**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-K**

 
| **ý** | **Annual  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934  for the fiscal year ended December 31, 2005**                                                                                                                                                                                                                                                                                                                      |
|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
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| **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: 001-15251**

 

**LaBRANCHE& CO INC.**

(Exact Name of Registrant as Specified in Its Charter)

 

| **Delaware**                    | ** ** | **13-4064735**      |
|---------------------------------|------------|---------------------|
| (State or Other Jurisdiction of |       | (I.R.S. Employer    |
| Incorporation or Organization)  |       | Identification No.) |

 

**One Exchange Plaza, New York, New York 10006**

(Address of Principal Executive Offices) (Zip Code)

 

**(212) 425-1144**

(Registrant’s telephone number, including area code)

 

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

 
| **Title of each Class:** | ** ** | **Name of each exchange on which registered:** |
|-----------------------------------------|------------|------------------------------------------------------------------------------|
| ** **                              | ** ** | ** **                                                                   |
| **Common Stock, par value $0.01**       | ** ** | **New York Stock Exchange**                                                  |

 

Securities registered pursuantto Section 12(g) of the Act:    **None**

 

Indicate bycheck mark if the registrant is a well-known seasoned issuer, as defined inRule 405 of the Securities Act. Yes o   No ý

 

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 orSection 15(d) of the Exchange Act. Yes o   No ý

 

Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter 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 ý   No o

 

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment tothis Form 10-K. o

 

Indicate bycheck mark whether the registrant is a large accelerated filer, an acceleratedfiler, or a non-accelerated filer. See definition of “accelerated filer” and “largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Largeaccelerated filer  o   Acceleratedfiler  ý   Non-acceleratedfiler  o

 

Indicate bycheck mark whether the registrant is a shell company (as defined inRule 12b-2 of the Act).   Yes o   No ý

 

The aggregate marketvalue of the Common Stock held by non-affiliates of the registrant, based uponthe last sale price of the Common Stock reported on the New York Stock Exchangeon June 30, 2005, was approximately $377,715,000.

 

The number of shares of Common Stock outstanding as ofMarch 10, 2006 was 60,714,487.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Portions of the registrant’s definitive ProxyStatement for the registrant’s 2006 Annual Meeting of Stockholders to be heldon May 16, 2006 are incorporated by reference in this Annual Report on Form10-K in response to Part II, item 5 and Part III, items 10, 11, 12, 13 and 14.

 

 

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**PARTI**

** **

*ThisAnnual Report on Form 10-K and the documents incorporated by reference containforward-looking statements that have been made pursuant to the provisions ofthe Private Securities Litigation Reform Act of 1995. These forward-lookingstatements are based on current expectations, estimates and projections aboutthe registrant’s industry, management’s beliefs and certain assumptions made bymanagement. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,”“seeks,” “estimates,” variations of such words and similar expressions areintended to identify such forward-looking statements. These statements are notguarantees of future performance and are subject to certain risks, uncertaintiesand assumptions that are difficult to predict; therefore, actual results maydiffer materially from those expressed or forecasted in any suchforward-looking statements. Unless required by law, the registrant undertakesno obligation to update publicly any forward-looking statements, whether as aresult of new information, future events or otherwise. However, readers shouldcarefully review the risk factors set forth herein and in other reports ordocuments the registrant files from time to time with the Securities andExchange Commission (the “SEC”).*

* *

# **Item 1.**                                   BUSINESS.

# ** **

## **Overview**

## ** **

We are the parent corporation of LaBranche& Co. LLC, one of the oldest and largest Specialists in equity securitieslisted on the New York and American Stock Exchanges. We are also the parent ofLaBranche Structured Holdings, Inc. (“LSHI”), the holding company for a groupof entities that are Specialists and Market-Makers in options, futures andexchange-traded funds, or “ETFs,” traded on various exchanges. As a Specialistand Market-Maker, we play an integral role in the central auction market byacting as the exclusive broker (i.e., agent) or market-maker (i.e., principal)in our portfolio of listed company stocks, options, futures and ETFs. TheSpecialist facilitates buying and selling of securities of the companies itrepresents by bringing timely information, critical expertise, and neededliquidity to the forefront of the auction marketplace. LaBranche FinancialServices, Inc. (“LFSI”), another of our operating subsidiaries, providessecurities execution, clearing and direct-access floor brokerage services toinstitutional investors.

 

LSHI is the sole member of LaBrancheStructured Products, LLC, a New York limited liability company (“LSP”),LaBranche Structured Products Specialists LLC, a New York limited liabilitycompany (“LSPS”), LaBranche Structured Products Europe Limited, a UnitedKingdom single member private company (“LSPE”), and LaBranche StructuredProducts Hong Kong Limited, a Hong Kong single member private company (“LSPH”). LSPis a registered broker-dealer that operates as a specialist in options, ETFsand futures on the AMEX, the New York Board of Trade (“NYBOT”), and thePhiladelphia Stock Exchange (“PHLX”), and as a market-maker in options, ETFsand futures on several exchanges. LSPS is a registered broker-dealer andoperates as a specialist in ETFs traded on the NYSE. LSPE was organized tooperate as a market-maker for ETFs in Europe traded on the London StockExchange and the Euroex and Euronext Exchanges, and was registered as abroker-dealer with the United Kingdom’s Financial Securities Authority in March2006. LSPH was organized to operate as a market-maker for ETFs and 

 

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engage in hedging transactionsin Asia, and is in the process of registering as a broker-dealer with Hong Kong’sSecurities and Futures Commission.

 

We are also the sole stockholder of LABDRServices, Inc. (“LABDR”) and the sole owner of LaBranche & Co. B.V. (“BV”).LABDR provides disaster recovery services and back-up facilities to otherLaBranche subsidiaries. BV represents LaBranche & Co. LLC in Europeanmarkets and provides client services to LaBranche & Co. LLC’s Europeanlisted companies.

 

We are a Delaware corporation that was incorporatedin June 1999. Our principal executive offices are located at One ExchangePlaza, 25th Floor, New York, New York 10006, and our telephone number is (212)425-1144. Our Internet address is www.labranche.com. We make available free ofcharge, on or through the investor relations section of our website, annualreports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form8-K and amendments to such reports filed or furnished pursuant to Section 13(a)or 15(d) of the Securities Exchange Act of 1934 as soon as reasonablypracticable after we electronically file such material with, or furnish it to,the Securities and Exchange Commission (“SEC”). These filings also areavailable on the SEC’s website at www.sec.gov.

 

Also available on our website are ourCorporate Governance Guidelines, our Code of Conduct (applicable to all ourdirectors, officers and employees) and the charters for our Audit Committee,Compensation Committee and Nominating & Corporate Governance Committee. Withinthe time period required by the SEC and the NYSE, if applicable, we will postany amendment and/or any waiver of our Code of Conduct.

 

We currently view our business as operatingprincipally in two separate segments: the Specialist and Market-Making segmentand the Execution and Clearing segment.

 

Our Specialist and Market-Making segment currentlyincludes the operations of LaBranche & Co. LLC, LSP, LSPS, LABDR and BV. Asof December 31, 2005, the entities within our Specialist and Market-Makingsegment were specialists on the NYSE, the AMEX, the NYBOT, and PHLX, as well asmarket-makers on several exchanges. Collectively, our Specialist andMarket-Making segment is the specialist for 563 common stock listings and 19ETFs on the NYSE and 91 common stock listings, 640 options listings, 5 futuresand 30 ETFs on the AMEX, PHLX, NYBOT and other exchanges, and is a market-makerfor ETFs, options and futures on various exchanges.

 

Our Execution and Clearing segment currently includesthe operations of LFSI, which provides securities execution and clearingservices to retail and institutional clients and correspondents. LFSI’s centralfocus is to bring the customer closer to the point of sale and provide pricediscovery at the highest possible speed and lowest possible cost.

 

Compensation and related benefits for certainemployees and certain company-wide professional fees are allocated to our twoprincipal business segments. However, certain revenues and administrative andcorporate overhead expenses, which consist primarily of interest on our publicdebt, are not specifically allocated to our two principal business segments andthus are 

 

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treated as “other” revenues and expenses. Adescription of our principal business segments is presented below.

 

**OurSpecialist and Market-Making Segment**

 

***TheSpecialist and Market-Making Industry***

 

Generally, trading of securities on the NYSE, the AMEXand other auction-based securities markets is conducted through an auctionprocess managed by the specialist for that security. The specialist is a broker-dealerwho applies for and, if accepted, is assigned the role to maintain a fair andorderly market in its specialist securities. The number of specialist units onthe NYSE and the AMEX has decreased substantially over the past several yearsdue to consolidation within the industry. There are currently seven NYSEspecialist firms, of which the five largest, as ranked by number of specialiststocks, were responsible for 95.2% and 95.1% of the average daily share volumetraded on the NYSE in 2005 and 2004, respectively. There are currently 14equity specialist firms, 16 option specialists and 11 ETF specialists on theAMEX. Many other firms act as market-makers in these securities on the AMEX, addingliquidity to the market in addition to the exclusive specialists’ obligation todo so. There are also many other market-makers on the other exchanges on whichwe make markets.

 

On the NYSE, specialist firms for cash equitysecurities compete for the original listing of these securities through anallocation process organized by the NYSE. As part of this allocation process,companies seeking a listing may select a specialist firm in one of two ways.Under the first method, the NYSE’s allocation committee selects the specialistfirm based on specific criteria. Under the second method, available sinceMarch 1997, the listing company requests that the allocation committeeselect three to five potential specialist firms suitable for the security,based on criteria specified by the listing company. The issuer then meets witheach specialist firm presented by the allocation committee. Within one weekafter meeting the competing specialist firms, the listing company selects aspecialist firm. Currently, almost every company listing on the NYSE chooses itsspecialist firm under the second allocation method.

 

On the AMEX, the specialist firm for each equitysecurity, option and future compete for the original listing of that securitythrough an allocation process organized by the AMEX. The AMEX has an allocationcommittee, which selects the specialist firm for each security based onspecified criteria, giving weight to the desires of the listed company. On boththe NYSE and AMEX, the specialist for each ETF is chosen by either the exchangeor the ETF issuer.

 

When assigned a particular security, the specialistfirm agrees to specific obligations. The specialist is required to maintain, asfar as practicable, a fair and orderly market. This implies that the tradingwill have reasonable depth and price continuity, so that, under normalcircumstances, a customer may buy or sell the security in a manner consistentwith market conditions. A specialist firm helps market participants achieveprice improvement in their trades because the best bids and offers arediscovered through the auction process. In performing its obligations, thespecialist firm is exposed to all transactions that occur in each of itsspecialist securities, either through electronic orders or floor brokers. Inany given transaction, the specialist firm may act as:

 

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•                  an auctioneer by setting openingprices for its specialist securities and by matching the highest bids with thelowest offers, permitting buyers and sellers to trade directly;

 

•                  a facilitator bringing togetherbuyers and sellers who do not know of each other in order to execute a tradewhich would not otherwise occur;

 

•                  an agent for broker-dealers who wishto execute transactions as instructed by their customers (typically, theseorders are limit orders entrusted to the specialist at prices above or belowthe current market price); or

 

•                  a principal using its own capital tobuy or sell securities for its own account.

 

In addition to normal specialist functions, aspecialist in ETFs may provide “seed” money to the ETF, creating shares in suchETF by purchasing and depositinga group of securities and/or cash into the fund

 

The specialist firm’s decision to buy or sell itsspecialist securities as principal may be based on obligation or inclination.For example, the specialist firm may be obligated to buy or sell its specialistsecurities to counter short-term imbalances in the prevailing market, thushelping to maintain a fair and orderly market in that stock. At other times,the specialist firm may be inclined to buy or sell the securities as principalbased on market conditions. In actively-traded securities, the specialist firmcontinually buys and sells its specialist securities at varying pricesthroughout each trading day. The specialist firm’s goal and expectation is toprofit from differences between the prices at which it buys and sells thesesecurities. In fulfilling its specialist obligations, however, the specialistfirm may, at times, be obligated to trade against the market, or may beprevented from participating in a trade, which could adversely impact itsprofitability. In addition, the specialist firm’s trading practices are subjectto a number of restrictions, as described in “Rules Governing Our Specialistand Market-Making Activities.”

 

### ***RecentTrends in Trading***

### * *

Specialist andmarket-making firms generate revenues by executing trades, either as agent orprincipal, in their specialist and market-making securities. Specialist firms’ revenuesgenerally are significantly impacted by the share volume of trading on theapplicable market. Market activity historically has tended to be cyclical, andtrading volumes from 2002 through 2004 evidenced a decline in individual andinstitutional trading.

 

Since 2000,ETFs have grown as an alternative to other investments. ETFs are share-basedinvestment funds that pool investors’ capital and trade on stock exchangesthroughout the day at prices determined by the market. ETFs attempt to imitatea stock market index or narrowly defined basket, rather than actively add orremove stocks. As a result, these ETFs offer investors the diversificationadvantages of a mutual fund, while also possessing certain tax and otheradvantages of traditional stocks. According to data provided by the InvestmentCompany Institute, ETF assets grew to approximately $296.0 billion as ofDecember 31, 2005 from $226.2 billion as of December 31, 2004, representing agrowth rate of approximately 31%. Some of the more recognizable ETFs are the Nasdaq100 Tracking Stock (QQQ)TM, Standard & Poors Depositary 

 

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Receipts (SPDRs)TM and Vanguard Index Participation Receipts (VIPERS)TM.We believe the increase in program trading during this period is at leastpartially related to the growth in ETFs because hedging trades executed bymarket makers tend to be done electronically and in small increments.

 

In 2005, trading volumes in cash equity securitiesgrew, as well. Average daily trading volume on the NYSE increased in 2005 to1.6 billion shares from approximately 1.4 billion shares in each of 2004 and2003. This increase in trading volume, in part, helped to stabilize our cashequity specialist revenues in 2005. This stabilization follows a period ofdeclining trading volume from 2002 through 2004, which may have beenattributable to:

 

•                  a relatively slow return by theretail investor to the equity markets following the 2000-2002 bear market;

 

•                  popular interest in alternativeinvestments, particularly residential real estate and commodities; and

 

•                  the continued emergence of a newclass of investors, including hedge funds, that invests in non-traditionalinstruments.

 

In addition to thehistorically lower trading volume on the NYSE, we believe several other factorsnegatively impacted equity specialists’ revenues from 2002 through 2004,including:

 

•                  declining volatility of stock pricesas measured by the CBOE’s Volatility Index®, a key measure of marketexpectation of near-term volatility and investor sentiment. As volatility inmarkets diminishes, the need for specialists to employ capital to mitigatevolatility decreases, which in turn reduces specialists’ level of principalparticipation; and

 

•                  increased program trading as apercentage of total NYSE average daily share volume. Program trading and thedecimalization of stock prices often results in a number of smaller ordersexecuted through the NYSE’s SuperDOT® system. As a result, block-tradingstrategies have become less prevalent.

 

Although these factorscontinued to adversely affect our cash equity specialists’ results in 2005, ourrevenues from our cash equities specialist business stabilized in 2005.

 

The recent changes ininvestor behavior from concentration on individual stocks to alternatives such assector and index trading, as well as ETFs, also has substantially fueled thegrowth for trading in options, futures and ETFs. Accordingly, over the past fewyears we have increased our focus on our options, futures and ETFs specialistand market making-operations.

 

The majority of trades in NYSE-listed stocks takeplace on the NYSE. In 2005, specialist firms handled approximately 76% oftrades in NYSE-listed stocks, a decline from approximately 79% in 2004. Thepercentage of trades in NYSE-listed stocks on the floor of the NYSE is affectedas follows:

 

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•                  some stocks are listed on multipleexchanges, such as regional exchanges, and trades take place on those exchangesas well as in the over-the-counter market and through alternative tradingsystems (“ATSs”); and

 

•                  at times, significant volume inNYSE-listed stocks takes place before and after regular NYSE trading hours.

 

Technological advances have contributed to increasedtrading through ATSs, such as electronic communications networks, or ECNs, andelectronic crossing systems. While the first ECN was created in 1969, most ofthe ECNs currently in operation were started only during the past severalyears. These systems electronically facilitate the matching of buy and sellorders that are entered by their network members. If a match does not occur,some ATSs will forward unfilled orders to other ATSs or to exchanges such asthe NYSE. Some of these networks also allow limited negotiation between membersto facilitate a match. These ATSs generally limit trades over their systems totheir members, who are typically large financial institutions, professionaltraders or brokerage firms. Additionally, some ATSs are being developed tofacilitate trading by retail investors. In April 1999, the SEC ruled thatthese networks are allowed, and in specified cases are required, to registerand become subject to regulation as stock exchanges. It is possible that thepresence of these ATSs and other emerging electronic trading systems havecontributed to the overall decline in the percentage of equity shares traded onthe NYSE over the past five years from approximately 83% to approximately 76%.Notwithstanding the presence of these ATSs and other emerging trading technologies,the NYSE remains the predominant trading marketplace for listed securities. Itis unclear, however, how ATSs and other new technologies, in addition to otherrecent events (such as the merger of the NYSE and Archipelago, the hybrid modeland Regulation NMS, all as described below), will continue to affect the futurepercentages of trading in listed stocks on the NYSE.

 

In response to the development of ATSs, in 2001 theNYSE launched Network NYSE, a suite of market information and auto-executionproducts offering new choices to different types of customers. Some examples ofthese products include:

 

•                  NYSE Direct+®, an automatic executionservice for limit orders up to 1,099 shares, enabling investors toautomatically execute orders at the national best bid offer;

 

•                  NYSE Open Book(SM), an online marketdata product allowing subscribers to view information on the NYSE limit orderbooks; and

 

•                  Institutional Express(SM), anelectronic gateway to satisfy large order requirements and the growinginformation needs of NYSE member firms and their institutional customers.

 

***Our Specialist and Market-MakingOperations***

 

Due largely to acquisitions and an increase in the number of ourspecialist stocks from 1997 through 2001, we historically experienced strongrevenue growth in our Specialist and Market-Making segment during that period. From2002 through 2004, however, our aggregate specialist and market making revenuesdeclined from $401.2 million in 2002 to $245.0 million in 2004.

 

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Our revenues stabilized in 2005, and our aggregate specialist andmarket-making revenues increased to an aggregate of $283.6 million. Theseresults were due, in part, to an overall increase in market trading and ourstrategic response to the above-described recent changes in investor behaviorfrom concentration on individual stocks to alternatives such as sector andindex trading, as well as ETFs. Over the past few years, we have increased ourfocus on our options, futures and ETFs specialist and market making-operations.The Specialist and Market-Making segment has been employing more capital in itstrading activities on more exchanges, and in derivative products and ETFs, inorder to seek growth opportunities while maintaining a leadership position inthe cash equities specialist market. Our initial acquisition strategy andstrategic organic growth has enabled us to gather products in our specialistand market-making operations on additional exchanges and in additionalcountries. A restructuring of certain of our specialist and market-makingsubsidiaries has allowed us to develop our specialist and market-makingoperations across various exchanges and marketplaces. These initiatives havealso enabled us to better allocate and deploy our capital, workforce andtechnology across our operations in order to more efficiently seek outopportunities as they arise. We also believe that a recently proposed NYSErule, pending approval by the SEC, could substantially reduce the liquid assetrequirements of our NYSE specialist operations, and could provide us withadditional capital to efficiently redeploy our working capital to newopportunities in other products and markets.

 

## ***Our NYSE and AMEX EquitySpecialists***

## ** **

Our NYSE and AMEX equity specialist operations are conducted throughour LaBranche & Co. LLC subsidiary. As a specialist in equity securitiesand rights listed on the NYSE and in equity securities on the AMEX, LaBranche& Co. LLC’s role is to maintain, as far as practicable, a fair and orderlymarket in its specialist stocks. In doing so, it provides a service to itslisted companies, and to the brokers, traders and investors who trade in itsspecialist stocks. As a result of our commitment to providing high qualityspecialist services, we have developed a solid reputation among ourconstituencies, including investors, members of the Wall Street community andour listed companies.

 

Since our initial public offering, we have increasedthe number of our listed companies and specialist market share both internallyand through acquisitions. Since the NYSE implemented its new specialistallocation process in March 1997, we have been selected by 194 new listedcompanies, resulting from 490 listing interviews through December 31, 2005. Inaddition, we have acquired eleven specialist operations since 1997, addingapproximately 500 NYSE common stocks and 52 AMEX common stocks. As a result ofinternal growth and selective acquisitions, our LaBranche & Co. LLCsubsidiary currently is a leading NYSE specialist as illustrated by thefollowing data:

 

•                  the dollar volume traded of stocksfor which LaBranche & Co. LLC was the specialist on the NYSE in 2005 was$3.4 trillion, or 24.7% of total 2005 NYSE dollar volume, and was $2.8trillion in 2004, or 25.4% of total 2004 NYSE dollar volume;

 

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•                  the share volume traded of stocks forwhich LaBranche & Co. LLC was the specialist on the NYSE in 2005 was 102.1 billion,or 26.3% of total 2005 NYSE share volume, and was 96.1 billion in 2004, or27.1% of total 2004 NYSE share volume; and

 

•                  as of December 31, 2005, the totalnumber of LaBranche & Co. LLC’s NYSE common stock listings was 563, or21.3% of all NYSE common stock listings, and as of December 31, 2004, its totalnumber of NYSE common stock listings was 580, or 22.1% of all NYSE common stocklistings.

 

By these threemeasurements, LaBranche & Co. LLC was one of the largest NYSE specialistfirms as of December 31, 2005 and 2004. In addition, LaBranche & Co. LLCacted as the specialist for 240 other NYSE-listed securities (e.g., preferredstocks and derivative securities).

 

As of December 31, 2005, LaBranche & Co. LLC’slisted companies included:

 

•                  105 of the S&P 500 Indexcompanies;

 

•                  30 of the S&P 100 Indexcompanies; and

 

•                  7 of the 30 companies comprising theDow Jones Industrial Average (“DJIA”). Our DJIA stocks are 3M Co., AltriaGroup, Inc., American Express Company, E.I. du Pont de Nemours and Company,Exxon Mobil Corporation, Merck & Co. Inc., and SBC Communications Inc.(renamed AT&T Inc after its acquisition of AT&T Corp. in 2005).

 

*Our**Options, Futures and ETFs Specialists and Market-Makers*

 

Through September 25, 2002, our AMEX specialistoperations for both equities and options were conducted entirely by LaBranche& Co. LLC. Since then, in order to continue our expansion into new productsand markets, we have conducted our options, ETFs and other derivativesspecialist and market-making business activities on the AMEX, NYBOT, PHLX,Chicago Board Options Exchange® (“CBOE”), and other exchanges through our LSPsubsidiary, and have conducted our NYSE ETFs specialist operations through ourLSPS subsidiary. Our equity specialist activities on the AMEX continue to beconducted by LaBranche & Co. LLC.

 

In August andSeptember 2005, we reorganized our options, futures and ETFs specialist andmarket-making operations under our LSHI holding company subsidiary in order tofacilitate the liquidity and working capital management of our specialist andmarket-making activities. During 2005, our options, futures and ETFs specialistand market-making operations continued to expand substantially, through our LSPand LSPS subsidiaries. From 2002 through 2005, we expanded our market-makingactivities to different derivative products as well as to other exchanges. Asof December 31, 2005, we acted as the specialist for 640 options, 5 futures and30 ETFs listed on the AMEX, NYBOT, PHLX and other exchanges, and acted as amarket-maker in ETFs,  options andfutures on several exchanges. We also were the specialist in 19 ETFs listed onthe NYSE.

 

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We are responsible for creating a fair and orderlymarket in the trading of our specialist options, futures and ETFs. In doing so,we may at times be obligated to trade against the market, adversely impactingthe profitability of the trade or creating a position that may not necessarilybe desired. To hedge the risk of our derivative positions, we may buy or sellthe underlying asset(s). As a market-maker, we also trade these derivativesecurities as principal out of both obligation and inclination.

 

As a registered market-maker in options, ETFs andfutures, our Specialist and Market-Making segment generally engages in a courseof dealings that is reasonably calculated to contribute to the maintenance of afair and orderly market. We also may hedge these positions with the underlyingassets or other financial instruments. In our market-making function, we bringimmediacy and liquidity to the markets when we choose to participate.

 

In January 2005, we formed LSPE to be a market-maker for ETFs traded onthe London Stock Exchange, Euroex and Euronext exchanges. In August 2005, weformed LSPH to be a market-maker in ETFs traded in Hong Kong and to conduct hedgingtransactions in Hong Kong markets related to our specialist and market-makingactivities. As part of our LSP-entity reorganization in August and September2005, both LSPE and LSPH became wholly-owned subsidiaries of LSHI. LSPE andLSPH have yet to commence operations. LSPE was registered as a broker-dealerwith the UK’s Financial Securities Authority (“FSA”) in March 2006, and LSPH isin the process of registering as a broker-dealer with Hong Kong’s Securitiesand Futures Commission (“SFC”). Upon commencement of operations, we expect LSPEand LSPH to strengthen our specialist and market-making relationships with U.S.ETF issuers abroad, which we believe will help our Specialist and Market-Makingsegment further diversify its exchange base and better manage its risk.

 

### *Our SpecialistSupport Services*

### * *

In April 2002, BV was organized to represent LaBranche& Co. LLC in European markets and to provide client services to LaBranche& Co. LLC’s European-listed companies. BV was established under Dutch law,and its office is in Amsterdam, The Netherlands. Through a services agreement,BV provides monitoring and trading services for LaBranche & Co. LLC’sspecialist stock positions, as specifically directed by appropriatelydesignated LaBranche & Co. LLC personnel. In addition, BV markets theservices of our specialist entities to existing and prospective EuropeanNYSE-listed issuers.

 

For detailed financial information in connection withour Specialist and Market-Making segment, please see “Management’s Discussionand Analysis of Financial Condition and Results of Operations—Specialist andMarket-Making Segment Operating Results” and Note 17 to the FinancialStatements filed herewith.

 

### ***RulesGoverning Our Specialist and Market- Making Activities***

### * *

Under NYSE and AMEX rules, a specialist has a duty tomaintain, as far as practicable, a fair and orderly market in its specialistsecurities. In order to fulfill its obligations, the specialist must at timestrade for its own account, even when it may adversely affect the specialist’s 

 

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profitability. In addition, under certaincircumstances, the specialist is prohibited from making trades as principal inits specialist stocks. The specialist’s obligations are briefly describedbelow.

 

*Requirement to Trade as Principal*.A specialist must buy and sell securities as principal when necessary tominimize an actual or reasonably anticipated short-term imbalance betweensupply and demand in the auction market. The specialist must effect thesetransactions when their absence could result in an unreasonable lack ofcontinuity and/or depth in its specialist stocks. The specialist is notexpected to act as a barrier in a rising market or as support in a fallingmarket, but must use its own judgment to try to keep such price increases anddeclines equitable and consistent with market conditions.

 

A specialist must makecontinuous two-sided quotations that are timely and that accurately reflectmarket conditions. In making these quotations, the specialist’s transactionsare calculated to contribute to the maintenance of price continuity withreasonable depth.

 

In addition, the specialist cannot be in a controlrelationship with any of its listed companies. Generally, this means a specialistmay not acquire more than 5% of any common or preferred issue of its specialiststocks and may not own 10% or more of any common or preferred stock. Aspecialist may not hold any position as an officer or director with, receivepayments or loans from, or engage in certain business transactions with any ofits listed companies.

 

*New SEC-Proposed Market Rules*.In February 2004 and again onAugust 2, 2004, the NYSE proposed to expand its Direct+® trading system toeliminate the current limits on size, timing and types of orders that currentlymay be executed electronically through the Direct+® system and thereby create aso-called hybrid market intended to incorporate a number of new trade executionoptions while preserving the option of access to auction price discovery anddeep liquidity. Specifically, the NYSE’s proposals would eliminate the1,099-share restriction on NYSE Direct+® orders, as well as the prohibitionagainst entering orders for the same account within 30 seconds, and wouldpermit market orders and immediate-or-cancel orders to be eligible for Direct+®execution. In addition, the NYSE’s proposals contain a number of other newfeatures designed to “create a liquidity pool accessible for electronic andauction price discovery; the opportunity for benefits associated with humanjudgment at the point of sale; and accountable performance with focusedcommunication by specialists.” The NYSE has begun the technological worknecessary to implement its proposed changes in the NYSE Direct+® system and, inDecember 2004, extended the pilot phase of this Direct+® system throughDecember 23, 2005, subject to review and approval of these proposed changes bythe SEC. It is possible that the NYSE may again extend this pilot phase inorder to complete the technological work to finalize the Direct+® system.

 

In February 2004,the SEC proposed new rules which would require, subject to certain exceptions,that every “order execution facility” (*i.e.*,every national securities exchange, national securities association thatoperates an order execution facility, alternative trading system, exchangespecialist and market maker, OTC market maker, block positioner and any otherbroker or dealer that executes orders internally by trading as principal orcrossing orders as agent) establish, maintain and enforce polices andprocedures reasonably designed to prevent the execution of a “trade-through” (*viz*., the execution of an order at a pricethat is inferior to a price displayed in another market) in its market. Asoriginally proposed, this requirement would apply 

 

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to all incoming orders in “NMS Stocks,” including all NASDAQ, NYSE andAMEX-listed stocks and any order execution facility that executes ordersinternally within its market, whether or not that market posts its best bid andoffer, and would have (1) allowed customers (and broker dealers tradingfor their own accounts) to “opt-out” of the protections of the rule byproviding informed consent to the execution of their orders, on anorder-by-order basis, in one market without regard to the possibility ofobtaining a better price in another market, and (2) taken into account thedifferences between the speed of execution in electronic versus manual marketsby providing an automated market with the ability to trade through anon-automated market at a price up to a certain amount away from the best bidor offer displayed by the non-automated market.

 

On April 6, 2005, the SEC adopted Regulation NMS (“RegulationNMS”). Regulation NMS is expected to become effective in the second half of2006 and could have a significant impact on the regulation of trading onsecurities exchanges and marketplaces. Specifically, the rule establishesinter-market protection against “trade-throughs” for all NMS stocks andprotection of only those quotations that are immediately accessible throughautomatic execution. The rule generally does not contain the “opt-out”exception described above that would have allowed market participants to disregarddisplayed quotations, but does include a number of exceptions to the “opt-out”proscription to help ensure that the rule is workable with high-volumesecurities. The rule also is anticipated to protect the best bids and offers ofeach exchange, Nasdaq, and the NASD’s Alternative Display Facility. While it istoo early to anticipate the impact that Regulation NMS could have on ourtrading, it is possible that the rule could materially affect our compliancecosts and alter the competitive environment in which our Specialist andMarket-Making segment functions. Refer to “—Recent Trends in NYSE Trading” for detailed discussion.

 

*The Recently-Consummated NYSEMerger.*On April 20, 2005, Archipelago Holdings, Inc.,entered into a definitive merger agreement with the NYSE, as amended on July20, 2005, pursuant to which Archipelago and NYSE agreed to combine theirbusinesses and become wholly-owned subsidiaries of NYSE Group, Inc., anewly-created, for-profit and publicly-traded holding company. On March 7,2006, the merger was consummated. Consequently, the former NYSE business is nowheld in three separate entities under the NYSE Group: New York Stock ExchangeLLC; NYSE Market, Inc. and NYSE Regulation, Inc. New York Stock Exchange LLCwill only hold the equity interests of NYSE Market and NYSE Regulation.

 

NYSE Market has issuedtrading licenses to all registered broker-dealers wishing to conduct businesson the NYSE, subject to payment of a fee to NYSE Market. These trading licensesreplaced the prior trading rights provided by the ownership or lease of an NYSEmembership prior to the NYSE/Archipelago merger. In January 2006, weparticipated in a “Dutch” auction for these trading licenses and successfullybid for 90 trading licenses in our Specialist and Market-Making segment (fiveadditional licenses were obtained for our Execution and Clearing segmentoperations).Organizations holding trading licenses generally are subject to the same rulesthat were applicable to member organizations prior to the merger. Each tradinglicense entitles its holder to physical and electronic access to the tradingfacilities of NYSE Market, subject to such limitations and requirements as maybe specified, and in each case 

 

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includes the right to designate a natural person, subject topre-approval by NYSE Regulation, who may have physical access to the floor andfacilities of NYSE Market to trade.

 

In connection with the NYSE/Archipelago merger, theNYSE amended NYSE Rule 103B, the Exchange Allocation Policy. The NYSE Market isgranted the right to determine the number and identity of specialist firms fromwhich a new listing issuer may choose its specialist, provided the groupconsists of at least four specialist firms. The NYSE Market and the issuer areprovided with the same material with respect to each specialist firm applicantas would have been reviewed by the Allocation Committee in allocating a listing.We, therefore, do not expect the NYSE merger to materially affect the specialistallocation process or our specialist operations on the NYSE.

 

## ***ListedCompany Services***

## ** **

We are committed to providing our listed companieswith a high level of service, in addition to our specialist functions on thetrading floor. Our corporate relations effort is devoted to serving our listedcompanies by providing them with current market information and insight ongeneral market trends. We organize an annual educational conference thatreviews trends in the securities industry and equity markets. For newly listedcompanies, we provide additional investor relations support services to assistthe companies with their transition to the exchange on which they are listed.These services add significant value for companies considering a listing on anexchange.

 

## ***Competitionin the Specialist and Market-Making Industry***

## ** **

We obtain each of our new listings on the NYSE andAMEX by participating in an allocation process. As part of this process, eitherthe allocation committee of the NYSE or AMEX or the listing company chooses thespecialist firm. We compete with other specialist firms based on a number offactors, including:

 

•                  the strength of our capital base;

 

•                  our willingness to commit our owncapital and trade for our own account while conducting our specialistoperations; and

 

•                  the ancillary services we offer ourspecialist companies, such as providing information on the trading activity intheir stocks.

 

The specialist industry experienced a vast andaccelerated consolidation over the period of 1995 through 2001 with the fivelargest specialist units, as ranked by their number of specialist stocklistings, accounting for 95.2% of the daily share volume traded on the NYSE in2005 as compared to 95.1% in 2004. The competition for obtaining newly listedcompanies is intense. We expect competition to continue and intensify as someof our competitors may have greater financial resources and product serviceofferings.

 

As more fully described above in “—The Recently-Consummated NYSE Merger,”under the newly released NYSE Rule 103B, “The Exchange Allocation Policy,” theNYSE Market is granted the right to determine the number and identity of specialistfirms from which a new listing

 

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issuer may choose a specialist, provided the groupconsists of at least four specialist firms. The NYSE Market and the issuer willbe provided with the same material with respect to each specialist firmapplicant as would have been reviewed by the Allocation Committee in allocatinga listing. We, therefore, do not expect the NYSE merger to materially affectthe specialist allocation process or our specialist operations on the NYSE.

 

## ***OurSpecialist and Market-Making Segment’s Competitive Position***

## ** **

We are committed to providing the highest qualityservice to our various constituencies. Our strong competitive position is basedon the following factors:

 

•                  *Leading Position in theSpecialist and Market-Making Market.* We have a long-standingreputation as a leading specialist firm. We have successfully grown ourbusiness and improved our services through widely varying market conditions.Our cash equities specialist operations during 2005 accounted for 25.1% of thedollar value and 26.4% of the share volume traded on the NYSE, and 124 of ourspecialist common stock listings were securities of non-U.S. companies as ofDecember 31, 2005. By these measures, we were the largest specialist firm onthe NYSE. We are also one of the largest ETF specialist firms on the NYSE andAMEX, as the specialist in 49 ETFs out of an aggregate of 201 listed ETFs as ofDecember 31, 2005. We are also one of the largest market-makers on variousexchanges in options futures and ETFs.

 

•                  *Diverse and High QualitySpecialist and Market-Making Securities.* The companies for whosesecurities we are specialist and market-maker operate in a variety ofindustries, including financial services, media, oil and gas, retail,technology and telecommunications. Many of these companies are leaders in theirrespective fields. They range in market capitalization from some of thesmallest on the NYSE and AMEX to some of the largest and most well-known. Beingthe specialist and market-maker in the securities of industry leaders couldbenefit us as these leading companies expand their businesses through internalgrowth and acquisitions.

 

•                  *Ability to deploy capitalefficiently.*We haveemployed more capital in our trading activities on more exchanges, and inderivative products and ETFs, in seeking growth opportunities while maintaininga leadership position in the cash equities specialist market. Our initialacquisition strategy and strategic organic growth has enabled us to gatherproducts in our specialist and market-making operations on additional exchangesand in additional countries. A restructuring of certain of our specialist andmarket-making subsidiaries has allowed us to develop our specialist andmarket-making operations across various exchanges and market places. Theorganizational structure of our Specialist and Market-Making segment shouldenable us to better allocate and deploy our capital, workforce and technologyacross our operations in order to more efficiently seek out opportunities asthey arise.

 

•                  *Strong Trading andTechnology Skills.* We utilize our trading skills to activelyparticipate as principal in trading our specialist and market-makingsecurities. We significantly improve liquidity in our specialist andmarket-making securities and 

 

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quickly and ably create ETFs for our ETFs specialistcustomers, particularly during periods of market volatility. Additionally, asthe securities trading marketplace becomes more electronic, as furtherevidenced by the NYSE’s proposed hybrid market model, we are developingelectronic trading capabilities which will allow us to interact in a “fast” andmore automated auction market. We have a technology group which developsalgorithmic models that may be used in electronic trading markets and in theproposed hybrid model.

 

•                  *Innovative Customer-Oriented Services.* In addition to ourspecialist and market-making functions on the trading floor, we provide ourspecialist-based listed companies with a high level of service (*e*.*g*., detailedinformation on the trading activity of their securities), as well as customizedsupport services to assist in their investor relations efforts.

 

•                  *Completed Acquisitions and Strategic Organic Growth.* Since1997, we have acquired eleven specialist operations adding approximately 500NYSE common stocks and 52 AMEX common stocks, solidifying our position as oneof the leading NYSE specialist firms, as well as establishing and expanding ourpresence on the AMEX. We also have continued our organic growth by creating thecurrent LSHI structure to facilitate our expansion within the options, futuresand ETFs specialist and market-making market. Our growth as a specialist inETFs has particularly played a role in this growth, as we are now thespecialist in 49 ETFs traded on the NYSE and the AMEX.

 

**Our Execution and Clearing Segment**

 

## ***RecentTrends in Execution and Clearing Industry***

## ** **

The traditional clearing industry has, over the last few years,consolidated down to a small number of highly capitalized and extremely focusedcompetitors. Mostly owned by or affiliated with large investment or commercialbanks, these few top competitors command the dominant share of thefully-disclosed correspondent clearing market. As a result, barriers to entryhave risen and the capital expenditures necessary to maintain market share haveincreased.

 

As the result of years of advances in order delivery and executiontechnology, trading costs for customers across all categories (retail,institutional, etc.) have dropped dramatically. These advances in tradingtechnologies, and the resulting economies afforded the customer, have alsoengendered an entirely new style of investment management, where algorithmsembedded in servers generate, direct and account for orders with minimal humaninteraction. Orders generated and delivered over purely electronic platformsnow account for more than 50% of NYSE volume.

 

In addition, there has arisen a number ofnon-traditional execution venues that bypass the traditional exchanges and ECN’sin which institutions can trade directly with each other without exposingorders to market-wide price verification.

 

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***OurExecution and Clearing Operations***

 

LFSI, which is the sole operating entity constituting our Execution andClearing segment, provides clearance and execution services to a range ofclients. To our broker dealer correspondents, we provide traditional clearanceservices. To our own customers, which include institutions and individuals, weprovide a range of customized execution services, including direct-accessbrokerage.

 

LFSI does not focus on commoditized bulk clearance and execution. LFSItargets businesses where our flexibility, customization and a versatileclearance platform provide us with a competitive advantage.

 

Our Institutional Executive Group (“IEG”) provides institutions withhighly customized service built around special execution needs. IEG focuses ontimely executions with minimal market impact. IEG handles and clears trades onevery major domestic stock exchange, with straight through processing fromorder origination to trade execution. IEG also provides soft dollar executionand other administrative services to institutional customers. IEG has activerelationships with over 255 accounts and is developing its business nationwide.

 

For detailed financial information in connection withour Execution and Clearing segment, please see “Management’s Discussion andAnalysis of Financial Condition and Results of Operations—Execution andClearing Segment Operating Results” and Note 17 to the Financial Statementsfiled herewith.

 

### ***Regulatory Matters***

### * *

The securities industry in the United States issubject to regulation under both Federal and state laws. In addition, the SEC,NYSE, AMEX and other regulatory organizations require compliance with their rulesand regulations.

 

Our broker-dealer subsidiaries are subject toregulations concerning the operational and financial aspects of theirrespective businesses. They are subject to registration requirements of variousgovernment entities and self-regulatory organizations (commonly referred to asSROs) with which they must comply before they may conduct business. Ourbroker-dealer subsidiaries are also subject to laws, rules and regulationsrequiring them to comply with financial reporting rules, trade practices,capital structure obligations and record retention requirements. Failure, oreven the assertion by a regulatory organization of failure, by any of ourbroker-dealer subsidiaries to comply with any of these laws, rules orregulations could result in censure, fine, the issuance of cease-and-desistorders or the suspension or disqualification of its directors, officers oremployees and other negative consequences, which could have an adverse effecton our business. Refer to “Legal Proceedings—Specialist Trading Investigations.”From time to time, in the ordinary course of business, we have been subject tofines for violations of such laws, rules or regulations.

 

Our trading subsidiaries are under constant review bythe NYSE, the AMEX and the other exchanges on which they conduct operations onall aspects of their operations and financial condition. In particular, as partof the price discovery mechanism implemented by the NYSE, 

 

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every NYSE specialist transaction is publishedimmediately and broadcast worldwide. The NYSE’s Market Surveillance Divisionemploys sophisticated monitoring and requires adherence to stringent rulesapproved by the SEC in its examination of NYSE specialists’ trading in allstocks. The NASD’s AMEX Regulation Division monitors and reviews specialists’adherence to AMEX rules and regulations, as well.

 

The USA PATRIOT Act of 2001 (the “PATRIOT Act”), whichwas extended on March 9, 2006, contains anti-money laundering and financial transparencylaws and mandates the implementation of various new regulations that apply tobroker-dealers and other U.S. financial institutions, including procedures forverifying client identity at account opening, and obligations to monitor clienttransactions and report suspicious activities. Through its provisions, thePATRIOT Act seeks to promote cooperation among U.S. financial servicescompanies, regulators and law enforcement officials in identifying parties thatmay be involved in terrorism or money laundering. The increased obligations offinancial institutions, including our broker-dealer subsidiaries, require theimplementation and maintenance of internal control procedures which haveincreased our costs and may subject us to liability.

 

### *Capital Requirements*

### * *

Our broker-dealer subsidiaries are also subject to netcapital requirements as required by SEC Rule 15c3-1, and net liquid assetrequirements as required by the NYSE and AMEX. Please refer to “Management’sDiscussion and Analysis of Financial Condition and Results ofOperations—Liquidity and Capital Resources” section for our broker-dealersubsidiaries’ capital requirements and actual amounts.

 

Failure by any of our broker-dealer subsidiaries tomaintain the required net capital and/or net liquid assets may subject it tosuspension or revocation of SEC registration or suspension or expulsion by therespective exchanges of which it is a member.

 

## **Employees**

## ** **

As of December 31, 2005,we had 525 full-time employees, of which 382 were employed at our Specialistand Market-Making segment, 96 were employed at our Execution and Clearingsegment, and 47 were employed at the holding company.

 

**Item 1A. RISKFACTORS**

 

The following risk factors should becarefully considered in evaluating our business and us because they have asignificant impact on our business, operating results, financial condition, andcash flows. If any of these risks actually occurs, our business, financialcondition, operating results and/or cash flows could be adversely affected.

 

*The market structure in which weoperate may change, making it difficult for us to maintain our levels ofprofitability.*

 

The market structure in which we operate is subjectto changes that could adversely affect our financial condition and results ofoperations. Most notably, the NYSE’s recently-consummated

 

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merger with Archipelago, aswell as recent proposed changes in the NYSE’s automated trade execution systemand the SEC’s recent proposed structural changes in the U.S. equity tradingmarkets, may have an adverse effect on our business.

 

In February 2004 and again on August 2,2004, the NYSE proposed to expand its Direct+® trading system to eliminate thecurrent limits on size, timing and types of orders that currently may beexecuted electronically through the Direct+® system and thereby create aso-called hybrid market intended to incorporate a number of new trade executionoptions while preserving the option of access to auction price discovery anddeep liquidity. Specifically, the NYSE’s proposals would eliminate the1,099-share restriction on NYSE Direct+® orders, as well as the prohibitionagainst entering orders for the same account within 30 seconds, and wouldpermit market orders and immediate-or-cancel orders to be eligible for Direct+®execution. In addition, the NYSE’s proposals contain a number of other newfeatures designed to “create a liquidity pool accessible for electronic andauction price discovery; the opportunity for benefits associated with humanjudgment at the point of sale; and accountable performance with focusedcommunication by specialists.” The NYSE has begun the technological worknecessary to implement its proposed changes in the NYSE Direct+® system and, inDecember 2004, extended the pilot phase of this Direct+® system throughDecember 23, 2005, subject to review and approval of these proposed changes bythe SEC. It is possible that the NYSE may again extend this pilot phase inorder to complete the technological work to finalize the Direct+® system.

 

In February 2004,the SEC proposed new rules which would require, subject to certain exceptions,that every “order execution facility” (*i.e.*,every national securities exchange, national securities association thatoperates an order execution facility, alternative trading system, exchangespecialist and market maker, OTC market maker, block positioner and any otherbroker or dealer that executes orders internally by trading as principal orcrossing orders as agent) establish, maintain and enforce polices andprocedures reasonably designed to prevent the execution of a “trade-through” (*viz*., the execution of an order at a pricethat is inferior to a price displayed in another market) in its market. Asoriginally proposed, this requirement would apply to all incoming orders in “NMSStocks,” including all NASDAQ, NYSE and AMEX-listed stocks and any orderexecution facility that executes orders internally within its market, whetheror not that market posts its best bid and offer, and would have(1) allowed customers (and broker dealers trading for their own accounts)to “opt-out” of the protections of the rule by providing informed consent tothe execution of their orders, on an order-by-order basis, in one marketwithout regard to the possibility of obtaining a better price in anothermarket, and (2) taken into account the differences between the speed ofexecution in electronic versus manual markets by providing an automated marketwith the ability to trade through a non-automated market at a price up to acertain amount away from the best bid or offer displayed by the non-automatedmarket.

 

On April 6, 2005, the SECadopted Regulation NMS (“Regulation NMS”). Regulation NMS is expected to becomeeffective in 2006 and could have a significant impact on the regulation oftrading on securities exchanges and marketplaces. Specifically, the ruleestablishes inter-market protection against “trade-throughs” for all NMS stocks and protection of only thosequotations that are immediately accessible through automatic execution. Therule generally does not contain the “opt-out” exception described above thatwould have allowed market participants to disregard displayed quotations, butdoes include a number of exceptions to the “opt-out”

 

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proscription to help ensure that the rule isworkable with high-volume securities. The rule also is anticipated to protectthe best bids and offers of each exchange, Nasdaq, and the NASD’s AlternativeDisplay Facility. While it is too early to anticipate the impact thatRegulation NMS could have on our trading, it is possible that the rule couldmaterially affect our compliance costs and alter the competitive environment inwhich our Specialist and Market-Making segment functions.

 

Therealso may be regulatory changes following the closing of the merger of the NYSEand Archipelago Holdings, Inc. Any failure by us to adapt to these changescould materially adversely affect our results in the new NYSE Market followingthe merger. Please see “—Risks Associated with the Recently-Consummated NYSEMerger” for a more detailed discussion.

 

*We are subject to extensiveregulation under federal and state laws that could result in investigations,fines or other penalties.*

 

On March 29, 2004, we entered into a definitiveagreement with the NYSE and the SEC to settle investigations by the NYSE andthe SEC concerning specialist trading activity. Pursuant to the agreement, andwithout admitting or denying any wrongdoing, we paid on April 7, 2004 atotal of $63.5 million with respect to certain trades that occurred duringthe five-year period from 1999 through 2003. In December 2004, our LaBranche& Co. LLC subsidiary received a notice from the NASD Amex RegulationDivision stating a preliminary determination by the NASD Amex RegulationDivision’s staff to seek disciplinary action against LaBranche & Co. LLCfor violations of certain federal securities laws and the AMEX’s Constitutionand Rules, including Sections 10(b), 9A and 17(a) of the Securities ExchangeAct of 1934, in connection with manual book freezes effected in one ofLaBranche & Co. LLC’s Amex specialist stocks during the period March 8,2004 through October 21, 2004. This notice of possible disciplinary action hasnot yet been resolved.

 

In addition, our broker-dealer subsidiariesare subject to increasing regulatory inquiries and informal investigations inthe ordinary course of business and, as a result, are spending more resourceson responding to, and defending, these inquiries and investigations. It ispossible that these additional resources could result in increased legal andprofessional fees, as well as additional fines and formal regulatory actionsgoing forward. It is too early to predict whether and to what extent any of theseregulatory inquiries could escalate. However, if any of these ordinaryinquiries progress into material regulatory or legal proceedings, suchproceedings could result in settlements, determinations or judgments requiringsubstantial payments of sanctions, fines and penalties, as well as the costs ofdefending these actions, which could materially and adversely affect ourbusiness and operations.

 

*We cannot assure you that we will be able to detect or prevent allemployee misconduct or rule violations.*

 

We are subject to extensive regulation under bothfederal and state laws. In addition, the SEC, the NYSE, the NASD, the AMEX,other SROs and state securities commissions require strict compliance withtheir respective rules and regulations. As a result of our acquisitions since1997 and the increase in the size of our business and in the number of ouremployees, the risk that we will not detect or prevent employee misconduct hasincreased. Employee misconduct that 

 

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may be difficult to detectcould result in losses. Misconduct by employees could include, among otherthings, binding us to transactions that exceed authorized limits or presentexcessive risks, violation of securities rules or exchange rules that have notbeen detected by the technological systems installed by the exchanges toprevent such violations or hiding from us unauthorized or unsuccessfulactivities, which, in any case, may result in unknown and unmanaged risks orlosses. Employee misconduct could also involve the improper use or disclosureof confidential information, which could result in regulatory sanctions andserious reputation or financial harm.

 

If there are any additional investigations oractions against us or any of our subsidiaries, such investigations or actionscould result in settlements, determinations or judgments requiring substantialpayments by us, including the costs of defending such investigations oractions, the imposition of substantial sanctions, fines or penalties and thesuspension or revocation of our registration with the SEC as a broker-dealer orour suspension or expulsion as a member firm of the NYSE, the AMEX and theother exchanges on which we operate, in which case we would be unable tooperate our business.

 

It also may bedifficult for us to comply with other new or revised legislation or regulationsimposed by the SEC, other U.S. or foreign governmental regulatory authoritiesand SROs, including the NYSE and the AMEX. The risks of failure to comply withforeign laws and rules will increase as our LSPE and LSPH subsidiaries begin tooperate as foreign broker-dealers. Failure to comply with any of these rules orregulations would have an adverse effect on our business, financial conditionand/or operating results. Other changes in the interpretation or enforcement ofexisting laws and rules by the SEC, these governmental authorities and SROsalso could have an adverse effect on our business, financial condition and/oroperating results.

 

*Failure to comply withundertakings set forth in the settlement with the NYSE and SEC could adverselyaffect us.*

 

In connectionwith the settlement of the NYSE and the SEC investigations concerning our NYSEspecialist trading activity, we agreed to, and we are complying with, thefollowing undertakings:

 

•                  implementation of systems andprocedures to ensure appropriate follow up and review with regard toinformation provided to LaBranche & Co. LLC on a daily basis by theNYSE with regard to specialists’ override of the Principal Inhibitor function,which identifies specialist principal trades that may have been effected whilean executable agency order was reflected in the order book on the same side ofthe market;

 

•                  creation of a committee, includingLaBranche & Co. LLC’s chief compliance officer and at least twomembers of senior management, specifically charged with meeting periodically(no less frequently than monthly) to evaluate specialist rule compliance;

 

•                  development and/or enhancement ofsystems and procedures to track and maintain records identifying theindividuals acting as specialist and clerk for each security at all timesthroughout each trading day;

 

•                  annual certification, throughLaBranche & Co. LLC’s chief executive officer, that a review has beenconducted by the chief compliance officer of trading in LaBranche & 

 

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Co. LLC’s principal account for the purpose ofdetecting interpositioning, trading ahead and unexecuted limit orderviolations;

 

•                  bi-annual assessment of, and reportson, the adequacy of the resources devoted to LaBranche & Co. LLC’scompliance function, and devotion of adequate funds and staffing to thecompliance department; and

 

•                  retention of an independentconsultant to review and evaluate LaBranche & Co. LLC’s compliancesystems, policies and procedures reasonably designed to ensure thatLaBranche & Co. LLC is in compliance with federal securities laws andNYSE rules with regard to specialist trading.

 

If we are, in the future, unable to maintain ourcompliance with any of these undertakings for reasons that we cannot foresee,such failure could have a material adverse effect on our business and ourregulatory compliance structure.

 

*We also are subject to the risksof securities laws liability and related civil litigation.*

 

Many aspects of our business involve substantialrisks of legal liability. A specialist is exposed to substantial risks ofliability under federal and state securities laws, other federal and state lawsand court decisions, as well as rules and regulations promulgated by the SEC,the NYSE and the AMEX.

 

The above-described settlement with the NYSE and SEChas also resulted in the initiation of purported class action and derivativeaction proceedings against us and certain of our officers and directors in theUnited States District Court for the Southern District of New York and otherproceedings in other courts, all of which are described under “Business—LegalProceedings.” In 2004 and early 2005, we also had received requests for information from the SEC and theUnited States Attorney’s Office for the Southern District of New York as partof an industry-wide investigation relating to activities of NYSE floorspecialists from 1999 through 2003. Two additional actions have been commenced byentities against four national securities exchanges and 35 securities brokers(including our LSP subsidiary) in the United States District Court for theNorthern District of Illinois, alleging that LSP conspired with the otherdefendants by allegedly failing to execute orders, canceling orders andrefusing to cancel orders for the purchase and sale of options.

 

While we deny the allegations of wrongdoing against us in theseactions, there can be no assurance as to the ultimate outcome or timing oftheir resolution. The range of possible resolutions could includedeterminations and judgments against us or settlements that could requiresubstantial payments by us, including the costs of defending suchinvestigations and suits, which could have a material adverse effect on ourfinancial condition, results of operations and cash flows.

 

We also are subject to the risk of civil litigation,employment claims and other actions in the ordinary course of our businessoperations. In particular, LFSI, as successor in interest to ROBB PECK McCOOEYClearing Corporation, or RPMCC, has been the target, from time to time, ofvarious claims and lawsuits incidental to the ordinary course of RPMCC’sbusiness 

 

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operations, and we have beenthe subject of a suit filed on behalf of a former employee by the EqualEmployment Opportunity Commission for discrimination on the basis ofdisability. It is possible that we could incur significant legal expenses indefending ourselves against these and future lawsuits or claims. An adverseresolution of any future lawsuits or claims against us could have an adverseeffect on our business, financial condition and/or operating results.

 

*We may have insufficient capitalin the future and may be unable to secure additional financing when we need it.*

 

Our business depends on the availability of adequatecapital. We cannot be sure that we will have sufficient capital in the futureor that additional financing will be available on a timely basis, or on termsfavorable to us. Historically, we have satisfied these needs with internallygenerated funds, the issuance of subordinated debt by our operatingsubsidiaries and the issuance of common stock and notes representing ourindebtedness. While we currently anticipate that our available cash resourceswill be sufficient to meet our anticipated working capital, regulatory capitaland capital expenditure requirements through at least the next twelve months,we may need to raise additional funds to:

 

•                  increase thecapital available to us for our inventory positions;

 

•                  expand ordiversify our operations;

 

•                  acquirecomplementary businesses; or

 

•                  respond tounanticipated capital requirements.

 

We may be required to obtain this additional financingon short notice as a result of rapid, unanticipated developments, such as asteep market decline.

 

*Our revenues may decrease due tochanges affecting the economy or changes affecting the securities markets, suchas decreased volume, volatility or liquidity.*

 

Adverse changes affecting the economy and/or thesecurities markets could result in a further decline in market volatility orliquidity, thus negatively impacting revenues at our Specialist andMarket-Making segment and our Execution and Clearing segment. Many elements ofour cost structure do not decline if we experience reductions in our revenuesand we may be unable to adjust our cost structure on a timely basis, or at all,and we could suffer losses.

 

The lack of growth in share volume, rising programtrading and low levels of volatility on the NYSE over the past three years havenegatively affected our results of operations and may adversely affect ouroperations in the future. Although U.S. equity prices generally recovered in2003, 2004 and 2005, adverse changes in the economy and the securities marketscould return, resulting in:

 

•                  losses fromdeclines in the market value of securities held in our accounts;

 

•                  a decline intrading volume on the NYSE, the AMEX and other exchanges;

 

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•                  a decline involatility in the securities markets in which we act as a specialist;

 

•                  the failure ofbuyers and sellers of securities to fulfill their settlement obligations; and

 

•                  furtherincreases in claims and litigation.

 

Whether market and economic conditions will continueto improve and whether we will be able to adequately protect our interests andmaintain revenues in the future is uncertain.

 

*Risks associated with our tradingtransactions could result in trading losses.*

 

A majority of our Specialist and Market-Makingsegment’s revenues are derived from trading by us as principal. We may incurtrading losses relating to these activities, since each such trade primarilyinvolves the purchase, sale or short sale of securities for our own account. Inany period, we may incur trading losses in a significant number of ourspecialist stocks, options, rights and ETFs for a variety of reasons, includingprice declines, lower trading volumes and the required performance of ourspecialist obligations. From time to time, we have large positionconcentrations in securities of a single issuer or issuers engaged in aspecific industry. In general, because our inventory of securities ismarked-to-market on a daily basis, any downward price movement in thesesecurities results in an immediate reduction of our revenues and operatingresults. Our specialist and market-maker trading in options, ETFs, futures,other derivative instruments and foreign currencies also exposes us to certainadditional risks associated with such factors as price fluctuations, foreignexchange currency movements, changes in the liquidity of markets, volatilityand counterparty credit. Although we have adopted and carry out risk managementprocedures, we cannot be sure that these procedures have been formulatedproperly to identify or completely limit our risks and, even if formulatedproperly, we cannot be sure that we will successfully implement theseprocedures. As a result, we may not be able to manage our risks successfully oravoid trading losses.

 

Our securities transactions are conducted asprincipal and agent with broker-dealer counterparties located in the UnitedStates. While the NYSE, the AMEX and the clearing houses monitor the creditstanding of the counterparties with which we conduct business, we cannot becertain that any of these counterparties will not default on their obligations.If any do, our business, financial condition and/or operating results could beadversely affected.

 

*Specialist and market-maker rulesrequire us to make unprofitable trades and refrain from making profitabletrades.*

 

Our roles as a specialist and market maker, attimes, require us to make trades that adversely affect our operating results.In addition, as a specialist and market-maker, we are at times required torefrain from trading for our own account in circumstances in which it may be toour advantage to trade. For example, we may be obligated to act as a principalwhen buyers or sellers outnumber each other and take a position counter to themarket, buying or selling shares to support an orderly market in the affectedstocks. In addition, specialists and market-makers generally may not trade fortheir own account when public buyers are meeting public sellers in an 

 

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orderly fashion and may notcompete with public orders at the same price. By having to support an orderlymarket, maintain inventory positions and refrain from trading under somefavorable conditions, we are subject to risk. In addition, one consequence ofthe SEC and the NYSE investigations of NYSE specialist trading practices may beamendments by the NYSE and, possibly, the AMEX, of the rules, practices andprocedures governing our specialist and market-making activities in a mannerthat could adversely affect our trading revenues.

 

*Failure to comply with net capitaland net liquid asset requirements may result in the revocation of ourregistration with the SEC or our expulsion from the NYSE and/or the AMEX.*

 

The SEC, the NYSE, the AMEX and various otherregulatory agencies have stringent rules with respect to the maintenance ofminimum levels of capital and net liquid assets by securities broker-dealersand specialist firms. Currently, LaBranche & Co. LLC and LSPS arerequired to maintain minimum combined net liquid assets of approximately$447.0 million. Failure by any of our broker-dealer and specialistsubsidiaries to maintain its required level of net capital and net liquidassets may subject it to suspension or revocation of its SEC registration orsuspension or expulsion by the NYSE and/or the AMEX. If this occurs, we wouldbe unable to operate our business. In addition, a change in these rules, theimposition of new rules or any unusually large capital requirement or chargeagainst the regulatory capital of any of our broker-dealer subsidiaries couldlimit those areas of our operations which require intensive use of capital.These rules also could restrict our ability to withdraw capital from ourbroker-dealer subsidiaries, thus limiting our ability to expand, diversify oreven maintain our present levels of business, pay dividends, repay debt andrepurchase shares of our outstanding common stock.

 

*We depend primarily on ourSpecialist and Market-Making activities, and if they fail to generate revenuesas anticipated, it would adversely affect our financial condition and resultsof operations.*

 

We derive the vast majority of our revenues fromspecialist and market-making activities. If demand for our specialist andmarket-making services fails to grow, grows more slowly than we currentlyanticipate or declines, our financial condition and results of operations wouldbe adversely affected. We expect our specialist and market-making activities tocontinue to account for the vast majority of our revenues for the foreseeablefuture. Our future success will depend on:

 

•                  continued growthin the volume of trading and the number of listings on the NYSE, the AMEX andother exchanges;

 

•                  being chosen asthe specialist for additional listed companies and ETFs;

 

•                  our ability torespond to regulatory and technological changes; and

 

•                  our ability torespond to changing demands in the marketplace.

 

Over the past few years, a number of alternativetrading systems have been developed or emerged. These alternative tradingsystems may compete with specialists by increasing trading in 

 

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NYSE-listed and AMEX-listedsecurities off the NYSE and the AMEX trading floors. This can be seen in thedecrease in the NYSE’s percentage of overall U.S. trading volume fromapproximately 84% in 2002 to approximately 76% in 2005. In addition, asdescribed above, the SEC and the NYSE’s market structure rule changes couldresult in increased trading of NYSE-listed and AMEX-listed securities inelectronically-matched orders and thus reduce levels of trading of suchsecurities through specialists.

 

Historically, a relatively small number oflisted companies has accounted for a significant portion of our revenues fromour NYSE specialist trading activities. The loss of any of these listedcompanies could have an adverse effect on our revenues. For the years endedDecember 31, 2003, 2004 and 2005, transactions in our 10 mostactively traded NYSE specialist stocks accounted for approximately 19.0%, 16.8%and 13.6% of our total NYSE principal trading revenues, respectively. Thecomposition of these ten most actively traded specialist stocks changesfrequently. We cannot be certain that we will be able to retain these or anyother of our top listed companies. We can lose these listed companies if theycease to be traded on the NYSE as a result of being acquired or otherwisedelisted. In addition, under NYSE procedures allowing listed companies greaterlatitude to request a change in their specialist or if the NYSE were todetermine that we have failed to fulfill our obligations as specialist for alisted company, our registration as the specialist for that listed companycould be canceled or suspended. Although we have further diversified ourspecialist and market-making operations into additional products andmarketplaces, this diversification may not adequately diminish our risk ofreliance on certain operations.

 

*We cannot assure you that we will continue to be able to effectivelycompete in the specialist and market-making industry.*

 

We cannot be sure that we will be able to competeeffectively with current or future competitors in the specialist andmarket-making industry. We obtain all our new equity listings on the NYSE bygoing through an allocation process. In this process, either a committee of theNYSE or the listing company chooses the specialist. The competition forobtaining new listing companies is intense. We expect competition to continueand further intensify in the future. We also compete with significantly largerentities to be the specialist in ETFs traded on the NYSE and the AMEX. Althoughwe have been able to secure a market share of the ETF specialist business withmany of the established ETF issuers, we cannot assure you that our growth inmarket share will continue as our competitors focus more resources on their ETFspecialist business or as market participants enter the ETF market. Some of ourcompetitors may have significantly greater financial and other resources thanwe have in both specialist and market-making activities and may have greatername recognition. These competitors may be able to respond more quickly to newor evolving opportunities and listing company requirements. They also may beable to undertake more extensive promotional activities to attract new listingcompanies, especially those which are not publicly-traded specialist firms. Ourfailure to compete effectively would have an adverse effect on our operatingresults.

 

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*We have significant debt obligations.*

 

We have a significant amount of debt. As of December31, 2005, our total debt outstanding was $493.8 million, excluding subordinatedliabilities related to contributed exchange memberships. LaBranche &Co. LLC also may borrow, subject to certain conditions, up to$200.0 million to finance its specialist security positions under acommitted line-of-credit with a U.S. commercial bank. Our significant level ofdebt could have important consequences, including the following:

 

•                  our ability to obtain additional financing to fundgrowth, working capital, capital expenditures, debt service requirements orother purposes may be impaired;

 

•                  our ability touse operating cash flow in other areas of our business may be limited becausewe dedicate a substantial portion of these funds to service our debt; and

 

•                  limitation onour flexibility to adjust to changing market conditions, changes in ourindustry and economic downturns.

 

*Our ability to take certainactions may be restricted by the terms of our outstanding indebtedness.*

 

The covenants in the indenture governing ouroutstanding 9.5% Senior Notes due 2009 and our outstanding 11.0% Senior Notesdue 2012, in the aggregate principal amount of approximately $460.0 million(collectively, the “outstanding senior notes”), LaBranche & Co. LLC’s$200.0 million committed line of credit agreement with a bank andsubordinated note purchase agreements (under which approximately$9.0 million remains outstanding), as well as any future financingagreements, may adversely affect our ability to finance future operations orcapital needs or to engage in other business activities. These covenants maylimit or restrict our ability and the ability of our subsidiaries, undercertain circumstances, to:

 

•                  incur additionaldebt;

 

•                  pay dividendsand make distributions;

 

•                  repurchase ourcommon stock or subordinated indebtedness prior to maturity;

 

•                  make certaininvestments;

 

•                  create liens onour assets;

 

•                  transfer or sellassets;

 

•                  enter intotransactions with affiliates;

 

•                  issue or sellstock of subsidiaries; or

 

•                  merge orconsolidate.

 

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For example, our ability to take certain actions, such as incurringadditional indebtedness (other than certain “permitted indebtedness”) or makingcertain “restricted payments” (such as paying dividends, redeeming stock orrepurchasing subordinated indebtedness prior to maturity), is limited if ourconsolidated fixed charge coverage ratio, as defined by our debt covenants andcalculated on a trailing four-quarter basis, is at or below a threshold of2.00:1, as more fully described in “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations – Capital Resources.” Althoughour consolidated fixed charge coverage ratio currently is above 2:00:1, we havein the past been below this ratio, which prevented us from making “restrictedpayments” exceeding $15.0 million in the aggregate over the life of theindenture. In addition, under the indenture governing our outstanding seniornotes, even if our consolidated fixed charge coverage ratio is 2.00:1 orgreater, we cannot make any such “restricted payments” if doing so will causeour cumulative “restricted payments” since May 18, 2004 to be greater thanthe sum of (A) 50.0% of our cumulative consolidated net income sinceJuly 1, 2004 (or, if such calculation is a loss, minus 100.0% of suchloss) and (B) 100.0% of the net cash proceeds received from any issuanceor sale of our capital stock since July 1, 2004 and certain other amounts.As of December 31, 2005, this covenant prevented us from making restrictedpayments in excess of $36.2 million. Although we have not made any restrictedpayments since May 18, 2004, we cannot be sure if, when or to what extentthe covenants in the indenture will prevent us from making restricted paymentsin the future.

 

In addition, our LaBranche & Co. LLC subsidiaryhas approximately $9.0 million principal amount outstanding subordinatedindebtedness. The note purchase agreement governing this subordinatedindebtedness requires LaBranche & Co. LLC to comply with certainfinancial ratios. LaBranche & Co. LLC’s ability to comply with theseratios may be affected by events beyond our or its control. If any of thecovenants in this agreement are breached, or if LaBranche & Co. LLC isunable to comply with required financial ratios, we or it may be in defaultunder such agreements. A significant portion of this indebtedness then maybecome immediately due and payable.

 

We are not certain whether we would have, or be ableto obtain, sufficient funds to make required accelerated payments under ourindebtedness, including payments on our outstanding senior notes.

 

*We may not be able to generatesufficient cash flows to meet our debt service obligations, including paymentson the outstanding senior notes.*

 

Ourability to generate sufficient cash flows from operations to make scheduledpayments on our debt obligations will depend on our future financialperformance, which will be, to an extent, subject to general economic,financial, competitive, regulatory and other factors that are beyond ourcontrol.

 

Wecannot provide assurance that our business will generate sufficient cash flowsor that future borrowings will be available to us in an amount sufficient toenable us to pay our debt, including the outstanding senior notes, or to fundour other liquidity needs. If our future cash flows from operations areinsufficient to pay our obligations as they mature or to fund our liquidity needs,we may be forced to sell assets, obtain additional equity capital orrestructure or 

 

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refinance all or a portionof our debt, including the outstanding senior notes, on or before maturity. Wecannot assure you that we will be able to repay or refinance our debt,including the outstanding senior notes, on a timely basis or on satisfactoryterms, if at all.

 

*We may not be able to finance achange of control offer required by the indenture governing the outstandingsenior notes.*

 

If we were to experience a change of control, wewould be required to offer to repurchase all outstanding senior notesthen-outstanding, as well as all of our then-outstanding 12.0% seniorsubordinated notes due 2007, in the aggregate principal amount of approximately$13.6 million (the “2007 notes”), in each case at a price equal to 101.0% oftheir principal amount, plus accrued and unpaid interest, if any, to the dateof repurchase. This purchase requirement may delay or make it harder for othersto obtain control of us. If a change of control were to occur, it is possiblethat we would not have sufficient funds to repurchase these notes or thatrestrictions in the credit agreement and LaBranche & Co. LLC’ssubordinated note purchase agreements and such other notes would not allow suchrepurchases. If we do not have sufficient funds at the time of a repurchaseobligation or cannot meet any obligations under the credit agreement, thesubordinated note purchase agreements, the indenture governing the outstandingsenior notes, or the indenture governing the 2007 notes, we would be forced toseek additional third-party financing. However, it is possible that we wouldnot be able to obtain such financing on favorable terms, or at all.

 

*Our success depends on our abilityto accurately process and record our transactions, and any failure to do socould subject us to losses.*

 

Our specialist, market-making and clearing andexecution activities require us to accurately record and process a very largenumber of transactions on a daily basis. Any failure or delay in recording orprocessing transactions could cause substantial losses for brokers, theircustomers and/or us and could subject us to claims for losses. We rely on ourstaff to operate and maintain our information and communications systemsproperly, and we depend on the integrity and performance of those systems. Ourrecording and processing of trades is subject to human and processing errors.Moreover, extraordinary trading volume or other events could cause ourinformation and communications systems to operate at an unacceptably low speedor even fail. Any significant degradation or failure of our information systemsor any other systems in the trading process could cause us to fail to completetransactions or could cause brokers who place trades through us to sufferdelays in trading.

 

Any information or communication systems failure ordecrease in information or communications systems performance that causesinterruptions in our operations could have an adverse effect on our business,financial condition and/or operating results. Our systems may fail as a resultof a hardware, software, power or telecommunications failure. In addition, ouroffices are located in close proximity to the site of the September 11,2001 terrorist attacks on the World Trade Center. The aftermath of the attackson the World Trade Center required us to close our operations and temporarilyoperate from our disaster recovery site. The NYSE also was forced to stopoperating for four consecutive trading days, which caused our operations tohalt. It is possible that additional terrorist attacks or acts of war may occurin the future and that such 

 

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attacks could compromise ordisable our systems. Although we have established back-up disaster recoverycenters in New Jersey and New York and have an overall business continuity planin the event of another disaster, these measures may not be effective inpreventing an interruption of our business.

 

We also are dependent on the proper andtimely function of complex information and communications systems maintainedand operated by or for the NYSE, the AMEX and clearing and depositaryinstitutions. Failures or inadequate or slow performance of any of thesesystems could adversely affect our ability to operate and completetrades. The failure to complete trades on a timely basis could subject us tolosses and claims for losses of brokers and their customers.

 

*Our future success will depend onthe ability to upgrade information and communications systems, and any failureto do so could harm our business and profitability.*

 

The development of complex communications and newtechnologies, including Internet-based technologies, may render our existinginformation and communications systems outdated. In addition, our informationand communications systems must be compatible with those of the NYSE and theAMEX. As a result, when and if the NYSE or the AMEX upgrades its systems, we willneed to make corresponding upgrades. Our future success will depend on ourability, on a cost-effective basis, to timely respond to changing technologies.Our failure to do so could have an adverse effect on our business, financialcondition and/or operating results.

 

The NYSE’s ability to develop information andcommunications systems and complex computer and other technology systems hasbeen instrumental in its growth and success. We are dependent on the continuingdevelopment of technological advances by the NYSE and the AMEX, a process overwhich we have no control. If the NYSE for any reason is unable to continue itshistory of computer-related and other technological developments and advances,it could have an adverse effect on the success of the NYSE, including itsability to grow, to manage its trading volumes and to attract new listings. Anysuch developments can be expected to adversely affect our operations, financialcondition and operating results.

 

*If we lose the services of our keypersonnel or cannot hire additional qualified personnel, our business will beharmed.*

 

Ourfuture success depends on the continued service of key employees, particularlyGeorge M.L. LaBranche, IV, our Chairman, Chief Executive Officer and President.The loss of the services of any of our key personnel or the inability toidentify, hire, train and retain other qualified personnel in the future couldhave an adverse effect on our business, financial condition and/or operatingresults. Competition for key personnel and other highly qualified management,trading, compliance and technical personnel is intense. We cannot assure youthat we will be able to attract or retain highly qualified personnel in thefuture.

 

Our current and prospective employees may experienceuncertainty about their future roles with us and our business prospects. Thisuncertainty may adversely affect our ability to attract and retain keypersonnel, which would adversely affect our business and results of operations.

 

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*We may have difficultysuccessfully managing our growth.*

 

Our business has grown since 1997, primarily due toacquisitions and organic growth through the continued expansion of ourspecialist and market-making operations. The growth of our business hasincreased the demands upon our management and operations. This growth hasrequired, and will continue to require, an increase in investment in managementpersonnel, financial and management systems and controls and facilities. Thescope of procedures for assuring compliance with applicable rules andregulations, including the Sarbanes-Oxley Act of 2002, has changed as the sizeand complexity of our business has increased. In response, we have implementedformal compliance procedures that are regularly updated. Our future operatingresults will depend on our ability to continue:

 

•                  to improve oursystems for operations, financial control and communication and informationmanagement;

 

•                  to refine ourcompliance procedures and enhance our compliance oversight;

 

•                  to raiseadditional capital if and when needed;

 

•                  to effectivelydeploy assets, capital or workforce;

 

•                  to maintainstrong relationships with, and attract new, listed companies; and

 

•                  to retain andincentivize our employees.

 

*Three of our current or formerexecutive officers are in a position to substantially control matters requiringa stockholder vote.*

 

Certain of our current and former managingdirectors who currently own a significant amount of our outstanding commonstock have entered into a stockholders’ agreement under which they have agreed,among other things, that their shares of our common stock will be voted, for aslong as they own their shares, as directed by a majority vote of George M.L.LaBranche, IV, our Chairman, Chief Executive Officer and President, Alfred O.Hayward, Jr., our executive officer, director and Chief Executive Officer ofLaBranche & Co. LLC, and James G. Gallagher, a former executiveofficer and director. Accordingly, these individuals have the ability tosubstantially control most matters requiring approval by our commonstockholders. These matters include the election and removal of directors andthe approval of any merger, consolidation or sale of all or substantially allour assets. This concentration of ownership could have the effect of delaying,deferring or preventing a change in control, a merger or consolidation, atakeover or another business combination.

 

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***Risks Associated with the Recently ConsummatedNYSE Merger***

 

*The value of the NYSE Group stock we received in the NYSE merger withArchipelago may significantly lose value following the merger.*

 

In connection with the recently-consummated merger between the NYSE andArchipelago, we received approximately 3.1 million shares of NYSE Group commonstock in exchange for our 39 NYSE memberships. Under the merger agreement,there are restrictions on the sale of the NYSE Group shares following themerger. As provided in the agreement, one-third of these NYSE Group shares willbe released from these sale restrictions on each of the first threeanniversaries of the closing of the merger. Although the agreement allows theNYSE to release these sale restrictions early in a secondary offering, we willonly be able to participate in such an offering by selling a small portion ofour NYSE Group stock. As a consequence, there is a risk that there could be asignificant drop in the value of the NYSE Group stock prior to the time we areable and choose to monetize the consideration we received in exchange for theNYSE memberships we held prior to the NYSE merger. We expect to mark our NYSEGroup shares to market, subject to any applicable discounts due to restrictionson transfer. Any substantial drop in the price of NYSE Group stock followingthe merger could require us to consider whether such drop in value has createdan impairment of our intangible assets. Such an impairment, if any, wouldadversely affect our financial results in a particular fiscal period.

 

*The regulatory environment following the NYSEmerger could change and thereby adversely affect our compliance and strategicefforts.*

 

As disclosed in connection with the NYSE merger, NYSE Regulation isexpected to perform the regulatory function for the NYSE and the Pacific StockExchange. In addition, the NYSE Group has proposed that technology play agreater role in trading, compliance and regulation. The NYSE Group also hasindicated that NYSE Regulation may be self-funding. It is possible that thesefactors could cause regulatory or technological errors, especially if NYSERegulation is unable to adequately self-fund its operations. This environmentcould produce additional regulatory scrutiny, which could cause us to expendadditional resources to monitor and enhance our compliance with NYSE rules. Wealso may be required to expend substantial resources to coordinate ourtechnological compliance systems with those of the new technologicalrequirements of the NYSE market, which could increase our overall Specialistand Market-Making segment operating expenses and adversely affect our operatingresults.

 

*The role of the specialist on the NYSE maysubstantially change following the merger and we may not be able to timelyadapt.*

 

Although senior NYSE officials have continued to publicly state thatthere will continue to be an auction market with a central point of sale on theNYSE following the merger, and that specialists will continue to play anintegral role in making a fair and orderly market and providing liquidity,there is speculation that large issuers’ stocks will trade entirelyelectronically with minimal participation by specialists. We may not be able toanticipate or adequately and effectively deploy capital, workforce andtechnology to respond to such a change. Although we have expended considerableresources to enable us to adapt to such a situation, we may not be able totimely or successfully do so. Any failure by us to anticipate, respond or adaptto a 

 

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changing NYSE Market followingthe merger could adversely affect our results of operations and financialcondition.

 

*The NYSE Group may not achieve the anticipated cost savings, technologyimprovements, growth opportunities and other benefits anticipated from thetransaction, which could adversely affect the operations of the NYSE specialistfirms following the merger.*

 

Some of the stated purposes of the NYSE’s merger with Archipelago arethe cost savings, the ability to compete with an increasingly electronicmarketplace, potential market growth opportunities and other synergies. Priorto the merger, the NYSE and Archipelago operated as separate companies withdifferent goals, technology, infrastructures and market structures. The successof the NYSE merger will depend, in part, on the ability to achieve these costsavings, efficiencies and technological and product advances. If the NYSE Groupis not able to successfully achieve these objectives, the anticipated costsavings, technological and revenue growth and synergies may not be realizedfully or at all, or may take longer to realize than expected. In such event,the new NYSE Market may lose listed companies, exchange-based trading marketshare and additional product lines and order flow. To the extent the NYSEMarket is unable to attract new listed companies or products or loses existinglisted companies and products, our financial results and operations could bematerially adversely affected.

 

# **Item 1B.**                          UNRESOLVED STAFF COMMENTS.

# ** **

None.

 

# **Item 2.**                                   PROPERTIES.

# ** **

Our offices are located at One Exchange Plaza, NewYork, New York, where we lease approximately 36,000 square feet under twoseparate leases expiring in January 2008, and at 120 Broadway, New York, NewYork, where we lease approximately 45,000 square feet under a sublease expiringin March 2006.  We are in the process ofnegotiating a short-term extension for the space at 120 Broadway while we areseeking alternative office space for a portion of our operations.  We also lease five trading posts on the floorof the NYSE, approximately 8,600 square feet of additional space at locationsin New York, New Jersey, Boston and Minnesota under leases expiring betweenMarch 2006 and September 2012. In addition, we lease approximately 1,000 squarefeet in Amsterdam, The Netherlands, under a lease expiring in April 2009,  a workstation (approximately 25 square feet)in London, England, under a month-to-month operating lease, and a three yearnew lease with approximately 133 square meters in Hong Kong under a leaseexpiring in November 2008. We believe that our current leased space is suitableand adequate for the operation of our business as presently conducted and ascontemplated to be conducted in the near future.

 

# **Item 3.**                                   LEGAL PROCEEDINGS.

# ** **

Specialist TradingInvestigations.  On March 30, 2004, LaBranche & Co. LLC and other NYSE specialistfirms entered into agreements with the SEC and NYSE to settle the SEC and NYSEinvestigations concerning alleged improper specialist trading practices byspecialists on the NYSE. Pursuant to the settlement, LaBranche & Co. LLCconsented, without admitting or 

 

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denying any wrongdoing, to an SEC orderinstituting administrative cease-and-desist proceedings, making findings, andimposing remedial sanctions and a cease-and-desist order. The SEC’s findings,neither admitted nor denied, included violations by LaBranche & Co. LLC ofSection 11(b) of the Exchange Act and Rule 11b-1 promulgated thereunder, NYSERules 104, 92, 123B, 401 and 342, and Section 15(b)(4)(E) of the ExchangeAct. The Section 15(b)(4)(E) finding includes a failure reasonably tosupervise individual specialists who, the finding states, violated Section10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder with respect totransactions in six particular stocks. Pursuant to the settlement, LaBranche& Co. LLC paid $41.6 million in restitution and $21.9 million in a civilmoney penalty, which we accrued for the year ended December 31, 2003, in connectionwith trades that occurred during the years 1999 through 2003 and has agreed toundertakings stated in the SEC’s order. Subsequently, we received additionalrequests for information from the SEC and also have received requests forinformation from the United States Attorney’s Office for the Southern Districtof New York as part of an industry-wide investigation relating to activities ofNYSE floor specialists in recent years. We cooperated with the requests andwill continue to cooperate with any future requests.

 

On April 12, 2005, criminal and civil chargeswere announced against a number of individuals employed or formerly employed asspecialists at the five largest NYSE specialist firms, including one specialistformerly employed by LaBranche & Co. LLC.

 

In re LaBrancheSecurities Litigation. On or about October 16, 2003 through December 16, 2003, ninepurported class action lawsuits were filed by purchasers of our common stock inthe United States District Court for the Southern District of New York,including Sofran v. LaBranche & Co Inc., et al., No. 03 CV 8201, Semon v.LaBranche & Co Inc., et al., No. 03 CV 8255, Haug v. LaBranche & Co.Inc., et al., No. 03 CV 8265, Labul v. LaBranche & Co Inc., et al., No. 03CV 8365, Murphy v. LaBranche & Co Inc., et al., No. 03 CV 8462, Strain v.LaBranche & Co Inc., et al., No. 03 CV 8509, Yopp v. LaBranche & CoInc., et al., No. 03 CV 8783, Ferris v. LaBranche & Co Inc., et al., No. 03CV 8806, and Levin v. LaBranche & Co Inc., et al., No. 03 CV 8918. On March 22,2004, the court consolidated these lawsuits under the caption In re LaBrancheSecurities Litigation, No. 03 CV 8201. The court named the following leadplaintiffs:  Anthony Johnson, ClydeFarmer, Edwin Walthall, Donald Stahl and City of Harper Woods RetirementSystem.

 

On June 7, 2004,plaintiffs filed a Consolidated Class Action Complaint. On July 12, 2004,plaintiffs filed a Corrected Consolidated Class Action Complaint. Plaintiffsallege that they represent a class consisting of persons and entities thatpurchased or otherwise acquired our common stock during the period beginning onAugust 19, 1999 and concluding on October 15, 2003. Plaintiffs allege that we,LaBranche & Co. LLC, and certain of our and/or LaBranche & Co. LLC’spast or present officers and/or directors, including George M.L. LaBranche, IV,William J. Burke, III, James G. Gallagher, Alfred O. Hayward, Jr., Robert M.Murphy and Harvey S. Traison, violated Section 10(b) of the Exchange Actand Rule 10b-5 promulgated thereunder and Section 20(a) of the Exchange Act byfailing to disclose improper specialist trading. Plaintiffs also allege thatMr. Gallagher violated Section 20A of the Exchange Act and two other of ourpast or present officers and/or directors, S. Lawrence Prendergastand George E. Robb, Jr., also violated Section 20(a) of theExchange Act. Plaintiffs seek unspecified money damages, attorneys’ fees andreimbursement of expenses.

 

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On December 12, 2005,motions to dismiss were granted in part and denied in part. The court dismissedthe Section 10(b) claims in their entirety against Messrs. Burke, Gallagher andTraison, dismissed the Section 10(b) claims for the period August 19, 1999through December 30, 2001 against Messrs. LaBranche, Murphy and Hayward, anddismissed the Section 20A claim against Mr. Gallagher.

 

In re NYSE SpecialistsSecurities Litigation. On or about October 16, 2003 through December 16, 2003, fourpurported class action lawsuits were brought by persons or entities whopurchased and/or sold shares of stocks of NYSE listed companies for whichLaBranche & Co. LLC and any other NYSE specialist firm acted as specialist,including Pirelli v. LaBranche & Co Inc., et al., No. 03 CV 8264, Marcus v.LaBranche & Co Inc., et al., No. 03 CV 8521, Empire v. LaBranche & CoInc., et al., No. 03 CV 8935, and the California Public Employees’Retirement System (CalPERS) v. The New York Stock Exchange, Inc., et al., No. 03 CV 9968. On March11, 2004, a fifth action asserting similar claims, RosenbaumPartners, LP v. The New York Stock Exchange, Inc., et al., No. 04 CV 2038, was filed in the United States District Court for theSouthern District of New York by an individual plaintiff who does not allege torepresent a class. On May 27, 2004, the court consolidated theselawsuits under the caption In re NYSE Specialists Securities Litigation, No. CV8264. The court named the following lead plaintiffs: California PublicEmployees’ Retirement System (“CalPERS”) and Empire Programs, Inc.

 

On September 15, 2004,plaintiffs filed a Consolidated Complaint for Violation of the FederalSecurities Laws and Breach of Fiduciary Duty alleging that they represent aclass consisting of all public investors who purchased and/or sold shares ofstock listed on the NYSE from October 17, 1998 to October 15, 2003. Plaintiffsallege that we, LaBranche & Co. LLC, Mr. LaBranche, and other NYSEspecialist firms and their respective parents and affiliates violated Section10(b), Rule 10b-5 and Section 20(a) by failing to disclose improper specialisttrading, improperly profiting on purchases and/or sales of NYSE-listedsecurities and breaching and/or aiding and abetting breaches of fiduciary duty.Plaintiffs also name the NYSE as a defendant. Plaintiffs seek unspecified moneydamages, restitution, forfeiture of fees, commissions and other compensation,equitable and/or injunctive relief, including an accounting of and theimposition of a constructive trust and/or asset freeze on trading proceeds, andattorneys’ fees and reimbursement of expenses.

 

On December 12, 2005,defendants’ motion to dismiss was granted in part and denied in part. The courtdismissed plaintiffs’ Section 10(b) and Section 20(a) claims against alldefendants for conduct that occurred before January 1, 1999 and dismissedplaintiffs’ breach of fiduciary duty claims against all defendants. The courtalso dismissed all claims against the NYSE and certain claims against certainparents and affiliates of specialists other than LaBranche & Co. LLC.

 

On February 2, 2006,plaintiffs filed an Amended Consolidated Complaint for Violation of the FederalSecurities Laws and Breach of Fiduciary Duty, adding Robert A. Martin as aplaintiff. This complaint is otherwise identical to plaintiffs’ Consolidated Complaintfor Violation of the Federal Securities Laws and Breach of Fiduciary Duty.

 

Henik/Lewis.On or about February 1, 2005 and March 30, 2005, two purported shareholderderivative actions, Henik v. LaBranche, et al., No. 05 CV 1087 and

 

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Lewis v. LaBranche,et al., No. 05 CV 3165, were filed by Diane Henik and Guy C. Lewis, who purportto be two of our shareholders, and who purport to act on behalf of us, againstcertain of our past or present directors and officers, including Messrs. LaBranche, Burke, Dooley, Gallagher, George, Hayward, Kiernan, Murphy,Prendergast, Robb and Traison and Ms. Filter, in the United States District Court for theSouthern District of New York. On April 15, 2005, the Henik and Lewis actions were consolidated. OnJune 14, 2005, the plaintiffs filed an amended consolidated complaint. Theamended complaint alleges breaches of fiduciary duty by thedefendants in the case (other than Ms. Filter, who is not named in the amendedcomplaint) arising out of alleged improper specialist trading and violations ofNYSE rules by LaBranche & Co. LLC. According to plaintiffs, the defendants “engaged in numerous acts, andon some occasions, failed to act, both of which caused LaBranche to sufferdamages,” “were extremely reckless with respect to LaBranche’s internalcontrols, its corporate governance practices, and their own formal oversightresponsibility,” “it [is] likely that some or all” defendants “actuallydirected, knew of, acquiesced after the fact, or could have easily discovered”the alleged improper trading, “there were numerous red flags . . .that were deliberately ignored that suggest that the Board actually knew of themisconduct alleged herein” or that “could have alerted a conscientious directorthat something was amiss,” and that the defendants “either knowingly breachedtheir fiduciary duties to LaBranche and its shareholders, or at the very least,engaged in extremely reckless conduct which also was a breach of fiduciaryduties.”  Plaintiffs seek unspecifiedmoney damages, attorneys’ fees and reimbursement of expenses.

 

Sternlicht. On or about November 14, 2005, a purported shareholder derivativeaction, Sternlicht v. LaBranche et al., No. 05-604042, was filed by LudwigSternlicht, who purports to be one of our stockholders, and who purports to acton behalf of us, against certain of our past or present directors and officers,including Messrs. LaBranche, Burke, Dooley, Gallagher, George, Hayward,Kiernan, Murphy, Prendergast, Robb and Traison, in the Supreme Court of theState of New York, County of New York. The allegations and relief sought inthis action are substantially the same as the allegations and relief sought inthe Henik action.

 

Last Atlantis,Rule and Martin. On January 20, 2004, six entitiesthat allege that they are purchasers and sellers of options commenced an actionin the United States District Court for the Northern District of Illinois, LastAtlantis Capital LLC v. Chicago Board Options Exchange, Inc., et al., No. 04 C0397, against four national securities exchanges (the American Stock Exchange,the Chicago Board Options Exchange, the Philadelphia Stock Exchange and PacificExchange) and 35 alleged securities brokers and/or dealers, including our LSPsubsidiary, who, plaintiffs allege, made markets in options on the namedexchanges. Plaintiffs allege that we and LSP conspired with other defendants byallegedly failing to execute orders, canceling orders, and refusing to cancelorders allegedly submitted by plaintiffs for the purchase and sale of options. Plaintiffsallege violations of federal antitrust laws (Sections 1 of the Sherman Act),and securities law (Section 10(b) of the Exchange Act and Rule 10b-5), breachof contract, common law fraud, breach of fiduciary duty, violations of anIllinois consumer fraud and deceptive business practices statute, and tortiousinterference with plaintiffs’ business. Injunctive relief and damages(including punitive damages) in an unspecified amount are sought.

 

On January 28,2005, Bryan Rule, an individual represented by the same counsel who representthe plaintiffs in the Last Atlantis case, commenced a substantially similaraction in the United States District Court for the Northern District ofIllinois, Rule v. Chicago Board Options 

 

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Exchange, Inc., et al., No. 05 CV 0539,making substantially the same allegations and seeking the same relief againstthe same defendants, including LSP and us.

 

On March 30,2005, the court dismissed the Last Atlantis action. On April 13, 2005,plaintiffs in the Last Atlantis action filed a motion for reconsideration. OnMay 9, 2005, the court denied plaintiffs’ motion for reconsideration withrespect to their antitrust claims but granted plaintiffs leave to seek tore-assert their securities law claims (Section 10(b) of the Exchange Act andRule 10b-5). On June 9, 2005, the court clarified its ruling on the motion forreconsideration and granted plaintiffs leave to seek to re-assert their breachof contract, common law fraud, breach of fiduciary duty, Illinois consumerfraud and deceptive business practices statute and tortious interference withplaintiffs’ business claims.

 

On June 1,2005, plaintiffs filed an amended complaint asserting securities law (Section10(b) of the Exchange Act and Rule 10b-5), breach of contract, common lawfraud, breach of fiduciary duty, Illinois consumer fraud and deceptive businesspractices statute and tortious interference with plaintiffs’ businessclaims.  Despite the court’s ruling on the motion for reconsideration,plaintiffs’ amended complaint also asserted federal antitrust law claims(Section 1 of the Sherman Act).

 

On June 24, 2005, plaintiffs filed a motionfor leave to file a second amended complaint, which does not include antitrustclaims, but does assert securities law (Section 10(b) of the Exchange Act andRule 10b-5), breach of contract, common law fraud, breach of fiduciary duty,Illinois consumer fraud and deceptive business practices statute, tortiousinterference with plaintiffs’ business, and tortious interference withcontracts claims, and purports to join Mr. Rule and River North Investors LLCas plaintiffs.

 

On July 15, 2005, the Court dismissed theRule action due to plaintiffs’ failure to serve process on the defendants inthe matter.

 

On September 28, 2005, Mr. Rule andRiver North Investors LLC, who, as stated above, now are plaintiffs in the LastAtlantis action, commenced an action in the United States District Court forthe Northern District of Illinois, Rule et al. v. Chicago Board OptionsExchange, Inc., et al., No. 05 C 5600.  The complaint in thisaction is substantially similar to the second amended complaint in the LastAtlantis action, making substantially the same allegations and seeking the samerelief against the same defendants, including LSP and us, except that thecomplaint in this action also asserts a federal antitrust law claim(Section 1 of the Sherman Act). Mr. Rule and River North Investors areproceeding pursuant to what the court has described as a stipulation that theirantitrust law claims have been dismissed on the same basis as the antitrust lawclaims were dismissed in the Last Atlantis action.

 

On September 30, 2005, Brad Martincommenced an action in the United States District Court for the NorthernDistrict of Illinois, Martin v. Chicago Board Options Exchange, Inc., etal., No. 05 C 5671.  The complaint in this action is substantiallysimilar to the second amended complaint in the Last Atlantis action and thecomplaint in the Rule action, making substantially the same allegationsand seeking the same relief against the same defendants, including LSP and us,except that the complaint in this action, like the complaint in theRule action, also asserts a federal antitrust law claim (Section 1 ofthe Sherman Act).   Mr. Martin isproceeding pursuant to 

 

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what the courthas described as a stipulation that their antitrust law claims have beendismissed on the same basis as the antitrust law claims were dismissed in theLast Atlantis action.

 

On October 4, 2005, the court grantedthe plaintiffs’ motion for leave to file a second amended complaint in the LastAtlantis action and to join Mr. Rule and River North Investors LLC asplaintiffs.  On October 5, 2005, the second amended complaint wasfiled.

 

On November 10, 2005, the court consolidated into the Last Atlantisaction, the Rule and River North Investors LLC action that was commenced onSeptember 28, 2005 (No. 05 C 5600) and the Martin action that was commenced onSeptember 30, 2005 (No. 05 C 5671).

 

EEOC/Servidio Litigation. On September 27, 2005, the Equal Employment Opportunity Commission (the “EEOC”)commenced an action in the United States District Court for the SouthernDistrict of New York, EEOC v. LaBranche & Co Inc., No. 05 CV8304, on behalf of Peter Servidio, a former employee of LaBranche & Co.LLC.  The complaint in this action alleges that we harassed anddiscriminated against Mr. Servidio on the basis of a disability, retaliatedagainst him for complaining about the alleged harassment and constructivelydischarged him.  The complaint seeks injunctive relief and monetarydamages, including reinstatement, back pay and front pay.

 

On September 28, 2005,Mr. Servidio moved to intervene in the action. Mr. Servidio’s complaint addsMr. Hayward and our former senior managing director of floor operations,Anthony Corso, as defendants, and also adds claims under the New York CityHuman Rights Law. The allegations in Mr. Servidio’s complaint include theallegations in the EEOC’s complaint and also allege that Mr. Servidio was notpromoted due to his disability. The EEOC complaint seeks (i) unspecifiedcompensation for past and future pecuniary and non-pecuniary losses resultingfrom the alleged discrimination, (ii) an order enjoining discrimination on thebasis of disability; and (iii) an order requiring institution and enforcementof policies providing equal employment opportunities for qualified individualswith disabilities. Mr. Servidio’s complaint seeks unspecified compensatorydamages, punitive damages, other affirmative relief, costs and attorneys’ fees.

 

NASD/AMEX Notice ofDisciplinary Action. On December 15, 2004, LaBranche &Co. LLC received a notice from the NASD Amex Regulation Division stating apreliminary determination has been made by the NASD Amex Regulation Division’sstaff to seek disciplinary action against LaBranche & Co. LLC forviolations of certain federal securities laws and the Amex Constitution andRules, including Sections 10(b), 9A and 17(a) of the Exchange Act, inconnection with manual book freezes effected in one of LaBranche & Co. LLC’sAmex specialist stocks during the period March 8, 2004 through October 21,2004.  Prior to receiving this notice, we had determined that theindividual specialist responsible for the book freezes failed to adhere tocompany policy and had terminated that employee. We have submitted a responseto the staff of the NASD Amex Regulation Division setting forth the reasons whydisciplinary action should not be brought against LaBranche & Co. LLC andwe are cooperating with the NASD Amex Regulation Division in this matter.

 

We believe that theclaims asserted against us by the plaintiffs in the pending proceedingsdescribed above are without merit, and we deny all allegations of wrongdoing. Therecan be no 

 

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assurance,however, as to the outcome or timing of the resolution of these proceedings. Wetherefore are unable to estimate the amount or potential range of any loss thatmay arise out of these proceedings. The range of possible resolutions couldinclude determinations and judgments against us or settlements that couldrequire substantial payments by us that could have a material adverse effect onour financial condition, results of operations and cash flows.

 

In addition to theproceedings described above, we and our operating subsidiaries have been thetarget, from time to time, of various claims, lawsuits and regulatory actionsincidental to the ordinary course of our and their respective businesses. Whilethe ultimate outcome of those claims, lawsuits and regulatory actions whichcurrently are pending cannot be predicted with certainty, we believe, based onour understanding of the facts of these claims, proceedings and regulatoryactions, that their ultimate resolution will not, in the aggregate, have amaterial adverse effect on our financial condition, results of operations orcash flows.

 

# **Item 4.**                                   SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS.

# ** **

There were no matters submitted to a vote of securityholders during the fourth quarter of our fiscal year ended December 31, 2005.

 

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**PARTII**

** **

# **Item 5.**            MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUERPURCHASES OF EQUITY SECURITIES.

# ** **

## **Market Information**

## ** **

Our common stock is quoted on the NYSE under thesymbol “LAB.” The following table sets forth the range of high and low closing salesprices for our common stock on the NYSE for each fiscal quarter within the twomost recent fiscal years:

 
| ** **     | ** ** | **Fiscal 2004** | ** ** | **Fiscal 2005** | ** ** |
|----------------|------------|----------------------|------------|----------------------|------------|
| ** **     | ** ** | **High**             | ** ** | **Low**              | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $                    | 12.10      |                 | $          | 8.97 |   | $ | 10.66 |   | $ | 7.90 |   |
| Second Quarter |       | $                    | 11.19      |                 | $          | 8.20 |   | $ | 9.98 |   | $ | 5.25 |   |
| Third Quarter  |       | $                    | 8.58       |                 | $          | 7.69 |   | $ | 9.59 |   | $ | 6.30 |   |
| Fourth Quarter |       | $                    | 9.12       |                 | $          | 7.09 |   | $ | 11.87 |   | $ | 8.63 |   |

 

## **Holders**

 

As of February 1, 2006, we had 158 stockholders ofrecord of our common stock and an estimated 7,200 beneficial owners. Theclosing sale price of our common stock on March 10, 2006 was $14.14 per share.

 

## **Dividends**

## ** **

We have not paid anydividends on our common stock since the third quarter of 2003. Thepayment of future dividends is within the discretion of our Board of Directorsand will depend on our future earnings, capital requirements, applicableregulatory restrictions, our financial condition, the application of thefinancial covenants contained in the indentures governing our currentlyoutstanding debt obligations and other relevant factors.

 

## **Securities Authorized forIssuance under Equity Compensation Plans**

## ** **

The information set forth under the caption “ExecutiveCompensation” in our definitive Proxy Statement to be used in connection withour 2005 Annual Meeting of Stockholders to be held on May 16, 2006, which willbe filed within 120 days of the end of our fiscal year ended December 31, 2005(the “2006 Proxy Statement”), is incorporated herein by reference.

 

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# **Item 6.**                                   SELECTED FINANCIALDATA.

# ** **

The selected financial data set forth below for theyears ended December 31, 2005, 2004, 2003 and 2002 and as ofDecember 31, 2005, 2004, 2003 and 2002 have been derived from ourconsolidated financial statements, which have been audited by KPMG LLP,independent registered public accounting firm, and are included elsewhere inthis filing. The selected financial data set forth below for the year endedDecember 31, 2001 and as of December 31, 2001 has been derived fromour consolidated financial statements, audited by Arthur Andersen LLP,independent public auditors, which are not included elsewhere in this filing.The selected financial data set forth below should be read in conjunction withthe consolidated financial statements and related notes thereto and with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,”which are included elsewhere in this filing.

 
| ** **                                                                       | ** ** | **For Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(000’s omitted)**                                                    | ** ** | **2005**                                            | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| **STATEMENT OF OPERATIONS DATA:**                                                | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues:                                                                        |       |                                                |       |   |   |   |   |   |   |   |   |
| Net gain on principal transactions                                               |       | $                                                   | 194,432    |   | $ | 182,535 |   | $ | 202,207 |   | $ | 342,400 |   | $ | 340,795 |   |
| Commissions                                                                      |       | 84,018                                              |       | 96,045 |   | 94,443 |   | 92,044 |   | 62,866 |   |
| Net gain (loss) on non-marketable investments                                    |       | 11,029                                              |       | 24,953 |   | 1,065 |   | 5,161 |   | (1,863 | ) |
| Interest                                                                         |       | 50,655                                              |       | 10,187 |   | 6,594 |   | 11,533 |   | 20,989 |   |
| Other                                                                            |       | 56                                                  |       | 5,327 |   | 1,680 |   | 1,707 |   | 1,343 |   |
| Total revenues                                                                   |       | 340,190                                             |       | 319,047 |   | 305,989 |   | 452,845 |   | 424,130 |   |
|                                                                             |       |                                                |       |   |   |   |   |   |   |   |   |
| Expenses:                                                                        |       |                                                |       |   |   |   |   |   |   |   |   |
| Employee compensation and benefits                                               |       | 103,531                                             |       | 99,310 |   | 99,123 |   | 131,511 |   | 110,832 |   |
| Interest                                                                         |       | 89,504                                              |       | 63,789 |   | 48,188 |   | 48,589 |   | 52,049 |   |
| Restitution and fines                                                            |       | —                                              |       | — |   | 63,519 |   | — |   | — |   |
| Goodwill impairment                                                              |       | —                                              |       | 37,600 |   | 170,302 |   | — |   | — |   |
| Exchange memberships impairment                                                  |       | —                                              |       | 18,327 |   | 515 |   | — |   | — |   |
| Debt repurchase premium                                                          |       | —                                              |       | 49,029 |   | — |   | — |   | — |   |
| Other                                                                            |       | 96,050                                              |       | 106,461 |   | 109,416 |   | 106,621 |   | 104,538 |   |
| Total expenses                                                                   |       | 289,085                                             |       | 374,516 |   | 491,063 |   | 286,721 |   | 267,419 |   |
|                                                                             |       |                                                |       |   |   |   |   |   |   |   |   |
| Income (loss) before minority interest and  provision (benefit) for income taxes |       | $                                                   | 51,105     |   | $ | (55,469 | ) | $ | (185,074 | ) | $ | 166,124 |   | $ | 156,711 |   |
| Net income (loss)                                                                |       | $                                                   | 37,521     |   | $ | (43,780 | ) | $ | (179,389 | ) | $ | 87,226 |   | $ | 71,587 |   |

 
| ** **                      | ** ** | **As of December 31,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|
| **(000’s omitted)**   | ** ** | **2005**                              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| **BALANCE SHEET DATA:**         |       |                                  |       |   |   |   |   |   |   |   |   |
| Total assets                    |       | $                                     | 4,284,295  |   | $ | 2,055,097 |   | $ | 1,963,090 |   | $ | 1,912,802 |   | $ | 2,000,837 |   |
| Total long term obligations (1) |       | 490,820                               |       | 498,733 |   | 275,891 |   | 383,233 |   | 429,205 |   |
| Stockholders’ equity       |       | $                                     | 733,456    |   | $ | 692,986 |   | $ | 772,964 |   | $ | 989,688 |   | $ | 928,358 |   |

 

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(1)                                  Includesobligations under our subordinated debt (excluding those related to contributedexchange memberships).

 
| ** **                        | ** ** | **For Year Ended December 31,** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------|------------|
| ** **                        | ** ** | **2005**                                            | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| **COMMON SHARE DATA:**            |       |                                                |       |   |   |   |   |   |   |   |   |
| Earnings (loss) per diluted share |       | $                                                   | .61        |   | $ | (0.77 | ) | $ | (3.08 | ) | $ | 1.34 |   | $ | 1.13 |   |
| Cash dividends declared per share |       | —                                              |       | — |   | $ | 0.24 |   | — |   | — |   |
|                                   |            |                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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# **Item 7.**            MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

# ** **

*You should read the following discussion of ourfinancial condition and results of operations together with the financialstatements and the notes to such statements included elsewhere in this filing.This discussion contains forward-looking statements based on our currentexpectations, assumptions, estimates and projections about us and our industry.These forward-looking statements involve risks and uncertainties including, butnot limited to those discussed in “Risk Factors” set forth in Item 1 of thisannual report. Our actual results could differ materially from thoseanticipated in these forward-looking statements as a result of certain factors.We undertake no obligation to update publicly any forward-looking statementsfor any reason, even if new information becomes available or other events occurin the future.*

 

## **Executive Overview**

## ** **

The equity and derivative trading business has been undergoingsignificant change for several years. Decimalization, sector trading and indextrading strategies have led to an increase in program trading as a percentageof equity trading volume. Block trading has declined and the average trade sizehas decreased significantly.

 

The equity markets have also experienced an extended period of lowervolatility. These factors have led to lower principal trading revenues in ourSpecialist and Market-Making segment as the markets have been relatively calm. Ourcash equity trading revenues have declined year over year by approximately tenpercent, but our trading revenues for our Specialist and Market-Making segmenthave stabilized over the past few quarters. In addition, increased technologyhas given us the ability to handle higher volumes without increasing costs. Volumeshave remained relatively low over the past few years but returned to a morehistorical rate of growth in 2005. The financial results of our specialist andmarket making business are highly dependent on trading volumes and volatility.It is our belief that as volumes grow, market volatility will return as well,which will enable us to participate as principal in more transactions in ourspecialist and market-making operations.

 

Further changes in technology will bring about changes in the waystocks, options and ETF’s are traded. The proposed hybrid model, currentlybeing tested by the NYSE, is expected to address many of the challenges thathave arisen since the advent of decimalization. The hybrid model will reducethe amount of labor needed to execute and report trades on the NYSE. Asproposed by the NYSE, the hybrid model is also expected to allow specialists tointeract in a “fast” and more automated market. It will provide specialistswith the tools to add liquidity to the market and to continue to add value tothe pricing and trading of individual stocks. Added technology will make ouremployees more efficient and should allow us to manage our compensation costsmore effectively. We believe that these coming changes will affect the way inwhich stocks are traded, yet preserve the fundamental elements of today’sauction market. Even with the completed NYSE/Archipelago merger and the hybridmodel and SEC’s Regulation NMS initiatives, senior NYSE officials havecontinued to publicly state that there will continue to be an auction marketwith a central point of sale. They have also stated that specialists willcontinue to play an integral role in providing liquidity and will continue tohave an affirmative 

 

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obligation to make a fair andorderly market. There is some speculation that large issuers’ stocks will tradeentirely electronically with minimal participation by specialists. A specialist’sprimary role is to provide liquidity by committing capital when marketimbalances occur, and we believe that technology cannot eliminate these marketimbalances. With this in mind, we are anticipating that specialists willcontinue to play an important role in all listed stocks. We believe that ourcash equity business will improve as trading volumes and market volatilitygrow.

 

Structured products such as ETFs have grown in popularity. ETFs whichhave some characteristics similar to sector and index funds trade continuallythroughout the day on an exchange. The liquidity and flexibility of beingexchange-traded has led to substantial growth in these products. ETF assetsgrew to approximately $296.0 billion as of December 31, 2005 from $226.2billion as of December 31, 2004. We have become a leading specialist in ETFs asthe number of ETFs has increased. ETFs now represent ownership of securities inAsia and emerging markets, as well as securities comprising indexes. We believethat the growth in these products will increase as investors seek to lowerinvestment costs, manage tax liability and hedge portfolio risks. It is ourintention to continue to work with ETF issuers as they seek to successfullylaunch new products and to provide added liquidity which will aid the growth ofindividual ETFs.

 

We also believe that options, indexes and other structured productswill trade differently. Certain option indexes and ETFs which do not requireprice discovery as a result of the liquidity and transparency of underlyingsecurities, will trade more electronically in a matching facility. We believemore complicated option and ETF products will require liquidity provided by aspecialist or primary market maker to best maximize price discovery. Weanticipate that these products will trade in an electronic format linked to aliquidity provider with an affirmative obligation to ensure best possiblepricing.

 

The emergence of exchanges that offer multiple trading venues andproducts signifies that the trading of cash equities, fixed income, options andstructured products may be converging into several marketplaces. We believethat this trend will accelerate and that the traditional cash equity specialistbusiness will be increasingly linked to other trading strategies. As evidencedby our specialist and market-making revenue growth from $245.0 million in 2004to $283.6 million in 2005, we believe we have successfully begun to execute ourstrategy to become a leading specialist and market-maker in this new tradingenvironment.

 

**NewAccounting Developments**

 

In December 2004, the FASB issued SFAS No. 123(R), “ShareBased Payment.” SFAS No. 123(R) is a revision of SFAS No. 123, “Accounting forStock-Based Compensation” and supercedes APB opinion No. 25, “Accounting forStock Issued to Employees” and amends SFAS No. 95, “Statement of Cash Flows.”SFAS No. 123(R) will require compensation costs related to share-based paymenttransactions to be recognized in the financial statements over the period thatan employee provides service in exchange for the award. SFAS No. 123(R) iseffective as of January 1, 2006, using the modified prospective method. Wecurrently do not expect the adoption of this standard will have a materialimpact on our financial condition, results of operations or 

 

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cash flows. Please refer to Footnote 2, “Summary ofSignificant Accounting Policies” of our consolidated financial statements inthis report for additional information and disclosure.

 

**CriticalAccounting Estimates**

 

*Goodwill and Other IntangibleAssets*

 

We determine the fair value of each of our reportingunits and the fair value of each reporting unit’s goodwill under the provisionsof Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill andOther Intangible Assets.”  In determiningfair value, we use standard analytical approaches to business enterprisevaluation (“BEV”), such as the market comparable approach and the incomeapproach. The market comparable approach is based on comparisons of the subjectcompany to similar companies engaged in an actual merger or acquisition or topublic companies whose stocks are actively traded. As part of this process,multiples of value relative to financial variables, such as earnings orstockholders’ equity, are developed and applied to the appropriate financialvariables of the subject company to indicate its value. The income approachinvolves estimating the present value of the subject company’s future cashflows by using projections of the cash flows that the business is expected togenerate, and discounting these cash flows at a given rate of return. Each ofthese BEV methodologies requires the use of management estimates andassumptions. For example, under the market comparable approach, we assigned acertain control premium to the public market price of our common stock as ofthe valuation date of our 2005 year-end impairment test, in estimating the fairvalue of our specialist reporting unit. Similarly, under the income approach,we assumed certain growth rates for our revenues, expenses, earnings beforeinterest, income taxes, depreciation and amortization, returns on workingcapital, returns on other assets and capital expenditures, among others. Wealso assumed certain discount rates and certain terminal growth rates in ourcalculations. For our year-end 2005 goodwill impairment tests, we engaged anindependent business valuation firm to assist us in our BEV analyses. Given thesubjectivity involved in selecting which BEV approach to use and in determiningthe input variables for use in our analyses, it is possible that a differentvaluation model and the selection of different input variables could produce amaterially different estimate of fair value of our goodwill.

 

We review the reasonableness of the carrying value ofour goodwill on an annual calendar basis (i.e., December 31) unless an event orchange in circumstances would require an interim reassessment of impairment. During 2005, there were no interim changes incircumstances that necessitated goodwill impairment testing prior to our annualrequired testing of goodwill. Asa result of our analysis of the above-mentioned factors for the year endedDecember 31, 2005, with the assistance of the independent business valuationfirm, we determined that there has been no impairment of our goodwill underSFAS No. 142. We cannot provide assurance that future goodwillimpairment testing will not result in impairment charges in subsequent periods.

 

Our other intangible assets, as defined under SFAS No.142, consists of our trade name. We determine the fair value of our trade nameby applying the income approach using the royalty savings methodology. Thismethod assumes that the trade name has value to the extent we are relieved ofthe obligation to pay royalties for the benefits received from it. Applicationof this methodology requires estimating an appropriate royalty rate, which istypically expressed as a percentage of revenue. Estimating an appropriateroyalty rate includes reviewing evidence from 

 

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comparable licensing agreements and consideringqualitative factors affecting the trade name. Given the subjectivity involvedin selecting which BEV approach to use and in determining the input variablesfor use in our analyses, it is possible that a different valuation model andthe selection of different input variables could produce a materially differentestimate of fair value of our trade name. We review the reasonableness of thecarrying amount of our trade name on an annual basis in conjunction with ourgoodwill impairment assessment. As of December 31, 2005, no impairment of ourtrade name existed. We cannot provide assurance that future trade nameimpairment testing will not result in impairment charges in subsequent periods.

 

We amortize our identifiable intangible stock listingrights over their estimated useful lives in accordance with SFAS No. 142, andtest for potential impairment whenever events or changes in circumstancessuggest that an asset or asset group’s carrying value may not be fully recoverablein accordance with SFAS No. 144. An impairment loss, calculated as thedifference between the estimated fair value and the carrying value of an assetor asset group is recognized if the sum of the estimated undiscounted cashflows relating to the asset or asset group is less than the correspondingcarrying value. As a result of our testing and analysis for the year endedDecember 31, 2005, with the assistance of an independent business valuationfirm, we determined that there has been no impairment of our stock listingrights under SFAS No. 144. We cannot provide assurance that future stocklisting rights impairment testing will not result in impairment charges insubsequent periods.

 

*Non-Marketable Securities*

 

The use of fair value to measure certainnon-marketable investments is a critical accounting estimate. Investments innon-marketable securities consist of investments in equity securities ofprivate companies, limited liability company interests and limited partnershipinterests, which do not have readily available price quotations. Certaininvestments in non-marketable securities are initially carried at cost, as anapproximation of fair value. Adjustments to carrying value are made if thereare third-party transactions evidencing a change in value. For certain otherinvestments in non-marketable securities, we adjust their carrying value byapplying the equity method of accounting, and for our investment in a limitedpartnership interest, we adjust its carrying value by recognizing our share ofthe partnership’s quarterly results of operations. In addition, if and whenavailable, management considers other relevant factors relating tonon-marketable investments in estimating their fair value, such as thefinancial performance of the entity, its cash flow forecasts, trends withinthat entity’s industry and any specific rights associated with ourinvestment—such as conversion features—among others.

 

Given management’s judgment involved in valuingcertain of our non-marketable securities, it is possible, as of a given pointin time, that a third-party could reach a different conclusion of fair valueutilizing the same variables as we have in our analysis.

 

*Other-Than-Temporary Impairmentof Exchange Memberships*

 

The determination of the fair value of our exchangememberships is a critical accounting estimate. Exchange memberships owned by usare originally carried at cost, pursuant to the American Institute of CertifiedPublic Accountants (“AICPA”) *Audit and AccountingGuide—Brokers and Dealers in Securities*. Adjustments to carryingvalue are made if we deem that an 

 

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“other-than-temporary” decline in value, as defined inEmerging Issues Task Force (“EITF”) Issue No. 03-1, *The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments,*and in Section M of Topic 5 of the SEC staffaccounting bulletin series (“SAB No. 59”), has occurred. In determining whether the value of our ownedexchange memberships is impaired (*i.e*., fair marketvalue is below cost) and whether such impairment is temporary orother-than-temporary, we consider many factors, including, but not limited to,information regarding recent sale and lease prices of exchange memberships,historical trends of sale and lease prices of memberships on a particularexchange and their duration, the current condition of the particular exchange’smarket structure, legal and regulatory developments affecting the particularexchange’s market structure and earnings capability, trends in new listings onthe particular exchange, general global and national economic factors and ourknowledge and judgment of the specialist and execution and clearing industriesand the securities market as a whole. As a result of our analysis of the above-mentionedfactors for the year ended December 31, 2005, we believe the carrying values ofour owned exchange memberships were not impaired.

 

We cannot provide assurance that the consistentapplication of this accounting policy to future reporting periods will notresult in further adjustments to the carrying value of any of our remaining exchange memberships following theconsummation of the NYSE merger with Archipelago. This accounting policy,however, will no longer be applied in future periods to our NYSE specialistoperations because our NYSE memberships were surrendered in connection with theNYSE/Archipelago merger and our NYSE specialist operations and clearingoperations will be conducted through trading licenses on the new NYSE Market.

 

**Useof Estimates**

 

The use ofgenerally accepted accounting principles requires management to make certainestimates. In addition to the estimates we make in connection with fair valuemeasurements and the accounting for goodwill and identifiable intangible assets,the use of estimates is also important in determining provisions for potentiallosses that may arise from litigation, regulatory proceedings and tax audits.

 

We estimate and provide forpotential losses that may arise out of litigation, regulatory proceedings andtax audits to the extent that such losses are probable and can be estimated, inaccordance with SFAS No. 5, “Accounting for Contingencies.” Significantjudgment is required in making these estimates and our final liabilities mayultimately be materially different. Our total liability in respect oflitigation and regulatory proceedings is determined on a case-by-case basis andrepresents an estimate of probable losses after considering, among otherfactors, the progress of each case or proceeding, our experience and theexperience of others in similar cases or proceedings, and the opinions andviews of legal counsel. Given the inherent difficulty of predicting the outcomeof our litigation and regulatory matters, particularly in cases or proceedingsin which substantial or indeterminate damages or fines are sought, we cannotestimate losses or ranges of losses for cases or proceedings where there isonly a reasonable possibility that a loss may be incurred. See “LegalProceedings” in Part I, Item 3 of this Annual Report on Form 10-K forinformation on our judicial, regulatory and arbitration proceedings.

 

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**Execution and Clearing Risk**

 

Our Execution and Clearing segment, through the normalcourse of business, enters into various securities transactions as agent. Theexecution, settlement and financing of these transactions can result inunrecorded market risk and concentration of credit risk. Our execution andclearing activities involve settlement and financing of various customersecurities transactions on a cash or margin basis. These activities may exposeus to risk in the event the customer or other broker is unable to fulfill itscontractual obligations and we have to purchase or sell securities at a loss.For margin transactions, we may be exposed to significant market risk in theevent margin requirements are not sufficient to fully cover losses thatcustomers may incur in their accounts.

 

**Restructuring of Our LaBranche StructuredProducts-Related Subsidiaries**

 

In August 2005, we formed LSHI, as a holding company to own allour LaBranche Structured Products-affiliated entities.  Pursuant to acontribution agreement among LSP, LSPS, LSHI and LaBranche & Co Inc,effective August 20, 2005, LSHI became the sole member of LSP, and,effective September 9, 2005, LSHI became the sole member of LSPS. Alsoeffective August 20, 2005, LSHI became the sole stockholder of LSPE, whichpreviously had been wholly-owned by LSP, pursuant to a distribution agreement betweenLSHI and LSP.  Other than these restructuring transactions, the structureand operations of each of LSP, LSPS and LSPE have not changed. OnAugust 25, 2005, we formed LSPH to operate as a market-maker in ETFs andengage in hedging transactions in Asia.  LSHI became the sole stockholderof LSPH in October 2005. LSPE was registered as a broker-dealer with theUnited Kingdom’s FSA in March 2006 and, LSPH is in the process of registeringas a broker-dealer with Hong Kong’s Securities and Futures Commission.

 

**Completed Senior Note Repurchase; Release ofLava Escrow**

 

In connection with the sale of our interest in Lava Trading Inc. (“Lava”)as part of an acquisition of Lava in August 2004, we received cash ofapproximately $39.0 million at the closing. Additional consideration ofapproximately $9.6 million was deposited in escrow to secure ourindemnification obligations as a selling stockholder of Lava untilNovember 2, 2005. Under the terms of the indenture governing ouroutstanding 9.5% Senior Notes due 2009 and our outstanding 11.0% Senior Notesdue 2012 (collectively, the “outstanding senior notes”), by the 361stday following the closing of the Lava acquisition, we were required to offer topurchase outstanding senior notes in an aggregate principal amount equal to theafter-tax proceeds of the sale of our interest in Lava in August 2004, ata price equal to 100.0% of the principal amount of such outstanding seniornotes.  Therefore, on July 29, 2005, we commenced an offer topurchase outstanding senior notes in the aggregate principal amount of up toapproximately $18.2 million. This excess proceeds offer expired onAugust 25, 2005, with $63,000 principal amount of outstanding senior noteshaving been tendered.  Following the closing of this transaction and theclosings of other previous offers to repurchase with immaterial ternders ofsenior notes, approximately $199.8 million aggregate principal amount of ourSenior Notes due 2009 remained outstanding and approximately $259.9 millionaggregate principal amount of our Senior Notes due 2012 remained outstanding.

 

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On October 31, 2005, the escrow in connection with the Lavatransaction was terminated and we received approximately $9.6 million asadditional consideration in connection with the Lava transaction. Therefore,under the indenture governing the outstanding senior notes we will again berequired to offer to purchase outstanding senior notes in an aggregateprincipal amount equal to the after-tax proceeds of this $9.6 million on orprior to October 27, 2006.

 

## **Results of Operations**

## ** **

Specialist and Market-Making Segment Operating Results

 
| ** **                         | ** ** | **For the Years Ended December 31,** | ** ** | **2005 vs. 2004  Percentage** | ** ** | **2004 vs. 2003  Percentage** | ** ** |
|------------------------------------|------------|---------------------------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| **(000’s omitted)**      | ** ** | **2005**                                                      | ** ** | **2004**                                | ** ** | **2003**                                | ** ** | **Change** | ** ** | **Change** | ** ** |
|                               |       |                                                          |       |                                    |       |                                    |       |   |   |   |   |
| **Revenues:**                      |       |                                                          |       |                                    |       |                                    |       |   |   |   |   |
| Net gain on principal transactions |       | $                                                             | 194,432    |                                    | $          | 182,535                                 |       | $ | 202,206 |   | 6.5 | % | (9.7 | )% |
| Commissions                        |       | 42,290                                                        |       | 48,781                                  |       | 47,450                                  |       | (13.3 | ) | (2.8 | ) |
| Interest                           |       | 46,682                                                        |       | 8,676                                   |       | 5,227                                   |       | 438.1 |   | 66.0 |   |
| Other                              |       | 169                                                           |       | 5,031                                   |       | 1,700                                   |       | (96.6 | ) | 195.9 |   |
| Total segment revenues             |       | 283,573                                                       |       | 245,023                                 |       | 256,583                                 |       | 15.7 |   | (4.5 | ) |
|                               |       |                                                          |       |                                    |       |                                    |       |   |   |   |   |
| Operating expenses                 |       | 180,991                                                       |       | 148,799                                 |       | 144,731                                 |       | 21.6 |   | 2.8 |   |
| Goodwill impairment                |       | —                                                        |       | 37,600                                  |       | 166,250                                 |       | (100.0 | ) | (77.4 | ) |
| Exchange memberships impairment    |       | —                                                        |       | 16,300                                  |       | —                                  |       | — |   | — |   |
| NYSE restitution settlement        |       | —                                                        |       | —                                  |       | 63,519                                  |       | (100.0 | ) | (100.0 | ) |
|                               |       |                                                          |       |                                    |       |                                    |       |   |   |   |   |
| Pre-tax income (loss)              |       | $                                                             | 102,582    |                                    | $          | 42,324                                  |       | $ | (117,917 | ) | 142.4 | % | 135.9 | % |

 

Revenues from our Specialist and Market-Making segmentconsist primarily of net gain earned from principal transactions in securitiesfor which we act as specialist and interest income. Net gain on principaltransactions represents trading gains net of trading losses and SEC transactionfees, where applicable, and are earned by us when we act as principal buyingand selling our specialist stocks, rights, options, ETFs and futures. Alsoincluded in net gain on principal transactions are net gains and lossesresulting from our market-making activities in ETFs, options and futures, thenet gains and losses resulting from trading of foreign currencies, futures andequities underlying the rights, ETFs and options for which we act asspecialist, and accrued dividends receivable or payable on our equitypositions. These revenues are primarily affected by changes in share volumetraded and fluctuations in prices of stocks, rights, options, ETFs and futuresin which we are the specialist or in which we make a market.

 

Commissions revenue generated by our Specialist andMarket-Making segment consists primarily of fees earned when our specialistsact as agents by executing limit orders on behalf of brokers, professionaltraders and broker dealers after a specified period of time; we do not earn commissionswhen we match market orders or when we act as a market-maker.

 

Interest revenue generated by our Specialist andMarket-Making segment consists primarily of interest earned in securitieslending transactions and inventory financing in connection with our trading inoptions, futures and ETFs.

 

Other revenue at our Specialist and Market-Makingsegment consists primarily of proprietary trading gains or losses and gains orlosses from an investment in a hedge fund.

 

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***KeyMetrics of our Specialist and Market-Making Activities—***Whenassessing the performance and financial results of a specific period,management examines certain metrics to ascertain their impact on cash equityspecialist financial results. Some of the key metrics that we review, and theirvalues for 2005, 2004 and 2003, are as follows: 

 
| ** **                                                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2005 vs. 2004  Percentage  Change** | ** ** | **2004 vs. 2003  Percentage  Change** | ** ** |
|---------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| NYSE average daily share volume (in  millions)                      |       | 1,602.2  |       | 1,456.7  |       | 1,398.4  |       | 10.0                                            | %          | 4.2                                             | %          |
| LAB share volume on the NYSE (in billions)                          |       | 102.1    |       | 96.1     |       | 94.5     |       | 5.5                                             | %          | 1.7                                             | %          |
| LAB dollar value on the NYSE (in billions)                          |       | $        | 3,370.8    |     | $          | 2,819.1  |       | $                                               | 2,477.4    |                                            | 19.0       | % | 13.8 | % |
| Share volume of principal shares traded (in  billions)              |       | 19.6     |       | 22.3     |       | 27.6     |       | (12.1                                           | )%         | (19.2                                           | )%         |
| Dollar value of principal shares traded (in  billions)              |       | $        | 692.5      |     | $          | 682.7    |       | $                                               | 725.1      |                                            | 1.4        | % | (5.8 | )% |
| Average closing price of the CBOE  Volatility Index                 |       | 12.8     |       | 15.5     |       | 22.0     |       | (17.4                                           | )%         | (29.5                                           | )%         |
| Program trading as a percentage of NYSE  average daily share volume |       | 57.1     |       | 50.6     |       | 37.5     |       | 12.8                                            | %          | 34.9                                            | %          |
| Number of Specialist ETFs                                           |       | 49       |       | 18       |       | 1        |       | 1,722                                           | %          | 17,000                                          | %          |
| Number of Specialist Options                                        |       | 640      |       | 321      |       | 215      |       | 92.2                                            | %          | 49.3                                            |       |

 

Generally, an increase in the average daily sharevolume on the NYSE, an increase in volatility (as measured by the averageclosing price of the CBOE’s Volatility Index®, or the “VIX”), an increase inthe dollar value and share volume of our principal shares or a decrease inprogram trading enables the specialist to increase its level of principalparticipation and thus its ability to realize net gain on principaltransactions. While these metrics are monitored by management each period, theyare not the sole indicators or factors in any given period that determine ourlevel of revenues, profitability or overall performance. Other factors, such asextreme price movements, unanticipated company news and events and otheruncertainties may influence our financial performance either positively ornegatively.

 

## **Year Ended December 31,2005 Compared to Year Ended December 31, 2004**

## ** **

The increase in net gain on principal transactions is attributableprimarily to our options, futures and ETFs specialist operations, with respectto which trading revenue increased by approximately 82% from 2004 to 2005. Thisrevenue growth was the result of an increase in the number of products traded,market-maker professionals and exchanges on which we trade our derivativeproducts. This was offset by a continued decrease in our cash equity specialistoperations, in which trading revenue decreased by approximately 10% from 2004to 2005. This decrease was at a lower rate than in 2004, but was similarly dueto a decline in principal shares traded as well as the continued decline inmarket volatility, as measured by the average closing price of the VIX. Anotherfactor that has reduced the opportunity for our cash equity specialists toparticipate is the continuing rise in program trading as a percentage of NYSEaverage daily share volume. Program trading involves reducing large shareorders into many smaller orders, resulting in the orders being matchedelectronically. These factors offset the benefit from the 

 

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increases in NYSE average dailyshare volume and share volume and dollar value traded for equity securities inwhich we are the specialist. We believe that market volatility has declined asthe level of mutual funds’ participation in the market has declined.

 

Interest revenue earned by our Specialist andMarket-Making segment was higher primarily due to an increase in securitieslending, known as “stock-borrow” transactions, resulting from increased tradingactivity in our options, futures and ETFs specialist and market-makingoperations.

 

Other revenue earned by our Specialist andMarket-Making segment was lower primarily due to decreased proprietary tradinggains.

 

For a discussion of operating expenses see “OurOperating Expenses” below.

 

## **Year Ended December 31,2004 Compared to Year Ended December 31, 2003**

## ** **

The decline in net gain on principal transactions in our Specialist andMarket-Making segment was attributable primarily to our cash equity specialistoperations. The decrease was due to a decline in principal shares traded, aswell as a significant decline in market volatility, as measured by the averageclosing price of the VIX. Another factor that reduced the opportunity for ourequity specialists to participate was the continuing rise in program trading asa percentage of NYSE average daily share volume. These factors offset thebenefit from the increases in NYSE average daily share volume and share volumeand dollar value traded for stocks in which we are the equity specialist. Thisrevenue growth was the result of an increase in the number of products traded,market-maker professionals and exchanges in which we trade our derivativeproducts.

 

Other revenue earned by our Specialist andMarket-Making segment was higher primarily due to increased proprietary tradinggains, and higher interest income from our stock-borrow transactions, resultingfrom increased trading activity in our options, futures and ETFs specialist andmarket-making operations and from our short to medium term investments.

 

### *For a discussion of operatingexpenses see “Our Operating Expenses” below.*

### * *

### *Execution and Clearing SegmentOperating Results*

### * *

| ** **                      | ** ** | **For the Years Ended December 31,** | ** ** | **2005 vs. 2004  Percentage** | ** ** | **2004 vs. 2003  Percentage** | ** ** |
|---------------------------------|------------|---------------------------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| **(000’s omitted)**   | ** ** | **2005**                                                      | ** ** | **2004**                                | ** ** | **2003**                                | ** ** | **Change** | ** ** | **Change** | ** ** |
| ** **                      | ** ** | ** **                                                    | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| REVENUES:                       |       |                                                          |       |                                    |       |                                    |       |   |   |   |   |
| Commissions                     |       | $                                                             | 41,729     |                                    | $          | 47,263                                  |       | $ | 46,994 |   | (11.7 | )% | 0.6 | % |
| Interest                        |       | 826                                                           |       | 388                                     |       | 360                                     |       | 112.9 |   | 7.8 |   |
| Other                           |       | 249                                                           |       | 365                                     |       | 555                                     |       | (31.8 | ) | (34.2 | ) |
| Total segment revenues          |       | 42,804                                                        |       | 48,016                                  |       | 47,909                                  |       | (10.9 | ) | 0.2 |   |
|                            |       |                                                          |       |                                    |       |                                    |       |   |   |   |   |
| Operating expenses              |       | 45,753                                                        |       | 52,827                                  |       | 57,293                                  |       | (13.4 | ) | (7.8 | ) |
| Goodwill impairment             |       | —                                                        |       | —                                  |       | 4,052                                   |       | (100.0 | ) | (100.0 | ) |
| Exchange memberships impairment |       | —                                                        |       | 2,027                                   |       | 515                                     |       | (100.00 | ) | 293.6 |   |
|                            |       |                                                          |       |                                    |       |                                    |       |   |   |   |   |
| Pre-tax loss                    |       | $                                                             | (2,949     | )                                       | $          | (6,838                                  | )          | $ | (13,951 | ) | 56.9 | % | 51.0 | % |

 

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Our Execution and Clearing segment’s commissionsrevenue includes fees charged to customers for execution, clearance anddirect-access floor brokerage activities.

 

Our Execution and Clearing segment’s other revenuesconsist of interest income, proprietary trading net gains or losses and feescharged to customers for use of our proprietary front-end order executionsystem.

 

## **Year Ended December 31,2005 Compared to Year Ended December 31, 2004**

## ** **

Commission revenuefrom our Execution and Clearing segment decreased as a result of a decline indirect-access floor broker order flow and reduced trade volume from clearancecustomers. This decline was partially offset by an increase in revenues fromour institutional group as a result of general growth and expansion of itscustomer base. Interest income increased as a result of additional amountsinvested in T-bills and an increase in interest rates. In addition, stockborrow income increased. Other revenue from our Execution and Clearing Segmentremained relatively flat.

 

For a discussion of operating expenses see “OurOperating Expenses” below.

 

## **Year Ended December 31,2004 Compared to Year Ended December 31, 2003**

## ** **

Other revenue from our Execution and Clearing segmentdecreased as LFSI ceased providing its proprietary front–end order executionsystem on a service bureau basis, and also decreased due to a decline ininterest income. Interest income decreased as a result of lower balances of ourshort term investments and reduced levels of stock-borrow transactions.

 

For a discussion of operating expenses see “OurOperating Expenses” below.

 

# **OtherSegment Operating Results**

 
| ** **                    | ** ** | **For the Years Ended December 31,** | ** ** | **2005 vs. 2004  Percentage** | ** ** | **2004 vs. 2003  Percentage** | ** ** |
|-------------------------------|------------|---------------------------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| **(000’s omitted)** | ** ** | **2005**                                                      | ** ** | **2004**                                | ** ** | **2003**                                | ** ** | **Change** | ** ** | **Change** | ** ** |
| ** **                    | ** ** | ** **                                                    | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| REVENUES:                     |       |                                                          |       |                                    |       |                                    |       |   |   |   |   |
| Interest                      |       | $                                                             | 3,145      |                                    | 1,313      |                                    | 1,199      |   | 139.6 | % | 9.5 | % |
| Other                         |       | 10,668                                                        |       | 24,695                                  |       | 298                                     |       | (56.8 | ) | 8,186.9 |   |
| Total segment revenues        |       | 13,813                                                        |       | 26,008                                  |       | 1,497                                   |       | (46.9 | ) | 1,637.3 |   |
|                          |       |                                                          |       |                                    |       |                                    |       |   |   |   |   |
| Operating expenses            |       | 62,341                                                        |       | 67,934                                  |       | 54,703                                  |       | (8.2 | ) | 24.2 |   |
| Debt repurchase premium       |       | —                                                        |       | 49,029                                  |       | —                                  |       | (100.0 | ) | — |   |
|                          |       |                                                          |       |                                    |       |                                    |       |   |   |   |   |
| Pre-tax loss                  |       | $                                                             | (48,528    | )                                       | $          | (90,955                                 | )          | $ | (53,206 | ) | 46.6 | % | 70.9 | % |
|                               |            |                                                               |            |                                         |            |                                         |            |  |  |  |  |  |  |  |

 

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The portion of our revenues that is not generated fromour two principal business segments consists primarily of unrealized gains orlosses on our non-marketable investments and interest income.

 

## **Year Ended December 31,2005 Compared to Year Ended December 31, 2004**

## ** **

Interest revenue increasedprimarily due to higher rates on our short-term investments. Other revenuesdecreased primarily as a result of the smaller realized gain from the finalinstallment from the sale of our investment in Lava in 2004 of $9.6 million in2005 (due to the release of an escrow) versus the $24.9 million realized gainduring 2004 in connection with the disposition of our investment in Lava duringthe third quarter of 2004.

 

For a discussion of operating expenses see “OurOperating Expenses” below.

 

## **Year Ended December 31,2004 Compared to Year Ended December 31, 2003**

## ** **

Other revenues increasedprimarily as a result of the $24.9 million realized gain from the dispositionof our investment in Lava during the third quarter of 2004.

 

For a further discussion of operating expenses see “OurOperating Expenses” below.

 

**Our Operating Expenses**

 
| ** **                                                  | ** ** | **For the Years Ended December 31,** | ** ** | **2005 vs. 2004  Percentage** | ** ** | **2004 vs. 2003  Percentage** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| **(000’s omitted)**                               | ** ** | **2005**                                                      | ** ** | **2004**                                | ** ** | **2003**                                | ** ** | **Change** | ** ** | **Change** | ** ** |
| ** **                                                  | ** ** | ** **                                                    | ** ** | ** **                              | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| EXPENSES:                                                   |       |                                                          |       |                                    |       |                                    |       |   |   |   |   |
| Employee compensation and related benefits                  |       | $                                                             | 103,531    |                                    | $          | 99,310                                  |       | $ | 99,123 |   | 4.3 | % | 0.2 | % |
| Interest                                                    |       | 89,504                                                        |       | 63,789                                  |       | 48,188                                  |       | 40.3 |   | 32.4 |   |
| Exchange, clearing and brokerage fees                       |       | 40,664                                                        |       | 39,010                                  |       | 40,406                                  |       | 4.2 |   | (3.5 | ) |
| Lease of exchange memberships                               |       | 3,979                                                         |       | 15,565                                  |       | 24,773                                  |       | (74.4 | ) | (37.2 | ) |
| Goodwill impairment                                         |       | —                                                        |       | 37,600                                  |       | 170,302                                 |       | (100.0 | ) | (77.9 | ) |
| Exchange memberships impairment                             |       | —                                                        |       | 18,327                                  |       | 515                                     |       | (100.0 | ) | 3,458.6 |   |
| Debt repurchase premium                                     |       | —                                                        |       | 49,029                                  |       | —                                  |       | (100.0 | ) | — |   |
| NYSE restitution settlement                                 |       | —                                                        |       | —                                  |       | 63,519                                  |       | — |   | (100.0 | ) |
| Other operating expenses                                    |       | 51,407                                                        |       | 51,886                                  |       | 44,237                                  |       | (0.9 | ) | 17.3 |   |
|                                                        |       |                                                          |       |                                    |       |                                    |       |   |   |   |   |
| Total expenses before provision (benefit)  for income taxes |       | 289,085                                                       |       | 374,516                                 |       | 491,063                                 |       | (22.8 | ) | (23.7 | ) |
|                                                        |       |                                                          |       |                                    |       |                                    |       |   |   |   |   |
| Provision (benefit) for income taxes                        |       | $                                                             | 13,584     |                                    | $          | (12,045                                 | )          | $ | (6,007 | ) | 212.8 | % | (100.5 | )% |

 

Our Specialist and Market-Making segment’s employeecompensation and related benefits expense consists of salaries, wages andprofitability-based compensation paid to our traders and related support staff.The employee compensation and benefits expense related to our Execution andClearing segment consists of salaries, wages and profitability-basedcompensation paid to our execution and clearing professionals, as well ascompensation based on commissions earned by various trading professionals.Profitability-based compensation may include cash

 

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compensation and stock-based compensation paid orgranted to managing directors, trading professionals and other employees basedon our profitability.

 

Interest expense is primarily incurred from theindebtedness in connection with our reorganization from partnership tocorporate form in 1999, our acquisitions, the issuance of promissory notes inexchange for our preferred stock and the 2004 refinancing of the majority ofour then-outstanding senior notes and senior subordinated notes. The interestexpense at our Specialist and Market-Making segment is primarily the result of inventoryfinancing costs relating to positions taken in connection with our options,futures and ETFs specialist and market-making operations and interest onsubordinated indebtedness that has been approved by the NYSE for inclusion inthe net capital of our LaBranche & Co. LLC subsidiary. Customers’ freecredit balances and bank loans generate interest expense at our Execution andClearing segment.

 

Exchange, clearing andbrokerage fees expense at our Specialist and Market-Making segment consistsprimarily of fees paid by us to the NYSE, AMEX, other exchanges, the DepositoryTrust Clearing Corporation (“DTCC”) and to third party execution and clearingcompanies. The fees paid by us to these entities are primarily based on the volumeof transactions executed by us as principal and as agent, a fee based onexchange seat use, an allocation fee requiring specialist firms to share thecost of newly allocated listings, technology fees, a flat annual fee andexecution and clearing fees. Our Execution and Clearing segment’s exchange,clearing and brokerage fees expense consists of floor brokerage fees paid todirect-access floor brokers and fees paid to various exchanges.

 

## **Year Ended December 31,2005 Compared to Year Ended December 31, 2004**

## ** **

While consolidated employee compensation and related benefits expenseincreased slightly in 2005 as compared to 2004, there were material changeswithin the components of employee compensation and benefits expense at each ofour business segments year over year. The main cause of these changes was theincrease in profitability-based compensation, salaries and related benefits inconnection with our options, futures and ETFs specialist and market-makingoperations resulting from increased trading and support personnel. Theseincreases were partially offset by decreases in compensation related to ourcash equity specialist activities due to a reduction in personnel. Thesatisfaction and payment of a retention bonus plan liability, and our December2005 termination of a deferred compensation plan, both related to a prioracquisition, also partially offset the increase in employee compensation.Salaries and profitability-based compensation at our Execution and Clearingsegment declined due to a decrease in trading and support personnel**.** Employee compensation and related benefits decreased to30.4% of revenues in 2005 from 31.1% in 2004.

 

Interest expense increased primarily as a result of increased inventoryfinancing costs relating to the growth and expansion of trading activity in ouroptions, futures and ETFs specialist and market-making operations. Inventoryfinancing costs increased from $8.4 million in 2004 to $36.6 million in 2005.While interest expense increased to 26.3% of total revenues in 2005 from 20.0%in 2004, stock borrow interest income increased to 9.8% of total revenues in2005 from 1.2% for 2004. Other interest expense, mainly related to long-termdebt, decreased from $55.4 million in 2004 to $52.9 in 2005, primarily due tolong-term debt repayments on maturity.

 

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Exchange, clearing and brokerage fees increased primarily due to increasedtrading activity in our options, futures and ETFs specialist and market-makingoperations. Partially offsetting the increase was a decrease in exchange,clearing and brokerage fees at our Execution and Clearing segment related tolower revenues from direct-access floor brokers. Exchange, clearing andbrokerage fees declined to 11.9% of revenues in 2005 from 12.2% in 2004.

 

Lease of exchangememberships decreased substantially as a result of the decline in the averageannual lease cost of an NYSE membership and a decrease in the number of ourNYSE leased memberships. Our average annual lease cost of an NYSE membership in2005 was approximately $70,000, as compared to approximately $235,000 in 2004. Additionally,we leased on average approximately 11 fewer NYSE seats in 2005 than we did in2004. Lease of exchange memberships expense decreased to 1.2% of total revenuesin 2005 from 4.9% for the same period in 2004.

 

Other operating expenses decreased in 2005 as compared to 2004primarily due to an decrease in legal, audit and other professional feesincurred primarily in connection with Sarbanes-Oxley Act compliance, as well asfees charged on a committed revolving credit facility established in the firstquarter of 2004, which was terminated upon the completion of the refinancing ofour indebtedness on May 18, 2004.

 

SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”)requires entities to test goodwill for possible impairment on an annual basis,or more frequently, if certain events and circumstances exist. We tested ourgoodwill for impairment at December 31, 2005, per the annual testing requirement,and noted no further impairment of this asset at that date. In September 2004,we recorded a goodwill impairment charge of $37.6 million, all of which wasattributable to our Specialist and Market-Making segment. The impairmentcharge, which represented the excess of the carrying value of our Specialistand Market-Making segment’s goodwill over its implied fair value, was necessaryto properly reflect the carrying value of our goodwill at September 30, 2004. Weupdated our third quarter 2004 goodwill valuation results at December 31, 2004,per the annual testing requirement, and noted no further impairment of thisasset at that date. For a more complete description of our methodology inevaluating the reasonableness of the carrying value of our goodwill, please see“—Critical Accounting Estimates.”

 

We did not record an exchange-membership impairment in 2005. In 2004,however, we recorded an $18.3 million other-than-temporary impairment chargerelated to our NYSE exchange memberships. Of this total, $16.3 million wasattributable to our Specialist and Market-Making segment and $2.0 million wasattributable to our Execution and Clearing segment.

 

Our 2004 operatingexpenses included a $49.0 million charge in connection with the repurchase of asubstantial portion of our then-outstanding senior notes and seniorsubordinated notes. This charge was attributable to a consent payment, whichwas offered to debt holders who tendered their 2004 Notes and 2007 Notes byApril 19, 2004, and a premium for tendering the 2004 Notes and 2007 Notes forpurchase prior to their maturity. No such expenses were incurred in 2005.

 

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Our expense for incometaxes increased in 2005 to $13.6 million, versus a tax benefit of $12.0 millionin 2004. Our effective tax rate rose to 26.6% in 2005 from 21.8% in 2004. The2004 effective rate was lower than the statutory rate mainly due to thereduction of non-deductible goodwill impairment limiting the tax benefit fromthe loss. In 2005, the effective rate was lower than the statutory rate due tosignificant tax benefits recognized by a tax rate change applied to the netdeferred tax liability for the Company.

 

## **Year Ended December 31,2004 Compared to Year Ended December 31, 2003**

## ** **

While consolidated employee compensation and benefits expense increasedslightly for 2004 as compared to 2003, there were material changes within thecomponents of employee compensation and benefits expense at each of oursegments year over year. The main cause of these changes was the increase inprofitability-based compensation, salaries and related benefits in connectionwith our options, futures and ETFs specialist and market-making operationsresulting from increased trading and support personnel. These increases werepartially offset by decreases in salaries related to our cash equity specialistactivities due to a reduction in personnel. The expiration and payment of aretention bonus plan liability, and a decrease in deferred compensationexpense, both related to a prior acquisition, also partially offset the overallincrease in employee compensation. Salaries and profitability-basedcompensation at our Execution and Clearing segment declined due to a decreasein trading and support personnel**.** Employeecompensation and related benefits decreased to 31.1% of revenues in 2004 from32.4% in 2003.

 

Interest expense increased primarily as a result of the issuance of ouroutstanding senior notes due 2009 and senior notes due 2012 in connection withthe repurchase on May 18, 2004 of substantially all the then-outstanding seniornotes and senior subordinated notes. As a result of the repurchase, we recorded$5.5 million of additional interest expense related to the acceleration of debtissuance cost amortization and senior notes discount accretion. The additionalinterest expense on our outstanding senior notes issued in our May 2004refinancing also contributed to the increase. The remaining increase ininterest expense was the result of increased inventory financing costs relatingto the growth and expansion of trading activity at our LSP and LSPSsubsidiaries. While interest expense increased to 20.0% of total revenues in2004 from 15.7% in 2003, non-tax deductible dividends on preferred stock wereeliminated effective July 2004.

 

Exchange, clearing and brokerage fees declined primarily due to thedecrease in fees related to our cash equity specialist activities. Contributingto the decrease was the elimination of the NYSE technology fee in July 2003,lower allocation fees for new listings, and a decrease in NYSE regulatory feesdue to a lower number of NYSE floor personnel. Partially offsetting thesedecreases was an increase in exchange, clearing and brokerage fees at ourExecution and Clearing segment related to higher revenues from direct-accessfloor brokers. Additionally, commissions expense and exchange fees related toour options, futures and ETFs specialist and market-making operations increaseddue to increased trading activity. Exchange, clearing and brokerage feesdeclined to 12.2% of revenues in 2004 from 13.2% in 2003.

 

Lease of exchangememberships decreased substantially as a result of the decline in the averageannual lease cost of an NYSE membership and a decrease in the number of ourNYSE

 

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leased memberships. Ouraverage annual lease cost of an NYSE membership in 2004 was approximately$235,000, as compared to approximately $316,000 in 2003. Additionally, weleased on average approximately 11 fewer NYSE seats for 2004 than we did in2003. Lease of exchange memberships expense decreased to 4.9% of total revenuesin 2004 from 8.1% in 2003.

 

Other operating expenses increased in 2004 as compared to 2003primarily due to an increase in legal, audit and other professional feesincurred primarily in connection with Sarbanes-Oxley Act compliance, therefinancing of our debt and litigation. Bank charges also increased due toinvestment banking fees relating to our debt refinancing and fees charged on acommitted revolving credit facility established in the first quarter of 2004,which was terminated upon the completion of the refinancing of our indebtednesson May 18, 2004. Additional expenses relating to our debt refinancing includedcredit rating service fees, as well as printing and filing fees. An increase ininsurance premiums also contributed to the increase.

 

In September 2004, we recorded a goodwill impairment charge of $37.6million, all of which was attributable to our Specialist and Market-Makingsegment. SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”)requires entities to test goodwill for possible impairment on an annual basis,or more frequently, if certain events and circumstances exist. We tested ourgoodwill for impairment at December 31, 2003, at which time we recorded animpairment charge of $170.3 million, of which $166.2 million was attributableto our Specialist and Market-Making segment and $4.1 million was attributableto our Execution and Clearing segment. Due to certain changes in circumstances,such as the decrease in our market capitalization and continued downward trendsin our principal trading revenues, we tested our goodwill for impairment as ofSeptember 30, 2004. The impairment charge, which represents the excess of thecarrying value of our Specialist and Market-Making segment’s goodwill over itsimplied fair value, was necessary to properly reflect the carrying value of ourgoodwill at September 30, 2004. We updated our third quarter 2004 goodwillvaluation results at December 31, 2004, per the annual testing requirement, andnoted no further impairment of this asset at that date. For a more completedescription of our methodology in evaluating the reasonableness of the carryingvalue of our goodwill, please see “—Critical Accounting Estimates.”

 

Exchange memberships impairment significantly increased in 2004 ascompared to 2003 as a result of an $18.3 million other-than-temporaryimpairment charge related to our NYSE exchange memberships. Of this total,$16.3 million was attributable to our Specialist and Market-Making segment and$2.0 million was attributable to our Execution and Clearing segment. The 2004impairment charge was related to the 39 NYSE memberships we owned (each ofwhich was valued at $1.5 million at December 31, 2004, compared to $2.0 millionat December 31, 2003), while the 2003 impairment charge was related to an AMEXmembership owned by our LFSI subsidiary.

 

We incurred a $49.0million charge in connection with the repurchase of a substantial portion ofour then-outstanding senior notes and senior subordinated notes. This chargewas attributable to a consent payment, which was offered to debt holders whotendered their senior notes due 2004 and senior subordinated notes due 2007 inApril 2004, and a premium for tendering these notes for purchase prior to their maturity.

 

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Our benefit for income taxes increased two-fold in 2004 toapproximately $12.0 million. Our effective tax rate rose to 21.8% in 2004 from3.2% in 2003 as a result of a non-deductible goodwill impairment charge andNYSE penalties of approximately $179.2 million in 2003, which almost equaledthat fiscal year’s book net loss. By contrast, the non-deductible goodwillimpairment charge of approximately $33.3 million in 2004 represented 59.7% ofthe book net loss for 2004. This permanent difference offset almost half of2004’s statutory tax rate of 46.1%, or approximately 18.0%.

 

## **Liquidity and CapitalResources**

## ** **

As of December 31, 2005, we had $4,284.3 million inassets, of which $506.3 million consisted of cash and short-term investments,primarily in government obligations maturing within three months, cash andsecurities segregated under federal regulations and overnight repurchase agreements.To date, we have financed our operations primarily with retained earnings fromoperations and proceeds from our debt and equity offerings. Due to the natureof the securities business and our role as a specialist, market-maker andexecution agent, the amount of our cash and short-term investments, as well asoperating cash flow, may vary considerably due to a number of factors,including the dollar value of our positions as principal, whether we are netbuyers or sellers of securities, the dollar volume of executions by ourcustomers and clearing house requirements, among others. Certain regulatoryrequirements constrain the use of a portion of our liquid assets for financing,investing or operating activities. Similarly, the nature of our business lines,the capital necessary to maintain current operations and our current fundingneeds subject our cash and cash equivalents to different requirements and uses.

 

As of December 31, 2005, the scheduled maturities ofour contractual obligations, without taking into account any availableroll-over provisions, were as follows:

 
| ** **                     | ** ** | **Total**                | ** ** | **<1 Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **>5 Years** | ** ** |
|--------------------------------|------------|--------------------------|------------|---------------------|------------|--------------------|------------|--------------------|------------|----------------------|------------|
| ** **                     | ** ** | **(000’s omitted)** | ** ** |
| Short Term and Long Term Debt* |       | $                        | 481,479    |                | $          | —             |       | $                  | 21,642     |                 | $          | 199,845 |   | $ | 259,992 |   |
| Subordinated Liabilities       |       | 12,395                   |       | 6,395               |       | 6,000              |       | —             |       | —               |       |
| Operating Lease Obligations    |       | 3,967                    |       | 1,933               |       | 1,798              |       | 135                |       | 101                  |       |
| **Total**                      |       | $                        | 497,841    |                | $          | 8,328              |       | $                  | 29,440     |                 | $          | 199,980 |   | $ | 260,093 |   |

 

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* Amounts represent aggregate amount to be paid atmaturity and do not include discounts of approximately $0.1 million as of December 31, 2005.

 

The above table includes indebtedness with primarilylong-term maturities, the interest and principal payments of which have asignificant effect on the cash available to finance our current and futureoperations. As ofDecember 31, 2005, our most significant long-term indebtedness was the $199.8million aggregate principal amount of our outstanding senior notes that maturein May 2009, and the $260.0 million aggregate principal amount of ouroutstanding senior notes that mature in May 2012.

 

At December 31, 2005, our net cash capital position was $106.9 million.Fluctuations in net cash capital are common and are a function of variabilityin our total assets, balance sheet composition and total capital. We attempt tomaintain cash capital sources in excess of our aggregate longer-term fundingrequirements (*i.e.*, positive net cash capital).Over the previous 12

 

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months, our net cash capitalhas averaged above $100 million.

 
| ** **                            | ** ** | **($ millions )** | ** ** |
|---------------------------------------|------------|-----------------------------|------------|
| ** **                            | ** ** | **2005**                    | ** ** | **2004** | ** ** |
| Cash Capital  Available:              |       |                        |       |   |   |   |   |
| Stockholders’ equity             |       | $                           | 733.5      |   | $ | 693.0 |   |
| Subordinated debt                     |       | 9.4                         |       | 17.3 |   |
| Long term debt > 1 year            |       | 481.4                       |       | 481.5 |   |
| Other holding company liabilities     |       | 35.6                        |       | 71.6 |   |
| Total cash capital available          |       | $                           | 1,259.9    |   | $ | 1,263.4 |   |
|                                  |       |                        |       |   |   |
| Cash Capital Required:                |       |                        |       |   |   |
| Regulatory capital                    |       | $                           | 449.7      |   | $ | 448.5 |   |
| Working capital                       |       | 119.1                       |       | 68.1 |   |
| Illiquid assets/long-term investments |       | 582.2                       |       | 634.7 |   |
| Subsidiary  intercompany              |       | 2.0                         |       | 17.1 |   |
| Total Cash Capital  Required          |       | $                           | 1,153.0    |   | $ | 1,168.4 |   |
| Net Cash Capital                      |       | $                           | 106.9      |   | $ | 95.0 |   |

 

“Cash Capital Available” is mainly comprised of stockholders’ equity,long term debt, subordinated debt and other liabilities of our parent holdingcompany which, in the aggregate, constitute the currency used to purchase ourassets and provide our working capital. This amount will principally beaffected as debt matures or is refinanced and as earnings are retained or paidas dividends. “Cash Capital Required” mainly consists of the assets used in ourbusinesses. Regulatory capital is defined as capital required by the SEC andapplicable exchanges to be maintained by broker-dealers. It is principallycomprised of cash, net equities, other investments and net receivables fromother broker-dealers. Working capital constitutes liquid assets provided to oursubsidiaries in excess of the required regulatory capital. Illiquid assets andlong term investments mainly are comprised of exchange memberhips, intangibleassets, such as goodwill, tradename and stock listing rights, deposits,deferred taxes and non-marketable investments. “Net Cash Capital” is consideredto be the excess of Cash Capital Available over Cash Capital Required, or “freecash,” which we can utilize to fund our business needs.

 

We also monitor alternative funding measures in addition to ouravailable net cash. The alternative funding measures are significanttransactions and actions we could take in a short-term time frame to generatecash to meet debt maturities or other business needs. More precisely, as ofDecembr 31, 2005, we have identified the following alternative funding measuresto support future debt maturity requirements:

 

•                  Liquidationof net invested capital at certain subsidiaries.

•                  Reductionof excess capital at LaBranche & Co LLC to only required net liquid assets(excess NLA dividend)

•                  Proposedreduction of NLA requirements by the NYSE and SEC.

•                  NYSEmerger consideration, including $300,000 and 80,177 shares of NYSE Group permembership, and the $70,570 permitted dividend per membership which wasdeclared immediately prior to the merger.

 

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**Alternative Funding Measures**

**$ millions**

** **
| Net cash capital                                      |   | $     | 106.9  |   |
|-------------------------------------------------------|--------|-------|--------|--------|
| Investment in subsidiaries                            |   | 104.5 |   |
| Excess NLA dividend at LLC                            |   | 12.3  |   |
| Proposed reduction of NLA requireents                 |   | 180.0 |   |
| NYSE group stock (1) (2)                              |   | 124.6 |   |
| NYSE merger consideration (1)                         |   | 9.4   |   |
| Total cash available from alternate funding  measures |   | $     | 537.7  |   |

 

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(1)          Computedon an after-tax basis

(2)          Basedon opening NYX price of $67.00 per share on March 8, 2006

 

In addition to the alternative funding measures above, we monitor thematurity profile of our unsecured debt to minimize refinancing risk, wemaintain relationships with debt investors and bank creditors, and weperiodically renew our secured committed credit facilities. Strongrelationships with a diverse base of creditors and debt investors are criticalto our liquidity. We also maintain available sources of short-term funding thatexceed actual utilization, thus allowing us to accommodate changes in investorappetite and credit capacity for our debt obligations.

 

 With respect to the managementof refinancing risk, the maturity profile of our long-term debt portfolio is monitoredon an ongoing basis and structured within the context of two significant debttranches with a significant spread of years between maturities (mid-term andlong-term.) Thus, we have strategically negotiated debt terms due 2009 and 2012for the significant debt tranches. In addition, the debt tranches have callprovisions which allow pre-maturity retirements as early as 2007. The debttranches have available maturities and calls over the six year period 2007through 2012 to allow us maximum flexibility in satisfying the debt maturitieswith payments and/or sufficient time to refinance the long-term debt asrequired. The following chart profiles our long-term debt maturity as ofDecember 31, 2005.

 

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**LAB Long Term Debt**

**Principal & Callable Repayment Schedule**

 

 
| **Senior Notes** | ** ** |
|------------------|------------|
| **Tranches**     | ** ** | **Due** | ** ** | **Rate** | ** ** |
| $200 million     |       | 2009 |   | 9.50 | % |
| $260 million     |       | 2012 |   | 11.00 | % |

 

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(1) Excludes ExtendibleSubordinated Debt of $2.3mm and $1.1mm in 2006 and 2007 respectively. Extendibledebt is defined as debt instruments with an extendiblematurity. Unless debt holders instruct thecompany to redeem their debt, the earliest maturity date of these instrumentsis automatically extended. Based on past experience,  themajority of the Company’s extendibles are expected to remain outstanding beyondtheir earliest maturity date.

 

Our outstanding senior noteswere issued pursuant to a new indenture that is similar to the indentures thatgoverned our senior notes due 2004 and senior subordinated notes due 2007 priorto their amendment in connection with our May 2004 debt refinancing. The newindenture includes certain covenants that, among other things, limit ourability to make certain investments, engage in transactions with stockholdersand affiliates, create liens on our assets and sell assets or engage in mergersand consolidations, except in accordance with certain specified conditions.****In addition, our ability to incuradditional indebtedness (other than certain “permitted indebtedness”), paydividends, redeem stock or repurchase subordinated indebtedness prior tomaturity is limited if our consolidated fixed charge coverage ratio is at orbelow a threshold of 2.00:1. The “consolidated fixed charge coverage ratio”reflects a comparison between (1) our consolidated earnings before interest,taxes, depreciation and amortization expenses, or “EBITDA,” and (2) the sum ofour consolidated interest expense and a tax-effected multiple of any dividendpayments with respect to our preferred stock. As of December 31, 2005, ourconsolidated fixed charge coverage ratio, as defined, was 2.02:1. The indenturegoverning our outstanding senior notes provides for certain exceptions to thelimitations on restricted payments, including, for example, the July 2004repurchase of all then-outstanding shares of our Series B preferred stock,repurchase of our outstanding senior notes, and any “restricted payments” up toan aggregate of $15.0 million over the life of the indenture.

 

In addition, under the indenture governing ouroutstanding senior notes, if, at any time, our cumulative “restricted payments”since May 18, 2004 generally are greater than (i) the sum of (A) 50.0% of ourcumulative consolidated net income, as defined in the indenture, since July 1, 2004(or, if such calculation is a loss, minus 100.0% of such loss) and (B) 100.0%of the net cash proceeds received from any issuance or sale of our capital stocksince July 1, 2004, plus

 

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(ii) $15.0 million, we will not be entitled to make a “restrictedpayment” at such time. As of December 31, 2005, our cumulative consolidated netincome since July 1, 2004 was $39.6 million, and we had received approximately$1.4 million upon the exercise of options since July 1, 2004. Accordingly, wecurrently are entitled to make restricted payments up to $21.2 million, plusthe $15.0 million “basket” described above, for an aggregate total of $36.2million. While we have not made any restricted payments since May 18, 2004, wecannot be sure if, when or to what extent this covenant will prevent or limitus from making restricted payments in the future.

 

The indenture governing ouroutstanding senior notes permits us to redeem some or all of the senior notesdue 2009 on or after May 15, 2007 and some or all of the senior notes due2012  on or after May 15, 2008 at varyingredemption prices, depending on the date of redemption. In addition, we havethe option to redeem up to 33.0% of the aggregate principal amount of the seniornotes due 2009 at a redemption price of 109.5% and up to 33.0% of the aggregateprincipal amount of the senior notes due 2012 at a redemption price of 111.0%using the proceeds of certain equity offerings which we may complete on orprior to May 15, 2007. Under the terms of the indenture, if we sellsubstantially all our assets or experience specific kinds of changes incontrol, we will be required to offer to repurchase outstanding senior notes,on a pro rata basis, at a price in cash equal to 101.0% of their principalamount, plus accrued and unpaid interest, if any, to the date of purchase.

 

After giving effect to ourMay 2004 debt refinancing and the repurchase of all then-outstanding shares ofour Series B preferred stock in July 2004, the after-tax earnings per shareimpact of our ongoing interest obligations with respect to our outstandingsenior notes is lower than the combined after-tax earnings per share impact ofour interest obligations with respect to the senior notes and senior subordinatednotes and our non-tax deductible dividend obligations with respect to ourthen-outstanding Series B preferred stock. To the extent we repurchase anyoutstanding senior notes in connection with future corporate strategicinitiatives, our fixed-term interest payments would be correspondingly reduced.

 

The remaining $13.6 millionaggregate principal amount of senior subordinated notes due 2007 that we didnot repurchase in connection with our May 2004 debt refinancing will continueto accrue interest at a rate of 12.0% per annum until they mature on March 2,2007. To the extent we are not prohibited under the terms of the indenturegoverning our outstanding senior notes, we may seek to repurchase some or allof the remaining 2007 senior subordinated notes from time to time on the openmarket.

 

In connection with the sale of our interest in Lava as part of anacquisition of Lava in August 2004, we received cash of approximately$39.0 million at the closing. Additional consideration of approximately $9.6million was deposited in escrow to secure our indemnification obligations as aselling stockholder of Lava until November 2, 2005. Under the terms of theindenture governing our outstanding senior notes, by the 361st dayfollowing the closing of the Lava acquisition, we were required to offer topurchase outstanding senior notes in an aggregate principal amount equal to theafter-tax proceeds of the disposition of our investment in Lava during thethird quarter of 2004, at a price equal to 100.0% of the principal amount ofsuch outstanding senior notes.  Therefore, on July 29, 2005, wecommenced an offer to purchase outstanding senior notes in the aggregateprincipal amount of up to approximately $18.2 million. This excess proceedsoffer expired on August 25, 2005, with $63,000 principal amount having

 

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been tendered.  Followingthe closing of this transaction and the closings of previous offers to repurchasewith immaterial tenders of senior notes, approximately $199.8 million aggregateprincipal amount of our senior notes due 2009 remained outstanding andapproximately $260.0 million aggregate principal amount of our senior notes due2012 remained outstanding.

 

On October 31, 2005, the escrow in connection with the Lavatransaction was terminated and we received approximately $9.6 million asadditional consideration in connection with the Lava transaction. Therefore,under the indenture governing our outstanding senior notes, we will again berequired to offer to purchase outstanding senior notes in an aggregateprincipal amount equal to the after-tax proceeds of this $9.6 million receipton or prior to October 27, 2006.

 

As of December 31, 2005, we owned 39 NYSE memberships out of a total1366 NYSE memberships, representing a 2.9% ownership interest in the NYSE. Uponconsummation of the NYSE merger with Archipelago on March 7, 2006, each NYSEmembership is entitled to receive in exchange for the NYSE membership $300,000in cash, plus 80,177 shares of NYSE Group common stock.. In addition,immediately prior to the consummation of the NYSE/Archipelago merger, the NYSEannounced a “permitted dividend” to be paid to each NYSE membership in theamount of approximately $70,570, which was equivalent to each membership’s pro rataportion of the NYSE’s “excess cash,” as defined in the NYSE/Archipelago mergeragreement. As a result of the NYSE/Archipelago merger, therefore, our 39 NYSEmemberships were converted into the right to receive an aggregate of $11.7million in cash (not including the permitted dividend) and 3,126,903 shares ofNYSE Group common stock. We received the permitted dividend with respect toeach of the 39 NYSE memberships on March 14, 2006. Based on informationprovided to us prior to the closing of the merger, we expect to receive themerger consideration on or about March 21, 2006.

 

A potential source ofliquidity for LaBranche & Co. LLC is the committed line of credit that itmaintains with a bank. In October 2005, LaBranche & Co. LLC extended this$200.0 million committed credit agreement to October 28, 2006 on the same termsand conditions. In connection with the credit agreement, we pay a quarterly feeof 0.25% of the total committed line of credit. Amounts outstanding under thiscredit facility would be secured by our inventory of specialist stocks and bearinterest at the bank’s broker loan rate. This facility can only be used tofinance inventory requirements at LaBranche & Co. LLC. In order to maintainthe availability of funds under this credit facility, we must comply withcertain financial and other covenants.

 

As a specialist andmarket-maker, we are required to maintain certain levels of capital and liquidassets as promulgated by various regulatory agencies which regulate ourbusiness. As part of our overall risk management procedures (for furtherdiscussion, refer to Part I, Item 3. “Quantitative and Qualitative Disclosuresabout Market Risk”), we attempt to balance our responsibility as specialist,market-maker and broker-dealer with our overall capital resources. Theserequirements restrict our ability to make use of cash and other liquid assetsfor corporate actions, such as repaying our debt, repurchasing stock or makingacquisitions.

 

As a broker-dealer,LaBranche & Co. LLC is subject to regulatory requirements intended toensure the general financial soundness and liquidity of broker-dealers andrequiring the maintenance of minimum levels of net capital, as defined in SECRule 15c3-1. LaBranche & Co.

 

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LLC is required to maintainminimum net capital, as defined, equivalent to the greater of $100,000 or 1/15 of aggregate indebtedness, asdefined. NYSE Rule 326(c) also prohibits a broker-dealer from repayingsubordinated borrowings, paying cash dividends, making loans to any parent,affiliates or employees, or otherwise entering into transactions which wouldresult in a reduction of its total net capital to less than 150.0% of itsrequired minimum capital. Moreover, broker-dealers are required to notify theSEC prior to repaying subordinated borrowings, paying dividends and makingloans to any parent, affiliates or employees, or otherwise entering intotransactions which, if executed, would result in a reduction of 30.0% or moreof their excess net capital (net capital less minimum requirement). The SEC hasthe ability to prohibit or restrict such transactions if the result is deemeddetrimental to the financial integrity of the broker-dealer. As of December 31,2005, LaBranche & Co. LLC’s net capital, as defined, was $459.8 million,which exceeded the minimum requirements by $458.1 million.

 

TheNYSE generally requires its specialist firms to maintain a minimum dollarregulatory capital amount in order to establish that they can meet, with theirown net liquid assets, their position requirement. As of December 31, 2005, LaBranche& Co. LLC’s and LSPS’ requiredcombined dollar amount of net liquid assets, as defined, was $447.0 million. LaBranche& Co. LLC’s actual net liquid assets, as defined, was $459.3 million as ofDecember 31, 2005. LSPS is not required to perform a net liquid assetscalculation because LaBranche & Co. LLC’s actual net liquid assets exceedthe combined net liquid assets requirement of LaBranche & Co. LLC and LSPS.The NYSE has filed a proposed rule withthe SEC which seeks to reduce the required net liquid ssset amounts forspecialists such as LaBranche & Co. LLC. Based on the currently proposedrule, we expect a reduction in our required net liquid assets of approximately$180.0 million. This reduction is expected to be effected in four equalquarterly installments commencing on the date the SEC approves the final rule. Thetiming and extent of any such reduction, however, has not been finallydetermined, and it is possible that the rule will not be approved by the SEC atall. A reduction in LaBranche & Co. LLC’s net liquid assets requirement,however, would allow funds no longer needed for net liquid assets purposes tobe used for other corporate purposes.

 

The AMEX generally requiresits equity specialist firms to maintain a cash or liquid asset position of thegreater of (a) $1.0 million or (b) an amount sufficient to assume a position ofsixty trading units of each security in which the specialist is registered. Asof December 31, 2005, LaBranche & Co. LLC satisfied the AMEX equityspecialist liquid asset requirements.

 

As a registeredbroker-dealer and member firm of the NYSE, LFSI also is subject to SEC Rule15c3-1, as adopted and administered by the NYSE and the SEC. Under thealternative method permitted by the rule, the minimum required net capital ofLFSI as of December 31, 2004 was equal to the greater of $1.5 million or 2.0%of aggregate debit items, as defined. As of December 31, 2005, LFSI’s netcapital, as defined, was $19.7 million, which exceeded its minimum net capitalrequirement by $18.2 million.

 

As a clearing broker-dealer,LFSI is subject to SEC Rule 15c3-3, as adopted and administered by the SEC. Asof January 4, 2006, to comply with its December 31, 2005 requirement, cash andU.S. Treasury Bills in the amount of $1.2 million were segregated in a specialreserve account for the exclusive benefit of customers, exceeding actualrequirements by $1.2 million. As of January 4, 2005, to comply with itsDecember 31, 2004 requirement, cash

 

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and U.S. Treasury Bills inthe amount of $0.1 million were segregated in a special reserve account for theexclusive benefit of customers, exceeding actual requirements by $0.1 million.In addition, the PAIB Calculation is computed in order for correspondent firmsto classify their assets held by LFSI as allowable assets in the correspondents’net capital calculation. As of January 4, 2006, to comply with its December 31,2005 requirement, cash and U.S. Treasury Bills in the amount of $5.7 millionwere segregated in a special reserve account for the exclusive benefit ofcustomers, exceeding actual requirements by $2.0 million. As of January 4,2005, to comply with its December 31, 2004 requirement, cash and U.S. TreasuryBills in the amount of $4.4 million were segregated in a special reserveaccount for the exclusive benefit of customers, exceeding actual requirementsby $3.4 million.

 

As a registeredbroker-dealer and AMEX member firm, LSP is subject to SEC Rule 15c3-1, asadopted and administered by the AMEX and the SEC. LSP is required to maintainminimum net capital, as defined, equivalent to the greater of $100,000 or 1/15 of aggregate indebtedness,as defined. As of December 31, 2005, LSP’s net capital, as defined, was$56.8 million, which exceeded its minimum net capital requirement by $55.7million.

 

As a specialist and member of the NYSE, LSPS issubject to the provisions of SEC Rule 15c3-1, as adopted and administered bythe SEC and NYSE. LSPS is required to maintain minimum net capital, as defined,equivalent to the greater of $100,000 or 1/15 of aggregateindebtedness, as defined. As of December 31, 2005, LSPS’ net capital, asdefined under SEC Rule 15c3-1, was $10.7 million, which exceeded the minimumrequirement by $10.6 million.

 

Failure by any of ourbroker-dealer subsidiaries to maintain its required net capital and net liquidassets, where applicable, may subject it to suspension or revocation of its SECregistration or its suspension or expulsion by the NYSE, the AMEX and/or anyother exchange of which it is a member firm.

 

As evidenced by theforegoing requirements, our broker-dealer subsidiaries require a substantialamount of capital. In particular, LaBranche & Co. LLC’s and LSPS’ combinednet liquid asset requirement of $447.0 million limits our ability to utilize asubstantial portion of our liquid assets for other corporate purposes. Althougha portion of the combined net liquid asset requirement of $447.0 million is metby LaBranche & Co. LLC’s and LSPS’ securities positions, pending trades andother assets associated with our equity and ETF specialist activities, asubstantial portion of LaBranche & Co. LLC’s cash and cash equivalents asof December 31, 2005 was used to meet their combined net liquid assetrequirement.

 

In connection with ouracquisition of ROBB PECK McCOOEY Financial Services, Inc. (“RPM”) in March2001, we assumed its liabilities and obligations under RPM’s deferredcompensation plan. The deferred compensation plan provided for the payment, onor before December 15, 2007, of approximately $30.2 million, plus interest at arate of 8.0% per year, to certain former employees of RPM. On December 15,2005, our board of directors, in accordance with the terms of the deferredcompensation plan, determined to terminate the plan and distribute the fullamount of remaining amounts owed under the plan, plus accrued and unpaidinterest at no additional cost. The aggregate amount paid to the participantsunder the deferred compensation plan in connection with this termination was$14.6 million. Prior to the termination of this plan, we had paid an additional$6.0 million to the former RPM employees in

 

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March 2005, in accordancewith the terms of the plan. Following the termination of the deferredcompensation plan, we have no further liabilities thereunder to the formeremployees of RPM.

 

As of December 31, 2005, thesubordinated indebtedness of LaBranche & Co. LLC aggregated $12.4 million(excluding subordinated liabilities related to contributed exchangememberships). This subordinated debt is comprised of senior subordinated notesand junior subordinated notes, which mature on various dates between February2007 and June 2008 and bear interest at annual rates ranging from 7.7% to10.0%. The senior subordinated notes were originally issued in theaggregate principal amount of $15.0 million, and, in accordance with theirterms, $3.0 million in principal amount must be repaid on June 3 of each of2004, 2005, 2006, 2007 and 2008. LaBranche & Co. LLC repaid $3.0 million inaccordance with these terms in each of June 2004 and 2005. LaBranche & Co.LLC may prepay, at a premium, all or any part of such senior subordinated notesat any time, provided that the amount prepaid is not less than 5.0% of theaggregate principal amount of such senior subordinated notes then outstanding. Uponthe occurrence of a change of control, LaBranche & Co. LLC may, but is notrequired to, make one irrevocable separate offer to each holder of the seniorsubordinated notes to prepay all the senior subordinated notes then held bythat holder. The occurrence of a change of control also constitutes an event ofacceleration under the senior subordinated notes. Each of the junior subordinated notes has anautomatic rollover provision, which extends the maturity for an additionalyear, unless the lender provides at least seven months advance notice of itsintention not to renew at maturity. LaBranche & Co. LLC is entitled toprepay—with written consent from the NYSE—the junior subordinated notes withoutpenalty under the terms of the agreements relating thereto.

 

As of December 31, 2005, our outstandingindebtedness included eight separate note obligations, each in the principalamount of $1.0 million, which mature in August 2007 and bear interest at anannual rate of 9.0%.

 

As of December 31, 2005, we have a taxpayable of $10.5 million and a tax receivable of $1.7 million with respect toour 2004 tax year. In addition, as the result of a Federal carry-back of netoperating losses generated in 2004, we received a refund in the amount of $18.3million in April 2005.****The 2005 taxpayable of $10.5 million included a pending tax assessment of $2.4 million asof April 2005.

 

Our “Other liabilities” of $11.9 millionreflected on the accompanying 2005 consolidated statement of financialcondition are comprised of legal and tax contingencies pursuant to SFAS 5. Suchcontingencies are considered long term, as there is no present obligation topay such liabilities in the foreseeable future.

 

Wecurrently anticipate that we will be able to meet our working capital,regulatory capital and capital expenditure requirements through at least thenext twelve months.

 

***CreditRatings***

 

Our outstanding senior notes were originallysold in private sales to institutional investors on May 18, 2004, andsubstantially all these senior noted were subsequently exchanged forsubstantially identical senior notes registered under the Securities Act of1933, as amended,

 

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pursuant to the terms of our May 2004 debtrefinancing. The senior subordinated notes that remain outstanding since ourMay 2004 debt refinancing, in the aggregate principal amount of $13.6 million,are publicly held but are no longer rated. The following table sets forth thecredit ratings on our registered outstanding senior notes as of December 31,2005:

 
| ** **        | ** ** | **Moody’s  Investors Service** | ** ** | **Standard &  Poor’s** | ** ** |
|-------------------|------------|------------------------------------------|------------|--------------------------------------|------------|
|              |       |                                     |       |                                 |       |
| 2009 Senior Notes |       | Ba2                                      |       | B                                    |       |
|              |       |                                     |       |                                 |       |
| 2012 Senior Notes |       | Ba2                                      |       | B                                    |       |

## ** **

## **In August 2005, although Moody’s Investor Services changedits credit rating of our outstanding senior notes from Ba1 to Ba2, it improvedits outlook to stable due to our high quality balance sheet and improvedliquidity. In September 2005, Standard & Poors also improved its outlook onour outstanding senior notes to stable, while affirming our B rating, due toour improved debt service and liquidity positions.**

## ** **

## **Cash Flows**

## ** **

Our cash flows are related primarily to our specialisttrading activities, as well as to our financing activities related to theexpansion of our business.

 

*Year Ended December 31, 2005*—Ourcash and cash equivalents decreased $17.1 million to $427.3 million at the endof 2005. The decrease was the result of the combined effects of a $7.3 millionrepayment of debt and minority interest obligations, a $1.3 million expenditurefor capital assets, a $14.6 million repayment of a deferred compensationarrangement offset by $6.0 million of positive net operating activity cashflows.

 

*Year Ended December 31, 2004*—Ourcash and cash equivalents decreased $47.4 million to $444.4 million at the endof 2004. The decrease was the result of $125.4 million used in our operatingactivities primarily from payment of the $63.5 million in restitution and finesin settlement of the prior year’s NYSE and SEC specialist investigation and a$74.0 million increase****in repurchaseagreements. This decrease was partially offset by $79.0 million provided as aresult of the refinancing of our indebtedness.

 

*Year Ended December 31, 2003*—Ourcash and cash equivalents increased by $414.9 million to $491.9 million at theend of 2003. This increase was primarily the result of investments in U.S.government obligations with original maturities of 90 days or less, as well asour operating activities. We used net cash of $44.0 million in our investingand financing activities primarily to buy back shares of our then-outstandingpreferred stock and to pay dividends on our common shares.

 

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# **Item 7A.**                          QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

# ** **

Due to regulatory requirements that prescribecommunication barriers between our broker-dealer subsidiaries, we employ differentcompliance risk management procedures at each such subsidiary. These riskprocesses are set forth below:

 

*Our Cash Equity Specialist RiskManagement Process*

 

Because our equity specialist activities on the NYSEand AMEX expose our capital to significant risks, managing these risks is aconstant priority for us. Our central role in the auction process helps us tomanage risks by incorporating up-to-date market information in the managementof our inventory, subject to our specialist obligations. We have developed arisk management process at our LaBranche & Co. LLC subsidiary that isdesigned to balance our ability to profit from our specialist activities withour exposure to potential losses. This risk management process includesparticipation by our corporate compliance committee, executive operatingcommittee, floor management committee, post managers, floor captains andspecialists. These parties’ roles are as follows:

 

*CorporateCompliance Committee*. Our corporate compliance committee was established in February 2002 and consistsof representatives from executive and senior management, compliance personnel,including our on-floor compliance officer, our general counsel and severaladditional senior floor specialists, known as post managers. The role of thecorporate compliance committee is to implement, monitor and report to seniormanagement on the statutory and regulatory compliance efforts of our specialistbusiness. The corporate compliance committee also advises the compliancedepartment in establishing, reviewing and revising our policies and proceduresgoverning LaBranche & Co. LLC’s regulatory compliance structure.

 

*Executive Operating Committee.*Ourexecutive operating committee is composed of two executive officers. Thiscommittee is responsible for approving all risk management procedures andtrading guidelines for our specialist stocks, after receiving recommendationsfrom our floor management committee. In addition, our executive operatingcommittee reviews all unusual situations reported to it by our floor managementcommittee.

 

*Floor Management Committee.*Our floor management committee is composed of eleven post managers, two floormanagers and one swat-team manager. This committee is responsible forformulating and overseeing our overall risk management procedures and tradingguidelines for each of our specialist stocks. In determining these proceduresand guidelines, the floor management committee considers the recommendations ofthe floor captains. The post managers meet with their respective floor captainson a weekly basis to review and, if necessary, revise the risk managementprocedures and trading guidelines for particular specialist stocks. Inaddition, post managers and floor managers are always available on the tradingfloor to review and assist with any unusual trading situations reported by afloor captain, and the swat-team manager is available to assess and provideassistance on break-out, or intense, trading situations. Our floor managementcommittee reports to our executive operating committee about each of thesetrading situations as they occur.

 

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*Floor Captains.*Weemploy thirteen floor captains who monitor the activities of our cash equityspecialists throughout the trading day from various positions at our tradingposts. The floor captains observe trades and constantly review tradingactivities on a real-time basis. In addition, the floor captains are readilyavailable to assist our specialists in determining when to deviate fromprocedures and guidelines in reacting to any unusual situations or marketconditions. The floor captains report these unusual situations and anydeviations from these procedures and guidelines to their respective postmanagers. Floor captains meet with each specialist at least once a week toevaluate each specialist’s adherence to our risk management procedures andtrading guidelines, as well as to review compliance reports generated by thecompliance department in monitoring and reviewing specialist tradingactivities. Floor captains also meet to review risk procedures and guidelinesand, if appropriate, make recommendations to the floor management committee.

 

*Specialists.*Ourspecialists conduct auctions of our specialist stocks based upon the conditionsof the marketplace. In doing so, specialists observe our risk managementprocedures and trading guidelines in tandem with their responsibility to createand maintain a fair and orderly market. Specialists immediately notify a floorcaptain of any unusual situations or market conditions requiring a deviationfrom our procedures and guidelines.

 

*On-Floor Compliance Officer*.We also have an on-floor compliance officer that monitors the specialists’compliance with NYSE rules throughout the day on an ad hoc basis. The on-floorcompliance officer reports his findings and on general on-floor complianceinitiatives on a daily basis to our equity specialist unit’s Chief ComplianceOfficer and Chief Executive Officer and provides summary updates of these effortsto the Corporate Compliance Committee on a monthly basis. Many of ourcompliance and risk management activities flow from the efforts of our on-floorcompliance initiative.

 

We believe that theenhancements we have made to our compliance procedures and guidelines inconnection with the undertakings set forth in our March 2004 settlement withthe SEC and NYSE and on a continuous basis as circumstances warrant haveimproved our risk management process.

 

Our equity specialist operations on the AMEX are conductedby six equity specialists. We have one post manager on the AMEX who monitorsthe trading activities of the AMEX equity specialists by observing trades andreviewing positions on a real-time basis. As a member of the floor managementcommittee, the post manager regularly communicates with other members of thefloor management committee regarding any deviations from our AMEX proceduresand guidelines set by our executive operating committee. We also have anon-floor compliance officer that monitors the specialists’ compliance with AMEXrules throughout the day on an ad hoc basis. The on-floor compliance officerreports his findings and on general on-floor compliance initiatives on a dailybasis to our equity specialist unit’s Chief Compliance Officer and ChiefExecutive Officer and provides summary updates of these efforts to theCorporate Compliance Committee on a monthly basis. Many of our compliance andrisk management activities flow from the efforts of our on-floor complianceinitiative.

 

*Circuit Breaker Rules.*TheNYSE and AMEX have instituted certain circuit breaker rules intended to halttrading in all NYSE/AMEX listed stocks in the event of a severe market

 

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decline. The circuit breaker rules impose temporaryhalts in trading when the Dow Jones Industrial Average drops a certain numberof points. Current circuit breaker levels are set quarterly at 10, 20 and30 percent of the Dow Jones Industrial Average closing values of theprevious month, rounded to the nearest 50 points. These rules provide investorsextra time to respond to severe market declines and provide us an additionalopportunity to assure compliance with our risk management procedures.

 

*Equity Market Risk*

 

We have developed a risk management process, which isintended to balance our ability to profit from our equity specialist activitieswith our exposure to potential losses. We have invested substantial capital,along with the NYSE, in real-time, on-line systems which give our managementinstant access to specific trading information at any time during the tradingday, including our aggregate long and short positions and our capital andprofit-and-loss information on an aggregate or per issue basis. Subject to thespecialist’s obligation to maintain a fair and orderly market and to applicableregulatory requirements, we constantly seek to manage our trading positionsrelative to existing market conditions.

 

A high concentration of equity specialists’ principaltrading revenue is generated from its ten and twenty-five most profitable NYSEspecialist stocks. However, the percentage of our equity specialist tradingrevenue generated from our ten most profitable specialist stocks has decreasedfrom 16.8% to 13.6% of total principal trading revenue in 2004 and 2005,respectively. The percentage of our equity specialist trading revenue generatedfrom our twenty-five most profitable specialist stocks has decreased from 33.6%to 23.8% of total principal trading revenue in 2004 and 2005, respectively. Weare not overly reliant on a particular group of specialist stocks, as thecomposition of our ten and twenty-five most profitable specialist stockschanges frequently.

 

Our equity specialist trading activities are subjectto a number of risks, including risks of price fluctuations, rapid changes inthe liquidity of markets and foreign exchange risk related to AmericanDepositary Receipts (“ADRs”). In any period, we may incur trading losses in ourspecialist stocks for a variety of reasons, including price fluctuations of ourspecialist stocks and carrying out our specialist obligations. From time totime, we may have large position concentrations in securities of a singleissuer or issuers engaged in a specific industry. In general, because our inventoryof securities is marked-to-market on a daily basis, any significant pricemovement in these securities could result in an immediate reduction of ourrevenues and operating profits.

 

*Our Options, Futures and ETFsSpecialist and Market-Making Risk Management Process*

 

As specialists in options, ETFs and futures, we have aresponsibility to maintain a fair and orderly market, and trade securities asprincipal out of both obligation and inclination. Our options, ETFs, futures,U.S. Government obligations and foreign currency specialist trading exposes usto certain risks, such as price and interest rate fluctuations, volatilityrisk, credit risk, foreign currency movements and changes in the liquidity ofmarkets.

 

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Additionally, as a market-maker in options, ETFs andfutures, we also trade as principal out of inclination. In our market-makingfunction, we bring immediacy and liquidity to the markets when we choose toparticipate. Our market-making activities expose us to certain risks,including, but not limited to, price fluctuations and volatility.

 

Certain members of management who oversee our options,futures and ETFs specialist and market making activities are responsible formanaging these risks. These individuals utilize a third-party softwareapplication to monitor specialist and market-making positions on a real-timebasis. By monitoring actual and theoretical profit and loss, volatility andother standard risk measures, these individuals seek to insure that our tradersoperate within the parameters set by management. Our traders purchase and sellfutures, options, the stocks underlying certain positions, U.S. Governmentsecurities and foreign currencies in an attempt to hedge market and foreigncurrency risk. Furthermore, our aggregate risk in connection with our options,futures and ETFs trading is under constant evaluation by certain members ofmanagement and our traders, and all significant trading strategies andpositions are closely monitored. Our options, futures and ETF trading isexecuted on national and foreign exchanges. These trades clear through theOptions Clearing Corporation, the National Securities Clearing Corporation orthe applicable exchange clearing organization, thereby reducing potentialcredit risk.

 

The following chart illustrates how specifiedmovements in the underlying securities prices of the options, futures and ETF’sin our specialist and market-making portfolios would have impacted profits andlosses: 

 
| ** **                    | ** ** | **Profit or (Loss) if the underlying securities move:** | ** ** |
|-------------------------------|------------|--------------------------------------------------------------------------------------------|------------|
| **(000’s omitted)** | ** ** | **-15.0%**                                                                                 | ** ** | **-5.0%** | ** ** | **0%** | ** ** | **+5.0%** | ** ** | **+15.0%** | ** ** |
| **Portfolio as of:**          |       |                                                                                       |       |   |   |   |   |   |   |   |   |
| March 31, 2005                |       | $                                                                                          | (10,167    | ) | $ | 8,609 |   | $ | (20 | ) | $ | 6,028 |   | $ | 15,930 |   |
| June 30, 2005                 |       | $                                                                                          | (20,676    | ) | $ | 13,324 |   | $ | (75 | ) | $ | 21,513 |   | $ | 53,516 |   |
| September 30, 2005            |       | $                                                                                          | (4,996     | ) | $ | 840 |   | $ | (28 | ) | $ | 2,125 |   | $ | 4,318 |   |
| December 31, 2005             |       | $                                                                                          | 29,894     |   | $ | 5,871 |   | $ | (150 | ) | $ | (2,054 | ) | $ | 24,498 |   |

 

The modeling of the risk characteristics of ourtrading positions involves a number of assumptions and approximations. Whilemanagement believes that these assumptions and approximations are reasonable,there is no standard methodology for estimating this risk, and differentmethodologies would produce materially different estimates. The zero percentchange column represents the profit or loss our options, futures and ETFsspecialist operations would experience on a daily basis if the relevant marketremained unchanged.

 

*Foreign Currency Risk*

 

In connection with the trading of U.S.-registeredshares of foreign issuers in connection with our cash equity specialistoperations, we are exposed to varying degrees of foreign currency risk. Thepricing of these securities is based on the value of the ordinary securities asdenominated in their local currencies. Thus, a change in a foreign currencyrate relative to the U.S. dollar will result in a change in the value ofU.S.-registered shares in which we are the specialist.

 

Our ETF specialist and market-makers tradeinternational ETFs that are denominated and settled in U.S. dollars, but thepricing of these ETFs is also affected by changes in the relevant

 

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foreign currency rates. We, therefore, hold variousforeign currencies in order to lessen the risks posed by changing foreigncurrency rates. In addition, LSP trades derivatives denominated in foreigncurrencies, which creates exposure to foreign currency risk.

 

The following chart illustrates how the specifiedmovements in foreign currencies relative to the U.S. dollar to which ourspecialist and market-making activities are exposed would have impacted ourprofits and losses:

 
| ** **                    | ** ** | **Profit or (Loss) if the foreign currencies relative  to the U.S. dollar move:** | ** ** |
|-------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **(000’s omitted)** | ** ** | **-15.0%**                                                                                                                               | ** ** | **-5.0%** | ** ** | **+5.0%** | ** ** | **+15.0%** | ** ** |
| **Portfolio as of:**          |       |                                                                                                                                     |       |   |   |   |   |   |   |
| March 31, 2005                |       | $                                                                                                                                        | (1,487     | ) | $ | (496 | ) | $ | 496 |   | $ | 1,487 |   |
| June 30, 2005                 |       | $                                                                                                                                        | (532       | ) | $ | (177 | ) | $ | 177 |   | $ | 532 |   |
| September 30, 2005            |       | $                                                                                                                                        | 2,296      |   | $ | 765 |   | $ | (765 | ) | $ | (2,296 | ) |
| December 31, 2005             |       | $                                                                                                                                        | (7,009     | ) | $ | (2,336 | ) | $ | 2,336 |   | $ | 7,009 |   |

 

The information in the abovetable is based on certain assumptions and it does not fully represent theprofit and loss exposure to changes in security prices, volatility, interestrates and other related factors.

 

*Execution and Clearing RiskManagement Process*

 

In connection with our specialist and market-makingactivities, we are engaged in various securities trading and lending activitiesand assume positions in stocks, rights, options, ETFs, U.S. Governmentsecurities, futures and foreign currencies for which we are exposed to creditrisk associated with the nonperformance of counterparties in fulfilling theircontractual obligations pursuant to these securities transactions. We are alsoexposed to market risk associated with the sale of securities not yetpurchased, which can be directly impacted by volatile trading on the NYSE, AMEXand other exchanges. Additionally, in the event of nonperformance andunfavorable market price movements, we may be required to purchase or sellfinancial instruments at a loss.

 

Our execution and clearing activities require that we executetransactions in accordance with customer instructions and accurately record andprocess the resulting transactions. Any failure, delay or error in executing,recording and processing transactions, whether due to human error or failure ofour information or communication systems, could cause substantial losses forbrokers, customers and/or us and could subject us to claims for losses.

 

Clearing activities include settling each transaction with both thecontra broker and the customer. In connection with our institutional and directaccess floor brokerage activities, a transaction is settled either when thecustomer pays for securities purchased and takes delivery, or deliverssecurities sold for payment. Settling transactions for retail customers andprofessional investors involves financing the transaction until the customermakes payment or, for margin accounts, advancing credit to the customer withinregulatory and internal guidelines. Clearing direct access brokers’transactions includes guaranteeing their transactions to the contra broker onthe exchange floor.

 

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These clearing activities may expose us to off-balance sheet risk inthe event customers or brokers are unable to fulfill their contractualobligations and it is necessary to purchase or sell securities at a loss. Formargin transactions, we may be exposed to off-balance sheet risk in the eventmargin requirements are not sufficient to fully cover losses that customers mayincur in their accounts.

 

The amount of risk related to our execution and clearance activities islinked to the size of the transaction, market volatility and thecreditworthiness of customers and brokers. Our largest transactions involvethose for institutional and direct access floor brokerage customers.

 

We systematically monitorour open transaction risk in connection with our execution and clearingactivities, starting when the transaction occurs and continuing until thedesignated settlement date. Transactions that remain unsettled after settlementdate are scrutinized and necessary action to reduce risk that is taken. Creditrisk that could result from contra brokers defaulting is minimized since muchof the settlement risk for transactions with brokers is essentially transferredto the National Stock Clearing Corporation. The credit risk associated withinstitutional and direct access clearing customers is minimized since thesecustomers have been qualified by the Depository Trust Company (“DTC”) or theDTC participants or have met the prime broker qualification standards at otherbrokerage firms. Before conducting business with a prospective customer, seniormanagement that oversees our execution and clearing operations, in conjunctionwith the related compliance department, reviews the prospective customer’sexperience in the securities industry, financial condition and personalbackground, including a background check with a risk reporting agency. Forretail customers and professional investors, we seek to control the risksassociated with customer activities by requiring customers to maintain margincollateral in compliance with various regulatory and internal guidelines. Wemonitor margin levels daily pursuant to such guidelines and require customersto deposit additional collateral or reduce positions when necessary.

 

*Operational Risk*

 

Operational risk relates to the risk of loss fromexternal events, and from failures in internal processes or informationsystems. In each of our business segments, we rely heavily on our informationsystems in managing our risk. Accordingly, working in conjunction with theNYSE, we have made significant investments in our trade processing andexecution systems. Our use of, and dependence on, technology has allowed us tosustain our growth over the past several years. Management members and floorcaptains at our NYSE and AMEX equity specialist operations must constantlymonitor our positions and transactions in order to mitigate our risks and identifytroublesome trends should they occur. The substantial capital we have invested,along with the NYSE, in real-time, on-line systems affords management instantaccess to specific trading information at any time during the trading day,including:

 

•                  ouraggregate long and short positions;

 

•                  thevarious positions of each of our trading professionals;

 

•                  ouroverall position in a particular stock; and

 

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•                  capitaland profit-and-loss information on an aggregate, per specialist or per issuebasis.

 

Our information systems send and receive data from theNYSE and AMEX through dedicated data feeds. The NYSE supplies us withspecialist position reporting system terminals both on the trading floor and inour offices. These terminals allow us to monitor our NYSE specialist tradingprofits and losses, as well as our positions. For our AMEX equity specialistoperations, our in-house technology staff has developed applications to monitorour current positions and profits and losses. Our options, futures and ETFsspecialist and market-making operations utilize a third-party softwareapplication to monitor our positions and profits and losses on a real-timebasis.

 

We have developed and implemented a businesscontinuity plan, which includes a comprehensive disaster recovery plan. We haveback-up disaster recovery centers in New York and New Jersey.

 

*Legal and Regulatory Risk*

 

Substantial legal liability or a significantregulatory action against us could have a material adverse effect on ourfinancial condition or cause significant harm to our reputation, which in turncould negatively affect our business prospects.

 

Our registered broker-dealer subsidiaries are subjectto certain regulatory requirements intended to insure their general financialsoundness and liquidity. These broker-dealers are subject to SEC Rules 15c3-1,15c3-3 and other requirements adopted and administered by both the NYSE andAMEX.

 

The USA PATRIOT Act of 2001 requires U.S. financialinstitutions, including banks, broker-dealers, futures commission merchants andinvestment companies, to implement policies, procedures and controls which arereasonably designed to detect and report instances of money laundering and thefinancing of terrorism. We actively monitor and update our anti-moneylaundering practices.

 

# **Item 8.**                                   FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA.

# ** **

***FinancialStatements***

 

The consolidated financial statements required by thisitem are submitted in a separate section beginning on page F-1 of this reportand are incorporated herein by reference.

 

***Supplementary Financial Information***

* *

*Selected Quarterly Financial Data(unaudited)*

* *

The following represents the Company’s unauditedquarterly results for fiscal 2005 and fiscal 2004. These quarterly results wereprepared in accordance with U.S. generally accepted accounting principles andreflect all adjustments that are, in the opinion of management,

 

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necessary for afair statement of the results and which are of a normal recurring nature. Dueto rounding of quarterly results, total amounts for each fiscal year may differimmaterially from the annual results reported in “—Financial Statements” underthis item.

 
| ** **                                                               | ** ** | **2005 Fiscal Quarter** | ** ** |
|--------------------------------------------------------------------------|------------|-----------------------------------|------------|
| **(000’s omitted, except per share data)** | ** ** | **First**                         | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| Total revenues                                                           |       | $                                 | 67,303     |   | $ | 77,745 |   | $ | 83,731 |   | $ | 111,411 |   |
| Total operating expenses                                                 |       | 63,591                            |       | 67,731 |   | 72,981 |   | 84,782 |   |
| Income before minority interest and  provision for income taxes          |       | 3,712                             |       | 10,014 |   | 10,750 |   | 26,629 |   |
| Minority interest                                                        |       | —                            |       | — |   | — |   | — |   |
| Income (loss) before provision for income  taxes                         |       | 3,712                             |       | 10,014 |   | 10,750 |   | 26,629 |   |
| Provision for income taxes                                               |       | 1,466                             |       | 1,272 |   | 1,592 |   | 9,254 |   |
| Net income                                                               |       | 2,246                             |       | 8,742 |   | 9,158 |   | 17,375 |   |
| Preferred dividends and discount accretion                               |       | —                            |       | — |   | — |   | — |   |
| Net income applicable to common  stockholders                            |       | $                                 | 2,246      |   | $ | 8,742 |   | $ | 9,158 |   | $ | 17,375 |   |
|                                                                     |       |                              |       |   |   |   |   |   |   |
| Earnings per share:                                                      |       |                              |       |   |   |   |   |   |   |
| Basic                                                                    |       | $                                 | 0.04       |   | $ | 0.14 |   | $ | 0.15 |   | $ | 0.29 |   |
| Diluted                                                                  |       | 0.04                              |       | 0.14 |   | 0.15 |   | 0.28 |   |

 
| ** **                                                                       | ** ** | **2004 Fiscal Quarter** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| **(000’s omitted, except per share data)**         | ** ** | **First**                         | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| Total revenues                                                                   |       | $                                 | 79,913     |   | $ | 90,702 |   | $ | 64,660 |   | $ | 83,772 |   |
| Total operating expenses                                                         |       | 66,272                            |       | 135,984 |   | 102,494 |   | 69,766 |   |
| Income (loss) before minority interest and  provision (benefit) for income taxes |       | 13,641                            |       | (45,282 | ) | (37,834 | ) | 14,006 |   |
| Minority interest                                                                |       | 175                               |       | 195 |   | 161 |   | (175 | ) |
| Income (loss) before provision (benefit)  for income taxes                       |       | 13,466                            |       | (45,477 | ) | (37,995 | ) | 14,181 |   |
| Provision (benefit) for income taxes                                             |       | 5,552                             |       | (20,976 | ) | (1,533 | ) | 4,912 |   |
| Net income (loss)                                                                |       | 7,914                             |       | (24,501 | ) | (36,462 | ) | 9,269 |   |
| Preferred dividends and discount accretion                                       |       | 1,056                             |       | 1,056 |   | 142 |   | — |   |
| Net income (loss) applicable to common  stockholders                             |       | $                                 | 6,858      |   | $ | (25,557 | ) | $ | (36,604 | ) | $ | 9,269 |   |
|                                                                             |       |                              |       |   |   |   |   |   |   |
| Earnings (loss) per share:                                                       |       |                              |       |   |   |   |   |   |   |
| Basic                                                                            |       | $                                 | 0.11       |   | $ | (0.43 | ) | $ | (0.61 | ) | $ | 0.15 |   |
| Diluted                                                                          |       | 0.11                              |       | (0.43 | ) | (0.61 | ) | 0.15 |   |

# ** **

# **Item 9.**            CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

# ** **

There were no disagreements with our auditors onaccounting and financial disclosure matters during the last two fiscal years.

 

73

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**Item 9A.****                          CONTROLSAND PROCEDURES.**

 

As of the end of the period covered by this report, an evaluation ofthe effectiveness of our disclosure controls and procedures was performed underthe supervision and with the participation of our management, including ourChief Executive Officer and Chief Financial Officer. Based on that evaluation,our Chief Executive Officer and Chief Financial Officer concluded that thesedisclosure controls and procedures were effective as of the end of the periodcovered by this report. In addition, no change in our internal control overfinancial reporting (as defined in Rule 13a-15(f) under the Securities ExchangeAct of 1934) occurred during the fourth quarter of our fiscal year endedDecember 31, 2005 that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

Management’s Report on Internal Control over Financial Reporting andthe Report of Independent Registered Public Accounting Firm thereon are setforth in a separate section beginning on F-1 of this Annual Report on Form10-K.

 

**Item 9B.****                          OTHERINFORMATION.**

 

None.

 

**PARTIII**

** **

# **Item 10.**                            DIRECTORS AND EXECUTIVEOFFICERS OF THE REGISTRANT.

# ** **

The information set forth under the caption “Directorsand Executive Officers” in our definitive Proxy Statement to be used inconnection with our 2006 Annual Meeting of Stockholders to be held on May 16,2006, which will be filed within 120 days of the end of our fiscal year endedDecember 31, 2005 (the “2006 Proxy Statement”) is incorporated herein byreference. Information relating to the availability of our Code of Conduct thatapplies to our senior financial officers is included on page 3 of this AnnualReport on Form 10-K.

 

# **Item 11.**                            EXECUTIVE COMPENSATION.

# ** **

The information set forth under the caption “ExecutiveCompensation” in the 2006 Proxy Statement is incorporated herein by reference.

 

# **Item 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS.

# ** **

The information set forth under the caption “BeneficialOwnership of Common Stock by Certain Stockholders and Management” in the 2006Proxy Statement is incorporated herein by reference.

 

74

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# **Item 13.**                            CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS.

# ** **

The information set forth under the caption “CertainRelationships and Related Transactions” in the 2006 Proxy Statement isincorporated herein by reference.

 

**Item 14.****                            PRINCIPALACCOUNTANT FEES AND SERVICES.**

 

The information set forthunder the caption “—Ratification of Appointment of Independent RegisteredPublic Accounting Firm — Audit Fees” in the 2006 Proxy Statement isincorporated herein by reference.

 

**PART IV**

 

**Item 15. EXHIBITS AND FINANCIAL STATEMENTSCHEDULE.**

 
| (a)      | Documents filed as part of this report |
|----------|----------------------------------------|
|     |                                   |
|     | (1)                                    | *Financial Statements* |
| * * | * *                               |
|     |                                   | • | Management’s Report on Internal Control over Financial Reporting |
|     |                                   | • | Report of Independent Registered Public Accounting Firm (Consolidated  Financial Statements) |
|     |                                   | • | Report of Independent Registered Public Accounting Firm (Internal  Control over Financial Reporting) |
|     |                                   | • | Consolidated Financial Statements: |
|     |                                   | Consolidated Statements of Financial  Condition |
|     |                                   | Consolidated Statements of Operations |
|     |                                   | Consolidated Statements of Changes in  Stockholders’ Equity |
|     |                                   | Consolidated Statements of Cash Flows |
|     |                                   | **•** | Notes to Consolidated Financial Statements |
|     |                                   |
| (2)      | *Financial Statement Schedule*         |
|     |                                   |
|     |                                   | • | Schedule 1. LaBranche & Co Inc. (Parent Company Only) Condensed  Financial Information: |
|     |                                   | Condensed Statements of Financial Condition |
|     |                                   | Condensed Statements of Operations |
|     |                                   | Condensed Statements of Changes in  Stockholders’ Equity |
|     |                                   | Condensed Statements of Cash Flows |
|     |                                   | Notes to Condensed Financial Statements |
|          |                                        |  |  |  |  |  |

 

Schedules not listed are omitted because of theabsence of conditions under which they are required or because the requiredinformation is included in the consolidated financial statements or notesthereto.

 

75

----

 

(3)           *Exhibits*:

 

The following exhibits are filed as part of thisreport or incorporated herein by reference.

 
| 2.1  |   | Plan of Incorporation of LaBranche & Co.*                                                                                                                                                                                                                            |
|------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.2  |   | Exchange Agreement by and among LaBranche & Co Inc.,  LaB Investing Co., L.L.C. and the members of LaB Investing Co. L.L.C. listed  on Schedule A thereto.*                                                                                                |
| 3.1  |   | Amended and Restated Certificate of Incorporation of LaBranche &  Co Inc.*                                                                                                                                                                                                |
| 3.2  |   | Amended and Restated Bylaws of LaBranche & Co Inc.*                                                                                                                                                                                                                       |
| 4.1  |   | Specimen Stock Certificate.*                                                                                                                                                                                                                                                  |
| 4.2  |   | Indenture, dated as of August 24, 1999, by and among  LaBranche & Co Inc., as issuer, and Firstar Bank, N.A., as  trustee, relating to the 9 1⁄2% Senior Notes due 2004.**                                                                              |
| 4.3  |   | Form of 9 1⁄2% Senior Notes due 2004 of LaBranche &  Co Inc. (included as Exhibit A to the Indenture filed as  Exhibit 4.2).**                                                                                                                     |
| 4.4  |   | Registration Rights Agreement, dated as of August 24, 1999, by  and among LaBranche & Co Inc., as issuer, and Salomon Smith  Barney Inc. and Donaldson, Lufkin & Jenrette Securities  Corporation, as initial purchasers.**                  |
| 4.5  |   | Indenture, dated as of March 2, 2000, by and among LaBranche &  Co., as issuer, and Firstar Bank, N.A., as trustee, relating to the 12%  Senior Subordinated Notes due 2007.***                                                                                           |
| 4.6  |   | Form of 12% Senior Subordinated Notes due 2007 of  LaBranche & Co Inc. (included as Exhibit A to the  Indenture filed as Exhibit 4.5).                                                                                                                |
| 4.7  |   | Registration Rights Agreement, dated as of March 2, 2000, by and  among LaBranche & Co Inc., as issuer, and Donaldson,  Lufkin & Jenrette Securities Corporation, Salomon Smith  Barney Inc. and ABN AMRO Incorporated, as initial purchasers.*** |
| 4.8  |   | Deferred Compensation Plan.*********                                                                                                                                                                                                                                          |
| 4.9  |   | Supplemental Indenture, dated as of April 20, 2004 with respect to  the Indenture dated August 24, 1999, between LaBranche & Co Inc., as  issuer and U.S. Bank National Association, as trustee, relating to the 91/2% Senior Notes due 2004.*******                      |
| 4.10 |   | Supplemental Indenture, dated as of April 20, 2004 with respect to  the Indenture dated March 2, 2000, between LaBranche & Co Inc., as issuer  and U.S. Bank National Association, as trustee, relating to the 12% Senior  Subordinated Notes due 2007.*******            |
| 4.11 |   | Indenture, dated as of May 18, 2004, by and among LaBranche & Co  Inc., as issuer, and U.S. Bank National Association, as trustee, relating to  the 91/2%  Senior Notes due 2009 and the 11% Senior Notes due 2012.*******                                                |
| 4.12 |   | Form of 91/2% Senior Note due 2009 and 11% Senior Note due 2012 (included  as Exhibit A to the Indenture filed as Exhibit 4.10).*******                                                                                                                                       |
| 4.13 |   | Registration Rights Agreement, dated as of May 4, 2004, by and among  LaBranche & Co Inc., as issuer, and Credit Suisse First Boston, as  initial purchaser.*******                                                                                                       |
| 10.1 |   | Agreement of Lease between Aetna Life Insurance Company and  LaBranche & Co., dated January 6, 1984, as amended to date.*                                                                                                                                       |

 

76

----

 
| 10.2  |   | Second Amendment to Lease Agreement by and between Bank of  Communications and LaBranche & Co. dated July 1995, as amended  to date.*                                                                                                                                                                                                             |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.3  |   | LaBranche & Co Inc. Equity Incentive Plan.*****                                                                                                                                                                                                                                                                                                             |
| 10.4  |   | LaBranche & Co Inc. Annual Incentive Plan.*                                                                                                                                                                                                                                                                                                                 |
| 10.5  |   | Form of Employment Letter between LaBranche & Co Inc. and its executive  officers.*                                                                                                                                                                                                                                                                         |
| 10.6  |   | Form of Agreement Relating to Noncompetition and Other Covenants.*                                                                                                                                                                                                                                                                                              |
| 10.7  |   | Form of Pledge Agreement.*                                                                                                                                                                                                                                                                                                                                      |
| 10.8  |   | Stockholders’ Agreement  by and among LaBranche & Co Inc. and the Stockholders listed on  Schedule I thereto.*                                                                                                                                                                                                                          |
| 10.9  |   | LaBranche & Co. Note Purchase Agreement, dated June 3,  1998, relating to the issuance of $15,000,000 aggregate principal amount of  7.69% Subordinated Notes.*                                                                                                                                                                                   |
| 10.10 |   | Amendment to Note Purchase Agreements, dated as of August 23,  1999, relating to the issuance of $20,000,000 aggregate principal amount of  8.17% Subordinated Notes and $15,000,000 aggregate principal amount of 7.69%  Subordinated Notes.**                                                                                                            |
| 10.11 |   | Form of Subordinated Note.*                                                                                                                                                                                                                                                                                                                                     |
| 10.12 |   | Amended and Restated Credit Agreement, dated as of October 31, 2002,  by and among LaBranche & Co. LLC and The Bank of New York.******                                                                                                                                                                                                                 |
| 10.13 |   | Form of Indemnification Agreement.*                                                                                                                                                                                                                                                                                                                             |
| 10.14 |   | Purchase Agreement, dated February 24, 2000, by and among  LaBranche & Co Inc. and Donaldson, Lufkin & Jenrette  Securities Corporation, Salomon Smith Barney Inc. and ABN AMRO  Incorporated, as initial purchasers, relating to the issuance of $250,000,000  aggregate principal amount of 12% Senior Subordinated Notes due 2007.*** |
| 10.15 |   | Amended and Restated Articles of Partnership of LaBranche &  Co.**                                                                                                                                                                                                                                                                                     |
| 10.16 |   | LaB Investing Co., L.L.C. Amended and Restated Operating Agreement.**                                                                                                                                                                                                                                                                                           |
| 10.17 |   | Agreement and Plan of Merger, dated as of January 18, 2001, by and  between LaBranche & Co Inc. and ROBB PECK McCOOEY Financial Services,  Inc.****                                                                                                                                                                                                         |
| 10.18 |   | Amendment No. 1, dated as of February 15, 2001, to Agreement and Plan  of Merger by and between LaBranche & Co Inc. and ROBB PECK McCOOEY  Financial Services, Inc.****                                                                                                                                                                                     |
| 10.19 |   | Amended and Restated LaBranche & Co Inc. Equity Incentive Plan.  *****                                                                                                                                                                                                                                                                                      |
| 10.20 |   | LaBranche & Co Inc. Senior Executive Bonus Plan.******                                                                                                                                                                                                                                                                                                      |
| 10.21 |   | Purchase Agreement, dated May 4, 2004, by and among LaBranche &  Co Inc., as issuer, and Credit Suisse First Boston, as initial purchaser,  relating to the issuance of $200,000,000 91⁄2% Senior Notes due 2009 and $260,000,000  11% Senior Notes due 2012.********                                                                                    |
| 10.22 |   | Form of Restricted Stock Unit Agreement.**********                                                                                                                                                                                                                                                                                                              |
| 12    |   | Statement re computation of ratios of earnings to fixed charges.                                                                                                                                                                                                                                                                                                |
| 21    |   | List of Subsidiaries.                                                                                                                                                                                                                                                                                                                                           |
| 23    |   | Consent of KPMG LLP.                                                                                                                                                                                                                                                                                                                                            |
| 31.1  |   | Certification of George M.L. LaBranche, IV, Chairman, Chief Executive  Officer and President, pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002.                                                                                                                                                                                                  |

 

77

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| 31.2 |   | Certification of Jeffrey M. Chertoff, Senior Vice President and Chief  Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                                                             |
|------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 32.1 |   | Certification of George M.L. LaBranche, IV, Chairman, Chief Executive  Officer and President, pursuant to Section 906 of the Sarbanes-Oxley Act  of 2002, regarding the information contained in LaBranche & Co Inc.’s  Annual Report on Form 10-K for the year ended December 31, 2005. |
| 32.2 |   | Certification of Jeffrey M. Chertoff, Senior Vice President and Chief  Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of  2002, regarding the information contained in LaBranche & Co Inc.’s Annual  Report on Form 10-K for the year ended December 31, 2005.     |

 

----

| *          |   | Incorporated by reference to our Registration Statement on  Form S-1 (Registration No. 333-81079), as amended, effective  August 18, 1999.                   |
|------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                                        |
| **         |   | Incorporated by reference to our Registration Statement on Form S-4  (Registration No. 333-88119), as amended, effective November 3, 1999.                                  |
|       |   |                                                                                                                                                                        |
| ***        |   | Incorporated by reference to our Annual Report on Form 10-K, filed on  March 30, 2000.                                                                                      |
|       |   |                                                                                                                                                                        |
| ****       |   | Incorporated by reference to our Current Report on Form 8-K, filed on  March 22, 2001.                                                                                      |
|       |   |                                                                                                                                                                        |
| *****      |   | Incorporated by reference to Exhibit 4.1 of our Registration  Statement on Form S-8 (Registration No. 333-102607), effective January 21, 2003.                              |
|       |   |                                                                                                                                                                        |
| ******     |   | Incorporated by reference to our Annual Report on Form 10-K, filed on  March 15, 2004                                                                                       |
|       |   |                                                                                                                                                                        |
| *******    |   | Incorporated by reference to Exhibits 4.2 through 4.5 of our  Quarterly Report on Form 10-Q for the three months ended June 30,  2004, filed August 9, 2004. |
|       |   |                                                                                                                                                                        |
| ********   |   | Incorporated by reference to our Registration Statement on Form S-4  (Registration No. 333-118248), as amended, effective September 9, 2004                                 |
|       |   |                                                                                                                                                                        |
| *********  |   | Incorporated by reference to Exhibit 4.7 of our Registration Statement  on Form S-4 (Registration No. 333-55862), as amended, effective March 1, 2001                       |
|       |   |                                                                                                                                                                        |
| ********** |   | Incorporated by reference to our Annual Report on Form 10-K, filed on  March 16, 2005                                                                                       |
|       |   |                                                                                                                                                                        |

 

78

----

 

**SIGNATURES**

** **

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 
| March 16, 2006 | **LaBRANCHE & CO INC.** |
|----------------|-----------------------------|
|           |                        |
|           | By:                         |  /s/ George M.L. LaBranche, IV |   |
|           |                        |   George M.L. LaBranche, IV |
|           |                        |   Chairman, Chief Executive  Officer and President |

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the registrant and in the capacities and on the datesindicated.

 
| **Signature**                   | ** ** | **Title**                                                                          | ** **                             | **Date** |
|---------------------------------|------------|------------------------------------------------------------------------------------|----------------------------------------|----------|
|                            |       |                                                                               |                                   |     |   |
| /s/ George M.L. LaBranche, IV   |       |                                                                               | Chairman, Chief Executive Officer and  |     | March 16, 2006 |
|  George M.L. LaBranche, IV |       | President (Principal Executive Officer)                                            |                                   |     |
|                            |       |                                                                               |                                   |     |
| /s/ Jeffrey M. Chertoff         |       |                                                                               | Senior Vice President and Chief        |     | March 16, 2006 |
| Jeffrey M. Chertoff             |       | Financial Officer (Principal Financial  Officer and Principal Accounting  Officer) |                                   |     |
|                            |       |                                                                               |                                   |     |
| /s/ Thomas E. Dooley            |       |                                                                               | Director                               |     | March 16, 2006 |
| Thomas E. Dooley                |       |                                                                               |                                   |     |
|                            |       |                                                                               |                                   |     |
| /s/ David A. George             |       |                                                                               | Director                               |     | March 16, 2006 |
| David A. George                 |       |                                                                               |                                   |     |
|                            |       |                                                                               |                                   |     |
| /s/ Donald E. Kiernan           |       |                                                                               | Director                               |     | March 16, 2006 |
| Donald E. Kiernan               |       |                                                                               |                                   |     |
|                            |       |                                                                               |                                   |     |
| /s/ Robert E. Torray            |       |                                                                               | Director                               |     | March 16, 2006 |
| Robert E. Torray                |       |                                                                               |                                   |     |
|                            |       |                                                                               |                                   |     |
| /s/Alfred O. Hayward, Jr.       |       |                                                                               | Executive Vice President and Director; |     | March 16, 2006 |
|  Alfred O. Hayward, Jr.    |       | Chief Executive Officer of LaBranche &  Co. LLC                                |                                   |     |
|                                 |            |                                                                                    |                                        |          |  |  |  |  |  |

 

79

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**Management’sReport on Internal Control over Financial Reporting**

** **

**Managementof LaBranche & Co Inc., together with its consolidated subsidiaries (the “Company”),is responsible for establishing and maintaining adequate internal control overfinancial reporting. The Company’s internal control over financial reporting isa process designed under the supervision of the Company’s principal executiveand principal financial officers to provide reasonable assurance regarding thereliability of financial reporting and the preparation of the Company’sfinancial statements for external reporting purposes in accordance with U.S.generally accepted accounting principles.**

** **

**As ofthe end of the Company’s 2005 fiscal year, management conducted an assessmentof the effectiveness of the Company’s internal control over financial reportingbased on the framework established in *Internal Control –Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission (“COSO”). Based on this assessment,management has determined that the Company’s internal control over financialreporting as of December 31, 2005 is effective.**

** **

**Ourinternal control over financial reporting includes policies and procedures thatpertain to the maintenance of records that, in reasonable detail, accuratelyand fairly reflect transactions and disposition of assets; provide reasonableassurances that transactions are recorded as necessary to permit preparation offinancial statements in accordance with U.S. generally accepted accountingprinciples and that receipts and expenditures are being made only in accordancewith authorizations of management; and provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use or dispositionof the Company’s assets that could have a material effect on our consolidatedfinancial statements.**

 

**Management’sassessment of the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2005 has been audited by KPMG LLP, anindependent registered public accounting firm, as stated in their report,appearing on page F-3 of this Annual Report on Form 10-K, which express anunqualified opinion on management’s assessment of the effectiveness of theCompany’s internal control over financial reporting as of December 31, 2005,and an unqualified opinion on the effectiveness of the Company’s internalcontrol over financial reporting as of December 31, 2005.**

 

F-1

----

 

**Report of Independent Registered PublicAccounting Firm**

 

The Board of Directorsand Stockholders

LaBranche & Co Inc.:

 

We have audited theaccompanying consolidated statements of financial condition of LaBranche &Co Inc. and subsidiaries as of December 31, 2005 and 2004, and the relatedconsolidated statements of operations, changes in stockholders’ equity and cashflows for each of the years in the three-year period ended December 31, 2005. Inconnection with our audits of the consolidated financial statements, we havealso audited the financial statement schedule. These consolidated financialstatements and the related financial statement schedule are the responsibilityof the Company’s management. Our responsibility is to express an opinion onthese financial statements and the related financial statement schedule basedon our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of LaBranche & Co Inc. andsubsidiaries as of December 31, 2005 and 2004, and the results of theiroperations and their cash flows for each of the years in the three-year periodended December 31, 2005, in conformity with U.S. generally accepted accountingprinciples. Also, in our opinion, the related financial statement schedule,when considered in relation to the basic consolidated financial statementstaken as a whole, presents fairly, in all material respects, the informationset forth therein.

 

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of LaBranche & Co Inc. and subsidiaries’internal control over financial reporting as of December 31, 2005, based oncriteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO), and our report dated March 14,2006 expressed an unqualified opinion on management’s assessment of, and theeffective operation of, internal control over financial reporting.

 

 
| /s/ KPMG LLP       |   |
|--------------------|--------|
| New York, New York |
| March 14, 2006     |

 

F-2

----

 

# **Report of Independent Registered Public Accounting Firm**

# ** **

The Board of Directors and Stockholders

LaBranche& Co Inc.:

 

We have audited management’s assessment, included in the accompanying *Management’s Report on Internal Control overFinancial Reporting,*that LaBranche & Co Inc. and subsidiariesmaintained effective internal control over financial reporting as of December31, 2005, based on criteriaestablished in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission (COSO).**LaBranche& Co Inc. and subsidiaries’ management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the Company’s internal control over financialreporting based on our audit.

 

We conducted our audit in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internal controlover financial reporting, evaluating management’s assessment, testing andevaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinion.

 

A company’s internal controlover financial reporting is a process designed to provide reasonable assuranceregarding the reliability of financial reporting and the preparation offinancial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2)provide reasonable assurance that transactions are recorded as necessary topermit preparation of financial statements in accordance with generallyaccepted accounting principles, and that receipts and expenditures of thecompany are being made only in accordance with authorizations of management anddirectors of the company; and (3) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effect on the financialstatements.

 

Because of inherent limitations, internal control over financialreporting may not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk that controlsmay become inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

 

F-3

----

 

In our opinion, management’s assessment that LaBranche & Co Inc.and subsidiaries maintained effective internal control over financial reportingas of December 31, 2005, is fairly stated, in all material respects, based on criteria established in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO).**Also, in ouropinion, LaBranche & Co Inc. and subsidiaries maintained, in all materialrespects, effective internal control over financial reporting as of December31, 2005, based on criteriaestablished in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission (COSO).

 

We also have audited, in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), the consolidated statements of financial condition of LaBranche& Co Inc. and subsidiariesas of December 31, 2005 and 2004, and the related consolidated statements of operations, changes in stockholders’equity and cash flows for each of the years in the three-year period endedDecember 31, 2005, and our report dated March14, 2006**expressed an unqualified opinion on those consolidatedfinancial statements.

 

 
| /s/ KPMG LLP       |   |
|--------------------|--------|
| New York, New York |
| March 14, 2006     |

 

F-4

----

 

**LaBRANCHE& CO INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF FINANCIAL CONDITION**

**(000’somitted, except share data)**

** **
| ** **                                                                                                                                                         | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                         | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                                                                                         |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                          |       | $                     | 427,284    |   | $ | 444,446 |   |
| Cash and securities segregated under  federal regulations                                                                                                          |       | 6,554                 |       | 13,511 |   |
| Securities purchased under agreements to  resell                                                                                                                   |       | 79,000                |       | 87,000 |   |
| Receivable from brokers, dealers and  clearing organizations                                                                                                       |       | 658,631               |       | 158,421 |   |
| Receivable from customers                                                                                                                                          |       | 3,659                 |       | 10,555 |   |
| Securities owned, at market value:                                                                                                                                 |       |                  |       |   |   |
| Corporate equities                                                                                                                                                 |       | 1,128,999             |       | 319,378 |   |
| Options                                                                                                                                                            |       | 411,887               |       | 110,705 |   |
| Exchange-traded funds                                                                                                                                              |       | 815,250               |       | 128,214 |   |
| Corporate bonds                                                                                                                                                    |       | 8                     |       | 8 |   |
| Commissions receivable                                                                                                                                             |       | 4,337                 |       | 5,428 |   |
| Exchange memberships contributed for use,  at market value                                                                                                         |       | 24,500                |       | 9,450 |   |
| Exchange memberships owned, at adjusted  cost (market value of $138,768 and $41,696, respectively)                                                                 |       | 59,664                |       | 59,332 |   |
| Office equipment and leasehold  improvements, at cost, less accumulated depreciation and amortization of  $12,364 and $10,655, respectively                        |       | 2,695                 |       | 3,459 |   |
| Intangible assets, net of accumulated  amortization:                                                                                                               |       |                  |       |   |   |
| Specialist stock lists                                                                                                                                             |       | 350,828               |       | 361,204 |   |
| Trade name                                                                                                                                                         |       | 25,011                |       | 25,011 |   |
| Goodwill                                                                                                                                                           |       | 250,569               |       | 250,569 |   |
|                                                                                                                                                               |       |                  |       |   |   |
| Other assets                                                                                                                                                       |       | 35,419                |       | 68,406 |   |
| Total assets                                                                                                                                                       |       | $                     | 4,284,295  |   | $ | 2,055,097 |   |
|                                                                                                                                                               |       |                  |       |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                     |       |                  |       |   |   |
| Liabilities:                                                                                                                                                       |       |                  |       |   |   |
| Payable to brokers and dealers                                                                                                                                     |       | $                     | 79,646     |   | $ | 120,434 |   |
| Payable to customers                                                                                                                                               |       | 4,858                 |       | 3,830 |   |
| Securities sold, but not yet purchased, at  market value:                                                                                                          |       |                  |       |   |   |
| Corporate equities                                                                                                                                                 |       | 1,845,234             |       | 265,078 |   |
| Options                                                                                                                                                            |       | 418,315               |       | 92,580 |   |
| Exchange-traded funds                                                                                                                                              |       | 392,713               |       | 142,735 |   |
| U.S. Government obligations                                                                                                                                        |       | 77,263                |       | 3⁄4 |   |
| Accrued compensation                                                                                                                                               |       | 22,722                |       | 38,195 |   |
| Accounts payable and other accrued expenses                                                                                                                        |       | 21,133                |       | 18,245 |   |
| Other liabilities                                                                                                                                                  |       | 11,859                |       | 12,510 |   |
| Income taxes payable                                                                                                                                               |       | 10,513                |       | 1,671 |   |
| Deferred tax liabilities                                                                                                                                           |       | 148,263               |       | 156,294 |   |
| Short term debt                                                                                                                                                    |       | 3,000                 |       | 2,000 |   |
| Long term debt                                                                                                                                                     |       | 481,425               |       | 481,448 |   |
| Subordinated liabilities:                                                                                                                                          |       |                  |       |   |   |
| Exchange memberships contributed for use,  at market value                                                                                                         |       | 24,500                |       | 9,450 |   |
| Other subordinated indebtedness                                                                                                                                    |       | 9,395                 |       | 17,285 |   |
| Total liabilities                                                                                                                                                  |       | 3,550,839             |       | 1,361,755 |   |
|                                                                                                                                                               |       |                  |       |   |   |
| Minority interest                                                                                                                                                  |       | 3⁄4                |       | 356 |   |
|                                                                                                                                                               |       |                  |       |   |   |
| Commitments and contingencies                                                                                                                                      |       |                  |       |   |   |
|                                                                                                                                                               |       |                  |       |   |   |
| Common stock, $.01 par value, 200,000,000  shares authorized; 60,623,819 and 60,532,080 shares issued And outstanding at  December 31, 2005 and 2004, respectively |       | 606                   |       | 605 |   |
| Additional paid-in capital                                                                                                                                         |       | 689,988               |       | 687,040 |   |
| Retained earnings                                                                                                                                                  |       | 42,862                |       | 5,341 |   |
| Total stockholders’ equity                                                                                                                                    |       | 733,456               |       | 692,986 |   |
| Total liabilities and stockholders’ equity                                                                                                                    |       | $                     | 4,284,295  |   | $ | 2,055,097 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

F-5

----

 

**LaBRANCHE& CO INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(000’somitted, except per share data)**

 
| ** **                                                                       | ** ** | **For the Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2005**                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                             |       |                                                          |       |   |   |   |   |
| REVENUES:                                                                        |       |                                                          |       |   |   |   |   |
| Net gain on principal transactions                                               |       | $                                                             | 194,432    |   | $ | 182,535 |   | $ | 202,207 |   |
| Commissions                                                                      |       | 84,018                                                        |       | 96,045 |   | 94,443 |   |
| Net gain on non-marketable investments                                           |       | 11,029                                                        |       | 24,953 |   | 1,065 |   |
| Interest                                                                         |       | 50,655                                                        |       | 10,377 |   | 6,786 |   |
| Other                                                                            |       | 56                                                            |       | 5,137 |   | 1,488 |   |
| Total revenues                                                                   |       | 340,190                                                       |       | 319,047 |   | 305,989 |   |
|                                                                             |       |                                                          |       |   |   |   |   |
| EXPENSES:                                                                        |       |                                                          |       |   |   |   |   |
| Employee compensation and related benefits                                       |       | 103,531                                                       |       | 99,310 |   | 99,123 |   |
| Interest                                                                         |       | 89,504                                                        |       | 63,789 |   | 48,188 |   |
| Exchange, clearing and brokerage fees                                            |       | 40,664                                                        |       | 39,010 |   | 40,406 |   |
| Lease of exchange memberships                                                    |       | 3,979                                                         |       | 15,565 |   | 24,773 |   |
| Depreciation and amortization of  intangibles                                    |       | 12,093                                                        |       | 12,221 |   | 12,803 |   |
| Legal and professional fees                                                      |       | 11,357                                                        |       | 12,749 |   | 8,034 |   |
| Communications                                                                   |       | 9,114                                                         |       | 8,594 |   | 8,705 |   |
| Occupancy                                                                        |       | 5,155                                                         |       | 5,254 |   | 5,832 |   |
| Restitution and fines                                                            |       | —                                                        |       | — |   | 63,519 |   |
| Goodwill impairment                                                              |       | —                                                        |       | 37,600 |   | 170,302 |   |
| Exchange memberships impairment                                                  |       | —                                                        |       | 18,327 |   | 515 |   |
| Debt repurchase premium                                                          |       | —                                                        |       | 49,029 |   | — |   |
| Other                                                                            |       | 13,688                                                        |       | 13,068 |   | 8,863 |   |
| Total expenses                                                                   |       | 289,085                                                       |       | 374,516 |   | 491,063 |   |
|                                                                             |       |                                                          |       |   |   |   |   |
| Income (loss) before minority interest and  provision (benefit) for income taxes |       | 51,105                                                        |       | (55,469 | ) | (185,074 | ) |
|                                                                             |       |                                                          |       |   |   |   |   |
| MINORITY INTEREST                                                                |       | —                                                        |       | 356 |   | 322 |   |
|                                                                             |       |                                                          |       |   |   |   |   |
| Income (loss) before provision (benefit)  for income taxes                       |       | 51,105                                                        |       | (55,825 | ) | (185,396 | ) |
|                                                                             |       |                                                          |       |   |   |   |   |
| PROVISION (BENEFIT) FOR INCOME TAXES                                             |       | 13,584                                                        |       | (12,045 | ) | (6,007 | ) |
|                                                                             |       |                                                          |       |   |   |   |   |
| Net income (loss)                                                                |       | 37,521                                                        |       | (43,780 | ) | (179,389 | ) |
| Preferred dividends and discount accretion                                       |       | —                                                        |       | 2,253 |   | 4,014 |   |
| Net income (loss) applicable to common  stockholders                             |       | $                                                             | 37,521     |   | $ | (46,033 | ) | $ | (183,403 | ) |
|                                                                             |       |                                                          |       |   |   |   |   |
| Weighted-average common shares outstanding:                                      |       |                                                          |       |   |   |   |   |
| Basic                                                                            |       | 60,617                                                        |       | 59,905 |   | 59,614 |   |
| Diluted                                                                          |       | 61,059                                                        |       | 59,905 |   | 59,614 |   |
| Earnings (loss) per share:                                                       |       |                                                          |       |   |   |   |   |
| Basic                                                                            |       | $                                                             | 0.62       |   | $ | (0.77 | ) | $ | (3.08 | ) |
| Diluted                                                                          |       | $                                                             | 0.61       |   | $ | (0.77 | ) | $ | (3.08 | ) |

 

See accompanying notes toconsolidated financial statements.

 

F-6

----

 

**LaBRANCHE& CO INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY(000’s omitted)**

** **
| ** **                                                                          | ** ** | **Common Stock** | ** ** | ** ** | ** ** | **Additional**           | ** ** | **Retained**             | ** ** | **Unearned** | ** ** | ** **       | ** ** |
|-------------------------------------------------------------------------------------|------------|-----------------------|------------|------------|------------|--------------------------|------------|--------------------------|------------|--------------|------------|------------------|------------|
| ** **                                                                          | ** ** | **Shares**            | ** ** | **Amount** | ** ** | **Preferred Stock** | ** ** | **Paid-in Capital** | ** ** | **Earnings** | ** ** | **Compensation** | ** ** | **Total** | ** ** |
|                                                                                |       |                  |       |       |       |                     |       |                     |       |         |       |             |       |   |   |
| BALANCE, December  31, 2002                                                         |       | 59,504                |       | $          | 595        |                     | $          | 61,361                   |       | $            | 679,601    |             | $          | 249,065 |   | $ | (934 | ) | $ | 989,688 |   |
|                                                                                |       |                  |       |       |       |                     |       |                     |       |         |       |             |       |   |   |
| Net loss                                                                            |       | —                |       | —     |       | —                   |       | —                   |       | (179,389     | )          | —           |       | (179,389 | ) |
|                                                                                |       |                  |       |       |       |                     |       |                     |       |         |       |             |       |   |   |
| Common and  preferred stock dividends and discount accretion                        |       | —                |       | —     |       | 688                      |       | —                   |       | (18,302      | )          | —           |       | (17,614 | ) |
| Recognition of  tax benefits related to employee option exercises                   |       | —                |       | —     |       | —                   |       | 372                      |       | —       |       | —           |       | 372 |   |
| Issuance of  restricted stock, shares for option exercises and related compensation |       | 287                   |       | 3          |       | —                   |       | 2,843                    |       | —       |       | 793              |       | 3,639 |   |
| Preferred stock  buyback                                                            |       | —                |       | —     |       | (23,732                  | )          | —                   |       | —       |       | —           |       | (23,732 | ) |
| BALANCE, December  31, 2003                                                         |       | 59,791                |       | $          | 598        |                     | $          | 38,317                   |       | $            | 682,816    |             | $          | 51,374 |   | $ | (141 | ) | $ | 772,964 |   |
|                                                                                |       |                  |       |       |       |                     |       |                     |       |         |       |             |       |   |   |
| Net loss                                                                            |       | —                |       | —     |       | —                   |       | —                   |       | (43,780      | )          | —           |       | (43,780 | ) |
|                                                                                |       |                  |       |       |       |                     |       |                     |       |         |       |             |       |   |   |
| Preferred stock  dividends and discount accretion                                   |       | —                |       | —     |       | —                   |       | —                   |       | (2,253       | )          | —           |       | (2,253 | ) |
| Recognition of  tax benefits related to employee option exercises                   |       | —                |       | —     |       | —                   |       | 1,371                    |       | —       |       | —           |       | 1,371 |   |
| Issuance of  restricted stock, shares for option exercises and related compensation |       | 741                   |       | 7          |       | —                   |       | 2,853                    |       | —       |       | 141              |       | 3,001 |   |
| Preferred stock  buyback                                                            |       | —                |       | —     |       | (38,317                  | )          | —                   |       | —       |       | —           |       | (38,317 | ) |
| BALANCE, December  31, 2004                                                         |       | 60,532                |       | $          | 605        |                     | —     |                     | $          | 687,040      |       | $                | 5,341      |   | — |   | $ | 692,986 |   |
|                                                                                |       |                  |       |       |       |                     |       |                     |       |         |       |             |       |   |   |
| Net income                                                                          |       | —                |       | —     |       | —                   |       | —                   |       | 37,521       |       | —           |       | 37,521 |   |
|                                                                                |       |                  |       |       |       |                     |       |                     |       |         |       |             |       |   |   |
| Preferred stock  dividends and discount accretion                                   |       | —                |       | —     |       | —                   |       | —                   |       | —       |       | —           |       | — |   |
| Recognition of  tax benefits related to employee option exercises                   |       | —                |       | —     |       | —                   |       | —                   |       | —       |       | —           |       | — |   |
| Issuance of  restricted stock, shares for option exercises and related compensation |       | 92                    |       | 1          |       | —                   |       | 2,948                    |       | —       |       | —           |       | 2,949 |   |
| Preferred stock  buyback                                                            |       | —                |       | —     |       | —                   |       | —                   |       | —       |       | —           |       | — |   |
| BALANCE, December  31, 2005                                                         |       | 60,624                |       | $          | 606        |                     | —     |                     | $          | 689,988      |       | $                | 42,862     |   | — |   | 733,456 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

F-7

----

 

**LaBRANCHE& CO INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(000’s omitted)**

** **
| ** **                                                                                          | ** ** | **For the Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2005**                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                           | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income (loss)                                                                                   |       | $                                                             | 37,521     |   | $ | (43,780 | ) | $ | (179,389 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities: |       |                                                          |       |   |   |   |   |
| Depreciation and amortization of  intangibles                                                       |       | 12,093                                                        |       | 12,221 |   | 12,803 |   |
| Amortization of debt issuance costs and  bond discount                                              |       | 1,753                                                         |       | 7,380 |   | 2,155 |   |
| Goodwill impairment                                                                                 |       | —                                                        |       | 37,600 |   | 170,302 |   |
| Minority interest in income of consolidated  subsidiary                                             |       | —                                                        |       | 356 |   | 322 |   |
| Compensation expense related to stock-based  compensation                                           |       | 2,949                                                         |       | 3,277 |   | 3,423 |   |
| Deferred tax provision (benefit)                                                                    |       | 21,932                                                        |       | (12,914 | ) | (23,329 | ) |
| Acceleration of preferred stock discount  accretion                                                 |       | —                                                        |       | 496 |   | 918 |   |
| Other-than-temporary impairment of exchange  memberships owned                                      |       | —                                                        |       | 18,327 |   | 515 |   |
| Tax benefit related to employee stock  transactions                                                 |       | —                                                        |       | 1,167 |   | 433 |   |
| Changes in operating assets and  liabilities:                                                       |       |                                                          |       |   |   |   |   |
| Cash and securities segregated under  federal regulations                                           |       | 6,957                                                         |       | (9,552 | ) | 12,053 |   |
| Securities purchased under agreements to  resell                                                    |       | 8,000                                                         |       | (74,000 | ) | 13,000 |   |
| Receivable from brokers, dealers and  clearing organizations                                        |       | (500,210                                                      | )          | (15,782 | ) | 2,748 |   |
| Receivable from customers                                                                           |       | 6,896                                                         |       | (7,121 | ) | 8,991 |   |
| United States Government obligations                                                                |       | —                                                        |       | — |   | 395,840 |   |
| Securities owned, at market value:                                                                  |       |                                                          |       |   |   |   |   |
| Corporate equities                                                                                  |       | (809,621                                                      | )          | (53,810 | ) | (159,273 | ) |
| Options                                                                                             |       | (301,182                                                      | )          | (37,011 | ) | (12,216 | ) |
| Exchange-traded funds                                                                               |       | (687,036                                                      | )          | (25,588 | ) | (81,171 | ) |
| Corporate bondsUnited States government  obligations                                                |       | —                                                        |       | (8 | ) | — |   |
| Commissions receivable                                                                              |       | 1,091                                                         |       | (815 | ) | (234 | ) |
| Other assets                                                                                        |       | 1,312                                                         |       | 1,414 |   | (3,773 | ) |
| Payable to brokers and dealers                                                                      |       | (40,788                                                       | )          | 75,262 |   | 28,755 |   |
| Payable to customers                                                                                |       | 1,028                                                         |       | (5,180 | ) | (12,961 | ) |
| Securities sold, but not yet purchased, at  market value:                                           |       |                                                          |       |   |   |   |   |
| Corporate equities                                                                                  |       | 1,580,156                                                     |       | 32,136 |   | 126,257 |   |
| Options                                                                                             |       | 325,735                                                       |       | 25,501 |   | 3,384 |   |
| Exchange-traded funds                                                                               |       | 249,978                                                       |       | 27,595 |   | 110,781 |   |
| United States Government obligations                                                                |       | 77,263                                                        |       | — |   | — |   |
| Accrued compensation                                                                                |       | (15,473                                                       | )          | (4,638 | ) | (12,352 | ) |
| Accounts payable and other accrued expenses                                                         |       | 2,888                                                         |       | (16,511 | ) | (12,958 | ) |
| Other liabilities                                                                                   |       | (651                                                          | )          | (63,085 | ) | 67,637 |   |
| Income taxes payable                                                                                |       | 8,842                                                         |       | 1,671 |   | (3,760 | ) |
| Net cash provided by (used in) operating  activities                                                |       | (8,567                                                        | )          | (125,392 | ) | 458,901 |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                           | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Payments for purchases of office equipment  and leasehold improvements                              |       | (953                                                          | )          | (668 | ) | (995 | ) |
| Payments for purchases of exchange  memberships                                                     |       | (332                                                          | )          | (340 | ) | (19 | ) |
| Net cash used in investing activities                                                               |       | (1,285                                                        | )          | (1,008 | ) | (1,014 | ) |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                           | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Repayment of subordinated debt, promissory  notes and long term debt                                |       | (6,954                                                        | )          | (3,000 | ) | — |   |
| Repayment of minority interest                                                                      |       | (356                                                          | )          | (322 | ) | — |   |
| Proceeds from exercise of stock options                                                             |       | —                                                        |       | 1,375 |   | 216 |   |
| Issuance of new senior notes                                                                        |       | —                                                        |       | 460,000 |   | — |   |
| Repurchase of old notes                                                                             |       | —                                                        |       | (336,458 | ) | — |   |
| Payment of common stock dividends                                                                   |       | —                                                        |       | — |   | (14,288 | ) |
| Payment of preferred stock dividends                                                                |       | —                                                        |       | (3,448 | ) | (4,313 | ) |
| Payment for preferred stock buyback                                                                 |       | —                                                        |       | (39,186 | ) | (24,650 | ) |
| Net cash provided by (used in) financing  activities                                                |       | (7,310                                                        | )          | 78,961 |   | (43,035 | ) |
| Increase (decrease) in cash and cash  equivalents                                                   |       | (17,162                                                       | )          | (47,439 | ) | 414,852 |   |
| CASH AND CASH EQUIVALENTS, beginning of  year                                                       |       | 444,446                                                       |       | 491,885 |   | 77,033 |   |
| CASH AND CASH EQUIVALENTS, end of year                                                              |       | $                                                             | 427,284    |   | $ | 444,446 |   | $ | 491,885 |   |
|                                                                                                |       |                                                          |       |   |   |   |   |
| **SUPPLEMENTAL DISCLOSURE OF CASH PAID DURING  THE YEAR FOR:**                                      | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest                                                                                            |       | $                                                             | 87,823     |   | $ | 63,533 |   | $ | 46,471 |   |
| Income taxes                                                                                        |       | $                                                             | 2,288      |   | $ | 525 |   | $ | 20,193 |   |
|                                                                                                     |            |                                                               |            |  |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to consolidatedfinancial statements.

 

F-8

----

** **

**LaBRANCHE & CO INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

** **

## **1.**                                      ORGANIZATIONAND DESCRIPTION OF BUSINESS

 

The condensedconsolidated financial statements include the accounts of LaBranche &Co Inc., a Delaware corporation (the “Holding Company”), and its subsidiaries,LaBranche & Co. LLC, a New York limited liability company, LaBrancheFinancial Services, Inc., a New York corporation (“LFSI”), LaBranche StructuredHoldings, Inc., a Delaware corporation (“LSHI”), LABDR Services, Inc.,a Delaware corporation (“LABDR”), and LaBranche & Co. B.V., aNetherlands private limited liability company (“BV”). The Holding Company isthe sole member of LaBranche & Co. LLC, the 100% stockholder of LFSI,LSHI and LABDR and the sole owner of BV. LSHI is a holding company that is thesole member of LaBranche Structured Products, LLC, a New York limited liabilitycompany (“LSP”), LaBranche Structured Products Specialists LLC, a New Yorklimited liability company (“LSPS”), LaBranche Structured Products EuropeLimited, a United Kingdom single member private company (“LSPE”), and LaBrancheStructured Products Hong Kong Limited, a Hong Kong single member privatecompany (“LSPH”, and collectively with the Holding Company, LaBranche &Co. LLC, LFSI, LSHI, LABDR, BV, LSP, LSPS and LSPE, the “Company”). LaBranche &Co. LLC is a registered broker-dealer that operates primarily as a specialistin equity securities and rights listed on the New York Stock Exchange (“NYSE”)and in equity securities on the American Stock Exchange (“AMEX”). LFSI is aregistered broker-dealer and a member of the NYSE and other exchanges andprovides securities execution, securities clearing and other related servicesto its own customers and customers of introducing brokers. LFSI also providesdirect-access floor brokerage services to institutional customers. LSP is aregistered broker-dealer that operates as a specialist in options, futures andExchange-Traded Funds (“ETFs”) on several exchanges, and as a market-marker inoptions, ETFs and futures on several exchanges. LSPS is a registered broker-dealer thatoperates as a specialist in ETFs traded on the NYSE. LSPE was organized tooperate as a market-maker for ETFs in Europe, and was registered as abroker-dealer with the United Kingdom’s Financial Securities Authority in March 2006.LSPH was organized to operate as a market-maker for ETFs and engage in hedgingtransactions in Asia, and is in the process of registering as a broker-dealerwith Hong Kong’s Securities and Futures Commission. LABDR providesdisaster recovery services and back-up facilities to other Holding Companysubsidiaries. BV represents LaBranche & Co. LLC in European marketsand provides client services to LaBranche & Co. LLC’s European listedcompanies.

 

## **2.**                                      SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES

 

### ***Basis of Presentation***

 

The preparation ofconsolidated financial statements in conformity with U.S. generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities at the date of theconsolidated financial statements and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from theseestimates. Certain prior period amounts have been reclassified to conform tothe current period presentation.

 

F-9

----

 

The consolidatedfinancial statements include the accounts of the Holding Company and itswholly-owned and majority-owned subsidiaries. All significant inter-companybalances and transactions have been eliminated in consolidation.

 

### ***Cash and Cash Equivalents***

 

Cash and cash equivalentsinclude all demand deposits held in banks and highly liquid investments withoriginal maturities of 90 days or less. Certain portions of these balances areused to meet regulatory requirements (see Note 8).

 

### ***Securities Transactions***

 

Principal securitiestransactions and the related gains and losses are recorded on a trade datebasis. Customer securities transactions are recorded on a settlement date basisand the related revenues and expenses are recorded on a trade date basis.Receivables from, and payables to, customers represent amounts due from or tocustomers of the Company in connection with cash and margin securitiestransactions. The value of certain receivables collateralized by customers’securities held by the Company and by other broker-dealers for delivery to theCompany, is not reflected in the accompanying consolidated financialstatements. Corporate equities, options, ETFs, futures and other securitiesowned, and securities sold, but not yet purchased, are reflected at marketvalue and unrealized gains and losses are presented as a component of “Net gainon principal transactions.” U.S. Government obligations, which are reportedunder “Securities owned, at market value” are reflected at market value. U.S.Government obligations included under “Cash and cash equivalents,” together withrelated interest receivable, which is reported under “Other assets,”approximate market value. Interest income related to U.S. Governmentobligations is included in “Revenues—Interest.” Dividend income and expense and Securities and Exchange Commission (“SEC”)fees, as well as gains and losses from the trading of foreign currencies, arealso presented as a component of “Net gain on principal transactions.” Dividendincome and expense are recognized on the record date, which does not differmaterially from the ex-date. In the normal course of business, the Company ispermitted to use client margin securities to finance customer securitiestransactions, subject to certain regulatory guidelines. The market value forequity securities, ETFs and futures contracts is based on the closing priceposted on the primary exchange on which they are traded. The market value ofexchange-traded options is based on the national best bid/offer as determinedby the Company’s options clearing agents.

 

Investments in non-marketablesecurities consist of investments in equity securities of private companies,limited liability company interests and limited partnership interests, and areincluded as part of “Other assets” on the consolidated statements offinancial condition. These investments do not have readily available pricequotations. Non-marketable investments are accounted for under the equitymethod, for those investments in which the Company’s voting interest is 20% to50%, or at fair value. In determining fair value, management of the Companyconsiders third-party transactions evidencing a change in value, the financialperformance of the investee, or any specific rights associated with theinvestment such as conversion features. Changes in fair value are recognized ifthe expected realizable value of the investment differs from its carryingvalue.

 

F-10

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### ***Collateralized Financing Transactions***

 

Securities purchased andsold under agreements to resell and repurchase, as well as securities borrowedand loaned for which cash is deposited or received, are treated ascollateralized financing transactions and are recorded at contract amount plusaccrued interest. It is the policy of the Company to obtain possession ofcollateral with market value equal to or in excess of the principal amountloaned under resale agreements. Collateral is valued daily, and the Company may requirecounterparties to deposit additional collateral when necessary. The marketvalue of securities received for securities purchased under agreements toresell at December 31, 2005 exceeded total cash paid. None of thesecurities received was subsequently repledged or resold.

 

### ***Intangible Assets***

 

Intangible assets arecomprised of the Company’s specialist stock lists, trade name and goodwillacquired in connection with various acquisitions and the limited partner buyoutthat occurred in 1999 concurrent with the Company’s reorganization frompartnership to corporate form. For material acquisitions through March 2001,the allocations of purchase price among these assets and determinations oftheir respective useful lives were based on independent appraisals. The usefullives of the acquired specialist stock lists were determined based uponanalysis of historical turnover characteristics of the specialist stockscomprising these lists. For acquisitions subsequent to March 2001, theallocations of purchase price and determinations of useful lives were basedupon management’s analysis of revenues, consideration paid, common stocklistings and other relevant data and ratios. This information was analyzed andcompared to the results of the independent appraisals conducted in connectionwith the acquisitions prior to April 2001.

 

*Goodwill—*Inaccordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFASNo. 142”), goodwill is not amortized. SFAS No. 142 requires thatgoodwill be tested annually for impairment (or more frequently when events orchanges in circumstances indicate impairment testing may be necessary) byapplying a fair value-based test. This test involves the comparison of the fairvalue of a reporting unit to its carrying value. If the carrying value of thereporting unit exceeds its estimated fair value, there is an indication thatgoodwill might be impaired, which requires additional testing. This additionaltesting entails estimating the implied fair value of reporting unitgoodwill—through the use of discounted cash flows analysis and othermeasures—and comparing this implied fair value of reporting unit goodwill toits carrying value. Any excess of carrying value of reporting unit goodwillover its implied fair value is recognized as an impairment loss. For the yearsended December 31, 2005, 2004 and 2003, the Company recorded goodwillimpairment charges of $-0-, $37.6 million and $170.3 million,  respectively (see Note 6).

 

*TradeName**—***Under******SFAS No. 142, the acquiredtrade name is not amortized. The Company tests its trade name for impairmentannually (or more frequently if events or changes in circumstances indicatethat the asset might be impaired) in conjunction with its goodwill impairmentassessment. If the carrying amount of the trade name exceeds its fair value, animpairment loss is recognized in an amount equal to that excess. As of December 31,2005, the Company’s trade name was not impaired.

 

F-11

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*SpecialistStock Lists**—***Acquiredspecialist stock lists are amortized over their respective useful lives. TheCompany assesses its specialist stock lists for possible impairment inaccordance with SFAS No. 144, “Accounting for the Impairment or Disposalof Long-Lived Assets” (“SFAS No. 144”). Pursuant to SFAS No. 144, theCompany evaluates its stock lists for potential impairment whenever events orchanges in circumstances indicate that their carrying amount may not befully recoverable. An impairment loss, calculated as the difference between theestimated fair value and the carrying value of the stock lists, is recognizedif the expected undiscounted cash flows relating to the stock lists are lessthan the corresponding carrying value. In conjunction with this evaluation, theCompany also reviews the reasonableness of the specialist stock lists’remaining useful lives. Any revisions to amortization periods are consideredwhen developing the aforementioned undiscounted cash flows. As of December 31,2005, the Company’s stock lists were not impaired.

 

### ***Exchange Memberships***

 

In accordance with theAmerican Institute of Certified Public Accountants’ (“AICPA”) *Audit and Accounting Guide—Brokers and Dealers in Securities,*exchange memberships owned by the Company are originally carried at cost or, ifan other-than-temporary impairment in value has occurred, at adjusted cost,which reflects management’s estimate of fair value. In determining whether another-than-temporary decline in value has occurred, the Company uses EmergingIssues Task Force (“EITF”) Issue No. 03-1, *The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments,*and Section M of Topic 5 of the SECstaff accounting bulletin series (“SAB No. 59”) as analogousguidance. For the years ended December 31, 2005, 2004 and 2003, theCompany recognized impairment losses of $-0-, $18.3 million and $0.5million,  respectively, on owned exchangememberships (see Note 5).

 

Certain employees of theCompany have contributed the use of nine memberships on the NYSE to theCompany. These memberships are subordinated to claims of general creditors andare carried at market value with a corresponding amount recorded assubordinated liabilities. The Company makes lease payments to these employeesfor the use of the exchange memberships at a rate that is commensurate with therent paid to non-affiliated parties for the use of their exchange memberships.

 

The Company leasesadditional memberships on the NYSE, the AMEX and the Chicago Board OptionsExchange® (“CBOE”) from non-affiliated parties and makes lease payments tothese parties at prevailing market rates.

 

### ***Income Taxes***

 

The Company accountsfor income taxes using the asset and liability method in accordance with SFAS No. 109,“Accounting for Income Taxes.”  SFAS No. 109requires the recognition of tax benefits or expenses based on the estimatedfuture tax effects of temporary differences between the financial statement andtax bases of an entity’s assets and liabilities. The effect on deferred taxesof a change in tax rates is recognized as income in the period that includesthe enactment date. Valuation allowances are established to reduce deferred taxassets to the amount that more likely than not will be realized. The Company’sdeferred tax assets are presented as a component of “Other assets” in theconsolidated statements of financial condition. Taxcontingencies, and related employment tax contingencies, are included under “Other

 

F-12

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liabilities” on the 2005 consolidated statement of financial condition.Contingent liabilities related to incometaxes are recorded when the criteria for loss recognition under SFAS No. 5,“Accounting for Contingencies” are met.

 

***Legal Contingencies***

 

The Companyrecords reserves related to legal proceedings in “Other liabilities.” Such reservesare established and maintained in accordance with SFAS No. 5, “Accounting forContingencies,” FASB Interpretation No. 14, “Reasonable Estimation of theAmount of a Loss; an Interpretation of SFAS No. 5,” and SEC Staff AccountingBulletin No. 92, “Accounting and Disclosures Relating to Loss Contingencies.”The determination of these reserve amounts requires significant judgment on thepart of management. Each legal proceeding is reviewed with counsel in eachaccounting period and the reserve is adjusted as deemed appropriate bymanagement.

 

### ***Depreciation and Amortization***

 

Depreciation of officeequipment is calculated using the straight-line method over estimated usefullives of 5 years. Amortization of leasehold improvements is calculated usingthe lower of the estimated useful life of the leasehold improvement or the termof the related lease. Estimated useful lives of leasehold improvements rangefrom 1 to 5 years.

 

Acquired specialist stocklists are amortized over useful lives ranging from 15 to 40 years.

 

***Stock-BasedCompensation***

 

Effective January 1,2003, the Company began to account for stock-based employee compensation inaccordance with the prospective method prescribed by SFAS No. 148, “Accountingfor Stock-Based Compensation-Transition and Disclosure, an Amendment of SFAS No. 123.”Under this method, compensation expense is recognized over the related serviceperiods based on the fair value, as of the date of grant, of stock options andrestricted stock units granted to employees on or after January 1, 2003.Such stock options and restricted stock units are included in “Stockholders’equity” under SFAS No. 148 when services required from employees inexchange for the awards are rendered and expensed.

 

Had the Companyrecognized compensation expense over the relevant service period under the fairvalue-based method of SFAS No. 123 with respect to stock options grantedfor the year ended December 31, 2003 and prior years, net income (loss)applicable to common stockholders would have been reduced (or increased, whereapplicable), resulting in pro forma net income (loss) applicable to commonstockholders and earnings (loss) per share as presented below:

 
| ** **                                                                                                  | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| **(000’s omitted, except per share data)**                                                             | ** ** | **2005**                          | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                        |       |                              |       |   |   |   |   |
| Net income  (loss) applicable to common stockholders, as reported                                           |       | $                                 | 37,521     |   | $ | (46,033 | ) | $ | (183,403 | ) |
| Add:  Stock-based compensation expense, net of related tax effects, included in  reported net income (loss) |       | 1,542                             |       | 1,647 |   | 1,788 |   |
| Less:  Stock-based compensation expense, net of related tax effect, determined under  SFAS 123              |       | (1,736                            | )          | (6,908 | ) | (8,913 | ) |
| Pro forma  net income (loss) applicable to common Stockholders                                              |       | 37,327                            |       | (51,294 | ) | (190,528 | ) |
|                                                                                                        |       |                              |       |   |   |   |   |
| Basic  earnings (loss) per share, as reported                                                               |       | $                                 | 0.62       |   | $ | (0.77 | ) | $ | (3.08 | ) |
| Basic  earnings (loss) per share, pro forma                                                                 |       | $                                 | 0.62       |   | $ | (0.86 | ) | $ | (3.20 | ) |
| Diluted  earnings (loss) per share, as reported                                                             |       | $                                 | 0.61       |   | $ | (0.77 | ) | $ | (3.08 | ) |
| Diluted  earnings (loss) per share, pro forma                                                               |       | $                                 | 0.61       |   | $ | (0.86 | ) | $ | (3.20 | ) |

 

F-13

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The effect of applyingSFAS No. 123 in the pro forma disclosure above may not berepresentative of the potential effect stock-based compensation would have onnet income (loss) in future periods.

 

### ***Recent Accounting Pronouncements***

 

In December 2004,the FASB issued SFAS No. 123(R), “Share Based Payment.” SFAS No. 123(R)is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”and supercedes APB opinion No. 25, “Accounting for Stock Issued toEmployees” and amends SFAS No. 95, “Statement of Cash Flows.” SFAS No. 123(R)will require compensation costs related to share-based payment transactions tobe recognized in the financial statements over the period that an employeeprovides service in exchange for the award. SFAS No. 123(R) is effectiveas of January 1, 2006, using the modified prospective method. The Companycurrently does not expect the adoption of this standard to have a materialimpact on its financial condition, results of operations or cash flows, but theCompany will continue to evaluate guidelines on this topic.

 

## **3.**                                      RECEIVABLEFROM AND PAYABLE TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS

 

The balances presented asreceivable from and payable to brokers, dealers and clearing organizationsconsist of the following:

 
| ** **                                                    | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------|------------|
| **(000’s omitted)**                                      | ** ** | **2005**              | ** ** | **2004** | ** ** |
|                                                          |       |                  |       |   |   |
| Receivable  from brokers, dealers and clearing organizations: |       |                  |       |   |   |
|                                                          |       |                  |       |   |   |
| Securities  borrowed                                          |       | $                     | 19,354     |   | $ | 56,327 |   |
| Receivable  from clearing brokers and clearing organizations  |       | 625,010               |       | 81,881 |   |
| Securities  failed to deliver                                 |       | 10,643                |       | 15,542 |   |
| Other  receivables from brokers and dealers                   |       | 3,624                 |       | 4,671 |   |
|                                                          |       | $                     | 658,631    |   | $ | 158,421 |   |
|                                                          |       |                  |       |   |   |
| Payable to  brokers and dealers:                              |       |                  |       |   |   |
|                                                          |       |                  |       |   |   |
| Securities  failed to receive                                 |       | 6,633                 |       | 6,502 |   |
| Securities  loaned                                            |       | 0                     |       | 6,930 |   |
| Payable to clearing  brokers                                  |       | 12,009                |       | 9,435 |   |
| Other  payables to brokers and dealers                        |       | 61,004                |       | 97,567 |   |
|                                                          |       | $                     | 79,646     |   | $ | 120,434 |   |

 

Withrespect to securities loaned, the Company receives collateral in the form ofcash in an amount in excess of the market value of such securities. Ifcounterparties to the Company’s securities loaned transactions have the right,by contract or custom, to sell or re-pledge the Company’s pledged proprietarysecurities, then the Company will disclose these securities as “securitiespledged to counterparties” on the accompanying consolidated statement offinancial condition. As of December 31, 2005, there were no pledgedproprietary securities related to the Company’s securities loaned transactions.

 

F-14

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TheCompany monitors the market value of securities borrowed and loaned on a dailybasis, with additional collateral obtained or refunded as necessary.

 

## **4.**                                      NON-MARKETABLESECURITIES

 

During 2005, the Company recognized a gain of approximately $11.0million related to its non-marketable investments. Included in this amount is$9.6 million related to the release of an escrow in connection with a 2004disposition of an investment. At December 31, 2005 and 2004,non-marketable securities totaling $7.1 million and $7.0 million, respectively,are included in “Other assets” on the consolidated statements of financialcondition.

 

## **5.**                                      EXCHANGEMEMBERSHIPS

 

In June 2004, theCompany recognized a charge of approximately $18.3 million to reflectmanagement’s determination of an other-than-temporary impairment of thecarrying value of the Company’s NYSE memberships, based on management’sestimate of their fair value. As part of the Company’s assessment of theother-than-temporary impairment of these assets, management of the Companyconsidered and evaluated various financial and economic factors directlyaffecting both the equity securities market as a whole and the specialistindustry in particular, including recent sale and lease prices of NYSEmemberships, historical trends of sales and lease prices of NYSE membershipsand their duration, the current condition of the NYSE market structure andlegal and regulatory developments affecting the NYSE market structure.

 

Ofthe total $18.3 million other-than-temporary impairment charge,approximately $16.3 million was attributed to the Company’s Specialistreporting unit and approximately $2.0 million was attributed to theCompany’s Execution and Clearing reporting unit. The Company does not expectany future impairments relating to NYSE memberships (see Note 20).

 

The Company previouslyrecorded a $0.5 million other-than-temporary impairment charge in December 2003relating to its Execution and Clearing reporting unit’s AMEX membership.

 

**6.**                                      GOODWILLAND IDENTIFIABLE INTANGIBLE ASSETS

 

*Goodwill*

 

For the year ended December 31,2004, the Company recognized a goodwill impairment charge of $37.6 million.This impairment charge was determined as part of the Company’s assessmentof the reasonableness of its goodwill carrying value during the third quarterof 2004. Although the Company’s annual goodwill impairment testing date is December 31,management undertook an interim review of the Company’s goodwill forimpairment, as required by SFAS No. 142, due to changes in circumstancesthat management believed would more likely than not reduce the fair value ofgoodwill below its carrying amount. The factors management considered indeciding to assess the reasonableness of the carrying value of goodwill at September 30,2004 primarily related to the continued downward trend in principal tradingrevenues at the Company’s Specialist reporting unit and the continued declinein the Company’s stock price through the nine months ended September 30,2004. Pursuant to SFAS No. 142, management

 

F-15

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subsequentlyupdated its goodwill valuation analysis through and including the Company’sannual impairment testing date, or December 31, 2004, and noted noindicators of further goodwill impairment.

 

The $39.0 milliondecrease in net carrying value of goodwill from $289.6 million as of December 31,2003 to $250.6 million as of December 31, 2004 was due to theaforementioned $37.6 million impairment charge and a $1.4 million tax benefiton stock-based compensation awarded in connection with a prior acquisition.

 

For the year ended December 31,2003, the Company recognized a goodwill impairment charge of approximately$170.3 million. The methods used by the Company in determining the fair valueof its equity and in estimating the implied fair value of its goodwill duringthe year ended December 31, 2004 were consistent with those used duringthe year ended December 31, 2003. However, the Company’s 2003 goodwillvaluation analysis included both reporting segments, Specialist and Executionand Clearing.

 

Of the total fiscal 2003$170.3 million goodwill impairment charge, approximately $166.2 million wasattributed to the Company’s Specialist reporting unit and approximately $4.1million was attributed to the Company’s Execution and Clearing reporting unit.

 

The $181.0 milliondecrease in net carrying value of goodwill from $470.6 million as of December 31,2002 to $289.6 million as of December 31, 2003 was due primarily to theaforementioned $170.3 million impairment charge and a $10.7 million deferredtax liability effect.

 

*IdentifiableIntangible Assets*

 

The Company’s acquiredspecialist stock lists are amortized over their respective lives ranging from15 to 40 years, with a weighted-average amortization period of 39.6 years. Thegross carrying amount, accumulated amortization and net carrying amount ofacquired specialist stock lists are set forth below as of December 31:

 
| **(000’s omitted)** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
|                     |       |     |       |     |       |
| Gross carrying amount    |       | $        | 406,190    |     | $          | 406,190 |   |
| Accumulated amortization |       | (55,362  | )          | (44,986  | )          |
| Net carrying  amount     |       | $        | 350,828    |     | $          | 361,204 |   |

 

Amortization expense wasapproximately $10.4 million for each of the years ended December 31, 2005,2004 and 2003. Estimated amortization expense for the existing specialist stocklists is $10.4 million for each of the fiscal years ending December 31,2006 through December 31, 2010.

 

F-16

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## **7.**                                      INCOMETAXES

 

The components of theprovision (benefit) for income taxes reflected on the accompanying consolidatedstatements of operations are set forth below:

 
| ** **                                       | ** ** | **For the  Years Ended December 31,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------|------------|
| **(000’s omitted)**                         | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Current income taxes:                            |       |                                       |       |   |   |   |   |
| Federal                                          |       | $                                          | (8,020     | ) | $ | 547 |   | $ | 10,904 |   |
| Foreign, state and local                         |       | (328                                       | )          | 322 |   | 6,418 |   |
| Total current                                    |       | (8,348                                     | )          | 869 |   | 17,322 |   |
|                                             |       |                                       |       |   |   |   |   |
| Deferred income taxes:                           |       |                                       |       |   |   |   |   |
| Federal                                          |       | 21,073                                     |       | (8,129 | ) | (14,685 | ) |
| Foreign, state and local                         |       | 859                                        |       | (4,785 | ) | (8,644 | ) |
| Total deferred                                   |       | 21,932                                     |       | (12,914 | ) | (23,329 | ) |
|                                             |       |                                       |       |   |   |   |   |
| Total provision (benefit) for  income taxes |       | $                                          | 13,584     |   | $ | (12,045 | ) | $ | (6,007 | ) |

 

Deferredtax assets and liabilities are determined based on the estimated future taxeffects of temporary differences between the financial statement and tax basesof assets and liabilities. The following table presents the components ofdeferred tax asset and liability balances:

 
| ** **                                             | ** ** | **For the  Years Ended December 31,** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------|------------|
| **(000’s omitted)**                               | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| **Deferred tax assets:**                               |       |                                       |       |   |   |
| Compensation related                                   |       | $                                          | 2,179      |   | $ | 9,963 |   |
| Acquisition intangibles and related goodwill           |       | 3,448                                      |       | 6,033 |   |
| NOL carry-forward                                      |       | 4,265                                      |       | 24,087 |   |
| Other                                                  |       | 2,652                                      |       | 2,423 |   |
| Total deferred tax assets                              |       | $                                          | 12,544     |   | $ | 42,506 |   |
|                                                   |       |                                       |       |   |   |
| **Deferred tax liabilities:**                          |       |                                       |       |   |   |
| Acquisition intangibles (equity purchases)             |       | $                                          | 122,740    |   | $ | 133,240 |   |
| Acquisition intangibles and goodwill (asset purchases) |       | 19,906                                     |       | 17,113 |   |
| Securities marked-to-market                            |       | 2,135                                      |       | 3,935 |   |
| Non marketable investment basis                        |       | 580                                        |       | 934 |   |
| Other                                                  |       | 2,902                                      |       | 1,072 |   |
| Total deferred tax liabilities                         |       | $                                          | 148,263    |   | $ | 156,294 |   |

 

The 2005 net decrease indeferred tax assets was mainly attributable to the reduction of deferredcompensation charges related to the termination of the RPM deferredcompensation plan of $8.6 million, a $2.6 million decrease in acquisition intangiblesamortized, a tax rate change of $1.0 million, the carryback of the Federal 2004net operating loss to 2002 resulting in an $18.3 million refund and 2005state/city NOL utilization of $1.5 million. There is no valuation allowancerecorded against the deferred tax assets. In assessing the realization ofdeferred tax assets, management considers whether it is more likely than notthat some portion or all of the deferred tax assets will not be deductible.Based on the Company’s level of historical taxable

 

F-17

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income, futurereversals of existing taxable differences and all other available evidence, thedeferred tax assets will more likely than not be realized.

 

The 2005 net decrease indeferred tax liabilities is due primarily to a tax rate change from 46.1% in2004 to 43.5% in 2005 resulting in an $8.8 million decrease.

 

TheCompany’s effective tax rate differs from the Federal statutory rate primarilydue to the nondeductible amortization of intangible assets, nondeductibleimpairment of exchange memberships, nondeductible impairment of goodwill,nondeductible penalties and state and local taxes. A reconciliation ofthe statutory U.S. Federal income tax rate of 35.0% to the Company’s effectiveincome tax rate is set forth below:

 
| ** **                                                            | ** ** | **For the  Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                            | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                  |       |                                       |       |   |   |   |   |
| U.S. Federal income tax rate                                          |       | 35.0                                       | %          | 35.0 | % | 35.0 | % |
| Increase (decrease) in taxes related to:                              |       |                                       |       |   |   |   |   |
| State and local taxes                                                 |       | 8.5                                        |       | 4.0 |   | 0.8 |   |
| Nondeductible acquisition intangibles and related goodwill impairment |       | —                                     |       | (20.8 | ) | (29.7 | ) |
| Nondeductible penalty expense                                         |       | —                                     |       | — |   | (4.1 | ) |
| Tax rate change and law change                                        |       | (15.3                                      | )          | — |   | — |   |
| Capital tax                                                           |       | 1.9                                        |       | — |   | — |   |
| Other                                                                 |       | (3.5                                       | )          | 3.6 |   | 1.2 |   |
| Effective tax rate                                                    |       | 26.6                                       | %          | 21.8 | % | 3.2 | % |

 

In2005, the Company recognized a tax benefit of $7.8 million for a tax ratechange and state tax law change and $1.3 million for a reduction in taxliabilities due to the close of the statute of limitations with respect to aprior federal tax year.

 

In2004, the Holding Company generated a tax net operating loss of $52.5 millionthat was carried-back to 2002 and resulted in a refund of $18.3 million thatwas received in April 2005. New York State and City, the principal stateand local tax filing jurisdictions of the Holding Company, only allow acarryforward for 20 years. The company estimates $27 million of the availablestate/city NOL will be utilized in 2005.

 

Asa result of the Company’s March 2001 acquisition of Internet Trading Technologies, Inc.(“ITTI”), net operating loss (“NOL”) carryforwards totaled $1.3 million and$1.6 million as of December 31, 2005 and 2004, respectively. Theutilization of these NOLs as a tax deduction is limited under Section 382of the Internal Revenue Code to $0.2 million per year. The Company was notallowed to utilize any ITTI NOLs in 2004 due to the overall tax net lossposition of the Holding Company. These NOLs will begin to expire between 2019and 2021.

 

Taxbenefits of approximately $1.2 million and $0.4 million for the years ended December 31,2004 and 2003, respectively, were credited directly to goodwill or additionalpaid-in capital in the accompanying consolidated statements of financialcondition and changes in stockholders’ equity. These tax benefits related tothe vesting of restricted stock units, shares of restricted stock and theexercise of stock options.

 

F-18

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## **8.**             CAPITALAND NET LIQUID ASSET REQUIREMENTS

 

LaBranche & Co. LLC, as a specialist and member ofthe NYSE and AMEX, is subject to the provisions of SEC Rule 15c3-1 asadopted and administered by the SEC, NYSE, and AMEX. LaBranche is required tomaintain minimum net capital, as defined, equivalent to the greater of $100,000or 1/15 of aggregate indebtedness, as defined.

 

As of December 31, 2005 and 2004, LaBranche &Co. LLC’s net capital, as defined under SEC Rule 15c3-1, was$459.8 million and $455.1 million, respectively, which exceededminimum requirements by $458.1 million and $453.2 million,respectively. LaBranche & Co. LLC’s aggregate indebtedness to net capitalratio was .05 to 1 and .06 to 1, as of December 31, 2005 and 2004,respectively.

 

The NYSE generally requires itsspecialist firms to maintain a minimum dollar regulatory capital amount inorder to establish that they can meet, with their own net liquid assets, theirposition requirement. LaBranche & Co. LLC’s and LSPS’ requiredcombined dollar amount of net liquid assets, as defined, was $447.0 million.LaBranche & Co. LLC’s actual net liquid assets, as defined, was $459.3million and $458.7 million as of December 31, 2005 and 2004, respectively. LSPSis not required to perform a net liquid assets calculation because LaBranche& Co. LLC’s actual net liquid assets exceed the combined net liquid assetsrequirement of LaBranche & Co. LLC and LSPS. The majority of LaBranche& Co. LLC’s and LSPS’ net liquid assets is comprised of cash and cashequivalents, marketable securities owned and receivables from broker-dealers.

 

The AMEX generally requires its equity specialistfirms to maintain a cash or liquid asset position of the greater of (a) $1million or (b) an amount sufficient to assume a position of sixty trading unitsof each security in which the equity specialist firm is registered. As ofDecember 31, 2005, LaBranche & Co. LLC satisfied the AMEX equity specialistliquid asset requirements.

 

As a registered broker-dealer and member firm of theNYSE, LFSI is also subject to SEC Rule 15c3-1, as adopted and administered bythe SEC and the NYSE. Under the alternative method permitted by this rule, theminimum required net capital is equal to the greater of $1.5 million or 2% ofaggregate debit items, as defined. As of December 31, 2005 and 2004, LFSI’s netcapital, as defined, was $19.7 million and $12.5 million, respectively, whichexceeded its minimum requirements by $18.2 million and $11.0 million,respectively.

 

As a clearing broker-dealer,LFSI is subject to SEC Rule 15c3-3, as adopted and administered by the SEC. Asof January 4, 2006, to comply with its December 31, 2005 requirement, cash andU.S. Treasury Bills in the amount of $1.2 million were segregated in a specialreserve account for the exclusive benefit of customers, exceeding actualrequirements by $1.2 million. As of January 4, 2005, to comply with itsDecember 31, 2004 requirement, cash and U.S. Treasury Bills in the amount of$0.1 million were segregated in a special reserve account for the exclusivebenefit of customers, exceeding actual requirements by $0.1 million. Inaddition, the PAIB Calculation is computed in order for correspondent firms toclassify their assets held by LFSI as allowable assets in the correspondents’net capital calculation. As of January 4, 2006, to comply with its December 31,2005 requirement, cash and U.S. Treasury Bills in the amount of $5.7 millionwere segregated in a special reserve account for the exclusive benefit ofcustomers, exceeding actual requirements by $2.0 million. As of January 4, 2005, to 

 

F-19

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comply with its December 31,2004 requirement, cash and U.S. Treasury Bills in the amount of $4.4 millionwere segregated in a special reserve account for the exclusive benefit ofcustomers, exceeding actual requirements by $3.4 million.

 

As a registered broker-dealer and AMEX member firm,LSP is subject to SEC Rule 15c3-1, as adopted and administered by the SEC andAMEX. LSP is required to maintain minimum net capital, as defined, equivalentto the greater of $100,000 or 1/15 of aggregateindebtedness, as defined. As of December 31, 2005 and 2004, LSP’s netcapital, as defined, was $56.8 million and $23.8 million, respectively, whichexceeded its minimum requirements by $55.7 million and $23.2 million,respectively.

 

LSPS, as a specialist and member of the NYSE, issubject to the provisions of SEC Rule 15c3-1, as adopted and administered bythe SEC and NYSE. LSPS is required to maintain minimum net capital, as defined,equivalent to the greater of $100,000 or 1/15 ofaggregate indebtedness, as defined. As of December 31, 2005 and 2004, LSPS’net capital, as defined under SEC Rule 15c3-1, was $10.7 million and $4.4million, respectively, which exceeded its minimum requirement by $10.6 millionand $4.3 million, respectively. LSPS’ aggregate indebtedness to net capitalratio was .16 to 1 and .13 to 1 as of December 31, 2005 and 2004, respectively.

 

**9.**             SHORTTERM AND LONG TERM DEBT

** **

*Debt Extinguishment and Refinancing*

 

On May 18, 2004, in connection with the refinancingof certain of the Company’s indebtedness, the Company repurchased approximately$93.1 million of its then-outstanding $100.0 million aggregate principalamount 9.5% senior notes due 2004 (the “2004 Notes”) and approximately $236.4million of its then-outstanding $250.0 million aggregate principal amount12.0% senior subordinated notes due 2007 (the “2007 Notes” and, together withthe 2004 Notes, the “Old Notes”), and paid for related consents delivered bythe holders of the Old Notes on or prior to April 19, 2004. The aggregatepurchase price paid by the Company for the Old Notes was approximately$386.9 million, which included the purchase price, premium and consentpayments of approximately $49.0 million in the aggregate, and accrued butunpaid interest on the Old Notes up to, but not including, the settlement date.Upon the completion of this debt repurchase and consent solicitation, theindentures governing the remaining outstanding Old Notes were stripped ofsubstantially all restrictive covenants, certain events of default and otherrelated provisions. In August 2004, the Company repaid $6.9 million of the 2004Notes that remained outstanding after the refinancing. Accordingly, there areno 2004 Notes outstanding as of December 31, 2004.

 

In order to fund the repurchase of the Old Notes andrelated consent solicitation, the Company issued $460.0 million aggregateprincipal amount of new senior notes (collectively, the “Original Senior Notes”)to qualified institutional buyers in the United States pursuant toRule 144A under the Securities Act of 1933, as amended (the “SecuritiesAct”), and outside the United States pursuant to Regulation S under theSecurities Act. The Original Senior Notes consisted of 9.5% Senior Notes due2009 in the aggregate principal amount of $200.0 million

 

F-20

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(the “Original 2009 Notes”)and 11.0% Senior Notes due 2012 in the aggregate principal amount of$260.0 million (the “Original 2012 Notes”).

 

## **On September 10, 2004, pursuant to a registration rightsagreement between the initial purchaser of the Original Senior Notes and theCompany, the Company offered to exchange (i) its 9.5% Senior Notes due2009 that have been registered under the Securities Act (the “2009 Senior Notes”),for an equal principal amount of outstanding Original 2009 Notes and(ii) its 11.0% Senior Notes due 2012 that have been registered under theSecurities Act (the “2012 Senior Notes,” and together with the 2009 SeniorNotes, the “Senior Notes”), for an equal principal amount of outstandingOriginal 2012 Notes.**

## ** **

The exchange offer expired on October 22, 2004, withthe holders of 98.5%, or $197.0 million aggregate principal amount, of Original2009 Notes having tendered their Original 2009 Notes for exchange, and theholders of 100.0%, or $260.0 million aggregate principal amount, of theOriginal 2012 Notes having tendered their Original 2012 Notes for exchange. Thenew Senior Notes represent the same indebtedness as the Original Senior Notesthat were exchanged and have been issued under the same indenture. Allsubsequent references to the term “2009 Senior Notes” include the $3.0 millionprincipal amount of Original 2009 Notes that were not tendered in the exchangeoffer and remain outstanding.

 

The Senior Notes were issuedpursuant to a new indenture that is similar to the indentures that governed theOld Notes prior to their amendment in connection with the May 2004 debtrefinancing. The new indenture includes certain covenants that, among otherthings, limit the Company’s ability to make certain investments, engage intransactions with stockholders and affiliates, create liens on the Company’sassets and sell assets or engage in mergers and consolidations, except inaccordance with certain specified conditions.****In addition, the Company’s ability to incur additional indebtedness(other than certain “permitted indebtedness”), pay dividends, redeem stock orrepurchase subordinated indebtedness prior to maturity will be limited if theCompany’s consolidated fixed charge coverage ratio is at or below a thresholdof 2.00:1 on and after December 31, 2004. The “consolidated fixed chargecoverage ratio” reflects a comparison between (1) the Company’s consolidatedearnings before interest, taxes, depreciation and amortization expenses, or “EBITDA,”and (2) the sum of the Company’s consolidated interest expense and atax-effected multiple of any dividend payments that the Company might make withrespect to preferred stock. As of December 31, 2005, the Company’s consolidatedfixed charge coverage ratio was approximately 2.02:1. The indenture governingthe Senior Notes provides for certain exceptions to the limitations onrestricted payments, including, for example, the Company’s July 2004 repurchaseof all then-outstanding shares of its Series B preferred stock, repurchase ofthe Company’s Senior Notes, and any “restricted payments” up to an aggregate of$15.0 million over the life of the indenture.

 

In addition, under the indenture governing the SeniorNotes, if, at any time, theCompany’s cumulative “restricted payments” since May 18, 2004 generallyare greater than (i) the sum of (A) 50.0% of the Company’s cumulative consolidated net income, as defined inthe indenture, since July 1, 2004 (or, if such calculation is a loss, minus100.0% of such loss), and (B) 100.0% of the net cash proceeds received from anyissuance or sale of the Company’s capitalstock since July 1, 2004, plus (ii) $15.0 million, the Company will not be entitled to make a “restricted payment”at such time. As of December 31, 2005, our cumulative consolidated net 

 

F-21

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income since July 1, 2004 was $39.6 million, and theCompany had received approximately $1.4 million upon the exercise of optionssince July 1, 2004. Accordingly, as of December 31, 2005 the Company was entitledto make restricted paymentsup to $21.2 million, plus the $15.0 million “basket” described above, for anaggregate total of $36.2 million.

 

The indenture governing the Senior Notes permits the Company to redeemsome or all of the 2009 Senior Notes on or after May 15, 2007 and some or allof the 2012 Senior Notes on or after May 15, 2008 at varying redemption prices,depending on the date of redemption. In addition, the Company has the option toredeem up to 33.0% of the aggregate principal amount of the 2009 Senior Notesat a redemption price of 109.5% and up to 33.0% of the aggregate principalamount of the 2012 Senior Notes at a redemption price of 111.0% using theproceeds of certain equity offerings which the Company may complete on or priorto May 15, 2007. Under the terms of the indenture, if the Company sellssubstantially all of its assets or experiences specific kinds of changes incontrol, the Company will be required to offer to repurchase Senior Notes, on apro rata basis, at a price in cash equal to 101.0% of their principal amount,plus accrued and unpaid interest, if any, to the date of purchase.

 

The Company’s short term and long term debt as of December 31, 2005 and2004 are as follows:

 

*Short Term Debt*

 

As of December 31, 2005, the Company had noshort-term debt other than the $3.0 million principal amount due on June 3,2006, with respect to the five subordinated notes in the initial aggregateprincipal amount of $15.0 million described below in Note 10. “SubordinatedLiabilities.”

 

As of December 31, 2004, the Holding Companywas obligated under a promissory note for $2.0 million assumed in connectionwith the RPM acquisition, which was issued to a family member of a formeremployee of RPM. This note bore interest at 12.5% per year until June 14, 2003,and bore interest at 8.0% per year through June 14, 2005, its maturity date. InJune 2005, the Company paid this $2.0 million note, plus accrued and unpaidinterest thereon, in full.

 

*Long Term Debt*

 

As of December 31, 2005, long term debt of the Company was comprised of(a) $459.8 million aggregate principal amount of Senior Notes, (b) $13.6million aggregate principal amount of remaining 2007 Notes, the carrying valueof which is approximately $13.5 million, and (c) eight separate $1.0 millionpromissory notes (this indebtedness accrued interest at the rate of 10.0% peryear until August 7, 2003 and thereafter accrues interest at a rate of 9.0% peryear, payable semiannually, and matures on August 7, 2007). Debt issuancecosts, totaling approximately $5.5 million for the 2009 Senior Notes andapproximately $7.2 million for the 2012 Senior Notes, are being amortized overthe life of the Senior Notes as an adjustment to interest expense. For the yearended December 31, 2005, interest expense related to the Senior Notes totaled$49.2 million. For the years ended December 31, 2005, 2004 and 2003, interestexpense related to the $8.0 million promissory notes totaled $0.7 million, $0.7million and $0.8 million, respectively.

 

F-22

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As of December 31, 2004, long term debt was comprised of (a) $459.9million aggregate principal amount of Senior Notes, (b) $13.6 million aggregateprincipal amount of remaining 2007 Notes, the carrying value of which wasapproximately $13.5 million, and (c) eight separate $1.0 million promissorynotes (this indebtedness accrued interest at the rate of 10.0% per year untilAugust 7, 2003 and thereafter accrues interest at a rate of 9.0% per year,payable semiannually, and matures on August 7, 2007). Debt issuance costs,totaling approximately $5.5 million for the 2009 Senior Notes and approximately$7.2 million for the 2012 Senior Notes, are being amortized over the life ofthe Senior Notes as an adjustment to interest expense. For the year endedDecember 31, 2004, interest expense related to the Senior Notes totaled $30.3million. For the years ended December 31, 2004, 2003 and 2002, interest expenserelated to the eight separate $1.0 million promissory notes totaled $0.7million, $0.8 million and $0.3 million, respectively.

 

Principal maturities of long term debt as of December31, 2005 are as follows:

 

| **(000’s  omitted)**    | ** ** | ** ** | ** ** |
|------------------------------|------------|------------|------------|
| ** **                   | ** ** | ** ** | ** ** |
| **Year Ending December 31,** | ** ** | **Amount** | ** ** |
| ** **                   | ** ** | ** ** | ** ** |
| 2006                         |       | $          | —     |   |
| 2007                         |       | 21,642     |       |
| 2008                         |       | —     |       |
| 2009                         |       | 199,845    |       |
| 2010                         |       | —     |       |
| Thereafter                   |       | 259,992    |       |
| **Total**                    |       | $          | 481,479    |   |

 

In October 2005, LaBranche & Co. LLC extended its$200.0 million committed line of credit agreement with a bank to October 2006on the same terms and conditions. The committed line of credit, which isavailable to finance LaBranche & Co. LLC’s specialist activities, may beextended by LaBranche & Co. LLC—subject to the bank’s approval—foradditional one-year terms by giving written notice to the bank at least 30 daysprior to the then-current scheduled termination date. Amounts outstanding underthis credit agreement would be secured by LaBranche & Co. LLC’s inventoryof specialist stocks and would bear interest at the bank’s broker loan rate. Inorder to maintain the availability of funds under this credit facility,LaBranche & Co. LLC must comply with certain financial and other covenants.LaBranche & Co. LLC is currently in compliance with these covenants.

 

## **10.**          SUBORDINATEDLIABILITIES

## ** **

LaBranche & Co. LLC is a party to subordinatedloan agreements under which it has incurred indebtedness approved by the NYSEfor inclusion as net capital, as defined. Interest is payable quarterly at anannual rate of 10.0%. Three agreements representing approximately $1.1 millionmature within the first six months of 2006, and four agreements representingapproximately $2.3 million mature within the last six months of 2006, Thesesubordinated loans all have automatic rollover provisions, and each scheduledmaturity date will be extended an additional year, unless the lender givesLaBranche & Co. LLC seven months advance notice that the maturity date willnot be extended. LaBranche & Co. LLC is entitled to prepay thesesubordinated loans without penalty under the terms of the agreements relatingthereto. Interest 

 

F-23

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expense incurred on these and other similarsubordinated loan agreements which have been repaid was approximately $0.4million for the year ended December 31, 2005 and $0.5 million for each of theyears ended December 31, 2004 and 2003.

 

In 1998, LaBranche & Co. LLC issued fivesubordinated notes representing aggregate indebtedness of $15.0 million, whichmature in equal installments of $3.0 million payable on June 3, 2004,2005, 2006, 2007 and 2008, and bear interest at an annual rate of 7.7%, payableon a quarterly basis. On June 3, 2005, LaBranche & Co. LLC repaid $3.0million of these subordinated notes. As of December 31, 2005, $9.0 millionremained outstanding under these subordinated notes, which are senior to allother subordinated notes of LaBranche & Co. LLC. The agreements coveringthese subordinated notes require LaBranche & Co. LLC to comply with certaincovenants that, among other things, restrict the type of business in whichLaBranche & Co. LLC may engage, set certain net capital levels and prohibitrestricted payments, as defined. Interest expense incurred on these subordinatednotes for the years ended December 31, 2005, 2004 and 2003 wasapproximately $0.8 million, $1.0 million and $1.2 million, respectively.

 

**11.****          STOCKHOLDERS’EQUITY**

 

On January 21, 2004, the Company completed an exchangeoffer pursuant to an exemption from registration under Section 3(a)(9) of theSecurities Act of 1933, as amended, pursuant to which the Company exchanged oneshare of a newly-created Series B preferred stock for each share of itsthen-issued and outstanding Series A preferred stock. In the exchange offer,all of the approximately 39,186 outstanding shares of Series A preferred stockwere exchanged by the fourteen holders of record for shares of the Company’sSeries B preferred stock. Issuance of the newly-created shares of Series Bpreferred stock was contingent upon the tender for exchange of 100% of thethen-issued and outstanding shares of Series A preferred stock.

 

On June 14, 2004, the Company commenced an offer topurchase any and all of the approximately 39,186 then-outstanding shares of itsSeries B preferred stock. On July 12, 2004, the offer expired with 100% of thethen-outstanding shares of Series B preferred stock having been tendered. OnJuly 13, 2004, the Company purchased all of the tendered shares at a price of$1,000 per share, plus accrued and unpaid dividends up to, but not including,the date of purchase for approximately $42.6 million and all then-outstandingshares of the Company’s Series B preferred stock were retired. As a result ofthe purchase, the Company recorded an expense in the third quarter of 2004 ofapproximately $0.5 million due to the acceleration of the discount accretion onthe shares that were purchased.

 

Of the approximately 39,186 then-outstanding shares ofthe Company’s Series B preferred stock, approximately 9,760 shares had beenheld in escrow in order to secure the indemnification obligations of the formerstockholders of RPM in connection with the Company’s acquisition of RPM inMarch 2001. In connection with the completion of the offer to purchase allthen-outstanding shares of the Company’s Series B preferred stock, this escrowarrangement was terminated in order to facilitate the Company’s objective ofrepurchasing and retiring all of its shares of Series B preferred stock withoutforfeiting any material right to indemnification under the merger agreementgoverning its acquisition of RPM.

 

F-24

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For the years ended December 31, 2005, 2004 and 2003,dividends declared per common share were $0.00, $0.00 and $0.24, respectively.In October 2003, the board of directors suspended indefinitely the payment ofdividends.

 

## **12.**          EARNINGS(LOSS) PER SHARE

## ** **

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

 
| ** **                                                                                                            | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| **(000’s omitted, except per  share data)**                                                                      | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income (loss)                                                                                                     |       | $                            | 37,521     |   | $ | (43,780 | ) | $ | (179,389 | ) |
| Less: preferred dividends and discount  accretion                                                                     |       | —                       |       | 2,253 |   | 4,014 |   |
| Numerator for basic and diluted earnings  (loss) per share – net income (loss) applicable to common stockholders |       | $                            | 37,521     |   | $ | (46,033 | ) | $ | (183,403 | ) |
| Denominator for basic earnings (loss) per  share – weighted-average number of common shares outstanding          |       | 60,617                       |       | 59,905 |   | 59,614 |   |
| Dilutive shares:                                                                                                      |       |                         |       |   |   |   |   |
| Stock options                                                                                                         |       | —                       |       | — |   | — |   |
| Restricted stock                                                                                                      |       | —                       |       | — |   | — |   |
| Restricted stock units                                                                                                |       | 442                          |       | — |   | 3⁄4 |   |
| Denominator for diluted earnings (loss) per  share – weighted-average number of common shares outstanding        |       | 61,059                       |       | 59,905 |   | 59,614 |   |
| Basic earnings (loss) per share                                                                                       |       | $                            | 0.62       |   | $ | (0.77 | ) | $ | (3.08 | ) |
| Diluted earnings (loss) per share                                                                                     |       | $                            | 0.61       |   | $ | (0.77 | ) | $ | (3.08 | ) |
|                                                                                                                       |            |                              |            |  |  |  |  |  |  |  |  |

 

The exercise prices for options to purchasean aggregate of 1,709,778 shares of common stock exceeded the average marketprice of the Company’s common stock for the year ended December 31, 2005. Inaddition, potential common shares relating to restricted stock and restrictedstock units whose fair value was below the average market price of the Company’scommon stock for the year ended December 31, 2005 totaled 651,518. Accordingly,the above calculations of diluted earnings per share for 2005 do not includethe antidilutive effect of these stock based awards. Potential common sharesrelating to options totaling 2,319,167 and 3,626,891 for the years ended December31, 2004 and 2003, respectively, and to restricted stock and restricted stockunits totaling 574,353 and 295,945 for the years ended December 31, 2004 and2003, respectively, were excluded from the diluted loss per share calculationfor the years ended December 31, 2004 and 2003 because their effect wasantidilutive.

 

## **13.**          ACQUISITIONS

## ** **

Effective October 24, 2002, the Holding Companyacquired all the outstanding stock of Hochstin & Company, Inc. (“Hochstin”),which conducted a rights specialist and floor brokerage business on the NYSE,for $7.8 million in cash, of which $3.6 million was paid at the closing and theremainder is to be, or was, paid by the Holding Company as follows: (a) $1.0million on each of October 24, 2003, 2004 and 2005, and (b) $1.2 million onOctober 24, 2007, although the final payment may be reduced to $200,000 if theemployment with LFSI of a certain former 

 

F-25

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employee of Hochstin is either terminated for cause byLFSI or is terminated voluntarily by such employee prior to October 24, 2007.The acquisition was accounted for under the purchase method of accounting. Theexcess of purchase price over fair value of net tangible assets ofapproximately $4.6 million was allocated to goodwill. The results of operationsformerly conducted by Hochstin have been included in the Company’s consolidatedfinancial statements since October 24, 2002.

 

**On April 22, 2003, LSP formed anoptions specialist joint account on the AMEX (the “Joint Account”) with BottaCapital Management, LLC (“Botta”). LSP contributed $1.5 million of capital forthe operation of the Joint Account and managed the Joint Account’s business onthe trading floor of the AMEX. Botta contributed its right to act as specialistin certain AMEX option listings. On October 10, 2005, the Joint Account wasterminated. Prior to its termination, annual net profits of the Joint Accountgenerated from specialist activities in the Joint Account’s AMEX listed optionswere shared by LSP and Botta on a 66%/34% basis, respectively, and LSP bore100% of any annual net losses. After the fourth anniversary of the formation ofthe Joint Account, Botta was no longer to have any interest in the JointAccount or the AMEX option listings it contributed to the Joint Account. Theresults of the Joint Account have been included in the Company’s consolidatedfinancial statements since April 22, 2003 through the date of its terminationon October 10, 2005. Botta’s share of the net assets and net income of the JointAccount are classified as minority interest on the accompanying 2004 and 2003consolidated statements of financial condition and statements of operations.**

** **

**On October 10, 2005, the JointAccount was reconstituted as a new option joint account on the AMEX (the “NewJoint Account”) among LSP, an unaffiliated individual and Kellogg Capital GroupLLC (“Kellogg”). LSP received back all of its capital contributed to the JointAccount and any undistributed profits from the Joint Account prior to October10, 2005. LSP contributed no capital to the New Joint Account, but didcontribute its right to act as specialist in certain AMEX option listings. Underthe terms of the New Joint Account, Kellogg is managing the New Joint Account’sbusiness on the floor of the AMEX. For the first three years of operation,annual net profits of the New Joint Account generated from its specialistactivities are shared by LSP, the individual and Kellogg on a 33-1/3%, 33-1/3%and 33-1/3% basis, respectively, and each of Kellogg and the individual bears50% of any net losses of the New Joint Account. After the third anniversary ofthe formation of the New Joint Account, LSP will no longer have any interest inthe New Joint Account or the AMEX option listings it contributed to the New JointAccount. The results of the New Joint Account are accounted on an equity basison the books of LSP.**

** **

## **14.**          EMPLOYEEINCENTIVE PLANS

## ** **

### *Equity Incentive Plan*

### * *

The Company sponsors an Equity Incentive Plan (“EIP”)which provides for grants of incentive stock options, nonqualified stockoptions, restricted shares of common stock, restricted stock units,unrestricted shares and stock appreciation rights. The Company has a total of7,687,500 shares of common stock reserved for issuance under the EIP, of which3,499,472 shares remain available for issuance as of December 31, 2005. Themaximum number of shares of common stock with respect to which options,restricted stock, restricted stock units or other 

 

F-26

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equity-based awards may be granted under the EIPduring any calendar year to any employee may not exceed 500,000 shares, subjectto adjustment upon certain corporate transactions.

 

### *Restricted Stockand Restricted Stock Units*

### * *

The Company has granted restricted stock units (“RSUs”)to employees in connection with its initial public offering and subsequently asstock-based compensation. The Company has granted restricted stock (“RS”) aspart of employment contracts and in connection with certain acquisitions. In general,both the restricted stock units and the restricted stock awards vest in one tofive annual installments on the anniversary of the date of grant. Compensationexpense for all of these RS and RSU awards is recognized on a straight-linebasis over the respective vesting periods. In addition, all of these awards aresubject to the employees’ continuing service with the Company and otherrestrictions. The weighted average grant-date value of the 806,000 RSUs grantedduring the year ended December 31, 2005 was $8.43 per share. For the yearsended December 31, 2005, 2004 and 2003, the Company recorded compensationexpense related to these awards, net of forfeitures, and a credit to additionalpaid-in-capital, of $2.7 million, $3.1 million and $3.4 million, respectively.

 

The following table provides information about grantsof RS and RSUs:

 

| ** **                                       | ** ** | **Number of Shares** | ** ** |
|--------------------------------------------------|------------|----------------------|------------|
| RS and RSUs Outstanding as of December 31,  2002 |       | 544,118              |       |
| Granted                                          |       | 46,000               |       |
| Vested                                           |       | (289,833             | )          |
| Forfeited                                        |       | (4,340               | )          |
| RS and RSUs Outstanding as of December 31,  2003 |       | 295,945              |       |
| Granted                                          |       | 600,000              |       |
| Vested                                           |       | (236,082             | )          |
| Forfeited                                        |       | (85,510              | )          |
| RS and RSUs Outstanding as of December 31,  2004 |       | 574,353              |       |
| Granted                                          |       | 806,000              |       |
| Vested                                           |       | (67,354              | )          |
| Forfeited                                        |       | (219,333             | )          |
| RS and RSUs Outstanding as of December 31,  2005 |       | 1,093,666            |       |

 

*Stock Options*

 

In general, the stock options granted to employees asstock-based compensation vest and become exercisable in annual installmentsover three years. Options granted as part of purchase accounting acquisitionswere fully vested and exercisable on the grant date. Pursuant to APBNo. 25, no compensation expense was recognized for any of these optiongrants since, on the date of grant, these options had no intrinsic value. Inaddition, these option grants will generally expire ten years from the date ofgrant, unless sooner terminated or exercised.

 

The following table provides information about optionsto purchase the Company’s common stock:

 

F-27

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| ** **                                   | ** ** | **Number of  Shares** | ** ** | **Weighted  Average Exercise Price per Share** | ** ** |
|----------------------------------------------|------------|-----------------------|------------|------------------------------------------------|------------|
| Options  Outstanding as of December 31, 2002 |       | 3,672,669             |       | 22.98                                          |       |
| Options Granted                              |       | —                |       | —                                         |       |
| Options Exercised                            |       | (15,778               | )          | 13.67                                          |       |
| Options Forfeited                            |       | (30,000               | )          | 35.00                                          |       |
| Options  Outstanding as of December 31, 2003 |       | 3,626,891             |       | 22.92                                          |       |
| Options Granted                              |       | —                |       | —                                         |       |
| Options Exercised                            |       | (493,890              | )          | 2.78                                           |       |
| Options Forfeited                            |       | (813,834              | )          | 26.44                                          |       |
| Options  Outstanding as of December 31, 2004 |       | 2,319,167             |       | $                                              | 25.97      |   |
| Options Granted                              |       | —                |       | —                                         |       |
| Options Exercised                            |       | —                |       | —                                         |       |
| Options Forfeited                            |       | (609,389              | )          | 27.61                                          |       |
| Options  Outstanding as of December 31, 2005 |       | 1,709,778             |       | $                                              | 25.39      |   |
|                                         |       |                  |       |                                           |       |
| Options  Exercisable as of:                  |       |                  |       |                                           |       |
| December 31, 2003                            |       | 2,074,391             |       | 13.76                                          |       |
| December 31, 2004                            |       | 1,632,500             |       | $                                              | 22.18      |   |
| December 31, 2005                            |       | 1,709,778             |       | $                                              | 25.39      |   |

 

The following table summarizes information about stockoptions outstanding as of December 31, 2005:

 
| ** **                    | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                           | ** ** |
|-------------------------------|------------|-------------------------|------------|---------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Number of  Shares**   | ** ** | **Weighted  Average  Remaining Contractual Life** | ** ** | **Weighted  Average  Exercise Price  per Share** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise Price  per Share** | ** ** |
| $11.00 – $20.99          |       | 764,778                 |       | 4.15                                              |       | $ | 13.93 |   | 764,778 |   | $ | 13.93 |   |
| 21.00 – 30.99            |       | 75,000                  |       | 6.82                                              |       | 27.50 |   | 75,000 |   | 27.50 |   |
| $31.00 – $40.99          |       | 870,000                 |       | 5.99                                              |       | $ | 35.29 |   | 870,000 |   | $ | 35.29 |   |
|                          |       | 1,709,778               |       |                                              |       |   |   | 1,709,778 |   |   |   |

 

*SeniorExecutive Bonus Plan*

 

The Senior Executive Bonus Plan, adopted in May 2003,is intended to provide for the payment to the Company’s Chief Executive Officerand next four most highly compensated executive officers of bonuses which areexempt from the $1.0 million deduction limitation imposed by Section 162(m) ofthe Internal Revenue Code of 1986, as amended. Bonuses are payable in cashand/or equity-based awards under the Company’s EIP. For the years endedDecember 31, 2004 and 2003, no bonuses were paid under this plan. However, forthe year ended December 31, 2005, these executive officers were awarded cashbonuses under this plan totaling approximately $3.3 million, and such amount isincluded in employee compensation and employee benefits in the Company’sConsoldated Statements of Operations.

 

## **15.**          RETIREMENTPLAN

## ** **

The Company has a defined contribution retirement plan(the “Plan”) that is subject to the provisions of the Employee Retirement IncomeSecurity Act of 1974 (“ERISA”).

 

All employees are eligible to participate in the Planafter they have completed three months of service. Participants are entitled tocontribute voluntarily in an amount equal to not less than 1% and not more than60% of their annual pre-tax compensation, up to the maximum 

 

F-28

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amount permitted under Internal Revenue Service (“IRS”)regulations for the applicable Plan year. The Company, acting in its solediscretion, can declare and make employer matching contributions and additionalvoluntary contributions for all eligible employees who have completed one yearof service, and/or have been credited with 1,000 hours of service. During theyears ended December 31, 2005, 2004 and 2003, the Company contributedapproximately $1.1 million, $0.8 million and $1.0 million, respectively, asemployer matching contributions to the Plan, and such amount is included inemployee compensation and employee benefits in the Company’s ConsoldatedStatements of Operations.

 

## **16.**          DISCLOSURESABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

## ** **

Substantially all the Company’s assets and liabilitiesare carried at fair value or contracted amounts, which approximate fair value.The fair value of fixed rate debt, in millions, is as follows**:**

 
| ** **        | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|-------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **        | ** ** | **Carrying Value**    | ** ** | **Fair Value**        | ** ** | **Carrying Value** | ** ** | **Fair Value** | ** ** |
| 2007 Notes        |       | 13.6                  |       | 15.2                  |       | 13.6 |   | 14.6 |   |
| 2009 Senior Notes |       | 199.8                 |       | 211.8                 |       | 199.9 |   | 202.9 |   |
| 2012 Senior Notes |       | 260.0                 |       | 283.4                 |       | 260.0 |   | 276.9 |   |
| Other             |       | $                     | 20.4       |                  | $          | 20.1 |   | $ | 27.3 |   | $ | 27.4 |   |
|                   |            |                       |            |                       |            |  |  |  |  |  |  |  |  |

 

For 2005 and 2004, the fair value of the 2007 Noteswas determined using current market rates to discount their cash flows as ofDecember 31, 2005 and 2004, respectively. The fair values of the 2009 SeniorNotes and 2012 Senior Notes were determined based upon their respective marketvalues as of December 31, 2005 and 2004, respectively. For both fiscal years,the fair value of the fixed rate and other notes was determined using currentmarket rates to discount their cash flows.

 

**17.**          BUSINESSSEGMENTS

** **

Segment information is presented in accordance withSFAS No. 131, “Disclosures About Segments of an Enterprise and RelatedInformation.” The Company’s business segments are based upon the nature of thefinancial services provided, their revenue source and the Company’s managementorganization.

 

The Company’s Specialist and Market-Making segmentoperates as a specialist in equities and rights listed on the NYSE, as aspecialist in equities, options, ETFs, and futures on several exchanges, aswell as a market-maker in ETFs, futures and options on several exchanges. Thissegment also provides support services for the NYSE specialist activities. TheSpecialist 

 

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and Market-Making segment currently includes theoperations of LaBranche & Co. LLC, LSP, LSPS, LABDR and BV since they sharesimilar economic characteristics.

 

The Company’s Execution and Clearing segment providessecurities execution, securities clearing and other related services to its owncustomers and customers of introducing brokers. This segment also providesdirect-access floor brokerage services to institutional customers. TheExecution and Clearing segment currently includes the operations of LFSI.

 

Revenues and expenses directly associated with eachsegment are included in determining its operating results. Other expenses,including corporate overhead, which are not directly attributable to aparticular segment, generally are allocated to each segment based on itsresource usage levels or other appropriate measures. Interest with respect tothe Senior Notes, certain administrative expenses, corporate overhead expensesand other sources of revenues are not specifically allocated by management whenreviewing the Company’s segments’ performance, and appear in the “Other”section. Selected financial information for each segment is set forth below:

 
| ** **                                        | ** ** | **For the Years Ended December 31,** | ** ** |
|---------------------------------------------------|------------|--------------------------------------|------------|
| **(000’s omitted):**                         | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Specialist  and Market Making Segment:**        |       |                                 |       |   |   |   |   |
| Revenues                                          |       | $                                    | 283,573    |   | $ | 245,023 |   | $ | 256,583 |   |
| Operating  expenses                               |       | 169,475                              |       | 137,150 |   | 133,016 |   |
| Goodwill  impairment                              |       | 3⁄4                               |       | 37,600 |   | 166,250 |   |
| Exchange  memberships impairment                  |       | 3⁄4                               |       | 16,300 |   | 3⁄4 |   |
| Restitution  and fines                            |       | 3⁄4                               |       | 3⁄4 |   | 63,519 |   |
| Depreciation  and amortization expense            |       | 11,516                               |       | 11,649 |   | 11,715 |   |
| Income  (loss) before minority interest and taxes |       | 102,582                              |       | 42,324 |   | (117,917 | ) |
| Segment  goodwill                                 |       | 250,569                              |       | 250,569 |   | 289,593 |   |
| Segment  assets                                   |       | $                                    | 4,102,592  |   | $ | 1,849,108 |   | $ | 1,785,098 |   |
|                                              |       |                                 |       |   |   |   |   |
| **Execution  and Clearing Segment:**              |       |                                 |       |   |   |   |   |
| Revenues                                          |       | $                                    | 42,804     |   | $ | 48,016 |   | $ | 47,909 |   |
| Operating  expenses                               |       | 45,303                               |       | 52,357 |   | 56,285 |   |
| Goodwill  impairment                              |       | 3⁄4                               |       | 3⁄4 |   | 4,052 |   |
| Exchange  memberships impairment                  |       | 3⁄4                               |       | 2,027 |   | 515 |   |
| Depreciation  and amortization expense            |       | 450                                  |       | 470 |   | 1,008 |   |
| Loss before  minority interest and taxes          |       | $                                    | (2,949     | ) | $ | (6,838 | ) | $ | (13,951 | ) |
|                                              |       |                                 |       |   |   |   |   |
| Segment  goodwill                                 |       | 3⁄4                               |       | 3⁄4 |   | 3⁄4 |   |
| Segment  assets                                   |       | $                                    | 51,940     |   | $ | 54,724 |   | $ | 59,927 |   |
|                                              |       |                                 |       |   |   |   |   |
| **Other  (1):**                                   |       |                                 |       |   |   |   |   |
| Revenues                                          |       | $                                    | 13,813     |   | $ | 26,008 |   | $ | 1,497 |   |
| Operating  expenses                               |       | 62,214                               |       | 67,832 |   | 54,623 |   |
| Debt  repurchase premium                          |       | 3⁄4                               |       | 49,029 |   | 3⁄4 |   |
| Depreciation  and amortization expense            |       | 127                                  |       | 102 |   | 80 |   |
| Loss before  minority interest and taxes          |       | (48,528                              | )          | (90,955 | ) | (53,206 | ) |
| Segment  assets                                   |       | $                                    | 129,763    |   | $ | 151,265 |   | $ | 118,065 |   |

 

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| **Total:**                                        |   |    |      |    |   |      |   |
|---------------------------------------------------|--------|---------|-----------|---------|--------|-----------|--------|
| Revenues                                          |   | $       | 340,190   |    | $      | 319,047   |   | $ | 305,989 |   |
| Operating  expenses                               |   | 276,992 |      | 257,339 |   | 243,924   |   |
| Goodwill  impairment                              |   | 3⁄4  |      | 37,600  |   | 170,302   |   |
| Exchange  memberships impairment                  |   | 3⁄4  |      | 18,327  |   | 515       |   |
| Debt  repurchase premium                          |   | 3⁄4  |      | 49,029  |   | 3⁄4    |   |
| Restitution  and fines                            |   | 3⁄4  |      | 3⁄4  |   | 63,519    |   |
| Depreciation  and amortization expense            |   | 12,093  |      | 12,221  |   | 12,803    |   |
| Income  (loss) before minority interest and taxes |   | $       | 51,105    |    | $      | (55,469   | )      | $ | (185,074 | ) |
| Goodwill                                          |   | 250,569 |      | 250,569 |   | 289,593   |   |
| Total assets                                      |   | $       | 4,284,295 |    | $      | 2,055,097 |   | $ | 1,963,090 |   |

 

----

(1)           Otheris comprised primarily of the interest costs on the Holding Company’sindebtedness, unallocated corporate administrative expenses, including legalcosts, unallocated revenues (primarily gains from non-marketable investmentsand interest income), and elimination entries.

 

## **18.**          FINANCIALINSTRUMENTS WITH CONCENTRATION OF CREDIT AND OFF-BALANCE SHEET RISK

## ** **

As specialists and market-makers on the NYSE, AMEX,NYBOT, PHLX and other exchanges, LaBranche & Co. LLC, LFSI, LSP and LSPSare engaged in various securities trading and lending activities. In connectionwith their specialist activities, LaBranche & Co. LLC, LSP and LSPS assumepositions in stocks for which they are responsible. LaBranche & Co. LLC,LFSI, LSP and LSPS are exposed to credit risk associated with thenonperformance of counterparties in fulfilling their contractual obligationspursuant to these securities transactions, and they are also exposed to marketrisk associated with the sale of securities sold but not yet purchased, whichcan be directly impacted by volatile trading on the NYSE, AMEX and otherexchanges. Additionally, in the event of nonperformance and unfavorable marketprice movements, LaBranche & Co. LLC, LFSI, LSP and LSPS may be required topurchase or sell financial instruments, which may result in a loss.

 

The Company enters into collateralized financingagreements in which it extends short-term credit to major financialinstitutions. The Company controls access to the collateral pledged by thecounterparties, which generally consists of U.S. equity and governmentsecurities. The value and adequacy of the collateral are continually monitored.Consequently, the risk of credit loss from counterparties’ failure to performin connection with collateralized lending activities is minimal.

 

In addition, LFSI, through the normal course ofbusiness, enters into various securities transactions as agent. The execution,settlement and financing of those transactions can result in off-balance sheetrisk and concentration of credit risk. LFSI’s execution and clearing activitiesinvolve settlement and financing of various customer securities transactions ona cash or margin basis. These activities may expose LFSI to off-balance sheetrisk in the event the customer or 

 

F-31

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other broker is unable to fulfill its contractualobligations and LFSI has to purchase or sell securities at a loss. For margintransactions, LFSI may be exposed to significant off-balance sheet risk in theevent margin requirements are not sufficient to fully cover losses thatcustomers may incur in their accounts.

 

LFSI seeks to control the risks associated withcustomer activities by requiring customers to maintain margin collateral incompliance with various regulatory and internal guidelines. LFSI monitorsmargin levels daily and pursuant to such guidelines, requires customers todeposit additional collateral or reduce positions when necessary.

 

LFSI is engaged in various brokerage activities inwhich its counterparties primarily include broker-dealers, banks and otherfinancial institutions. LFSI may be exposed to the risk of default, whichdepends on the creditworthiness of the counterparty. It is LFSI’s policy toreview, as necessary, the credit standing of each counterparty with which itconducts business.

 

LSP and LSPS use derivative financial instruments,including exchange-traded options, ETFs and domestic and foreign futurescontracts, for trading purposes and to financially hedge other positions ortransactions as part of their specialist and market-making businesses andoverall risk management process. These financial instruments subject LSP andLSPS to varying degrees of market, credit and foreign exchange risk. LSP andLSPS record their derivative trading activities at market value, withcorresponding gains or losses recorded in “Net gain on principal transactions.”Gains or losses from foreign currency transactions are also recorded in “Netgain on principal transactions.” In order to minimize risk, managementcontinually monitors positions, gain and loss, volatility and other standardrisk measures on a real-time basis and communicates its risk tolerance to LSP’sand LSPS’ traders.

 

## **19.**          COMMITMENTSAND CONTINGENCIES

## ** **

*Contingencies*

 

Specialist TradingInvestigations. On March 30, 2004, LaBranche & Co. LLC and other NYSE specialistfirms entered into agreements with the SEC and NYSE to settle the SEC and NYSEinvestigations concerning alleged improper specialist trading practices byspecialists on the NYSE. Pursuant to the settlement, LaBranche & Co. LLCconsented, without admitting or denying any wrongdoing, to an SEC orderinstituting administrative cease-and-desist proceedings, making findings, andimposing remedial sanctions and a cease-and-desist order. The SEC’s findings,neither admitted nor denied, included violations by LaBranche & Co. LLC ofSection 11(b) of the Exchange Act and Rule 11b-1 promulgated thereunder, NYSERules 104, 92, 123B, 401 and 342, and Section 15(b)(4)(E) of the ExchangeAct. The Section 15(b)(4)(E) finding includes a failure reasonably tosupervise individual specialists who, the finding states, violated Section10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder with respect totransactions in six particular stocks. Pursuant to the settlement, LaBranche& Co. LLC paid $41.6 million in restitution and $21.9 million in a civilmoney penalty, which the Company accrued for the year ended December 31, 2003,in connection with trades that occurred during the years 1999 through 2003 andhas agreed to undertakings stated in the SEC’s order. Subsequently, the Companyreceived additional requests for information from the SEC and also has receivedrequests for information from the United States Attorney’s Office for theSouthern 

 

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District of New York as part of anindustry-wide investigation relating to activities of NYSE floor specialists inrecent years. The Company has cooperated with the requests and will continue tocooperate with any future requests.

 

On April 12, 2005, criminal and civil chargeswere announced against a number of individuals employed or formerly employed asspecialists at the five largest NYSE specialist firms, including one specialistformerly employed by LaBranche & Co. LLC.

 

In re LaBrancheSecurities Litigation. On or about October 16, 2003 through December 16, 2003, ninepurported class action lawsuits were filed by purchasers of the Company’scommon stock in the United States District Court for the Southern District ofNew York, including Sofran v. LaBranche & Co Inc., et al., No. 03 CV 8201,Semon v. LaBranche & Co Inc., et al., No. 03 CV 8255, Haug v. LaBranche& Co. Inc., et al., No. 03 CV 8265, Labul v. LaBranche & Co Inc., etal., No. 03 CV 8365, Murphy v. LaBranche & Co Inc., et al., No. 03 CV 8462,Strain v. LaBranche & Co Inc., et al., No. 03 CV 8509, Yopp v. LaBranche& Co Inc., et al.,No. 03 CV 8783, Ferris v. LaBranche & Co Inc., et al., No. 03 CV 8806, andLevin v. LaBranche & Co Inc., et al., No. 03 CV 8918. On March 22,2004, the court consolidated these lawsuits under the caption In re LaBrancheSecurities Litigation, No. 03 CV 8201. The court named the following leadplaintiffs:  Anthony Johnson, ClydeFarmer, Edwin Walthall, Donald Stahl and City of Harper Woods RetirementSystem.

 

On June 7, 2004,plaintiffs filed a Consolidated Class Action Complaint. On July 12, 2004,plaintiffs filed a Corrected Consolidated Class Action Complaint. Plaintiffsallege that they represent a class consisting of persons and entities thatpurchased or otherwise acquired the Company’s common stock during the period beginningon August 19, 1999 and concluding on October 15, 2003. Plaintiffs allege thatthe Company, LaBranche & Co. LLC, and certain of the Company’s and/orLaBranche & Co. LLC’s past or present officers and/or directors, includingGeorge M.L. LaBranche, IV, William J. Burke, III, James G. Gallagher, Alfred O.Hayward, Jr., Robert M. Murphy and Harvey S. Traison, violatedSection 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunderand Section 20(a) of the Exchange Act by failing to disclose improperspecialist trading. Plaintiffs also allege that Mr. Gallagher violated Section20A of the Exchange Act and two other of the Company’s past or present officersand/or directors, S. Lawrence Prendergast andGeorge E. Robb, Jr., also violated Section 20(a) of the ExchangeAct. Plaintiffs seek unspecified money damages, attorneys’ fees andreimbursement of expenses.

 

On December 12, 2005,motions to dismiss were granted in part and denied in part. The court dismissedthe Section 10(b) claims in their entirety against Messrs. Burke, Gallagher andTraison, dismissed the Section 10(b) claims for the period August 19, 1999through December 30, 2001 against Messrs. LaBranche, Murphy and Hayward, anddismissed the Section 20A claim against Mr. Gallagher.

 

In re NYSE SpecialistsSecurities Litigation. On or about October 16, 2003 through December 16, 2003, fourpurported class action lawsuits were brought by persons or entities whopurchased and/or sold shares of stocks of NYSE listed companies for whichLaBranche & Co. LLC and any other NYSE specialist firm acted as specialist,including Pirelli v. LaBranche & Co Inc., et al., No. 03 CV 8264, Marcus v.LaBranche & Co Inc., et al., No. 03 CV 8521, Empire v. LaBranche & CoInc., et al., No. 03 CV 8935, and the California Public Employees’Retirement 

 

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System (CalPERS)v. The New York Stock Exchange, Inc., et al.,No. 03 CV 9968. On March 11, 2004, a fifth action asserting similar claims, RosenbaumPartners, LP v. The New York Stock Exchange, Inc., et al., No. 04 CV 2038, was filed in the United States District Court for theSouthern District of New York by an individual plaintiff who does not allege torepresent a class. On May 27, 2004, the court consolidated these lawsuitsunder the caption In re NYSE Specialists Securities Litigation, No. CV 8264. Thecourt named the following lead plaintiffs: California Public Employees’Retirement System (“CalPERS”) and Empire Programs, Inc.

 

On September 15, 2004,plaintiffs filed a Consolidated Complaint for Violation of the FederalSecurities Laws and Breach of Fiduciary Duty alleging that they represent aclass consisting of all public investors who purchased and/or sold shares ofstock listed on the NYSE from October 17, 1998 to October 15, 2003. Plaintiffsallege that the Company, LaBranche & Co. LLC, Mr. LaBranche, and other NYSEspecialist firms and their respective parents and affiliates violated Section10(b), Rule 10b-5 and Section 20(a) by failing to disclose improper specialisttrading, improperly profiting on purchases and/or sales of NYSE-listedsecurities and breaching and/or aiding and abetting breaches of fiduciary duty.Plaintiffs also name the NYSE as a defendant. Plaintiffs seek unspecified moneydamages, restitution, forfeiture of fees, commissions and other compensation,equitable and/or injunctive relief, including an accounting of and theimposition of a constructive trust and/or asset freeze on trading proceeds, andattorneys’ fees and reimbursement of expenses.

 

On December 12, 2005,defendants’ motion to dismiss was granted in part and denied in part. The courtdismissed plaintiffs’ Section 10(b) and Section 20(a) claims against alldefendants for conduct that occurred before January 1, 1999 and dismissed plaintiffs’breach of fiduciary duty claims against all defendants. The court alsodismissed all claims against the NYSE and certain claims against certainparents and affiliates of specialists other than LaBranche & Co. LLC.

 

On February 2, 2006,plaintiffs filed an Amended Consolidated Complaint for Violation of the FederalSecurities Laws and Breach of Fiduciary Duty, adding Robert A. Martin as aplaintiff. This complaint is otherwise identical to plaintiffs’ ConsolidatedComplaint for Violation of the Federal Securities Laws and Breach of FiduciaryDuty.

 

Last Atlantis,Rule and Martin. On January 20, 2004, six entitiesthat allege that they are purchasers and sellers of options commenced an actionin the United States District Court for the Northern District of Illinois, LastAtlantis Capital LLC v. Chicago Board Options Exchange, Inc., et al., No. 04 C0397, against four national securities exchanges (the American Stock Exchange,the Chicago Board Options Exchange, the Philadelphia Stock Exchange and PacificExchange) and 35 alleged securities brokers and/or dealers, including theCompany’s LSP subsidiary, who, plaintiffs allege, made markets in options onthe named exchanges. Plaintiffs allege that the Company and LSP conspired withother defendants by allegedly failing to execute orders, canceling orders, andrefusing to cancel orders allegedly submitted by plaintiffs for the purchaseand sale of options. Plaintiffs allege violations of federal antitrust laws(Sections 1 of the Sherman Act), and securities law (Section 10(b) of theExchange Act and Rule 10b-5), breach of contract, common law fraud, breach offiduciary duty, violations of an Illinois consumer fraud and deceptive businesspractices statute, and tortious interference with plaintiffs’ business.

 

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Injunctive relief and damages (includingpunitive damages) in an unspecified amount are sought.

 

On January 28,2005, Bryan Rule, an individual represented by the same counsel who representthe plaintiffs in the Last Atlantis case, commenced a substantially similaraction in the United States District Court for the Northern District ofIllinois, Rule v. Chicago Board Options Exchange, Inc., et al., No. 05 CV 0539,making substantially the same allegations and seeking the same relief againstthe same defendants, including LSP and the Company.

 

On March 30,2005, the court dismissed the Last Atlantis action. On April 13, 2005,plaintiffs in the Last Atlantis action filed a motion for reconsideration. OnMay 9, 2005, the court denied plaintiffs’ motion for reconsideration withrespect to their antitrust claims but granted plaintiffs leave to seek tore-assert their securities law claims (Section 10(b) of the Exchange Act andRule 10b-5). On June 9, 2005, the court clarified its ruling on the motion forreconsideration and granted plaintiffs leave to seek to re-assert their breachof contract, common law fraud, breach of fiduciary duty, Illinois consumerfraud and deceptive business practices statute and tortious interference withplaintiffs’ business claims.

 

On June 1,2005, plaintiffs filed an amended complaint asserting securities law (Section10(b) of the Exchange Act and Rule 10b-5), breach of contract, common lawfraud, breach of fiduciary duty, Illinois consumer fraud and deceptive businesspractices statute and tortious interference with plaintiffs’ businessclaims.  Despite the court’s ruling on the motion for reconsideration,plaintiffs’ amended complaint also asserted federal antitrust law claims (Section1 of the Sherman Act).

 

On June 24, 2005, plaintiffs filed a motionfor leave to file a second amended complaint, which does not include antitrustclaims, but does assert securities law (Section 10(b) of the Exchange Act andRule 10b-5), breach of contract, common law fraud, breach of fiduciary duty,Illinois consumer fraud and deceptive business practices statute, tortiousinterference with plaintiffs’ business, and tortious interference withcontracts claims, and purports to join Mr. Rule and River North Investors LLCas plaintiffs.

 

On July 15, 2005, the Court dismissed theRule action due to plaintiffs’ failure to serve process on the defendants inthe matter.

 

On September 28, 2005, Mr. Rule andRiver North Investors LLC, who, as stated above, now are plaintiffs in the LastAtlantis action, commenced an action in the United States District Court forthe Northern District of Illinois, Rule et al. v. Chicago Board OptionsExchange, Inc., et al., No. 05 C 5600.  The complaint in thisaction is substantially similar to the second amended complaint in the LastAtlantis action, making substantially the same allegations and seeking the samerelief against the same defendants, including LSP and the Company, except thatthe complaint in this action also asserts a federal antitrust law claim(Section 1 of the Sherman Act). Mr. Rule and River North Investors areproceeding pursuant to what the court has described as a stipulation that theirantitrust law claims have been dismissed on the same basis as the antitrust lawclaims were dismissed in the Last Atlantis action.

 

F-35

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On September 30, 2005, Brad Martincommenced an action in the United States District Court for the NorthernDistrict of Illinois, Martin v. Chicago Board Options Exchange, Inc., etal., No. 05 C 5671.  The complaint in this action is substantiallysimilar to the second amended complaint in the Last Atlantis action and thecomplaint in the Rule action, making substantially the same allegationsand seeking the same relief against the same defendants, including LSP and theCompany, except that the complaint in this action, like the complaint in theRule action, also asserts a federal antitrust law claim (Section 1 ofthe Sherman Act).   Mr. Martin isproceeding pursuant to what the court has described as a stipulation that theirantitrust law claims have been dismissed on the same basis as the antitrust lawclaims were dismissed in the Last Atlantis action.

 

On October 4, 2005, the court granted theplaintiffs’ motion for leave to file a second amended complaint in the LastAtlantis action and to join Mr. Rule and River North Investors LLC asplaintiffs.  On October 5, 2005, the second amended complaint wasfiled.

 

On November 10, 2005, the court consolidated into the Last Atlantisaction, the Rule and River North Investors LLC action that was commenced onSeptember 28, 2005 (No. 05 C 5600) and the Martin action that was commenced onSeptember 30, 2005 (No. 05 C 5671).

 

EEOC/Servidio Litigation. On September 27, 2005, the Equal Employment Opportunity Commission (the “EEOC”)commenced an action in the United States District Court for the SouthernDistrict of New York, EEOC v. LaBranche & Co Inc., No. 05 CV8304, on behalf of Peter Servidio, a former employee of LaBranche & Co.LLC.  The complaint in this action alleges that the Company harassed anddiscriminated against Mr. Servidio on the basis of a disability, retaliatedagainst him for complaining about the alleged harassment and constructively dischargedhim.  The complaint seeks injunctive relief and monetary damages,including reinstatement, back pay and front pay.

 

On September 28, 2005,Mr. Servidio moved to intervene in the action. Mr. Servidio’s complaint addsMr. Hayward and the Company’s former senior managing director of flooroperations, Anthony Corso, as defendants, and also adds claims under the NewYork City Human Rights Law. The allegations in Mr. Servidio’s complaint includethe allegations in the EEOC’s complaint and also allege that Mr. Servidio wasnot promoted due to his disability. The EEOC complaint seeks (i) unspecifiedcompensation for past and future pecuniary and non-pecuniary losses resultingfrom the alleged discrimination, (ii) an order enjoining discrimination on thebasis of disability; and (iii) an order requiring institution and enforcementof policies providing equal employment opportunities for qualified individualswith disabilities. Mr. Servidio’s complaint seeks unspecified compensatorydamages, punitive damages, other affirmative relief, costs and attorneys’ fees.

 

NASD/AMEX Notice ofDisciplinary Action. On December 15, 2004, LaBranche &Co. LLC received a notice from the NASD Amex Regulation Division stating apreliminary determination has been made by the NASD Amex Regulation Division’sstaff to seek disciplinary action against LaBranche & Co. LLC forviolations of certain federal securities laws and the Amex Constitution andRules, including Sections 10(b), 9A and 17(a) of the Exchange Act, inconnection with manual book freezes effected in one of LaBranche & Co. LLC’sAmex specialist stocks during the period March 8, 2004 through October 21,2004.  Prior to receiving 

 

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this notice, theCompany had determined that the individual specialist responsible for the bookfreezes failed to adhere to company policy and had terminated that employee.The Company has submitted a response to the staff of the NASD Amex RegulationDivision setting forth the reasons why disciplinary action should not bebrought against LaBranche & Co. LLC and the Company is cooperating with theNASD Amex Regulation Division in this matter.

 

The Company believes thatthe claims asserted against it by the plaintiffs in the pending proceedings describedabove are without merit, and the Company denies all allegations of wrongdoing. Therecan be no assurance, however, as to the outcome or timing of the resolution ofthese proceedings. The Company therefore is unable to estimate the amount orpotential range of any loss that may arise out of these proceedings. The rangeof possible resolutions could include determinations and judgments against theCompany or settlements that could require substantial payments by the Companythat could have a material adverse effect on the Company’s financial condition,results of operations andcash flows.

 

In addition to the proceedings described above, the Company and itsoperating subsidiaries have been the target, from time to time, of variousclaims, lawsuits and regulatory actions incidental to the ordinary course ofits and their respective businesses. While the ultimate outcome of thoseclaims, lawsuits and regulatory actions which currently are pending cannot bepredicted with certainty, the Company believes, based on its understanding ofthe facts of these claims, proceedings and regulatory actions, that theirultimate resolution will not, in the aggregate, have a material adverse effecton the Company’s financial condition, results of operations or cash flows.

 

*Commitments*

 

The Company has entered into long-term non-cancelableoperating lease agreements for certain office space and equipment, which expireat various dates through 2012. Certain lease agreements contain escalationclauses providing for increased rental payments based on increases inmaintenance charges and real estate taxes. Minimum future rental commitmentsunder existing non-cancelable leases for office space and equipment are asfollows:

 

| **Years Ending December 31,** | ** ** | ** ** | ** ** |
|-------------------------------|------------|------------|------------|
|                          |       |       |       |
| 2006                          |       | 1,932,594  |       |
| 2007                          |       | 1,594,034  |       |
| 2008                          |       | 203,633    |       |
| 2009                          |       | 77,881     |       |
| 2010                          |       | 57,520     |       |
| Thereafter                    |       | 101,290    |       |
| **Total**                     |       | $          | 3,966,952  |   |
|                               |            |            |            |  |

** **

**F-37**

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** **

**20.**          SUBSEQUENTEVENTS

** **

As of December 31, 2005 the Company owned 39NYSE memberships out of a total 1366 NYSE memberships, representing a 2.9%ownership interest in the NYSE. The Company has accounted for its investment inthese memberships under the adjusted cost method since its inception. On April20, 2005, the NYSE and Archipelago Holdings, Inc. entered into adefinitive merger agreement, as amended and restated on July 20, 2005 (as soamended, the “NYSE Merger Agreement”), pursuant to which Archipelago and NYSEagreed to combine their businesses and become wholly-owned subsidiaries of NYSEGroup, Inc. (“NYSE Group”), a newly-created, for-profit andpublicly-traded holding company (collectively, the “NYSE Merger”).

 

On March 7, 2006, the NYSE Merger was consummated,and each NYSE membership became entitled to receive in exchange for the NYSEmembership $300,000 in cash, plus 80,177 shares of NYSE Group common stock. Inaddition, immediately prior to the consummation of the NYSE Merger, the NYSEannounced a “permitted dividend” to be paid to each NYSE membership in theamount of approximately $70,570, which was equivalent to the membership’s prorata portion of the NYSE’s “excess cash,” as defined in the NYSE MergerAgreement. The Company received the permitted dividend with respect to each of its39 NYSE memberships on March 14, 2006. Based on information provided to theCompany prior to the consummation of the NYSE Merger, the NYSE Group expects todeliver the merger consideration on or about March 21, 2006.

 

As a result of the NYSE Merger, the Company’s 39NYSE memberships were converted into the right to receive an aggregate of $11.7million in cash (not including the permitted dividend)  and3,126,903 shares of NYSE Group common stock. The $11.7 million cash portion ofthe merger consideration will be treated as receipt of monetary considerationfor which a realized gain will be recognized in the first quarter of 2006.After the consummation of the NYSE Merger, the Company will account for itsinvestment in the NYSE Group common stock as owned restricted stock andreflected at the estimated fair value of such restricted shares pursuant to theAmerican Institute of Certified Public Accountants *Audit andAccounting Guide—Brokers and Dealers in Securities.*The shares of NYSE Group common stock tobe received in the NYSE Merger will be subject to a three-year restriction ontransfer. The restriction will be removed in equal one-third installments oneach of March 7, 2007, 2008 and 2009, unless the restrictions are removedearlier by the NYSE Group in its sole discretion. The amount of the discount fromthe published market value of the NYSE Group conmmon stock, if any, as a resultof these transfer restrictions has yet to be determined by the Company.

 

Prior to the closing of the NYSE Merger, theCompany participated in a “Dutch” auction in early January 2006 for tradinglicenses which will replace the prior trading rights provided by the ownershipor lease of an NYSE membership. The Company successfully bid for 95 tradinglicenses at anannual price of $49,290 each, the minimum bid accepted by the NYSE. The licenses became active for trading on theNYSE on March 8, 2006.

 

F-38

----

 

**Schedule 1.**

 

**LaBRANCHE& CO INC.**

**(ParentCompany Only)**

**CONDENSEDSTATEMENTS OF FINANCIAL CONDITION**

**(000’somitted, except share data)**

 
| ** **                                                                                                                                                         | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                                                                                         | ** ** | **2005**         | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                                                                                         |       |             |       |   |   |
| Cash and cash equivalents                                                                                                                                          |       | $                | 27,710     |   | $ | 373 |   |
| Securities purchased under agreements to  resell                                                                                                                   |       | 79,000           |       | 87,000 |   |
| Investment in subsidiaries, at equity value                                                                                                                        |       | 1,117,978        |       | 1,077,366 |   |
| Other assets                                                                                                                                                       |       | 25,867           |       | 81,783 |   |
| Total assets                                                                                                                                                       |       | $                | 1,250,555  |   | $ | 1,246,522 |   |
|                                                                                                                                                               |       |             |       |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                     |       |             |       |   |   |
| Liabilities:                                                                                                                                                       |       |             |       |   |   |
| Interest payable                                                                                                                                                   |       | $                | 6,854      |   | $ | 6,854 |   |
| Accrued compensation                                                                                                                                               |       | 974              |       | 20,145 |   |
| Accounts payable and other accrued expenses                                                                                                                        |       | 5,972            |       | 5,974 |   |
| Other liabilities                                                                                                                                                  |       | 11,259           |       | 12,390 |   |
| Income taxes payable                                                                                                                                               |       | 5,643            |       | 1,671 |   |
| Deferred tax liabilities                                                                                                                                           |       | 4,972            |       | 23,054 |   |
| Short term debt                                                                                                                                                    |       | —           |       | 2,000 |   |
| Long term debt                                                                                                                                                     |       | 481,425          |       | 481,448 |   |
| Total liabilities                                                                                                                                                  |       | 517,099          |       | 553,536 |   |
| Common stock, $.01 par value, 200,000,000  shares authorized; 60,623,819 and 60,532,080 shares issued and outstanding at  December 31, 2005 and 2004, respectively |       | 606              |       | 605 |   |
| Additional paid-in-capital                                                                                                                                         |       | 689,988          |       | 687,040 |   |
| Retained earnings                                                                                                                                                  |       | 42,862           |       | 5,341 |   |
|                                                                                                                                                               |       |             |       |   |   |
| Total stockholders’ equity                                                                                                                                    |       | 733,456          |       | 692,986 |   |
| Total liabilities and stockholders’ equity                                                                                                                    |       | $                | 1,250,555  |   | $ | 1,246,522 |   |

 

See accompanying notes to condensed financialstatements.

 

F-39

----

 

**LaBRANCHE& CO INC.**

**(ParentCompany Only)**

**CONDENSEDSTATEMENTS OF OPERATIONS**

**(000’somitted)**

 
| ** **                                           | ** ** | **For the Years Ended December 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                           | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                 |       |                                 |       |   |   |   |   |
| REVENUES (LOSS):                                     |       |                                 |       |   |   |   |   |
| Earnings (loss) from investment in  subsidiaries     |       | $                                    | 63,080     |   | $ | 963 |   | $ | (155,401 | ) |
| Investment income                                    |       | 18,990                               |       | 30,775 |   | 6,152 |   |
| Total revenue (loss)                                 |       | 82,070                               |       | 31,738 |   | (149,249 | ) |
| EXPENSES:                                            |       |                                 |       |   |   |   |   |
| Interest                                             |       | 51,726                               |       | 53,809 |   | 42,598 |   |
| Employee compensation and related benefits           |       | 7,042                                |       | 7,192 |   | 11,205 |   |
| Debt repurchase premium                              |       | 3⁄4                               |       | 49,029 |   | 3⁄4 |   |
| Other                                                |       | 8,750                                |       | 11,701 |   | 5,555 |   |
| Total expenses                                       |       | 67,518                               |       | 121,731 |   | 59,358 |   |
| Income (loss) before income tax benefit              |       | 14,552                               |       | (89,993 | ) | (208,607 | ) |
| INCOME TAX BENEFIT                                   |       | (22,969                              | )          | (46,213 | ) | (29,218 | ) |
| Net income (loss)                                    |       | 37,521                               |       | (43,780 | ) | (179,389 | ) |
| Preferred dividends and discount accretion           |       | 3⁄4                               |       | 2,253 |   | 4,014 |   |
| Net income (loss) applicable to common  stockholders |       | $                                    | 37,521     |   | $ | (46,033 | ) | $ | (183,403 | ) |

 

See accompanying notes to condensed financialstatements.

 

F-40

----

 

**LaBRANCHE& CO INC.**

**(ParentCompany Only)**

**CONDENSEDSTATEMENTS OF CHANGES IN**

**STOCKHOLDERS’EQUITY**

**(000’somitted)**

See accompanying notes to condensed financialstatements.

 
| ** **                                                                          | ** **   | **Common Stock** | ** ** | ** ** | ** ** | **Additional**      | ** ** | **Retained**        | ** ** | **Unearned** | ** ** | ** **       | ** ** |
|-------------------------------------------------------------------------------------|--------------|------------------|------------|------------|------------|---------------------|------------|---------------------|------------|--------------|------------|------------------|------------|
| ** **                                                                          | *** *** | **Shares**       | ** ** | **Amount** | ** ** | **Preferred Stock** | ** ** | **Paid-in Capital** | ** ** | **Earnings** | ** ** | **Compensation** | ** ** | **Total** | ** ** |
|                                                                                |         |             |       |       |       |                |       |                |       |         |       |             |       |   |   |
| BALANCE, December 31, 2002                                                          |         | 59,504           |       | $          | 595        |                | $          | 61,361              |       | $            | 679,601    |             | $          | 249,065 |   | $ | (934 | ) | $ | 989,688 |   |
|                                                                                |         |             |       |       |       |                |       |                |       |         |       |             |       |   |   |
| Net loss                                                                            |         | —           |       | —     |       | —              |       | —              |       | (179,389     | )          | —           |       | (179,389 | ) |
|                                                                                |         |             |       |       |       |                |       |                |       |         |       |             |       |   |   |
| Common and preferred stock dividends and  discount accretion                        |         | —           |       | —     |       | 688                 |       | —              |       | (18,302      | )          | —           |       | (17,614 | ) |
| Recognition of tax benefits related to  employee option exercises                   |         | —           |       | —     |       | —              |       | 372                 |       | —       |       | —           |       | 372 |   |
| Issuance of restricted stock, shares for  option exercises and related compensation |         | 287              |       | 3          |       | —              |       | 2,843               |       | —       |       | 793              |       | 3,639 |   |
| Preferred stock buyback                                                             |         | —           |       | —     |       | (23,732             | )          | —              |       | —       |       | —           |       | (23,732 | ) |
| BALANCE, December 31, 2003                                                          |         | 59,791           |       | $          | 598        |                | $          | 38,317              |       | $            | 682,816    |             | $          | 51,374 |   | $ | (141 | ) | $ | 772,964 |   |
|                                                                                |         |             |       |       |       |                |       |                |       |         |       |             |       |   |   |
| Net loss                                                                            |         | —           |       | —     |       | —              |       | —              |       | (43,780      | )          | —           |       | (43,780 | ) |
|                                                                                |         |             |       |       |       |                |       |                |       |         |       |             |       |   |   |
| Preferred stock dividends and discount  accretion                                   |         | —           |       | —     |       | —              |       | —              |       | (2,253       | )          | —           |       | (2,253 | ) |
| Recognition of tax benefits related to  employee option exercises                   |         | —           |       | —     |       | —              |       | 1,371               |       | —       |       | —           |       | 1,371 |   |
| Issuance of restricted stock, shares for  option exercises and related compensation |         | 741              |       | 7          |       | —              |       | 2,853               |       | —       |       | 141              |       | 3,001 |   |
| Preferred stock buyback                                                             |         | —           |       | —     |       | (38,317             | )          | —              |       | —       |       | —           |       | (38,317 | ) |
| BALANCE, December 31, 2004                                                          |         | 60,532           |       | $          | 605        |                | —     |                | $          | 687,040      |       | $                | 5,341      |   | — |   | $ | 692,986 |   |
|                                                                                |         |             |       |       |       |                |       |                |       |         |       |             |       |   |   |
| Net income                                                                          |         | —           |       | —     |       | —              |       | —              |       | 37,521       |       | —           |       | 37,521 |   |
|                                                                                |         |             |       |       |       |                |       |                |       |         |       |             |       |   |   |
| Preferred stock dividends and discount  accretion                                   |         | —           |       | —     |       | —              |       | —              |       | —       |       | —           |       | — |   |
| Recognition of tax benefits related to  employee option exercises                   |         | —           |       | —     |       | —              |       | —              |       | —       |       | —           |       | — |   |
| Issuance of restricted stock, shares for  option exercises and related compensation |         | 92               |       | 1          |       | —              |       | 2,948               |       | —       |       | —           |       | 2,949 |   |
| Preferred stock buyback                                                             |         | —           |       | —     |       | —              |       | —              |       | —       |       | —           |       | — |   |
| BALANCE, December 31, 2005                                                          |         | 60,624           |       | $          | 606        |                | —     |                | $          | 689,988      |       | $                | 42,862     |   | — |   | 733,456 |   |

** **

See accompanying notes to condensed financialstatements.

 

F-41

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**LaBRANCHE& CO INC.**

**(ParentCompany Only)**

**CONDENSEDSTATEMENTS OF CASH FLOWS**

**(000’somitted)**

** **
| ** **                                                                                          | ** ** | **For the Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                          | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| CASH FLOWS  FROM OPERATING ACTIVITIES:                                                              |       |                                 |       |   |   |   |   |
| Net income (loss)                                                                                   |       | $                                    | 37,521     |   | $ | (43,780 | ) | $ | (179,389 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities: |       |                                 |       |   |   |   |   |
| Depreciation and amortization of  intangibles                                                       |       | 127                                  |       | 102 |   | 80 |   |
| Amortization of debt issuance costs and  bond discount                                              |       | 1,708                                |       | 7,335 |   | 2,110 |   |
| Compensation expense related to stock based  compensation                                           |       | 140                                  |       | 1,169 |   | 2,631 |   |
| Tax benefit related to exercise of stock  options                                                   |       | —                               |       | 1,424 |   | 433 |   |
| Acceleration of preferred stock discount  accretion                                                 |       | —                               |       | 496 |   | 918 |   |
| Undistributed equity earnings from  investment in subsidiaries                                      |       | (63,080                              | )          | (963 | ) | 155,401 |   |
| Deferred tax benefit                                                                                |       | (22,968                              | )          | (46,213 | ) | (29,218 | ) |
| Changes in  operating assets and liabilities:                                                       |       |                                 |       |   |   |   |   |
| Securities purchased under agreements to  resell                                                    |       | 8,000                                |       | (74,000 | ) | 13,000 |   |
| United States government obligations                                                                |       | —                               |       | — |   | 28,897 |   |
| Other assets                                                                                        |       | 57,104                               |       | (3,948 | ) | 26,715 |   |
| Interest payable                                                                                    |       | —                               |       | (7,577 | ) | (419 | ) |
| Accrued compensation                                                                                |       | (19,171                              | )          | (11,924 | ) | 171 |   |
| Accounts payable and other accrued expenses                                                         |       | (2                                   | )          | (22,225 | ) | 181 |   |
| Other liabilities                                                                                   |       | (1,131                               | )          | 314 |   | 4,118 |   |
| Taxes payable                                                                                       |       | 8,858                                |       | 42,380 |   | 32,367 |   |
| Net cash  provided by (used in) operating activities                                                |       | 7,106                                |       | (157,410 | ) | 57,996 |   |
|                                                                                                |       |                                 |       |   |   |   |   |
| CASH FLOWS  FROM INVESTING ACTIVITIES:                                                              |       |                                 |       |   |   |   |   |
| Payments for office equipment and leasehold  improvements                                           |       | (174                                 | )          | (55 | ) | (39 | ) |
| Return of capital from subsidiary                                                                   |       | 77,309                               |       | 86,000 |   | 82,554 |   |
| Payment for investment in subsidiary                                                                |       | (54,897                              | )          | (59,000 | ) | (59,145 | ) |
| Net cash provided by investing activities                                                           |       | 22,238                               |       | 26,945 |   | 23,370 |   |
|                                                                                                |       |                                 |       |   |   |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                               |       |                                 |       |   |   |   |   |
| Repayment of subordinated debt and  promissory notes                                                |       | (2,063                               | )          | — |   | — |   |
| Payment of common and preferred dividends                                                           |       | —                               |       | (3,448 | ) | (18,600 | ) |
| Proceeds from exercise of stock options                                                             |       | —                               |       | 1,375 |   | 216 |   |
| Issuance of new senior notes                                                                        |       | —                               |       | 460,000 |   | — |   |
| Repayment of old notes                                                                              |       | —                               |       | (336,458 | ) | — |   |
| Payments for preferred stock buyback                                                                |       | —                               |       | (39,186 | ) | (24,650 | ) |
| Net cash provided by (used in) financing  activities                                                |       | (2,063                               | )          | 82,283 |   | (43,034 | ) |
| Effect of foreign currency translation                                                              |       | 56                                   |       | (37 | ) | (38 | ) |
| Increase (decrease) in cash and cash  equivalents                                                   |       | 27,337                               |       | (48,219 | ) | 38,294 |   |
| CASH AND  CASH EQUIVALENTS, beginning of year                                                       |       | 373                                  |       | 48,592 |   | 10,298 |   |
| CASH AND  CASH EQUIVALENTS, end of year                                                             |       | $                                    | 27,710     |   | $ | 373 |   | $ | 48,592 |   |
| SUPPLEMENTAL DISCLOSURE OF CASH PAID DURING  THE YEAR FOR:                                          |       |                                 |       |   |   |   |   |
| Income taxes                                                                                        |       | $                                    | 1,765      |   | $ | 404 |   | $ | 20,193 |   |
| Interest                                                                                            |       | 50,019                               |       | 53,539 |   | 42,704 |   |

 

See accompanying notes to condensed financialstatements.

 

F-42

----

 

**LaBRANCHE& CO INC.**

**(ParentCompany Only)**

**NOTESTO CONDENSED FINANCIAL STATEMENTS**

** **

## **1.**             OVERVIEW

## ** **

The accompanying condensed financial statements ofLaBranche & Co Inc. (Parent Company Only) should be read in conjunctionwith the consolidated financial statements of LaBranche & Co Inc. andSubsidiaries and the notes thereto contained elsewhere in this filing.

 

## **2.**             TRANSACTIONSWITH SUBSIDIARIES

## ** **

LaBranche & Co Inc. has transactions with itsconsolidated subsidiaries determined on an agreed-upon basis.

 

LaBranche & Co Inc. received cash dividends fromits consolidated subsidiaries totaling $77.0 million, $86.0 million and $82.6million for the years ended December 31, 2005, 2004 and 2003, respectively.

 

F-43

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