (unaudited)       | 3      |
|                                                                                                             |   |
| Consolidated Statement of Changes in Stockholders’   Equity-Six Months ended June 30, 2011 (unaudited) | 4      |
|                                                                                                             |   |
| Consolidated Statements of Cash Flows-Six Months ended   June 30, 2011 and 2010 (unaudited)                 | 5      |
|                                                                                                             |   |
| Notes to Consolidated Financial Statements                                                                       | 6      |
|                                                                                                             |   |
| Item 2. Management’s Discussion and Analysis of Financial   Condition and Results of Operations             | 23     |
|                                                                                                             |   |
| Item 3. Quantitative and Qualitative Disclosures About   Market Risk                                             | 36     |
|                                                                                                             |   |
| Item 4. Controls and Procedures                                                                                  | 37     |
|                                                                                                             |   |
| PART II-OTHER   INFORMATION                                                                                 | 38     |
|                                                                                                             |   |
| Item   1. Legal Proceedings                                                                                      | 38     |
|                                                                                                             |   |
| Item   1A. Risk Factors                                                                                          | 38     |
|                                                                                                             |   |
| Item 2. Unregistered Sales of Equity Securities and   Use of Proceeds                                            | 39     |
|                                                                                                             |   |
| Item 3. Defaults Upon Senior Securities                                                                          | 39     |
|                                                                                                             |   |
| Item   4. Other Information                                                                                      | 39     |
|                                                                                                             |   |
| Item   5. Exhibits                                                                                               | 39     |
|                                                                                                             |   |
| SIGNATURES                                                                                                       | 40     |
|                                                                                                             |   |
| EXHIBIT INDEX                                                                                               | 41     |
|                                                                                                             |   |
| EX-31.1:   CERTIFICATION                                                                                         |   |
|                                                                                                             |   |
| EX-31.2:   CERTIFICATION                                                                                         |   |
|                                                                                                             |   |
| EX-32.1:   CERTIFICATION                                                                                         |   |
|                                                                                                             |   |
| EX-32.2: CERTIFICATION                                                                                           |   |

 

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Table of Contents

 

**Available Information**

 

We are required to file current, annual and quarterly reports, proxy statements and other information required by the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with the Securities and Exchange Commission (the “SEC”). You may read and copy any document we file with the SEC at the SEC’s Public Reference Room located at 100 F Street, N.E., Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an internet website at http://www.sec.gov, from which interested persons can electronically access our SEC filings.

 

We will make available, free of charge through our internet site http://www.kbw.com, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, Forms 3, 4 and 5 filed by or on behalf of directors, executive officers and certain large stockholders, and any amendments to those documents filed or furnished pursuant to the Exchange Act. These filings will become available as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC.

 

We also make available, on the Investor Relations page of our website, our (i) Corporate Governance Guidelines, (ii) Code of Business Conduct and Ethics, (iii) Supplement to Code of Business Conduct and Ethics for CEO and Senior Financial Officers and (iv) the charters of the Audit, Compensation, and Corporate Governance and Nominations Committees of our Board of Directors. You will need to have Adobe Acrobat Reader software installed on your computer to view these documents, which are in the PDF format. These documents will also be available in print without charge to any person who requests them by writing or telephoning: KBW, Inc., Office of the General Counsel, 787 Seventh Avenue, New York, New York, 10019, U.S.A., telephone number (212) 887-7777.  These documents, as well as the information on our website, are not a part of this report.

 

1

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Table of Contents

 

**PART I-FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements.**

 

**KBW, INC. and SUBSIDIARIES**

**Consolidated Statements of Financial Condition**

**(Dollars in thousands)**

 
| ** **                                                                                                       | ** ** | **June 30,** | ** ** | ** **            | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                       | ** ** | **2011**          | ** ** | **December 31,** | ** ** |
| ** **                                                                                                       | ** ** | **(unaudited)**   | ** ** | **2010**              | ** ** |
| **ASSETS**                                                                                                       | ** ** | ** **        | ** ** | ** **            | ** ** |
| Cash and cash   equivalents                                                                                      |       | $                 | 114,234    |                  | $          | 162,272 |   |
| Financial   instruments owned, at fair value:                                                                    |       |              |       |                  |       |
| Equities                                                                                                         |       | 208,068           |       | 114,612               |       |
| Corporate and   other debt                                                                                       |       | 51,364            |       | 93,599                |       |
| Mortgage and other   asset-backed securities                                                                     |       | 24,065            |       | 43,232                |       |
| U.S. Government   and agency securities                                                                          |       | 2,383             |       | 369                   |       |
| Other investments                                                                                                |       | 59,486            |       | 51,336                |       |
| Total financial   instruments owned, at fair value:                                                              |       | 345,366           |       | 303,148               |       |
| Receivables from   clearing brokers                                                                              |       | 77,899            |       | 138,212               |       |
| Accounts   receivable                                                                                            |       | 14,306            |       | 26,691                |       |
| Fixed assets, at   cost, less accumulated depreciation and amortization of $33,480 in 2011 and   $30,663 in 2010 |       | 16,748            |       | 17,383                |       |
| Other assets                                                                                                     |       | 57,290            |       | 51,951                |       |
| **Total   assets**                                                                                               |       | $                 | 625,843    |                  | $          | 699,657 |   |
|                                                                                                             |       |              |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                    |       |              |       |                  |       |
| **Liabilities:**                                                                                                 |       |              |       |                  |       |
| Financial   instruments sold, not yet purchased, at fair value:                                                  |       |              |       |                  |       |
| Equities                                                                                                         |       | $                 | 118,816    |                  | $          | 75,470 |   |
| Corporate debt                                                                                                   |       | 19,632            |       | 5,414                 |       |
| U.S. Government   and agency securities                                                                          |       | 14,144            |       | 12,957                |       |
| Total financial   instruments sold, not yet purchased, at fair value:                                            |       | 152,592           |       | 93,841                |       |
| Accrued   compensation and benefits                                                                              |       | 11,151            |       | 116,589               |       |
| Income taxes   payable                                                                                           |       | 7,610             |       | 9,161                 |       |
| Accounts payable,   accrued expenses and other liabilities                                                       |       | 20,437            |       | 21,949                |       |
| **Total   liabilities**                                                                                          |       | 191,790           |       | 241,540               |       |
|                                                                                                             |       |              |       |                  |       |
| **Stockholders’   equity:**                                                                                 |       |              |       |                  |       |
| Preferred stock                                                                                                  |       | —            |       | —                |       |
| Common stock                                                                                                     |       | 310               |       | 317                   |       |
| Paid-in capital                                                                                                  |       | 162,162           |       | 183,975               |       |
| Retained earnings                                                                                                |       | 282,394           |       | 285,677               |       |
| Notes receivable   from stockholders                                                                             |       | —            |       | (100                  | )          |
| Accumulated other   comprehensive loss                                                                           |       | (10,813           | )          | (11,752               | )          |
| **Total   stockholders’ equity**                                                                            |       | 434,053           |       | 458,117               |       |
| **Total   liabilities and stockholders’ equity**                                                            |       | $                 | 625,843    |                  | $          | 699,657 |   |

 

See accompanying notes to consolidated financial statements.

 

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**KBW, INC. and SUBSIDIARIES**

**Consolidated Statements of Operations**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 
| ** **                                                  | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                  | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                  | ** ** | **2011**                         | ** ** | **2010**                       | ** ** | **2011** | ** ** | **2010** | ** ** |
| **Revenues:**                                               | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Investment banking                                          |       | $                                | 15,204     |                           | $          | 61,173 |   | $ | 52,852 |   | $ | 131,135 |   |
| Commissions                                                 |       | 32,190                           |       | 36,098                         |       | 66,619 |   | 71,502 |   |
| Principal   transactions, net                               |       | 11,952                           |       | 3,262                          |       | 29,292 |   | 22,309 |   |
| Interest and   dividend income                              |       | 3,151                            |       | 3,670                          |       | 6,355 |   | 6,554 |   |
| Investment   advisory fees                                  |       | 301                              |       | 497                            |       | 585 |   | 791 |   |
| Other                                                       |       | 1,234                            |       | 1,106                          |       | 3,512 |   | 6,825 |   |
| **Total   revenues**                                        |       | 64,032                           |       | 105,806                        |       | 159,215 |   | 239,116 |   |
| ** **                                                  |       |                             |       |                           |       |   |   |   |   |
| **Expenses:**                                               |       |                             |       |                           |       |   |   |   |   |
| Compensation and   benefits                                 |       | 38,895                           |       | 65,059                         |       | 95,529 |   | 146,937 |   |
| Occupancy and   equipment                                   |       | 5,629                            |       | 5,503                          |       | 11,288 |   | 11,115 |   |
| Communications and   data processing                        |       | 9,088                            |       | 8,159                          |       | 17,783 |   | 15,815 |   |
| Brokerage and   clearance                                   |       | 4,580                            |       | 3,780                          |       | 9,496 |   | 8,866 |   |
| Business   development                                      |       | 4,637                            |       | 3,801                          |       | 9,261 |   | 7,261 |   |
| Professional   services                                     |       | 4,636                            |       | 2,152                          |       | 8,338 |   | 9,213 |   |
| Interest                                                    |       | 356                              |       | 267                            |       | 665 |   | 525 |   |
| Other                                                       |       | 3,093                            |       | 2,225                          |       | 5,945 |   | 4,214 |   |
| **Total   expenses**                                        |       | 70,914                           |       | 90,946                         |       | 158,305 |   | 203,946 |   |
| **(Loss)   / income before income taxes**                   |       | (6,882                           | )          | 14,860                         |       | 910 |   | 35,170 |   |
| **Income   tax (benefit) / expense**                        |       | (2,634                           | )          | 6,704                          |       | 517 |   | 15,393 |   |
| **Net   (loss) / income**                                   |       | $                                | (4,248     | )                              | $          | 8,156 |   | $ | 393 |   | 19,777 |   |
|                                                        |       |                             |       |                           |       |   |   |   |   |
| **Earnings   per common share:**                            |       |                             |       |                           |       |   |   |   |   |
| Basic                                                       |       | $                                | (0.14      | )                              | $          | 0.22 |   | $ | — |   | $ | 0.54 |   |
| Diluted                                                     |       | $                                | (0.14      | )                              | $          | 0.22 |   | $ | — |   | $ | 0.54 |   |
|                                                        |       |                             |       |                           |       |   |   |   |   |
| **Dividends   declared per common share**                   |       | $                                | 0.05       |                           | $          | — |   | $ | 0.10 |   | $ | — |   |
|                                                        |       |                             |       |                           |       |   |   |   |   |
| **Weighted   average number of common shares outstanding:** |       |                             |       |                           |       |   |   |   |   |
| Basic                                                       |       | 32,579,146                       |       | 32,481,478                     |       | 32,849,263 |   | 32,361,823 |   |
| Diluted                                                     |       | 32,579,146                       |       | 32,481,478                     |       | 32,849,263 |   | 32,361,823 |   |

 

See accompanying notes to consolidated financial statements.

 

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**KBW, INC. and SUBSIDIARIES**

**Consolidated Statement of Changes in Stockholders’ Equity and Comprehensive Income**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 
| ** **                                                                                             | ** ** | ** **    | ** ** | ** ** | ** ** | ** **  | ** ** | ** **   | ** ** | **Notes**        | ** ** | **Accumulated**               | ** ** | ** **             | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|---------------|------------|------------|------------|-------------|------------|--------------|------------|------------------|------------|-------------------------------|------------|------------------------|------------|
| ** **                                                                                             | ** ** | ** **    | ** ** | ** ** | ** ** | ** **  | ** ** | ** **   | ** ** | **Receivable**   | ** ** | **Other**                     | ** ** | **Total**              | ** ** |
| ** **                                                                                             | ** ** | **Preferred** | ** ** | **Common** | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | **from**         | ** ** | **Comprehensive**             | ** ** | **Stockholders’** | ** ** |
| ** **                                                                                             | ** ** | **Stock**     | ** ** | **Stock**  | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Stockholders** | ** ** | **(Loss) / Income** | ** ** | **Equity**             | ** ** |
| **Balance   at December 31, 2010**                                                                     |       | $             | —     |       | $          | 317         |       | $            | 183,975    |             | $          | 285,677                       |       | $                      | (100       | ) | $ | (11,752 | ) | $ | 458,117 |   |
| Net income                                                                                             |       | —        |       | —     |       | —      |       | 393          |       | —           |       | —                        |       | 393                    |       |
| Other   comprehensive income, currency translation adjustment                                          |       | —        |       | —     |       | —      |       | —       |       | —           |       | 939                           |       | 939                    |       |
| Total   comprehensive income                                                                           |       |          |       |       |       |        |       |         |       |             |       |                          |       | 1,332                  |       |
| Dividends on   common stock                                                                            |       | —        |       | —     |       | —      |       | (3,676       | )          | —           |       | —                        |       | (3,676                 | )          |
| Amortization of   stock-based compensation                                                             |       | —        |       | —     |       | 29,475      |       | —       |       | —           |       | —                        |       | 29,475                 |       |
| Cancellation of   667,898 shares of restricted stock in satisfaction of withholding tax   requirements |       | —        |       | (7         | )          | (18,099     | )          | —       |       | —           |       | —                        |       | (18,106                | )          |
| Cancellation of   1,644,922 shares of common stock related to the stock repurchase program             |       | —        |       | (16        | )          | (36,781     | )          | —       |       | —           |       | —                        |       | (36,797                | )          |
| Issuance of 1,580,913   shares of common stock                                                         |       | —        |       | 16         |       | 35,093      |       | —       |       | —           |       | —                        |       | 35,109                 |       |
| Restricted stock   units converted                                                                     |       | —        |       | —     |       | (720        | )          | —       |       | —           |       | —                        |       | (720                   | )          |
| Stock-based awards   vested                                                                            |       | —        |       | —     |       | (34,287     | )          | —       |       | —           |       | —                        |       | (34,287                | )          |
| Excess net tax   benefit related to stock-based awards                                                 |       | —        |       | —     |       | 3,506       |       | —       |       | —           |       | —                        |       | 3,506                  |       |
| Repayment of notes   receivable from stockholders                                                      |       | —        |       | —     |       | —      |       | —       |       | 100              |       | —                        |       | 100                    |       |
| **Balance   at June 30, 2011**                                                                         |       | $             | —     |       | $          | 310         |       | $            | 162,162    |             | $          | 282,394                       |       | $                      | —     |   | $ | (10,813 | ) | $ | 434,053 |   |

 

Description of preferred stock and details:

 
| ** **        | ** ** | ** **         | ** ** | **Number of Shares** | ** ** |
|-------------------|------------|--------------------|------------|--------------------------------|------------|
| ** **        | ** ** | **Par Value** | ** ** | **Authorized**                 | ** ** | **Issued** | ** ** | **Outstanding** | ** ** |
| June 30, 2011     |       | $                  | 0.01       |                           | 10,000,000 |   | — |   | — |   |
| December 31, 2010 |       | $                  | 0.01       |                           | 10,000,000 |   | — |   | — |   |

 

Description of common stock and details:

 
| ** **        | ** ** | ** **         | ** ** | **Number of Shares** | ** **  |
|-------------------|------------|--------------------|------------|--------------------------------|-------------|
| ** **        | ** ** | **Par Value** | ** ** | **Authorized**                 | ** **  | **Issued*** | ** ** | **Outstanding*** | ** ** |
| June 30, 2011     |       | $                  | 0.01       |                           | 140,000,000 |   | 30,970,075 |   | 30,970,075 |   |
| December 31, 2010 |       | $                  | 0.01       |                           | 140,000,000 |   | 31,701,982 |   | 31,701,982 |   |

 

----

(*) These share amounts exclude vested restricted stock units.

 

See accompanying notes to consolidated financial statements.

 

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**KBW, INC. and SUBSIDIARIES**

**Consolidated Statements of Cash Flows**

**(unaudited)**

**(Dollars in thousands)**

 
| ** **                                                                                            | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                            | ** ** | **2011**                                          | ** ** | **2010** | ** ** |
|                                                                                                  |       |                                              |       |   |   |
| **Cash   flows from operating activities:**                                                           |       |                                              |       |   |   |
| Net income                                                                                            |       | $                                                 | 393        |   | $ | 19,777 |   |
| **Adjustments   to reconcile net income to net cash provided by / (used in) operating   activities:** |       |                                              |       |   |   |
| Amortization of   stock-based compensation                                                            |       | 29,475                                            |       | 24,078 |   |
| Depreciation and   amortization                                                                       |       | 2,801                                             |       | 2,512 |   |
| Deferred income   tax expense / (benefit)                                                             |       | 1,396                                             |       | (391 | ) |
| **(Increase)   decrease in operating assets:**                                                        |       |                                              |       |   |   |
| Financial   instruments owned, at fair value                                                          |       | (41,905                                           | )          | (99,361 | ) |
| Receivables from   clearing brokers                                                                   |       | 60,351                                            |       | 31,534 |   |
| Accounts   receivable                                                                                 |       | 12,570                                            |       | 10,885 |   |
| Other assets                                                                                          |       | (6,650                                            | )          | (4,384 | ) |
| **Increase   (decrease) in operating liabilities:**                                                   |       |                                              |       |   |   |
| Financial   instruments sold, not yet purchased, at fair value                                        |       | 58,711                                            |       | 23,268 |   |
| Accrued   compensation and benefits                                                                   |       | (105,893                                          | )          | (41,069 | ) |
| Accounts payable,   accrued expenses and other liabilities                                            |       | (1,473                                            | )          | 12,948 |   |
| Income taxes   payable                                                                                |       | (1,547                                            | )          | 7,987 |   |
| **Net   cash provided by / (used in) operating activities**                                           |       | 8,229                                             |       | (12,216 | ) |
| **Cash   flows from investing activities:**                                                           |       |                                              |       |   |   |
| Purchase of   furniture, equipment and leasehold improvements                                         |       | (2,177                                            | )          | (1,998 | ) |
| **Net   cash used in investing activities**                                                           |       | (2,177                                            | )          | (1,998 | ) |
| **Cash   flows from financing activities:**                                                           |       |                                              |       |   |   |
| Cash dividends   paid                                                                                 |       | (3,676                                            | )          | — |   |
| Issuance of shares   of common stock                                                                  |       | 102                                               |       | 109 |   |
| Cancellation of   restricted stock in satisfaction of withholding tax requirements                    |       | (18,106                                           | )          | (11,861 | ) |
| Cancellation of   shares of common stock related to the stock repurchase program                      |       | (36,797                                           | )          | — |   |
| Excess net tax   benefit related to stock-based awards                                                |       | 3,506                                             |       | 1,585 |   |
| Repayment of notes   receivable from stockholders                                                     |       | 100                                               |       | 509 |   |
| **Net   cash used in financing activities**                                                           |       | (54,871                                           | )          | (9,658 | ) |
| **Currency   adjustment:**                                                                            |       |                                              |       |   |   |
| Effect of exchange   rate changes on cash                                                             |       | 781                                               |       | (2,053 | ) |
| **Net   decrease in cash and cash equivalents**                                                       |       | (48,038                                           | )          | (25,925 | ) |
| **Cash   and cash equivalents at the beginning of the period**                                        |       | 162,272                                           |       | 203,180 |   |
| **Cash   and cash equivalents at the end of the period**                                              |       | $                                                 | 114,234    |   | $ | 177,255 |   |
|                                                                                                  |       |                                              |       |   |   |
| **Supplemental   disclosures of cash flow information:**                                              |       |                                              |       |   |   |
| Cash paid during   the period for:                                                                    |       |                                              |       |   |   |
| Income taxes                                                                                          |       | $                                                 | 1,959      |   | $ | 8,427 |   |
| Interest                                                                                              |       | $                                                 | 712        |   | $ | 434 |   |

 

See accompanying notes to consolidated financial statements.

 

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**KBW, INC. and SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 

**(1)****                         ****Organization and Basis of Presentation**

 

The consolidated financial statements include the accounts of KBW, Inc., and its wholly owned subsidiaries (the “Company”), Keefe, Bruyette & Woods, Inc. (“Keefe”), Keefe, Bruyette & Woods Limited (“KBWL”), Keefe, Bruyette & Woods Asia Limited (“KBWAL”), KBW Asset Management, Inc. and KBW Ventures, Inc. Keefe is a regulatory member of the Financial Industry Regulatory Authority (“FINRA”) and is principally a broker-dealer in securities and a market-maker in certain financial services stocks and bonds in the United States. KBWL is authorized and regulated by the U.K. Financial Services Authority (“FSA”) and a member of the London Stock Exchange, Euronext, SIX Swiss Exchange and Deutsche Boerse.  KBWAL is a securities firm licensed and regulated by the Securities and Futures Commission in Hong Kong.   Keefe’s, KBWL’s and KBWAL’s customers are predominantly institutional investors including other brokers and dealers, commercial banks, asset managers and other financial institutions. Keefe has a clearing arrangement with Pershing LLC on a fully disclosed basis. KBWL has a clearing arrangement with Pershing Securities Limited on a fully disclosed basis and is responsible for clearance and settlement for both KBWL and KBWAL.

 

**(2)****                         ****Summary of Significant Accounting Policies**

 

***(a)******              ******Principles of Consolidation***

 

The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and include the accounts of the Company and its consolidated subsidiaries. All intercompany transactions and balances have been eliminated.

 

The Company consolidates entities for which it has a controlling financial interest as defined in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, *Consolidation*.  The usual condition for a controlling financial interest is ownership of a majority voting interest.  As a result, the Company generally consolidates entities when they have ownership, directly or indirectly, of over 50 percent of the outstanding voting shares of another entity.  Since a controlling financial interest may be achieved through arrangements that do not involve voting interest, the Company also evaluates entities for consolidation under the “variable interest model” in accordance with ASC 810.  The Company consolidates variable interest entities when it has determined to hold the power that most significantly impacts the entity’s economic performance or a right to absorb a majority of the entity’s expected losses, or expected residual returns, or both.  The Company had no variable interest entities that required consolidation at June 30, 2011 and December 31, 2010.

 

In addition, the Company evaluates its investments in limited partnerships under ASC 810.  Under ASC 810, the general partners in limited partnerships are presumed to have control unless the limited partners have either a substantial ability to dissolve the limited partnership or otherwise can remove the general partner without cause or have substantial participating rights.  There were no limited partnership interests that required consolidation at June 30, 2011 and December 31, 2010.

 

***(b)******              ******Use of Estimates***

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the Company’s financial statements and these footnotes including securities valuations, compensation accruals and other matters. Management believes that the estimates used in preparing the Company’s consolidated financial statements are reasonable. Actual results may differ from these estimates.

 

***(c)******               ******Cash and Cash Equivalents***

 

 Cash equivalents include investments with an original maturity of three months or less. Due to the short-term nature of these instruments, carrying value approximates their fair value.

 

6

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Table of Contents

 

**KBW, INC. and SUBSIDIARIES**

**Notes to Consolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 

***(d)******              ******Fair Value of Financial Instruments***

 

The Company accounts for financial instruments that are being measured and reported on a fair value basis in accordance with ASC 820, *Fair Value Measurements and Disclosures*.  ASC 820 defines fair value, establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements.  ASC 820 defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an ordinary transaction between current market participants at the measurement date.”

 

Fair value is generally based on quoted market prices. If quoted market prices are not available, fair value is determined based on other relevant factors, including dealer price quotations, price activity for equivalent instruments and valuation pricing methods. Among the factors considered by the Company in determining the fair value of financial instruments for which there are no current quoted market prices are credit spreads, the terms and liquidity of the instrument, the financial condition, operating results and credit ratings of the issuer or underlying company, the quoted market price of publicly traded securities with similar duration and yield, assessing the underlying investments, market-based information, such as comparable company transactions, performance multiples and changes in market outlook as well as other measurements.  Financial instruments owned and financial instruments sold, not yet purchased are stated at fair value, with related changes in unrealized appreciation or depreciation reflected in principal transactions, net in the accompanying consolidated statements of operations. Financial assets and financial liabilities carried at contract amounts may include receivables from clearing brokers, securities purchased under resale agreements, short-term borrowings and securities sold under repurchase agreements. See Note 3 of the Notes to Consolidated Financial Statements for additional discussion of ASC 820.

 

ASC 825, *Financial Instruments*, provides entities the option to measure certain financial assets and financial liabilities at fair value with changes in fair value recognized in earnings each period.  ASC 825 permits the fair value option election, on an instrument-by-instrument basis, either at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument.  Such election must be applied to the entire instrument and not only a portion of the instrument.  The Company applied the fair value option for certain eligible instruments, including all private equity securities and limited partnership interests, as these financial instruments had been accounted for at fair value by the Company prior to the fair value option election in accordance with ASC 940*, Financial Services — Broker and Dealers.*Generally, the fair values of these financial instruments have been determined based on company performance and, in those instances where market values are readily ascertainable, by reference to recent significant events occurring in the marketplace or quoted market prices.  ASC 820 permits, as a practical expedient, the use of the net asset value per share, or its equivalent, of an entity to estimate its fair value. The Company’s partnership interests are recorded at fair value, determined by using net asset values or capital statements provided by the general partner, updated for capital contributions and distributions, and changes in market conditions up to the reporting date.

 

***(e)******               ******Receivables From and Payable To Clearing Brokers***

 

Receivables from and payable to clearing brokers include the net proceeds from securities sold, including financial instruments sold not yet purchased, commissions related to securities transactions, margin loans and related interest and deposits with clearing brokers. Proceeds related to financial instruments sold, not yet purchased may be restricted until the securities are purchased.  Balances are presented net when the right of set-off exists.

 

***(f)******                 ******Fixed Assets***

 

Furniture and other equipment, computer equipment and software are carried at cost and depreciated on a straight-line basis using estimated useful lives of the related assets, generally two to five years. Leasehold improvements are amortized on a straight-line basis over the lesser of the economic useful life of the improvement or the term of the respective leases.

 

***(g)******              ******Revenue Recognition***

 

*Investment Banking*

 

The Company earns fees for providing strategic advisory services in mergers and acquisitions (“M&A”) and other transactions which are predominantly composed of fees based on a successful completion of a transaction, and from capital markets, which is comprised of underwriting securities’ offerings and arranging private placements, including securitized debt offerings.

 

7

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Table of Contents

 

**KBW, INC. and SUBSIDIARIES**

**Notes to Consolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 

Strategic advisory revenues are recorded when earned, the fees are determinable and collection is reasonably assured. Non-refundable upfront fees are generally deferred and recognized as revenue ratably over the expected period in which the related services are rendered.  Upon successful completion of a transaction or termination of an engagement, the recognition of revenue would be accelerated.

 

Capital markets revenue consists of:

 

·        Underwriting revenues, which are recognized on trade date, net of related syndicate expenses, at the time the underwriting is completed. In syndicated underwritten transactions, management estimates the Company’s share of transaction-related expenses incurred by the syndicate, and the Company recognizes revenue net of such expense. On final settlement, the Company adjusts these amounts to reflect the actual transaction-related expenses and resulting underwriting fee.

 

·        Private placement revenues, which are recorded when the services related to the underlying transaction are completed under the terms of the engagement.  This is generally the closing date of the transaction.

 

Since the Company’s investment banking revenues are generally recognized at the time of completion of each transaction or when the services are performed, these revenues typically vary between periods and may be considerably affected by the timing of the closing of significant transactions.

 

*Commissions*

 

The Company’s sales and trading business generates revenue from equity securities’ trading commissions paid by institutional investor customers.  Commissions are recognized on a trade date basis.

 

*Principal transactions*

 

Financial instruments owned, at fair value and financial instruments sold, not yet purchased, at fair value are recorded on a trade-date basis with realized and unrealized gains and losses reflected in principal transactions, net in the consolidated statements of operations.

 

*Interest and dividend income*

 

The Company recognizes contractual interest on financial instruments owned at fair value on an accrual basis as a component of interest and dividend income.** **Dividend income is recognized on the ex-dividend date.

 

*Investment advisory fees*

 

The Company recognizes management fees from managed funds over the period that the related service is provided based upon a percentage of account balances, capital invested, capital commitments or some combination thereof.  The Company also may be entitled to receive incentive fees based on a percentage of a fund’s return or when the return on assets under management exceeds certain performance targets. Some incentive fees are based on investment performance over a 12-month period and are subject to adjustment prior to the end of the measurement period. Accordingly, these incentive fees are recognized in the consolidated statements of operations when the measurement period ends.

 

***(h)     Stock-Based Compensation***

 

Stock-based compensation is measured at fair value on the date of grant and amortized to compensation expense over the requisite service period, net of estimated forfeitures. Compensation expense for awards with performance conditions is recognized over the requisite service period based on the probable outcome of the performance condition at each reporting date.  At the end of the performance period, the total compensation cost recognized will be the grant-date fair value of all units that actually vest based on the outcome of the performance conditions.  Stock-based awards that do not require future service (i.e. vested awards and certain awards granted to retirement eligible employees) are expensed immediately on the date of grant.  Withholding tax obligations may be satisfied 

 

8

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Table of Contents

 

**KBW, INC. and SUBSIDIARIES**

**Notes to Consolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 

by the repurchase of shares by the Company.  Such shares are cancelled upon repurchase.

 

***(i)      Income Taxes***

 

Deferred tax assets and liabilities are recognized for the future tax effect of differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period that includes the enactment date.  In the event it is more likely than not that a deferred tax asset will not be realized, a valuation allowance is recorded.

 

The Company applies ASC 740, *Income Taxes*, which prescribes a single, comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on its tax returns.  Income tax expense is based on pre-tax accounting income, including adjustments made for the recognition or derecognition related to uncertain tax positions**.**

 

***(j)******                 ******Earnings Per Common Share (“EPS”)***

 

Basic EPS is computed by dividing net income applicable to common shareholders, which represents net income reduced by the allocation of earnings to participating securities, by the weighted average number of common shares.  Losses are not allocated to participating securities.  The weighted average number of common shares outstanding includes restricted stock units for which no future service is required as a condition to the delivery of the underlying common stock.  Diluted EPS includes the determinants of basic EPS and, in addition, gives effect to potentially dilutive common shares related to Company stock compensation plans.

 

ASC 260, *Earnings Per Share*, addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and therefore need to be included in the earnings allocation in calculating EPS under the two-class method. Accordingly, the Company treats unvested share-based payment awards that have non-forfeitable rights to dividend or dividend equivalents as a separate class of securities in calculating EPS.

 

The Company has granted performance equity awards (“Performance Awards”) that vest and convert to shares of common stock only if the Company achieves predetermined performance goals.  Since the issuance of the shares is contingent upon the satisfaction of certain conditions, the Performance Awards are included in diluted EPS based on the number of shares (if any) that would be issuable if the end of the reporting period were the end of the contingency period.

 

***(k)******              ******Foreign Currency Translation***

 

The Company translates the statements of financial condition of the Company’s foreign subsidiaries at the exchange rates in effect as of the end of each reporting period.  The consolidated statements of operations are translated at the average rates of exchange during the period. The resulting translation adjustments of the Company’s foreign subsidiaries are recorded directly to accumulated other comprehensive income (loss) in the consolidated statements of changes in stockholders’ equity and comprehensive income.  Gains or losses resulting from foreign currency transactions are included in net income.

 

***(l)******                 ******Reclassifications***

 

Certain amounts from prior periods have been reclassified to conform to the current period presentation.

 

**(3)****                         ****Financial Instruments**

 

The Company accounts for financial instruments that are being measured and reported on a fair value basis in accordance with ASC 820.  This includes those items currently reported in financial instruments owned, at fair value and financial instruments sold, not yet purchased, at fair value on the consolidated statements of financial condition.

 

As defined in ASC 820, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various methods, primarily market and income approaches. Based on these approaches, the Company utilizes assumptions that market 

 

9

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Table of Contents

 

**KBW, INC. and SUBSIDIARIES**

**Notes to Consolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 

participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable firm inputs. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques, the Company is required to provide the information set forth below according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values.   Financial instrument assets and liabilities carried at fair value have been classified and disclosed in one of the following three categories:

 
| Level 1 |   | Quoted market prices in active markets for   identical assets or liabilities.                 |
|---------|--------|-----------------------------------------------------------------------------------------------|
| Level 2 |   | Observable market based inputs or   unobservable inputs that are corroborated by market data. |
| Level 3 |   | Unobservable inputs that are not   corroborated by market data.                               |

 

Level 1 primarily consists of listed financial instruments whose value is based on quoted market prices, such as listed equities, equity options and warrants, and preferred stock.  This category also may include U.S. Government and agency securities for which the Company typically receives independent external valuation information.  There were no transfers in or out of Level 1 during the three and six months ended June 30, 2011.

 

Level 2 includes those financial instruments that are valued using multiple valuation techniques, primarily the market and income approaches.   The valuation methodologies utilized are calibrated to observable market inputs.  The Company considers recently executed transactions, market price quotations and various assumptions, including credit spreads, the terms and liquidity of the instrument, the financial condition, operating results and credit ratings of the issuer or underlying company, the quoted market price of publicly traded securities with similar duration and yield, time value, yield curve, as well as other measurements. In order to be classified as Level 2, substantially all of these assumptions would need to be observable in the marketplace or can be derived from observable data or supported by observable levels at which transactions are executed in the marketplace. Financial instruments in this category include certain corporate debt, collateralized debt obligations (“CDOs”) primarily collateralized by company trust preferred and capital securities, certain convertible preferred stock, convertible debt, residential and commercial mortgage-backed securities and asset-backed securities.  There were no transfers in or out of Level 2 during the three and six months ended June 30, 2011.

 

Fair value of corporate debt, certain convertible preferred stock, convertible debt, residential and commercial mortgage-backed securities and asset-backed securities classified as Level 2 was determined by using quoted market prices, broker or dealer quotes, or alternate pricing sources with reasonable levels of price transparency.  Fair value of CDOs primarily collateralized by banking and insurance company trust preferred and capital securities was determined primarily by considering recently executed transactions of similar securities and certain assumptions, including the financial condition, operating results and credit ratings of the issuer or underlying companies.

 

Level 3 is comprised of financial instruments whose fair value is estimated based on multiple valuation techniques, primarily market and income approaches. The valuation methodologies utilized may include significant inputs that are unobservable from objective sources. The Company considers various market inputs and assumptions, such as recently executed transactions, market price quotations, discount margins, market spreads applied, the terms and liquidity of the instrument, the financial condition, operating results and credit ratings of the issuer or underlying company, the quoted market price of publicly traded securities with similar duration and yield, time value, yield curve, default rates, as well as other measurements.  Included in this category are certain corporate and other debt, including banking and insurance company trust preferred, private equity securities and other investments including limited and general partnership interests.

 

Fair value of banking and insurance company trust preferred and capital securities classified as Level 3 was determined by primarily utilizing a market spread method for each of the individual trust preferred and capital securities utilizing credit spreads for secondary market trades for trust preferred and capital securities for issues which were substantially similar to such positions based on certain assumptions. The key market inputs in this method are the discount margins, market spreads applied, the yield expectations for similar instruments and the financial condition, operating results and credit ratings of the issuer or underlying company.

 

Fair value of private equity securities classified as Level 3 was determined by assessing market-based information, such as performance multiples, comparable company transactions and changes in market outlook. Fair value of limited and general partnership interests classified as Level 3 was determined by using net asset values or capital statements provided by the general partner, updated

 

10

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Table of Contents

 

**KBW, INC. and SUBSIDIARIES**

**Notes to Consolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 

for capital contributions and distributions and changes in market conditions up to the reporting date.  Private equity securities and limited and general partnership interests generally trade infrequently.

 

The following table provides information related to financial instruments where a practical expedient was used as the basis to measure the fair value of certain entities that calculate a net asset value per share (or equivalent):

 
| ** **                       | ** ** | **As of June 30, 2011** | ** ** | **As of December 31, 2010** | ** ** | ** **          | ** ** | ** **                 | ** ** |
|----------------------------------|------------|---------------------------------------------|------------|-------------------------------------------------|------------|---------------------|------------|----------------------------|------------|
| **Type of Investment** | ** ** | **Fair Value**                         | ** ** | **Unfunded   Commitments**                      | ** ** | **Fair Value** | ** ** | **Unfunded   Commitments** | ** ** | **Redemption   Frequency** | ** ** | **Notice   Period** | ** ** |
| Long/short hedge funds (a)       |       | $                                           | 21,567     |                                            | $          | —              |       | $                          | 14,197     |   | $ | — |   | Monthly |   | 30Days |   |
| Public/private equity funds (b)  |       | 37,919                                      |       | 14,291                                          |       | 37,139              |       | 15,975                     |       | n/a |   | n/a |   |
|                             |       | $                                           | 59,486     |                                            | $          | 14,291              |       | $                          | 51,336     |   | $ | 15,975 |   |   |   |   |   |

 

----

(a)          This category includes investments in hedge funds that invest primarily in domestic long/short positions in equity securities and various derivatives, including options on securities and stock index options with respect to companies in the financial services sector. Management of these funds also has the ability to invest in foreign equities and fixed income securities. The fair values of investments in this category have been estimated using the net asset value per share, or equivalent, of the investments.  Investments in this category can be redeemed monthly; however, the general partner may impose a “gate” for any withdrawal over 20% of the total fund net asset value.

 

(b)         This category includes several funds that invest primarily in domestic public and private companies operating in the financial services sector. Management of these funds also have the ability to invest in foreign public and private equities, debt financial instruments, warrants, hybrid securities and membership interests in the financial services sector. The fair values of investments in this category have been estimated using asset values based on capital statements provided by the general partner, updated, as necessary, for capital contributions and distributions and changes in market conditions up to the reporting date. These investments generally cannot be redeemed, unless approved by the general partners.  Upon liquidation of the underlying investments prior to the life expectancy / maturity of the funds, management of the funds can elect to make distributions to the limited partners. The time horizon for such distributions is at the discretion of the general partners but should not exceed the time horizon of the fund’s life expectancy. It is estimated that these investments would be liquidated approximately ten years following the initial investment date, some with options to extend for up to a two year period, ranging from 2010 — 2020.  Additional expenses, such as legal and administrative associated with the final liquidation can be incurred. Therefore, it is possible that upon final liquidation of the investments, the final funds distributed could be different from the estimated value of the investment.  However, these differences are not expected to be material.

 

In determining the appropriate levels, the Company performed a detailed analysis of the assets and liabilities that are subject to ASC 820. At each reporting period, all assets and liabilities for which the fair value measurement is based on significant unobservable inputs are classified as Level 3.

 

11

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Table of Contents

 

**KBW, INC. and SUBSIDIARIES**

**Notes to Consolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 

**Assets at Fair Value as of June 30, 2011**

 
| ** **                                        | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|---------------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|-----------|------------|
| **Financial instruments owned, at   fair value:** |       |             |       |             |       |             |       |      |       |
| Equities                                          |       | $                | 186,653    |             | $          | 18               |       | $         | 17,953     |   | $ | 204,624 |   |
| Corporate and other debt:                         |       |             |       |             |       |             |       |      |       |
| Corporate debt                                    |       | 587              |       | 39,443           |       | —           |       | 40,030    |       |
| CDOs                                              |       | —           |       | 5,388            |       | —           |       | 5,388     |       |
| Other debt obligations(1)                    |       | —           |       | —           |       | 5,946            |       | 5,946     |       |
| Total corporate and other debt                    |       | 587              |       | 44,831           |       | 5,946            |       | 51,364    |       |
| Mortgage and other asset-backed securities:       |       |             |       |             |       |             |       |      |       |
| Agency residential mortgage-backed securities     |       | —           |       | 16,766           |       | —           |       | 16,766    |       |
| Commercial mortgage-backed securities             |       | —           |       | 7,023            |       | —           |       | 7,023     |       |
| Asset-backed securities                           |       | —           |       | 276              |       | —           |       | 276       |       |
| Total mortgage and other asset-backed securities  |       | —           |       | 24,065           |       | —           |       | 24,065    |       |
| U.S. Government and agency securities             |       | 2,383            |       | —           |       | —           |       | 2,383     |       |
| Other investments(2)                         |       | —           |       | —           |       | 59,486           |       | 59,486    |       |
| Total non-derivative trading assets               |       | 189,623          |       | 68,914           |       | 83,385           |       | 341,922   |       |
| Equity options/warrants                           |       | 3,444            |       | —           |       | —           |       | 3,444     |       |
| **Total financial instruments owned**             |       | $                | 193,067    |             | $          | 68,914           |       | $         | 83,385     |   | $ | 345,366 |   |

 

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(1) Consists of bank and insurance company trust preferred and capital securities.

(2) Consists of limited and general partnership interests.

 

**Liabilities at Fair Value as of June 30, 2011**

 
| ** **                                                          | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total**  | ** ** |
|---------------------------------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|------------|------------|
| **Financial instruments sold, not   yet purchased, at fair value:** |       |             |       |             |       |             | ** ** | ** ** | ** ** |
| Equities                                                            |       | $                | 118,503    |             | $          | —           |       | $          | —     |   | $ | 118,503 |   |
| Corporate debt                                                      |       | —           |       | 19,632           |       | —           |       | 19,632     |       |
| U.S. Government and agency securities                               |       | 14,144           |       | —           |       | —           |       | 14,144     |       |
| Total non-derivative trading liabilities                            |       | 132,647          |       | 19,632           |       | —           |       | 152,279    |       |
| Equity options/warrants                                             |       | 313              |       | —           |       | —           |       | 313        |       |
| **Total financial instruments sold,   not yet purchased**           |       | $                | 132,960    |             | $          | 19,632           |       | $          | —     |   | $ | 152,592 |   |

 

12

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Table of Contents

 

**KBW, INC. and SUBSIDIARIES**

**Notes to Consolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 

**Assets at Fair Value as of December 31, 2010**

 
| ** **                                        | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|---------------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|-----------|------------|
| **Financial instruments owned, at   fair value:** |       |             |       |             |       |             |       |      |       |
| Equities                                          |       | $                | 95,821     |             | $          | 18               |       | $         | 16,654     |   | $ | 112,493 |   |
| Corporate and other debt:                         |       |             |       |             |       |             |       |      |       |
| Corporate debt                                    |       | 2,236            |       | 74,246           |       | —           |       | 76,482    |       |
| CDOs                                              |       | —           |       | 5,310            |       | 1                |       | 5,311     |       |
| Other debt obligations(1)                    |       | —           |       | —           |       | 11,806           |       | 11,806    |       |
| Total corporate and other debt                    |       | 2,236            |       | 79,556           |       | 11,807           |       | 93,599    |       |
| Mortgage and other asset-backed securities:       |       |             |       |             |       |             |       |      |       |
| Agency residential mortgage-backed securities     |       | —           |       | 40,160           |       | —           |       | 40,160    |       |
| Non-agency residential mortgage-backed securities |       | —           |       | 3,072            |       | —           |       | 3,072     |       |
| Total mortgage and other asset-backed securities  |       | —           |       | 43,232           |       | —           |       | 43,232    |       |
| U.S. Government and agency securities             |       | 369              |       | —           |       | —           |       | 369       |       |
| Other investments(2)                         |       | —           |       | —           |       | 51,336           |       | 51,336    |       |
| Total non-derivative trading assets               |       | 98,426           |       | 122,806          |       | 79,797           |       | 301,029   |       |
| Equity options/warrants                           |       | 2,119            |       | —           |       | —           |       | 2,119     |       |
| **Total financial instruments owned**             |       | $                | 100,545    |             | $          | 122,806          |       | $         | 79,797     |   | $ | 303,148 |   |

 

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(1) Consists of bank and insurance company trust preferred and capital securities.

(2) Consists of limited and general partnership interests.

 

**Liabilities at Fair Value as of December 31, 2010**

 
| ** **                                                          | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total**  | ** ** |
|---------------------------------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|------------|------------|
| **Financial instruments sold, not   yet purchased, at fair value:** |       |             |       |             |       |             | ** ** | ** ** | ** ** |
| Equities                                                       |       | $                | 74,584     |             | $          | —           |       | $          | —     |   | $ | 74,584 |   |
| Corporate debt                                                      |       | —           |       | 5,414            |       | —           |       | 5,414      |       |
| U.S. Government and agency securities                               |       | 12,957           |       | —           |       | —           |       | 12,957     |       |
| Total non-derivative trading liabilities                            |       | 87,541           |       | 5,414            |       | —           |       | 92,955     |       |
| Equity options/warrants                                             |       | 886              |       | —           |       | —           |       | 886        |       |
| **Total financial instruments sold,   not yet purchased**      |       | $                | 88,427     |             | $          | 5,414            |       | $          | —     |   | $ | 93,841 |   |

 

The non-derivative trading assets/liabilities categories were reported in financial instruments owned, at fair value and financial instruments sold, not yet purchased, at fair value on the Company’s consolidated statements of financial condition.

 

The derivative financial instruments were reported on a gross basis by level. The Company’s derivative activities included in financial instruments owned and financial instruments sold, not yet purchased consist of writing and purchasing listed equity options and warrants.

 

13

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Table of Contents

 

**KBW, INC. and SUBSIDIARIES**

**Notes to Consolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 

The following table provides a reconciliation of the beginning and ending balances for the non-derivative trading assets measured at fair value using significant unobservable inputs (Level 3) for the three months ended June 30, 2011 and 2010:

 

**Level 3 Financial Assets**

** **
| **Three Months Ended   June 30, 2011** | ** ** | **Balance as of   March 31, 2011** | ** ** | **Total gains   and (losses)   (realized   and   unrealized)** | ** ** | **Purchases** | ** ** | **(Sales)** | ** ** | **Transfers   in/(out) of   Level 3** | ** ** | **Balance as of   June 30, 2011** | ** ** | **Changes in   unrealized gains   and (losses)   included in   earnings related   to assets still   held at reporting   date** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|---------------|------------|-------------|------------|-------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equities                                                   |       | $                                                      | 16,826     |                                                                     | $          | 1,069         |       | $           | 58         |                                            | $          | —                                                |       | $                                                                                                                                                                           | —     |   | $ | 17,953 |   | $ | 1,069 |   |
| Corporate   and other debt:                                |       |                                                   |       |                                                                     |       |          |       |        |       |                                            |       |                                                  |       |                                                                                                                                                                        |       |
| CDOs                                                       |       | 1                                                      |       | —                                                                   |       | —        |       | (1          | )          | —                                          |       | —                                                |       | —                                                                                                                                                                      |       |
| Other   debt obligations                                   |       | 10,203                                                 |       | 1,002                                                                    |       | —        |       | (5,259      | )          | —                                          |       | 5,946                                                 |       | (172                                                                                                                                                                        | )          |
| Total corporate and other debt                             |       | 10,204                                                 |       | 1,002                                                                    |       | —        |       | (5,260      | )          | —                                          |       | 5,946                                                 |       | (172                                                                                                                                                                        | )          |
| Other   investments                                        |       | 58,942                                                 |       | 1,202                                                                    |       | 395           |       | (1,053      | )          | —                                          |       | 59,486                                                |       | 1,200                                                                                                                                                                       |       |
| Total   Level 3 financial assets                           |       | $                                                      | 85,972     |                                                                     | $          | 3,273         |       | $           | 453        |                                            | $          | (6,313                                                | )          | $                                                                                                                                                                           | —     |   | $ | 83,385 |   | $ | 2,097 |   |

 
| **Three Months Ended   June 30, 2010** | ** ** | **Balance as of   March 31, 2010** | ** ** | **Total gains   and (losses)   (realized and   unrealized)** | ** ** | **Purchases/   (sales/other   settlements), net** | ** ** | **Transfers in/(out)   of Level 3** | ** ** | **Balance as of   June 30, 2010** | ** ** | **Changes in unrealized   gains and (losses)   included in earnings   related to assets still   held at reporting date** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|----------------------------------------------------|------------|-------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equities                                                   |       | $                                                      | 23,265     |                                                                        | $          | (525                                                   | )          | $                                                  | (4,315     | )                                                     | $          | —                                                                                                                                                                               |       | $ | 18,425 |   | $ | 159 |   |
| Corporate   and other debt:                                |       |                                                   |       |                                                                        |       |                                                   |       |                                               |       |                                                  |       |                                                                                                                                                                                 |       |
| Corporate   debt                                           |       | 9,651                                                  |       | (150                                                                        | )          | —                                                 |       | —                                             |       | 9,501                                                 |       | (150                                                                                                                                                                                 | )          |
| CDOs                                                       |       | 1                                                      |       | —                                                                      |       | —                                                 |       | —                                             |       | 1                                                     |       | —                                                                                                                                                                               |       |
| Other   debt obligations                                   |       | 11,895                                                 |       | 491                                                                         |       | —                                                 |       | —                                             |       | 12,386                                                |       | 491                                                                                                                                                                                  |       |
| Total   corporate and other debt                           |       | 21,547                                                 |       | 341                                                                         |       | —                                                 |       | —                                             |       | 21,888                                                |       | 341                                                                                                                                                                                  |       |
| Other   investments                                        |       | 45,092                                                 |       | 791                                                                         |       | 2,059                                                  |       | —                                             |       | 47,942                                                |       | 778                                                                                                                                                                                  |       |
| Total   Level 3 financial assets                           |       | $                                                      | 89,904     |                                                                        | $          | 607                                                    |       | $                                                  | (2,256     | )                                                     | $          | —                                                                                                                                                                               |       | $ | 88,255 |   | $ | 1,278 |   |

 

14

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Table of Contents

 

**KBW, INC. and SUBSIDIARIES**

**Notes to Consolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 
| **Six Months Ended   June 30, 2011** | ** ** | **Balance as of   December 31,   2010** | ** ** | **Total gains   and (losses)   (realized   and   unrealized)** | ** ** | **Purchases** | ** ** | **(Sales)** | ** ** | **Transfers   in/(out) of   Level 3** | ** ** | **Balance as of   June 30, 2011** | ** ** | **Changes in   unrealized gains   and (losses)   included in   earnings related   to assets still   held at reporting   date** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|---------------|------------|-------------|------------|-------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equities                                                 |       | $                                                      | 16,654     |                                                                     | $          | 1,241         |       | $           | 58         |                                            | $          | —                                                |       | $                                                                                                                                                                           | —     |   | $ | 17,953 |   | $ | 1,241 |   |
| Corporate and other debt:                                |       |                                                   |       |                                                                     |       |          |       |        |       |                                            |       |                                                  |       |                                                                                                                                                                        |       |
| CDOs                                                     |       | 1                                                      |       | 29                                                                       |       | —        |       | (30         | )          | —                                          |       | —                                                |       | —                                                                                                                                                                      |       |
| Other debt obligations                                   |       | 11,806                                                 |       | 1,462                                                                    |       | —        |       | (7,322      | )          | —                                          |       | 5,946                                                 |       | 63                                                                                                                                                                          |       |
| Total corporate and other debt                           |       | 11,807                                                 |       | 1,491                                                                    |       | —        |       | (7,352      | )          | —                                          |       | 5,946                                                 |       | 63                                                                                                                                                                          |       |
| Other investments                                        |       | 51,336                                                 |       | 2,103                                                                    |       | 7,804         |       | (1,757      | )          | —                                          |       | 59,486                                                |       | 1,762                                                                                                                                                                       |       |
| Total Level 3 financial assets                           |       | $                                                      | 79,797     |                                                                     | $          | 4,835         |       | $           | 7,862      |                                            | $          | (9,109                                                | )          | $                                                                                                                                                                           | —     |   | $ | 83,385 |   | $ | 3,066 |   |

 
| **Six Months Ended   June 30, 2010** | ** ** | **Balance as of   December 31,   2009** | ** ** | **Total gains   and (losses)   (realized   and   unrealized)** | ** ** | **Purchases/   (sales/other   settlements),   net** | ** ** | **Transfers   in/(out) of   Level 3** | ** ** | **Balance as of   June 30, 2010** | ** ** | **Changes in   unrealized gains   and (losses)   included in   earnings related   to assets still held   at reporting date** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equities                                                 |       | $                                                      | 15,873     |                                                                     | $          | (498                                                | )          | $                                               | 3,050      |                                                  | $          | —                                                                                                                                                                         |       | $ | 18,425 |   | $ | 186 |   |
| Corporate and other debt:                                |       |                                                   |       |                                                                     |       |                                                |       |                                            |       |                                                  |       |                                                                                                                                                                           |       |
| Corporate debt                                           |       | 10,000                                                 |       | (499                                                                     | )          | —                                              |       | —                                          |       | 9,501                                                 |       | (499                                                                                                                                                                           | )          |
| CDOs                                                     |       | 1                                                      |       | —                                                                   |       | —                                              |       | —                                          |       | 1                                                     |       | —                                                                                                                                                                         |       |
| Other debt obligations                                   |       | 12,347                                                 |       | 39                                                                       |       | —                                              |       | —                                          |       | 12,386                                                |       | 39                                                                                                                                                                             |       |
| Total corporate and other debt                           |       | 22,348                                                 |       | (460                                                                     | )          | —                                              |       | —                                          |       | 21,888                                                |       | (460                                                                                                                                                                           | )          |
| Other investments                                        |       | 41,917                                                 |       | 2,619                                                                    |       | 3,406                                               |       | —                                          |       | 47,942                                                |       | 2,606                                                                                                                                                                          |       |
| Total Level 3 financial assets                           |       | $                                                      | 80,138     |                                                                     | $          | 1,661                                               |       | $                                               | 6,456      |                                                  | $          | —                                                                                                                                                                         |       | $ | 88,255 |   | $ | 2,332 |   |

 

Total gains and losses represent the total gains and/or losses (realized and unrealized) recorded for the Level 3 financial assets and were reported in principal transactions, net in the accompanying consolidated statements of operations. Additionally, the change in the unrealized gains and losses may be offset by realized gains and losses during the period.

 

The Company adopted Accounting Standards Update No. 2010-06 related to disclosure requirements on the activity in Level 3 fair value instruments, which required separate presentation of purchases and sales of Level 3 financial assets beginning in the quarter ended March 31, 2011.  Purchases/(sales/other settlements) represent the net amount of purchases, sales and other settlements of Level 3 financial assets during the period in 2010. The amounts were recorded on the transaction dates at the transaction amounts.

 

Transfers in/(out) of Level 3 represent existing financial assets that were previously categorized at a higher/lower level.  Transfers in or out of Level 3 result from changes in the observability of inputs used in determining fair values for different types of financial assets.  Transfers were reported at their fair value as of the actual date in which such changes in the fair value inputs occurs.

 

15

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Table of Contents

 

**KBW, INC. and SUBSIDIARIES**

**Notes to Consolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 

The amount of unrealized gains and losses included in earnings attributable to the change in unrealized gains and losses relating to Level 3 assets still held at the end of the period were reported in principal transactions, net in the accompanying consolidated statements of operations.  The change in unrealized gains and losses may be offset by realized gains and losses during the period.

 

**(4)****                         ****Short-Term Borrowings**

 

From time to time, the Company obtains secured short-term borrowings primarily through bank loans.  There were no short-term borrowing obligations outstanding during the six month period ended June 30, 2011.

 

**(5)****                         ****Commitments and Contingencies**

 

***(a)******              ******Leases***

 

As of June 30, 2011, there were no significant changes in the Company’s lease agreements since December 31, 2010.

 

***(b)******              ******Litigatio******n***

 

In the ordinary course of business, the Company may be a defendant or codefendant in legal proceedings.  At June 30, 2011, the Company believes, based on currently available information, that the results of such proceedings, in the aggregate, will not have a material adverse effect on the Company’s financial condition. The results of such proceedings could be material to the Company’s operating results for any particular period, depending, in part, upon additional developments affecting such matters and the operating results for such period. Legal reserves have been established in accordance with ASC 450, *Contingencies*. Once established, reserves are adjusted when there is more information available or when an event occurs requiring a change.

 

*Sentinel Management Group Litigation*

 

On January 12, 2009, Frederick J. Grede, as Liquidation Trustee and Representative of the Estate of Sentinel Management Group, Inc. (“Sentinel”), filed a lawsuit in the United States District Court for the Northern District of Illinois against Keefe and against Delores E. Rodriguez; Barry C. Mohr, Jr.; and Jacques De Saint Phalle (all former employees of Keefe) and Cohen & Company Securities, LLC.  Ms. Rodriguez and Mr. Mohr were employed by Cohen & Company subsequent to being employed by Keefe and the complaint relates to activities by them at both Keefe and their subsequent employer.

 

The complaint alleges that Keefe recommended and sold to Sentinel Management Group structured finance products that were unsuitable for purchase.  The complaint alleges the following causes of action against Keefe, aiding and abetting breach of fiduciary duty by an officer and director of Sentinel; commercial bribery; violations of federal and state securities laws; violation of the Illinois Consumer Fraud Act; negligence; unjust enrichment; and avoidance and recovery of fraudulent transfers.  The complaint specifies that Sentinel sustained a loss associated with the sale of securities sold by Keefe of $4,920, and interrogatory responses from the Trustee in discovery now contend that Sentinel lost $5,629; however various causes of action in the complaint seek to recover amounts substantially in excess of that amount up to an amount in excess of $130,000, representing amounts paid for all securities purchased from Keefe regardless of suitability or whether there were losses on these securities.  Keefe believes the claims are without merit and will defend these claims vigorously. On April 1, 2009, Keefe filed a Motion to Dismiss the Complaint.  On July 29, 2009, the court denied most of the relief sought in Keefe’s Motion to Dismiss, though it dismissed the Illinois Consumer Fraud Act claim and granted Keefe’s motion to sever the Trustee’s case against Keefe from the case against Cohen.  On October 29, 2010, Keefe served the Trustee with a Motion for Summary Judgment on Count VIII of the complaint.  On December 20, 2010, the Court granted a joint motion by Keefe and the Trustee to stay the case for ninety days.  On March 15, 2011, the Court granted a joint motion by Keefe and the Trustee to stay the case for an additional ninety days, through June 13, 2011.  On June 15, 2011, the Court granted another joint motion by Keefe and the Trustee to stay the case for an additional ninety days, through September 13, 2011.

 

On August 26, 2009, Keefe filed a Third-Party Complaint against Eric A. Bloom, the former President and CEO of Sentinel, and Charles K. Mosley, the former Senior Vice President and head trader of Sentinel, alleging fraud and seeking contribution for any damages for which Keefe is held liable to the Trustee.  The court stayed and severed this Third-Party Complaint on October, 7, 2009.

 

16

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Table of Contents

 

**KBW, INC. and SUBSIDIARIES**

**Notes to Consolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 

On May 21, 2009 the Trustee filed an additional complaint in the same court and against the same parties (the “Second Complaint”).  The Trustee claimed to be acting in the Second Complaint in his capacity as liquidation trustee and as an assignee of claims of Sentinel’s customers.  The Second Complaint makes substantially the same allegations as the complaint described above.  Keefe believes the claims in the Second Complaint are also without merit and will defend these claims vigorously.  On July 28, 2009, in *Grede v. Bank of New York Mellon* et al filed in the same court, in which the Trustee alleged similar customer claims as an assignee, the court dismissed the Trustee’s claims due to lack of standing.  The Trustee has appealed the court’s dismissal of *Grede v. Bank of New York Mellon* and, on August 19, 2009, the court stayed the Second Complaint while the Trustee’s appeal in *Grede v. Bank of New York Mellon* is pending.   On March 18, 2010, the Seventh Circuit reversed the district court, holding that the Trustee had standing to pursue the assigned customer claims against Bank of New York Mellon.  Currently, the Second Complaint remains stayed.

 

***(c)******               ******Investment Commitments***

 

As of June 30, 2011, the Company had approximately $14,291, including $8,680 to affiliated funds, in outstanding commitments for additional funding to limited partnership investments.

 

***(d)******              ******Underwriting Commitment***

 

In connection with investment banking activities, the Company may from time to time enter into underwriting commitments.  As of June 30, 2011, the Company had an open underwriting commitment of approximately $136,900, which was subsequently settled in July 2011.

 

**(6)****                         ****Financial Instruments with Off-Balance-Sheet Risk**

 

In the normal course of its principal trading activities, the Company enters into transactions in financial instruments with off-balance-sheet risk. These financial instruments, such as options, warrants, futures and mortgage-backed to-be-announced (“TBA”) securities, contain off-balance-sheet risk inasmuch as ultimate settlement of these transactions may have market and/or credit risk in excess of amounts which are recognized in the consolidated financial statements. Transactions in listed options and warrants are conducted through regulated exchanges, which clear and guarantee performance of counterparties.

 

Also, in connection with its principal trading activities, the Company has sold securities that it does not currently own and will, therefore, be obligated to purchase such securities at a future date. The Company has recorded this obligation in the financial statements at market values of the related securities and will record a trading loss if the market value of the securities increases subsequent to the purchase date.

 

***(a)******              ******Broker-Dealer Activities***

 

The Company clears securities transactions on behalf of customers through its clearing brokers. In connection with these activities, customers’ unsettled trades may expose the Company to off-balance-sheet credit risk in the event customers are unable to fulfill their contracted obligations. The Company seeks to control the risk associated with its customer activities by monitoring the creditworthiness of its customers.

 

***(b)******              ******Derivative Financial Instruments***

 

The Company’s derivative activities consist of writing and purchasing listed equity options and/or warrants and, from time to time, futures on interest rate, currency and equity products and mortgage-backed TBA securities for trading for our own account.  Options and warrants are included in financial instruments owned, at fair value and financial instruments sold, not yet purchased, at fair value in the accompanying consolidated statements of financial condition. See also Note 3 of the Notes to Consolidated Financial Statements for additional details. As a writer of options, the Company receives a cash premium at the beginning of the contract period and bears the risk of unfavorable changes in the fair value of the financial instruments underlying the options. Options written do not expose the Company to credit risk since they obligate the Company (not its counterparty) to perform.

 

In order to measure derivative activity, notional or contract amounts are frequently utilized. Notional contract amounts, which are not included on the consolidated statements of financial condition, are used as a basis to calculate contractual cash flows to be exchanged and generally are not actually paid or received.

 

17

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Table of Contents

 

**KBW, INC. and SUBSIDIARIES**

**Notes to Consolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 

A summary of the Company’s listed options, warrants, futures contracts and TBA securities is as follows:

 
| ** **                                    | ** ** | **Current**  | ** ** | **Average** | ** ** | **End of**     | ** ** |
|-----------------------------------------------|------------|--------------|------------|-------------|------------|---------------------|------------|
| ** **                                    | ** ** | **Notional** | ** ** | **Fair**    | ** ** | **Period**          | ** ** |
| ** **                                    | ** ** | **Value**    | ** ** | **Value**   | ** ** | **Fair Value** | ** ** |
| June 30,   2011:                         |       |         |       |        |       |                |       |
| Purchased   options/warrants                  |       | $            | 67,214     |        | $          | 5,207               |       | $ | 3,444 |   |
| Written options                               |       | $            | 9,581      |        | $          | 527                 |       | $ | 313 |   |
| Short futures   contracts                     |       | $            | 9,810      |        | $          | —              |       | $ | — |   |
| Long agency   mortgage-backed TBA securities  |       | $            | 810        |        | $          | 550                 |       | $ | 891 |   |
| Short agency   mortgage-backed TBA securities |       | $            | 15,225     |        | $          | 13,761              |       | $ | 15,960 |   |
|                                          |       |         |       |        |       |                |       |
|                                          |       |         |       |        |       |                |       |
| December 31,   2010:                     |       |         |       |        |       |                |       |
| Purchased   options/warrants                  |       | $            | 27,055     |        | $          | 5,336               |       | $ | 2,119 |   |
| Written options                               |       | $            | 8,015      |        | $          | 1,756               |       | $ | 886 |   |
| Short futures   contracts                     |       | $            | 5,181      |        | $          | —              |       | $ | — |   |
| Short agency   mortgage-backed TBA securities |       | $            | 31,000     |        | $          | (19                 | )          | $ | (185 | ) |

 

The following table summarizes the net gains from trading activities included in principal transactions, net with respect to the consolidated statements of operations for the three and six months ended June 30, 2011 and 2010:

 
| ** **                                 | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                 | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| **Type of Instrument**           | ** ** | **2011**                         | ** ** | **2010**                       | ** ** | **2011** | ** ** | **2010** | ** ** |
| Equities                                   |       | $                                | 1,503      |                           | $          | (4,406 | ) | $ | 6,903 |   | $ | 645 |   |
| Corporate and other debt                   |       | 6,723                            |       | 2,013                          |       | 12,685 |   | 10,844 |   |
| Mortgage and other asset-backed securities |       | 2,525                            |       | 4,864                          |       | 7,601 |   | 8,201 |   |
| Other investments                          |       | 1,201                            |       | 791                            |       | 2,103 |   | 2,619 |   |
| Total                                      |       | $                                | 11,952     |                           | $          | 3,262 |   | $ | 29,292 |   | $ | 22,309 |   |

 

The revenue related to the equities and mortgage and other asset-backed securities categories included realized and unrealized gains and losses on both derivative instruments and non-derivative instruments. Corporate and other debt and other investments included realized and unrealized gains and losses on non-derivative instruments.

 

18

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Table of Contents

 

**KBW, INC. and SUBSIDIARIES**

**Notes to Consolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 

**(7)****                         ****Concentrations of Credit Risk**

 

The Company is engaged in various securities trading and brokerage activities servicing primarily domestic and foreign institutional investors. Nearly all of the Company’s transactions are executed with and on behalf of institutional investors, including other brokers and dealers, commercial banks, mutual funds, and other financial institutions. The Company’s exposure to credit risk associated with the non-performance of these customers in fulfilling their contractual obligations pursuant to securities transactions can be directly impacted by volatile securities markets.

 

A substantial portion of the Company’s marketable securities are common stock and debt of financial institutions. The credit and/or market risk associated with these holdings can be directly impacted by factors that affect this industry such as volatile equity and credit markets and actions of regulatory authorities.

 

**(8)****                        ****Stockholders’ Equity**

 

*Dividends Declared on Common Stock*

 

During the six months ended June 30, 2011, the Company’s board of directors declared and the Company paid dividends of $0.10 per share totaling $3,698.

 

*Stock Repurchase Program*

 

On July 28, 2010, the Company’s board of directors approved a stock repurchase program, authorizing the Company to repurchase in the aggregate up to $70,000 of its outstanding common stock. Purchases by the Company under this program may be made from time to time at prevailing market prices in open market purchases, privately negotiated transactions, block purchase techniques or otherwise, as determined by the Company’s management.  During the six months ended June 30, 2011, the Company repurchased and retired 1,644,922 shares of the Company’s common stock at an average price of $22.37 per share, for an aggregate purchase price of $36,797.

 

This program does not obligate the Company to acquire any particular amount of common stock.  The timing, frequency and amount of repurchase activity will depend on a variety of factors such as levels of cash generation from operations, cash requirements for investments in the Company’s business, current stock price, market conditions and other factors.  The stock repurchase program may be suspended, modified or discontinued at any time and has no set expiration date.

 

*Notes Receivable from Stockholders*

 

Notes receivable from stockholders represented full recourse notes issued to employees for the purchase of stock acquired pursuant to the Company’s terminated book value stock purchase plan. The loans were fully paid in the first quarter of 2011.

 

**(9)****                         ****Stock-Based and Other Incentive Compensation**

 

At June 30, 2011, the Company had one effective incentive compensation arrangement under the 2009 Incentive Compensation Plan (the “Plan”).  The Plan permits the Company to issue shares of common stock pursuant to the grant or exercise of stock options, stock appreciation rights, restricted stock awards (“RSAs”), restricted stock units, performance unit awards and performance share awards, as well as grant cash-based awards and other awards to directors, officers, employees and consultants.

 

*Restricted Stock Awards*

 

As part of the 2010 year-end performance award process, the Company granted 2,147,042 RSAs under the Plan to certain employees in February 2011 (“2010 Bonus Awards”). The aggregate fair value of the RSAs granted in connection with the 2010 Bonus Awards on the grant date was $59,001.  This value was based upon the grant date share price of $27.48.  RSAs are actual shares of common stock issued to the recipient that are restricted.   The stock granted in connection with the 2010 Bonus Awards generally vests over a three year period. Vesting would accelerate on a change in control, death or permanent disability. Unvested RSAs are eligible to receive dividends but are subject to forfeiture upon termination of employment.

 

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Table of Contents

 

**KBW, INC. and SUBSIDIARIES**

**Notes to Consolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 

For 2010 Bonus Awards that were granted to retirement-eligible employees, the Company recognized the grant date fair value as compensation expense for such awards on the date of grant instead of over the service period specified in the award terms. For employees who will be retirement-eligible prior to vesting of the 2010 Bonus Awards, the Company recognizes compensation expense ratably from the grant date to the retirement eligibility date. The Company recorded accelerated non-cash incremental compensation expense of $10,134 in the first quarter of 2011 related to 2010 Bonus Awards granted to retirement-eligible employees.

 

*Long Term Incentive Program*

 

In February 2010, the Company approved awards under a Long Term Incentive Plan (“LTIP”) to three members of senior management.  The LTIP awards have established performance cycles (2010, 2010 through 2011 and 2010 through 2012) and amounts payable in cash based on the Company’s achievement of certain levels of cumulative growth in adjusted earnings per share during each performance cycle.

 

*Performance Equity Awards*

 

In March 2011, the Company granted Performance Awards to three members of senior management.   The Performance Awards provide for the issuance of up to 120,240 shares of Common Stock to the recipients in the aggregate, contingent upon achievement of a target level of “Return on KBW Average Equity” as defined in the Performance Awards.  The share price on the Performance Awards grant date was $24.93.  The three year performance period began on January 1, 2011 and ends on December 31, 2013. The range of possible Performance Awards vesting is between 0% and 200% of the target, so that the minimum number of shares that may be awarded to the recipients in the aggregate is zero and the maximum number is 240,480.  In addition, these Performance Awards contain “clawback” provisions that provide for repayment of all or a portion of shares issued in the event of certain accounting restatements, thereby creating at-risk performance units for these executives.  Unvested Performance Awards are subject to forfeiture upon termination of employment.  Under the Performance Award agreements, in the event of (i) termination by us without “cause,” (ii) termination by the employee for “good reason” or (iii) the employee’s death, “disability,” or “retirement,” (as each such term is defined in the Plan) during any performance cycle or period, such employee will be entitled to payment of a pro-rata portion (based on the portion of such performance cycle or period that he was actively employed by us) of his award with respect to such performance cycle or period, provided that the performance goals with respect to such performance cycle or period are achieved.  In the event of a change in control, as defined in the Plan, the target performance goals applicable to any outstanding Performance Awards shall be deemed to have been attained in full (unless actual performance exceeds the target performance goal, in which case actual performance shall be used) and all of the applicable shares will be deemed vested and subject to payment as provided in the Plan.

 

**(10)****                  ****Transactions with Affiliated Funds**

 

The Company has formed nonconsolidated investment funds, KBW Financial Services Master Fund, Ltd., KBW Financial Services Fund, L.P., KBW Financial Services Fund, Ltd. and KBW Capital Partners I, L.P., with third-party investors. The Company generally acts as the investment manager for these funds and, as such, is entitled to receive management fees and, in certain cases, incentive fees. These fees amounted to $539 and $716 for the six month periods ended June 30, 2011 and 2010, respectively. As of June 30, 2011 and 2010, the fees receivable from these funds were $65 and $164, respectively. Additionally, the Company may invest alongside the third-party investors in certain funds. The aggregate carrying value of the Company’s interests in these funds was $26,035 and $19,075 as of June 30, 2011 and 2010, respectively. The Company elected to apply the fair value option to these investments in affiliated funds.  Net realized and unrealized gains on investments in affiliated funds were $1,643 and $1,445 for the six months ended June 30, 2011 and 2010, respectively. See Note 5 for the Company’s commitments related to affiliated funds.

 

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Table of Contents

 

**KBW, INC. and SUBSIDIARIES**

**Notes to Consolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 

**(11)****                  ****Earnings Per Share**

 

The computations of basic and diluted earnings per share are set forth below:

 
| ** **                                                                                    | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                    | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                                    | ** ** | **2011**                         | ** ** | **2010**                       | ** ** | **2011** | ** ** | **2010** | ** ** |
| **Net (loss) / income**                                                                       |       | $                                | (4,248     | )                              | $          | 8,156 |   | 393 |   | 19,777 |   |
| **Less: Dividends and allocation of   undistributed earnings to participating securities(1)** |       | (197                             | )          | 897                            |       | (390 | ) | 2,159 |   |
| **Net (loss) / income applicable to   common shareholders**                                   |       | $                                | (4,445     | )                              | $          | 7,259 |   | 3 |   | 17,618 |   |
|                                                                                          |       |                             |       |                           |       |   |   |   |   |
| **Weighted average number of common   shares outstanding(1)(2):**                             |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                                         |       | 32,579,146                       |       | 32,481,478                     |       | 32,849,263 |   | 32,361,823 |   |
| Effect of dilutive securities - performance equity   awards                                   |       | —                           |       | —                         |       | — |   | — |   |
| Diluted                                                                                       |       | 32,579,146                       |       | 32,481,478                     |       | 32,849,263 |   | 32,361,823 |   |
| **Earnings per common share:**                                                                |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                                         |       | $                                | (0.14      | )                              | $          | 0.22 |   | — |   | 0.54 |   |
| Diluted                                                                                       |       | $                                | (0.14      | )                              | $          | 0.22 |   | — |   | 0.54 |   |

 

----

(1) Participating securities in the form of unvested share based payment awards amounted to weighted average shares of 4,149,375 and 4,015,440 for the three months ended June 30, 2011 and 2010, respectively and 3,959,891 and 3,965,285 for the six months ended June 30, 2011 and 2010, respectively.  Dividends declared on participating securities amounted to $197 and $390, net of estimated forfeitures, for the three and six months ended June 30, 2011, respectively.  No dividends were declared for the three and six months ended June 30, 2010.

 

(2) Basic and diluted common shares outstanding were equal for the periods presented under the two-class method.

 

**(12)****                  ****Income Taxes**

 

The Company applies the provisions of ASC 740, which prescribes the recognition and measurement criteria related to tax positions taken or expected to be taken in a tax return.  For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities.  In addition, the following information required by ASC 740 is provided:

 

·                  The Company’s gross unrecognized tax benefits, excluding interest and penalties, has decreased by approximately $500  since December 31, 2010 as a result of state and local audit settlements.

 

·                  The Company classifies interest and penalties, if any, related to tax uncertainties as income tax expense.   This amount has decreased by approximately $700 since December 31, 2010 as a result of state and local audit settlements.

 

·                  The Company and its subsidiaries file consolidated federal and various state, local and foreign tax returns.  The federal income tax returns have been audited and/or closed through 2005 and are currently under examination for years 2006 to 2008.  Various state, local and foreign returns are subject to audits by tax authorities beginning with the 2007 tax year.  The settlement of any outstanding audits within the next 12 months, if any, is not anticipated to have a significant impact on the Company’s financial position.

 

**(13)****                  ****Industry Segment Data**

 

The Company follows the provisions of ASC 280, *Segment Reporting*, in disclosing its business segments. Pursuant to that guidance, an entity is required to determine its business segments based on the way management organizes the segments within the enterprise for making operating decisions and assessing performance. Based upon these criteria, the Company has determined that its entire business should be considered a single segment.

 

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**KBW, INC. and SUBSIDIARIES**

**Notes to Consolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 

**(14)****                  ****Net Capital Requirement**

 

Keefe is a registered U.S. broker-dealer that is subject to the Uniform Net Capital Rule (SEC Rule 15c3-1 or the Net Capital Rule) administered by the SEC and FINRA, which requires the maintenance of minimum net capital. Keefe has elected to use the basic method to compute net capital as permitted by the Net Capital Rule, which requires Keefe to maintain minimum net capital, as defined, of $2,317 as of June 30, 2011. These rules also require Keefe to notify and sometimes obtain approval from FINRA for significant withdrawals of capital.

 
| ** **                             | ** ** | **June 30, 2011** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|
| Net Capital                            |       | $                           | 101,788    |   |
| Net Capital in   Excess of Requirement |       | $                           | 99,471     |   |

 

KBWL is an investment firm authorized and regulated by the FSA in the United Kingdom and is subject to the capital requirements of the FSA. As of June 30, 2011, KBWL was in compliance with its local capital requirements.  At June 30, 2011, KBWL’s capital resources of approximately $34,440 exceeded the capital resources requirement by approximately $22,864.

 

**(15)****                  ****Recent Accounting Developments**

 

In June 2011, the FASB issued ASU No. 2011-05*, Presentation of Comprehensive Income (Topic 220)*.**ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. An entity can elect to present items of net income and other comprehensive income in one continuous statement or in two separate, but consecutive, statements.  ASU 2011-05 is effective for interim and annual periods beginning after December 15, 2011. The Company expects to adopt ASU 2011-05 on January 1, 2012. The Company is currently evaluating the presentation alternatives permitted under this new guidance. ASU 2011-05 will not have a monetary impact on the Company’s financial statements.

 

In May 2011, the FASB issued ASU No. 2011-04*, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs. * ASU 2011-04 clarifies how a principal market is determined, addresses the fair value measurement of instruments with offsetting market or counterparty credit risks and the concept of valuation premise and highest and best use, extends the prohibition on blockage factors to all three levels of the fair value hierarchy and requires additional disclosures. ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011. The Company expects to adopt ASU 2011-04 on January 1, 2012. The Company is currently evaluating the requirements of this new guidance and the potential impact on the Company’s financial statements.

 

**(16)****                  ****Subsequent Events**

 

*Declaration of Quarterly Dividend*

 

On July 28, 2011, the Company’s board of directors declared a quarterly dividend of $0.05 per share on its outstanding common stock.  The dividend is payable on September 15, 2011 to shareholders of record on September 2, 2011.

 

*Stock Repurchase Program*

 

From July 1, 2011 through August 4, 2011, the Company repurchased and retired 130,000 shares of the Company’s common stock at an average price of $15.15 for an aggregate purchase price of $1,969.

 

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**Item 2*.   *Management’s Discussion and Analysis of Financial Condition and Results of Operations.**

 

*The following discussion should be read in conjunction with our unaudited consolidated financial statements and the related notes included elsewhere in this report.*

 

**Cautionary Statement Regarding Forward-Looking Statements**

 

We have made statements in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in other sections of this report that are forward-looking statements. In some cases, you can identify these statements by forward-looking words such as “may,” “might,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of these terms and other comparable terminology. These forward-looking statements, which are based on various underlying assumptions and expectations and are subject to risks, uncertainties and other unknown factors, may include projections of our future financial performance based on our growth strategies and anticipated trends in our business. These statements are only predictions based on our current expectations and projections about future events. There are or may be important factors that could cause our actual results, level of activity, performance or achievements to differ materially from the historical or future results, level of activity, performance or achievements expressed or implied by such forward-looking statements. These factors include, but are not limited to, those discussed in the section entitled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2010.

 

Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy or completeness of any of these forward-looking statements. You should not rely upon forward-looking statements as predictions of future events. We are under no duty to update any of these forward-looking statements after the date of filing of this report to conform such statements to actual results or revised expectations.

 

**Overview**

 

We are a leading full service investment bank specializing in the financial services industry. Our principal activities are:  (i) investment banking, including mergers and acquisitions (“M&A”) and other strategic advisory services, equity and fixed income securities offerings, and mutual thrift conversions, (ii) equity and fixed income sales and trading, (iii) research that provides fundamental, objective analysis that identifies investment opportunities and helps our investor customers make better investment decisions, and (iv) asset management, including investment management and other advisory services to institutional clients and private high net worth clients and various investment vehicles.

 

Within our full service business model, our focus includes bank and thrift holding companies, banking companies, thrift institutions, insurance companies, broker-dealers, mortgage banks, asset management companies, mortgage and equity real estate investment trusts, and other real estate components, consumer and specialty finance firms, financial processing companies and securities exchanges.  We emphasize serving investment banking clients in the small and mid cap segments of the financial services industry although our clients also include many large-cap companies.  Our sales customers are primarily institutional investors.

 

Most revenues with respect to our services provided are primarily determined as a result of active competition in the marketplace. Our revenues are primarily generated through advisory, underwriting and private placement fees earned through our investment banking activities, commissions earned on equity sales and trading activities, including fixed income, interest and dividends earned on our securities’ inventories and profit and losses from trading activities related to the securities’ inventories.

 

Our largest expense is compensation and benefits.  Our performance is dependent on our ability to attract, develop and retain highly skilled employees who are motivated to provide quality service and guidance to our clients.

 

Many external factors affect our revenues and profitability. Such factors include equity and fixed income trading prices and volumes, the volatility of these markets, the level and shape of the yield curve, political events and regulatory developments, including recent government participation in providing capital to financial institutions, and competition. These factors influence our investment banking operations in that such factors affect the number and timing of equity and fixed income securities issuances and M&A activity within the financial services industry. These same factors also affect our sales and trading business by impacting equity and fixed income trading prices and volumes and valuations in secondary financial markets. Commission rates, market volatility and other factors also affect our sales and trading revenues. These market forces may cause our revenues and earnings to fluctuate significantly from period to period and the results of any one period should not be considered indicative of future results.  See “—Business Environment.”

 

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A significant portion of our expense base is variable, including employee compensation and benefits, brokerage and clearance, communication and data processing and business development expenses. Our remaining costs generally do not directly relate to the service revenues earned.

 

Certain data processing systems that support equity and fixed income trading, research, payroll, human resources and employee benefits are service bureau based and are operated in the vendors’ data centers. We believe that this stabilizes our fixed costs associated with data processing. We also license vendor information databases to support investment banking, sales and trading and research. Vendors may, at the end of contractual terms, terminate our rights or modify or significantly alter product and service offerings or related fees, which may affect our ongoing business activities or related costs.

 

**Business Environment**

 

Global economic and financial market conditions can materially affect our financial performance.   The Company’s principal sources of revenue are derived from financial services sector capital markets, M&A and advisory and sales and trading of equity and fixed income securities.  The potential impact of the sovereign debt crisis in Europe and the ongoing efforts for a solution to the U.S. government deficit, together with other continuing economic uncertainties in the global markets, including the evolving regulatory environment in the banking and other financial industries, led to reduced capital raising activity and created volatility in equity markets.  These factors negatively impacted our investment banking activity and resulted in lower trading volumes for financial services industry securities in the second quarter of 2011. In the U.S., the KBW Bank Index declined by 7.5% for the first half of 2011 while the KBW Regional Banking Index declined by 3.5%.  In Europe, the KBW European Large-Cap Banking Index declined by 4.9% and the KBW European Mid & Small-Cap Banking Index declined by 16.5% in the first half of 2011.  M&A activity among banks continued to be depressed during the quarter based in part on these factors.

 

It is difficult to predict how long these conditions will continue to negatively impact our overall revenues. We believe that we remain well capitalized and well positioned to assist our clients in raising capital and in providing needed advice in M&A and other transactions for the financial services industry in the U.S., Europe and Asia.

 

**Results of Operations**

 

***Three Months Ended June 30, 2011 Compared with Three Months Ended June 30, 2010***

 

*Overview*

 

Total revenues were $64.0 million for the three months ended June 30, 2011 compared with $105.8 million for the same period in 2010, a decrease of $41.8 million, or 39.5%.  This decrease was primarily due to a decrease in investment banking revenues of $46.0 million, partially offset by an increase in principal transactions, net revenue of $8.7 million.

 

Total expenses were $70.9 million for the three months ended June 30, 2011 compared with $90.9 million for the same period in 2010, a decrease of $20.0 million, or 22.0%.  Compensation and benefits expense decreased $26.2 million, which was partially offset by an increase in non-compensation expenses of $6.1 million.

 

We recorded a net loss of $4.2 million, or $0.14 per diluted share, for the three months ended June 30, 2011 compared with net income of $8.2 million, or $0.22 per diluted share, for the three months ended June 30, 2010.  For the three months ended June 30, 2010 our non-GAAP operating net income was $9.3 million, or $0.26 per diluted share, after adjusting for the 2006 one-time restricted stock awards granted to employees in connection with our IPO, which were fully vested and amortized in 2010.  See “—2010 Three Month Non-GAAP Financial Measures” for a reconciliation of our non-GAAP measures to their corresponding GAAP amounts**.**

 

The following table provides a comparison of our revenues and expenses for the periods presented (dollars in thousands):

 

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| ** **                                | ** ** | **Three Months Ended** | ** ** | ** **           | ** ** | ** **        | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|----------------------|------------|-------------------|------------|
| ** **                                | ** ** | **June 30,**                | ** ** | **Period-to-Period** | ** ** |
| ** **                                | ** ** | **2011**                         | ** ** | **2010**             | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| **Revenues:**                             |       |                             |       |                 |       |              |       |   |   |
| Investment banking                        |       | $                                | 15,204     |                 | $          | 61,173            |       | $ | (45,969 | ) | (75.1 | )% |
| Commissions                               |       | 32,190                           |       | 36,098               |       | (3,908            | )          | (10.8 | ) |
| Principal transactions, net               |       | 11,952                           |       | 3,262                |       | 8,690             |       | 266.4 |   |
| Interest and dividend income              |       | 3,151                            |       | 3,670                |       | (519              | )          | (14.1 | ) |
| Investment advisory fees                  |       | 301                              |       | 497                  |       | (196              | )          | (39.4 | ) |
| Other                                     |       | 1,234                            |       | 1,106                |       | 128               |       | 11.6 |   |
| **Total revenues**                        |       | 64,032                           |       | 105,806              |       | (41,774           | )          | (39.5 | ) |
|                                      |       |                             |       |                 |       |              |       |   |   |
| **Expenses:**                             |       |                             |       |                 |       |              |       |   |   |
| Compensation and benefits                 |       | 38,895                           |       | 65,059               |       | (26,164           | )          | (40.2 | ) |
| Non-compensation expenses:                |       |                             |       |                 |       |              |       |   |   |
| Occupancy and equipment                   |       | 5,629                            |       | 5,503                |       | 126               |       | 2.3 |   |
| Communications and data processing        |       | 9,088                            |       | 8,159                |       | 929               |       | 11.4 |   |
| Brokerage and clearance                   |       | 4,580                            |       | 3,780                |       | 800               |       | 21.2 |   |
| Business development                      |       | 4,637                            |       | 3,801                |       | 836               |       | 22.0 |   |
| Professional services                     |       | 4,636                            |       | 2,152                |       | 2,484             |       | 115.4 |   |
| Interest                                  |       | 356                              |       | 267                  |       | 89                |       | 33.3 |   |
| Other                                     |       | 3,093                            |       | 2,225                |       | 868               |       | 39.0 |   |
| Non-compensation expenses                 |       | 32,019                           |       | 25,887               |       | 6,132             |       | 23.7 |   |
| **Total expenses**                        |       | 70,914                           |       | 90,946               |       | (20,032           | )          | (22.0 | ) |
| **(Loss) / income before income   taxes** |       | (6,882                           | )          | 14,860               |       | (21,742           | )          | N/M |   |
| **Income tax (benefit) / expense**        |       | (2,634                           | )          | 6,704                |       | (9,338            | )          | N/M |   |
| **Net (loss) / income**                   |       | $                                | (4,248     | )                    | $          | 8,156             |       | $ | (12,404 | ) | N/M | % |

 

**N/M—Not Meaningful**

 

***2010 Three Month Non-GAAP Financial Measures***

 

Results for the three months ended June 30, 2011 were reported only on a GAAP basis, as all IPO restricted stock awards fully vested prior to that period.  We reported our compensation and benefits expense, compensation ratio, net income and diluted earnings per share on a non-GAAP basis (“Non-GAAP Financial Measures”) for the three months ended June 30, 2010 in our June 30, 2010 Form 10-Q.  Each of the Non-GAAP Financial Measures exclude compensation expense related to the amortization of IPO restricted stock awards, which were granted in November 2006 and fully vested in November 2010. While we have granted restricted stock awards and other share-based compensation in connection with our regular compensation of employees and new hires, we do not expect to make any such substantial grants to employees as we did when we granted IPO restricted stock awards.

 

Our management utilized such non-GAAP calculations as an additional device to aid in understanding and analyzing our financial results for prior periods. Specifically, our management believes that these Non-GAAP Financial Measures provide useful information by excluding the amortization expense of the IPO awards, which may not be indicative of our core operating results and business outlook. Our management believes that these Non-GAAP Financial Measures allow for a better evaluation of the operating performance of our business and facilitate meaningful comparison of our results in the current period to those in prior periods. Such periods did not and likely will not include substantial grants of restricted stock awards to employees such as the Company-wide IPO restricted stock awards.  Our reference to these Non-GAAP Financial Measures should not be considered as a substitute for results that are presented in a manner consistent with GAAP. These Non-GAAP Financial Measures are provided to enhance investors’ overall understanding of our current financial performance.

 

A limitation of utilizing these Non-GAAP Financial Measures is that the GAAP accounting effects of these events do in fact reflect the underlying financial results of our business and these effects should not be ignored in evaluating and analyzing our financial results. Therefore, management believes that our GAAP measures of compensation and benefits expense, compensation ratio, net income and diluted earnings per share and the same respective Non-GAAP Financial Measures of our financial performance should be considered together.

 

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The following table provides GAAP measures of compensation and benefits expense, compensation ratio, net income and diluted earnings per share for the three months ended June 30, 2010 and details with respect to reconciling the aforementioned line items on a non-GAAP basis for the three months ended June 30, 2010:

 
| ** **                                                                                   | ** ** | **Three Months Ended   June 30, 2010**                          | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **(dollars in thousands, except   per share information)** | ** ** |
| **Compensation and benefits   expense:**                                                     |       |                                                                                |       |
| Compensation and benefits expense - GAAP basis                                               |       | $                                                                                   | 65,059     |   |
| Adjustment to exclude amortization expense of the   IPO awards (a)                      |       | (2,105                                                                              | )          |
| Non-GAAP operating compensation and benefits   expense (b)                              |       | $                                                                                   | 62,954     |   |
|                                                                                         |       |                                                                                |       |
| **Compensation ratio (c):**                                                                  |       |                                                                                |       |
| Compensation ratio - GAAP basis                                                              |       | 61.5                                                                                | %          |
| Non-GAAP operating compensation ratio (b)                                               |       | 59.5                                                                                | %          |
|                                                                                         |       |                                                                                |       |
| **Net income:**                                                                              |       |                                                                                |       |
| Net income - GAAP basis                                                                      |       | $                                                                                   | 8,156      |   |
| Adjustment to exclude amortization expense of the   IPO awards, net of tax benefit (a)  |       | 1,158                                                                               |       |
| Non-GAAP operating net income (b)                                                       |       | $                                                                                   | 9,314      |   |
|                                                                                         |       |                                                                                |       |
| **Diluted earnings per share:**                                                              |       |                                                                                |       |
| Diluted earnings per share - GAAP basis                                                      |       | $                                                                                   | 0.22       |   |
| Adjustment to exclude amortization expense of the   IPO awards, net of tax benefit (a)  |       | 0.04                                                                                |       |
| Non-GAAP operating diluted earnings per share   (b)                                     |       | $                                                                                   | 0.26       |   |

 

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| (a) |   | The adjustment represents the exclusion of   the compensation expense related to the amortization of the IPO restricted   stock awards, which were granted to employees in November 2006 and fully   vested in November 2010. |
|-----|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (b) |   | A Non-GAAP Financial Measure that management   believes provides the most meaningful comparison between historical, present   and future periods.                                                                                       |
| (c) |   | The compensation ratio was calculated by   dividing compensation and benefits expense by total revenues for each   respective period.                                                                                                   |

 

***Revenues***

 

*Investment Banking*

 

Investment banking revenue was $15.2 million for the three months ended June 30, 2011 compared with $61.2 million for the same period in 2010, a decrease of $46.0 million, or 75.1%.   Capital markets revenue was $8.3 million for the three months ended June 30, 2011 compared with $46.7 million for the same period in 2010, a decrease of $38.4 million, primarily due to a lower number of U.S. equity capital market transactions in the second quarter of 2011 compared with the second quarter of 2010 as the total capital raising for banking companies decreased significantly.  M&A and advisory revenue was $6.9 million for the three months ended June 30, 2011 compared with $14.5 million for the same period in 2010, a decrease of $7.6 million.  This decrease was primarily due to a lower number of M&A and advisory engagements completed in the second quarter of 2011.

 

*Commissions*

 

Commissions revenue was $32.2 million for the three months ended June 30, 2011 compared with $36.1 million for the same period in 2010, a decrease of $3.9 million, or 10.8%**. **U.S. equity commissions were $23.0 million for the three months ended June 30, 2011 compared with $28.5 million for the same 2010 period, a decrease of $5.5 million, or 19.3%, reflecting lower market trading volumes.  Non-U.S. equity commissions were $9.2 million for the three months ended June 30, 2011 compared with $7.6 million for the same period in 2010, an increase of $1.6 million, or 21.1%, reflecting higher Asian equity commissions revenue.

 

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*Principal Transactions, Net*

 

Principal transactions, net revenue increased $8.7 million to $12.0 million for the three months ended June 30, 2011 compared with $3.3 million for the same period in 2010.  Trading for our own account, including firm investments, resulted in a net gain of $2.4 million for the three months ended June 30, 2011 compared with a net loss of $2.8 million for the same period in 2010.  The realized gains and change in the fair value of our trust preferred backed collateralized debt obligations and related securities owned resulted in a net gain of $2.3 million for the three months ended June 30, 2011 compared with a net gain of $0.2 million for the same period in 2010.  Fixed income revenue was $8.3 million for the three months ended June 30, 2011 compared with $6.9 million for the same period in 2010.  Equity market making resulted in a net loss of $1.1 million for the three months ended June 30, 2011 and remained relatively unchanged compared with the same period in 2010.

 

*Interest and Dividend Income*

 

Interest and dividend income was $3.2 million for the three months ended June 30, 2011 compared with $3.7 million for the same period in 2010, a decrease of $0.5 million, or 14.1%.  The decrease was primarily due to lower levels of interest bearing assets**.**

 

***Expenses***

 

*Compensation and Benefits*

 

Compensation and benefits expense decreased $26.2 million, or 40.2%, to $38.9 million for the three months ended June 30, 2011 compared with $65.1 million for the same period in 2010.  Compensation and benefits as a percentage of total revenue (“compensation ratio”) was 60.7% for the three months ended June 30, 2011 compared with a non-GAAP operating compensation ratio, after adjusting for expenses associated with the IPO restricted stock awards, of 59.5% for the same period in 2010. See “-2010 Three Month Non-GAAP Financial Measures” for a reconciliation of our non-GAAP measures to their corresponding GAAP amounts.

 

*Communications and Data Processing*

 

Communications and data processing expense was $9.1 million for the three months ended June 30, 2011 compared with $8.2 million for the same period in 2010, an increase of $0.9 million, or 11.4%.  The increase was primarily due to higher market data costs in the second quarter of 2011 compared with the same period in 2010.

 

*Business Development*

 

Business development expense was $4.6 million for the three months ended June 30, 2011 compared with $3.8 million for the same period in 2010, an increase of $0.8 million, or 22.0%.  The increase was primarily due to higher travel and entertainment expenses in the second quarter of 2011 compared with the same period in 2010.

 

*Professional Services*

 

Professional services expense was $4.6 million for the three months ended June 30, 2011 compared with $2.2 million for the same period in 2010, an increase of $2.5 million.  The increase was primarily due to higher legal costs in the second quarter of 2011 compared with the same period in 2010.

 

*Income Tax (Benefit) / Expense*

 

Income tax benefit was $2.6 million for the three months ended June 30, 2011, which resulted in an effective tax rate of 38.3%, compared with income tax expense of $6.7 million for the same period in 2010, which resulted in an effective tax rate of 45.1%.  The change was, primarily due to the Company’s pretax loss and reduced state and local tax expense.

 

***Six Months Ended June 30, 2011 Compared with Six Months Ended June 30, 2010***

 

*Overview*

 

Total revenues were $159.2 million for the six months ended June 30, 2011 compared with $239.1 million for the same period in 2010, a decrease of $79.9 million, or 33.4%.  This decrease was primarily due to a decrease in investment banking revenues of $78.3 million, partially offset by an increase in principal transactions, net revenue of $7.0 million.

 

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Total expenses were $158.3 million for the six months ended June 30, 2011 compared with $203.9 million for the same period in 2010, a decrease of $45.6 million, or 22.4%.  Compensation and benefits expense decreased $51.4 million, which was partially offset by an increase in non-compensation expenses of $5.8 million.

 

We recorded net income of $0.4 million for the six months ended June 30, 2011 compared with $19.8 million, or $0.54 per diluted share, for the six months ended June 30, 2010.  For the six months ended June 30, 2010 our non-GAAP operating net income was $22.4 million, or $0.62 per diluted share, after adjusting for the 2006 one-time restricted stock awards granted to employees in connection with our IPO, which were fully vested and amortized in 2010.  See “—2010 Six Month Non-GAAP Financial Measures” for a reconciliation of our non-GAAP measures to their corresponding GAAP amounts**.**

 

The following table provides a comparison of our revenues and expenses for the periods presented (dollars in thousands):

 
| ** **                         | ** ** | **For the Six Months Ended** | ** ** | ** **           | ** ** | ** **        | ** ** |
|------------------------------------|------------|--------------------------------------------------|------------|----------------------|------------|-------------------|------------|
| ** **                         | ** ** | **June 30,**                                | ** ** | **Period-to-Period** | ** ** |
| ** **                         | ** ** | **2011**                                         | ** ** | **2010**             | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| **Revenues:**                      |       |                                             |       |                 |       |              |       |   |   |
| Investment banking                 |       | $                                                | 52,852     |                 | $          | 131,135           |       | $ | (78,283 | ) | (59.7 | )% |
| Commissions                        |       | 66,619                                           |       | 71,502               |       | (4,883            | )          | (6.8 | ) |
| Principal transactions, net        |       | 29,292                                           |       | 22,309               |       | 6,983             |       | 31.3 |   |
| Interest and dividend income       |       | 6,355                                            |       | 6,554                |       | (199              | )          | (3.0 | ) |
| Investment advisory fees           |       | 585                                              |       | 791                  |       | (206              | )          | (26.0 | ) |
| Other                              |       | 3,512                                            |       | 6,825                |       | (3,313            | )          | (48.5 | ) |
| **Total revenues**                 |       | 159,215                                          |       | 239,116              |       | (79,901           | )          | (33.4 | ) |
|                               |       |                                             |       |                 |       |              |       |   |   |
| **Expenses:**                      |       |                                             |       |                 |       |              |       |   |   |
| Compensation and benefits          |       | 95,529                                           |       | 146,937              |       | (51,408           | )          | (35.0 | ) |
| Non-compensation expenses:         |       |                                             |       |                 |       |              |       |   |   |
| Occupancy and equipment            |       | 11,288                                           |       | 11,115               |       | 173               |       | 1.6 |   |
| Communications and data processing |       | 17,783                                           |       | 15,815               |       | 1,968             |       | 12.4 |   |
| Brokerage and clearance            |       | 9,496                                            |       | 8,866                |       | 630               |       | 7.1 |   |
| Business development               |       | 9,261                                            |       | 7,261                |       | 2,000             |       | 27.5 |   |
| Professional services              |       | 8,338                                            |       | 9,213                |       | (875              | )          | (9.5 | ) |
| Interest                           |       | 665                                              |       | 525                  |       | 140               |       | 26.7 |   |
| Other                              |       | 5,945                                            |       | 4,214                |       | 1,731             |       | 41.1 |   |
| Total non-compensation expenses    |       | 62,776                                           |       | 57,009               |       | 5,767             |       | 10.1 |   |
| **Total expenses**                 |       | 158,305                                          |       | 203,946              |       | (45,641           | )          | (22.4 | ) |
| **Income before income taxes**     |       | 910                                              |       | 35,170               |       | (34,260           | )          | (97.4 | ) |
| **Income tax expense**             |       | 517                                              |       | 15,393               |       | (14,876           | )          | (96.6 | ) |
| **Net income**                     |       | $                                                | 393        |                 | $          | 19,777            |       | $ | (19,384 | ) | (98.0 | )% |

 

***2010 Six Month Non-GAAP Financial Measures***

 

Results for the six months ended June 30, 2011 were reported only on a GAAP basis, as all IPO restricted stock awards fully vested prior to that period.  The following table provides GAAP measures of compensation and benefits expense, compensation ratio, net income and diluted earnings per share for the six months ended June 30, 2010 and details with respect to reconciling the aforementioned line items on a non-GAAP basis for the six months ended June 30, 2010:

 

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| ** **                                                                                   | ** ** | **Six Months Ended   June 30, 2010**                            | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **(dollars in thousands, except   per share information)** | ** ** |
| **Compensation and benefits   expense:**                                                     |       |                                                                                |       |
| Compensation and benefits expense - GAAP basis                                               |       | $                                                                                   | 146,937    |   |
| Adjustment to exclude amortization expense of the   IPO awards (a)                      |       | (4,663                                                                              | )          |
| Non-GAAP operating compensation and benefits   expense (b)                              |       | $                                                                                   | 142,274    |   |
|                                                                                         |       |                                                                                |       |
| **Compensation ratio (c):**                                                                  |       |                                                                                |       |
| Compensation ratio - GAAP basis                                                              |       | 61.5                                                                                | %          |
| Non-GAAP operating compensation ratio (b)                                               |       | 59.5                                                                                | %          |
|                                                                                         |       |                                                                                |       |
| **Net income:**                                                                              |       |                                                                                |       |
| Net income - GAAP basis                                                                      |       | $                                                                                   | 19,777     |   |
| Adjustment to exclude amortization expense of the   IPO awards, net of tax benefit (a)  |       | 2,622                                                                               |       |
| Non-GAAP operating net income (b)                                                       |       | $                                                                                   | 22,399     |   |
|                                                                                         |       |                                                                                |       |
| **Diluted earnings per share:**                                                              |       |                                                                                |       |
| Diluted earnings per share - GAAP basis                                                      |       | $                                                                                   | 0.54       |   |
| Adjustment to exclude amortization expense of the   IPO awards, net of tax benefit (a)  |       | 0.08                                                                                |       |
| Non-GAAP operating diluted earnings per share   (b)                                     |       | $                                                                                   | 0.62       |   |

 

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| (a) |   | The adjustment represents the exclusion of   the compensation expense related to the amortization of the IPO restricted   stock awards, which were granted to employees in November 2006 and fully   vested in November 2010. |
|-----|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (b) |   | A Non-GAAP Financial Measure that management   believes provides the most meaningful comparison between historical, present   and future periods.                                                                                       |
| (c) |   | The compensation ratio was calculated by   dividing compensation and benefits expense by total revenues for each   respective period.                                                                                                   |

 

See the section entitled “-2010 Six Month Non-GAAP Financial Measures” for a discussion regarding the reasons why management believes a presentation of  Non-GAAP Financial Measures provides useful information for investors regarding our financial condition and results of operations.

 

***Revenues***

 

*Investment Banking*

 

Investment banking revenue was $52.9 million for the six months ended June 30, 2011 compared with $131.1 million for the same period in 2010, a decrease of $78.3 million, or 59.7%.  Capital markets revenue was $36.5 million for the six months ended June 30, 2011 compared with $100.2 million for the same period in 2010, a decrease of $63.7 million, or 63.6%, primarily due to fewer completed U.S. equity capital market transactions in 2011 as the total capital raising for banking companies decreased significantly.  M&A and advisory revenue was $16.4 million for the six months ended June 30, 2011 compared with $30.9 million for the same period in 2010, a decrease of $14.5 million, or 46.9%, primarily due to fewer completed M&A and advisory engagements.

 

*Commissions*

 

Commissions revenue was $66.6 million for the six months ended June 30, 2011 compared with $71.5 million for the same period in 2010, a decrease of $4.9 million, or 6.8%.  U.S. equity commissions were $46.8 million for the six months ended June 30, 2011 compared with $53.5 million for the same 2010 period, a decrease of $6.7 million, or 12.5%, reflecting lower market trading volumes.  Non-U.S. equity commissions were $19.8 million for the six months ended June 30, 2011 compared with $18.0 million for the same period in 2010, an increase of $1.8 million, or 10.0%, reflecting higher Asian commissions revenue.

 

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*Principal Transactions, Net*

 

Principal transactions, net revenue increased $7.0 million, or 31.3%, to $29.3 million for the six months ended June 30, 2011 compared with $22.3 million for the same period in 2010.  Trading for our own account, including firm investments, resulted in a net gain of $8.0 million for the six months ended June 30, 2011 compared with $4.6 million for the same period in 2010.  The realized gains and change in the fair value of our trust preferred backed collateralized debt obligations and related securities owned resulted in a net gain of $3.1 million for the six months ended June 30, 2011 compared with a net loss of $0.2 million for the same period in 2010.  Fixed income revenue was $20.6 million for the six months ended June 30, 2011 compared with $19.8 million for the same period in 2010. Equity market making resulted in a net loss of $2.4 million for the six months ended June 30, 2011 compared with a net loss of $2.0 million for the same period in 2010.

 

*Other*

 

Other revenues were $3.5 million for the six months ended June 30, 2011 compared with $6.8 million for the same period in 2010, a decrease of $3.3 million, or 48.5%.  The decrease was primarily due to lower fees earned by the loan portfolio sales group in 2011 compared with the same period in 2010.

 

***Expenses***

 

*Compensation and Benefits*

 

Compensation and benefits expense was $95.5 million for the six months ended June 30, 2011 compared with $146.9 million for the same period in 2010, a decrease of $51.4 million, or 35.0%.  Compensation and benefits as a percentage of total revenue (“compensation ratio”) was 60.0% for the six months ended June 30, 2011 compared with a non-GAAP operating compensation ratio, after adjusting for expenses associated with the IPO restricted stock awards, of 59.5% for the same period in 2010. See “-2010 Six Month Non-GAAP Financial Measures” for a reconciliation of our non-GAAP measures to their corresponding GAAP amounts.

 

*Communications and Data Processing*

 

Communications and data processing expense was $17.8 million for the six months ended June 30, 2011 compared with $15.8 million for the same period in 2010, an increase of $2.0 million, or 12.4%.  The increase was primarily due to higher market data costs in 2011 compared with the same period in 2010.

 

*Business Development*

 

Business development expense was $9.3 million for the six months ended June 30, 2011 compared with $7.3 million for the same period in 2010, an increase of $2.0 million, or 27.5%.  The increase was primarily due to higher travel and entertainment expenses in 2011 compared with the same period in 2010.

 

*Professional Services*

 

Professional services expense was $8.3 million for the six months ended June 30, 2011 compared with $9.2 million for the same period in 2010, a decrease of $0.9 million, or 9.5%.  The decrease was primarily due to lower legal costs in 2011 compared with the same period in 2010.

 

*Other*

 

Other expenses were $5.9 million for the six months ended June 30, 2011 compared with $4.2 million for the same period in 2010, an increase of $1.7 million, or 41.1%.  The increase was primarily due to higher foreign currency losses in 2011.

 

*Income Tax Expense*

 

Income tax expense was $0.5 million for the six months ended June 30, 2011, which resulted in an effective tax rate of 56.8%, compared with $15.4 million for the same period in 2010, which resulted in an effective tax rate of 43.8%.

 

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**Critical Accounting Policies and Estimates**

 

The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and of revenues and expenses during the reporting periods. We base our estimates and assumptions on historical experience and on various other factors that we believe are reasonable under the circumstances. The use of different estimates and assumptions could produce materially different results. For example, if factors such as those described in Item 1A under “Risk Factors” cause actual events to differ from the assumptions we used in applying the accounting policies, our results of operations, financial condition and liquidity could be materially adversely affected.

 

Our significant accounting policies are summarized in Note 2 of the Notes to Consolidated Financial Statements. On an ongoing basis, we evaluate our estimates and assumptions, particularly as they relate to accounting policies that we believe are most important to the presentation of our financial condition and results of operations. We regard an accounting estimate or assumption to be most important to the presentation of our financial condition and results of operations where the nature of the estimate or assumption is material due to the level of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, as well as the impact of the estimate or assumption on our financial condition or operating performance is material.

 

Based on these criteria, we believe the following to be our critical accounting policies:

 

***Fair Value of Financial Instruments***

 

We account for financial instruments that are being measured and reported on a fair value basis in accordance with FASB Accounting Standards CodificationTM (“ASC”) 820, *Fair Value Measurements and Disclosures.*ASC 820 defines fair value, establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements. ASC 820 defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an ordinary transaction between current market participants at the measurement date.”  See Note 3 of the Notes to Consolidated Financial Statements for a more detailed discussion of fair value of financial instruments.

 

ASC 825, *Financial Instruments,*provides entities the option to measure certain financial assets and financial liabilities at fair value with changes in fair value recognized in earnings each period.  ASC 825 permits the fair value option election, on an instrument-by-instrument basis, either at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument.  Such election must be applied to the entire instrument and not only a portion of the instrument. We applied the fair value option for certain eligible instruments, including all private equity securities and limited partnership interests, as these financial instruments had been accounted for at fair value prior to the fair value option election in accordance with the ASC 940, *Financial Services-Broker and Dealers.*

 

Financial instruments are valued at quoted market prices, if available. For financial instruments that do not have readily determinable fair values through quoted market prices, the determination of fair value is based upon consideration of available information, including types of financial instruments, current financial information, restrictions on dispositions, fair values of underlying financial instruments and quotations for similar instruments.

 

The valuation process for financial instruments may include the use of valuation models and other techniques. Adjustments to valuations derived from valuations models may be made when, in management’s judgment, either the size of the position in the financial instrument in a nonactive market or other features of the financial instrument such as its complexity, or the market in which the financial instrument is traded (such as counterparty, credit, concentration or liquidity) require that an adjustment be made to the value derived from the models. An adjustment may be made if a financial instrument is subject to sales restrictions that would result in a price less than the quoted market price. Adjustments from the price derived from a valuation model reflects management’s judgment that other participants in the market for the financial instrument being measured at fair value would also consider in valuing that same financial instrument and are adjusted for assumptions about risk uncertainties and market conditions. Results from valuation models and valuation techniques in one period may not be indicative of future period fair value measurements.

 

*Fair Value Hierarchy*

 

In determining fair value, we utilize various methods including the market and income approaches. Based on these approaches, we utilize assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable firm inputs. We utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques, we are required to provide the following information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the

 

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information used to determine fair values.   Financial instrument assets and liabilities carried at fair value have been classified and disclosed in one of the following three categories:

 
| Level 1 |   | Quoted market prices in active markets for   identical assets or liabilities.                 |
|---------|--------|-----------------------------------------------------------------------------------------------|
| Level 2 |   | Observable market based inputs or   unobservable inputs that are corroborated by market data. |
| Level 3 |   | Unobservable inputs that are not   corroborated by market data.                               |

 

Level 1 primarily consists of listed financial instruments whose value is based on quoted market prices, such as listed equities, equity options and warrants, and preferred stock. This category may also include U.S. Government and agency securities for which we typically receive independent external valuation information.

 

Level 2 includes those financial instruments that are valued using multiple valuation techniques, primarily market and income approaches.  The valuation methodologies utilized are calibrated to observable market inputs. We consider recently executed transactions, market price quotations and various assumptions, such as credit spreads, the terms and liquidity of the instrument, the financial condition, operating results and credit ratings of the issuer or underlying company, the quoted market price of publicly traded securities with similar duration and yield, time value, yield curve, as well as other measurements. In order to be classified as Level 2, substantially all of these assumptions would need to be observable in the marketplace or can be derived from observable data or supported by observable levels at which transactions are executed in the marketplace. Financial instruments in this category include certain corporate debt, CDOs primarily collateralized by banking and insurance company trust preferred and capital securities, certain convertible preferred stock, convertible debt, residential and commercial mortgage-backed securities and asset-backed securities.

 

Fair value of corporate debt, certain convertible preferred stock, convertible debt, residential and commercial mortgage-backed securities and asset-backed securities classified as Level 2 was determined by using quoted market prices, broker or dealer quotes, or alternate pricing sources with reasonable levels of price transparency.  Fair value of CDOs primarily collateralized by banking and insurance company trust preferred and capital securities was determined primarily by considering recently executed transactions of similar securities and certain assumptions, including the financial condition, operating results and credit ratings of the issuer or underlying companies.

 

Level 3 is comprised of financial instruments whose fair value is estimated based on multiple valuation techniques, primarily market and income approaches. The valuation methodologies utilized may include significant inputs that are unobservable from objective sources. We consider various market inputs and assumptions, such as recently executed transactions, market price quotations, discount margins, market spreads applied, the terms and liquidity of the instrument, the financial condition, operating results and credit ratings of the issuer or underlying company, the quoted market price of publicly traded securities with similar duration and yield, time value, yield curve, default rates, as well as other measurements.  Included in this category are certain corporate and other debt, including banking and insurance company trust preferred and capital securities, private equity securities and other investments including limited and general partnership interests.

 

Fair value of banking and insurance company trust preferred and capital securities was determined by utilizing a market spread method for each of the individual trust preferred and capital securities utilizing credit spreads for secondary market trades for trust preferred and capital securities for issues which were substantially similar to such positions based on certain assumptions. The key market inputs in this method are the discount margins, market spreads applied, the yield expectations for similar instruments and the financial condition, operating results and credit ratings of the issuer or underlying company.

 

Fair value of private equity securities was determined by assessing market-based information, such as performance multiples, comparable company transactions and changes in market outlook. Fair value of limited and general partnership interests was determined by using net asset values or capital statements provided by the general partner, as a practical expedient, updated for changes in market conditions up to the reporting date.  Private equity securities and limited and general partnership interests generally trade infrequently.

 

The variables affecting fair value estimates of these financial instruments can change rapidly and unexpectedly, which could have a significant impact on the fair value estimates of these financial instruments. Results from valuation techniques in one period may not be indicative of future period fair value measurements.

 

Our Level 3 assets were $83.4 million as of June 30, 2011, which represented approximately 13.3% of total assets and approximately 24.1% of total assets measured at fair value.

 

The availability of observable inputs can vary from product to product and is affected by a wide variety of factors, including, for example, the type of product, whether the product is new and not yet established in the marketplace, and other characteristics

 

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particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by management in determining fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.

 

Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measure. When market assumptions are not readily available, management’s assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date. We use prices and inputs that are current as of the measurement date, including during periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2, or from Level 2 to Level 3.

 

*Fair Value of Financial Instruments Control Process*

 

We employ a variety of control processes to validate the fair value of our financial instruments, including those derived from utilizing valuation techniques. Individuals outside of the trading departments obtain independent prices, as appropriate. Where a valuation technique is used to determine fair value, recently executed comparable transactions and other observable market data are considered for purposes of validating assumptions underlying the valuation technique. These control processes are designed to assure that the values used for financial reporting are based on observable inputs wherever possible. In the event that observable inputs are not available, the control processes are designed to assure that the valuation approach utilized is appropriate and consistently applied and that the assumptions are reasonable. These control processes include reviews by personnel with relevant expertise who are independent from the trading desks, including involvement by senior management.

 

***Income Taxes***

 

Deferred tax assets and liabilities are recognized for the future tax attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period that includes the enactment date.   In the event it is more likely than not that a deferred tax asset will not be realized, a valuation allowance will be recorded.

 

We apply ASC 740, *Income Taxes,*which prescribes a single, comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the Company has taken or expects to take on its tax returns.  Income tax expense is based on pre-tax accounting income, including adjustments made for the recognition or derecognition related to uncertain tax positions.

 

**Contractual Obligations**

 

As of June 30, 2011, our contractual obligations with respect to operating leases have not significantly changed since December 31, 2010.  Investment commitments were $14.3 million, including $8.7 million to an affiliated fund, as of June 30, 2011.  We had an underwriting commitment of approximately $136.9 million as of June 30, 2011, which was subsequently settled in July 2011.

 

**Recently Issued Accounting Standards, Not Yet Adopted**

 

In June 2011, the FASB issued ASU No. 2011-05*, Presentation of Comprehensive Income (Topic 220)*.**ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. An entity can elect to present items of net income and other comprehensive income in one continuous statement or in two separate, but consecutive, statements.  ASU 2011-05 is effective for interim and annual periods beginning after December 15, 2011. We expect to adopt ASU 2011-05 on January 1, 2012.  We are currently evaluating the presentation alternatives permitted under this new guidance. ASU 2011-05 will not have a monetary impact on our financial statements.

 

In May 2011, the FASB issued ASU No. 2011-04*, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs. * ASU 2011-04 clarifies how a principal market is determined, addresses the fair value measurement of instruments with offsetting market or counterparty credit risks and the concept of valuation premise and highest and best use, extends the prohibition on blockage factors to all three levels of the fair value hierarchy and requires additional disclosures. ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011. We

 

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expect to adopt ASU 2011-04 on January 1, 2012. We are currently evaluating the requirements of this new guidance and the potential impact on our financial statements.

 

**Off-Balance Sheet Arrangements**

 

In the normal course of our principal trading activities, we may enter into transactions in financial instruments with off-balance-sheet risk. These financial instruments, such as options, warrants, futures contracts and mortgage-backed to-be-announced securities, contain off-balance-sheet risk inasmuch as ultimate settlement of these transactions may have market and/or credit risk in excess of amounts which are recognized in the consolidated financial statements. Transactions in listed options and warrants are conducted through regulated exchanges, which clear and guarantee performance of counterparties. As described in Item 3 — “Quantitative and Qualitative Disclosures About Market Risk — Credit Risk,” through indemnification provisions in our clearing agreements with our clearing brokers, customer activities may expose us to off-balance sheet credit risk, which we seek to mitigate through customer screening and collateral requirements.

 

We are a member of various exchanges that trade and clear securities, options, warrants and or futures contracts. As a member of these exchanges, we may be required to pay a proportionate share of the financial obligations of another member who may default on its obligations to the exchange. To mitigate these performance risks, the exchanges often require members to post collateral as well as meet minimum financial standards. While the rules governing different exchange memberships vary, our guarantee obligations generally would arise only if the exchange had previously exhausted its resources. In addition, any such guarantee obligation would be apportioned among the other non-defaulting members of the exchange. Any potential contingent liability under these membership agreements cannot be estimated. We have not recorded any contingent liability in our consolidated financial statements for these agreements and currently believe that any potential requirement to make payments under these agreements is remote**.**

 

**Liquidity and Capital Resources**

 

We are the parent of Keefe, Bruyette & Woods, Inc. (“Keefe”), Keefe, Bruyette & Woods Limited (“KBWL”), Keefe, Bruyette & Woods Asia Limited (“KBWAL”), KBW Asset Management, Inc. (“KBWAM”) and KBW Ventures, Inc.  Dividends and other transfers from our subsidiaries are our primary source of funds to satisfy our capital and liquidity requirements. Applicable laws and regulations, primarily the net capital rules discussed below, restrict dividends and transfers from Keefe, KBWL and KBWAL to us. Our rights to participate in the assets of any subsidiary are also subject to prior claims of the subsidiary’s creditors, including customers and trade creditors of Keefe, KBWL, KBWAL and KBWAM.

 

We monitor and evaluate the composition and size of our assets and operating liabilities. As a result of our market making, customer and principal activities, the overall size of total assets and operating liabilities fluctuate from period to period. Our assets generally consist of cash and cash equivalents, financial instruments, resale agreement balances and receivables.

 

Our operating activities in the period generate and use cash resulting from net income or loss and fluctuations in our current assets and liabilities. The most significant fluctuations in current assets and liabilities have resulted from changes in the level of customer activity, changes in the types of and value of the financial instruments owned on a principal basis and shifts in our investment positions in response to changes in our trading strategies or prevailing market conditions. We have not relied significantly on leverage. Our moderate use of leverage does not expose us to potential requirements to sell assets as a result of margin calls due to decreases in the fair value of financial instruments.

 

We have historically satisfied our capital and liquidity requirements through capital from our stockholders and internally generated cash from operations. As of June 30, 2011, we had liquid assets of $192.1 million, consisting of cash and cash equivalents and receivables from clearing brokers.  From time to time, we may obtain a short term subordinated loan from our U.S. clearing broker or others to support underwriting activity over a very short time. We may also finance fixed income positions with securities sold under repurchase agreements as well as utilizing margin borrowing from the clearing brokers.

 

Although we believe such sources remain available, we do not currently plan to obtain such short-term subordinated financing from any outside source. We do not currently have any long term debt obligations and therefore, are not exposed to the breach of any debt covenants.

 

We have an effective “universal” shelf registration statement on form S-3 on file with the SEC.  This shelf registration statement enables us to sell, from time to time, the securities covered by the registration statement in one or more public offerings. The securities covered by the registration statement include common stock, preferred stock, depositary shares, senior debt securities, subordinated debt securities, warrants, stock purchase contracts, and stock purchase units. We may offer any of these securities independently or together in any combination with other securities. In addition, selling shareholders may use the shelf registration

 

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statement to offer, from time to time, shares of our common stock.  Our status as a “well-known seasoned issuer,” as such term is defined in the federal securities laws, enables us, among other things, to enter the public markets and consummate sales off the shelf registration statement in rapid fashion and with little or no notice.

 

The timing of cash bonus payments to our employees may significantly affect our cash position and liquidity from period to period. While our employees are generally paid salaries semi-monthly during the year, cash bonus payments, which make up a larger portion of total compensation, are generally paid once a year. Cash bonus payments for a given year are generally paid in February of the following year. We continually monitor our liquidity position and believe our available liquidity will be sufficient to fund our operations over the next twelve months.

 

Our dividend policy currently contemplates the payment of a quarterly cash dividend. On April 27, 2011, our board of directors declared a cash dividend of $0.05 per share of common stock (equaling an aggregate payment of $1.8 million based on 36.5 million total shares outstanding on April 29, 2011, including shares underlying vested restricted stock units), which cash dividend was paid on June 15, 2011 to stockholders of record as of the close of business on June 3, 2011.  On July 28, 2011, our board of directors declared a cash dividend of $0.05 per share of common stock (equaling an aggregate payment of approximately $1.8 million based on approximately 36 million total shares outstanding on July 29, 2011, including shares underlying vested restricted stock units), which cash dividend will be paid on September 15, 2011 to stockholders of record as of the close of business on September 2, 2011.

 

On July 28, 2010, our board of directors authorized management to repurchase in the aggregate up to $70.0 million worth of shares of our common stock from time to time at prevailing market prices in open market purchases, in private negotiated transactions, in block purchases or otherwise, as may be determined by  management.  During the three months ended June 30, 2011, we repurchased 1,139,222 shares of our common stock at an average price of $20.94 per share, for an aggregate purchase price of $23.9 million. As of June 30, 2011, we had $27.9 million remaining of total repurchase amount authorized under the program.

 

The dividend to be paid on September 15, 2011 and any additional purchases under our share repurchase program are expected to be funded from available cash resources.  Our board of directors may, in its sole discretion, amend or repeal our dividend policy at any time and decrease or eliminate dividend payments and our management may terminate the share repurchase program at any time.  If we had insufficient cash to pay dividends in the amounts set forth in our dividend policy or to buy back shares, we would need either to reduce or eliminate such programs or fund a portion of them with borrowings or financings from other sources. Shares of common stock repurchased are expected to be cancelled immediately and therefore reduce common stock and paid in capital.

 

As a registered broker-dealer and member firm of FINRA, as successor to the NYSE, Keefe is subject to the uniform net capital rule of the SEC. We use the basic method permitted by the uniform net capital rule, which generally requires that the ratio of aggregate indebtedness to net capital cannot exceed 15 to 1. FINRA, as successor to the NYSE, may prohibit a member firm from expanding its business or paying dividends if resulting net capital would be below the regulatory minimum required capital. We do not expect that these requirements will materially impact our ability to meet our current and future obligations.

 

At June 30, 2011, Keefe’s net capital under the SEC’s Uniform Net Capital Rule was $101.8 million, or $99.5 million in excess of the minimum required net capital.

 

KBWL is subject to the capital requirements of the U.K. Financial Services Authority. KBWL’s total capital resources of $34.4 million exceeded the capital resources requirement by approximately $22.9 million at June 30, 2011.

 

***Cash Flows***

 

*Six months ended June 30, 2011.** *** Cash decreased $48.0 million during the six months ended June 30, 2011, primarily due to cash flows used in financing activities of $54.9 million, partially offset by cash provided by operating activities of $8.2 million.

 

Net income, after adjusting for non-cash expense and revenue items of $33.7 million, provided cash of $34.1 million.  The non-cash items consisted of expenses of $29.5 million resulting from the amortization of stock based compensation expenses, $2.8 million related to depreciation and amortization expense and $1.4 million related to deferred income tax expense. Cash of $24.4 million was used as a result of an increase in operating assets, primarily attributable to a decrease in receivables from clearing brokers of $60.4 million, partially offset by an increase in financial instruments owned, at fair value of $41.9 million.  Cash of $50.2 million was used as a result of a decrease in operating liabilities, primarily attributable to a decrease in accrued compensation and benefits of $105.9 million, partially offset by an increase in financial instruments sold, not yet purchased, at fair value of $58.7  million.

 

We used $2.2 million in our investing activities for the purchase of fixed assets. Cash used in financing activities was $54.9 million primarily as a result of the cancellation of restricted stock in satisfaction of withholding tax requirements and the cancellation of shares of common stock related to the stock repurchase program.

 

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*Six months ended June 30, 2010.** *** Cash decreased $25.9 million during the six months ended June 30, 2010, primarily due to cash used in operating and financing activities of $12.2 million and $9.7 million, respectively.

 

Net income, after adjusting for non-cash expense and revenue items of $26.2 million, provided cash of $46.0 million.  The non-cash items consisted of expenses of $24.1 million resulting from the amortization of stock-based compensation and $2.5 million related to depreciation and amortization, partially offset by a $0.4 million deferred income tax benefit. Cash of $61.3 million was used as a result of an increase in operating assets, primarily attributable to an increase in financial instruments owned, at fair value of $99.4 million, partially offset by decreases in receivables from clearing brokers and accounts receivable of $31.5 million and $10.9 million, respectively.  Cash of $3.1 million was provided as a result of an increase in operating liabilities, primarily attributable to increases in financial instruments sold, not yet purchased, at fair value and accounts payable, accrued expenses, and other liabilities of $23.3 million and $12.9 million, respectively, partially offset by a decrease in accrued compensation and benefits of $41.1 million.

 

We used $2.0 million in our investing activities for the purchase of fixed assets. Cash used in financing activities was $9.7 million, primarily as a result of the cancellation of restricted stock in satisfaction of withholding tax requirements.

 

**Item 3.            Quantitative and Qualitative Disclosures About Market Risk.**

 

***Market Risk***

 

Market risk represents the risk of loss that may result from the change in value of a financial instrument due to fluctuations in its market price. Market risk may be exacerbated in times of trading illiquidity when market participants refrain from transacting in normal quantities and/or at normal bid-offer spreads. Our exposure to market risk is directly related to our role as a financial intermediary in customer trading and to our market making and investment activities. Market risk is inherent in financial instruments.

 

We trade in equity and debt securities as an active participant in both listed and over the counter markets. We typically maintain securities in inventory to facilitate our market making activities and customer order flow. We may use a variety of risk management techniques and hedging strategies in the ordinary course of our trading business to manage our exposures.

 

In connection with our sales and trading business, management also reviews reports appropriate to the risk profile of specific trading activities. Management monitors risks in its trading activities by establishing and periodically reviewing limits for each trading desk and reviewing daily trading results, inventory aging, securities concentrations and ratings. Typically, market conditions are evaluated and transaction details and securities positions are reviewed. These activities seek to ensure that trading strategies are within acceptable risk tolerance parameters. Activities include price verification procedures, position reconciliations and reviews of transaction bookings. We believe these procedures, which stress timely communications between traders, trading management and senior management, are important elements of the risk management process.

 

The following table sets forth our monthly high, low and average long/short financial instruments owned, including the market value of listed options and warrants, for the six months ended June 30, 2011:

 
| ** **                                 | ** ** | **High**                             | ** ** | **Low** | ** ** | **Average** | ** ** |
|--------------------------------------------|------------|--------------------------------------|------------|---------|------------|-------------|------------|
| ** **                                 | ** ** | **(dollars in thousands)** | ** ** |
| **Long Value:**                            |       |                                 |       |    |       |        |       |
| Equities                                   |       | $                                    | 208,068    |    | $          | 114,612     |       | $ | 167,972 |   |
| Corporate and other debt                   |       | $                                    | 100,504    |    | $          | 51,364      |       | $ | 77,113 |   |
| U.S. Government and agency securities      |       | $                                    | 9,025      |    | $          | —      |       | 2,303 |   |
| Mortgage and other asset-backed securities |       | $                                    | 127,826    |    | $          | 4,369       |       | $ | 44,254 |   |
| Other investments                          |       | $                                    | 59,543     |    | $          | 51,336      |       | $ | 56,881 |   |
| **Short Value:**                           |       |                                 |       |    |       |        |       |
| Equities                                   |       | $                                    | 118,816    |    | $          | 74,577      |       | $ | 94,733 |   |
| Corporate and other debt                   |       | $                                    | 19,632     |    | $          | 5,414       |       | $ | 10,996 |   |
| U.S. Government and agency securities      |       | $                                    | 62,650     |    | $          | 5,531       |       | $ | 26,822 |   |

 

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***Interest Rate Risk***

 

Interest rate risk represents the potential loss from adverse changes in market interest rates. As we may hold debt securities from time to time, we are exposed to interest rate risk arising from changes in the level and volatility of interest rates and in the shape of the yield curve. Interest rate risk is primarily managed through the use of short positions in U.S. Government and agency securities.

 

***Credit Risk***

 

We engage in various securities underwriting, trading and brokerage activities servicing a diverse group of domestic and foreign corporations and institutional investor clients. Our exposure to credit risk associated with the nonperformance of these clients in fulfilling their contractual obligations pursuant to securities transactions can be directly impacted by volatile trading markets which may impair the client’s ability to satisfy its obligations to us. Our principal activities are also subject to the risk of counterparty nonperformance. Pursuant to our Clearing Agreements with Pershing LLC and Pershing Securities Limited, we are required to reimburse our clearing broker without limit for any losses incurred due to a counterparty’s failure to satisfy its contractual obligations. In these situations, we may be required to purchase or sell financial instruments at unfavorable market prices to satisfy obligations to other customers or counterparties. We seek to mitigate the risks associated with sales and trading services through active customer screening and selection procedures and through requirements that clients maintain collateral in appropriate amounts where required or deemed necessary.

 

***Inflation Risk***

 

Because a significant portion of our assets are relatively liquid in nature, they are not significantly affected by inflation. However, the rate of inflation affects such expenses as employee compensation and communications charges, which may not be readily recoverable in the prices of services we offer. To the extent inflation results in rising interest rates and has other adverse effects on the securities markets, it may adversely affect our combined financial condition and results of operations in certain businesses.

 

***Operational Risk***

 

Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. We are focused on maintaining our overall operational risk management framework and minimizing or mitigating these risks through continual assessment, reporting and monitoring of potential operational risks.

 

**Item 4.*           *Controls and Procedures.**

 

Our management, with the participation of the Chief Executive Officer and the Chief Financial Officer (our principal executive officer and principal financial officer, respectively), evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act as of the end of the period covered by this report.

 

Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) are effective to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by us in such reports is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions.

 

There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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**PART II-OTHER INFORMATION**

 

**Item 1.            Legal Proceedings.**

 

Our businesses, as well as the financial services industry generally, are subject to extensive regulation. From time to time, in the ordinary course of our business, we are involved in judicial, regulatory and arbitration proceedings and inquiries concerning matters arising in connection with the conduct of our businesses.

 

**Sentinel Litigation**

 

On January 12, 2009, Frederick J. Grede, as Liquidation Trustee and Representative of the Estate of Sentinel Management Group, Inc., filed a lawsuit in the United States District Court for the Northern District of Illinois against Keefe and against Delores E. Rodriguez; Barry C. Mohr, Jr.; and Jacques De Saint Phalle (all former employees of Keefe) and Cohen & Company Securities, LLC.  Ms. Rodriguez and Mr. Mohr were employed by Cohen & Company subsequent to being employed by Keefe and the complaint relates to activities by them at both Keefe and their subsequent employer.

 

The complaint alleges that Keefe recommended and sold to Sentinel Management Group structured finance products that were unsuitable for purchase.  The complaint alleges the following causes of action against Keefe, aiding and abetting breach of fiduciary duty by an officer and director of Sentinel; commercial bribery; violations of federal and state securities laws; violation of the Illinois Consumer Fraud Act; negligence; unjust enrichment; and avoidance and recovery of fraudulent transfers.  The complaint specifies that Sentinel sustained a loss associated with the sale of securities sold by Keefe of $4.9 million and interrogatory responses from the Trustee in discovery now contend that Sentinel lost $5.6 million; however various causes of action in the complaint seek to recover amounts substantially in excess of that amount up to an amount in excess of $130 million, representing amounts paid for all securities purchased from Keefe regardless of suitability or whether there were losses on these securities.  Keefe believes the claims are without merit and will defend these claims vigorously. On April 1, 2009, Keefe filed a Motion to Dismiss the Complaint.  On July 29, 2009, the court denied most of the relief sought in Keefe’s Motion to Dismiss, though it dismissed the Illinois Consumer Fraud Act claim and granted Keefe’s motion to sever the Trustee’s case against Keefe from the case against Cohen.  On August 29, 2010, Keefe served the Trustee with a Motion for Summary Judgment on Count VIII of the complaint.  On December 20, 2010, the Court granted a joint motion by Keefe and the trustee to stay the case for ninety days.  On March 15, 2011, the Court granted a joint motion by Keefe and the Trustee to stay the case for an additional ninety days, through June 13, 2011.  On June 15, 2011, the Court granted another joint motion by Keefe and the Trustee to stay the case for an additional ninety days, through September 13, 2011.

 

On August 26, 2009, Keefe filed a Third-Party Complaint against Eric A. Bloom, the former President and CEO of Sentinel, and Charles K. Mosley, the former Senior Vice President and head trader of Sentinel, alleging fraud and seeking contribution for any damages for which Keefe is held liable to the Trustee.  The court stayed and severed this Third-Party Complaint on October, 7, 2009.

 

On May 21, 2009 the Trustee filed an additional complaint in the same court and against the same parties (the “Second Complaint”).  The Trustee claimed to be acting in the Second Complaint in his capacity as liquidation trustee and as an assignee of claims of Sentinel’s customers.  The Second Complaint makes substantially the same allegations as the complaint described above.  Keefe believes the claims in the Second Complaint are also without merit and will defend these claims vigorously.  On July 28, 2009, in *Grede v. Bank of New York Mellon* et al filed in the same court, in which the Trustee alleged similar customer claims as an assignee, the court dismissed the Trustee’s claims due to lack of standing.  The Trustee has appealed the court’s dismissal of *Grede v. Bank of New York Mellon* and, on August 19, 2009, the court stayed the Second Complaint while the Trustee’s appeal in *Grede v. Bank of New York Mellon* is pending.   On March 18, 2010, the Seventh Circuit reversed the district court, holding that the Trustee had standing to pursue the assigned customer claims against Bank of New York Mellon.  Currently, the Second Complaint remains stayed.

 

**Item 1A.        ****Risk Factors.**

 

There have not been any material changes from the risk factors previously disclosed in Part I, Item 1A. of our Annual Report on Form 10-K for the year ended December 31, 2010.

 

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**Item 2.           ****Unregistered Sales of Equity Securities and Use of Proceeds.**

 

There were no unregistered sales of equity securities during the quarter ended June 30, 2011 (dollars in thousands, except per share information).

 
| **Period**                      | ** ** | **Total Number   of Shares   Purchased   (1)(3)** | ** ** | **Average Price   Paid Per   Share** | ** ** | **Total Number of   Shares Purchased   as Part of Publicly   Announced Plans   or Programs (2)(3)** | ** ** | **Approximate Dollar   Value of Shares that   May Yet Be   Purchased Under the   Plans or Programs** | ** ** |
|---------------------------------|------------|-------------------------------------------------------------|------------|------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| April 1, 2011 to April 30, 2011 |       | 197,099                                                     |       | $                                              | 23.73      |                                                                                                                                             | 192,800    |                                                                                                                                                   | $          | 47,182 |   |
| May 1, 2011 to May 31, 2011     |       | 437,773                                                     |       | $                                              | 21.27      |                                                                                                                                             | 436,100    |                                                                                                                                                   | $          | 37,906 |   |
| June 1, 2011 to June 30, 2011   |       | 524,193                                                     |       | $                                              | 19.58      |                                                                                                                                             | 510,322    |                                                                                                                                                   | $          | 27,906 |   |
| TOTAL                           |       | 1,159,065                                                   |       | $                                              | 20.93      |                                                                                                                                             | 1,139,222  |                                                                                                                                                   |       |   |

 

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| (1)    |   | 19,843 shares were purchased other than as   part of a publicly announced plan or program. These shares repurchased are   equal to the number of shares that were withheld from certain employees to   fund applicable taxes owed by them as a result of the vesting of restricted   stock awards.                                                                                                                                                                                                                                                                                                                                                                                                             |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| (2)    |   | On July 28, 2010 our board of directors   approved and adopted a stock repurchase program, which authorizes management   to repurchase up to $70.0 million worth of shares of our common stock from   time to time (at prevailing market prices) in open market purchases, in   private negotiated transactions, in block purchases or otherwise, as may be   determined by management. This stock repurchase program, which was publicly   announced on July 29, 2010, will terminate once the aggregate price of all   shares repurchased under the program equals the maximum authorized repurchase   amount of $70.0 million, although management may elect to terminate the   program at an earlier time. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| (3)    |   | All shares were immediately retired upon   purchase by us.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |

 

**Item 3.            Defaults Upon Senior Securities.**

 

None.

 

**Item 4.            Other Information.**

 

None.

 

**Item 5.            Exhibits.**

 

See Exhibit Index.

 

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**SIGNATURES**

 

 Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Date: August 5, 2011

 
|   | KBW, INC. |
|--------|-----------|
|   |      |
|   |      |   |
|   | By:       | /s/ JOHN G. DUFFY |
|   |      | Name: John G. Duffy |
|   |      | Title: Chairman and Chief Executive Officer |
|   |      |   |
|   |      |   |
|   | By:       | /s/ ROBERT GIAMBRONE |
|   |      | Name: Robert Giambrone |
|   |      | Title: Chief Financial Officer |

 

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**EXHIBIT INDEX**

 
| **Exhibit   Number** | ** ** | **Description**                                                                                                                                                       |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1                 |       | Certification of the Chief Executive Officer   pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                        |
| 31.2                 |       | Certification of the Chief Financial Officer   pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                        |
| 32.1                 |       | Certification of Chief Executive Officer   pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906   of the Sarbanes-Oxley Act of 2002. |
| 32.2                 |       | Certification of Chief Financial Officer   pursuant to 18 U.S.C. Section 1350, as adopted pursuant to   Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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