Siebert Financial Corp: Form 10-Q for the period ended Mar 31, 2024

The following discussion provides a narrative of our financial performance and condition that should be read in conjunction with the accompanying financial statements and related notes included under Part I, Item 1 of this Report. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in our 2023 Form 10-K, particularly in Part I, Item 1A – Risk Factors.

Overview

We are a financial services company and provide a wide variety of financial services to our clients. We operate in business lines such as retail brokerage, investment advisory, insurance, and technology development through our wholly-owned and majority-owned subsidiaries.

Results in the businesses in which we operate are highly correlated to general economic conditions and, more specifically, to the direction of the U.S. equity and fixed-income markets. Market volatility, overall market conditions, interest rates, economic, political, and regulatory trends, and industry competition are among the factors which could affect us and which are unpredictable and beyond our control. These factors affect the financial decisions made by market participants who include investors and competitors, impacting their level of participation in the financial markets. In addition, in periods of reduced financial market activity, profitability is likely to be adversely affected because certain expenses remain relatively fixed, including salaries and related costs, as well as portions of communications costs and occupancy expenses. Accordingly, earnings for any period should not be considered representative of earnings to be expected for any other period.

Trends and Key Factors Affecting our Operations

Interest Rates

We are exposed to market risk from changes in interest rates. Such changes in interest rates primarily impact revenue from interest, marketing, and distribution fees. We primarily earn interest, marketing and distribution fees from margin interest charged on clients’ margin balances, interest on cash and securities segregated for regulatory purposes, and distribution fees from money market mutual funds in clients’ accounts. Securities segregated for regulatory purposes consist solely of U.S. government securities. If prices of U.S. government securities within our portfolio decline, we anticipate the impact to be temporary as we intend to hold these securities to maturity. We seek to mitigate this risk by managing the average maturities of our U.S. government securities portfolio and setting risk parameters for securities owned, at fair value.

Technology Initiatives

At the end of 2023, we reassessed our technology needs and strategic direction and hired new technology personnel, changed our primary software development vendor, and made additional investments in technology development related to our Retail Platform and additional technology services for our customers.

We believe these changes will be key to creating a Retail Platform and additional technology services for the next generation of retail customers, correspondent clearing, as well as the overall growth of our business.

Transaction with Kakaopay

On April 27, 2023, we entered into the First Tranche Stock Purchase Agreement with Kakaopay pursuant to which we issued to Kakaopay 8,075,607 shares of our common stock at a per share price of Two Dollars Fifteen Cents ($2.15), which represented at the time of issuance 19.9% of our outstanding equity securities on a fully diluted basis (the “First Tranche”). The First Tranche closed on May 18, 2023. Refer to Note 5 – Kakaopay Transaction in our 2023 Form 10-K for further detail.

RISE

RISE was an institutional brokerage for which all its revenue producing customers transitioned to other prime service providers by the first quarter of 2022. As part of this transition, Siebert had an agreement with JonesTrading Institutional Service, LLC (“JonesTrading”) whereby JonesTrading pays RISE a percentage of the income produced by certain historical clients of RISE less any related expenses. For the three months ended March 31, 2024 and 2023, this agreement resulted in pre-tax loss of $9,000 and pre-tax income of $54,000, respectively.

Client Account and Activity Metrics

The following tables set forth metrics we use in analyzing our client account and activity trends for the periods indicated.

Client Account Metrics

• Retail customer net worth represents the total value of securities and cash in the retail customer accounts after deducting margin debits
• Retail customer margin debit balances represents credit extended to our customers to finance their purchases against current positions
• Retail customer credit balances represents client cash held in brokerage accounts
• Retail customer money market fund value represents all retail customers accounts invested in money market funds
• Retail customer accounts represents the number of retail customers

Statements of Operations and Financial Condition

Statements of Operations for the Three Months Ended March 31, 2024 and 2023

Revenue

Commissions and fees for the three months ended March 31, 2024 were $2,300,000 and increased by $453,000 from the corresponding period in the prior year, primarily due to market conditions.

Interest, marketing and distribution fees for the three months ended March 31, 2024 were $8,763,000 and increased by $1,790,000 from the corresponding period in the prior year primarily due to rising interest rates that resulted in increased interest income received on U.S. government securities and cash deposits.

Principal transactions and proprietary trading for the three months ended March 31, 2024 were $3,506,000 and increased by $706,000 from the corresponding period in the prior year, primarily due to the factors discussed below.

The increase in realized and unrealized gain on primarily riskless principal transactions was primarily due to market conditions. The increase in unrealized gain on our portfolio of U.S. government securities was due to the following. We invested in 1-year treasury bills and 2-year treasury notes in order to enhance our yield on excess 15c3-3 deposits. During 2022, there was an increase in U.S. government securities yields, which created an unrealized loss on our U.S. government securities portfolio. In 2023, we began to record the reversal of the unrealized loss resulting in an unrealized gain due to the securities coming closer to maturity. We continually invest in US government securities based on market yields and cash needs.

Below is a summary of the change in the principal transactions and proprietary trading line item for the periods presented.

Market making for the three months ended March 31, 2024 was $672,000 and increased by $327,000 from the corresponding period in the prior year, primarily due to market conditions.

Stock borrow / stock loan for the three months ended March 31, 2024 was $4,098,000 and increased by $656,000 from the corresponding period in the prior year primarily due to the growth of stock locate and securities lending businesses.

Advisory fees for the three months ended March 31, 2024 were $490,000 and increased by $46,000 from the corresponding period in the prior year, primarily due to growth in platform assets.

Other income for the three months ended March 31, 2024 was $627,000 and increased by $308,000 from the corresponding period in the prior year, primarily due to fees related to administrative services.

Operating Expenses

Employee compensation and benefits for the three months ended March 31, 2024 were $10,376,000 and increased by $3,409,000 from the corresponding period in the prior year, primarily due to an increase in commission payouts, executive and incentive compensation, as well as additional personnel related to technology initiatives.

Clearing fees, including execution costs for the three months ended March 31, 2024 were $428,000 and increased by $73,000 from the corresponding period in the prior year, primarily due to the timing of fees within the periods presented.

Technology and communications expenses for the three months ended March 31, 2024 were $876,000 and increased by $87,000 from the corresponding period in the prior year, primarily due to an increase in costs related to a technology partner.

Other general and administrative expenses for the three months ended March 31, 2024 were $1,029,000 and decreased by $64,000 from the corresponding period in the prior year, primarily due to a decrease in office expenses and payroll processing services related to a paymaster.

Data processing expenses for the three months ended March 31, 2024 were $751,000 and decreased by $100,000 from the corresponding period in the prior year, primarily due a decrease in service bureau fees.

Rent and occupancy expenses for the three months ended March 31, 2024 were $497,000 and increased by $19,000 from the corresponding period in the prior year.

Professional fees for the three months ended March 31, 2024 were $1,037,000 and decreased by $37,000 from the corresponding period in the prior year primarily due to a decrease in legal fees offset by an increase in accounting and other consulting services.

Depreciation and amortization expenses for the three months ended March 31, 2024 were $255,000 and increased by $65,000 from the corresponding period in the prior year, primarily due to depreciation of the Miami office building in 2024.

Interest expense for the three months ended March 31, 2024 was $51,000 and decreased by $37,000 from the corresponding period in the prior year, primarily due to the repayment of a loan with East West Bank in the second quarter of 2023.

Advertising and promotion expense for the three months ended March 31, 2024 was $54,000 and increased by $82,000 from the corresponding period in the prior year, primarily due to a reversal related to advertising expenses in 2023 as well as an increase in marketing initiatives in 2024.

Non-Operating Income (Loss)

The earnings of equity method investment in related party for the three months ended March 31, 2024 was $0 and decreased by $38,000 from the corresponding period in the prior year, primarily due to the exit of our investment in Tigress in the third quarter of 2023.

Provision For (Benefit From) Income Taxes

The provision from income taxes for the three months ended March 31, 2024 was $1,415,000 and increased from the provision for income taxes by $279,000 from the corresponding period in the prior year. The change from the corresponding period in the prior year is primarily due to an increase in pre-tax earnings in the first quarter of 2024. Refer to Note 15 – Income Taxes for additional detail.

Net Income (Loss) Attributable to Noncontrolling Interests

As further discussed in Note 1 – Organization and Basis of Presentation, we consolidate RISE’s financial results into our financial statements and reflect the portion of RISE not held by Siebert as a noncontrolling interests in our financial statements. The net loss attributable to noncontrolling interests for the three months ended March 31, 2024 was $1,000, and decreased by $20,000 from the corresponding period in the prior year, due to less activity in RISE in 2024.

Statements of Financial Condition As of March 31, 2024 and December 31, 2023

Assets

Assets as of March 31, 2024 were $742,303,000 and decreased by $59,497,000 from December 31, 2023, primarily due to a decrease in cash and securities segregated for regulatory purposes.

Liabilities

Liabilities as of March 31, 2024 were $667,472,000 and decreased by $63,619,000 from December 31, 2023, primarily due to a decrease in payables to customers and securities loaned, partially offset by an increase in bank loans.

Liquidity and Capital Resources

Overview

We expect to use our available cash, cash equivalents, and potential future borrowings under our debt agreements and potential issuance of new debt or equity, to support and invest in our core business, including investing in new ways to serve our customers, potentially seeking strategic acquisitions to leverage existing capabilities, and for general capital needs (including capital, deposit, and collateral requirements imposed by regulators and SROs). Based on our current level of operations, we believe our available cash, available lines of credit, overall access to capital markets, and cash provided by operations will be adequate to meet our current liquidity needs for the foreseeable future. As of the date of this Report, other than the items detailed in the section below, there are no known or material events that would require us to use large amounts of our liquid assets to cover expenses.

Kakaopay

The net capital infusion from Kakaopay to Siebert from the First Tranche was approximately $14.8 million after the issuance cost. This capital is currently being used to enhance our regulatory capital, and is primarily invested in U.S. government securities and is in the line item “Securities owned, at fair value” on the statements of financial condition.

Cash and Cash Equivalents

Our cash and cash equivalents were $2.9 million and $5.7 million as of March 31, 2024 and December 31, 2023, respectively.

Debt Agreements

We have a $4.3 million outstanding on our mortgage with East West Bank and have $4.8 million outstanding on our line of credit for short term overnight demand borrowing of up to $25 million with BMO Harris as of March 31, 2024. As of March 31, 2024, we were in compliance with all covenants related to our debt agreements.

Cash Requirements

The following table summarizes our short- and long-term material cash requirements as of March 31, 2024.

(1) Pursuant to the Settlement Agreement with Kakaopay, as of March 29, 2024, we will pay Kakaopay a fee of $5 million (payable in ten quarterly installments). Refer to Note 5 – Kakaopay Transaction in the Company’s 2023 Form 10-K for further detail.

(2) On December 30, 2021, we purchased the Miami office building and financed part of the purchase price with a mortgage with East West Bank.

(3) In 2023 we entered into agreements with technology vendors for certain development projects related to our Retail Platform. As of March 31, 2024, we have incurred approximately $1.8 million out of the $3.3 million total budget for these vendors.

(4) On July 7, 2023, we entered into a lease agreement expiring in December 2028 for office space in the World Financial Center in New York City. The estimated build out cost for this office space is approximately $800,000. As of March 31, 2024, we have incurred approximately $664,000 out of the $800,000 of the estimated build out costs. As of March 31, 2024, we have incurred approximately $99,000 out of the $144,000 estimated build out costs to build out our office space in Omaha, Nebraska.

Shelf Registration Statement

On February 18, 2022, we filed a shelf registration statement on Form S-3 that was declared effective on March 2, 2022 by the SEC for the potential offering, issuance and sale by Siebert of up to $100.0 million of our common stock, preferred stock, warrants to purchase our common stock and/or preferred stock, units consisting of all or some of these securities and subscription rights to purchase all or some of these securities. However, since we filed the 2023 Form 10-K after its scheduled due date, we no longer satisfy the eligibility requirements for use of registration statements on Form S-3, which requires that we file in a timely manner all reports required to be filed during the prior twelve calendar months. As a result, we have suspended use of the shelf registration statement.

At the Market Offering

On May 27, 2022, we entered into a Capital on DemandTM Sales Agreement with JonesTrading as agent, pursuant to which we could offer and sell, from time to time through JonesTrading, shares of our common stock having an aggregate offering amount of up to $9.6 million under our shelf registration statement on Form S-3. For the three months ended March 31, 2024 and 2023, we did not sell any shares pursuant to this Sales Agreement. As noted above, since Siebert filed its 2023 Form 10-K after its schedule due date, Siebert no longer satisfies the eligibility requirement for use of registration statements on Form S-3. As a result, Siebert has suspended use of the shelf registration statement and is not able to access the At the Market program as of the date of this Report. Refer to Note 18 – Commitments, Contingencies, and Other for additional detail.

Net Capital, Reserve Accounts, Segregation of Funds, and Other Regulatory Requirements

MSCO is subject to the Uniform Net Capital Rules of the SEC (Rule 15c3-1) and the Customer Protection Rule (15c3-3) of the Exchange Act and maintains capital and segregated cash reserves in excess of regulatory requirements. Requirements under these regulations may vary; however, MSCO has adequate reserves and contingency funding plans in place to sufficiently meet any regulatory requirements. In addition to net capital requirements, as a self-clearing broker-dealer, MSCO is subject to cash deposit and collateral requirements with clearing houses, such as the DTCC and OCC, which may fluctuate significantly from time to time based upon the nature and size of clients’ trading activity and market volatility. RISE, as a member of FINRA, is subject to the SEC Uniform Net Capital Rule 15c3-1 and the corresponding regulatory capital requirements.

MSCO can transfer funds to Siebert as long as MSCO maintains its liquidity and regulatory capital requirements. RISE can transfer funds to its shareholders, of which Siebert is entitled to its proportional ownership interest, as long as RISE maintains its liquidity and regulatory capital requirements. For the three months ended March 31, 2024 and 2023, MSCO and RISE had sufficient net capital to meet their respective liquidity and regulatory capital requirements. Refer to Note 16 – Capital Requirements for more detail about our capital requirements.

Cash Flows

Cash used in operating activities consisted of net income adjusted for certain non-cash items. Net operating assets and liabilities at any specific point in time are subject to many variables, including variability in customer activity, the timing of cash receipts and payments, and vendor payment terms. The total changes in our statements of cash flows, especially our operating cash flow, are not necessarily indicative of the ongoing results of our business as we have customer assets and liabilities on our statements of financial condition.

For the three months ended March 31, 2024, cash used in operating activities increased by $23.0 million compared to the prior year period, which was primarily driven by the net change in receivables from customers, securities borrowed, and securities loaned.

For the three months ended March 31, 2024, cash used in investing activities increased by $0.7 million compared to the prior year period, which was primarily driven by the build out of the New York office as well as the development of the new Retail Platform in 2024, partially offset by the build out of the Miami office building occurring in 2023.

For the three months ended March 31, 2024, cash flows provided by financing activities increased by $5.0 million compared to 2023, which was primarily driven by the draws on bank loans and the repayment of principal of Siebert’s line of credit in 2023.

Long Term Contracts

Effective August 1, 2021, MSCO entered into an amendment to its clearing agreement with NFS that, among other things, extends the term of their arrangement for an additional four-year period commencing on August 1, 2021 and ending July 31, 2025. As part of this agreement, we received a one-time business development credit of $3 million, and NFS will pay us four annual credits of $100,000 over the term of the agreement. The amendment also provides for an early termination fee; however, as of March 31, 2024, we do not expect to terminate the contract with NFS before the end of the contract term. Refer to Note 13 – Deferred Contract Incentive and Note 18 – Commitments, Contingencies and Other for additional detail.

Effective June 2023, MSCO entered into an amendment to its service agreement with Broadridge Securities Processing Solutions, LLC that, among other things, extends the term of their arrangement for a five-year period ending June 2028, with an option to terminate after three years. The total minimum expense for this arrangement is estimated at approximately $1.2 million over the duration of the contract.

Off-Balance Sheet Arrangements

We enter into various transactions to meet the needs of customers, conduct trading activities, and manage market risks and are, therefore, subject to varying degrees of market and credit risk. In the normal course of business, our customer activities involve the execution, settlement, and financing of various customer securities transactions. These activities may expose us to off-balance sheet risk in the event the customer or other broker is unable to fulfill their contracted obligations and we are forced to purchase or sell the financial instrument underlying the contract at a loss. There were no material losses for unsettled customer transactions for the three months ended March 31, 2024 and 2023. Refer to Note 17 – Financial Instruments with Off-Balance Sheet Risk for additional detail.

Uncertain Tax Positions

We account for uncertain tax positions in accordance with the authoritative guidance issued under ASC 740-10, which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. We may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. The tax benefits recognized in the financial statements from such position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. ASC 740-10 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure requirements.

We recognize interest and penalties related to unrecognized tax benefits on the provision for income taxes line on the statements of operations. Accrued interest and penalties would be included on the related tax liability line on the statements of financial condition.

As of both March 31, 2024 and December 31, 2023, we recorded an uncertain tax position of $1,405,000 related to various tax matters, which is included in the line item “Taxes payable” in the statements of financial condition.

Critical Accounting Policies and Estimates

Certain of our accounting policies that involve a higher degree of judgment and complexity are discussed in Part I, Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2023 Form 10-K. As of March 31, 2024, there have been no changes to our critical accounting policies or estimates.

New Accounting Standards

In December 2023, the Financial Accounting Standards Board (“FASB”) issued ASU 2023-09, “Improvements to Income Tax Disclosures” (“ASU 2023-09”). The ASU is intended to enhance the transparency and decision usefulness of income tax disclosures. The amendments in the ASU address investor requests for enhanced income tax information primarily through changes to the rate reconciliation and income taxes paid information. ASU 2023-09 will be effective for us for annual periods beginning after December 15, 2024, though early adoption is permitted. We are still evaluating the presentational effect that ASU 2023-09 will have on our consolidated financial statements, but we expect considerable changes to our income tax footnote.

Refer to Note 2 – New Accounting Standards for additional information regarding new ASU’s issued by the FASB.

Financial Instruments Held For Trading Purposes

We do not directly engage in derivative transactions, have no interest in any special purpose entity and have no liabilities, contingent or otherwise, for the debt of another entity.

Financial Instruments Held For Purposes Other Than Trading

We generally invest our cash and cash equivalents temporarily in dollar denominated bank account(s). These investments are not subject to material changes in value due to interest rate movements.

We invest cash and securities segregated for regulatory purposes in dollar denominated bank accounts which are not subject to material changes in value due to interest rate movements. We also invest cash and securities segregated for regulatory purposes and securities owned, at fair value in U.S. government securities which may be subject to material changes in value due to interest rate movements. Securities owned, at fair value invested in U.S. government securities are generally purchased to enhance yields on required regulatory deposits. While the value of the government securities may be subject to material changes in value, we believe any reduction in value would be temporary since the securities would mature at par value.

Customer transactions are cleared through clearing brokers on a fully disclosed basis and are also self-cleared by MSCO. If customers do not fulfill their contractual obligations any loss incurred in connection with the purchase or sale of securities at prevailing market prices to satisfy customer obligations may be incurred by Siebert. We regularly monitor the activity in customer accounts for compliance with margin requirements. We are exposed to the risk of loss on unsettled customer transactions if customers and other counterparties are unable to fulfill their contractual obligations. There were no material losses for unsettled customer transactions in the last five years.

Disclosure Controls and Procedures

We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Executive Vice President / Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Report pursuant to Rule 13a-15(e) or Rule 15d-15(e) of the Exchange Act. Based on its evaluation, our management, including our Chief Executive Officer and our Executive Vice President / Chief Financial Officer, concluded that as of the end of the period covered by this quarterly report, our disclosure controls and procedures were ineffective, based on the material weaknesses in internal control over financial reporting as previously disclosed in our 2023 Form 10-K.

Ongoing Remediation of Previously Identified Material Weakness

Management is in the process of implementing the following measures to ensure that the control deficiencies contributing to the material weakness are remediated: (i) designing and implementing controls related to provisioning, privileged access, and user access reviews, (ii) developing an enhanced risk assessment process to evaluate logical access, and (iii) improving the existing training program associated with control design and implementation. The material weakness will not be considered remediated until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. We expect that the remediation will be completed prior to the end of 2024.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the most recently completed fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

In addition to the other information set forth in this Report, investors should carefully consider the risk factors discussed in Part I, Item 1A - Risk Factors in our 2023 Form 10-K and under Part II, Item 1A. of our Form 10-Qs. Each of such risk factors could materially affect our business, financial position, and results of operations. As of the date of this Report, other than the supplemental risk factor provided below, there have been no material changes from the risk factors disclosed in our 2023 Form 10-K.

We are in the process of selecting a new independent registered public accounting firm, and the timing of retaining such firm is not certain.

As previously disclosed in a Current Report on Form 8-K filed on May 16, 2024, on May 13, 2024, we finalized discussions with our independent registered public accounting firm, Baker Tilly, that Baker Tilly was resigning its engagement with us upon completion of Baker Tilly’s review of our financial statements for the quarter ended March 31, 2024. We are in the process of selecting a new independent registered public accounting firm. We cannot assure you that we will retain a new independent registered public accounting firm in time to timely complete a review of our financial statements for the three months ended June 30, 2024 or any subsequent period. If we are unable to complete such reviews in a timely manner the filing of our financial reports may be delayed, which could have a material adverse impact on our business.