RISK FACTORS
We caution the reader that the following risks and those risks described elsewhere in this report and in our other SEC filings could have a material adverse effect on our business, prospects, financial condition, results of operations or cash flow or could cause a decline in the Company's stock price.
Risks Related to the Spin-off
We may not achieve the benefits expected from our Spin-off from GAMCO and may be more susceptible to adverse events.
We expect that, as a company independent from GAMCO, we will be able to grow organically and through acquisitions. Nonetheless, we may not be able to achieve either of these goals. Furthermore, by separating from GAMCO, there is a risk that we may be more susceptible to adverse events than we would have otherwise experienced as a subsidiary of GAMCO. As a subsidiary of GAMCO, we enjoyed certain benefits, including economies of scope and scale in costs, employees and business relationships. These benefits may not be as readily achievable as a smaller, stand-alone company.
Certain of our directors and officers may have actual or potential conflicts of interest because of their positions or relationships with GAMCO.
Mario J. Gabelli serves as our Chairman and Chief Executive Officer and also continues to serve as Chairman and Chief Executive Officer of GAMCO. Our President, Marc Gabelli, is a son of Mario J. Gabelli and also serves on the GAMCO Board. Marc Gabelli continues to have responsibilities relating to GAMCO, including continuing to serve on the GAMCO Board and participating on GAMCO's portfolio management team. Kevin Handwerker, Associated Capital's Executive Vice President, General Counsel and Secretary also serves in the same capacities for GAMCO. In addition, some of our portfolio managers and employees will initially be provided pursuant to the Transitional Services Agreement with GAMCO and will be officers or employees of GAMCO. Such dual assignments could create, or appear to create, potential conflicts of interest when our and GAMCO's officers and directors face decisions that could have different implications for the two companies.
Associated Capital has renounced its rights to certain business opportunities, and our certificate of incorporation will provide that no director or officer of Associated Capital will breach their fiduciary duty and therefore be liable to Associated Capital or its stockholders by reason of the fact that any such individual directs a corporate opportunity to another person or entity (including GAMCO) instead of Associated Capital, or does not refer or communicate information regarding such corporate opportunity to Associated Capital, unless (x) such opportunity was expressly offered to such person solely in his or her capacity as a director or officer of Associated Capital or as a director or officer of any of our subsidiaries, and (y) such opportunity relates to a line of business in which Associated Capital or any of its subsidiaries is then directly engaged; provided, however, if the conditions specified in the immediately preceding clauses (x) and (y) are satisfied, any officer or director of Associated Capital may pursue such corporate opportunity (or direct it to another person or entity) if either (i) Associated Capital renounces its interest in the potential business opportunity in writing or (ii) Associated Capital does not within a reasonable period of time, begin to pursue, or thereafter continue to pursue, such corporate opportunity diligently and in good faith. Our certificate of incorporation specifically provides that any person purchasing, receiving or otherwise becoming an owner of any shares of our capital stock, or any interest therein, will be deemed to have notice of and to have consented to the corporate opportunity policy contained in our certificate of incorporation.
Also, some of our directors, executive officers, portfolio managers and teammates own shares of GAMCO common stock and GAMCO restricted stock awards ("RSAs") or other GAMCO equity awards. At the time of the Spin-off, these equity awards were supplemented by the awarding of Associated Capital RSAs. Specifically, outstanding RSAs relating to GAMCO remain unchanged, with each RSA holder also receiving an equal number of RSAs relating to Associated Capital. The terms of the new Associated Capital RSAs are the same as the terms of the pre-Spin-off GAMCO RSAs. The purpose of the issuance was to ensure that any employee who had GAMCO RSAs was granted an equal number of AC RSAs so that the total value of the RSAs post-spin-off was equivalent to the total value pre-spin-off. The ownership of these RSAs may create, or may create the appearance of, conflicts of interest.
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In addition, potential conflicts of interest could arise in connection with the resolution of any dispute that may arise between GAMCO and Associated Capital regarding the terms of the agreements governing the separation and the relationship thereafter between the companies. The executive officers and other personnel of GAMCO who serve as directors or executive management of Associated Capital may interpret these agreements in their capacity as GAMCO employees in a manner that would adversely affect the business of Associated Capital.
Also, certain subsidiaries of GAMCO and GSI are investment advisers. The executive officers and other personnel of GAMCO who also serve as directors or executive management of Associated Capital may be confronted with the possibility of making decisions in their GAMCO capacity that would adversely affect the business of Associated Capital.
Associated Capital and GAMCO expect to be vigilant in attempting to identify and resolve any potential conflicts of interest, including but not limited to the types described above, at the earliest possible time. However, there can be no guarantee that the interests of Associated Capital may not be adversely affected at some point by such a conflict.
The separation from GAMCO may adversely affect the level of our assets under management ("AUM").
Our revenues are dependent on the amount of our AUM as well as the performance of our products. Many investors may have invested assets in alternative investment products (the "Alternative Investments") in part because GSI was a subsidiary of GAMCO. There can be no assurance that we will be able to attract investors to the Alternative Investments at the same rate as in prior years. In addition, we can make no assurance that current investors will not redeem their investments from the Alternative Investments as a result of our changed relationship with GAMCO. The occurrence of either of these events could adversely affect our business, results of operations and financial condition.
Concerns about our prospects as a stand-alone company could affect our ability to attract and retain employees or individuals whom we are attempting to recruit as employees.
Our employees or individuals whom we are attempting to recruit as employees may have concerns about our prospects as a stand-alone company, including our ability to maintain our independence and our inability to continue our current reliance on GAMCO's resources. If we are not successful in assuring our employees or individuals whom we are attempting to recruit as employees of our prospects as an independent company, our employees or recruits may seek or accept other employment, which could adversely affect our business and our results of operations.
We may have been able to receive better terms from unaffiliated third parties than the terms provided in our agreements with GAMCO.
The agreements related to our separation from GAMCO, including, but not limited to, the Separation Agreement, the Transitional Services Agreement and the Service Mark and Name License Agreement, were negotiated in the context of our separation from GAMCO while Associated Capital was still majority-owned by GAMCO. Accordingly, they may not reflect terms that would have been reached between unaffiliated parties. The terms of the agreements we negotiated in the context of our separation related to, among other things, indemnities and other obligations between GAMCO and us. Had these agreements been negotiated with unaffiliated third parties, they might have been more favorable to us.
In connection with the Spin-off, GAMCO has indemnified us for certain liabilities. There can be no assurance that the indemnity will be sufficient to insure us against the full amount of such liabilities, or that GAMCO's ability to satisfy its indemnification obligations will not be impaired in the future.
Pursuant to the Separation Agreement, GAMCO will agree to indemnify us from certain liabilities. Third parties could seek to hold us responsible for any of the liabilities that GAMCO has agreed to retain, and there can be no assurance that the indemnity from GAMCO will be sufficient to protect us against the full amount of such liabilities or that GAMCO will be able to fully satisfy its indemnification obligations. Moreover, even if we ultimately succeed in recovering from GAMCO any amounts for which we are held liable, we may be temporarily required to bear those losses until such recovery. Each of these risks could adversely affect our business, results of operations and financial condition.
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Risks Related to Our Industry
Changes in laws or regulations or in governmental policies and compliance with existing laws or regulations could limit the sources and amounts of our revenues, increase our costs of doing business, decrease our profitability and materially and adversely affect our business.
Our business is subject to extensive regulation in the United States, primarily at the federal level, including regulation by the SEC under the Advisers Act as well as other securities laws, by the Department of Labor under ERISA, and regulation by FINRA and state regulators. The Advisers Act imposes numerous obligations on investment advisors, including record-keeping, advertising and operating requirements, fiduciary and disclosure obligations, custodial requirements and prohibitions on fraudulent activities. In addition, our businesses are also subject to regulation by the FCA in the United Kingdom, and we are also subject to the laws of other non-U.S. jurisdictions and non-U.S. regulatory agencies or bodies.
Our failure to comply with applicable laws or regulations could result in fines, censure, suspensions of personnel or other sanctions, including revocation of our subsidiaries' registrations as an investment advisor or broker-dealer. Industry regulations are designed to protect our clients and investors in our funds and other third parties who deal with us and to ensure the integrity of the financial markets. Our industry is frequently altered by new laws or regulations and by revisions to, and evolving interpretations of, existing laws and regulations, both in the United States and in other nations. Changes in laws or regulations or in governmental policies could limit the sources and amounts of our revenues, increase our costs of doing business, decrease our profitability and materially and adversely affect our business.
We are subject to extensive and pervasive regulation around the world.
Our business is subject to extensive regulation around the world. These regulations subject our business activities to a pervasive array of increasingly detailed operational requirements, compliance with which is costly, time-consuming and complex. We may be adversely affected by our failure to comply with current laws and regulations or by changes in the interpretation or enforcement of existing laws and regulations. Challenges associated with interpreting regulations issued in numerous countries in a globally consistent manner may add to such risks if regulators in different jurisdictions have inconsistent views or provide only limited regulatory guidance. In particular, violation of applicable laws or regulations could result in fines, temporary or permanent prohibition of certain activities, reputational harm and related client terminations, suspensions of employees or revocation of their licenses, suspension or termination of investment adviser, broker-dealer or other registrations or other sanctions, which could have a material adverse effect on our reputation or business and may cause our AUM, revenue and earnings to decline.
New tax legislation or changes in U.S. and foreign tax laws and regulations or challenges to Associated Capital's historical taxation practices may adversely affect Associated Capital's effective tax rate, business and overall financial condition.
Our businesses may be affected by new tax legislation or regulations, or the modification of existing tax laws and regulations, by U.S. or non-U.S. authorities. In particular, the Foreign Account Tax Compliance Act ("FATCA") has introduced expansive new investor onboarding, withholding and reporting rules aimed at ensuring U.S. persons with financial assets outside of the United States pay appropriate taxes. The FATCA rules will impact both U.S. and non-U.S. funds and subject Associated Capital to extensive additional administrative burdens. Certain of our FATCA compliance are done by third parties, and we cannot be certain that they will always comply with applicable FATCA rules. Similarly, there has been renewed momentum by several European Union ("EU") Member States to introduce national FTTs, which would impose taxation on a broad range of financial instrument and derivatives transactions. If introduced as proposed, FTTs could have an adverse effect on Associated Capital's financial results and on clients' performance results. In addition, the Organization for Economic Co-operation and Development recently launched a BEPS proposal that aims to rationalize tax treatment across jurisdictions. If the BEPS proposal becomes the subject of legislative action in the format proposed, it could have unintended taxation consequences for collective investment vehicles and our tax position, which could adversely affect our financial condition.
We also manage significant assets in products and accounts that have specific tax and after-tax related objectives, which could be adversely impacted by changes in tax policy. Additionally, any new legislation, modification or interpretation of tax laws could impact Associated Capital's corporate tax position. The application of complex tax regulations involves numerous uncertainties and in the normal course of business, U.S. and non-U.S. tax authorities may review and challenge Associated Capital's historical tax positions. These challenges may result in adjustments to Associated Capital's tax position, or impact the timing or amount of, taxable income, deductions or other tax allocations, which may adversely affect Associated Capital's effective tax rate and overall financial condition.
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To the extent we are forced to compete on the basis of price, we may not be able to maintain our current fee structure.
The investment management business is highly competitive and has relatively low barriers to entry. To the extent we are forced to compete on the basis of price, we may not be able to maintain our current fee structure. Although our investment management fees vary from product to product, historically we have competed primarily on the performance of our products and not on the level of our investment management fees relative to those of our competitors. In recent years, however, there has been a trend toward lower fees in the investment management industry. In order to maintain our fee structure in a competitive environment, we must be able to continue to provide clients with investment returns and service that make investors willing to pay our fees. We cannot be assured that we will succeed in providing investment returns and service that will allow us to maintain our current fee structure. Fee reductions on existing or new business could have an adverse effect on our profit margins and results of operations.
Catastrophic and unpredictable events could have a material adverse effect on our business.
A terrorist attack, political unrest, war (whether or not directly involving the United States), power failure, cyber-attack, technology failure, natural disaster or many other possible catastrophic or unpredictable events could adversely affect our future revenues, expenses and earnings by, among other things: causing disruptions in United States, regional or global economic conditions; interrupting our normal business operations; inflicting employee casualties, including loss of our key executives; requiring substantial expenditures and expenses to repair, replace and restore normal business operations; and reducing investor confidence.
Pursuant to the Transitional Services Agreement with GAMCO, we have a disaster recovery plan to address certain contingencies, but we cannot assure you that this plan will be effective or sufficient in responding to, eliminating or ameliorating the effects of all disaster scenarios. If our employees or vendors we rely upon for support in a catastrophic event are unable to respond adequately or in a timely manner, we may lose clients resulting in a decrease in AUM which may have a material adverse effect on revenues and net income.
The soundness of other financial institutions could adversely affect our business.
Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We and the investments we manage may have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including: brokers and dealers, commercial banks, investment banks, clearing organizations, mutual and hedge funds and other institutions. Many of these transactions expose us and the accounts we manage to credit risk in the event of the counterparty's default. There is no assurance that any such losses would not materially and adversely impact Associated Capital's revenues and earnings.
Risks Related to Our Business
Control by Mario J. Gabelli of a majority of the combined voting power of Associated Capital common stock may give rise to conflicts of interests.
Mario J. Gabelli, through his control and majority ownership of GGCP and his individual ownership of Associated Capital common stock, will beneficially own a majority of our outstanding Associated Capital Class B Stock, representing approximately 94.7% voting control. As long as Mario J. Gabelli indirectly beneficially owns a majority of the combined voting power of Associated Capital common stock, he will have the ability to elect all of the members of our Board and thereby control our management and affairs, including determinations with respect to acquisitions, dispositions, borrowings, issuances of common stock or other securities, and the declaration and payment of dividends on the Associated Capital common stock. In addition, Mario J. Gabelli will be able to determine the outcome of all matters submitted to a vote of our stockholders for approval and will be able to cause or prevent a change in control of Associated Capital. As a result of Mario J. Gabelli's control, none of our agreements with Mario J. Gabelli and other companies controlled by him can be assumed to have been arrived at through "arm's-length" negotiations, although the parties endeavor to implement market-based terms. There can be no assurance that we would not have received more favorable terms, or offered less favorable terms to, an unaffiliated party.
In addition, Mario J. Gabelli, through his control and majority ownership of GGCP, controls GAMCO, and he could take actions that favor GAMCO over Associated Capital.
We may compete with GAMCO for clients and investment opportunities.
Although our business is expected to focus primarily on alternative investment management and institutional services, while GAMCO is expected to focus primarily on its mutual fund and institutional and private wealth management businesses, situations may arise where we find ourselves directly competing with GAMCO for investment clients and opportunities. For example, it is possible that a potential investor might consider investing in Associated Capital and GAMCO investment products and that such potential investor will have to choose between our investment products and those offered by GAMCO. In addition, Associated Capital and GAMCO could pursue the same investment opportunities in the future.
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Investors in our products have the right to redeem their investments in our products on a regular basis and could redeem a significant amount of AUM during any given quarterly period, which would result in significantly decreased revenues.
Subject to any specific redemption provisions applicable to a product, investors may generally redeem their investments in our products on an annual or quarterly basis following the expiration of a specified period of time. In a declining market, the pace of redemptions and consequent reduction in our AUM potentially could accelerate. Furthermore, investors in our products may also invest in products managed by other alternative asset managers that have restricted or suspended redemptions or may in the future do so. Such investors may redeem capital from our products, even if our performance is superior to such other alternative asset managers' performance, if they are restricted or prevented from redeeming capital from those other managers.
The decrease in revenues that would result from significant redemptions in our products could have a material adverse effect on our results of operations, cash flows and business. In 2009, due to factors related to the financial crisis, investors redeemed approximately $62 million invested in Associated Capital's products which represented approximately 20% of Associated Capital's AUM at that time. If economic and market conditions remain uncertain or worsen, we may once again experience significant redemptions.
Our business and financial condition may be materially adversely impacted by the highly variable nature of our revenues, results of operations and cash flows. In a typical year, a substantial portion of our incentive allocation income is determined and recorded in the fourth quarter of each year, which means that our interim results are not expected to be indicative of our results for a full year.
Our revenues are influenced by the combination of the amount of AUM and the investment performance of our products. Asset flows, whether inflows or outflows, can be highly variable from month to month and quarter to quarter. Furthermore, our products' investment performance, which affects the amount of AUM, can be volatile due to, among other things, general market and economic conditions. Accordingly, our revenues, results of operations and cash flows may be highly variable. This variability is exacerbated during the fourth quarter of each fiscal year, primarily due to the fact that a substantial portion of our revenues historically has been, and we expect will continue to be, derived from incentive allocation income from our products. Incentive allocation income is contingent on the investment performance of the products as of the relevant measurement period, which generally is as of the end of each calendar year. We may also experience fluctuations in our results from quarter to quarter due to a number of other factors, including changes in management fees resulting from changes in the values of our products' investments, other changes in the amount of AUM, changes in our operating expenses, unexpected business developments and initiatives and, as discussed above, general economic and market conditions. Such variability and unpredictability may lead to volatility or declines in the price of the our Stock and cause our results for a particular period not to be indicative of our performance in a future period or meaningful as a basis of comparison against results for a prior period.
The amount of incentive allocation income that may be generated by our products is uncertain until it is determined and realized at a particular point in time. We generally do not record incentive allocation income in our interim financial statements other than incentive allocation income earned as a result of investor redemptions during the period. As a result of these and other factors, our interim results may not be indicative of historical performance or the results that may be expected for a full year.
In addition, a substantial portion of our products' AUM have "high-water marks." This means that if an investor experiences losses in a given year, we will not be able to earn incentive allocation income with respect to such investor's investment unless and until our investment performance surpasses the high-water mark. The incentive allocation income we earn is therefore dependent on the net asset value of each investor's investment in our products. As of December 31, 2015, approximately 5% of our AUM was below a high-water mark, with a loss carryforward amount that was approximately 0.3% of AUM. We can make no assurances that our investors will not experience losses in future years and, as a result, we may not earn incentive allocation income in those or subsequent years until such losses are earned back.
A decline in the prices of securities generally could lead to a decline in our AUM, revenues and earnings.
Substantially all of our revenues are directly related to both the amount of our AUM and the performance of our investment products. Under our investment advisory contracts, the investment advisory fees we receive are typically based on the market value of AUM. Accordingly, a decline in the prices of securities generally may cause our revenues and net income to decline by either causing the value of our AUM to decrease, which would result in lower investment advisory fees, or causing our clients to withdraw funds in favor of investments they perceive to offer greater opportunity or lower risk, which would also result in lower fees. The securities markets are highly volatile, and securities prices may increase or decrease for many reasons beyond our control, including but not limited to economic and political events, war (whether or not directly involving the United States), acts of terrorism, unanticipated changes in currency exchange rates, interest rates, inflation rates, the yield curve, defaults by derivative counterparties, bond default risks, decreases in commodity prices, slowing growth in other countries, particularly China, the sovereign debt crisis in Europe and other factors that are difficult or impossible to predict or even to identify. If a decline in securities prices caused our revenues to decline, it could have a material adverse effect on our earnings.
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The loss of the services of Mario J. Gabelli and other key personnel could have a material adverse effect on our business.
We are dependent on the efforts of Mario J. Gabelli, our Executive Chairman and Chief Executive Officer. In this regard, it is expected that Mario J. Gabelli will resign as our Chief Executive Officer approximately one year after the date of the Spin-off. However, it is expected that he will remain our Executive Chairman after he resigns as Chief Executive Officer. The loss of the services of Mario J. Gabelli could have a material adverse effect on our business, and we cannot provide assurance that we will be able to find a suitable replacement as Chief Executive Officer if Mario J. Gabelli resigns in a year as expected.
Our future success depends to a substantial degree on our ability to retain and attract other qualified personnel to conduct our investment management business. The market for qualified portfolio managers is extremely competitive and has grown more so in recent periods as the investment management industry has experienced growth. We anticipate that it will be necessary for us to add portfolio managers and investment analysts as we further diversify our investment products and strategies. There can be no assurance, however, that we will be successful in our efforts to recruit and retain the required personnel. In addition, our investment professionals and senior marketing personnel have direct contact with our clients, which can lead to strong client relationships. The loss of these personnel could jeopardize our relationships with certain clients, and result in the loss of such accounts. The loss of key management professionals or the inability to recruit and retain sufficient portfolio managers and marketing personnel could have a material adverse effect on our business.
We have experienced and may again experience periods of rapid growth and significant declines in AUM, which place significant demands on our legal, compliance, accounting, risk management, administrative and operational resources.
Our AUM grew from approximately $230 million as of December 31, 1999 to $814 million as of December 31, 2004. Between December 31, 2004 and December 31, 2008, our AUM had declined to $295 million due to investment losses and redemptions experienced by our funds over that period. As of December 31, 2015, our AUM had grown to approximately $1.08 billion.
Rapid changes in our AUM impose significant demands on our legal, compliance, accounting, risk management, administrative and operational infrastructure. The complexity of these demands and the time and expense required to address them, is a function not simply of the amount by which our AUM have changed, but also of significant differences in the investing strategies employed within our funds and the time periods during which these changes occur. Furthermore, our future growth will depend on, among other things, our ability to develop and maintain highly reliable operating platforms, management systems and financial reporting and compliance infrastructures that are also sufficiently flexible to promptly and appropriately address our business needs, applicable legal and regulatory requirements and relevant market and other operating conditions, all of which can change rapidly.