2009 annual report
Legg Mason is a leading global asset management
firm with recognized local, regional and global
portfolio management expertise on the ground,
around the world. Our global asset management
affiliates are among industry leaders in their unique
areas of specialization and combined offer a full
spectrum of equity, fixed income, liquidity and
alternative solutions. At Legg Mason, our aim is to
be one of the best asset managers in the world.
We strive to deliver investment excellence,
including world-class distribution and superb
client service. Today, Legg Mason serves
individual and institutional investors in over
190 countries around the world.
Financial Highlights
(dollars in thousands, except per share amounts)
Years Ended March 31,
2005
2006
2007
2008
2009
Operating results(1)
Operating revenues
Operating income (loss)
Income (loss) from continuing operations before
income tax provision (benefit) and minority interest
Net income (loss)(2)
$1,570,700
489,117
$2,645,212
679,730
$4,343,675 $ 4,634,086
1,050,176
1,028,298
$ 3,357,367
(669,180)
470,758
408,431
715,462
1,144,168
1,043,854
646,818
443,871
267,610
(3,155,857)
(1,947,928)
Per common share
Diluted Income(2)
Income (loss) from continuing operations per diluted share
Cash income (loss) from continuing operations per diluted share(3)
Dividends declared
Book value
$ 3.53
2.56
3.17
0.550
20.97
$ 8.80
3.35
4.10
0.690
41.67
$ 4.48 $ 1.86
1.86
2.86
0.960
46.99
4.48
5.86
0.810
45.99
$ (13.85)
(13.85)
(15.74)
0.960
31.13
Financial condition
Total assets
Total stockholders’ equity
$8,219,472
2,293,146
$9,302,490
5,850,116
$9,604,488 $11,830,352
6,620,503
6,541,490
$ 9,321,354
4,454,477
(1) Reflects results of Citigroup’s Asset Management business (“CAM”) and Permal Group Ltd. (“Permal”) since acquisition in fiscal 2006 and discontinued private client, capital markets and
mortgage banking and servicing operations, where applicable.
(2) Fiscal 2006 includes gain on sale of discontinued operations, net of income taxes, of $644,040 or $4.94 per share. Fiscal 2008 includes impairment charges related to intangible assets, net
of income tax benefits, of $94,813 or $0.66 per share. Fiscal 2009 includes losses related to the elimination of exposure to Structured Investment Vehicles, net of income tax benefits and
compensation related adjustments, of $1,376,579 or $9.79 per share and impairment charges related to goodwill and intangible assets, net of income tax benefits, of $863,352 or $6.14 per share.
(3) Cash income from continuing operations per diluted share represents a performance measure that is based on a methodology other than generally accepted accounting principles (“non-GAAP”).
For more information regarding this non-GAAP financial measure, see Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Annual Report and
the corporate website at www.leggmason.com under the “Investor Relations—Financial Information” section.
“ No chalk” is the standard at Legg Mason.
Like an athlete competing on a playing
field, our employees are expected to
steer clear of the boundary lines for
ethical behavior so that we never have
“chalk on our shoes.”
Dear Fellow Shareholder,
In this, my first letter as Legg Mason’s Chairman and CEO, I would like to
report the fiscal year results and discuss our strategic plan to move the
company forward and position it for renewed growth and profitability. We
aim to achieve our plan with these key beliefs: straight talk, smart strategy,
excellent investing, superb service, and “no chalk” integrity.
Extreme Markets and Extremely Disappointing Results
2008 represented one of the most difficult economic periods in modern
financial history and certainly the worst that I have witnessed. Economic
fundamentals deteriorated rapidly and led to a sharp decline in the equity
markets and continuing dislocations in the credit markets. The global market
decline was significantly impacted by the failure of major financial institutions
and the freeze in the credit markets, resulting in unprecedented government
intervention. Investors flocked to cash at historic levels and rapid deleveraging
throughout all asset classes further fueled severe disruptions in the markets.
As of March 31, 2009, Legg Mason’s assets under management were
$632.4 billion, a decrease of 33% from $950.1 billion as of March 31, 2008.
For the fiscal year ended March 31, 2009, we recorded revenues of $3.4 billion,
down 28% from our record $4.6 billion in fiscal year 2008. The net loss for
the same period was $1.9 billion, or $13.85 per diluted share, versus net
income of $267.6 million, or $1.86 per diluted share for the prior year. Our
cash loss was $2.2 billion, or $15.74 per diluted share for fiscal year 2009,
compared to cash income of $412.3 million, or $2.86 per diluted share for
the prior year.
Our fiscal year results were primarily driven by two significant items. First,
we took certain actions to support and completely eliminate securities issued
by structured investment vehicles (“SIVs”) from our money market funds
and balance sheet, which resulted in net losses totaling $1.4 billion and
$313.7 million for the current and prior fiscal years, respectively. We feel
strongly that these actions were necessary in order to protect our fund
investors, the long-term value of our money market franchise and, ultimately,
our shareholders. Second, net income was also reduced by net non-cash
impairment charges related to certain intangible assets of $863.4 million
for the fiscal year ended March 31, 2009 and $94.8 million for the prior
fiscal year.
LEgg MaSon
2009 Annual Report
We believe that cash income, excluding SIV securities losses and impairment
charges, is an appropriate metric for evaluating the value of our business
and measuring our results, and totaled $471.0 million, or $3.32 per diluted
share in fiscal year 2009, versus $877.0 million, or $6.09 per diluted share,
for the prior fiscal year. These results reflect disappointing investment
performance and asset flows, particularly at Private Capital Management,
Legg Mason Capital Management, and certain strategies at Western
Asset. To be clear, we know that we cannot improve on our earnings
power without delivering on our fundamental goal of sustained
investment excellence.
Overall, Legg Mason stock declined by 71.6% versus a 46.8% decline in
the SNL Asset Manager Index for the year ended March 31, 2009. While
the market clearly took its toll on all competitors, our results for the fiscal
year were substantially below the industry and unacceptable going forward.
Strategies and Progress
Against this backdrop of market volatility and disappointing results, we
determined that it was imperative to take a step back and review our strategy
and evaluate the overall capabilities and effectiveness of our business. This
comprehensive review by the Executive Committee, which drew significantly
on input from leaders of our investment managers, our board, and outside
experts, led to a very explicit expansion of our model.
Our enhanced multi-manager model retains the core elements of a
diversified multi-manager structure and investment autonomy, but adds
three important ingredients:
1) Strategic engagement among Legg Mason and its affiliates on key
business matters ranging from capital deployment for growth and
expansion to best practices for performance measurement and
risk management;
2) Distribution leverage whereby affiliates collaborate with Legg Mason’s
Americas and International groups to efficiently gain share across the
vital retail and instividual markets worldwide; and
3) Service management to make sure all shared services (operations and
technology, legal and compliance, fund administration, human resources,
and finance) are delivered in an effective and efficient manner.
We took this concept of an enhanced multi-manager model and compressed
it to a clear focus on three pillars: first and foremost, investment excellence;
second, world-class distribution; and, finally, superb service. As I write this
letter in mid-June, let me expand and update you on job number one,
investment performance.
2
oUTCoME oF STRaTEgIC REVIEW
affirmed
• Multi-Manager Model
• Investment Autonomy • World-Class Distribution
added
• Strategic Engagement
• Service Management
ThREE PILLaRS oF gRoWTh
• Investment Excellence
• World-Class Distribution
• Superb Service
Executive Committee
(piCturEd abovE)
Importantly, we are seeing some encouraging signs of improvement. Our
rate of outflows has declined since the quarter ended December 2008.
(second from right)
Mark R. Fetting
Chairman and
Chief Executive Officer
(left to right)
Ronald R. Dewhurst
Senior Executive Vice President,
Head of International Asset Management
David R. odenath
Additionally, after disappointing investment performance during the past fiscal
year, we have experienced improvements since our fiscal year end, including
at Legg Mason Capital Management and Western Asset. The percentage
of our long-term mutual fund assets outperforming their category average
increased from 43% to 56% for the one year, 52% to 55% for the three years,
47% to 58% for the five years, and 75% to 78% for the ten years ended
March 31, 2009 versus May 31, 2009. We are encouraged by these short-
term signs; however, we recognize that sustained outperformance will be
Senior Executive Vice President,
needed in order to experience a continued improvement in flows.
Head of the Americas
Jeffrey a. nattans
Senior Vice President,
It is important to note that despite the challenges of the past year, several
of our managers performed very well on a relative basis. ClearBridge Advisors,
Head of Specialized Managers
our largest equity manager, experienced notable improvements in investment
Charles J. (“C.J.”) Daley, Jr.
performance. Permal, our fund-of-hedge-funds manager, maintained their
Senior Vice President,
record of solid performance and has consistently received accolades for
Chief Financial Officer and Treasurer
their robust process and leadership, particularly in response to the recent
Joseph a. Sullivan
stresses in the hedge fund space. Royce, specializing in smaller company
Senior Executive Vice President,
Chief Administrative Officer
investing, continued to outperform benchmarks, and the firm’s Charlie
Dreifus was named Morningstar’s 2008 Domestic Stock Fund Manager of
the Year for his management of Royce Special Equity Fund.
In fiscal year 2009, we also achieved progress in pursuit of this expanded
strategy, including capitalizing on strategic growth initiatives, through new
product development and the expansion of our multi-channel distribution
strategies; effectively managing our cost structure; and improving our
financial strength and protecting our balance sheet. We have been hard at
work in each of these areas. Over the course of fiscal year 2009, specific
actions included:
• Completing the build-out of our senior management team for the future
that includes C.J. Daley, Chief Financial Officer; Ron Dewhurst, Head of
International Asset Management; Dave Odenath, Head of the Americas;
3
LEgg MaSon
2009 Annual Report
Jeff Nattans, Head of Specialized Managers; and Joe Sullivan, Chief
Administrative Officer. Along these lines, the reorganization of our business
into two divisions: Americas and International, reflects our desire to
expand our global, multi-affiliate, multi-channel business model, and
further aligns our structure with our strategic priorities.
• Fortifying our capital base. In calendar year 2008, we raised a total of
$2.4 billion in capital via two transactions, including, in May 2008, a
$1.15 billion offering of equity units. We strengthened our balance sheet
through the repayment of debt and added flexibility by amending our
debt covenants in March 2009. Additionally, in May of this year, we made
the difficult decision to reduce our quarterly cash dividend to $0.03 per
share to further strengthen our cash position.
• Reducing our operating expense structure through strategic, but difficult,
cost-cutting initiatives. In October 2008, we announced a goal of
reducing operating expenses by $50 million, out of a corporate expense
base of approximately $600 million, and are now on course to realize
approximately $160 million in sustainable run-rate cost savings by
September of this year.
• Eliminating all of the remaining securities issued by SIVs from our money
market funds and balance sheet. In March 2009, we were able to take
this final proactive step to resolve the SIV issue. Since the SIV market
became illiquid in the fall of 2007, we systematically reduced our total
exposure from $10 billion to zero. We achieved these results without
external assistance and now have greater optionality in managing our
balance sheet.
Milestones and Metrics going Forward
Our approach this fiscal year, amidst these extreme market conditions,
has been measured and deliberate to put our major challenges behind us.
Now, we are able to work more aggressively on all fronts to accelerate the
progress of our company onto a path of sustainable, profitable growth. We
will measure our progress against several key business metrics. First, we
are focused on rebuilding our earnings base and returning our earnings
margins to historic levels, and our leaner expense structure better positions
us to achieve this. Second, we are focused on rebuilding our level of assets
under management through sustained investment performance and inflows.
Our long-term performance remains strong, and we are diligently committed
to improving upon one-, three-, and five-year performance. Recent
enhancements undertaken by our affiliates on the investment side and
improvements in short-term performance are encouraging, but we know
that we must do better. Lastly, we are focused on growth, both organically
and through the addition of new product capabilities that we believe will
leverage upon the distribution and corporate resources of Legg Mason.
4
In March 2009, we announced the launch of the Western
Asset Municipal Defined Opportunity Trust (MTT), a new,
non-diversified, closed-end fund that raised almost $240 million
in its initial public offering. In conjunction with the launch,
Western Asset’s Municipal Bond Portfolio team and
members of our senior leadership team rang the closing bell
at the New York Stock Exchange. Western Asset, one of the
world’s largest managers of fixed income investments, is also
Legg Mason’s largest affiliate.
Our international investment affiliates are located
throughout the Americas, Asia-Pacific and Europe
and offer a range of products for institutional and
retail investors in multiple currencies. Crystal Chan,
head of investments at Legg Mason Hong Kong,
was profiled by the Hong Kong Economic Journal in
its January 20, 2009 edition. Note: The copyright is
owned by Hong Kong Economic Journal Co. Ltd. All
rights reserved.
Legg MAson
2009 Annual Report
As we have stated in the past, we are confident in our managers and realize that
to outperform over the long term, there will be periods of underperformance.
We are hopeful that recent positive trends in the equity and credit markets
and improvements in our short-term performance, combined with the
underlying strength of our managers and operating flexibility, will lead
to increased market share over time, particularly as the broader markets
continue to improve and investor confidence returns.
Appreciation and Closing
Before closing, I want to acknowledge with deep gratitude the tremendous
leadership and dedication of Chip Mason, who retired from our Board of
Directors this year, 46 years after founding Mason & Company, a predecessor
to Legg Mason. Chip is most remembered for his prescience on the financial
services industry, superb leadership skills, and unwavering ethics. All of us
will be forever grateful for the successes and guidance he brought to Legg
Mason. I would also like to thank Jim Ukrop, who will be retiring from our
Board of Directors later this year, for his commitment and service to Legg
Mason over the years. I wish both Chip and Jim continued future success.
At Legg Mason, our aim is to be one of the best asset management firms
in the world. We are an investment-driven culture, and we aim to deliver
investment excellence, including superb client service, to all of our investors
around the world. We believe in our diversified, enhanced multi-manager
model. And we are focused on restoring our historically strong investment
performance, extending our global expansion, and returning to our path of
sustainable, profitable growth.
I cannot fully express my sincere gratitude to each Legg Mason employee
whose talent, professionalism, and dedication have enabled us to weather
this severe economic downturn. While we do not know what the future will
bring, I am confident that, more than ever, Legg Mason has the character
and competencies to lead in this coveted business and deliver strong returns
to our shareholders.
Permal, led by Isaac Souede, is one of the world’s
largest and oldest fund-of-hedge-fund managers
and provides investment opportunities in directional
and absolute return strategies across global financial
markets. In April 2009, Legg Mason and Permal
announced the launch of the Legg Mason Permal
Tactical Asset Allocation Fund, the first U.S.-domiciled,
Legg Mason open-end mutual fund that provides
individual investors access to Permal’s multi-strategy
global allocation strategy.
Mark R. Fetting
Chairman, President and Chief Executive Officer
June 15, 2009
Legg Mason’s Asset Management Symposium
showcases some of our leading investment
managers who discuss their market perspectives
and insights, including, in 2008, Chuck Royce from
Royce & Associates, Hersh Cohen from ClearBridge
Advisors, Bill Miller from Legg Mason Capital
Management and Ken Leech from Western Asset.
5
Montreal
Toronto
Kitchener
Chicago
Cincinnati
Baltimore
Easton
Boston
Stamford
New York
Philadelphia
Wilmington
Pasadena
San Francisco
Naples
Miami
Nassau
On the ground worldwide
Our managed assets now include $219.8 billion from clients domiciled
outside the United States. We have investment teams on the ground
around the world, including nearly 550 portfolio managers or research
analysts, 115 of which are located outside the United States. Our
affiliates offer a full spectrum of asset classes and investment mandates
to a broad range of clients in diverse geographies and in multiple
currencies. At year end, our firmwide client base extended to over
190 countries around the world.
São Paulo
Santiago
Western Asset is one of the
world’s largest managers of
fixed income investments,
offering a broad range
of fixed income services
representing a global array
of currencies, investment
strategies and markets.
Western Asset has an
integrated global investment
platform and offers over
100 products, managed
globally, in 17 currencies. At
year end, clients domiciled
outside the United States
contributed over 30% of
Western Asset’s total assets
under management.
Permal is one of the oldest
and largest fund-of-hedge-
fund managers in the world,
with over 30 years of
experience in the hedge
fund industry. In addition
to providing investment
opportunities in directional
and absolute return
strategies, the firm offers
multiple investment
programs covering a variety
of geographic regions,
investment strategies and
risk/return objectives to a
client base that extends to
more than 80 countries.
ClearBridge Advisors offers
a range of investment styles,
from small-cap value to
large-cap growth, all utilizing
a bottom-up, fundamental
approach to security
selection that is primarily
research driven with a
focus on companies with
solid economic returns
relative to their risk-adjusted
valuations. The firm’s
portfolio managers have
proven track records, with
an average of 24 years of
industry experience.
For more than 30 years,
Royce & Associates has
concentrated on investing in
smaller companies. Royce’s
investment team uses a
bottom-up, value-oriented
approach, seeking compa-
nies with strong balance
sheets, above-average
returns on capital and trading
at substantial discounts to
their intrinsic value. The firm
is particularly well-known
for its family of mutual
funds, The Royce Funds.
Established in 1982, Legg
Mason Capital Management
specializes in long-term,
valuation-based equity
management for its clients
around the world. The
firm’s investment team of
more than 40 professionals
applies its diverse talents,
perspectives and distinct
process across six equity
mandates: Value Equity,
Growth Equity, Opportunity
Equity, Mid-Cap, All Cap
and American Leading
Companies Equity.
London
Warsaw
Frankfurt
Paris
Luxembourg
Milan
Madrid
Tokyo
Dubai
Taipei
Hong Kong
Singapore
Sydney
Melbourne
Founded in 1986, Brandy-
wine Global has pursued
a singular investment
approach—value investing.
Brandywine Global works
consistently to strengthen
its fundamental and
quantitative research
capabilities and broaden
their application to new
securities and new markets.
The firm offers an array of
equity, fixed income and
balanced portfolios that
invest in U.S., international
and global markets.
Batterymarch, a pioneer in
quantitative equity manage-
ment, was one of the first
U.S.-based managers
to invest in international
and emerging markets.
Established in 1969, the
firm uses proprietary
strategies grounded in
time-tested fundamental
analysis to invest in
approximately 50 countries.
Each of Batterymarch’s
core and style products is
characterized by rigorous
bottom-up stock selection,
integrated risk control and
cost-efficient trading.
Headquartered in Naples,
Florida, Private Capital
Management was founded
in 1986. The firm is focused
on a single investment
discipline—US Value Equity.
Private Capital Management
pursues an absolute
return-oriented invest-
ment philosophy by
utilizing a bottom-up,
all-cap, value-oriented
investment approach.
Legg Mason Investment
Counsel provides highly
customized portfolio manage-
ment and trust services to
wealthy individuals, families
and institutions. The firm is
also nationally recognized
for expertise in socially
responsive investing. Portfolio
managers work directly with
clients to set investment
strategy and design a tailored
portfolio of individual securi-
ties across a broad array of
asset classes. The firm’s
proprietary fundamental
equity and fixed income
research focuses on quality
and competitive advantage.
The Legg Mason Global
Equities Group is a collection
of specialty firms that are
dedicated to global equities.
Each manager pursues a
unique investment strategy
and process, but collectively
benefit from the global
resources of Legg Mason.
The group includes Esemplia
Emerging Markets, Congruix
Investment Management,
and managers largely
dedicated to local equities
based in Australia, Hong
Kong and Poland.
Board of Directors
(left to right)
Nicholas J. St. George
Private Investor
roger W. Schipke
Private Investor
(Chairman of the Compensation Committee)
John E. Koerner iii
Managing Member, Koerner Capital, LLC
robert E. angelica
Private Investor; Former Chairman and CEO,
AT&T Investment Management Corporation
8
(left to right)
dennis r. beresford
Professor, University of Georgia;
Former Chairman of Financial Accounting
Standards Board (Chairman of Audit Committee)
Cheryl Gordon Krongard
Private Investor; Former CEO,
Rothschild Asset Management
Mark r. Fetting
Chairman, President and Chief Executive Officer,
Legg Mason, Inc.
Kurt L. Schmoke
Dean, School of Law at Howard University;
Former Mayor of Baltimore
Harold L. adams
Chairman Emeritus, RTKL Associates, Inc.
(left to right)
James E. ukrop
Chairman, Ukrop’s Super Markets, Inc.
Scott C. Nuttall
Member, Kohlberg Kravis Roberts & Co.
Margaret Milner richardson
Private Consultant and Investor; Former
U.S. Commissioner of Internal Revenue
W. allen reed
Private Investor; Retired CEO,
GM Asset Management Corporation
(Lead Independent Director and Chairman of
Nominating & Corporate Governance Committee)
NOTE: Barry Huff was elected to our Board of
Directors on June 9, 2009 (not pictured).
SELECTED FINANCIAL DATA
(Dollars in thousands, except per share amounts or unless otherwise noted)
2009
Years Ended March 31,
2007
2008
2006
2005
OPERATING RESULTS(1)
Operating revenues
Operating expenses, excluding impairment
Impairment of goodwill and intangible assets
Operating income (loss)
Other income (expense)
Fund support
Income (loss) from continuing operations
before income tax provision (benefit)
and minority interests
Income tax provision (benefit)
Income (loss) from continuing operations
before minority interests
Minority interests, net of tax
Income (loss) from continuing operations
Income from discontinued operations, net of tax
Gain on sale of discontinued operations, net of tax
Net income (loss)
PER SHARE
Net income (loss) per share:
Basic
Income (loss) from continuing operations
Income from discontinued operations
Gain on sale of discontinued operations
Diluted
Income (loss) from continuing operations
Income from discontinued operations
Gain on sale of discontinued operations
Weighted average shares outstanding:
Basic
Diluted(2)
Dividends declared
BALANCE SHEET
Total assets
Long-term debt
Total stockholders’ equity
FINANCIAL RATIOS AND OTHER DATA
Cash income (loss) from continuing operations
$ 3,357,367 $ 4,634,086 $4,343,675 $2,645,212 $1,570,700
1,081,583
—
489,117
(18,359)
—
2,718,577
1,307,970
(669,180)
(203,441)
(2,283,236)
3,432,910
151,000
1,050,176
971
(607,276)
3,315,377
—
1,028,298
15,556
—
1,965,482
—
679,730
35,732
—
(3,155,857)
(1,210,853)
443,871
175,995
1,043,854
397,612
715,462
275,595
470,758
175,334
(1,945,004)
(2,924)
(1,947,928)
—
—
$(1,947,928) $
267,876
(266)
267,610
—
—
295,424
—
295,424
113,007
—
267,610 $ 646,818 $1,144,168 $ 408,431
439,867
(6,160)
433,707
66,421
644,040
646,242
4
646,246
—
572
$
(13.85) $
—
—
$
(13.85) $
$
(13.85) $
—
—
$
(13.85) $
1.88 $
—
—
1.88 $
1.86 $
—
—
1.86 $
4.58 $
—
—
4.58 $
4.48 $
—
—
4.48 $
3.60 $
0.55
5.35
9.50 $
3.35 $
0.51
4.94
8.80 $
2.86
1.09
—
3.95
2.56
0.97
—
3.53
140,669
140,669
142,018
143,976
141,112
144,386
120,396
130,279
$
.960 $
.960 $
.810 $
.690 $
103,428
117,074
.550
$ 9,321,354 $11,830,352 $9,604,488 $9,302,490 $8,219,472
811,164
2,293,146
2,973,392
4,454,477
2,257,773
6,620,503
1,202,960
5,850,116
1,112,624
6,541,490
per diluted share (non-GAAP)(3)
$
(15.74) $
2.86 $
5.86 $
4.10 $
3.17
Profit margin:(4)
Pre-tax
After-tax
Total debt to total capital(5)
Assets under management (in millions)
Full-time employees
(94.0)%
(58.0)%
42.0%
$ 632,404 $
3,890
9.6%
5.8%
29.4%
24.0%
14.9%
14.5%
27.0%
16.6%
18.0%
30.0%
18.8%
26.1%
950,122 $ 968,510 $ 867,550 $ 374,529
5,580
4,030
3,820
4,220
(1) Reflects results of Citigroup’s asset management business (“CAM”) and Permal Group Ltd (“Permal”) since acquisition in fiscal 2006 and discontinued private client,
capital markets and mortgage banking and servicing operations, where applicable.
(2) Basic shares and diluted shares are the same for periods with a net loss.
(3) Cash income (loss) from continuing operations is a non-GAAP performance measure we define as income from continuing operations, plus amortization and deferred
taxes related to intangible assets and goodwill less deferred income taxes on goodwill and indefinite-life intangible asset impairments. See Supplemental Non-GAAP
Information in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(4) Calculated based on income from continuing operations before minority interests.
(5) Calculated based on total debt as a percentage of total capital (total stockholders’ equity plus total debt) as of March 31.
9
MANAgEMENT’S DISCuSSIoN AND A NALySIS oF
FINANCIAL Co NDITIoN AND R ESuLTS oF o pERATIoNS
EXECUTIVE OVERVIEW
Legg Mason, Inc., a holding company, with its subsidiar-
ies (which collectively comprise “Legg Mason”) is a global
asset management firm. Acting through our subsidiaries,
we provide investment management and related services
to institutional and individual clients, company-sponsored
mutual funds and other investment vehicles. We offer these
products and services directly and through various finan-
cial intermediaries. We have operations principally in the
United States of America and the United Kingdom and
also have offices in Australia, Bahamas, Brazil, Canada,
Chile, China, Dubai, France, Germany, Italy, Japan,
Luxembourg, Poland, Singapore, Spain and Taiwan.
We operate in one reportable business segment, Asset
Management. In connection with changes to our execu-
tive management during fiscal 2009 and a desire to
expand multi-channel distribution capabilities and to
better align our resources to access new growth opportu-
nities, we realigned our management responsibilities. As
a result, we now manage our business in two divisions or
operating segments, Americas and International, which
are primarily based on the geographic location of the
advisor or the domicile of fund families we manage. Our
division managers report directly to our Chief Executive
Officer. The Americas Division consists of our U.S.-
domiciled fund families, the separate account businesses
of our U.S.-based investment affiliates and the domestic
distribution organization. Similarly, the International
Division consists of our fund complexes, distribution
teams and investment affiliates located outside the U.S.
We believe this structure will provide greater focus and
allow us to maximize distribution efforts and more effi-
ciently take advantage of growth opportunities locally and
abroad. Presentation of all previously reported amounts
have been conformed to the new management structure.
Our operating revenues primarily consist of investment
advisory fees, from separate accounts and funds, and
distribution and service fees. Investment advisory fees
are generally calculated as a percentage of the assets of
the investment portfolios that we manage. In addition,
performance fees may be earned under certain investment
advisory contracts for exceeding performance bench-
marks. Distribution and service fees are fees received
for distributing investment products and services or for
providing other support services to investment portfolios,
and are generally calculated as a percentage of the assets
in an investment portfolio or as a percentage of new assets
added to an investment portfolio. Our revenues, therefore,
are dependent upon the level of our assets under manage-
ment, and thus are affected by factors such as securities
market conditions, our ability to attract and maintain
assets under management and key investment personnel,
and investment performance. Our assets under manage-
ment primarily vary from period to period due to inflows
and outflows of client assets and market performance.
Client decisions to increase or decrease their assets under
our management, and decisions by potential clients to
utilize our services, may be based on one or more of a
number of factors. These factors include our reputation in
the marketplace, the investment performance, both abso-
lute and relative to benchmarks or competitive products,
of our products and services, the client or potential client’s
situation, including investment objectives, liquidity needs,
investment horizon and amount of assets managed, our
relationships with distributors and the external economic
environment, including market conditions.
The fees that we charge for our investment services
vary based upon factors such as the type of underly-
ing investment product, the amount of assets under
management, and the type of services (and investment
objectives) that are provided. Fees charged for equity
asset management services are generally higher than fees
charged for fixed income and liquidity asset manage-
ment services. Accordingly, our revenues will be affected
by the composition of our assets under management.
In addition, in the ordinary course of our business, we
may reduce or waive investment management fees, or
limit total expenses, on certain products or services for
particular time periods to manage fund expenses, or for
other reasons, and to help retain or increase managed
assets. Under revenue sharing agreements, certain of
our subsidiaries retain different percentages of revenues
to cover their costs, including compensation. As such,
our net income, profit margin and compensation as a
percentage of operating revenues are impacted based on
which subsidiaries generate our revenues, and a change
in assets under management at one subsidiary can have
a dramatically different effect on our revenues and
earnings than an equal change at another subsidiary.
The most significant component of our cost structure is
employee compensation and benefits, of which a majority
is variable in nature and includes incentive compensation
that is primarily based upon revenue levels and profits.
The next largest component of our cost structure is distri-
bution and servicing fees, which are primarily fees paid to
third party distributors for selling our asset management
10
products and services and are largely variable in nature.
Certain other operating costs are fixed in nature, such
as occupancy, depreciation and amortization, and fixed
contract commitments for market data, communication
and technology services, and usually do not decline with
reduced levels of business activity or, conversely, usually
do not rise proportionately with increased business activity.
Our financial position and results of operations are mate-
rially affected by the overall trends and conditions of the
financial markets, particularly in the United States, but
increasingly in the other countries in which we operate.
Results of any individual period should not be considered
representative of future results. Our profitability is sensi-
tive to a variety of factors, including the amount and
composition of our assets under management, and the
volatility and general level of securities prices and interest
rates, among other things. Sustained periods of unfavor-
able market conditions are likely to affect our profitability
adversely. In addition, the diversification of services and
products offered, investment performance, access to dis-
tribution channels, reputation in the market, attracting
and retaining key employees and client relations are sig-
nificant factors in determining whether we are successful
in attracting and retaining clients. The economic down-
turn of the past year contributed to a significant contrac-
tion in our business.
The financial services business in which we are engaged is
extremely competitive. Our competition includes numer-
ous global, national, regional and local asset management
firms, broker-dealers and commercial banks. The industry
has been dramatically impacted by the economic down-
turn of the past year, and in prior years by the consolida-
tion of financial services firms through mergers and acqui-
sitions. During the fiscal years ended March 31, 2009 and
2008, the fixed income markets have endured substantial
turmoil. One effect of this turmoil was that liquidity in
the markets for many types of asset backed commercial
paper and medium term notes issued by structured invest-
ment vehicles (“SIVs”) became substantially reduced. As
a result, and to protect our clients, we entered into several
arrangements during fiscal 2008 and 2009 to provide
support to liquidity funds that are managed by a subsid-
iary that had invested in SIV securities.
The industry in which we operate is also subject to
extensive regulation under federal, state, and foreign
laws. Like most firms, we have been impacted by the
regulatory and legislative changes. Responding to these
changes has required us to incur costs that continue to
impact our profitability.
All references to fiscal 2009, 2008 or 2007 refer to our fis-
cal year ended March 31 of that year. Terms such as “we,”
“us,” “our,” and “company” refer to Legg Mason.
BUSINESS ENVIRONMENT AND
RESULTS OF OPERATIONS
The financial environment globally and in the United
States was volatile during fiscal 2009 and challenging
market conditions persisted throughout most of our fiscal
year. The sharp decline in equity markets and continu-
ing dislocations in the credit markets adversely affected
the entire financial sector during fiscal 2009. The equity
markets suffered from pullback in consumer spend-
ing, which led to weak performance in global markets,
increased unemployment, and significant declines in the
values of assets owned by financial institutions. Investors’
confidence continued to weaken, which caused a shift
in the markets from equity and corporate bonds to U.S.
treasury notes and bonds. As a result, all three major U.S.
equity market indices declined sharply during the fiscal
year. The Dow Jones Industrial Average,(1) NASDAQ
Composite Index(2) and the S&P 500(3) were down 38%,
33% and 40%, respectively, for the fiscal year. The
Barclays Capital U.S. Aggregate Bond Index(4) increased
3% and the Barclays Capital Global Aggregate Bond
Index(4) decreased 5%. During fiscal 2009, the Federal
Reserve Board reduced the discount rate by 2.00% to
the current rate of 0.25%. Our results were negatively
impacted by many of these factors. The financial envi-
ronment in which we operate continues to be challeng-
ing moving into fiscal 2010. We expect the challenges
presented by the credit markets to persist throughout the
next fiscal year. We cannot predict how these uncertain-
ties will impact the Company’s results.
(1) Dow Jones Industrial Average is a trademark of Dow Jones & Company, which is not affiliated with Legg Mason.
(2) NASDAQ is a trademark of the NASDAQ Stock Market, Inc., which is not affiliated with Legg Mason.
(3) S&P is a trademark of Standard & Poor’s, a division of the McGraw-Hill Companies, Inc., which is not affiliated with Legg Mason.
(4) Barclays Capital U.S. Aggregate Bond Index and Barclays Capital Global Aggregate Bond Index are trademarks of Barclays Capital, which is not affiliated with Legg Mason.
11
The following table sets forth, for the periods indicated, items in the Consolidated Statements of Operations as a per-
centage of operating revenues and the increase (decrease) by item as a percentage of the amount for the previous period:
Percentage of Operating Revenues
Years Ended
March 31,
2008
2009
2007
Period to Period Change(1)
2009
2008
Compared Compared
to 2008
to 2007
Operating Revenues
Investment advisory fees
Separate accounts
Funds
Performance fees
Distribution and service fees
Other
Total operating revenues
Operating Expenses
Compensation and benefits
Distribution and servicing
Communications and technology
Occupancy
Amortization of intangible assets
Impairment of goodwill and intangible assets
Other
Total operating expenses
Operating Income (Loss)
Other Income (Expense)
Interest income
Interest expense
Fund support
Other
Total other income (expense)
Income (Loss) from Continuing Operations
before Income Tax Provision (Benefit)
and Minority Interests
Income tax provision (benefit)
Income (Loss) from Continuing Operations
before Minority Interests
Minority interests, net of tax
Income from Continuing Operations
Gain on sale of discontinued operations,
net of tax
Net Income (Loss)
30.3%
54.7
0.5
14.2
0.3
100.0
31.6%
50.1
2.9
14.9
0.5
100.0
33.3%
46.5
3.3
16.5
0.4
100.0
(30.5)%
(20.8)
(86.9)
(31.4)
(54.0)
(27.6)
1.3%
14.7
(6.7)
(3.4)
53.9
6.7
33.7
28.9
5.6
6.2
1.1
39.0
5.4
119.9
(19.9)
1.7
(4.5)
(68.0)
(3.3)
(74.1)
(94.0)
(36.1)
(57.9)
(0.1)
(58.0)
33.9
27.5
4.2
2.8
1.2
3.3
4.4
77.3
22.7
1.7
(1.8)
(13.1)
0.1
(13.1)
9.6
3.8
5.8
—
5.8
36.1
27.5
4.0
2.3
1.6
—
4.8
76.3
23.7
1.4
(1.6)
—
0.5
0.3
24.0
9.1
14.9
—
14.9
—
(58.0)%
—
5.8%
—
14.9%
(27.9)
(23.9)
(2.3)
61.9
(36.3)
n/m
(13.3)
12.4
n/m
(26.8)
82.0
n/m
n/m
n/m
n/m
n/m
n/m
n/m
n/m
n/m
n/m
0.1
6.5
10.7
29.2
(16.3)
n/m
0.9
8.1
2.1
30.6
15.7
n/m
n/m
n/m
(57.5)
(55.7)
(58.5)
n/m
(58.6)
n/m
(58.6)
n/m—not meaningful
(1) Calculated based on the change in actual amounts between fiscal years as a percentage of the prior year amount.
12
FISCAL 2009 COMPARED WITH FISCAL 2008
Financial Overview
Net loss for the year ended March 31, 2009 totaled
$1.9 billion, or $13.85 per diluted share, compared to net
income of $267.6 million, or $1.86 per diluted share in the
prior year. During fiscal 2009, we eliminated the exposure
to SIVs of all liquidity funds managed by a subsidiary by
purchasing and subsequently selling, or reimbursing the
funds for a portion of the losses they incurred in selling,
all securities issued by SIVs held in our liquidity funds
and held by us. The majority of these SIV securities were
supported under capital support arrangements, letters of
credit or a total return swap (“TRS”) prior to the purchase.
These transactions, along with charges related to remain-
ing capital support arrangements that support securities
other than SIVs, resulted in aggregate charges during
the fiscal year of $2.3 billion. Also, during fiscal 2009,
impairment charges of $1.3 billion were recorded, related
to goodwill and intangible assets, primarily in our former
Wealth Management division, as a result of declines in the
assets under management (“AUM”) and projected cash
flows of affiliates in that division, and a reduction in the
value of certain acquired management contract intangible
assets and a related trade name. Cash loss from continu-
ing operations (see Supplemental Non-GAAP Financial
Information) was $2.2 billion, or $15.74 per diluted share,
compared to cash income of $412.3 million, or $2.86
per diluted share, in the prior year. These decreases were
primarily due to an increase in net losses related to the
elimination of SIV exposure, net of income tax benefits
and compensation related adjustments, of $1.1 billion, or
$7.61 per diluted share, and an increase in pre-tax impair-
ment charges of $1.2 billion, or $8.25 per diluted share.
The pre-tax profit margin from continuing operations
declined to (94.0%) from 9.6% in the prior year. The pre-
tax profit margin from continuing operations, as adjusted
(see Supplemental Non-GAAP Financial Information),
declined to (132.2%) from 13.2% in the prior year.
During fiscal 2009, losses related to liquidity fund sup-
port and the impairment charge reduced the pre-tax profit
margin by 66.2 percentage points and 39.0 percentage
points, respectively, and reduced the pre-tax profit margin,
as adjusted, by 93.1 percentage points and 54.8 percentage
points, respectively. During fiscal 2008, losses related to
liquidity fund support and the impairment charge reduced
the pre-tax profit margin by 11.0 percentage points and
3.3 percentage points, respectively, and reduced the pre-tax
profit margin, as adjusted, by 15.1 percentage points and
4.5 percentage points, respectively.
Assets Under Management
The components of the changes in our AUM (in billions)
for the years ended March 31 were as follows:
Beginning of period
Investment funds, excluding
liquidity funds:
Sales
Redemptions
Separate account flows, net
Liquidity fund flows, net
Net client cash flows
Market performance(1)
Dispositions
End of period
(1) Includes impact of foreign exchange
2009
$ 950.1
2008
$968.5
35.6
(58.3)
(121.2)
(15.0)
(158.9)
(157.7)
(1.1)
$ 632.4
38.5
(57.1)
(13.4)
5.7
(26.3)
9.9
(2.0)
$950.1
AUM at March 31, 2009 were $632.4 billion, a decrease
of $317.7 billion or 33% from March 31, 2008. The
decrease in AUM was attributable to net client outflows
of $159 billion and market depreciation of $158 billion,
of which approximately 10% was related to the impact
of foreign currency exchange fluctuation. There were
net client outflows in all asset classes. The majority of
outflows were in fixed income with $89 billion, or 56%
of the outflows, followed by equity outflows and liquidity
outflows of $47 billion and $23 billion, respectively. The
majority of fixed income outflows were in products man-
aged by Western Asset Management Company (“Western
Asset”) that have experienced investment performance
issues, especially over the last fiscal year. Equity out-
flows were primarily experienced by key equity products
managed at ClearBridge Advisors LLC (“ClearBridge”),
Legg Mason Capital Management, Inc. (“LMCM”) and
Permal. Due in part to investment performance issues,
we have experienced net equity outflows since fiscal
2007. We generally earn higher fees and profits on equity
AUM, and outflows in this asset class will more nega-
tively impact our revenues and net income than would
outflows in other asset classes. In addition, due in part
to recent investment performance issues, we have experi-
enced outflows in our fixed income asset class for the past
five quarters.
Our investment advisory and administrative contracts
are generally terminable at will or upon relatively short
notice, and investors in the mutual funds that we man-
age may redeem their investments in the funds at any
time without prior notice. Institutional and individual
13
clients can terminate their relationships with us, reduce
the aggregate amount of assets under management, or
shift their funds to other types of accounts with differ-
ent rate structures for any number of reasons, including
investment performance, changes in prevailing interest
rates, changes in our reputation in the marketplace,
changes in management or control of clients or third
party distributors with whom we have relationships, loss
of key investment management personnel or financial
market performance.
In response to the unprecedented market turmoil, during the
December quarter, Permal temporarily modified its redemp-
tion notice timing to require 95 day prior notification rather
than the historical 20 days. With the objective of returning
to the 20 day notice period by January 2010, the current 95
day notice period for redemptions will be reduced to 65 days
beginning with the September 30, 2009 redemption date.
As of March 31, 2009, Permal had received approximately
$2.4 billion of gross redemption notices that, unless with-
drawn, will be redeemed in the June quarter.
AUM by Asset Class
AUM by asset class (in billions) as of March 31 were as follows:
Equity
Fixed Income
Liquidity
Total
2009
$126.9
357.6
147.9
$632.4
% of
Total
20.1
56.5
23.4
100.0
2008
$271.6
508.2
170.3
$950.1
% of
Total
28.6
53.5
17.9
100.0
%
Change
(53.3)
(29.6)
(13.2)
(33.4)
The component changes in our AUM by asset class (in billions) for the fiscal year ended March 31, 2009 were as follows:
Fixed Income
$508.2
Liquidity
$170.3
Total
$ 950.1
35.6
(58.3)
(121.2)
(15.0)
(158.9)
(157.7)
(1.1)
$ 632.4
%
Change
(38.0)
(12.2)
3.2
(18.1)
—
—
(8.2)
(15.0)
(23.2)
0.8
—
$147.9
% of
Total
33.1
50.3
16.6
100.0
March 31, 2008
Investment funds, excluding liquidity funds
Sales
Redemptions
Separate account flows, net
Liquidity fund flows, net
Net client cash flows
Market performance
Dispositions
March 31, 2009
Equity
$271.6
20.9
(32.2)
(35.3)
—
(46.6)
(97.0)
(1.1)
$126.9
14.7
(26.1)
(77.7)
—
(89.1)
(61.5)
—
$357.6
Average AUM by asset class (in billions) for the year ended March 31 were as follows:
Equity
Fixed Income
Liquidity
Total
2009
$203.2
438.0
169.2
$810.4
% of
Total
25.1
54.0
20.9
100.0
2008
$327.6
498.6
163.9
$990.1
14
AUM by Division
AUM by division (in billions) as of March 31 were as follows:
Americas
International
Total
2009
$446.5
185.9
$632.4
% of
Total
70.6
29.4
100.0
2008
$671.2
278.9
$950.1
% of
Total
70.6
29.4
100.0
%
Change
(33.5)
(33.3)
(33.4)
The component changes in our AUM by division (in billions) for the year ended March 31, 2009 were as follows:
March 31, 2008
Investment funds, excluding liquidity funds
Sales
Redemptions
Separate account flows, net
Liquidity fund flows, net
Net client cash flows
Market performance
Dispositions
March 31, 2009
Americas
$ 671.2
28.3
(46.4)
(84.5)
(6.7)
(109.3)
(114.3)
(1.1)
$ 446.5
International
$278.9
7.3
(11.9)
(36.7)
(8.3)
(49.6)
(43.4)
—
$185.9
Total
$ 950.1
35.6
(58.3)
(121.2)
(15.0)
(158.9)
(157.7)
(1.1)
$ 632.4
During April 2009, we estimate that our AUM increased
approximately 1% from March 31, 2009 as a result of
positive market performance of 4% offset by net client
outflows of 3%. These outflows were consistent with
March quarter outflows. Equity assets and fixed income
assets increased 7% partially offset by a decrease in liquid-
ity assets of 1%.
Investment Performance(5)
Legg Mason is a diversified global asset management
company that offers a wide range of investment prod-
ucts. We provide investment services to both retail and
institutional clients that span many asset classes, levels
of risk, geographic locations and investment styles. As of
March 31, 2009 and 2008, equity assets accounted for
20% and 29%, respectively, fixed income accounted for
57% and 53%, respectively, and liquidity accounted for
the remaining 23% and 18%, respectively, of our assets
under management.
The past 12 months were characterized by significant vol-
atility with erratic, unprecedented price movements across
a variety of markets. The markets have been significantly
impacted by the failure of major financial institutions, the
freeze in the credit markets and unprecedented govern-
ment intervention. In addition, the downturn in housing
that led the U.S. into a broader slowdown set off financial
turmoil that continues. As a result, financial stocks led the
equity markets lower, with the S&P 500 Financials Index
down 63%, compared to the broader S&P 500 Index,
which dropped 38%. As of March 31, 2009, for the trail-
ing 1-year, 3-year, 5-year, and 10-year periods approxi-
mately 49%, 53%, 58%, and 88% of our marketed
equity composite(6) assets outpaced their benchmarks,
respectively. As of March 31, 2008, for the trailing 1-year,
3-year, 5-year, and 10-year periods approximately 53%,
53%, 49%, and 94% of our marketed equity composite
assets outpaced their benchmarks, respectively.
In the fixed income markets, the economic crisis deep-
ened, but the government’s numerous actions laid the
foundation for a recovery, causing investor confidence to
improve modestly late in the March 2009 quarter. The
new fiscal stimulus package designed to aid the economy,
and the government’s intention to issue more public debt
for financing, caused yields to rise during the quarter.
(5) Index performance in this section includes reinvestment of dividends and capital gains.
(6) A composite is an aggregation of discretionary portfolios (separate accounts and investment funds) into a single group that represents a particular investment objective or strategy.
Each of our asset managers has its own specific guidelines for including portfolios in its marketed composites. Assets under management that are not managed in accordance with
the guidelines are not included in a composite. As of March 31, 2009, 85% of our equity assets under management and 84% of our fixed income assets under management were in
marketed composites. As of March 31, 2008, 86% of our equity assets under management and 83% of our fixed income assets under management were in marketed composites.
15
For the 1-year period, Treasury yields have decreased sig-
nificantly while long term rates have increased resulting
in a steeper yield curve. In addition, the worst perform-
ing sectors were home equity asset-backed securities and
investment grade corporate securities as measured by the
Barclays ABS Home Equity Index returning (35)% and
the Barclays U.S. Corporate Investment Grade Index
returning (7)% for the 1-year period. As of March 31,
2009, for the trailing 1-year, 3-year, 5-year, and 10-year
periods approximately 31%, 12%, 32%, and 17% of our
marketed fixed income composite assets outpaced their
benchmarks, respectively. As of March 31, 2008, for
the trailing 1-year, 3-year, 5-year, and 10-year periods
approximately 4%, 21%, 54%, and 74% of our fixed
income marketed composite assets outpaced their bench-
marks, respectively.
As of March 31, 2009, for the trailing 1-year, 3-year,
5-year, and 10-year periods 43%, 52%, 47%, and 75% of
our U.S. long-term mutual fund(7) assets outpaced their
Lipper category average, respectively.
As of March 31, 2008, for the trailing 1-year, 3-year,
5-year, and 10-year periods 41%, 45%, 57%, and 85% of
our U.S. long-term mutual fund(7) assets outpaced their
Lipper category average, respectively.
As of March 31, 2009, for the trailing 1-year, 3-year,
5-year, and 10-year periods 47%, 60%, 49%, and 76% of
our U.S. equity mutual fund(7) assets outpaced their Lipper
category average, respectively. As of March 31, 2008, for
the trailing 1-year, 3-year, 5-year, and 10-year periods
45%, 50%, 50%, and 91% of our U.S. equity mutual fund(7)
assets outpaced their Lipper category average, respectively.
As of March 31, 2009, for the trailing 1-year, 3-year,
5-year, and 10-year periods 38%, 41%, 45%, and 72% of
our U.S. fixed income mutual fund(7) assets outpaced their
Lipper category average, respectively. As of March 31,
2008, for the trailing 1-year, 3-year, 5-year, and 10-year
periods 33%, 34%, 67%, and 68% of our U.S. fixed
income mutual fund(7) assets outpaced their Lipper cat-
egory average, respectively.
Revenue by Division
Operating revenues by division (in millions) for the years ended March 31 were as follows:
Americas
International
Total
2009
$2,290.5
1,066.9
$3,357.4
% of
Total
68.2
31.8
100.0
2008
$3,217.2
1,416.9
$4,634.1
% of
Total
69.4
30.6
100.0
%
Change
(28.8)
(24.7)
(27.6)
The decrease in operating revenues in the Americas divi-
sion was primarily due to decreased mutual fund advisory
fees on assets managed by LMCM, ClearBridge and
Royce & Associates, LLC (“Royce”), decreased sepa-
rate account advisory fees on assets managed by Private
Capital Management, LP (“PCM”), ClearBridge and
LMCM and decreased distribution and service fee rev-
enues from U.S. retail equity funds. The decrease in oper-
ating revenues in the International division was primarily
due to a decline in fund revenues and performance fees
at Permal, lower separate account advisory fees on assets
managed by Western Asset and decreased distribution and
service fee revenues from International balanced and fixed
income funds.
RESULTS OF OPERATIONS
Operating Revenues
Revenues from continuing operations for the year ended
March 31, 2009 were $3.4 billion, down 28% from
$4.6 billion in the prior year primarily as a result of an
18% decrease in average AUM, due to a decline in aver-
age equity assets of approximately 38% and fixed income
assets of approximately 12%. The shift in the mix of
AUM from higher fee equity assets to a greater percentage
of fixed income and liquidity assets also contributed to the
revenue decline. Operating revenues were also negatively
impacted by a decline in performance fees of approxi-
mately $115.3 million, or 87%.
(7) Source: Lipper Inc. includes open-end, closed-end, and variable annuity funds. As of March 31, 2009 and 2008, the U.S. long-term mutual fund assets represented in
the data accounted for 12% and 14%, respectively, of our total assets under management. The performance of our U.S. long-term mutual fund assets is included in the
marketed composites.
16
Investment advisory fees from separate accounts decreased
$447.3 million, or 31%, to $1.0 billion. Of this decrease,
$273.1 million was the result of lower average equity assets
at PCM, ClearBridge, LMCM and Brandywine Global
Investment Management, LLC (“Brandywine”), $80.9 mil-
lion was the result of lower average fixed income assets man-
aged at Western Asset, and $43.9 million was the result of the
sale of the Legg Mason Private Portfolio Group (“LMPPG”)
business. See Note 2 of Notes to Consolidated Financial
Statements for a description of the sale.
Investment advisory fees from funds decreased $483.4 mil-
lion, or 21%, to $1.8 billion. Of this decrease approxi-
mately $450 million was the result of lower average equity
assets managed primarily at LMCM, ClearBridge, Permal,
and Royce, approximately $76 million was the result of
lower average fixed income assets managed at Western
Asset, offset by approximately $42 million which was the
result of increased liquidity assets managed, primarily at
Western Asset.
Performance fees decreased 87%, or $115.3 million, to
$17.4 million during fiscal 2009, primarily as a result of a
decrease in performance fees earned on alternative invest-
ment products at Permal.
Distribution and service fees decreased 31% to $475.0 mil-
lion primarily as a result of a decline in average AUM of the
retail share classes of our domestic and international equity
funds, which resulted in a decrease of $176.7 million.
Operating Expenses
During the past year, market conditions have contributed
to a reduction in our AUM, revenues and earnings. As
discussed above, although a significant portion of our
expenses are variable and largely increase or decrease
proportionately with revenue, a portion of our expenses
are fixed and do not decline with reduced revenues. As a
result of the substantial decline in revenues during fiscal
2009, certain actions were taken to reduce our corporate
cost structure. These cost-saving measures primarily
include reductions in headcount and discretionary incen-
tive compensation in administrative and business sup-
port functions, significant reductions in the utilization
of consultants for technology projects, and substantial
curtailment of travel and entertainment costs. These
measures, and other less significant actions, have resulted
in the elimination of approximately $135 million in costs
on an annualized basis, before costs incurred to achieve
these savings, such as severance. The discussion below
for each of our operating expenses identifies the amount
of variance attributable to cost-savings achieved in fiscal
2009, where applicable.
Compensation and benefits decreased 28% to $1.1 bil-
lion. This decrease was primarily driven by a $341 million
decrease in revenue share based compensation related to
lower revenues in fiscal 2009; the impact of cost savings
initiatives, such as reductions in headcount, discretion-
ary incentives and other discretionary compensation that
lowered compensation by approximately $86 million
and a decrease in deferred compensation obligations of
approximately $59 million resulting from market losses on
invested assets of deferred compensation plans (which are
largely offset by losses in other non-operating expense).
These decreases were offset in part by lower incentive
compensation reductions of $40 million related to charges
to provide support for certain liquidity funds that held
SIV-issued securities. Compensation as a percentage of
operating revenues decreased slightly to 33.7% from
33.9% in the prior fiscal year as compensation reductions
related to unrealized market losses on deferred compensa-
tion plans were substantially offset by fixed compensation
costs of administrative and sales personnel which do not
vary with revenues.
Distribution and servicing expenses decreased 24% to
$970.0 million, primarily as a result of a decrease in aver-
age AUM in certain products for which we pay fees to
third-party distributors.
Communications and technology expense decreased 2% to
$188.3 million, primarily as a result of cost savings initia-
tives that led to an $11.3 million decrease in technology
consulting fees, offset in part by a $4.1 million increase in
market data costs for services previously included in Other
expenses, and a $3.2 million increase in depreciation
expense related to investment management infrastructure.
Occupancy expense increased 62% to $209.5 million, pri-
marily as a result of lease reserves related to office vacan-
cies totaling $70.1 million and accelerated depreciation of
assets in vacated space of $9.0 million.
Amortization of intangible assets decreased 36% to
$36.5 million, primarily as a result of the sale of the
LMPPG business, which reduced amortization expense
by $10.6 million, and the impact of the impairment
of intangible assets in fiscal year 2008, which reduced
amortization expense by $6.6 million.
17
Impairment charges increased to $1.3 billion. Approximately
$1.2 billion of the total impairment charges relate to
goodwill and intangible assets in our former Wealth
Management division as a result of significant declines
in the AUM and a reduction in projected cash flows
of the division. The remaining $146 million relates to
certain acquired management contracts, as a result of
a more accelerated rate of client attrition, and a related
trade name. See Critical Accounting Policies and Note 5
of Notes to Consolidated Financial Statements for fur-
ther discussion of the impairment charges.
Other expenses decreased $27.8 million to $182.1 million,
primarily as a result of cost savings initiatives that resulted
in reduced travel and entertainment costs of $11.4 mil-
lion, lower professional fees of $7.2 million and lower
advertising costs of $5.4 million. In addition, the sale of
the LMPPG overlay and implementation business elimi-
nated support costs of approximately $5 million.
Operating expenses in fiscal 2010 will continue to benefit
from the cost reduction initiatives implemented in fiscal
2009. In addition, we have planned and are in the process
of implementing additional cost reductions to bring the
total amount to $160 million on an annualized basis by
September 30, 2009. However, our business is dynamic
and requires us to incur incremental expenses from time to
time to grow and better support the business. For example,
operating expenses in fiscal 2010 will reflect incremental
costs of approximately $10 million associated with the
relocation of our corporate headquarters. In addition, from
time to time we fill key positions and take actions to retain
key talent that would require additional compensation.
As discussed above, during fiscal 2010, we will relocate
our corporate headquarters. We are currently pursuing
sub-tenants for certain floors under lease that will be unoc-
cupied as a result of headcount reductions. Given the cur-
rent commercial real estate market, at the time we secure
a sub-lease or the space is deemed to be permanently
abandoned, we will likely recognize a charge for the pres-
ent value of the amount by which our commitment under
our lease exceeds the amount due to us under the expected
sub-lease terms. However, subsequent to any such charge,
occupancy expense will be reduced by the amount of our
lease costs attributable to the sublet floors.
Non-Operating Income (Expense)
Interest income decreased 27% to $56.3 million primarily
as a result of a decline in average interest rates earned on
investment balances, which decreased interest income by
$42.1 million, offset in part by higher average investment
account balances due to proceeds from the issuance of
debt, which increased interest income by $25.3 million.
Interest expense increased 82% to $150.5 million as a
result of higher debt levels. We raised $1.15 billion in May
2008 by issuing Equity Units, and $1.25 billion by issu-
ing 2.5% convertible senior notes in January 2008, which
resulted in an increase of approximately $83.1 million in
interest expense. These increases were offset in part by the
impact of the repayment of $425 million principal amount
of 6.75% senior notes in July 2008 and lower interest
rates paid on our term loan, which together resulted in a
decrease of $28.6 million.
During fiscal 2010, interest expense will increase by
$32.3 million as a result of the adoption of FASB
Staff Position (“FSP”) No. APB 14-1, “Accounting for
Convertible Debt Instruments That May Be Settled
in Cash upon Conversion (Including Partial Cash
Settlement),” related to our 2.5% convertible senior
notes. See Other Recent Accounting Developments in
Note 1 of Notes to Consolidated Financial Statements
for more information on this FSP.
Fund support losses increased $1.7 billion, primarily as a
result of continued SIV price deterioration and our elimina-
tion of SIV exposure. See Note 17 of Notes to Consolidated
Financial Statements for additional information.
Other non-operating income (expense) decreased $116.0 mil-
lion to a loss of $109.2 million, primarily as a result of an
increase of $58.3 million in unrealized market losses on
assets held in deferred compensation plans, which are offset
by corresponding compensation reductions discussed above,
and $33.1 million in unrealized market losses on invest-
ments in proprietary fund products.
Income Tax Benefit
The income tax benefit was $1.2 billion compared to
income tax expense of $176.0 million in the prior year,
primarily as a result of the losses related to liquidity fund
support and charges for impairment of goodwill and intan-
gible assets. The effective tax rate was a benefit of 38.4% in
the current year compared to a 39.7% provision in the prior
year. The current year benefit rate is primarily driven by the
impact of the SIV-related charges with lower state tax ben-
efits. In addition, the current year includes approximately
$80 million in tax benefits associated with the restructur-
ing of a foreign subsidiary, offset by the impact of a non-
deductible portion of the goodwill impairment charge.
18
Supplemental Non-GAAP Financial Information
Cash Income from Continuing Operations
As supplemental information, we are providing a perfor-
mance measure that is based on a methodology other than
generally accepted accounting principles (“non-GAAP”)
for “cash income from continuing operations” that man-
agement uses as a benchmark in evaluating and compar-
ing the period-to-period operating performance of Legg
Mason. We define “cash income from continuing opera-
tions” as income (loss) from continuing operations, plus
amortization and deferred taxes related to intangible assets
and goodwill less deferred income taxes on goodwill and
indefinite-life intangible asset impairment. We believe that
cash income (loss) from continuing operations provides a
good representation of our operating performance adjusted
for non-cash acquisition related items and it facilitates
comparison of our results to the results of other asset man-
agement firms that have not engaged in significant acquisi-
tions, including any related goodwill or intangible asset
impairments. We also believe that cash income (loss) from
continuing operations is an important metric in estimating
the value of an asset management business. This measure
is provided in addition to income from continuing opera-
tions, but is not a substitute for income from continuing
operations and may not be comparable to non-GAAP per-
formance measures, including measures of cash earnings
or cash income, of other companies. Further, cash income
from continuing operations is not a liquidity measure and
should not be used in place of cash flow measures deter-
mined under GAAP. We consider cash income from con-
tinuing operations to be useful to investors because it is an
important metric in measuring the economic performance
of asset management companies, as an indicator of value
and because it facilitates comparisons of our operating
results with the results of other asset management firms
that have not engaged in significant acquisitions.
In calculating cash income from continuing operations,
we add the impact of the amortization of intangible assets
from acquisitions, such as management contracts, to
income from continuing operations to reflect the fact that
this non-cash expense makes it difficult to compare our
operating results with the results of other asset manage-
ment firms that have not engaged in significant acquisi-
tions. Deferred taxes on indefinite-life intangible assets
and goodwill represent actual tax benefits that are not
realized under GAAP absent an impairment charge or the
disposition of the related business. Because we actually
receive these tax benefits on indefinite-life intangible assets
and goodwill over time, we add them to income in the
calculation of cash income from continuing operations.
Conversely, we subtract income taxes on these impairment
charges that have been recognized under GAAP.
Should a disposition or impairment charge occur on
indefinite-life intangible assets or goodwill, its impact on
cash income from continuing operations may distort actual
changes in the operating performance or value of our firm.
Accordingly, we monitor changes in indefinite-life intan-
gible assets and goodwill and the related impact, including
taxes, on cash income from continuing operations to ensure
appropriate adjustments and explanations accompany dis-
closures of cash income from continuing operations.
Although depreciation and amortization on fixed assets
are non-cash expenses, we do not add these charges in cal-
culating cash income from continuing operations because
these charges are related to assets that will ultimately
require replacement.
19
A reconciliation of income from continuing operations to cash income from continuing operations (in thousands except
per share) is as follows:
Income (Loss) from Continuing Operations
Plus (Less):
Amortization of intangible assets
Deferred income taxes on intangible assets
Deferred income taxes on impairment charges
Cash Income (Loss) from Continuing Operations
Cash Income (Loss) from Continuing Operations per Diluted Share
Income (Loss) from Continuing Operations per diluted share
Amortization of intangible assets
Deferred income taxes on intangible assets
Deferred income taxes on impairment charges
Cash Income (Loss) from Continuing Operations per Diluted Share
For the Years Ended March 31,
2008
2009
$267,610
$(1,947,928)
36,488
142,494
(444,618)
$(2,213,564)
$
$
(13.85)
0.26
1.01
(3.16)
(15.74)
57,271
143,600
(56,187)
$412,294
$
$
1.86
0.40
0.99
(0.39)
2.86
The decrease in cash income from continuing operations
was primarily due to an increase in pre-tax impairment
charges of $1.2 billion, or $8.25 per diluted share, and
an increase in net losses related to the elimination of SIV
exposure of $1.1 billion, or $7.61 per diluted share.
Pre-tax Profit Margin from Continuing
Operations, as Adjusted
We believe that pre-tax profit margin from continu-
ing operations adjusted for distribution and servicing
expense is a useful measure of our performance because it
indicates what our margins would have been without the
distribution revenues that are passed through to third par-
ties as a direct cost of selling our products, and thus shows
the effect of these revenues on our margins. This measure
is provided in addition to the Company’s pre-tax profit
margin from continuing operations calculated under
GAAP, but is not a substitute for calculations of margin
under GAAP and may not be comparable to non-GAAP
performance measures, including measures of adjusted
margins, of other companies.
A reconciliation of pre-tax profit margin from continuing operations adjusted for distribution and servicing expense (in
thousands) is as follows:
Operating Revenues, GAAP basis
Less:
Distribution and servicing expense
Operating Revenues, as adjusted
Income (Loss) before Income Tax Provision (Benefit)
and Minority Interests
Pre-tax profit margin, GAAP basis
Pre-tax profit margin, as adjusted
For the Years Ended March 31,
2009
$ 3,357,367
2008
$4,634,086
969,964
$ 2,387,403
1,273,986
$3,360,100
$(3,155,857)
$ 443,871
(94.0)%
(132.2)
9.6%
13.2
During fiscal 2009, losses related to liquidity fund sup-
port and impairment charges reduced the pre-tax profit
margin by 66.2 percentage points and 39.0 percent-
age points, respectively, and reduced the pre-tax profit
margin, as adjusted, by 93.1 percentage points and 54.8
percentage points, respectively. During fiscal 2008, losses
related to liquidity fund support and the impairment of
management contracts reduced the pre-tax profit margin
by 11.0 percentage points and 3.3 percentage points,
respectively, and reduced the pre-tax profit margin, as
adjusted, by 15.1 percentage points and 4.5 percentage
points, respectively.
20
FISCAL 2008 COMPARED WITH FISCAL 2007
Financial Overview
During fiscal 2008, we entered into several transactions
to provide support to certain liquidity funds that held
securities issued by SIVs that are managed by a subsidiary.
These transactions resulted in aggregate charges during
the fiscal year of $607.3 million. Also, during fiscal 2008,
an impairment charge of $151.0 million was recorded
for a reduction in the value of certain acquired manage-
ment contract intangible assets. Net income for the year
ended March 31, 2008 totaled $267.6 million, or $1.86
per diluted share, a decrease of 59% and 58%, respec-
tively, from the prior year. Cash income from continu-
ing operations (see Supplemental Non-GAAP Financial
Information) was $412.3 million, or $2.86 per diluted
share, each representing a decrease of 51% from the prior
year. These decreases were primarily due to net losses
related to liquidity fund support, net of income tax bene-
fits and compensation related adjustments, of $313.7 mil-
lion, or $2.18 per diluted share, and the pre-tax impair-
ment charge of $151.0 million, or $1.05 per diluted share.
The pre-tax profit margin from continuing operations
declined to 9.6% from 24.0% in the prior year. The pre-
tax profit margin from continuing operations, as adjusted
(see Supplemental Non-GAAP Financial Information),
declined to 13.2% from 33.2% in the prior year. During
fiscal 2008, losses related to liquidity fund support and
the impairment charge reduced the pre-tax profit mar-
gin by 11.0 percentage points and 3.3 percentage points,
respectively, and reduced the pre-tax profit margin, as
adjusted, by 15.1 percentage points and 4.5 percentage
points, respectively.
Assets Under Management
The components of the changes in our assets under manage-
ment (“AUM”) (in billions) for the years ended March 31
were as follows:
Beginning of period
Net client cash flows
Market performance
Acquisitions (dispositions), net
End of period
2008
$968.5
(26.3)
9.9
(2.0)
$950.1
2007
$867.6
44.2
57.5
(0.8)
$968.5
AUM at March 31, 2008 were $950.1 billion, a decrease
of $18.4 billion or 2% from March 31, 2007. Net client
cash outflows for the fiscal year were $26.3 billion and
were driven by outflows in equity assets of approximately
$44 billion, resulting, in part, from lower relative invest-
ment performance, partially offset by approximately
$15 billion and $3 billion of fixed income and liquidity
inflows, respectively.
AUM by Asset Class
AUM by asset class (in billions) as of March 31 were as follows:
Equity
Fixed Income
Liquidity
Total
2008
$271.6
508.2
170.3
$950.1
% of
Total
28.6
53.5
17.9
100.0
2007
$338.0
470.9
159.6
$968.5
Average AUM by asset class (in billions) for the year ended March 31 were as follows:
Equity
Fixed Income
Liquidity
Total
2008
$327.6
498.6
163.9
$990.1
% of
Total
33.1
50.3
16.6
100.0
2007
$325.1
441.9
138.8
$905.8
% of
Total
34.9
48.6
16.5
100.0
% of
Total
35.9
48.8
15.3
100.0
%
Change
(19.6)
7.9
6.7
(1.9)
%
Change
0.8
12.8
18.1
9.3
21
AUM by Division
AUM by division (in billions) as of March 31 were as follows:
Americas
International
Total
2008
$671.2
278.9
$950.1
% of
Total
70.6
29.4
100.0
2007
$693.8
274.7
$968.5
% of
Total
71.6
28.4
100.0
%
Change
(3.3)
1.5
(1.9)
The component changes in our AUM by division (in billions) for the year ended March 31, 2008 were as follows:
March 31, 2007
Net client cash flows
Market performance
Acquisitions (dispositions), net
March 31, 2008
Americas
$693.8
(8.7)
(12.6)
(1.3)
$671.2
International
$274.7
(17.6)
22.5
(0.7)
$278.9
Total AUM
$968.5
(26.3)
9.9
(2.0)
$950.1
Revenue by Division
Operating revenues by division (in millions) for the years ended March 31 were as follows:
Americas
International
Total
2008
$3,217.2
1,416.9
$4,634.1
% of
Total
69.4
30.6
100.0
2007
$3,169.4
1,174.3
$4,343.7
% of
Total
73.0
27.0
100.0
%
Change
1.5
20.7
6.7
The increase in operating revenues in the Americas divi-
sion was primarily due to increased mutual fund advisory
fees on assets managed by Western Asset and Royce and
increased separate account advisory fees on assets man-
aged by Western Asset and Brandywine. These were par-
tially offset by decreased separate account advisory fees on
assets managed by PCM, decreased mutual fund advisory
fees on assets managed by ClearBridge and decreased
distribution and service fee revenues from U.S. retail
equity funds. The increase in operating revenues in the
International division was primarily due to increased fund
revenues at Permal and Legg Mason Poland.
RESULTS OF OPERATIONS
Operating Revenues
Revenues from continuing operations for the year ended
March 31, 2008 were $4.6 billion, up 7% from $4.3 bil-
lion in the prior year primarily as a result of a 9% increase
in average AUM, principally in the liquidity and fixed
income asset classes.
Investment advisory fees from separate accounts increased
1%, or $18.7 million, to $1.46 billion, primarily as a
result of higher average assets managed by Western Asset,
Brandywine and Batterymarch Financial Management
Inc., offset in part by a decline in advisory fees due to
lower average assets managed by PCM and ClearBridge.
Investment advisory fees from funds increased 15% to
$2.3 billion, primarily as a result of an increase in aver-
age assets managed by Permal, Western Asset and Royce.
These increases were partially offset by a decrease in aver-
age assets managed by ClearBridge.
Performance fees decreased 7%, or $9.5 million, to
$132.7 million during fiscal 2008, primarily as a result of
decreases in performance fees earned by Western Asset,
and LMCM, which were partially offset by an increase in
performance fees earned by Permal.
Distribution and service fees decreased 3% to $692.3 mil-
lion primarily as a result of a decline in average AUM of
the retail share classes of our domestic equity funds.
Operating Expenses
Compensation and benefits remained flat at $1.6 billion,
as increased revenue-share based incentive expense on
22
higher revenues along with higher salary and benefits at
certain of our subsidiaries were substantially offset by
incentive expense reductions related to charges to provide
support for certain liquidity funds that hold SIV-issued
securities. See Note 17 of Notes to Consolidated Financial
Statements for further discussion of these charges related
to our liquidity business. Compensation as a percentage of
operating revenues was 33.9% for fiscal 2008, down from
36.1% for fiscal 2007, primarily as a result of a reduction
in compensation resulting from adjustments related to
liquidity fund support.
Distribution and servicing expenses increased 7% to
$1.3 billion, primarily as a result of increased average
AUM at Permal and in liquidity assets for which we pay
higher relative fees to third party distributors.
Communications and technology expense increased
11% to $192.8 million, primarily as a result of increased
depreciation expense, technology maintenance, and other
expenditures related to investment management and busi-
ness continuity infrastructure and office relocations.
Occupancy expense increased 29% to $129.4 million,
primarily as a result of higher rent at new office locations
and the impact of duplicate rent on facilities during relo-
cation periods.
Expense for impairment of management contracts was
$151.0 million, related to the impairment of certain
acquired management contracts as a result of a more
accelerated rate of client attrition than previously esti-
mated. See Note 5 of Notes to Consolidated Financial
Statements for further discussion of the impairment of
management contracts.
Other operating expenses increased 1% to $209.9 mil-
lion, driven primarily by increased promotional expenses,
offset in part by decreased expenses under a transition
services agreement with Citigroup related to the integra-
tion of businesses acquired from Citigroup and prior year
losses on the disposal of certain fixed assets as a result of
office relocations.
Other Income (Expense)
Interest income increased $18.0 million to $76.9 million,
primarily as a result of higher average firm investment
account balances, offset in part by a decline in average
interest rates earned on these balances. Interest expense
increased $11.2 million to $82.7 million due to $500 mil-
lion of new borrowings under our $1.0 billion unsecured
revolving credit facility and the issuance of $1.25 billion
of convertible senior notes in January 2008, offset in part
by $150 million of principal reduction made on our
$700 million term loan.
Other non-operating income (expense) decreased
$628.7 million to a loss of $600.5 million, primarily
as a result of losses related to liquidity fund support of
approximately $607.3 million, which excludes $1.0 mil-
lion of financing costs included in interest expense. See
Note 17 of Notes to Consolidated Financial Statements
for additional information.
Provision for Income Taxes
The provision for income taxes decreased 56% to
$176.0 million, primarily as a result of lower earnings
due to losses related to liquidity fund support and the
impairment of acquired management contract assets
recorded during fiscal 2008. The effective tax rate
increased to 39.7% from 38.1% in the prior year pri-
marily reflecting an increase in earnings in higher state
income tax rate jurisdictions as a result of the impair-
ment and liquidity fund support charges at lower relative
state income tax rates.
23
Supplemental Non-GAAP Financial Information
Cash Income from Continuing Operations
A reconciliation of income from continuing operations to cash income from continuing operations (in thousands except
per share) is as follows:
Income from Continuing Operations
Plus (less):
Amortization of intangible assets
Deferred income taxes on intangible assets
Deferred income taxes on impairment charges
Cash Income from Continuing Operations
Cash Income per Diluted Share
Income from continuing operations per diluted share
Amortization of intangible assets
Deferred income taxes on intangible assets
Deferred income taxes on impairment charges
Cash Income per Diluted Share
For the Years Ended March 31,
2007
2008
$646,246
$267,610
57,271
143,600
(56,187)
$412,294
$
$
1.86
0.40
0.99
(0.39)
2.86
68,410
130,758
—
$845,414
$
$
4.48
0.47
0.91
—
5.86
The decrease in cash income from continuing opera-
tions in fiscal 2008 is primarily due to net losses related
to liquidity fund support of $313.7 million, or $2.18 per
diluted share, and the impairment of management con-
tracts, net of income tax benefits, of $94.8 million, or
$0.66 per diluted share.
Pre-tax Profit Margin from Continuing Operations, as Adjusted
A reconciliation of pre-tax profit margin from continuing operations adjusted for distribution and servicing expense (in
thousands) is as follows:
Operating Revenues, GAAP basis
Less:
Distribution and servicing expense
Operating Revenues, as adjusted
Income from Continuing Operations before Income Tax Provision
and Minority Interests
Pre-tax profit margin, GAAP basis
Pre-tax profit margin, as adjusted
For the Years Ended March 31,
2008
$4,634,086
2007
$4,343,675
1,273,986
$3,360,100
1,196,019
$3,147,656
$ 443,871
$1,043,854
9.6%
13.2
24.0%
33.2
During fiscal 2008, losses related to liquidity fund sup-
port and the impairment of management contracts
reduced the pre-tax profit margin by 11.0 percentage
points and 3.3 percentage points, respectively, and
reduced the pre-tax profit margin, as adjusted, by 15.1
percentage points and 4.5 percentage points, respectively.
24
LIQUIDITY AND CAPITAL RESOURCES
The primary objective of our capital structure and funding
practices is to appropriately support our business strate-
gies and to provide needed liquidity at all times, includ-
ing maintaining required capital in certain subsidiaries.
Liquidity and the access to liquidity is important to the
success of our ongoing operations. During fiscal 2008 and
2009, we entered into a series of arrangements to provide
financial support to certain liquidity funds managed by
a subsidiary that had invested in asset backed commer-
cial paper and medium term notes issued by SIVs. These
arrangements are described in the Liquidity Fund Support
section below. Our overall funding needs and capital base
are continually reviewed to determine if the capital base
meets the expected needs of our businesses. In order to
ensure adequate resources for the liquidity fund support
transactions as well as for general corporate purposes, we
increased our capital base by $1.15 billion through the
issuance of Equity Units during fiscal 2009. We intend to
continue to explore potential acquisition opportunities as
a means of diversifying and strengthening our asset man-
agement business. These opportunities may from time to
time involve acquisitions that are material in size and may
require, among other things, and, subject to existing cov-
enants, the raising of additional equity capital and/or the
issuance of additional debt.
Our assets consist primarily of intangible assets, goodwill,
cash and cash equivalents, refundable income taxes, invest-
ment advisory and related fee receivables and investment
securities. Our assets have been principally funded by
equity capital, long-term debt and the results of our ongo-
ing operations. At March 31, 2009, our cash, total assets,
long-term debt and stockholders’ equity were $1.1 billion,
$9.3 billion, $3.0 billion and $4.5 billion, respectively.
The following table summarizes our consolidated statements of cash flows for the years ended March 31 (in millions):
Cash flows from operating activities
Cash flows used for investing activities
Cash flows from (used for) financing activities
Effect of exchange rate changes
Net change in cash and cash equivalents
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of year
2009
$ 437.9
(1,090.9)
301.1
(27.2)
(379.1)
1,463.6
$ 1,084.5
2008
$ 1,144.3
(2,103.3)
1,220.6
18.4
280.0
1,183.6
$ 1,463.6
2007
$ 905.4
(542.1)
(209.4)
6.2
160.1
1,023.5
$1,183.6
Cash flows from operating activities were $437.9 million
during fiscal 2009 compared to cash flows of $1,144.3 mil-
lion for the prior fiscal year. The decrease in operating cash
flows is primarily due to lower earnings driven by AUM
and revenue declines in the current year.
Cash outflows for investing activities during fiscal 2009
were $1.1 billion, primarily attributable to the purchase
of SIV securities from our liquidity funds, which used
$2.9 billion, including $801.8 million of net cash col-
lateral returned upon termination of associated support
agreements. As discussed below, the liquidity fund sup-
port payments were funded in part with a portion of the
proceeds of two debt issuances during calendar year 2008.
The outflows were offset, in part, by proceeds from the
sale of securities purchased under agreements to resell
and SIV securities of $604.6 million and $513.9 million,
respectively, cash proceeds of $181.1 million received for
the sale of LMPPG and the return of a portion of a con-
tingent earnout payment from the PCM acquisition of
$120.0 million that was previously funded into escrow.
Cash flows from financing activities provided $301.1 mil-
lion, primarily due to the $1.1 billion in net proceeds
from the offering of Equity Units in May, offset in part
by the repayment of the $425 million 6.75% senior notes
in July and the $250 million repayment on our $500 mil-
lion unsecured revolving credit facility in March 2009.
A portion of the proceeds of the Equity Units offering
and a $1.25 billion offering of convertible senior notes in
January 2008 has been used to help fund the liquidity
fund support and the senior notes repayment discussed
above. In fiscal 2009, 2008 and 2007, we paid cash divi-
dends of $135.9 million, $132.8 million, and $109.9 mil-
lion, respectively. On May 5, 2009, the Board of Directors
approved a regular quarterly cash dividend in the amount
25
of $0.03 per share, representing a quarterly reduction of
$0.21 per share from our prior dividend.
We expect that over the next twelve months our operat-
ing activities will be adequate to support our operating
cash needs. During the past year, difficult market condi-
tions have contributed to a reduction in our AUM and
revenues and resulted in a reduction in the cash generated
by our operations, which is our primary source of added
liquidity. If this trend continues, we would expect that the
available cash generated by our operations would continue
to decrease. However, in an effort to mitigate the effects
of declining market conditions and lower revenue levels,
we have reduced our corporate expenses by approximately
$135 million on an annualized basis as of March 31,
2009, excluding costs to achieve these savings, such as
severance, and have planned additional reductions of
approximately $25 million in fiscal 2010. In addition, we
also expect to receive approximately $600 million in tax
refunds in fiscal 2010, primarily attributable to the carry-
back tax benefit on the realized losses incurred on the
sale of SIV securities. These refunds are expected to be
received in the next six months.
During fiscal 2008, we initiated a plan to repatriate accu-
mulated earnings of approximately $225 million from cer-
tain foreign subsidiaries in order to replenish funds used
for the contingent acquisition payment in the U.S. to the
former owners of Permal. We repatriated approximately
$36 million of these funds during fiscal 2008. We antici-
pate repatriating additional amounts starting in fiscal year
2010, although timing is currently uncertain. Any repatri-
ated amounts will effectively increase our available cash.
In addition to our ordinary operating cash needs, as
discussed above, we anticipate several other cash needs
during the next twelve months. In November 2009,
we may be required to pay up to $286 million under
the agreements governing the Permal acquisition, with
the amount of the payment to be determined based on
Permal’s operating results. The final payment for this
transaction in November 2011 will be between $60 mil-
lion and $320 million based on Permal’s results and the
amount of the fiscal 2010 payment. We may pay up to
25% of each of these payments in shares of our common
stock. In addition, during fiscal 2010, we will move into
a new corporate headquarters and expect to incur total
costs for the new building of approximately $92 million,
primarily for leasehold improvements, fixtures and furni-
ture, of which approximately $44 million was paid dur-
ing the year ended March 31, 2009. As discussed below,
if our earnings remain at current levels, we would expect
to repay a portion of our bank debt by December 2009.
We may also elect to utilize our available resources for
any number of activities, including seed capital invest-
ments in new products, repayment of outstanding debt,
or acquisitions.
As described above, we currently project that our avail-
able cash and cash flows from operating activities will be
sufficient to fund our liquidity needs. Accordingly, we
do not currently expect to raise additional debt or equity
financing over the next twelve months. However, there
can be no assurances of these expectations as our projec-
tions could prove to be incorrect, currently unexpected
events may occur that require additional liquidity, such as
an acquisition opportunity, or market conditions might
significantly worsen, affecting our results of operations
and generation of available cash. If this were to occur, we
would likely seek to manage our available resources by
taking actions such as additional cost-cutting, reducing
our expected expenditures on investments, selling assets
(such as investment securities), repatriating earnings from
foreign subsidiaries, or modifying arrangements with our
affiliates and/or employees. Should these types of actions
prove insufficient, we may seek to raise additional equity
or debt. However, current market conditions would make
it difficult to raise additional capital, and would increase
the costs of doing so. In addition, our debt covenants cur-
rently prevent us from incurring more than $250 million
in additional indebtedness.
26
Financing Transactions
The table below reflects our primary sources of financing (in thousands) as of March 31, 2009:
Face
Amount
Amount Outstanding
at March 31,
2009
Type
2.5% Convertible Senior Notes
5.6% Senior Notes from Equity Units
Revolving Credit Agreement
5-year term loan
6.75% Senior Notes
$1,250,000 $1,250,000
1,150,000
1,150,000
250,000
500,000
550,000
700,000
—
425,000
2008
$1,250,000
—
500,000
550,000
424,959
Maturity
January 2015
June 2021
Interest Rate
2.50%
5.60%
LIBOR + 2.25% October 2010
LIBOR + 2.25% October 2010
6.75%
July 2008
In May 2008, we issued 23 million Equity Units for
$1.15 billion, of which $50 million was used to pay issuance
costs. Each unit consists of a 5% interest in $1,000 princi-
pal amount of 5.6% senior notes due June 30, 2021 and a
purchase contract to purchase a varying number of shares
of our common stock by June 30, 2011. The notes and pur-
chase contracts are separate and distinct instruments, but
their terms are structured to simulate a conversion of debt
to equity and potentially remarketed debt approximately
three years after issuance. The holders also receive a quar-
terly contract adjustment payment on the purchase contract
at an annual rate of 1.4% of the commitment amount and
are required to pledge their interests in the senior notes to
us as collateral on their purchase commitment. The net
proceeds from the Equity Units offering of approximately
$1.11 billion are being used for general corporate purposes,
which to date has primarily included the purchase of SIV
securities from liquidity funds managed by a subsidiary and
repayment of outstanding debt.
During January 2008, we increased our capital base by
$1.25 billion through the sale of 2.5% convertible senior
notes. The proceeds strengthened our balance sheet and
provided additional liquidity that has been used for general
corporate purposes, including the purchase of SIV securi-
ties from our liquidity funds. In connection with this
financing, we entered into economic hedging transactions
that increase the effective conversion price of the notes.
These hedging transactions had a net cost to us of $83 mil-
lion, which we paid from the proceeds of the notes. This
transaction closed on January 31, 2008. We used approxi-
mately $180 million of the capital raised to purchase and
retire preferred stock convertible into 2.5 million shares of
our common stock.
During November 2007, we borrowed an aggregate of
$500 million under our unsecured revolving credit facility
for general corporate purposes. This facility matures on
October 14, 2010, may be prepaid at any time and con-
tains customary covenants and default provisions. On
January 3, 2008, we amended the credit agreement to
increase the maximum amount that we may borrow from
$500 million to $1 billion. On March 4, 2008, we elected
to procure a letter of credit (“LOC”) to support up to
$150 million of certain SIV-issued holdings in a liquidity
fund under this facility. See discussion on liquidity fund
support below. In March 2009, we repaid $250 million of
the outstanding borrowings under this credit facility and
amended the credit agreement to decrease the maximum
amount that we may borrow from $1 billion to $500 mil-
lion and further modified covenants, as discussed below.
On December 1, 2005, we completed the acquisition
of Citigroup’s asset management business (“CAM”) in
exchange for (i) all outstanding stock of our subsidiaries
that constituted our Private Client and Capital Markets
businesses; (ii) 5,393,545 shares of common stock and
13.346632 shares of our non-voting convertible preferred
stock, which is convertible, upon transfer, into 13,346,632
shares of common stock; and (iii) $512 million in cash
borrowed under a $700 million five-year syndicated term
loan facility. Under the terms of the agreement, we paid a
post-closing purchase price adjustment of $84.7 million to
Citigroup in September 2006, based on the retention of
certain AUM nine months after the closing. During fiscal
2009 and 2008, we issued approximately .36 million and
5.53 million common shares, respectively, upon conver-
sion of approximately .36 and 5.53 shares, respectively,
of the convertible preferred stock that was issued in the
CAM acquisition. During the fourth quarter of fiscal
2008, we repurchased 2.5 shares (convertible into 2.5 mil-
lion common shares) of the convertible preferred stock for
approximately $180 million in cash.
27
In October 2005, we borrowed $700 million through
a syndicated five-year unsecured floating-rate term loan
agreement to primarily fund the cash portion of the pur-
chase price of the Citigroup transaction. Effective with
the closing of the Citigroup transaction, we entered into
a $400 million three-year amortizing interest rate swap
(“Swap”) to hedge a portion of the $700 million floating
rate term loan at a fixed rate of 4.9%. During the March
2007 quarter, this Swap began to unwind in accordance
with its terms and we repaid a corresponding $50 million
of the debt. During fiscal 2008, we repaid $100 million
of the debt. The outstanding balance under this facility
was $550 million at March 31, 2009 and the Swap fully
matured in December 2008.
Also in connection with the Citigroup transaction, one of
our subsidiaries borrowed $83.2 million under a 364-day
promissory note. During the fiscal year ended March 31,
2007, we paid from available cash the balance outstanding
on this note.
Included in outstanding debt as of March 31, 2008 is
$425 million principal amount of senior notes due July 2,
2008, which bear interest at 6.75%. The notes were issued
at a discount to yield 6.80%. The accreted balance of
$425 million was repaid from available cash in July 2008.
The agreements entered into as part of our January 2008
issuance of $1.25 billion in 2.5% convertible senior notes
prevent us from incurring additional debt, with a few
exceptions, if our debt to EBITDA ratio (as defined in the
documents) exceeds 2.5. The May 2008 issuance of Equity
Units resulted in our debt to EBITDA ratio exceeding that
limit, although we received a waiver of the covenant to
allow us to complete the transaction. The waiver prevents
us from issuing more than $250 million in additional debt
at any time when our debt to EBITDA ratio exceeds 2.5.
The sales of SIV securities during fiscal year 2009 reduced
our EBITDA under the definition, thus further increasing
our ratio for purposes of this covenant. As a result of these
two events, we may not, subject to a few limited exceptions,
incur more than $250 million in new indebtedness until
the effects of the sales of SIV securities is no longer in the
trailing twelve month EBITDA calculation and when we
have substantially reduced our outstanding indebtedness.
Our $500 million revolving line of credit, as revised, of which
$250 million is currently outstanding, and our $550 mil-
lion term loan also contain financial covenants. These
covenants include: maximum debt to EBITDA ratio of 3.0
and minimum EBITDA to interest expense ratio of 4.0. The
maximum debt to EBITDA ratio was increased from 2.5
to 3.0 in a November 2008 amendment. In March 2009,
the maximum debt to EBITDA ratio was revised to allow
us to reduce includable debt by unrestricted cash in excess
of up to $500 million in working capital. Debt is defined
to include all obligations for borrowed money, excluding
the debt incurred in the equity units offering and non-
recourse debt, and under capital leases. EBITDA is defined
as consolidated net income plus/minus tax expense, interest
expense, depreciation and amortization, amortization of
intangibles, any extraordinary expenses or losses, any non-
cash charges and up to $3.0 billion in realized losses result-
ing from liquidity fund support. As of March 31, 2009,
Legg Mason’s debt to EBITDA ratio was 1.8 and EBITDA
to interest expense ratio was 6.2, and therefore Legg Mason
is in compliance with these covenants. If our net income
remains at current levels or further declines, or if we spend
our available cash, it may impact our ability to maintain
compliance with these covenants. If we determine that our
compliance with these covenants may be under pressure,
we may elect to take a number of actions, including reduc-
ing our expenses in order to increase our EBITDA, use
available cash to repay all or a portion of our $800 million
outstanding debt subject to these covenants or seek to nego-
tiate with our lenders to modify the terms or to restructure
our debt. Based on March run rate EBITDA, and factoring
projected cost savings, we would be required to repay over
half of our outstanding bank debt by December 2009 to
maintain compliance with our covenants. However, based
on improved April run rate results, repayment of debt may
not be required to maintain compliance with our covenants.
We anticipate that we will have available cash to repay all
or a portion of our bank debt, should it be necessary. Using
available cash to repay indebtedness would make the cash
unavailable for other uses and might affect the liquidity
discussions and conclusions above. Entering into any modi-
fication or restructuring of our debt would likely result in
additional fees or interest payments.
Our outstanding debt is currently rated investment grade
by all three rating agencies that follow us: Moody’s Investor
Services (“Moody’s”), Standard and Poor’s Rating Services
(“Standard and Poor’s”), and Fitch Ratings. Our current
Moody’s rating is A3 with a negative outlook. Our current
Standard and Poor’s rating is BBB+ with a negative outlook
and our current Fitch rating is A- with a negative outlook. In
the event of a one level downgrade by Moody’s or Standard
and Poor’s, the interest rate on our five-year term loan and
revolving line of credit will increase by 0.25% per annum.
28
Effective November 1, 2005, we acquired 80% of the
outstanding equity of Permal. Concurrent with the
acquisition, Permal completed a reorganization in which
the residual 20% of outstanding equity was converted to
preference shares, resulting in Legg Mason owning 100%
of the outstanding voting common stock of Permal. We
have the right to purchase the preference shares over the
four years subsequent to the closing and, if that right is
not exercised, the holders of those equity interests have
the right to require us to purchase the interests in the
same general time frame for approximately the same con-
sideration. The maximum aggregate price, including ear-
nout payments related to each purchase and based upon
future revenue levels, for all equity interests in Permal is
$1.386 billion excluding acquisition costs and dividends.
During fiscal 2008, payments of $240 million were made
to the former owners of Permal, representing earnout pay-
ments based upon Permal’s revenues through the second
anniversary date and the purchase of 37.5% of the prefer-
ence shares, of which $208 million was paid in cash and
the balance was in our common stock. It is anticipated
that we will acquire the remaining 62.5% of the prefer-
ence shares in fiscal 2010 at amounts based on Permal’s
revenues, at which time we may be required to pay up to
$286 million under the agreements governing the Permal
acquisition. The final payment for this transaction on the
sixth anniversary in fiscal 2012 will be between $60 mil-
lion and $320 million based on Permal’s revenues and
the amount of the fiscal 2010 payment. We may elect to
deliver up to 25% of each of the future payments in the
form of shares of our common stock. In addition, dur-
ing fiscal 2009, 2008 and 2007, we paid an aggregate
amount of approximately $31.5 million in dividends on
the preference shares, and we will pay a minimum of
$7.5 million in dividends on the preference shares in fis-
cal 2010. All payments for preference shares, including
dividends, are recognized as additional goodwill.
On August 1, 2001, we purchased PCM for cash of
approximately $682 million, excluding acquisition costs.
The transaction included two contingent payments based
on PCM’s revenue growth for the years ending on the third
and fifth anniversaries of closing, with the aggregate pur-
chase price to be no more than $1.382 billion. During fiscal
2005, we made the maximum third anniversary payment
of $400 million to the former owners of PCM. During fis-
cal 2007, we paid from available cash into escrow the maxi-
mum fifth anniversary payment of $300 million of which
$150 million remained in escrow subject to certain limited
claw-back provisions until July 2009. During fiscal 2009,
the contingency was settled at which time $30 million was
released from escrow to the sellers and $120 million was
returned to us and recorded as a reduction of goodwill.
In April 2008, we completed a sale in which Citigroup
Global Markets Inc., an affiliate of Citigroup, acquired
a majority of the overlay and implementation business
of LMPPG, including its managed account trading and
technology platform. The sale produced cash proceeds of
approximately $181 million.
In fiscal 2002, the Board of Directors previously autho-
rized us, at our discretion, to purchase up to 3.0 million
shares of our common stock. During the June 2007
quarter, we repurchased 40,150 shares for $4.0 million.
On July 19, 2007, the Board of Directors authorized
us to repurchase, from time to time, up to 5.0 million
shares of our common stock to replace the previous share
repurchase authorization. In January 2008, the Board
of Directors also authorized us to repurchase non-voting
convertible preferred stock representing up to 4 million
shares of common stock from the proceeds from the con-
vertible senior notes discussed above. In February 2008,
we repurchased and retired preferred stock convertible
into 2.5 million shares of common stock for $180 mil-
lion. Also, during fiscal 2008, we repurchased 1.1 million
shares of common stock for $94 million under the new
authorization, in addition to the 40,150 shares above.
There were no repurchases during fiscal 2009 and 2007.
Certain of our asset management subsidiaries maintain
various credit facilities for general operating purposes.
See Notes 6 and 7 of Notes to Consolidated Financial
Statements for additional information. Certain subsidiar-
ies are also subject to the capital requirements of various
regulatory agencies. All such subsidiaries met their respec-
tive capital adequacy requirements.
Liquidity Fund Support
During fiscal 2009 and 2008, we entered into a series
of arrangements to provide financial support to certain
liquidity funds. During fiscal 2009, we purchased and
subsequently sold, or reimbursed the funds for a portion
of their losses incurred in selling, all outstanding securi-
ties issued by SIVs held in various liquidity funds man-
aged by one of our subsidiaries, the majority of which
were previously supported under these arrangements.
During fiscal 2009, we also sold Canadian conduit securi-
ties purchased from one of our liquidity funds during fis-
cal 2008. In fiscal 2009, we provided additional support
to liquidity funds that was not related to SIV securities.
29
As of March 31, 2009 and 2008, the support amounts and related cash collateral (in thousands) were as follows:
Earliest
Transaction
Date
Description
Letters of Credit(2)
November 2007
Capital Support Agreement(3)
November 2007
Purchase of Canadian Conduit Securities(4) December 2007
Total Return Swap(3)
December 2007
Purchase of Non-bank Sponsored SIVs(3,5)
December 2007
Letter of Credit(6)
March 2008
Capital Support Agreements(6)
March 2008
Capital Support Agreements(7)
September 2008
Capital Support Agreements(3)
October 2008
Total
Support
Amount
—
$
—
—
—
—
—
—
34,500
7,000
$41,500
2009
2008
$
Cash
Support
Collateral(1) Amount
$ 335,000
15,000
94,000
890,000
82,000
150,000
400,000
—
—
$1,966,000
—
—
—
—
—
—
—
34,500
7,000
$41,500
Cash
Collateral(1)
$286,250
15,000
—
139,480
—
—
400,000
—
—
$840,730
(1) Included in restricted cash on the Consolidated Balance Sheet
(2) Pertains to Citi Institutional Liquidity Fund P.L.C. (USD Fund) and Prime Cash Reserves Portfolio
(3) Pertains to Citi Institutional Liquidity Fund P.L.C. (USD Fund)
(4) Pertains to the Legg Mason Western Asset Canadian Money Market Fund
(5) Securities issued by SIVs
(6) Pertains to Citi Institutional Liquid Reserves Portfolio, a Series of Master Portfolio Trust
(7) Pertains to Western Asset Institutional Money Market Fund, Citi Institutional Liquidity Fund P.L.C. (Euro Fund) and Citi Institutional Liquidity Fund P.L.C.
(Sterling Fund)
During fiscal 2008, we entered into arrangements
with two third party banks to provide LOCs for an
aggregate amount of approximately $485 million for
the benefit of three liquidity funds managed by one
of our subsidiaries as discussed in Note 17 of Notes
to Consolidated Financial Statements. As part of the
LOC arrangements, we agreed to reimburse to the
banks any amounts that may be drawn on the LOCs
and, to support four of these agreements, we provided
approximately $286 million in cash collateral as of
March 31, 2008. Additionally, one of the arrangements
was supported with $150 million in excess capacity on
our $1 billion revolving credit facility. In fiscal 2009,
these LOCs terminated in accordance with their terms
upon the purchase of the underlying securities from the
funds, as described below, and $286 million in collat-
eral was returned.
During fiscal 2008, we entered into six capital support
agreements (“CSAs”). Under the terms of the CSAs, we
agreed to provide up to a maximum of $415 million in
support to two liquidity funds in certain circumstances
upon the funds realizing a loss from specific underlying
securities. We provided $415 million in collateral to sup-
port each CSA up to the maximum contribution amount.
During fiscal 2009, $200 million in principal amount
of securities supported by one of these CSAs matured
and were paid in full. The related CSA terminated in
accordance with its terms and collateral of $15 million
was returned. The remaining CSAs terminated in accor-
dance with their terms upon the purchase of the underly-
ing securities from the funds, as described below, and the
remaining $400 million in collateral was returned.
Also during fiscal year 2008, we entered into a TRS
arrangement with a major bank (the “Bank”) pursuant to
which the Bank purchased securities issued by three SIVs
from a Dublin-domiciled liquidity fund managed by one
of our subsidiaries. The $890 million in face amount of
commercial paper was purchased by the Bank for cash at
an aggregate amount of $832 million, which represents
an estimate of value determined for collateral purposes.
In addition, we reimbursed the fund for the $59.5 million
difference between the fund’s carrying value, includ-
ing accrued interest, and the amount paid and provided
$139.5 million in cash collateral, which under the terms
of the agreements could be increased or decreased based
on changes in the value, or upon maturities, of the under-
lying securities.
During fiscal 2009, we provided additional support to
two liquidity funds in the form of two standby letters of
credit in the total amount of approximately $257 million.
We provided collateral equal to the total support amount
under the LOCs. These LOCs terminated in accordance
with their terms upon the purchase of the underlying
30
securities from the funds, as described below, and the
$257 million of collateral was returned.
During fiscal 2009, we entered into and amended vari-
ous capital support agreements. Under the terms of the
new and amended CSAs, we agreed to provide up to
a maximum of $1.07 billion in support to particular
liquidity funds in certain circumstances upon the funds
realizing a loss from specific underlying securities. We
provided $1.07 billion in collateral to support each CSA
up to the maximum contribution amount. CSAs aggre-
gating $1.03 billion terminated in accordance with their
terms upon the purchase of the underlying securities
from the funds, as described below, and $1.03 billion
of collateral was returned. Contributions made under
any of our CSAs will not result in our acquiring an
ownership or other interest in the fund. The four CSAs
remaining at March 31, 2009 include a recovery clause
in which the funds are required to reimburse us for all
contributions made upon the expiration of the CSA to
the extent that the funds subsequently receive payments
from the issuer of the underlying securities or upon the
sale or other disposition thereof that exceed the amor-
tized cost of the underlying securities at the time the
amounts are paid under the CSAs.
During fiscal 2009, $440 million in principal amount of
securities previously supported under the TRS arrange-
ment matured and were paid in full and an additional
$95 million in principal amount of securities under the
TRS arrangement was repaid. Also during fiscal 2009,
non-bank sponsored SIV securities purchased from a
Dublin-domiciled liquidity fund in fiscal 2008 matured
and $82 million in principal amount and interest was
paid in full.
During fiscal 2009, we paid $2.9 billion for an aggregate
$3.0 billion in principal amount (plus $24 million of
accrued interest) of non-bank sponsored SIV securities
from six liquidity funds that were previously supported
under twelve CSAs and seven LOCs. Upon the purchase
of these securities, the twelve CSAs aggregating $1.4 bil-
lion and seven LOCs aggregating $742 million were ter-
minated in accordance with their terms. Collateral of
$2.0 billion was returned, which includes the return of
$1.03 billion and $257 million of collateral provided
during the current fiscal year to support new or amended
CSAs and LOCs, respectively.
During fiscal 2009, the $3.0 billion of purchased secu-
rities were sold along with $355 million of securities
previously supported by the TRS and $76 million of
Canadian conduit securities held on our balance sheet,
to third parties for $627.3 million, net of transaction
costs. The TRS terminated in accordance with its terms
upon the sale of the securities and $209 million of col-
lateral was returned.
During fiscal 2009, we also paid $181.2 million to reim-
burse two funds for a portion of losses they incurred in
selling SIV securities.
Our four remaining CSAs to provide an aggregate
$42 million of support for investments in non-SIV
securities to certain funds expire on or before March 31,
2010. If the funds continue to hold the underlying
securities and market conditions have not improved
when the agreements expire, we will likely be required
to utilize cash to address our obligations under these
support arrangements.
Off-Balance Sheet Arrangements
Off-balance sheet arrangements, as defined by the
Securities and Exchange Commission (“SEC”), include
certain contractual arrangements pursuant to which a
company has an obligation, such as certain contingent
obligations, certain guarantee contracts, retained or
contingent interest in assets transferred to an unconsoli-
dated entity, certain derivative instruments classified as
equity or material variable interests in unconsolidated
entities that provide financing, liquidity, market risk
or credit risk support. Disclosure is required for any
off-balance sheet arrangements that have, or are reason-
ably likely to have, a material current or future effect
on our financial condition, results of operations, liquid-
ity or capital resources. We generally do not enter into
off-balance sheet arrangements, as defined, other than
those described in the Contractual Obligations and
Contingent Payments section that follows and Variable
Interest Entities and Liquidity Fund Support dis-
cussed in Notes 1, 16 and 17 of Notes to Consolidated
Financial Statements.
As previously discussed, during fiscal 2009 and 2008,
we entered into various off-balance sheet arrangements
to provide support to certain of our liquidity funds.
These arrangements, most of which were terminated
or expired prior to March 31, 2009, included letters of
credit, capital support agreements and a TRS, which
are fully described above and in Note 17 of Notes to
Consolidated Financial Statements.
31
In January 2008, we entered into hedge and warrant
transactions on the convertible notes with certain finan-
cial institution counterparties to increase the effective
conversion price of the convertible senior notes. See Note
7 of Notes to Consolidated Financial Statements.
Contractual Obligations and Contingent Payments
We have contractual obligations to make future pay-
ments in connection with our long-term debt and non-
cancelable lease agreements. In addition, as described in
Liquidity and Capital Resources above, we have made
or expect to make contingent payments under business
purchase agreements. See Notes 6, 7, and 9 of Notes to
Consolidated Financial Statements for additional disclo-
sures related to our commitments.
The following table sets forth these contractual and con-
tingent obligations (in millions) by fiscal year:
Contractual Obligations
Short-term borrowings(1)
Long-term borrowings by
contract maturity
Coupon interest on short-term
and long-term borrowings(2)
Minimum rental and
service commitments
Minimum commitments
under capital leases(3)
Total Contractual Obligations
Contingent Obligations
Contingent payments related
to business acquisitions(4)
Capital support(5)
Total Contractual and
2010
2011
2012
2013
2014
Thereafter
Total
$250.0
$
—
$
—
$
—
$
—
$
—
$ 250.0
8.2
553.8
2.6
1.1
0.9
2,406.8
2,973.4
135.5
122.1
112.3
112.2
112.2
615.5
1,209.8
161.5
110.8
102.2
94.2
87.6
674.3
1,230.6
31.3
586.5
2.4
789.1
1.9
219.0
—
207.5
—
200.7
—
3,696.6
35.6
5,699.4
293.5
41.5
—
—
60.0
—
—
—
—
—
—
—
353.5
41.5
Contingent Obligations(6,7)
$921.5
$789.1
$279.0
$207.5
$200.7
$3,696.6
$6,094.4
(1) Represents borrowing under our revolving line of credit which does not expire until October 2010. However, we may elect to repay this debt in fiscal 2010 if we have
sufficient available cash.
(2) Coupon interest on floating rate long-term debt is based on rates at March 31, 2009 and includes 1.4% contract adjustment payments on Equity Units.
(3) The amount of commitments reflected for any year represents the maximum amount that could be payable at the earliest possible date under the terms of the agreements.
(4) The amount of contingent payments reflected for any year represents the maximum amount that could be payable at the earliest possible date under the terms of business
purchase agreements.
(5) The amount of contingent obligations under capital support agreements represents the maximum amount that could be payable at any time up through the contracts’
termination dates.
(6) The table above does not include approximately $29.5 million in capital commitments to investment partnerships in which Legg Mason is a general or limited partner.
These obligations will be funded, as required, through the end of the commitment periods that range through fiscal 2011.
(7) The table above does not include amounts for uncertain tax positions of $35.1 million (net of the federal benefit for state tax liabilities) because the timing of any related
cash outflows cannot be reliably estimated.
32
MARKET RISK
A risk management committee oversees and coordinates
risk management activities of Legg Mason and its sub-
sidiaries. In addition, certain risk activities are managed
at the subsidiary level. The following describes certain
aspects of our business that are sensitive to market risk.
Revenues and Net Income
The majority of our revenue is calculated from the market
value of our AUM. Accordingly, a decline in the value of
securities will cause our AUM to decrease. In addition, our
fixed income and liquidity AUM are subject to the impact
of interest rate fluctuations, as rising interest rates may
tend to reduce the market value of bonds held in various
mutual fund portfolios or separately managed accounts.
Performance fees may be earned on certain investment
advisory contracts for exceeding performance benchmarks.
Declines in market values of AUM will result in reduced
fee revenues and net income. We generally earn higher fees
on equity assets than fees charged for fixed income and
liquidity assets. Declines in market values of AUM in this
asset class will disproportionately impact our revenues. In
addition, under revenue sharing agreements, certain of our
subsidiaries retain different percentages of revenues to cover
their costs, including compensation. Our net income, profit
margin and compensation as a percentage of operating
revenues are impacted based on which subsidiaries generate
our revenues, and a change in AUM at one subsidiary can
have a dramatically different effect on our revenues and
earnings than an equal change at another subsidiary.
Trading and Non-trading Assets and Liabilities
Our trading and non-trading assets and liabilities are
comprised of investment securities, including seed capital
in sponsored mutual funds and products, securities issued
by SIVs and other conduit investments, derivative instru-
ments, limited partnerships, limited liability companies
and certain other investment products.
Beginning in November 2007, we entered into a series of
arrangements to provide credit support to certain liquidity
funds. These arrangements included LOCs, CSAs, a TRS
arrangement and the purchase of securities issued by SIVs
and other conduits, all of which substantially increased
our exposure to the risk of security price fluctuations.
During fiscal 2009, we purchased and subsequently
sold, or the funds sold, all remaining securities issued
by SIVs held in our liquidity funds, effectively eliminat-
ing our exposure. Prior to the purchase, the majority of
these SIV securities were supported under capital support
arrangements, letters of credit and a TRS. The various
support arrangements terminated in accordance with their
terms upon the purchase. During fiscal 2009, we also sold
Canadian conduit securities purchased from one of our
liquidity funds during fiscal 2008. As of March 31, 2009,
four CSAs to provide up to a maximum of $41.5 million
in support of net asset values of four funds, with underly-
ing investments in over $1.8 billion in non-asset backed
securities, remain outstanding. During April 2009, one of
the CSAs representing $7.0 million of the $41.5 million
terminated while incurring no loss. These fund support
arrangements and the related risks are discussed below.
Trading investments at March 31, 2009 and 2008 subject
to risk of security price fluctuations are summarized (in
thousands) below.
Investment securities:
Investments relating to
long-term incentive
compensation plans
Proprietary fund products
and other investments
Securities issued by SIVs
Total trading investments
2009
2008
$128,785
$207,305
207,307
—
$336,092
140,267
141,509
$489,081
Approximately $119.0 million and $169.8 million of trad-
ing investments related to long-term incentive compensa-
tion plans as of March 31, 2009 and 2008, respectively,
have offsetting liabilities such that fluctuation in the market
value of these assets and the related liabilities will not have
a material effect on our net income or liquidity. However,
it may have an impact on our compensation expense with a
corresponding offset in other non-operating income. Other
trading investments of $9.8 million and $37.5 million at
March 31, 2009 and 2008, respectively, relate to other
long-term incentive plans and the related liabilities do not
completely offset due to vesting provisions. Therefore, fluc-
tuations in the market value of these trading investments
will impact our compensation expenses, non-operating
income and net income.
Approximately $207.3 million and $140.3 million of
trading assets at March 31, 2009 and 2008, respectively,
are investments in proprietary fund products and other
investments for which fluctuations in market value will
impact our non-operating income. Of these amounts, the
fluctuations in market value of approximately $46.3 mil-
lion and $67.4 million of proprietary fund products as of
March 31, 2009 and 2008, respectively, have offsetting
33
compensation expense under revenue share agreements
and the fluctuations in market value of approximately
$16.6 million as of March 31, 2009 is related to minority
interest of consolidated investment funds. Investments
in proprietary fund products are not liquidated until the
related fund establishes a track record, has other investors,
or a decision is made to no longer pursue the strategy.
The remaining trading assets at March 31, 2008 include
$141.5 million in investments issued by SIVs acquired from
liquidity funds a subsidiary manages, of which $82.0 mil-
lion matured and was paid in full in May 2008. The fair
value of these trading assets fluctuated with market changes
and impacted our non-operating income and net income. As
of March 31, 2009, all securities issued by SIVs were sold.
Non-trading assets and liabilities at March 31, 2009 and 2008 subject to risk of security price fluctuations are summa-
rized (in thousands) below.
Investment securities:
Available-for-sale
Investments in partnerships and LLCs
Other investments
Total non-trading investments
Derivative assets:
Total return swap
Total non-trading assets
Derivative liabilities:
Fund support arrangements
2009
$ 6,818
59,515
1,423
67,756
—
$67,756
$20,631
2008
$ 7,700
81,703
1,323
90,726
45,706
$136,432
$551,654
As previously discussed, by March 31, 2009, we effectively
eliminated our exposure to SIVs. As of March 31, 2009,
we recorded derivative liabilities on fund support arrange-
ments of $20.6 million, for which our exposure was limited
to approximately $41.5 million. After the termination of
one of the fund support arrangements in April 2009 for
$7.0 million, our current exposure and additional poten-
tial losses on supported securities are $34.5 million and
$13.9 million, respectively.
Valuation of trading and non-trading investments is
described below within Critical Accounting Policies under
the heading “Valuation of Financial Instruments.” The
elimination of SIV exposure from our Balance Sheet and
money market funds as of March 31, 2009 substantially
reduced the sensitivity of our financial position to mar-
ket risk. See Notes 1 and 17 of Notes to Consolidated
Financial Statements for further discussion of derivatives
and liquidity fund support actions.
The following is a summary of the effect of a 20% increase or decrease in the market values of our financial instru-
ments subject to market valuation risks at March 31, 2009:
Trading investments:
Investment related to deferred compensation plans
Proprietary fund products and other
Total trading investment(1)
Available-for-sale investments
Investments in partnerships and LLCs
Other investments
Total investments subject to market risk
Derivative liabilities:
Fund support arrangements
Carrying Value
Fair Value
Assuming a
20% Increase
Fair Value
Assuming a
20% Decrease
$128,785
207,307
336,092
6,818
59,515
1,423
$403,848
$154,542
248,768
403,310
8,180
71,418
1,708
$484,616
$103,028
165,846
268,874
5,454
47,612
1,138
$323,078
$ 20,631
$ 16,505
$ 24,757
(1) Gains and losses related to certain investments in deferred compensation plans and proprietary fund products are directly offset by a corresponding adjustment to com-
pensation expense and related liability, or minority interest. As a result, a 20% increase or decrease in the unrealized market value of our financial instruments subject to
market valuation risks would result in a $40.8 million increase or decrease in our pre-tax earnings, respectively, as of March 31, 2009.
34
Foreign Exchange Sensitivity
We operate primarily in the United States, but provide ser-
vices, earn revenues and incur expenses outside the United
States. Accordingly, fluctuations in foreign exchange rates
for currencies, principally in Brazil, the United Kingdom,
Poland, Australia, and Japan, may impact our comprehen-
sive income and net income. Certain of our subsidiaries
have entered into forward contracts to manage the impact
of fluctuations in foreign exchange rates on their results of
operations. We do not expect foreign currency fluctuations
to have a material effect on our comprehensive income or
net income or liquidity.
Interest Rate Risk
Exposure to interest rate changes on our outstanding debt
is mitigated as a substantial portion of our debt is at fixed
interest rates. At March 31, 2009 and 2008, approximately
$806 million and $1,061 million, respectively, of our
outstanding floating rate debt is subject to fluctuations
in interest rates and will have an impact on our non-
operating income and net income. As of March 31, 2009,
we estimate that a 1% change in interest rates would result
in a net annual change to interest expense of $8.1 million.
See Note 7 of Notes to Consolidated Financial Statements
for additional disclosures regarding debt.
CRITICAL ACCOUNTING POLICIES
Accounting policies are an integral part of the preparation
of our financial statements in accordance with account-
ing principles generally accepted in the United States
of America. Understanding these policies, therefore, is
a key factor in understanding our reported results of
operations and financial position. See Note 1 of Notes
to Consolidated Financial Statements for a discussion of
our significant accounting policies and other informa-
tion. Certain critical accounting policies require us to
make estimates and assumptions that affect the amounts
of assets, liabilities, revenues and expenses reported in
the financial statements. Due to their nature, estimates
involve judgment based upon available information.
Therefore, actual results or amounts could differ from
estimates and the difference could have a material impact
on the consolidated financial statements.
We consider the following to be among our current account-
ing policies that involve significant estimates or judgments.
Revenue Recognition
The vast majority of our revenues are calculated as a per-
centage of the fair value of our AUM. The underlying
securities within the portfolios we manage, which are not
reflected within our consolidated financial statements,
are generally valued as follows: (i) with respect to securi-
ties for which market quotations are readily available,
the market value of such securities; and (ii) with respect
to other securities and assets, fair value as determined in
good faith.
For most of our mutual funds and other pooled products,
the boards of directors or similar bodies are responsible
for establishing policies and procedures related to the
pricing of securities. Each board of directors generally
delegates the execution of the various functions related
to pricing to a fund valuation committee which, in turn,
may rely on information from various parties in pricing
securities such as independent pricing services, the fund
accounting agent, the fund manager, broker-dealers,
and others (or a combination thereof). The funds have
controls reasonably designed to ensure that the prices
assigned to securities they hold are accurate. Management
has established policies to ensure consistency in the appli-
cation of revenue recognition.
As manager and advisor for separate accounts, we are
generally responsible for the pricing of securities held
in client accounts (or may share this responsibility with
others) and have established policies to govern valuation
processes similar to those discussed above for mutual
funds that are reasonably designed to ensure consistency
in the application of revenue recognition. Management
relies extensively on the data provided by independent
pricing services and the custodians in the pricing of sepa-
rate account AUM. Separate account customers typically
select the custodian.
Valuation processes for AUM are dependent on the nature
of the assets and any contractual provisions with our cli-
ents. Equity securities under management for which mar-
ket quotations are available are usually valued at the last
reported sales price or official closing price on the primary
market or exchange on which they trade. Debt securities
under management are usually valued at bid, or the mean
between the last quoted bid and asked prices, provided by
independent pricing services that are based on transactions
in debt obligations, quotations from bond dealers, market
transactions in comparable securities and various other rela-
tionships between securities. Short-term debt obligations
are generally valued at amortized cost, which is designed
to approximate fair value. The vast majority of our AUM
is valued based on data from third parties such as indepen-
dent pricing services, fund accounting agents, custodians
35
and brokers. This varies slightly from time to time based
upon the underlying composition of the asset class (equity,
fixed income and liquidity) as well as the actual underlying
securities in the portfolio within each asset class. Regardless
of the valuation process or pricing source, we have estab-
lished controls reasonably designed to assess the reasonable-
ness of the prices provided. Where market prices are not
readily available, or are determined not to reflect fair value,
value may be determined in accordance with established
valuation procedures based on, among other things, unob-
servable inputs. Management fees on AUM where fair val-
ues are based on unobservable inputs are not material. As
of March 31, 2009, equity, fixed income and liquidity
AUM values aggregated $126.9 billion, $357.6 billion, and
$147.9 billion, respectively.
As the vast majority of our AUM is valued by independent
pricing services based upon observable market prices or
inputs, we believe market risk is the most significant risk
underlying valuation of our AUM. The recent economic
events and financial market declines have increased market
price volatility; however, the valuation of the vast majority
of the securities held by our funds and in separate accounts
continues to be derived from readily available market price
quotations. As of March 31, 2009, less than 2% of total
AUM is valued based on unobservable inputs.
Valuation of Financial Instruments
Substantially all financial instruments are reflected in
the financial statements at fair value or amounts that
approximate fair value, except long-term debt. Trading
investments, Investment securities and derivative assets
and liabilities included in the Consolidated Balance
Sheets include forms of financial instruments. Unrealized
gains and losses related to these financial instruments are
reflected in net income or other comprehensive income,
depending on the underlying purpose of the instrument.
For investments, we value equity and fixed income securi-
ties using closing market prices for listed instruments or
broker or dealer price quotations, when available. Fixed
income securities may also be valued using valuation
models and estimates based on spreads to actively traded
benchmark debt instruments with readily available mar-
ket prices. We evaluate our non-trading Investment secu-
rities for “other than temporary” impairment. Impairment
may exist when the fair value of an investment security
has been below the adjusted cost for an extended period of
time. If an “other than temporary” impairment is deter-
mined to exist, the difference between the adjusted cost
of the investment security and its current fair value is rec-
ognized as a charge to earnings in the period in which the
impairment is determined.
In fiscal 2009 and 2008, we entered into various credit
support arrangements for certain liquidity funds man-
aged by a subsidiary that qualify as derivative transac-
tions. The fair values of these derivative instruments are
based on management’s estimates of expected outcomes
derived from pricing data for the underlying securities
and/or detailed collateral analyses. During fiscal 2009,
we purchased and subsequently sold all supported securi-
ties issued by SIVs held in our liquidity funds, effectively
eliminating our exposure to SIVs, and the various support
arrangements terminated in accordance with their terms
upon the purchase. As of March 31, 2009, four capital
support arrangements, which support investments in non-
asset backed securities, remained outstanding for which a
derivative liability of $20.6 million was included in Other
current liabilities in the Consolidated Balance Sheet. No
derivative asset was recorded as of March 31, 2009. As
of March 31, 2008, we had $45.7 million of derivative
assets included in Other current assets and $551.7 mil-
lion of derivative liabilities included in Other current
liabilities in the Consolidated Balance Sheet. Exposure on
these derivative instruments was based on the underlying
securities’ values and related gains and losses may vary
significantly in relation to their recorded balances. None
of these derivative transactions were designated for hedge
accounting as defined in SFAS No. 133, “Accounting for
Derivative Instruments and Hedging Activities,” and the
related gains and losses are included in Fund support in
the Consolidated Statement of Operations in fiscal 2009
and 2008.
For trading and non-trading investments in illiquid or
privately held securities for which market prices or quo-
tations are not readily available, the determination of
fair value requires us to estimate the value of the securi-
ties using a variety of methods and resources, including
the most current available financial information for the
investment and the industry. As of March 31, 2009 and
2008, we owned approximately $42.2 million and
$156.6 million, respectively, of trading and non-trading
financial investments that were valued on our assump-
tions or estimates and unobservable inputs.
At March 31, 2009 and 2008, we also have approximately
$59.5 million and $81.7 million, respectively, of other
investments, such as investment partnerships, that are
36
included in Other assets on the Consolidated Balance
Sheets. These investments are generally accounted for
under the cost or equity method.
Effective April 1, 2008, we adopted Statement No. 157,
“Fair Value Measurements” (“SFAS 157”), which defines
fair value, establishes a framework for measuring fair value
and increases disclosures about fair value measurements.
SFAS 157 defines fair value as the exchange price that
would be received for an asset or paid to transfer a liability
in the principal or most advantageous market for the asset
or liability in an orderly transaction between market par-
ticipants on the measurement date. Under SFAS 157, a fair
value measurement should reflect all of the assumptions
that market participants would use in pricing the asset or
liability, including assumptions about the risk inherent in a
particular valuation technique, the effect of a restriction on
the sale or use of an asset, and the risk of non-performance.
SFAS 157 establishes a hierarchy that prioritizes the inputs
for valuation techniques used to measure fair value. The
fair value hierarchy gives the highest priority to quoted
prices in active markets for identical assets or liabilities
and the lowest priority to unobservable inputs.
Our financial instruments measured and reported at
fair value are classified and disclosed in one of the fol-
lowing categories:
Level 1—Financial instruments for which prices are
quoted in active markets, which, for us, include invest-
ments in publicly traded mutual funds with quoted
market prices and equities listed in active markets.
Level 2—Financial instruments for which: prices are
quoted for similar assets and liabilities in active mar-
kets; prices are quoted for identical or similar assets
in inactive markets; or prices are based on observable
inputs, other than quoted prices, such as models or
other valuation methodologies. For us, this category
may include repurchase agreements, fixed income
securities and certain proprietary fund products.
Level 3—Financial instruments for which values are
based on unobservable inputs, including those for
which there is little or no market activity. This category
includes derivative assets and liabilities related to fund
support arrangements and investments in partnerships,
limited liability companies, and private equity funds.
This category may also include certain proprietary
fund products with redemption restrictions.
The valuation of an asset or liability may involve inputs
from more than one level of the hierarchy. The level in
the fair value hierarchy within which a fair value measure-
ment in its entirety falls is determined based on the lowest
level input that is significant to the fair value measure-
ment in its entirety.
Proprietary fund products are valued at net asset value
(“NAV”) determined by the fund administrator. These
funds are typically invested in exchange-traded invest-
ments with observable market prices. Their valuations
may be classified as Level 1, Level 2 or Level 3 based on
whether the fund is exchange-traded, the frequency of the
related NAV determinations and the impact of redemp-
tion restrictions. For investments in illiquid and privately-
held securities (private equity and investment partner-
ships) for which market prices or quotations may not be
readily available, management must estimate the value of
the securities using a variety of methods and resources,
including the most current available financial information
for the investment and the industry to which it applies in
order to determine fair value. These valuation processes
for illiquid and privately-held securities inherently require
management’s judgment and are therefore classified in
Level 3.
Our liquidity fund support has taken the form of CSAs,
LOCs, a TRS arrangement and purchases of securities
from funds as more fully described in Note 17. The CSAs,
LOCs, and TRS arrangement are considered derivative
assets or liabilities for accounting purposes representing
the Company’s rights and obligations under the sup-
port, the fair value of which is based principally on the
value of the underlying securities. Substantially all of the
underlying securities supported and all of the securities
purchased from liquidity funds were issued by SIVs and
had no active market such that fair value was determined
based on an evaluation of the issuer trust and its underly-
ing collateral, which are primarily comprised of asset and
mortgage backed securities, corporate bonds, and collat-
eralized debt obligations. These instruments may or may
not have financial guaranty insurance. Of the total SIV
securities we owned or supported in liquidity funds prior
to the sale of SIV securities, over 60% of the underlying
trust collateral securities were valued based on prices from
well recognized third party pricing services that utilize
available market data; over 35% of the collateral securities
were valued based on spreads to benchmark debt instru-
ments with available prices; and less than 5% of the col-
lateral values were based on broker quotes.
37
All security prices, including prices for underlying trust
collateral securities, whether direct market quotes,
adjusted comparable security prices, or broker quotes, are
subject to internal analyses that consider market observa-
tions, broker quotes and other tests to substantiate their
fair values. Broker quotes used are indicative but not firm
or tradable bids. Exclusive of these internal analytics, we
generally do not obtain more than one price per instru-
ment, unless we are relying on broker quotes, where we
generally seek to use an average of at least two quotes.
The prices utilized for underlying trust collateral securi-
ties incorporated both non-performance and liquidity
risks inherent in these securities and there were no further
considerations of credit risk necessary relating to the trust
or the issuers of the SIVs. In estimating the fair values for
SIV-related financial assets and liabilities (both securi-
ties owned and fund support derivatives) we assumed the
value of the related SIV security equaled its percentage
share of the sum of the values of the underlying collateral
securities plus cash and other assets held by the trust, net
of reported trust liabilities. In following this valuation
approach, we assume that the SIV trust will distribute to
holders all income and other returns received from the
collateral securities. When no direct price for a particular
collateral security is available, the price is based upon
a review of available information, including prices for
securities we believe are comparable. We use professional
judgment to consider adjustments where appropriate
including, for example, based on the nature of the col-
lateral and its issue date. While these determinations
may reflect, in whole or part, market observations, they
are inherently subjective and it is not possible to further
quantify the impact of changes in these assumptions. Our
credit risk is not a material factor to the fair value of the
related derivative liabilities because, among other things,
the majority of our liquidity fund support required cash
collateral and we had available cash to cover uncollateral-
ized positions.
These valuation processes for supported or purchased
SIV-issued securities inherently required management’s
judgment and therefore the related assets and liabilities
were classified in Level 3. Market changes affecting the
underlying collateral are a primary contributor to changes
in the fair values of the liquidity fund support assets and
liabilities and the related gains and losses.
As of March 31, 2009, approximately 1% of total assets
and less than 1% of total liabilities meet the definition of
Level 3.
Any transfers between categories are measured at the
beginning of the period.
See Note 3 of Notes to Consolidated Financial Statements
for additional information.
Intangible Assets and Goodwill
Balances as of March 31, 2009 are as follows:
Asset management contracts
Indefinite-life intangible assets
Trade names
Goodwill
Americas
88,243
$
2,541,557
69,800
907,078
$3,606,678
International
11,797
$
1,211,404
—
279,669
$1,502,870
Total
$ 100,040
3,752,961
69,800
1,186,747
$5,109,548
Our identifiable intangible assets consist primarily of asset
management contracts, contracts to manage proprietary
mutual funds or funds-of-hedge funds and trade names
resulting from acquisitions. Asset management contracts
are amortizable intangible assets that are capitalized at
acquisition and amortized over the expected life of the
contract. Contracts to manage proprietary mutual funds
or funds-of-hedge funds are indefinite-life intangible
assets because we assume that there is no foreseeable limit
on the contract period due to the likelihood of continued
renewal at little or no cost. Similarly, trade names are con-
sidered indefinite-life intangible assets because they are
expected to generate cash flows indefinitely.
In allocating the purchase price of an acquisition to intan-
gible assets, we must determine the fair value of the assets
acquired. We determine fair values of intangible assets
acquired based upon projected future cash flows, which
38
take into consideration estimates and assumptions includ-
ing profit margins, growth or attrition rates for acquired
contracts based upon historical experience, estimated
contract lives, discount rates, projected net client flows
and market performance. The determination of estimated
contract lives requires judgment based upon historical cli-
ent turnover and attrition rates and the probability that
contracts with termination provisions will be renewed.
The discount rate employed is a weighted average cost of
capital that takes into consideration a premium represent-
ing the degree of risk inherent in the asset as more fully
described below.
For indefinite-life intangible assets and goodwill, we proj-
ect the impact of both net client flows and market appreci-
ation/depreciation on cash flows for the near-term (gener-
ally the first five years) based on a year-by-year assessment
that considers current market conditions, our past experi-
ence, relevant publicly available statistics and projections,
and discussions with our own market experts. Beyond five
years, our projections for net client flows and market per-
formance migrate towards relevant long-term rates in line
with our own results and industry growth statistics. We
believe our growth assumptions are reasonable given our
consideration of multiple inputs, including internal and
external sources described above. However, there continues
to be significant volatility and uncertainty in the markets,
and our assumptions are subject to change based on fluc-
tuations in our actual results and market conditions.
Goodwill represents the residual amount of acquisition
cost in excess of identified tangible and intangible assets
and assumed liabilities.
Given the relative significance of our intangible assets
and goodwill to our consolidated financial statements,
on a quarterly basis we consider if triggering events have
occurred that may indicate a significant change in fair
values. Triggering events may include significant adverse
changes in our business, legal or regulatory environment,
loss of key personnel, significant business dispositions, or
other events. If a triggering event has occurred, we per-
form detail tests, which include critical reviews of all sig-
nificant assumptions, to determine if any intangible assets
or goodwill are impaired. At a minimum, we perform
these detail tests for indefinite-life intangible assets and
goodwill annually at December 31.
Amortizable Intangible Assets
Intangible assets subject to amortization are consid-
ered for impairment at each reporting period using an
undiscounted cash flow analysis. Significant assump-
tions used in assessing the recoverability of management
contract intangible assets include projected cash flows
generated by the contracts and the remaining lives of the
contracts. Projected cash flows are based on fees generated
by current AUM for the applicable contracts. Contracts
are generally assumed to turnover evenly throughout the
life of the intangible asset. The remaining life of the asset
is based upon factors such as average client retention and
client turnover rates. If the amortization periods are not
appropriate, the expected lives are adjusted and the impact
on the fair value is assessed. Actual cash flows in any one
period may vary from the projected cash flows without
resulting in an impairment charge because a variance in
any one period must be considered in conjunction with
other assumptions that impact projected cash flows.
Management contract intangible assets related to retail
separately managed accounts sold through broker-dealer
sponsored programs acquired in the CAM transaction
(“CAM management contracts”) represented approxi-
mately $128.3 million or 69% of our total net amortiz-
able intangible assets as of December 31, 2008, with a
remaining life of approximately 9 years. However, we have
experienced a recent trend of increased client outflows
associated with these contracts. In addition, changes at
the primary underlying program sponsor announced dur-
ing the March quarter are expected to contribute further
to this trend. The combination of these events has caused
us to reduce the remaining expected life by approximately
40% to 5 years. The impact of reduced AUM levels, com-
bined with the shorter expected life (recovery period), has
resulted in our cumulative expected future cash flows to
fall below the carrying value of the asset. On a discounted
cash flow basis, this resulted in an impairment charge
of $72 million. After the impairment charge, the CAM
management contracts represent approximately $52 mil-
lion or 52% of our total net amortizable intangible assets.
As a result of significant client attrition, related declines
in AUM and the associated revised estimate of remaining
useful lives, our evaluation during fiscal 2009 of PCM’s
asset management contracts indicated the carrying value
would not be fully recoverable. Based upon projected cash
flows on remaining acquired contracts, discounted at a
rate of 14.8%, the value of contracts was determined to
be impaired and we recognized charges for the remaining
book value totaling $26.6 million in fiscal 2009. Current
cash flow projections were significantly lower than previ-
ous projections as a result of continued AUM outflows
39
and decreased market value resulting in part from the
recent severe market declines.
The estimated useful lives of amortizable intangible assets
currently range from 1 to 9 years with a weighted-average
life of approximately 5 years.
Indefinite-Life Intangible Assets
For intangible assets with lives that are indeterminable
or indefinite, fair value is determined based on projected
discounted cash flows. We have two primary types of
indefinite-life intangible assets: proprietary fund contracts
and to a lesser extent, trade names.
The discounted projected cash flows used to value intan-
gible assets take into consideration estimates of profit
margins, growth rates, which includes estimates of both
AUM flows and market expectations by asset class (equity,
fixed income and liquidity), and discount rates. An asset
is determined to be impaired if the current implied fair
value is less than the recorded carrying value of the asset.
If such impairment exists, the difference between the cur-
rent implied fair value and the carrying value of the asset
reflected on the financial statements is recognized as an
expense in the period in which the impairment is deter-
mined to be other than temporary.
Projected cash flows are based on annualized cash flows
for the applicable contracts projected forward 40 years,
assuming annual cash flow growth from estimated net
client flows and projected market performance. Contracts
that are managed and operated as a single unit, such as
contracts within the same family of funds, are reviewed
in aggregate and are considered interchangeable because
investors can transfer between funds with limited restric-
tions. Similarly, cash flows generated by new funds added
to the fund group are included when determining the fair
value of the intangible asset. Actual cash flows in any one
period may vary from the projected cash flows without
resulting in an impairment charge because a variance in
any one period must be considered in conjunction with
other assumptions that impact projected cash flows.
The domestic mutual fund contracts acquired in the
CAM acquisition of $2,502 million and the Permal
funds-of-hedge funds contracts of $947 million account
for approximately 65% and 25%, respectively, of our
indefinite-life intangible assets. As a result of the dra-
matic changes in market conditions during the fiscal
year, we revised our growth assumptions downward,
to project contraction to minimal growth for the
domestic mutual fund contracts and contraction for
the Permal contracts through the next two years. Cash
flows from the domestic mutual fund contracts were
assumed to have a five year average annual growth rate
of approximately 4.0%, with a long-term annual rate
of approximately 7.5% thereafter. Cash flows on the
Permal contracts were assumed to have a five year aver-
age annual growth rate of approximately 2.5%, with a
long-term annual rate of approximately 8.0% thereafter.
We believe our growth assumptions are reasonable given
our consideration of multiple inputs, including internal
and external sources described above. However, there
continues to be significant volatility and uncertainty in
the markets, and our assumptions are subject to change
based on fluctuations in our actual results and market
conditions. The projected cash flows from the domestic
mutual funds and Permal funds are discounted at 13.7%
and 14.7%, respectively. Changes in assumptions, such as
an increased discount rate or declining cash flows, could
result in impairment. Assuming all other factors remain
the same, actual results and changes in assumptions for
the domestic mutual fund and Permal fund-of-hedge
funds contracts would have to cause our cash flow pro-
jections over the long-term to deviate more than 16%
and 20%, respectively, from previous projections or the
discount rate would have to be raised to 15% and 17%,
respectively, for the assets to be deemed impaired. With
continued deterioration in the markets or other unfavor-
able factors, it is reasonably possible that actual cash
flows from either or both the domestic mutual fund or
Permal fund contracts could deviate from projections by
more than 16% and 20%, respectively. The approximate
fair values of these assets exceed their carrying values by
$480.3 million and $240.0 million, respectively.
Trade names account for less than 2% of indefinite-life
intangible assets. The significant decrease in PCM’s
assets under management and related cash flows gener-
ated assessed values that resulted in full impairment of
the $47 million PCM trade name asset during fiscal
2009. The assessment of this trade name fair value was
based on a discounted cash flow model applying an
after-tax royalty rate to PCM’s expected future revenues,
using a discount rate of 14.8% and long-term annual
growth of 5%. Although the discounted cash flow model
resulted in an immaterial assessed value, based on other
qualitative factors, we believed the remaining amount
was impaired.
40
Goodwill
Goodwill is evaluated at the reporting unit level and is
considered for impairment when the carrying amount of
the reporting unit exceeds the implied fair value of the
reporting unit. In estimating the implied fair value of
the reporting unit, we use valuation techniques based on
discounted projected cash flows, similar to techniques
employed in analyzing the purchase price of an acquisi-
tion target. Allocations of goodwill to our divisions for
changes in our management structure, acquisitions and
dispositions are based on relative fair values of the busi-
nesses added to or sold from the divisions.
Significant assumptions used in assessing the implied fair
value of the reporting unit under the discounted cash flow
method include the projected cash flows generated by the
reporting unit, including profit margins, expected current
and long-term cash flow growth rates, and the discount
rate used to determine the present value of the cash flows.
Cash flow growth rates consider estimates of both AUM
flows and market expectations by asset class (equity, fixed
income and liquidity), by investment manager and by
reporting unit based upon, among other things, historical
experience and expectations of future market performance
from internal and external sources. The impact of both
net client flows and market appreciation/depreciation on
cash flows are projected for the near-term (generally the
first five years) based on a year-by-year assessment that
considers current market conditions, our experience, rel-
evant publicly available statistics and projections, and dis-
cussions with our own market experts. Actual cash flows
in any one period may vary from the projected cash flows
without resulting in an impairment charge because a vari-
ance in any one period must be considered in conjunction
with other assumptions that impact projected cash flows.
Discount rates are based on appropriately weighted esti-
mated costs of debt and capital. We estimate the cost
of debt based on published debt rates. We estimate the
cost of capital based on the Capital Asset Pricing Model,
which considers the risk-free interest rate, market risk and
size premiums, peer-group betas and unsystematic risk.
The discount rates are also calibrated based on an assess-
ment of relevant market values.
Goodwill in the Americas reporting unit principally
originated from the acquisitions of CAM and Royce.
The value of this reporting unit is based on projected
net cash flows of assets managed in our U.S. mutual
funds, closed end funds and other proprietary funds, in
addition to separate account assets of our U.S. manag-
ers. Goodwill in the International reporting unit princi-
pally originated from the acquisitions of Permal and the
international CAM businesses. The projected cash flows
are discounted at 14.0% and 14.5%, respectively, for the
Americas and International divisions to determine the
present value of cash flows. As of March 31, 2009, the
implied fair values exceed the carrying values for both
the Americas and International divisions. Projected cash
flows, on an aggregate basis across all asset classes in the
Americas division, are assumed to have a five year average
annual growth rate of approximately 4%, with a long-
term annual growth rate of approximately 10%. Projected
cash flows, on an aggregate basis across all asset classes
in the International division are assumed to have a five
year average annual growth rate of approximately 6%,
with a long-term annual growth rate of approximately
10%. Cash flow growth of 4% and 6% for Americas and
International, respectively, over the next five years is based
on separate factors for equity, fixed income, and liquidity
products. Equity product growth projections are based
on historical recovery trends following prior recessionary
periods, in context with our long-term growth experience
and current market conditions. Fixed income product
growth projections are based on the past experience of our
primary fixed income manager and current market influ-
ences relevant to their business. On a combined basis for
both equity and fixed income product types, these projec-
tions rely on an expectation that markets relevant to these
products will stabilize with some rebalancing from fixed
income to equity products during fiscal 2010. Long-term
growth of 10% for both divisions is based on our histori-
cal experience and available historic market statistics. We
believe our growth assumptions are reasonable given our
consideration of multiple inputs, including internal and
external sources described above. However, there con-
tinues to be significant volatility and uncertainty in the
markets, and our assumptions are subject to change based
on fluctuations in our actual results and market condi-
tions. Assuming all other factors remain the same, actual
results and changes in assumptions for the Americas and
International reporting units would have to cause our cash
flow projections over the long-term to deviate more than
42% and 34%, respectively, from previous projections or
the discount rate would have to increase approximately 5
and 4 percentage points, respectively, for goodwill to be
considered for impairment.
Under our prior management structure and related
reporting units of Managed Investments, Institutional
41
and Wealth Management, we recognized an impair-
ment charge of $1,161,900 for the Wealth Management
division during the third quarter of fiscal 2009. The
severe market turmoil experienced during the December
quarter had a more significant impact on the Wealth
Management division than on our other divisions. AUM
in that division decreased over 30% as a result of both
net client outflows and market depreciation. As a result
of the dramatic changes in market conditions during
the December quarter, growth assumptions were revised
downward, to project contraction through the next two
years. Further, the applicable discount rate was increased
from 12.5% to 14.7% based on changes in interest rates
and market risk factors. The combined impact of these
factors decreased projected cash flows of the Wealth
Management division by over 60% from our prior pro-
jections resulting in the impairment charge. Prior to the
impairment charge, the majority of the goodwill of this
division arose from the acquisition of PCM. Projected
cash flows for the Wealth Management division were
assumed to have a five year average annual growth rate
of approximately 3.0%, with a long-term annual growth
rate of approximately 8.0% compared to prior average
growth rates of 7.3% and 10.0%, respectively. Growth
of 3% over the next five years was based on the cur-
rent market conditions, our past experience, market
statistics and prospects of each of our more significant
managers in this division. These projections relied on
the expectation that markets relevant to products in
this division will stabilize by fiscal 2011. Actual results
will invariably differ from our assumptions, the impact
of which could be material to the financial statements.
Goodwill is the residual value of a reporting unit after
all other identifiable assets in that reporting unit have
been valued, including management contract intangible
assets. If goodwill has been determined to be impaired,
variances in assumptions that impact the value of the
reporting unit will generally also impact the values
of identifiable assets within the reporting unit before,
and to a greater extent than, they impact goodwill. For
example, if our growth assumptions for the Wealth
Management Division and all its related intangible
assets were decreased for all periods by 1%, the goodwill
impairment charge recorded for the division would have
increased by less than 2%, because the other intangible
assets within the division would have correspondingly
decreased in value. Likewise, if the discount rate for the
Wealth Management Division and all its related intan-
gible assets had been 15.7% (1 percentage point higher),
the goodwill impairment charge recorded for the divi-
sion would have increased by less than 2%.
As indicated above, we performed our annual assess-
ment of goodwill as of December 31. However, given the
restructuring of our reporting units in the fourth quarter
of fiscal 2009, we reassessed the fair values of our former
reporting units as of March 31, 2009, the results of which
indicated the fair values of each reporting unit exceeded
its respective carrying value.
As of March 31, 2009, considering relevant prices of Legg
Mason’s common shares and based on dilutive shares out-
standing, inclusive of shares issuable under Equity Units,
our market capitalization, along with a reasonable control
premium, approximates its carrying value. In an acquisi-
tion, there is typically a premium paid over current mar-
ket prices of publicly traded companies that relates to the
ability to control the operations of an acquired company.
Recent market evidence regarding this control factor sug-
gests premiums of 30% to 45% and higher as realistic and
common, and Legg Mason believes such premiums to be
a reasonable estimation for our equity value. Our market
evidence is from a published source and included 150
transactions from the quarter ended September 30, 2008.
Although there is limited transaction data subsequent to
September 30, 2008, more recent transactions support or
exceed the high end of our range. We exclude consider-
ation of transactions with unique circumstances and find
that transaction values for asset management firms relative
to their respective book values do not vary significantly
from relative transaction values in other industries.
Continued disruption and depressed financial markets
will further increase the potential for impairment of our
goodwill and/or other intangible asset carrying values.
Stock-Based Compensation
Our stock-based compensation plans include stock options,
employee stock purchase plans, performance share awards,
restricted stock awards and deferred compensation payable
in stock. Under our stock compensation plans, we issue
equity awards to officers and key employees.
During fiscal 2007, we adopted SFAS No. 123 (R),
“Share-Based Payment” and related pronouncements
using the modified-prospective method and the related
transition election. Under this method, compensation
expense for the years ended March 31, 2009, 2008 and
2007 includes compensation cost for all non-vested share-
based awards at their grant-date fair value amortized over
42
the respective vesting periods on the straight-line method.
Unamortized deferred compensation is recognized as a
reduction of additional paid-in capital. Also under SFAS
No. 123 (R), cash flows related to income tax deductions
in excess of or less than the stock-based compensation
expense are classified as financing cash flows.
We granted 1.5 million, 0.9 million, and 1.0 million stock
options, including grants to non-employee directors, in
fiscal 2009, 2008 and 2007, respectively. For additional
information on share-based compensation, see Note 12 of
Notes to Consolidated Financial Statements.
We determine the fair value of each option grant using the
Black-Scholes option-pricing model, except for market-
based grants, for which we use a Monte Carlo option-
pricing model. Both models require management to
develop estimates regarding certain input variables. The
inputs for the Black-Scholes model include: stock price
on the date of grant, exercise price of the option, dividend
yield, volatility, expected life and the risk-free interest
rate, all of which except the grant date stock price and
the exercise price require estimates or assumptions. We
calculate the dividend yield based upon the average of the
historical quarterly dividend payments over a term equal
to the vesting period of the options. We estimate volatil-
ity equally weighted between the historical prices of our
stock over a period equal to the expected life of the option
and in part upon the implied volatility of market-listed
options at the date of grant. The expected life is the esti-
mated length of time an option is held before it is either
exercised or canceled, based upon our historical option
exercise experience. The risk-free interest rate is the rate
available for zero-coupon U.S. Government issues with a
remaining term equal to the expected life of the options
being valued. If we used different methods to estimate our
variables for the Black-Scholes and Monte Carlo models,
or if we used a different type of option-pricing model, the
fair value of our option grants might be different.
Income Taxes
Legg Mason and its subsidiaries are subject to the income
tax laws of the federal, state and local jurisdictions of
the U.S. and numerous foreign jurisdictions in which we
operate. We file income tax returns representing our fil-
ing positions with each jurisdiction. Due to the inherent
complexities arising from conducting business and being
taxed in a substantial number of jurisdictions, we must
make certain estimates and judgments in determining our
income tax provision for financial statement purposes.
These estimates and judgments are used in determining
the tax basis of assets and liabilities, and in the calculation
of certain tax assets and liabilities that arise from differ-
ences in the timing of revenue and expense recognition
for tax and financial statement purposes. Management
assesses the likelihood that we will be able to realize our
deferred tax assets. If it is more likely than not that the
deferred tax asset will not be realized, then a valuation
allowance is established with a corresponding increase to
deferred tax provision.
Substantially all of Legg Mason’s deferred tax assets relate
to U.S. and United Kingdom (“U.K.”) taxing jurisdic-
tions. Although Legg Mason has been historically profit-
able, the current year SIV losses resulted in a U.S. tax loss
for fiscal 2009. We believe SIV losses incurred on liquid-
ity fund guarantees are unique and isolated. Therefore,
any analysis of Legg Mason’s core U.S. earnings expected
to recur in the future should exclude incurred SIV losses.
As of March 31, 2009, U.S. deferred tax assets accu-
mulated $1.3 billion, realization of which is expected to
require $5.7 billion of future U.S. earnings. Based on esti-
mates of future taxable income, using the same assump-
tions as those used in our goodwill impairment testing, it
is more likely than not that current tax benefits are realiz-
able and no valuation allowance is necessary at this time.
To the extent our analysis of the realization of deferred tax
assets relies on deferred tax liabilities, we have considered
the timing, nature and jurisdiction of reversals. While
tax planning may enhance our positions, the realization
of current tax benefits is not dependent on any significant
tax strategies. As of March 31, 2009, U.K. deferred tax
assets are not material.
In the event we determine all or any portion of our
deferred tax assets are not realizable, we will be required
to establish a valuation allowance by a charge to the
income provision in the period in which that determina-
tion is made. Depending on the facts and circumstances,
the charge could be material to our earnings.
Included in Refundable income taxes in the Consolidated
Balance Sheet at March 31, 2009 is $603 million in tax
refunds expected during fiscal year 2010, of which $275 mil-
lion, $271 million and $57 million, relates to net operating
and capital loss carrybacks and other refunds, respectively.
The calculation of our tax liabilities involves uncertainties
in the application of complex tax regulations. We recognize
liabilities for anticipated tax uncertainties in the U.S. and
43
other tax jurisdictions based on our estimate of whether,
and the extent to which, additional taxes will be due.
date on which such statement is made or to reflect the
occurrence of unanticipated events.
RECENT ACCOUNTING DEVELOPMENTS
See discussion of Recent Accounting Developments in
Note 1 of Notes to Consolidated Financial Statements.
FORWARD-LOOKING STATEMENTS
We have made in this 2009 Annual Report, and from
time to time may otherwise make in our public fil-
ings, press releases and statements by our management,
“forward-looking statements” within the meaning of
the Private Securities Litigation Reform Act of 1995,
including information relating to anticipated growth in
revenues or earnings per share, anticipated changes in our
business or in the amount of our client AUM, anticipated
future performance of our business, anticipated future
investment performance of our subsidiaries, our expected
future net client cash flows, anticipated expense levels,
changes in expenses, the expected effects of acquisitions
and expectations regarding financial market conditions.
The words or phrases “can be,” “may be,” “expects,” “may
affect,” “may depend,” “believes,” “estimate,” “project,”
“anticipate” and similar words and phrases are intended
to identify such forward-looking statements. Such
forward-looking statements are subject to various known
and unknown risks and uncertainties and we caution
readers that any forward-looking information provided
by or on behalf of Legg Mason is not a guarantee of
future performance.
Actual results may differ materially from those in for-
ward-looking information as a result of various factors,
some of which are beyond our control, including but
not limited to those discussed below and those discussed
under the heading “Risk Factors” and elsewhere in our
Annual Report on Form 10-K and our other public fil-
ings, press releases and statements by our management.
Due to such risks, uncertainties and other factors, we
caution each person receiving such forward-looking infor-
mation not to place undue reliance on such statements.
Further, such forward-looking statements speak only as
of the date on which such statements are made, and we
undertake no obligations to update any forward-looking
statement to reflect events or circumstances after the
Our future revenues may fluctuate due to numerous fac-
tors, such as: the total value and composition of AUM; the
volatility and general level of securities prices and interest
rates; the relative investment performance of company-
sponsored investment funds and other asset management
products compared with competing offerings and mar-
ket indices; investor sentiment and confidence; general
economic conditions; our ability to maintain investment
management and administrative fees at current levels;
competitive conditions in our business; the ability to
attract and retain key personnel and the effects of acquisi-
tions, including prior acquisitions. Our future operating
results are also dependent upon the level of operating
expenses, which are subject to fluctuation for the follow-
ing or other reasons: variations in the level of compensa-
tion expense incurred as a result of changes in the number
of total employees, competitive factors, changes in the
percentages of revenues paid as compensation or other
reasons; variations in expenses and capital costs, including
depreciation, amortization and other non-cash charges
incurred by us to maintain our administrative infrastruc-
ture; unanticipated costs that may be incurred by Legg
Mason from time to time to protect client goodwill, to
otherwise support investment products or in connection
with litigation or regulatory proceedings; and the effects
of acquisitions and dispositions.
Our business is also subject to substantial governmental
regulation and changes in legal, regulatory, accounting,
tax and compliance requirements that may have a sub-
stantial effect on our business and results of operations.
EFFECTS OF INFLATION
The rate of inflation can directly affect various expenses,
including employee compensation, communications
and technology and occupancy, which may not be read-
ily recoverable in charges for services provided by us.
Further, to the extent inflation adversely affects the
securities markets, it may impact revenues and recorded
intangible asset and goodwill values. See discussion
of “Market Risks—Revenues and Net Income” and
“Critical Accounting Policies—Intangible Assets and
Goodwill” previously discussed.
44
REpoRT oF MANAg EMENT o N INTERNAL CoNTRoL oVER FINANCIAL REpoRTINg
The management of Legg Mason, Inc. is responsible for establishing and maintaining adequate internal control over
financial reporting.
Legg Mason’s internal control over financial reporting is a process designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
accounting principles generally accepted in the United States of America. Legg Mason’s internal control over finan-
cial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of Legg Mason; (ii) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with
accounting principles generally accepted in the United States of America, and that receipts and expenditures of Legg
Mason are being made only in accordance with authorizations of management and directors of Legg Mason; and (iii)
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition
of Legg Mason’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstate-
ments. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of compliance with the policies or proce-
dures may deteriorate.
Management assessed the effectiveness of Legg Mason’s internal control over financial reporting as of March 31,
2009, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission
(“COSO”) in Internal Control—Integrated Framework. Based on that assessment, management concluded that, as of
March 31, 2009, Legg Mason’s internal control over financial reporting is effective based on the criteria established in
the COSO framework.
The effectiveness of Legg Mason’s internal control over financial reporting as of March 31, 2009, has been audited
by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report appear-
ing herein, which expresses an unqualified opinion on the effectiveness of Legg Mason’s internal control over financial
reporting as of March 31, 2009.
Mark R. Fetting
Chairman and Chief Executive Officer
Charles J. Daley, Jr.
Senior Vice President, Chief Financial Officer and Treasurer
45
REpoRT oF I NDEpENDENT R EgISTERED p ubLIC ACCouNTINg FIRM
To the Board of Directors
and Stockholders of Legg Mason, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations,
comprehensive income, changes in stockholders’ equity and cash flows present fairly, in all material respects, the finan-
cial position of Legg Mason, Inc. and its subsidiaries at March 31, 2009 and March 31, 2008, and the results of their
operations and their cash flows for each of the three years in the period ended March 31, 2009 in conformity with
accounting principles generally accepted in the United States of America. Also in our opinion, the Company main-
tained, in all material respects, effective internal control over financial reporting as of March 31, 2009, based on criteria
established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for main-
taining effective internal control over financial reporting and for its assessment of the effectiveness of internal control
over financial reporting, included in the accompanying Report of Management on Internal Control over Financial
Reporting. Our responsibility is to express opinions on these financial statements and on the Company’s internal con-
trol over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards
of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and per-
form the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement
and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the
financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the finan-
cial statements, assessing the accounting principles used and significant estimates made by management, and evaluating
the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining
an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits
also included performing such other procedures as we considered necessary in the circumstances. We believe that our
audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over financial reporting includes those poli-
cies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect
the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of
management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detec-
tion of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstate-
ments. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of compliance with the policies or proce-
dures may deteriorate.
Baltimore, Maryland
May 29, 2009
46
CoNSoLIDATED S TATEMENTS oF op ERATIoNS
(Dollars in thousands, except per share amounts)
OPERATING REVENUES
Investment advisory fees
Separate accounts
Funds
Performance fees
Distribution and service fees
Other
Total operating revenues
OPERATING EXPENSES
Compensation and benefits
Distribution and servicing
Communications and technology
Occupancy
Amortization of intangible assets
Impairment of goodwill and intangible assets
Other
Total operating expenses
OPERATING INCOME (LOSS)
OTHER INCOME (EXPENSE)
Interest income
Interest expense
Fund support
Other
Total other income (expense)
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAX PROVISION (BENEFIT)
AND MINORITY INTERESTS
Income tax provision (benefit)
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE MINORITY INTERESTS
Minority interests, net of tax
INCOME (LOSS) FROM CONTINUING OPERATIONS
Gain on sale of discontinued operations, net of tax
NET INCOME (LOSS)
NET INCOME (LOSS) PER SHARE
Basic:
Income (loss) from continuing operations
Gain on sale of discontinued operations
Diluted:
Income (loss) from continuing operations
Gain on sale of discontinued operations
See notes to consolidated financial statements.
2009
Years Ended March 31,
2008
2007
$ 1,017,195
1,836,350
17,429
475,003
11,390
3,357,367
1,132,216
969,964
188,312
209,537
36,488
1,307,970
182,060
4,026,547
(669,180)
56,272
(150,465)
(2,283,236)
(109,248)
(2,486,677)
$1,464,512
2,319,788
132,740
692,277
24,769
4,634,086
1,569,517
1,273,986
192,821
129,425
57,271
151,000
209,890
3,583,910
1,050,176
$1,445,796
2,023,140
142,245
716,402
16,092
4,343,675
1,568,568
1,196,019
174,160
100,180
68,410
—
208,040
3,315,377
1,028,298
76,923
(82,681)
(607,276)
6,729
(606,305)
58,916
(71,474)
—
28,114
15,556
(3,155,857)
(1,210,853)
443,871
175,995
1,043,854
397,612
(1,945,004)
(2,924)
(1,947,928)
—
$(1,947,928)
267,876
(266)
267,610
—
$ 267,610
646,242
4
646,246
572
$ 646,818
$
$
$
$
(13.85)
—
(13.85)
(13.85)
—
(13.85)
$
$
$
$
1.88
—
1.88
1.86
—
1.86
$
$
$
$
4.58
—
4.58
4.48
—
4.48
47
CoNSoLIDATED bALANCE Sh EETS
(Dollars in thousands)
ASSETS
Current Assets
Cash and cash equivalents
Securities purchased under agreements to resell
Restricted cash
Receivables:
Investment advisory and related fees
Other
Investment securities
Refundable income taxes
Deferred income taxes
Other
Total current assets
Fixed assets, net
Intangible assets, net
Goodwill
Deferred income taxes
Other
Total Assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Current Liabilities
Accrued compensation
Accounts payable and accrued expenses
Short-term borrowings
Current portion of long-term debt
Fund support
Other
Total current liabilities
Deferred compensation
Deferred income taxes
Other
Long-term debt
Total Liabilities
Commitments and Contingencies (Note 9)
Stockholders’ Equity
March 31,
2009
2008
$1,084,474
—
41,688
$ 1,463,554
604,642
844,728
293,084
306,837
336,092
603,668
94,112
99,432
2,859,387
367,043
3,922,801
1,186,747
524,488
225,862
489,081
14,512
235,300
283,585
4,685,752
346,802
4,109,735
2,536,816
848,488 —
136,888
$9,321,354
151,247
$11,830,352
$ 374,025
400,761
250,000
8,188
20,631
227,588
1,281,193
105,115
258,944
256,421
2,965,204
4,866,877
$
608,465
490,141
500,000
432,119
551,654
157,068
2,739,447
149,953
355,239
139,556
1,825,654
5,209,849
Common stock, par value $.10; authorized 500,000,000 shares;
issued 141,853,025 shares in 2009 and 138,556,117 shares in 2008
Convertible preferred stock, par value $10; authorized 4,000,000 shares;
14,185
13,856
0 and 0.36 shares outstanding in 2009 and 2008, respectively
— —
Shares exchangeable into common stock
Additional paid-in capital
Employee stock trust
Deferred compensation employee stock trust
Retained earnings
Accumulated other comprehensive income (loss), net
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
See notes to consolidated financial statements.
48
3,069
3,284,347
(35,094)
35,094
1,155,660
(2,784)
4,454,477
$9,321,354
4,982
3,278,376
(29,307)
29,307
3,240,359
82,930
6,620,503
$11,830,352
CoNSoLIDATED S TATEMENTS oF Ch ANgES IN S ToCkhoLDERS’ EquITy
(Dollars in thousands)
COMMON STOCK
Beginning balance
Stock options and other stock-based compensation
Deferred compensation employee stock trust
Deferred compensation, net
Conversion of debt
Exchangeable shares
Business acquisitions
Shares repurchased and retired
Preferred share conversions
Ending balance
SHARES EXCHANGEABLE INTO COMMON STOCK
Beginning balance
Exchanges
Ending balance
ADDITIONAL PAID-IN CAPITAL
Beginning balance
Stock options and other stock-based compensation
Deferred compensation employee stock trust
Deferred compensation, net
Convertible debt
Exchangeable shares
Business acquisitions
Cost of convertible note hedge, net
Future tax benefit on convertible note hedge
Shares repurchased and retired
Preferred share conversions
Ending balance
EMPLOYEE STOCK TRUST
Beginning balance
Shares issued to plans
Distributions and forfeitures
Ending balance
DEFERRED COMPENSATION EMPLOYEE STOCK TRUST
Beginning balance
Shares issued to plans
Distributions and forfeitures
Ending balance
RETAINED EARNINGS
Beginning balance
Adjustment on adoption of FIN 48
Net income (loss)
Dividends declared
Ending balance
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS), NET
Beginning balance
Realized and unrealized holding gains (losses) on investment
securities, net of tax
Unrealized and realized gains (losses) on cash flow hedge, net of tax
Foreign currency translation adjustment
Ending balance
TOTAL STOCKHOLDERS’ EQUITY
See notes to consolidated financial statements.
Years Ended March 31,
2008
2009
2007
$
13,856
109
16
92
—
76
—
—
36
14,185
4,982
(1,913)
3,069
$
13,178
157
5
30
—
8
39
(114)
553
13,856
5,188
(206)
4,982
$
12,971
86
5
19
76
21
—
—
—
13,178
5,720
(532)
5,188
3,278,376
37,988
6,505
33,107
(73,430)
1,837
—
—
—
—
(36)
3,284,347
(29,307)
(5,787)
—
(35,094)
29,307
5,787
—
35,094
3,372,385
91,873
4,915
24,195
—
198
32,461
(83,125)
113,858
(277,831)
(553)
3,278,376
(31,839)
(4,689)
7,221
(29,307)
31,839
4,689
(7,221)
29,307
3,235,583
80,514
5,228
17,675
32,874
511
—
—
—
—
—
3,372,385
(45,924)
(772)
14,857
(31,839)
45,924
772
(14,857)
31,839
3,240,359
—
(1,947,928)
(136,771)
1,155,660
3,112,844
(3,550)
267,610
(136,545)
3,240,359
2,580,898
—
646,818
(114,872)
3,112,844
82,930
37,895
14,944
61
938
(86,713)
(2,784)
$ 4,454,477
(24)
(1,523)
46,582
82,930
$6,620,503
97
(738)
23,592
37,895
$6,541,490
49
CoNSoLIDATED S TATEMENTS oF Co MpREhENSIVE INCoME (LoSS)
(Dollars in thousands)
2009
$(1,947,928)
Years Ended March 31,
2008
$267,610
2007
$646,818
(86,713)
46,582
23,592
13
48
61
(11)
(13)
(24)
37
60
97
938
(85,714)
$(2,033,642)
(1,523)
45,035
$312,645
(738)
22,951
$669,769
NET INCOME (LOSS)
Other comprehensive income gains (losses):
Foreign currency translation adjustment
Unrealized gains (losses) on investment securities:
Unrealized holding gains (losses) net of tax provision (benefit)
of $9, $(8) and $24, respectively
Reclassification adjustment for (gains) losses included
in net income
Net unrealized gains (losses) on investment securities
Unrealized and realized gains (losses) on cash flow hedge, net of tax
provision (benefit) of $666, $(1,080) and $(524), respectively
Total other comprehensive income (loss)
COMPREHENSIVE INCOME (LOSS)
See notes to consolidated financial statements.
50
CoNSoLIDATED S TATEMENTS oF C ASh FLowS
(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)
Realized loss on sale of SIV securities
Gain on sale of discontinued operations, net of tax
Non-cash items included in net income:
Depreciation and amortization
Amortization of deferred sales commissions
Accretion and amortization of securities discounts and premiums, net
Stock-based compensation
Unrealized losses (gains) on investments
Unrealized losses on fund support
Impairment of goodwill and intangible assets
Deferred income taxes
Other
Decrease (increase) in assets excluding acquisitions:
Investment advisory and related fees receivable
Net purchases of trading investments
Other receivables
Other assets
Increase (decrease) in liabilities excluding acquisitions:
Accrued compensation
Deferred compensation
Accounts payable and accrued expenses
Other liabilities
Net cash provided by operating activities of discontinued operations
CASH PROVIDED BY OPERATING ACTIVITIES
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from (payments for):
Fixed assets
Business acquisitions and related costs
Contractual acquisition earnout settlements (payments)
Proceeds from sale of assets
Fund Support:
Restricted cash, net principally collateral
Payments under liquidity fund support arrangements
Proceeds from sale of SIV securities
Purchases of SIV securities, net of distributions
Net (increase) decrease in securities purchased under agreements to resell
Purchases of investment securities
Proceeds from sales and maturities of investment securities
CASH USED FOR INVESTING ACTIVITIES
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in short-term borrowings
Proceeds from issuance of long-term debt, net
Purchase of convertible note hedge, net
Third party distribution financing, net
Repayment of principal on long-term debt
Issuance of common stock
Repurchase of stock
Dividends paid
Excess tax benefit associated with stock-based compensation
CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES
EFFECT OF EXCHANGE RATE CHANGES ON CASH
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR
CASH AND CASH EQUIVALENTS AT END OF YEAR
SUPPLEMENTARY DISCLOSURE
Cash paid for:
Income taxes
Interest
See notes to consolidated financial statements.
2009
Years Ended March 31,
2008
2007
$(1,947,928)
2,257,217
—
$ 267,610
—
—
$ 646,818
—
(572)
138,445
35,619
7,177
56,993
106,797
25,996
1,307,970
(805,127)
17,918
227,137
(95,074)
(626,392)
431,593
(234,817)
(44,838)
(89,380)
(331,420)
—
437,886
(130,950)
(7,524)
120,000
181,147
801,793
(305,933)
513,855
(2,868,815)
604,642
(1,293)
2,172
(1,090,906)
(250,000)
1,089,463
—
(4,814)
(429,608)
31,983
—
(135,878)
—
301,146
(27,206)
(379,080)
1,463,554
$ 1,084,474
141,083
39,139
1,059
49,345
43,960
607,276
151,000
(173,150)
2,266
66,907
(92,772)
26,095
72,585
45,268
13,940
(30,332)
(87,015)
—
1,144,264
(184,275)
(14,858)
(207,500)
—
(851,688)
(59,537)
49,915
(229,810)
(604,642)
(6,095)
5,180
(2,103,310)
500,000
1,252,600
(83,125)
5,264
(114,867)
35,920
(277,945)
(132,821)
35,587
1,220,613
18,370
279,937
1,183,617
$ 1,463,554
137,852
64,265
1,295
40,654
(7,141)
—
—
128,801
8,854
(23,797)
(138,167)
30,354
(3,863)
(25,803)
38,912
136,516
(130,079)
572
905,471
(112,026)
(60,330)
(384,748)
—
—
—
—
—
(20,787)
35,788
(542,103)
(83,227)
—
—
3,617
(61,096)
26,728
—
(109,919)
14,466
(209,431)
6,210
160,147
1,023,470
$1,183,617
$ 156,129
158,499
$ 250,352
74,084
$ 260,015
71,226
51
NoTES T o CoNSoLIDATED F INANCIAL S TATEMENTS
(Amounts in thousands, except per share amounts or unless otherwise noted)
1. SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
Basis of Presentation
Legg Mason, Inc. (“Parent”) and its subsidiaries (collec-
tively, “Legg Mason”) are principally engaged in provid-
ing asset management and related financial services to
individuals, institutions, corporations and municipalities.
The consolidated financial statements include the
accounts of the Parent and its subsidiaries in which it
has a controlling financial interest. Generally, an entity
is considered to have a controlling financial interest
when it owns a majority of the voting interest in an
entity. Legg Mason is also required to consolidate any
variable interest entity (“VIE”) in which it is considered
to be the primary beneficiary. See discussion of Variable
Interest Entities that follows for a further discussion of
VIEs. All material intercompany balances and transac-
tions have been eliminated.
Unless otherwise noted, all per share amounts include
common shares of Legg Mason, shares issued in connec-
tion with the acquisition of Legg Mason Canada Inc.,
which are exchangeable into common shares of Legg
Mason on a one-for-one basis at any time, and non-voting
convertible preferred stock, which was convertible into
shares of Legg Mason common stock. These non-voting
convertible preferred shares are considered “participating
securities” and therefore are included in the calculation of
basic earnings per common share. There is no convertible
preferred stock outstanding as of March 31, 2009.
Certain amounts in prior period financial statements
have been reclassified to conform to the current period
presentation, including fund support previously reported
as Other current liabilities, Other non-operating expense,
and Net purchases of trading investments.
All references to fiscal 2009, 2008 or 2007 refer to Legg
Mason’s fiscal year ended March 31 of that year.
Use of Estimates
The consolidated financial statements are prepared in
accordance with accounting principles generally accepted
in the United States of America, which require manage-
ment to make assumptions and estimates that affect
the amounts reported in the financial statements and
accompanying notes, including revenue recognition,
valuation of financial instruments, intangible assets and
goodwill, stock-based compensation and income taxes.
Management believes that the estimates used are reason-
able, although actual amounts could differ from the esti-
mates and the differences could have a material impact on
the consolidated financial statements.
Cash and Cash Equivalents
Cash equivalents are highly liquid investments with origi-
nal maturities of 90 days or less.
Repurchase Agreements
Legg Mason invests in short-term securities purchased
under overnight agreements to resell collateralized by U.S.
government and agency securities. Securities purchased
under agreements to resell are accounted for as collateral-
ized financings and are carried at contractual amounts,
plus accrued interest.
Restricted Cash
Restricted cash at March 31, 2009 is $41,688, which pri-
marily represents cash collateral required under support
arrangements for certain liquidity funds that a subsidiary
manages. This cash is not available to Legg Mason for
general corporate use. The decrease in restricted cash
from March 31, 2008 of $803,040 is primarily the result
of the return of restricted cash due to the termination of
the support arrangements for certain liquidity funds that
held securities issued by structured investment vehicles
and other similar conduits (“SIVs”). See Note 17 for a dis-
cussion of these support arrangements.
Financial Instruments
Substantially all financial instruments are reflected in the
financial statements at fair value or amounts that approxi-
mate fair value, except long-term debt.
Legg Mason holds debt and marketable equity investments
which are classified as available-for-sale, held-to-maturity
or trading. Debt and marketable equity securities classified
as available-for-sale are reported at fair value and resulting
unrealized gains and losses are reflected in stockhold-
ers’ equity and comprehensive income, net of applicable
income taxes. Debt securities, for which there is positive
intent and ability to hold to maturity, are classified as held-
to-maturity and are recorded at amortized cost.
Amortization of discount or premium is recorded under
the interest method and is included in interest income.
Certain investment securities are classified as trading
securities. These investments are recorded at fair value
and unrealized gains and losses are included in current
52
period earnings. Realized gains and losses for all invest-
ments are included in current period earnings.
Equity and fixed income securities are valued using clos-
ing market prices for listed instruments or broker or
dealer price quotations, when available. Fixed income
securities may also be valued using valuation models and
estimates based on spreads to actively traded benchmark
debt instruments with readily available market prices.
Derivative Instruments
The fair values of derivative instruments are recorded as
assets or liabilities on the Consolidated Balance Sheets.
Legg Mason previously did not engage in derivative or
hedging activities, except as described below and to hedge
interest rate risk on debt, as described in Note 7. Legg
Mason has also used currency and other hedges to hedge
the risk of movement in exchange rates or interest rates on
financial assets on a limited basis.
Legg Mason evaluates its non-trading investment securi-
ties for “other than temporary” impairment. Impairment
may exist when the fair value of an investment security
has been below the adjusted cost for an extended period of
time. If an “other than temporary” impairment is deter-
mined to exist, the difference between the value of the
investment security recorded on the financial statements
and its fair value is recognized as a charge to income in
the period the impairment is determined to be other than
temporary. As of March 31, 2009 and 2008, the amount
of unrealized losses for investment securities not recog-
nized in income was not material.
For investments in illiquid and privately-held securities
for which market prices or quotations may not be readily
available, management estimates the value of the securities
using a variety of methods and resources, including the most
current available financial information for the investment
and the industry. As of March 31, 2009 and 2008, Legg
Mason had approximately $42.2 million and $156.6 mil-
lion, respectively, of trading and non-trading financial
instruments which were valued based upon management’s
assumptions or estimates, taking into consideration avail-
able financial information of the company and industry.
At March 31, 2009 and 2008, Legg Mason had approxi-
mately $59.5 million and $81.7 million, respectively, of
investments in partnerships and limited liability corpo-
rations. These investments are reflected in Other non-
current assets on the Consolidated Balance Sheets and are
accounted for under the cost or equity method.
In addition to the financial instruments described above
or the derivative instruments described below, other finan-
cial instruments that are carried at fair value or amounts
that approximate fair value include Cash and cash equiva-
lents, Securities purchased under agreements to resell
and Short-term borrowings. The fair value of Long-term
debt at March 31, 2009 and 2008 was $2,804,262 and
$2,264,720 respectively. These fair values were estimated
using current market prices.
Legg Mason applies hedge accounting as defined in SFAS
No. 133, “Accounting for Derivative Instruments and
Hedging Activities,” (“SFAS 133”) to the aforementioned
debt interest rate risk hedge. Adjustment of this cash flow
hedge is recorded in Other comprehensive income (loss).
The gains or losses on other derivative instruments not
designated for hedge accounting are included as Other
income (expense) in the Consolidated Statements of
Operations and are not material except as described below.
In fiscal 2009 and fiscal 2008, Legg Mason entered into
various credit support arrangements for certain liquid-
ity funds managed by a subsidiary. These arrangements
included letters of credit, capital support agreements and
a total return swap (“TRS”) that qualify as derivative
transactions and are described more fully in Note 17.
The fair values of these derivative instruments are based
on expected outcomes derived from pricing data for the
underlying securities and/or detailed collateral analyses
based on the most recent available information. The fair
values of these derivative assets as of March 31, 2009
and 2008 are zero and $45.7 million, respectively, and
are included in Other current assets in the Consolidated
Balance Sheet. The fair values of derivative liabilities
as of March 31, 2009 and 2008 of $20.6 million and
$551.7 million, respectively, are included in Fund sup-
port in the Consolidated Balance Sheet. None of these
derivative transactions are designated for hedge account-
ing as defined in SFAS 133 and the related gains and
losses are included in Fund support in the Consolidated
Statement of Operations.
Fair Value Measurements
Effective April 1, 2008, Legg Mason adopted Statement
No. 157, “Fair Value Measurements” (“SFAS 157”), which
defines fair value, establishes a framework for measuring
fair value and increases disclosures about fair value mea-
surements. SFAS 157 defines fair value as the exchange
price that would be received for an asset or paid to
transfer a liability in the principal or most advantageous
53
market for the asset or liability in an orderly transaction
between market participants on the measurement date.
Under SFAS 157, a fair value measurement should reflect
all of the assumptions that market participants would
use in pricing the asset or liability, including assumptions
about the risk inherent in a particular valuation tech-
nique, the effect of a restriction on the sale or use of an
asset, and the risk of non-performance.
In February 2008, FASB Staff Position (“FSP”) No. FAS
157-2, “Effective Date of FASB Statement No. 157,” par-
tially deferred SFAS 157 for one year for non-recurring
fair value measurements of non-financial assets and
liabilities, such as acquired intangibles and goodwill.
Application of SFAS 157’s measurement framework to
financial assets and liabilities has not materially impacted
Legg Mason’s financial position and results of operations
for the year ended March 31, 2009 as most financial
assets and liabilities were already carried at fair value.
Legg Mason is continuing to evaluate its adoption of
the deferred provisions of SFAS 157 for non-recurring
fair value measurements and does not expect a material
impact, if any, on its consolidated financial statements.
In October 2008, FSP No. FAS 157-3, “Estimating Fair
Value of a Financial Asset in an Inactive Market” was
issued to clarify existing standards on fair value determi-
nations. This new guidance required retroactive applica-
tion to previously unissued financial statements, including
interim periods ended September 30, 2008, and did not
have a material impact on Legg Mason’s consolidated
financial statements.
In April 2009, the FASB issued three FSPs intended to
provide additional application guidance and enhance
disclosures regarding fair value measurements and
impairments of securities: FSP FAS 157-4, Determining
Fair Value When the Volume and Level of Activity for
the Asset or Liability Have Significantly Decreased and
Identifying Transactions That Are Not Orderly; FSP
FAS 107-1 and APB 28-1, Interim Disclosures about Fair
Value of Financial Instruments; and FSP FAS 115-2 and
FAS 124-2, Recognition and Presentation of Other-Than-
Temporary Impairments.
FSP FAS 157-4 relates to determining fair values when
there is no active market or where the price inputs being
used represent distressed sales. It reaffirms that the objec-
tive of fair value measurements is to reflect at the date of
the financial statements how much an asset would be sold
for in an orderly transaction (as opposed to a distressed
or forced transaction) under current market conditions.
Specifically, it reaffirms the need to use judgment to
ascertain if a formerly active market has become inac-
tive and in determining fair values when markets have
become inactive.
FSP FAS 107-1 and APB 28-1 relates to fair value disclo-
sures for any financial instruments that are not currently
reflected on the balance sheet of companies at fair value.
Prior to issuing this FSP, fair values for these assets and
liabilities were only disclosed once a year. The FSP now
requires these disclosures on a quarterly basis, providing
qualitative and quantitative information about fair value
estimates for all those financial instruments not measured
on the balance sheet at fair value.
FSP FAS 115-2 and FAS 124-2 relates to other-than-
temporary impairments and is intended to bring greater
consistency to the timing of impairment recognition. It is
also intended to provide greater clarity to investors about
the credit and noncredit components of impaired debt
securities that are not expected to be sold. The FSP also
requires increased and more timely disclosures regarding
expected cash flows, credit losses, and an aging of securi-
ties with unrealized losses.
The FSPs are effective no later than our June 2009 quar-
ter, but may be early adopted. Legg Mason is currently
evaluating the adoption of these FSPs and they are cur-
rently not expected to have a material impact on Legg
Mason’s consolidated financial position.
SFAS 157 establishes a hierarchy that prioritizes the inputs
for valuation techniques used to measure fair value. The
fair value hierarchy gives the highest priority to quoted
prices in active markets for identical assets or liabilities
and the lowest priority to unobservable inputs.
Legg Mason’s financial instruments measured and reported
at fair value are classified and disclosed in one of the follow-
ing categories:
Level 1—Financial instruments for which prices are
quoted in active markets, which, for Legg Mason, include
investments in publicly traded mutual funds with quoted
market prices and equities listed in active markets.
Level 2—Financial instruments for which: prices are
quoted for similar assets and liabilities in active markets;
prices are quoted for identical or similar assets in inactive
markets; or prices are based on observable inputs, other
54
than quoted prices, such as models or other valuation
methodologies. For Legg Mason, this category may
include repurchase agreements, fixed income securities,
and certain proprietary fund products.
Level 3—Financial instruments for which values are
based on unobservable inputs, including those for
which there is little or no market activity. This category
includes derivative liabilities related to fund support
arrangements, investments in partnerships, limited
liability companies, and private equity funds, and pre-
viously included derivative assets related to fund sup-
port arrangements and certain owned securities issued
by SIVs. This category may also include certain propri-
etary fund products with redemption restrictions.
The valuation of an asset or liability may involve inputs
from more than one level of the hierarchy. The level in
the fair value hierarchy within which a fair value measure-
ment in its entirety falls is determined based on the lowest
level input that is significant to the fair value measure-
ment in its entirety.
Proprietary fund products are valued at net asset value
(“NAV”) determined by the respective fund administra-
tor. These funds are typically invested in exchange-traded
investments with observable market prices. Their valua-
tions may be classified as Level 1, Level 2 or Level 3 based
on whether the fund is exchange-traded, the frequency
of the related NAV determinations and the impact of
redemption restrictions. For investments in illiquid and
privately-held securities (private equity and investment
partnerships) for which market prices or quotations may
not be readily available, management must estimate the
value of the securities using a variety of methods and
resources, including the most current available financial
information for the investment and the industry to which
it applies in order to determine fair value. These valuation
processes for illiquid and privately-held securities inher-
ently require management’s judgment and are therefore
classified in Level 3.
Legg Mason’s liquidity fund support has taken the form
of capital support agreements, letters of credit, a TRS and
purchases of securities from funds as more fully described
in Note 17. The capital support agreements, letters of
credit and TRS were considered derivative assets or liabili-
ties for accounting purposes representing the Company’s
rights and obligations under the support, the fair value
of which was based principally on changes in the value
of the underlying securities. Substantially all of the
underlying securities supported and all of the securities
purchased from liquidity funds were issued by SIVs and
had no active market such that fair value was determined
based on an evaluation of the issuer trust and its underly-
ing collateral, which was primarily comprised of asset
and mortgage backed securities, corporate bonds, and
collateralized debt obligations. These instruments may or
may not have had financial guaranty insurance. Of the
total SIV securities previously owned by Legg Mason or
supported in liquidity funds, over 60% of the underlying
trust collateral securities were valued based on prices from
well recognized third party pricing services that utilize
available market data; over 35% of the collateral securities
were valued based on spreads to benchmark debt instru-
ments with available prices; and less than 5% of the col-
lateral values were based on broker quotes.
All security prices, including prices for underlying trust
collateral securities, whether direct market quotes,
adjusted comparable security prices, or broker quotes,
were subject to internal analyses that considered market
observations, broker quotes and other tests to substanti-
ate their fair values. Broker quotes used were indicative
but not firm or tradable bids. The aggregate fair values of
the underlying trust collateral securities were the primary
input to determine the fair value of the supported or pur-
chased SIV-issued securities. The determination of fair
values of underlying trust collateral securities considered
both non-performance risks and liquidity risks. Legg
Mason’s credit risk was not a material factor to the fair
value of the related derivative liabilities because, among
other things, the majority of our liquidity fund support
required cash collateral.
These valuation processes for supported or purchased
SIV-issued securities inherently required management’s
judgment and therefore the related assets and liabilities
were classified in Level 3. Market changes affecting
the underlying collateral were a primary contributor to
changes in the fair values of the liquidity fund support
assets and liabilities and the related gains and losses.
Any transfers between categories are measured at the
beginning of the period.
See Note 3 for additional information regarding fair value
measurements and Legg Mason’s adoption of SFAS 157.
Also effective April 1, 2008, Legg Mason adopted
Statement No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities” (“SFAS 159”). SFAS 159
55
permits companies to choose to measure certain financial
instruments and certain other items at fair value. The
standard requires that unrealized gains and losses on
items for which the fair value option has been elected be
reported in earnings. At this time, the Company has not
elected to apply the fair value option to any of its finan-
cial instruments.
Fixed Assets
Fixed assets consist of equipment, software and leasehold
improvements and capital lease assets. Equipment consists
primarily of communications and technology hardware
and furniture and fixtures. Software includes both pur-
chased software and internally developed software. Fixed
assets are reported at cost, net of accumulated deprecia-
tion and amortization. Capital lease assets are initially
reported at the lesser of the present value of the related
future minimum lease payments or the asset’s then cur-
rent fair value, subsequently reduced by accumulated
depreciation. Depreciation and amortization are deter-
mined by use of the straight-line method. Equipment is
depreciated over the estimated useful lives of the assets,
generally ranging from three to eight years. Software is
amortized over the estimated useful lives of the assets,
which are generally three years. Leasehold improvements
and capital lease assets are amortized or depreciated over
the initial term of the lease unless options to extend are
likely to be exercised. Maintenance and repair costs are
expensed as incurred. Internally developed software is
reviewed periodically to determine if there is a change in
the useful life, or if an impairment in value may exist. If
impairment is deemed to exist, the asset is written down
to its fair value or is written off if the asset is determined
to no longer have any value.
Intangible Assets and Goodwill
Intangible assets consist principally of asset management
contracts, contracts to manage proprietary funds and
trade names resulting from acquisitions. Intangible assets
are amortized over their estimated useful lives, using the
straight-line method, unless the asset is determined to
have an indefinite useful life. Asset management contracts
are amortizable intangible assets that are capitalized at
acquisition and amortized over the expected life of the
contract. The value of contracts to manage assets in
proprietary funds and the value of trade names are clas-
sified as indefinite-life intangible assets. The assignment
of indefinite lives to proprietary fund contracts is based
upon the assumption that there is no foreseeable limit on
the contract period to manage proprietary funds due to
the likelihood of continued renewal at little or no cost.
The assignment of indefinite lives to trade names is based
on the assumption that they are expected to generate cash
flows indefinitely.
Goodwill represents the excess cost of a business acqui-
sition over the fair value of the net assets acquired.
Indefinite-life intangible assets and goodwill are not
amortized for book purposes. Given the relative signifi-
cance of intangible assets and goodwill to the Company’s
consolidated financial statements, on a quarterly basis
Legg Mason considers if triggering events have occurred
that may indicate that the fair values have declined below
their respective carrying amounts. Triggering events may
include significant adverse changes in the Company’s
business, legal or regulatory environment, loss of key per-
sonnel, significant business dispositions, or other events.
If a triggering event has occurred, the Company will per-
form detail tests, which include critical reviews of all sig-
nificant assumptions to determine if any intangible assets
or goodwill are impaired. At a minimum, the Company
performs these detail tests annually at December 31, for
indefinite-life intangible assets and goodwill, consider-
ing factors such as projected cash flows and revenue
multiples, to determine whether the value of the assets is
impaired and the amortization periods are appropriate. If
an asset is impaired, the difference between the value of
the asset reflected on the financial statements and its cur-
rent fair value is recognized as an expense in the period
in which the impairment is determined. The fair values
of intangible assets subject to amortization are reviewed
at each reporting period using an undiscounted cash flow
analysis. For intangible assets with indefinite lives, fair
value is determined based on anticipated discounted cash
flows. Goodwill is evaluated at the reporting unit level,
and is deemed to be impaired if the carrying amount of
the reporting unit goodwill exceeds its implied fair value.
In estimating the fair value of the reporting unit, Legg
Mason uses valuation techniques based on discounted
cash flows similar to models employed in analyzing
the purchase price of an acquisition target. Goodwill
is deemed to be recoverable at the reporting unit level,
which is also our operating segment level that Legg
Mason defines as the Americas and International divi-
sions. This results from the fact that operating segment
managers, who report to the Chief Executive Officer,
manage the business at the division level and do not
receive discrete financial information, such as operating
results, at any lower level, such as the advisory affiliate
level. Prior to March 31, 2009, Legg Mason’s reporting
56
units were its Managed Investments, Institutional and
Wealth Management divisions. Allocations of goodwill
to Legg Mason’s divisions for management restructures,
acquisitions and dispositions are based on relative fair
values of the respective businesses restructured, added to
or sold from the divisions. See Note 5 for additional infor-
mation regarding intangible assets and goodwill and Note
18 for additional business segment information.
Translation of Foreign Currencies
Assets and liabilities of foreign subsidiaries that are
denominated in non-U.S. dollar functional currencies are
translated at exchange rates as of the Consolidated Balance
Sheet dates. Revenues and expenses are translated at aver-
age exchange rates during the period. The gains or losses
resulting from translating foreign currency financial state-
ments into U.S. dollars are included in stockholders’ equity
and comprehensive income. Gains or losses resulting from
foreign currency transactions are included in net income.
Investment Advisory Fees
Legg Mason earns investment advisory fees on assets in
separately managed accounts, investment funds, and
other products managed for Legg Mason’s clients. These
fees are primarily based on predetermined percentages
of the market value of the assets under management
(“AUM”), are recognized over the period in which services
are performed and may be billed in advance of the period
earned based on AUM at the beginning of the billing
period in accordance with the related advisory contracts.
Revenue associated with advance billings is deferred and
included in Other (current) liabilities in the Consolidated
Balance Sheet and is recognized over the period earned.
Performance fees may be earned on certain investment
advisory contracts for exceeding performance benchmarks
and are recognized at the end of the performance mea-
surement period. Accordingly, neither advanced billings
or performance fees are subject to reversal.
Legg Mason has ultimate responsibility for the valuation
of AUM, substantially all of which is based on observ-
able market data from independent pricing services, fund
accounting agents, custodians or brokers.
Distribution and Service Fees Revenue and Expense
Distribution and service fees represent fees earned from
funds to reimburse the distributor for the costs of mar-
keting and selling fund shares and servicing proprietary
funds and are generally determined as a percentage of
client assets. Reported amounts also include fees earned
from providing client or shareholder servicing, including
record keeping or administrative services to proprietary
funds. Distribution fees earned on company-sponsored
investment funds are reported as revenue. When Legg
Mason enters into arrangements with broker-dealers or
other third parties to sell or market proprietary fund
shares, distribution and service fee expense is accrued
for the amounts owed to third parties, including finders’
fees and referral fees paid to unaffiliated broker-dealers or
introducing parties. Distribution and servicing expense
also includes payments to third parties for certain share-
holder administrative services and sub-advisory fees paid
to unaffiliated asset managers.
Deferred Sales Commissions
Commissions paid to financial intermediaries in connec-
tion with sales of certain classes of company-sponsored
mutual funds are capitalized as deferred sales commis-
sions. The asset is amortized over periods not exceeding
six years, which represent the periods during which com-
missions are generally recovered from distribution and
service fee revenues and from contingent deferred sales
charges (“CDSC”) received from shareholders of those
funds upon redemption of their shares. CDSC receipts
are recorded as distribution and servicing revenue when
received and a reduction of the unamortized balance of
deferred sales commissions, with a corresponding expense.
Management periodically tests the deferred sales com-
mission asset for impairment by reviewing the changes in
value of the related shares, the relevant market conditions
and other events and circumstances that may indicate an
impairment in value has occurred. If these factors indi-
cate an impairment in value, management compares the
carrying value to the estimated undiscounted cash flows
expected to be generated by the asset over its remain-
ing life. If management determines that the deferred
sales commission asset is not fully recoverable, the asset
will be deemed impaired and a loss will be recorded in
the amount by which the recorded amount of the asset
exceeds its estimated fair value. For the years ended
March 31, 2009, 2008, and 2007, no impairment charges
were recorded. Deferred sales commissions, included in
Other non-current assets in the Consolidated Balance
Sheets, were $18.9 million and $22.6 million at March 31,
2009 and 2008, respectively.
Income Taxes
Deferred income taxes are provided for the effects of
temporary differences between the tax basis of an asset
or liability and its reported amount in the financial
57
statements. Deferred income tax assets are subject to a val-
uation allowance if, in management’s opinion, it is more
likely than not that these benefits will not be realized.
Legg Mason’s deferred income taxes principally relate to
net operating loss carryforwards, business combinations,
amortization and accrued compensation.
Effective April 1, 2007, Legg Mason adopted the provi-
sions of Financial Accounting Standards Board (“FASB”)
Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes” (“FIN 48”). FIN 48 clarifies previously
issued FASB Statement No. 109, “Accounting for Income
Taxes,” by prescribing a recognition threshold and a mea-
surement attribute in financial statements for tax positions
taken or expected to be taken in a tax return. Under FIN
48, a tax benefit should only be recognized if it is more
likely than not that the position will be sustained based
on its technical merits. A tax position that meets this
threshold is measured as the largest amount of benefit that
has a greater than 50% likelihood of being realized upon
settlement by the appropriate taxing authority having full
knowledge of all relevant information. FIN 48 also pro-
vides guidance on derecognition, classification, interest and
penalties, interim accounting, disclosure and transition.
The Company’s accounting policy is to classify interest
related to tax matters as interest expense and related pen-
alties, if any, as other operating expense.
See Note 8 for additional information regarding income
taxes and Legg Mason’s adoption of FIN 48.
Loss Contingencies
Legg Mason accrues estimates for loss contingencies
related to legal actions, investigations, and proceedings,
exclusive of legal fees, when it is probable that a liability
has been incurred and the amount of loss can be reason-
ably estimated.
Stock-Based Compensation
Legg Mason’s stock-based compensation includes stock
options, employee stock purchase plans, restricted stock
awards, performance shares payable in common stock and
deferred compensation payable in stock. Under its stock
compensation plans, Legg Mason issues equity awards to
officers and other key employees.
During fiscal 2007, Legg Mason adopted SFAS No. 123
(R), “Share-Based Payment” and related pronouncements
using the modified-prospective method and the related
transition election. Under this method, compensation
expense for the years ended March 31, 2009, 2008 and
2007 includes costs for all non-vested share-based awards
at their grant-date fair value amortized over the respective
vesting periods on the straight-line method. Legg Mason
determines the fair value of stock options using the Black-
Scholes option pricing model, with the exception of mar-
ket-based performance grants, which are valued with a
Monte Carlo option-pricing model. See Note 12 for addi-
tional information regarding stock-based compensation.
Earnings Per Share
Basic earnings per share (“EPS”) is calculated by divid-
ing net income by the weighted average number of shares
outstanding. The calculation of weighted average shares
includes common shares, shares exchangeable into com-
mon stock and convertible preferred shares that are con-
sidered participating securities. Diluted EPS is similar to
basic EPS, but adjusts for the effect of potential common
shares unless they are antidilutive. For periods with a net
loss, potential common shares are considered antidilutive.
See Note 14 for additional discussion of EPS.
Variable Interest Entities
Special purpose entities (“SPEs”) are trusts, partner-
ships, corporations or other vehicles that are established
for a limited business purpose. SPEs generally involve
the transfer of assets and liabilities in which the trans-
feror may or may not have continued involvement, derive
continued benefit, exhibit control or have recourse. Legg
Mason does not utilize SPEs as a form of financing or to
provide liquidity, nor has Legg Mason recognized any
gains or losses from the sale of assets to SPEs.
In accordance with FASB Interpretation Number 46
(R), “Consolidation of Variable Interest Entities—an
interpretation of ARB No. 51,” (“FIN 46 (R)”) all SPEs
are designated as either a voting interest entity or a VIE,
with VIEs subject to consolidation by the party deemed
to be the primary beneficiary, if any. A VIE is an entity
that does not have sufficient equity at risk to finance its
activities without additional subordinated financial sup-
port, either contractual or implied, or in which the equity
investors do not have the characteristics of a controlling
financial interest. The primary beneficiary is the entity
that will absorb a majority of the VIE’s expected losses,
or if there is no such entity, the entity that will receive a
majority of the VIE’s expected residual returns, if any. In
accordance with FIN 46 (R), Legg Mason’s determination
of expected residual returns excludes gross fees paid to
a decision maker. Under current guidance, it is unlikely
58
that Legg Mason will be the primary beneficiary for VIEs
created to manage assets for clients unless its ownership
interest, including interests of related parties, in a VIE
is substantial, unless Legg Mason may earn significant
performance fees from the VIE or unless Legg Mason is
considered to have a material implied variable interest.
FIN 46 (R) also requires the disclosure of VIEs in
which Legg Mason is a sponsor or is considered to have
a significant variable interest. In determining whether
a variable interest is significant, Legg Mason considers
the same factors used for determination of the primary
beneficiary. In determining whether it is the primary
beneficiary of these VIEs, Legg Mason considers both
qualitative and quantitative factors such as the voting
rights of the equity holders, economic participation of
all parties, including how fees are earned by and paid
to Legg Mason, related party ownership, guarantees
and implied relationships. In determining the primary
beneficiary, Legg Mason must make assumptions and
estimates about, among other things, the future per-
formance of the underlying assets held by the VIE,
including investment returns, cash flows and credit and
interest rate risks. These assumptions and estimates
have a significant bearing on the determination of the
primary beneficiary. If Legg Mason’s assumptions or
estimates were to be materially incorrect, Legg Mason
might be required to consolidate additional VIEs.
Consolidation of these VIEs would result in an increase
in assets with a corresponding increase in minority inter-
ests on the Consolidated Balance Sheets and a decrease
in investment advisory fees and an increase or decrease
in non-operating income with a corresponding offset
in Minority interests on the Consolidated Statements
of Operations. See Note 16 for additional discussion of
variable interests.
Supplemental Cash Flow Information
The following non-cash activities are excluded from the
Consolidated Statements of Cash Flows. During fiscal
2007, holders of the $76 million in zero-coupon contin-
gent convertible senior notes converted the notes into 756
thousand shares of common stock. There were no zero-
coupon contingent convertible senior notes outstanding
after the conversion in fiscal 2007.
During fiscal 2008, the second anniversary contingent
acquisition payments of $240 million were made to the
former owners of Permal, of which $208 million was paid
in cash and the balance was in shares of common stock.
Other Recent Accounting Developments
The following other relevant accounting pronouncements
were recently issued.
In December 2007, the FASB issued Statement Nos.
141 (revised 2007), “Business Combinations” (“SFAS
141 (R)”), and 160, “Noncontrolling Interests in
Consolidated Financial Statements, an Amendment of
ARB No. 51” (“SFAS 160”). SFAS 141 (R) will signifi-
cantly change how business acquisitions are accounted
for and will impact financial statements both on the
acquisition date and in subsequent periods. SFAS 141
(R) requires the acquiring entity in a business combina-
tion to recognize all the assets acquired and liabilities
assumed in the transaction, including contingent con-
sideration, and also requires acquisition related costs to
be expensed as incurred. In April 2009, the FASB issued
FSP FAS 141 (R)-1, “Accounting for Assets Acquired
and Liabilities Assumed in a Business Combination
That Arise from Contingencies” to address application
issues arising from contingencies in a business combina-
tion. SFAS 160 will change the accounting and report-
ing for minority interests, which will be recharacterized
as noncontrolling interests and classified as a component
of equity. SFAS 141 (R), the related FSP and SFAS 160
are effective for fiscal year 2010. SFAS 141 (R) will be
applied prospectively. SFAS 160 requires retroactive
adoption of the presentation and disclosure requirements
for existing minority interests and other requirements of
SFAS 160 will be applied prospectively. When SFAS 141
(R) and the related FSP are adopted, they will impact
how Legg Mason accounts for acquisitions in the future
and tax uncertainties from prior acquisitions. Legg
Mason is currently evaluating the adoption of SFAS 160
and it is not expected to have a material impact on Legg
Mason’s consolidated financial statements.
In March 2008, the FASB issued Statement 161,
“Disclosures about Derivatives and Hedging Activities”
(“SFAS 161”), which amends SFAS 133, by requiring
expanded disclosures about an entity’s derivative instru-
ments and hedging activities for increased qualitative,
quantitative, and credit-risk factors. As SFAS 161 only
contains disclosure provisions, effective for fiscal 2010,
it will not impact Legg Mason’s accounting for deriva-
tive transactions.
In April 2008, the FASB issued a final FSP FAS 142-3,
“Determination of the Useful Life of Intangible Assets,”
which amends the factors that should be considered in
59
developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset
under FASB Statement No. 142, “Goodwill and Other
Intangible Assets” (“SFAS 142”). FSP FAS 142-3 will
be effective for fiscal 2010, and is not expected to have
a material impact on Legg Mason’s consolidated finan-
cial statements.
In May 2008, the FASB issued FSP No. APB 14-1,
“Accounting for Convertible Debt Instruments That
May Be Settled in Cash upon Conversion (Including
Partial Cash Settlement)” (“FSP APB 14-1”). This FSP
requires that issuers of convertible debt instruments
that may be settled in cash upon conversion (including
partial cash settlement) should separately account for
the liability and equity (conversion feature) components
of the instruments. As a result, interest expense should
be imputed and recognized based upon the entity’s
nonconvertible debt borrowing rate, which will result
in lower net income. The 2.5% convertible senior notes
issued by Legg Mason in January 2008 will be subject
to FSP APB 14-1. Prior to FSP APB 14-1, Accounting
Principles Board Opinion No. 14, “Accounting for
Convertible Debt and Debt Issued with Stock Purchase
Warrants” (“APB 14”), provided that no portion of the
proceeds from the issuance of the instrument should
be attributable to the conversion feature. When Legg
Mason is required to retroactively adopt FSP APB 14-1
in fiscal 2010, interest expense for fiscal 2008 and 2009
will be increased by $6.6 million and $32.3 million. In
addition, the carrying amount of the 2.5% convertible
senior notes will be discounted (decreased), additional
paid-in capital increased and retained earnings decreased
by $233.2 million, $272.1 million and $38.9 million,
respectively, as of March 31, 2009.
In June 2008, the FASB issued FSP EITF 03-6-1,
“Determining Whether Instruments Granted in
Share-Based Payment Transactions are Participating
Securities” (“FSP EITF 03-6-1”). FSP EITF 03-6-1
requires that unvested share-based payment awards that
contain nonforfeitable rights to dividends or dividend
equivalents (whether paid or unpaid) are participat-
ing securities and shall be included in the computa-
tion of EPS pursuant to the two-class method. FSP
EITF 03-6-1 will be effective for fiscal 2010, and is not
expected to have a material impact on Legg Mason’s
consolidated financial statements.
Also in June 2008, the FASB ratified EITF 07-5,
“Determining Whether an Instrument (or Embedded
Feature) Is Indexed to an Entity’s Own Stock” (“EITF
07-5”) to provide guidance for determining whether an
equity-linked financial instrument (or embedded feature)
is indexed to an entity’s own stock. EITF 07-5 is effective
for Legg Mason’s fiscal year 2010 and will not impact the
accounting for either the 2.5% Convertible Senior Notes
or the 5.6% Senior Notes more fully described in Note 7.
2. ACQUISITIONS AND DISPOSITIONS
On February 26, 2008, Legg Mason announced a
definitive agreement in which Citigroup Global Markets
Inc., an affiliate of Citigroup Inc. (“Citigroup”), would
re-acquire a majority of the overlay and implementa-
tion business of Legg Mason Private Portfolio Group
(“LMPPG”), which includes its managed account
trading and technology platform. In undertaking this
transaction, Legg Mason continued its focus on its core
asset management business. Legg Mason had originally
acquired this business from Citigroup in the December
2005 acquisition of Citigroup’s worldwide asset man-
agement business (“CAM”). The net assets held for sale
at March 31, 2008 of approximately $170 million were
comprised primarily of intangible assets, net and allo-
cated goodwill and are included in Other current assets
on the Consolidated Balance Sheet. The sale closed
on April 1, 2008 and cash proceeds of approximately
$181 million were received. After transaction costs, the
gain on the sale of this business was approximately
$5.5 million ($3.4 million after tax), which was recog-
nized in the first quarter of fiscal 2009.
Effective November 1, 2005, Legg Mason acquired 80%
of the outstanding equity of Permal, a leading global
funds-of-hedge funds manager. Concurrent with the
acquisition, Permal completed a reorganization in which
the residual 20% of outstanding equity was converted to
preference shares, resulting in Legg Mason owning 100%
of the outstanding voting common stock of Permal. Legg
Mason has the right to purchase the preference shares
over four years from closing and, if that right is not exer-
cised, the holders of those shares have the right to require
Legg Mason to purchase the interests in the same general
time frame for approximately the same consideration.
The maximum aggregate price, including earnout pay-
ments related to each purchase and based upon future
operating results, for all equity interests in Permal is
$1.386 billion excluding acquisition costs and dividends.
During fiscal 2008, payments of $240 million were made
60
to the former owners of Permal, representing earnout
payments based upon Permal’s operating results through
the second anniversary date and the purchase of 37.5%
of the preference shares, of which $208 million was paid
in cash and the balance was in its common stock. It is
anticipated that Legg Mason will acquire the remaining
62.5% of the preference shares in fiscal 2010 at amounts
based on Permal’s operating results, at which time Legg
Mason may be required to pay up to $286 million under
the agreements governing the Permal acquisition. The
final payment for this transaction on the sixth anni-
versary in fiscal 2012 will be between $60 million and
$320 million based on Permal’s operating results and the
amount of the fiscal 2010 payment. Legg Mason may
elect to deliver up to 25% of each of the future payments
in the form of shares of its common stock. In addition,
during fiscal 2009, 2008 and 2007, Legg Mason paid an
aggregate amount of approximately $31.5 million in divi-
dends on the preference shares, and will pay a minimum
of $7.5 million in dividends on the preference shares in
fiscal 2010. All payments for preference shares, including
dividends, are recognized as additional goodwill.
On August 1, 2001, Legg Mason purchased Private
Capital Management (“PCM”) for cash of approxi-
mately $682 million, excluding acquisition costs. The
transaction included two contingent payments based
on PCM’s revenue growth for the years ending on the
third and fifth anniversaries of closing, with the aggre-
gate purchase price to be no more than $1.382 billion.
During fiscal 2005, Legg Mason made the maximum
third anniversary payment of $400 million to the for-
mer owners of PCM. During fiscal 2007, we paid from
available cash the maximum fifth anniversary payment
of $300 million, of which $150 million remained in
escrow subject to certain limited clawback provisions
through fiscal 2010. During fiscal 2009, the remain-
ing contingency was settled by releasing $30 million to
the sellers and returning $120 million to Legg Mason,
which was recorded as a reduction of goodwill.
3. INVESTMENTS AND FAIR VALUES
OF ASSETS AND LIABILITIES
as described in Note 1. Investments as of March 31, 2009
and 2008 are as follows:
Investment securities:
Trading(1)
Available-for-sale
Other(2)
Total
2009
2008
$336,092
6,818
1,423
$344,333
$489,081
7,700
1,323
$498,104
(1) Includes assets of deferred compensation plans of $128,785 and $207,305,
respectively. Fiscal 2008 includes $141,509 of investments issued by structured
investment vehicles and other conduit investments acquired from proprietary
liquidity funds. The remainder represents seed investments in proprietary prod-
ucts and investments in VIEs. In fiscal 2009, all investments issued by structured
investment vehicles and other conduit investments acquired from proprietary
liquidity funds were sold.
(2) Includes investments in private equity securities that do not have readily deter-
minable fair values.
Legg Mason uses the specific identification method to
determine the cost of a security sold and the amount
reclassified from accumulated other comprehensive
income into earnings. The proceeds and gross realized
gains and losses from sales and maturities of available-for-
sale investments are as follows:
Years Ended March 31,
2007
2008
2009
AVAILABLE-FOR-SALE
Proceeds
Gross realized gains
Gross realized losses
$2,173
5
(84)
$5,194
34
(14)
$21,745
259
(117)
The net unrealized and realized gain (loss) for investment
securities classified as trading was ($1,995,428), ($62,001)
and $7,141 for fiscal 2009, 2008 and 2007, respectively.
The realized and unrealized losses for fiscal 2009 and
2008 primarily relate to losses on SIV-issued securities
purchased from certain liquidity funds.
Legg Mason’s available-for-sale investments consist of
mortgage-backed securities, U.S. government and agency
securities, corporate bonds and equity securities. Gross
unrealized gains and losses for investments classified as
available-for-sale were $209 and ($39), respectively, as of
March 31, 2009, and $154 and ($82), respectively, as of
March 31, 2008.
Legg Mason has investments in debt and equity securities
that are generally classified as available-for-sale and trading
Legg Mason had no investments classified as held-to-
maturity as of March 31, 2009 and 2008.
61
The fair values of financial assets and (liabilities) of the Company were determined using the following categories of
inputs at March 31, 2009:
ASSETS:
Investments relating to long-term
incentive compensation plans(1)
Proprietary fund products and
other investments(2)
Total trading investment securities
Available-for-sale debt securities
Investments in partnerships and LLCs
Derivative assets:
Currency hedge derivatives
Equity securities
LIABILITIES:
Derivative liabilities:
Fund support(3)
Quoted
prices in
active markets
(Level 1)
Significant
other observable
inputs
(Level 2)
Significant
unobservable
inputs
(Level 3)
Value as of
March 31, 2009
$128,785
$
—
$
—
$128,785
115,117
243,902
3,105
796
8,203
—
$256,006
51,471
51,471
3,701
—
—
—
$55,172
40,719
40,719
12
58,719
—
2,340
$101,790
207,307
336,092
6,818
59,515
8,203
2,340
$412,968
$
—
$
—
$ (20,631)
$ (20,631)
(1) Primarily mutual funds where there is minimal market risk to the Company as any change in value is offset by an adjustment to compensation expense and related liability.
(2) Primarily mutual funds that are approximately equally invested in equity and debt securities. Includes approximately $16.6 million related to minority interests of consoli-
dated investment funds.
(3) See Note 2 for additional information on the fair value of liquidity fund support.
The table below presents a summary of changes in financial assets and (liabilities) measured at fair value using signifi-
cant unobservable inputs (Level 3) for the period from April 1, 2008 to March 31, 2009:
Value as of Purchases, sales, Net transfer Realized and
unrealized
April 1,
gains/(losses), net
2008
issuances and
settlements, net
in (out) of
Level 3
Value as of
March 31,
2009
$ 141,509
$2,300,697
$
(96)
$(2,442,110)
$
—
ASSETS:
Securities issued by SIVs(1)
Proprietary fund products and
other investments
Investments in partnerships and LLCs
Total return swap(1)
Other investments
LIABILITIES:
Total return swap(1)
Fund support(1,2)
23,781
67,022
45,706
1,903
$ 279,921
(13,781)
874
(45,706)
23
$2,242,107
—
$
(551,654)
$(551,654)
$ 188,103
—
$ 188,103
52,041
(1,385)
—
—
$50,560
$
$
—
—
—
Total realized and unrealized losses, net
Total net losses for the period included in earnings attributable
to the change in unrealized gains (losses) relating to those assets
and liabilities still held at the reporting date
(21,322)
(7,792)
—
426
$(2,470,798)
40,719
58,719
—
2,352
$101,790
$ (188,103)
531,023
$ 342,920
$(2,127,878)
$
—
(20,631)
$ (20,631)
$
(49,319)
(1) See Note 17 for further discussion of liquidity fund support.
(2) The decrease in the fund support derivative liability resulted from the termination of fund support agreements, upon the purchase of SIV securities from the funds.
Realized and unrealized gains and losses recorded for Level 3 investments are included in Fund support and Other non-
operating income (expense) on the Consolidated Statements of Operations.
62
4. FIXED ASSETS
The following table reflects the components of fixed assets as of March 31:
Equipment
Software
Leasehold improvements and capital lease assets
Total cost
Less: accumulated depreciation and amortization
Fixed assets, net
2009
$ 180,668
193,109
314,963
688,740
(321,697)
$ 367,043
2008
$ 175,255
159,428
257,812
592,495
(245,693)
$ 346,802
Depreciation and amortization expense was $101,957, $83,812 and $69,442 for fiscal 2009, 2008, and 2007, respectively.
5. INTANGIBLE ASSETS AND GOODWILL
Goodwill and indefinite-life intangible assets are not
amortized and the values of identifiable intangible assets
are amortized over their useful lives, unless the assets are
determined to have indefinite useful lives. Goodwill and
indefinite-life intangible assets are analyzed to determine
if the fair market value of the assets exceeds the book
value. If the fair value is less than the book value, Legg
Mason will record an impairment charge.
The following tables reflect the components of intangible assets as of March 31:
AMORTIZABLE ASSET MANAGEMENT CONTRACTS
Cost
Accumulated amortization
Net
INDEFINITE-LIFE INTANGIBLE ASSETS
Fund management contracts
Trade names
Intangible assets, net
2009
$ 208,416
(108,376)
100,040
3,752,961
69,800
3,822,761
$3,922,801
2008
$ 356,779
(119,033)
237,746
3,755,189
116,800
3,871,989
$4,109,735
The decrease in amortizable asset management con-
tracts during fiscal 2009 is primarily due to an impair-
ment of management contracts related to intangible
assets acquired in the acquisition of CAM and PCM of
$72,326 and $26,644, respectively, net of accumulated
amortization of $13,041 and $31,532, respectively. The
assets under management and related revenues associ-
ated with these acquired management contracts declined
significantly during fiscal year 2009. Based on recent cli-
ent turnover data, the estimated lives of the CAM retail
separately managed accounts contracts were decreased
from 9 years to 5 years at March 31, 2009. The fair
value of the remaining acquired management contracts
were determined using valuation techniques based on
discounted cash flows over the estimated 5-year remain-
ing life, using a risk-adjusted discount rate. Based upon
the continued significant decline in AUM, Legg Mason
wrote off the remaining balance of the PCM manage-
ment contracts.
During fiscal 2008, amortizable asset management
contracts decreased primarily due to an impairment of
intangible assets acquired in the acquisition of PCM of
$151,000, net of accumulated amortization of $88,824,
and the transfer of $102,640, net of accumulated amorti-
zation of $24,775, relating to the pending sale of the over-
lay and implementation business of LMPPG, into Other
current assets as assets held for sale. The acquired man-
agement contracts from the PCM transaction and related
assets under management declined significantly during
fiscal year 2008. Based on revised attrition estimates, the
remaining useful lives of the acquired contracts were from
1 to 5 years at March 31, 2008.
63
As of March 31, 2009, management contracts are being
amortized over a weighted-average life of 5.2 years.
Estimated amortization expense for each of the next five
fiscal years is as follows:
2010
2011
2012
2013
2014
Thereafter
Total
$ 23,097
23,076
20,205
15,448
9,301
8,913
$100,040
The change in indefinite-life intangible assets is primarily
attributable to the impairment of PCM’s trade name and
the impact of foreign currency translation. As a result of
significant declines in AUM and other significant changes
at PCM, Legg Mason recognized an impairment for the
PCM trade name asset of $47,000 in fiscal 2009.
The change in the carrying value of goodwill since April 1, 2008 is summarized below:
Balance, beginning of year
Business acquisitions and related costs (see Note 2)
Contractual acquisition earn out payments (settlements) (see Note 2)
Assets held for sale, primarily LMPPG
Impairment for former Wealth Management Division
Impact of excess tax basis amortization
Other, including changes in foreign exchange rates
Balance, end of year
2009
$ 2,536,816
7,524
(120,000)
—
(1,161,900) —
(20,868)
(54,825)
$ 1,186,747
2008
$2,432,840
12,365
160,000
(69,297)
(22,908)
23,816
$2,536,816
The severe market turmoil experienced during fiscal
2009 had a more significant impact on the former Wealth
Management division than on Legg Mason’s other former
divisions. AUM decreased over 30% in that division as a
result of both net client outflows and market depreciation.
As a result of the dramatic changes in market conditions
during the year, Legg Mason revised its growth assumptions
downward, to project contraction through the next two
years. Further, the applicable discount rate was increased
from 12.5% to 14.7% in the December quarter based on
changes in interest rates and risk factors. The combined
impact of these factors decreased projected cash flows of
the Wealth Management division by over 60% from Legg
Mason’s prior projections. As a result, the carrying value of
Legg Mason’s Wealth Management division goodwill was
impaired, and a $1,161,900 impairment charge was recorded.
Based on the revenues and earnings of Permal, additional
contingent consideration of $160,000 was paid during fis-
cal year 2008 with a corresponding increase in goodwill.
At March 31, 2008, Legg Mason transferred $65,724 of
goodwill relating to the pending sale of the overlay and
implementation business of LMPPG into Other current
assets as assets held for sale.
Legg Mason also recognizes the tax benefit of the amor-
tization of excess tax basis related to the CAM acquisi-
tion. In accordance with SFAS, No. 109, “Accounting for
Income Taxes,” the tax benefit is recorded as a reduction
of goodwill and deferred tax liabilities.
6. SHORT-TERM BORROWINGS
On October 14, 2005, Legg Mason entered into an
unsecured 5-year $500 million revolving credit agree-
ment. During November 2007, Legg Mason borrowed
$500 million under this revolving credit facility for
general corporate purposes, the proceeds of which have
been invested in short-term instruments. On January 3,
2008, the revolving credit agreement was amended to
increase the maximum amount that Legg Mason may
borrow from $500 million to $1 billion and to allow it
to draw a portion of the availability in the form of letters
of credit (“LOCs”). On March 30, 2009, the revolving
credit agreement was amended to decrease the maximum
amount that Legg Mason may borrow from $1 billion to
$500 million. In connection with the amendments, the
64
revolving credit facility rate was increased from LIBOR
plus 35 basis points to LIBOR plus 60 basis points as of
March 31, 2008 and to LIBOR plus 225 basis points as
of March 31, 2009. These rates may change in the future
based on changes in Legg Mason’s credit ratings. As of
March 31, 2009 and 2008, there was $250 million and
$500 million, respectively, outstanding under this facil-
ity. On March 7, 2008, Legg Mason elected to procure a
LOC for a money market fund to support up to $150 mil-
lion of the fund’s holdings in certain SIV-issued securities
using capacity on the revolving credit agreement as col-
lateral. This LOC terminated in accordance with its terms
upon Legg Mason’s purchase of the underlying securities
from the fund during fiscal 2009.
Legg Mason maintains two additional borrowing facili-
ties, a $100 million, 1-year revolving credit agreement and
a $40 million credit line. Both facilities are for general
operating purposes. There were no borrowings outstand-
ing under these facilities as of March 31, 2009 and 2008.
The revolving credit facility is with the same lenders as
the $550 million term loan described in Long-Term Debt
below. These facilities have standard financial covenants
that were revised during fiscal 2009, including a maxi-
mum net debt to EBITDA ratio of 3.0 (previously 2.5 on
gross debt) and minimum EBITDA to interest ratio of
4.0. As of March 31, 2009, EBITDA, as defined, excludes
up to $3.0 billion (previously $2.75 billion) in realized
losses resulting from liquidity fund support. See Note
17 for further discussion of liquidity fund support. As
of March 31, 2009. Legg Mason’s debt to EBITDA ratio
was 1.8 and EBITDA to interest expense ratio was 6.2,
and therefore Legg Mason has maintained compliance
with the applicable covenants. If net income remains
at current levels or further declines, or if Legg Mason
spends available cash, other than to repay debt, it may
impact the ability to maintain compliance with these
covenants. If Legg Mason determines that compliance
with these covenants may be under pressure, a number
of actions may be taken, including reducing expenses to
increase EBITDA, using available cash to repay all or a
portion of the $800 million outstanding debt subject to
these covenants or seeking to negotiate with lenders to
modify the terms or to restructure the debt.
7. LONG-TERM DEBT
The accreted value of long-term debt consists of the following:
6.75% senior notes
5-year term loan
Third-party distribution financing
2.5% convertible senior notes
5.6% senior notes from Equity Units
Other term loans
Subtotal
Less: current portion
Total
March 31, 2009
$
—
550,000
4,067
1,250,000
1,150,000 —
19,325
2,973,392
8,188
$2,965,204
March 31, 2008
$ 424,959
550,000
8,881
1,250,000
23,933
2,257,773
432,119
$1,825,654
6.75% Senior Notes
On July 2, 2001, Legg Mason issued $425,000 principal
amount of senior notes, which bear interest at 6.75%. The
notes were sold at a discount to yield 6.80%. The net pro-
ceeds of the notes were approximately $421,000, after pay-
ment of debt issuance costs. The $425 million principal
amount of 6.75% senior notes was paid on July 2, 2008.
5-Year Term Loan
On October 14, 2005, Legg Mason entered into an unse-
cured term loan agreement for an amount not to exceed
$700 million. Legg Mason used this term loan to pay
a portion of the purchase price, including acquisition
related costs, in the acquisition of CAM. The term loan
facility will be payable in full at maturity in calendar year
2010 and currently bears interest at LIBOR plus 225 basis
points. During fiscal 2008 and 2007, Legg Mason repaid
an aggregate of $150 million of the outstanding borrow-
ings on this term loan, and did not make any payments
during fiscal 2009. The outstanding balance at March 31,
2009 is $550 million, which had an average interest rate
65
of 3.3% for fiscal 2009. This term loan contains standard
covenants including leverage and interest coverage ratios
more fully described above in Note 6. Legg Mason has
maintained compliance with the applicable covenants of
this borrowing facility.
3-Year Term Loan
In connection with the CAM acquisition, on December 1,
2005, Legg Mason entered into a $16 million, 3-year term
loan. During the year ended March 31, 2008, the 3-year
term loan was repaid.
Third Party Distribution Financing
On July 31, 2006, Legg Mason entered into a four-year
agreement with a financial institution to finance, on a
non-recourse basis, up to $90.7 million for commis-
sions paid to financial intermediaries in connection with
sales of certain share classes of proprietary funds. The
outstanding balance at March 31, 2009 was $4 million.
Distribution fee revenues, which are used to repay the
financing, are based on the average AUM of the respec-
tive funds. Interest has been imputed at an average rate of
3.8%. In April 2009, Legg Mason terminated the agree-
ment and the outstanding balance will be paid in the nor-
mal course of operations.
2.5% Convertible Senior Notes
and Related Hedge Transactions
On January 14, 2008, Legg Mason sold $1.25 billion of
2.5% convertible senior notes (“the Notes”). The Notes
are convertible, if certain conditions are met, at an initial
conversion rate of 11.3636 shares of Legg Mason common
stock per $1,000 principal amount of Notes (equivalent
to a conversion price of approximately $88.00 per share),
or a maximum of 14.2 million shares, subject to adjust-
ment. Unconverted notes mature in January 2015. Upon
conversion of a $1,000 principal amount note, the holder
will receive cash in an amount equal to $1,000 or, if less,
the conversion value of the note. If the conversion value
exceeds the principal amount of the Note at conver-
sion, Legg Mason will also deliver, at its election, cash or
common stock or a combination of cash and common
stock for the conversion value in excess of $1,000. The
agreement governing the issuance of the notes contains
certain covenants for the benefit of the initial purchaser
of the notes, including leverage and interest coverage
ratio requirements, that may result in the notes becom-
ing immediately due and payable if the covenants are not
met. The leverage covenant was waived to accommodate
the Equity Units issuance in May 2008, discussed below.
Otherwise, Legg Mason has maintained compliance with
the applicable covenants.
In connection with the sale of the Notes, on January
14, 2008, Legg Mason entered into convertible note
hedge transactions with respect to its common stock (the
“Purchased Call Options”) with financial institution
counterparties (“Hedge Providers”). The Purchased Call
Options are exercisable solely in connection with any con-
versions of the Notes in the event that the market value
per share of Legg Mason common stock at the time of
exercise is greater than the exercise price of the Purchased
Call Options, which is equal to the $88 conversion price
of the Notes, subject to adjustment. Simultaneously, in
separate transactions Legg Mason also sold to the Hedge
Providers warrants to purchase, in the aggregate and sub-
ject to adjustment, 14.2 million shares of common stock
on a net share-settled basis at an exercise price of $107.46
per share of common stock. The Purchased Call Options
and warrants are not part of the terms of the Notes and
will not affect the holders’ rights under the Notes. These
hedging transactions had a net cost of $83 million, which
was paid from the proceeds of the Notes and recorded as a
reduction of additional paid-in capital.
If, when the notes are converted, the market price per
share of Legg Mason common stock exceeds the $88 exer-
cise price of the Purchased Call Options, the Purchased
Call Options entitle Legg Mason to receive from the
Hedge Providers shares of Legg Mason common stock,
cash, or a combination of shares of common stock and
cash, that will match the shares or cash Legg Mason
must deliver under terms of the Notes. Additionally,
if at the same time the market price per share of Legg
Mason common stock exceeds the $107.46 exercise price
of the warrants, Legg Mason will be required to deliver
to the Hedge Providers net shares of common stock, in
an amount based on the excess of such market price per
share of common stock over the exercise price of the war-
rants. These transactions effectively increase the conver-
sion price of the Notes to $107.46 per share of common
stock. Legg Mason has contractual rights, and at execu-
tion of the related agreements, had the ability to settle
its obligations under the conversion feature of the Notes,
the Purchased Call Options and warrants, with Legg
Mason common stock. Accordingly, these transactions are
accounted for as equity, with no subsequent adjustment
for changes in the value of these obligations.
66
As discussed above in Note 1 under the heading “Other
Recent Accounting Developments,” new accounting stan-
dards require, effective April 1, 2009, that Legg Mason
revalue the Notes and impute interest based on the mar-
ket rate on the issuance date for comparable debt without
a conversion feature.
5.6% Senior Notes from Equity Units
In May 2008, Legg Mason issued 23 million Equity
Units for $1.15 billion, of which $50 million was used to
pay issuance costs. Each unit consists of a 5% interest in
$1,000 principal amount of 5.6% senior notes due June
30, 2021 and a detachable contract to purchase a vary-
ing number of shares of Legg Mason’s common stock for
$50 by June 30, 2011. The notes and purchase contracts
are separate and distinct instruments, but their terms
are structured to simulate a conversion of debt to equity
and potentially remarketed debt approximately three
years after issuance. The holders’ obligations to purchase
shares of Legg Mason’s common stock are collateralized
by their pledge of the notes or other prescribed collateral.
In connection with the issuance of the Equity Units,
Legg Mason incurred issuance costs of $36.2 million,
of which $27.6 million was allocated to the equity com-
ponent of the Equity Units and recorded as a reduction
of Additional paid-in capital. For their commitment to
purchase shares of Legg Mason’s common stock, holders
also receive quarterly payments, referred to as Contract
Adjustment Payments (“CAP”), at a fixed annual rate
of 1.4% of the commitment amount over the three-year
contract term. Upon issuance of the Equity Units, Legg
Mason recognized a $45.8 million liability for the fair
value of its obligation (based upon discounted cash flows)
to pay unitholders a quarterly contract adjustment pay-
ment. This amount also represented the fair value of Legg
Mason’s commitment under the contract to issue shares of
common stock in the future at designated prices, and was
recorded as a reduction to Additional paid-in capital. The
CAP obligation liability is being accreted over the approx-
imate three year contract term by charges to Interest
expense based on a constant rate calculation. Subsequent
contract adjustment payments reduce the CAP obligation
liability, which as of March 31, 2009, is $31.8 million
and is included in Other liabilities on the Consolidated
Balance Sheet.
Each purchase contract obligates Legg Mason to sell a
number of newly issued shares of common stock that are
based on a settlement rate determined by Legg Mason’s
stock price at the purchase date. The settlement rate
adjusts with the price of Legg Mason stock in a way
intended to maintain the original investment value when
Legg Mason’s common stock is priced between $56.30
and $67.56 per share. The settlement rate is 0.7401 shares
of Legg Mason common stock, subject to adjustment,
for each Equity Unit if the market value of Legg Mason
common stock is at or above $67.56. The settlement rate
is 0.8881 shares of Legg Mason common stock, subject to
adjustment, for each Equity Unit if the market value of
Legg Mason common stock is at or below $56.30. If the
market value of Legg Mason common stock is between
$56.30 and $67.56, the settlement rate will be a number
of shares of Legg Mason common stock equal to $50
divided by the market value. The maximum number of
shares that may be issued, subject to adjustment, is 20.4
million. As the purchase contracts were deemed to be
equity upon issuance, Legg Mason will not incur a gain or
loss on their settlement.
Shares of Legg Mason’s common stock issuable under the
Equity Unit purchase contracts are currently anti-dilutive
under the treasury stock method because the market
price of Legg Mason common stock is less than $67.56
per share. In the event the probability of a successful
remarketing of the Equity Unit notes becomes remote, the
amount of shares issuable under the purchase contracts
that must be included in diluted earnings per share would
be determined under the if-converted method.
Legg Mason has the option to remarket the notes begin-
ning December 27, 2010, and is required to attempt to
remarket the notes by June 30, 2011. Upon a successful
remarketing, the interest rate and maturity date of the
senior notes will be reset such that the notes may remain
outstanding for some time after the exercise of the pur-
chase contracts and the related issuance of Legg Mason
common shares. If such remarketing is not successful dur-
ing this period, the note holders can put their notes at par
to Legg Mason upon the settlement of the purchase con-
tracts. Further, notes not redeemed or remarketed by June
30, 2013, can be called at par by Legg Mason.
Other Term Loans
Legg Mason entered into a loan in fiscal 2005 to finance
leasehold improvements. The outstanding balance at
March 31, 2009 was $6.2 million, which bears interest at
4.2% and is due October 31, 2010. In fiscal 2006, Legg
Mason entered into a $12.8 million term loan agree-
ment to finance the acquisition of an aircraft. The loan
bears interest at 5.9%, is secured by the aircraft, and has
67
a maturity date of January 1, 2016. The outstanding bal-
ance at March 31, 2009 was $10.8 million.
As of March 31, 2009, the aggregate maturities of long-
term debt (current accreted value of $2,973,392), based on
their contractual terms, are as follows:
2010
2011
2012
2013
2014
Thereafter
Total
$
8,188
553,779
2,594
1,107
894
2,406,830
$2,973,392
Interest Rate Swap
Effective December 1, 2005, Legg Mason executed a
3-year amortizing interest rate swap (“Swap”) with a
large financial institution to hedge interest rate risk on a
portion of its $700 million, 5-year term loan. Under the
terms of the Swap, Legg Mason paid a fixed interest rate
of 4.9% on a notional amount of $400 million. During
the March 2007 quarter, this Swap began to unwind at
$50 million per quarter. Quarterly payments or receipts
under the Swap exactly offset changes in the floating rate
interest payments on $400 million in principal of the term
loan. Since the terms and conditions of the hedge were not
expected to be changed, then as long as at least the unam-
ortized balance of the Swap was outstanding on the 5-year
term loan, the Swap continued to be an effective cash flow
hedge. As a result, changes in the market value of the Swap
were recorded as a component of Other comprehensive
income. The Swap matured on December 1, 2008 and the
estimated unrealized loss previously included in Other
comprehensive income of $157 was realized as Other
non-operating income (expense) on the maturity date.
This amount was offset by lower interest expense on the
hedged debt.
8. INCOME TAXES
The components of income (loss) from continuing operations before income tax provision (benefit) and minority inter-
ests are as follows:
2009
2008
2007
Pretax Income (Loss)
Domestic
Foreign
Total
$(3,020,987)
(134,870)
$(3,155,857)
$ 216,617
227,254
$ 443,871
The components of income tax (benefit) expense from continuing operations are as follows:
Federal
Foreign
State and local
Total income tax provision (benefit)
Current
Deferred
Total income tax provision (benefit)
2009
$(1,064,698)
32,845
(179,000)
$(1,210,853)
$ (405,726)
(805,127)
$(1,210,853)
2008
$ 91,736
52,698
31,561
$ 175,995
$ 349,145
(173,150)
$ 175,995
$ 779,508
264,346
$1,043,854
2007
$ 285,219
57,976
54,417
$ 397,612
$ 268,811
128,801
$ 397,612
As of March 31, 2009, Legg Mason has refundable income taxes of approximately $603,668, comprised of $546,473 in
federal net operating loss and capital loss carryback claims and $57,195 of refunds due on prior year return filings.
68
A reconciliation of the difference between the effective income tax rate and the statutory federal income tax rate for
continuing operations is as follows:
Tax provision (benefit) at statutory U.S. federal income tax rate
State income taxes, net of federal income tax benefit
Differences in tax rates applicable to non-U.S. earnings
Repatriation of foreign earnings
Loss on Canadian restructuring
Changes in tax rates on deferred tax assets and liabilities
Other non-deductible expenses, principally goodwill impairment in 2009
Other, net
Effective income tax (benefit) rate
2009
(35.0)%
(3.7)
—
(0.1)
(2.9)
0.3
2.5
0.5
(38.4)
2008
35.0%
4.5
(2.5)
4.1
—
(3.7)
0.9
1.4
39.7
2007
35.0%
3.3
(1.1)
—
—
—
0.2
0.7
38.1
Deferred income taxes are provided for the effects of tem-
porary differences between the tax basis of an asset or lia-
bility and its reported amount in the Consolidated Balance
Sheets. These temporary differences result in taxable or
deductible amounts in future years. A summary of Legg
Mason’s deferred tax assets and liabilities are as follows:
DEFERRED TAX ASSETS
Accrued compensation and benefits
Accrued expenses
Operating loss carryforwards
Capital loss carryforwards
Deferred liquidity fund support charges
Convertible senior note hedge
Foreign tax credit carryforward
Other
Deferred tax assets
Valuation allowance
Deferred tax assets after valuation allowance
DEFERRED TAX LIABILITIES
Basis differences, principally for intangible assets and goodwill
Depreciation and amortization
Other
Deferred tax liabilities
Net deferred tax asset (liability)
2009
$ 146,486
59,696
633,395
7,155
21,855
92,300
30,964 —
13,328
1,005,179
(35,542)
$ 969,637
2009
$ 249,383
36,057
541
$ 285,981
$ 683,656
2008
$ 124,504
22,310
27,866
12,534
201,230
113,858
2,258
504,560
(35,146)
$ 469,414
2008
$ 271,565
317,218
570
$ 589,353
$(119,939)
Certain tax benefits associated with Legg Mason’s employee
stock plans are recorded directly in Stockholders’ equity.
Stockholders’ equity increased by $35,587 and $14,466 in
2008 and 2007, respectively, as a result of these tax benefits.
No tax benefit was recorded to equity in 2009 due to the
net operating loss position of the Company.
In connection with the sale of the Notes in January 2008,
Legg Mason entered into the Purchase Call Options with
the Hedge Providers (see Note 7). The $297.5 million cost
of the call options was reflected in the financial statements
as a reduction of additional paid-in capital. For income
tax purposes, the call options and Notes are considered
part of a single, integrated transaction and the cost of the
call options is therefore tax deductible over the term of the
Notes. Accordingly, Legg Mason will have related future
tax benefits of $113.9 million over a period of up to the
seven year term of the notes. The benefit of this deferred
tax asset was recorded as an increase in additional paid-in
capital and therefore will not reduce future tax provisions.
69
The balance of this deferred tax asset at March 31, 2009
is $92.3 million.
Legg Mason has various loss carryforwards that may
provide future tax benefits. Related valuation allow-
ances are established in accordance with SFAS No. 109,
“Accounting for Income Taxes,” if it is management’s opin-
ion that it is more likely than not that these benefits will
not be realized. Substantially all of Legg Mason’s deferred
tax assets relate to U.S. and United Kingdom (“U.K.”)
taxing jurisdictions. As of March 31, 2009, gross U.S.
deferred tax assets accumulated $1.3 billion, realization
of which is expected to require approximately $5.7 billion
of future U.S. earnings. Based on estimates of future tax-
able income, using the same assumptions as those used
in Legg Mason’s goodwill impairment testing, it is more
likely than not that current tax benefits are realizable and
no valuation allowance is necessary at this time. To the
extent the analysis of the realization of deferred tax assets
relies on deferred tax liabilities, Legg Mason has consid-
ered the timing, nature and jurisdiction of reversals. While
tax planning may enhance Legg Mason’s tax positions,
the realization of current tax benefits is not dependent on
any significant tax strategies. As of March 31, 2009, U.K.
deferred tax assets are not material.
The following deferred tax assets and valuation allowances relating to loss carryforwards have been recorded at March 31,
2009 and 2008, respectively.
Deferred tax assets
U.S. Federal net operating losses
U.S. state net operating losses(1,2)
Non-U.S. net operating losses
Non-U.S. capital losses(1)
Total deferred tax assets for loss carryforwards
Valuation allowances
U.S. state net operating losses
Non-U.S. net operating losses
Non-U.S. capital losses
Other deferred tax assets
Total valuation allowances
2009
$504,779
96,898
31,718
7,155
$640,550
$
989
27,398
7,155
—
$ 35,542
2008
$
—
3,139
24,727
12,534
$40,400
$ 1,005
20,864
12,534
743
$35,146
Expires Beginning
after Fiscal Year
2029
2010
2010
2010
(1) U.S. subsidiaries of Permal file separate federal income tax returns, apart from Legg Mason Inc.’s consolidated federal income tax return, due to the Permal acquisition
structure, and separate state income tax returns.
(2) Substantially all of the U.S. state net operating losses carryforward through fiscal year 2029.
As a result of the adoption of FIN 48, effective April 1,
2007 the Company recorded a decrease in beginning
retained earnings and an increase in the liability for
unrecognized tax benefits of approximately $3.6 million
(net of the federal benefit for state tax liabilities). All of
this amount, if recognized, would reduce future income
tax provisions and favorably impact effective tax rates.
Legg Mason had total gross unrecognized tax benefits
of approximately $43.7 million and $29.3 million as of
March 31, 2009 and March 31, 2008, respectively. Of
these totals, $34.3 million and $21.1 million, respectively
(net of the federal benefit for state tax liabilities) are the
amounts of unrecognized benefits which, if recognized,
would favorably impact future income tax provisions and
effective tax rates.
70
A reconciliation of the beginning and ending amount of unrecognized gross tax benefits for the years ended March 31,
2009 and 2008 is as follows:
Balance, beginning of year
Additions based on tax positions related to the current year
Additions for tax positions of prior years
Reductions for tax positions of prior years
Decreases related to settlements with taxing authorities
Expiration of statute of limitations
Balance, end of year
As of March 31, 2009, management does not anticipate
any material increases or decreases in the amounts of
unrecognized tax benefits over the next twelve months.
The Company recognizes interest accrued related to unrec-
ognized tax benefits in interest expense and penalties in
other operating expense. During the years ended March 31,
2009 and 2008, the Company recognized approximately
$5.4 million and $1.2 million, respectively, which was sub-
stantially all interest. At March 31, 2009 and 2008, Legg
Mason had approximately $5.0 million and $2.9 million,
respectively, accrued for interest and penalties on tax con-
tingencies in the Consolidated Balance Sheets.
Legg Mason is under examination by the Internal Revenue
Service and other tax authorities in various states. The fol-
lowing tax years remain open to income tax examination
for each of the more significant jurisdictions where Legg
Mason is subject to income taxes: after fiscal year 2002 for
U.S. federal; after fiscal year 2005 for the United Kingdom;
after fiscal year 2002 for the state of Connecticut; after fis-
cal year 2003 for the states of California and New York;
and after fiscal year 2005 for the state of Maryland and
most other states in which Legg Mason is subject to income
tax. The Company expects to close certain state audits
within the next twelve months but does not anticipate mak-
ing any significant cash payments related to these audits.
During the quarter ended September 30, 2007, the United
Kingdom enacted the Finance Act of 2007, which reduced
the corporate tax rate from 30% to 28% for tax periods end-
ing after April 1, 2008. The impact on deferred tax liabili-
ties in fiscal 2007 at the time of the change in fiscal 2008
was a one-time tax benefit approximating $18.5 million.
In fiscal 2008, Legg Mason initiated plans to repatri-
ate earnings from certain foreign subsidiaries for up to
$225 million to be used for the contingent acquisition
2009
$29,287
15,756
14,366
(4,082)
(11,665) —
—
$43,662
2008
$28,706
6,192
3,110
(7,941)
(780)
$29,287
payments to the former owners of Permal discussed in
Note 9. During fiscal 2008, $36 million was repatriated
under this plan and an additional income tax provision
of approximately $18.4 million (net of foreign tax credits
not previously recognized) was recognized. No further
repatriation beyond the $225 million of foreign earnings
is contemplated.
Except as noted above, Legg Mason intends to per-
manently reinvest cumulative undistributed earnings
of its non-U.S. subsidiaries in non-U.S. operations.
Accordingly, no U.S. federal income taxes have been
provided for the undistributed earnings to the extent
that they are permanently reinvested in Legg Mason’s
non-U.S. operations. It is not practical at this time to
determine the income tax liability that would result upon
repatriation of the earnings.
9. COMMITMENTS AND CONTINGENCIES
Legg Mason leases office facilities and equipment under
non-cancelable operating leases and also has multi-year
agreements for certain services. These leases and service
agreements expire on varying dates through fiscal 2025.
Certain leases provide for renewal options and contain
escalation clauses providing for increased rentals based
upon maintenance, utility and tax increases.
As of March 31, 2009, the minimum annual aggregate
rentals under operating leases and servicing agreements
are as follows:
2010
2011
2012
2013
2014
Thereafter
Total
$ 161,480
110,795
102,163
94,187
87,604
674,336
$1,230,565
71
During the quarter ended September 30, 2008, a subsid-
iary executed a lease for facilities obligating Legg Mason
to aggregate payments of $103 million through 2024,
which is included above.
Legg Mason also entered into an agreement to lease new
office space in Baltimore as a replacement for its cur-
rent headquarters when the current lease expires in fiscal
2010. The new lease has an annual base rent of approxi-
mately $11.9 million, which is included above. The initial
lease term will expire in April 2024, with two renewal
options of 10 and five years.
The table above does not include aggregate rental com-
mitments of $35.6 million for property and equipment
under capital leases.
One such lease was amended during fiscal 2008 to include
a put/purchase option agreement with the owner of land
and a building. The agreement is for a fixed price of
$29.0 million, if executed. The seller has a put option
through December 2012 and beginning in November 2011
a buyer purchase option becomes exercisable. A $4 million
escrow deposit was made in connection with the put/
purchase option agreement.
The minimum rental commitments in the table above
have not been reduced by $100.7 million for minimum
sublease rentals to be received in the future under non-
cancelable subleases, of which approximately 90% is due
from one counterparty. If a sub-tenant defaults on a sub-
lease, Legg Mason may have to incur operating charges
to reflect expected future sublease rentals at reduced
amounts, as a result of the current commercial real
estate market.
Included in the table above is $92.8 million in commit-
ments related to office space that has been vacated, but
for which a sublease is being pursued. A lease liability
was established in fiscal 2009 for the present value of the
excess existing lease obligations over the estimated sub-
lease income and related costs. The lease liability takes
into consideration various assumptions, including the
amount of time it will take to secure a sublease agree-
ment and prevailing rental rates in the applicable real
estate markets. These assumptions are based upon input
from commercial real estate consultants. As of March 31,
2009, this liability aggregated $63.7 million, but is sub-
ject to adjustment based on circumstances in the real
estate markets that may require a change in the assump-
tions or the actual terms of a sublease that is ultimately
72
secured. The liability as of March 31, 2009 is principally
related to a bankrupt subtenant that defaulted on a sub-
lease with Legg Mason in fiscal 2009. These and other
related costs incurred during fiscal 2009 aggregated
$79.0 million.
As noted above, during fiscal 2010, Legg Mason will
relocate to its new corporate headquarters. Legg Mason
is currently pursuing sub-tenants for certain floors under
the lease that will be unoccupied as a result of headcount
reductions. Given the current commercial real estate mar-
ket, at the time a sublease is secured or the space is deemed
to be permanently abandoned, a charge will be recognized
for the present value of the amount by which the commit-
ment under the lease exceeds the amount due under the
expected sublease terms.
The following table reflects rental expense under all oper-
ating leases and servicing agreements.
Rental expense
Less: sublease income
Net rent expense
2007
2009
2008
$127,949 $128,111 $107,710
10,561
$112,461 $117,241 $ 97,149
15,488
10,870
Legg Mason recognizes rent expense ratably over the lease
period based upon the aggregate lease payments. The lease
period is determined as the original lease term without
renewals, unless and until the exercise of lease renewal
options is reasonably assured, and also includes any period
provided by the landlord as a “free rent” period. Aggregate
lease payments include all rental payments specified in
the contract, including contractual rent increases, and are
reduced by any lease incentives received from the land-
lord, including those used for tenant improvements.
As of March 31, 2009 and 2008, Legg Mason had com-
mitments to invest approximately $29,466 and $50,585,
respectively, in limited partnerships that make private
investments. These commitments will be funded as
required through the end of the respective investment
periods ranging through fiscal 2011.
During fiscal 2008, Legg Mason recorded contingent pay-
ment obligations of $160 million related to the Permal
acquisition in addition to the $161 million previously
recorded obligation. During fiscal year 2008, payments of
$240 million were made to the former owners of Permal
of which $208 million was paid in cash and the balance
was in common stock. In fiscal 2010, Legg Mason may be
required to pay up to $286 million under the agreements
governing the Permal acquisition, with the amount of the
payment to be determined based on Permal’s operating
results. The final payment for this transaction on the sixth
anniversary in fiscal 2012 will be between $60 million and
$320 million based on Permal’s revenues and the amount
of the fiscal 2010 payment. See Note 2, Acquisitions and
Dispositions, for additional information related to the
Permal acquisition.
See Note 17, Liquidity Fund Support, for additional infor-
mation related to Legg Mason’s commitments.
In the normal course of business, Legg Mason enters into
contracts that contain a variety of representations and war-
ranties and which provide general indemnifications. Legg
Mason’s maximum exposure under these arrangements is
unknown, as this would involve future claims that may be
made against Legg Mason that have not yet occurred.
Legg Mason has been the subject of customer complaints
and has also been named as a defendant in various legal
actions arising primarily from securities brokerage, asset
management and investment banking activities, including
certain class actions, which primarily allege violations of
securities laws and seek unspecified damages, which could
be substantial. Legg Mason is also involved in governmen-
tal and self-regulatory agency inquiries, investigations and
proceedings. In the Citigroup transaction, Legg Mason
transferred to Citigroup the subsidiaries that constituted
its Private Client/Capital Markets (“PC/CM”) businesses,
thus transferring the entities that would have primary
liability for most of the customer complaint, litigation
and regulatory liabilities and proceedings arising from
those businesses. However, as part of that transaction,
Legg Mason agreed to indemnify Citigroup for most
customer complaint, litigation and regulatory liabilities
of Legg Mason’s former PC/CM businesses that result
from pre-closing events. While the ultimate resolution of
these matters cannot be currently determined based on
current information, after consultation with legal counsel,
management believes that any accrual or range of reason-
ably possible losses as of March 31, 2009 or 2008, is not
material. Similarly, although Citigroup transferred to
Legg Mason the entities that would be primarily liable for
most customer complaint, litigation and regulatory liabili-
ties and proceedings of the CAM business, Citigroup
has agreed to indemnify Legg Mason for most customer
complaint, litigation and regulatory liabilities of the CAM
business that result from pre-closing events. In accordance
with SFAS No. 5 “Accounting for Contingencies,” Legg
Mason has established provisions for estimated losses
from pending complaints, legal actions, investigations and
proceedings. After consultation with legal counsel, Legg
Mason does not believe that the resolution of these actions
will have a material adverse effect on Legg Mason’s finan-
cial condition. However, the results of operations could
be materially affected during any period if liabilities in
that period differ from Legg Mason’s prior estimates,
and Legg Mason’s cash flows could be materially affected
during any period in which these matters are resolved. In
addition, the ultimate costs of litigation-related charges
can vary significantly from period to period, depending
on factors such as market conditions, the size and volume
of customer complaints and claims, including class action
suits, and recoveries from indemnification, contribution
or insurance reimbursement.
Legg Mason and a current and former officer, together
with an underwriter in a public offering, are named as
defendants in a consolidated legal action. The action
alleges that the defendants violated the Securities
Exchange Act of 1934 and the Securities Act of 1933 by
making misleading statements to the public and omit-
ting certain material facts with respect to the acquisi-
tion of the CAM business in public statements and in a
prospectus used in a secondary stock offering in order to
artificially inflate the price of Legg Mason common stock.
The action sought certification of a class of sharehold-
ers who purchased Legg Mason common stock either
between February 1, 2006 and October 10, 2006 or in
a secondary public offering on or about March 9, 2006
and seeks unspecified damages. Legg Mason intends to
defend the action vigorously. On March 17, 2008, the
action was dismissed with prejudice. However, the plain-
tiffs have appealed this dismissal of the complaint under
the Securities Act. The dismissal of the claims under the
Exchange Act on behalf of the proposed claim of pur-
chases between February 1, 2006 and October 10, 2006
was not appealed and is final. Legg Mason cannot accu-
rately predict the eventual outcome of the appeal at this
point, or whether the action will have a material adverse
effect on Legg Mason.
As of March 31, 2009 and 2008, Legg Mason’s liability for
losses and contingencies was $1,800 and $1,700, respec-
tively. During fiscal 2009, 2008 and 2007, Legg Mason
recorded litigation-related charges of approximately $600,
$1,100, and $100, respectively (net of recoveries of $100
in fiscal 2008). During fiscal 2009, 2008, and 2007,
73
the liability was reduced for settlement payments of
approximately $500, $2,100 and $1,800, respectively.
10. EMPLOYEE BENEFITS
Legg Mason, through its subsidiaries, maintains vari-
ous defined contribution plans covering substantially all
employees. Through its primary plan, Legg Mason can
make two types of discretionary contributions. One is a
profit sharing contribution to eligible Plan participants
based on a percentage of qualified compensation and the
other is a 50% match of employee 401(k) contributions up
to 6% of employee compensation with a maximum of five
thousand dollars per year. Match contributions amounted
to $14,366, $39,446 and $40,686 in fiscal 2009, 2008 and
2007, respectively. Legg Mason elected to not make a profit
sharing contribution in fiscal 2009. In addition, employees
can make voluntary contributions under certain plans.
11. CAPITAL STOCK
At March 31, 2009, the authorized numbers of common,
preferred and exchangeable shares were 500 million, 4
million and an unlimited number, respectively. In addi-
tion, at March 31, 2009 and 2008, there were 10.9 million
and 13.8 million shares of common stock, respectively,
reserved for issuance under Legg Mason’s equity plans and
1.2 million and 2.0 million common shares, respectively,
reserved for exchangeable shares issued in connection with
the acquisition of Legg Mason Canada Inc. Exchangeable
shares are exchangeable at any time by the holder on a one-
for-one basis into shares of Legg Mason’s common stock
and are included in basic shares outstanding. In connection
with the acquisition of CAM, Legg Mason issued 13.35
shares, $10 par value per share, of non-voting Legg Mason
convertible preferred stock, which were convertible, upon
transfer into 13.35 million shares of common stock. During
fiscal 2009 and 2008, Legg Mason issued approximately
0.36 million and 5.53 million common shares, respectively,
upon conversion of approximately 0.36 and 5.53, respec-
tively, of the non-voting convertible preferred stock. Also,
during fiscal 2008, Legg Mason repurchased 2.5 shares of
the non-voting convertible preferred stock using proceeds
from the 2.5% convertible senior notes. As of March 31,
2009, there were no outstanding shares of non-voting
convertible preferred stock. As discussed in Note 7, in May
2008, Legg Mason issued $1.15 billion of Equity Units,
each unit consisting of a 5% interest in $1,000 principal
amount of senior notes due June 30, 2021, and a purchase
contract committing the holder to purchase shares of Legg
Mason’s common stock by June 30, 2011. The maximum
amount of shares that may be issued, and are reserved for
issuance, is approximately 20.4 million, subject to adjust-
ment. Also discussed in Note 7, in January 2008, Legg
Mason issued $1.25 billion of 2.5% contingent convertible
senior notes, which, if certain conditions are met, could
result in the issuance of a maximum of 14.2 million shares
of Legg Mason common stock, subject to adjustment.
Changes in common stock and shares exchangeable into common stock for the three years ended March 31, 2009,
2008 and 2007 are as follows:
COMMON STOCK
Beginning balance
Shares issued for:
2009
Years Ended March 31,
2008
2007
138,556
131,777
129,710
Stock option exercises and other stock based compensation
Deferred compensation trust
Deferred compensation
Conversion of debt
Exchangeable shares
Shares repurchased and retired
Permal contingent payment
Conversion of non-voting preferred stock
Ending balance
SHARES EXCHANGEABLE INTO COMMON STOCK
Beginning balance
Exchanges
Ending balance
1,094
155
922
—
761
—
—
365
141,853
1,983
(761)
1,222
1,569
53
298
—
82
(1,140)
392
5,525
138,556
2,065
(82)
1,983
863
53
183
756
212
—
—
—
131,777
2,277
(212)
2,065
74
Dividends declared per share were $0.96, $0.96 and $0.81
for fiscal 2009, 2008 and 2007, respectively. Dividends
declared but not paid at March 31, 2009, 2008 and 2007
were $34,043, $33,103 and $29,430, respectively and are
included in Other current liabilities.
On July 19, 2007, Legg Mason announced that its Board
of Directors authorized it to purchase 5.0 million shares of
Legg Mason common stock in open-market purchases. This
authorization replaced a prior Board of Directors authoriza-
tion to purchase up to 3.0 million shares of Legg Mason
common stock. There was no expiration date attached to
this new authorization. During the fiscal years ended March
31, 2009 and 2007, no shares were repurchased. During the
fiscal year ended March 31, 2008, 1.1 million shares were
repurchased under this authorization for $97,945.
awards, performance shares payable in common stock,
and deferred compensation payable in stock. Effective
July 19, 2007, the number of shares authorized to be
issued under Legg Mason’s active equity incentive stock
plan was increased by 5 million to 29 million. However,
Legg Mason has agreed that it will not issue the final
1 million shares without additional stockholder
approval. Shares available for issuance as of March 31,
2009 were 4.3 million. Options under Legg Mason’s
employee stock plans have been granted at prices not
less than 100% of the fair market value. Options are
generally exercisable in equal increments over three to
five years and expire within five to ten years from the
date of grant. See Note 1 for a further discussion of
stock-based compensation.
In fiscal 2008, Legg Mason issued 392 common shares in
connection with the contingent acquisition payment made
to the former owners of Permal as discussed in Note 2.
12. STOCK-BASED COMPENSATION
Legg Mason’s stock-based compensation includes stock
options, employee stock purchase plans, restricted stock
Compensation expense for continuing operations relating
to stock options, the stock purchase plan and deferred
compensation payable in stock for the years ended March
31, 2009, 2008 and 2007 was $24,364, $25,188 and
$23,817, respectively. The related income tax benefit for
the years ended March 31, 2009, 2008 and 2007 was
$9,385, $9,724 and $8,452, respectively.
Stock option transactions under Legg Mason’s equity incentive plans during the three years ended March 31, 2009 are
summarized below:
Options outstanding at March 31, 2006
Granted
Exercised
Canceled
Options outstanding at March 31, 2007
Granted
Exercised
Canceled
Options outstanding at March 31, 2008
Granted
Exercised
Canceled
Options outstanding at March 31, 2009
Number
of Shares
6,370
1,006
(820)
(78)
6,478
933
(1,675)
(272)
5,464
1,496
(1,104)
(656)
5,200
Weighted-Average
Exercise Price
Per Share
$ 43.56
96.60
28.17
65.39
$ 53.48
100.77
28.43
94.00
$ 67.20
29.54
25.01
68.24
$ 65.19
The total intrinsic value of options exercised during the
years ended March 31, 2009, 2008 and 2007 was $10,456,
$109,626 and $55,046, respectively. At March 31, 2009,
options outstanding had no aggregate intrinsic value
because the current market price of Legg Mason stock was
less than the exercise prices of all options outstanding.
75
The following information summarizes Legg Mason’s stock options outstanding at March 31, 2009:
Exercise
Price Range
$ 12.65–$ 25.00
25.01– 35.00
35.01– 94.00
94.01– 100.00
100.01– 132.18
Option Shares
Outstanding
349
1,992
500
670
1,689
5,200
At March 31, 2009, 2008 and 2007, options were exercis-
able on 2,455, 3,197, and 4,156 shares, respectively, and
the weighted average exercise prices were $67.05, $45.54
and $33.88, respectively. Stock options exercisable at
March 31, 2009 have a weighted-average remaining con-
tractual life of 3.0 years. At March 31, 2009, there was no
aggregate intrinsic value of options exercisable.
The following information summarizes Legg Mason’s
stock options exercisable at March 31, 2009:
Exercise
Price Range
$ 25.01–$ 35.00
35.01– 94.00
94.01– 100.00
100.01– 132.18
Option Shares
Exercisable
935
432
281
807
2,455
Weighted-Average
Exercise Price
Per Share
$ 29.44
51.06
95.23
109.39
The following information summarizes unvested stock
options under Legg Mason’s equity incentive plans for the
year ended March 31, 2009:
Shares unvested at
March 31, 2008
Granted
Vested(1)
Canceled/forfeited
Shares unvested at
March 31, 2009
Number
of Shares
Weighted-Average
Grant Date
Fair Value
2,267
1,496
(362)
(656)
$32.45
13.36
38.16
26.04
2,745
$22.70
(1) Generally, vesting occurs in July of each year.
Weighted-Average
Exercise Price
Per Share
$ 14.98
31.84
52.25
95.22
106.84
Weighted-Average
Remaining Life
(in years)
7.3
4.3
2.8
5.3
5.3
Unamortized compensation cost related to unvested
options at March 31, 2009 was $46,023 and is expected to
be recognized over a weighted-average period of 2.1 years.
Legg Mason also has an equity plan for non-employee
directors that replaced its stock option plan for non-
employee directors during fiscal 2006. Under the equity
plan, directors may elect to receive shares of stock or
restricted stock units. Prior to a July 19, 2007 amendment
to the Plan, directors could also elect to receive stock
options. Options granted under either plan are immedi-
ately exercisable at a price equal to the market value of the
shares on the date of grant and have a term of not more
than ten years. Shares, options, and restricted stock units
issuable under the equity plan are limited to 625 shares in
aggregate, of which 126 shares were issued under the plan
as of March 31, 2009. At March 31, 2009, there are 355
stock options and 39 restricted stock units outstanding
under both plans.
Cash received from exercises of stock options under Legg
Mason’s equity incentive plans was $25,463, $30,944 and
$20,690 for the years ended March 31, 2009, 2008 and
2007, respectively. The tax benefit expected to be realized
for the tax deductions from these option exercises totaled
$3,853, $41,189 and $13,965 for the years ended March
31, 2009, 2008 and 2007, respectively.
The weighted average fair value of stock options granted
in fiscal 2009, 2008 and 2007, using the Black-Scholes
option pricing model, was $13.36, $31.76 and $33.17 per
share, respectively.
76
The following weighted average assumptions were used in
the model for grants in fiscal 2009, 2008, and 2007.
Expected dividend yield
Risk-free interest rate
Expected volatility
Expected lives (in years)
2009
0.89%
3.46%
56.65%
5.28
2008
0.81%
4.71%
29.17%
4.95
2007
0.79%
4.68%
31.43%
5.37
Legg Mason uses an equally weighted combination of
both implied and historical volatility to measure expected
volatility for calculating Black-Scholes option values.
Legg Mason has a qualified Employee Stock Purchase
Plan covering substantially all U.S. employees. Shares
of common stock are purchased in the open market on
behalf of participating employees, subject to a 4.5 mil-
lion total share limit under the plan. Purchases are made
through payroll deductions and Legg Mason provides a
10% contribution towards purchases, which is charged to
earnings. During the fiscal years ended March 31, 2009,
2008 and 2007, approximately 188, 59 and 43 shares,
respectively, have been purchased in the open market on
behalf of participating employees.
On January 28, 2008, the Compensation Committee of
Legg Mason approved grants to senior officers of 120 per-
formance shares that upon vesting, subject to certain con-
ditions, are distributed as shares of common stock. The
grants will vest ratably on January 28 of each of the five
years following the grant date, upon attaining the service
criteria and the stock price hurdles beginning at $77.97 in
year one and ending at $114.15 in year five.
The weighted average fair value per share for these awards
of $11.81 was estimated as of the grant date using a grant
price of $70.88, and a Monte Carlo option-pricing model
with the following assumptions:
Expected dividend yield
Risk-free interest rate
Expected volatility
1.33%
3.30%
36.02%
In connection with the termination of one of the senior
officers in fiscal 2009, 20 performance shares were volun-
tarily forfeited, resulting in a charge of $550 representing
an acceleration of expense associated with the unvested
portion of the award.
Restricted stock transactions during the twelve months
ended March 31, 2009, 2008, 2007, respectively are sum-
marized below:
Number
of Shares
Weighted-
Average Grant
Date Value
Unvested Shares at
March 31, 2006
Granted
Vested
Canceled/forfeited
Unvested Shares at
March 31, 2007
Granted
Performance Shares Granted
Vested
Canceled/forfeited
Unvested Shares at
March 31, 2008
Granted
Vested
Canceled/forfeited
Unvested Shares at
March 31, 2009
496
289
(120)
(102)
563
229
120
(219)
(51)
642
975
(235)
(41)
$120.89
107.08
113.25
128.34
114.03
92.51
59.07
108.16
115.48
98.30
34.75
106.76
78.82
1,341
$ 51.26
The restricted stock awards were non-cash transactions.
In fiscal 2009, 2008 and 2007, Legg Mason recognized
$32,629, $25,015 and $17,039, respectively, in compen-
sation expense for all restricted stock awards. The tax
benefit expected to be realized for the tax deductions from
restricted stock totaled $2,870, $4,771 and $5,320 for
years ended March 31, 2009, 2008 and 2007, respectively.
Unamortized compensation cost related to unvested
restricted stock awards for 1,341 shares not yet recognized
at March 31, 2009 was $47,014 and is expected to be rec-
ognized over a weighted-average period of 3.1 years.
Deferred compensation payable in shares of Legg Mason
common stock has been granted to certain employees in
an elective plan. The vesting in the plan is immediate and
the plan provides for discounts of up to 10% on contribu-
tions and dividends. There is no limit on the number of
shares authorized to be issued under the plan. In fiscal
2009, 2008 and 2007, Legg Mason recognized $322,
$254 and $247, respectively, in compensation expense.
During fiscal 2009, 2008 and 2007, Legg Mason issued
125, 48 and 46 shares, respectively, under the plan with
a weighted-average fair value per share at grant date of
$39.62, $84.11 and $87.26, respectively.
77
13. DEFERRED COMPENSATION STOCK TRUST
Legg Mason has issued shares in connection with cer-
tain deferred compensation plans that are held in rabbi
trusts. Assets of rabbi trusts are consolidated with those
of the employer, and the value of the employer’s stock
held in the rabbi trusts is classified in stockholders’
equity and accounted for in a manner similar to treasury
stock. Therefore, the shares Legg Mason has issued to
its rabbi trust and the corresponding liability related to
the deferred compensation plans are presented as compo-
nents of stockholders’ equity as Employee stock trust and
Deferred compensation employee stock trust, respectively.
Shares held by the trust at March 31, 2009 and 2008 were
2,003 and 1,190, respectively.
14. EARNINGS PER SHARE
Basic earnings per share (“EPS”) is calculated by divid-
ing net income or loss by the weighted average number
of shares outstanding. The calculation of weighted aver-
age shares includes common shares, shares exchangeable
into common stock and convertible preferred shares
that are considered participating securities. Diluted
EPS is similar to basic EPS, but adjusts for the effect
of potential common shares except when inclusion is
antidilutive. In situations where a net loss is reported,
the inclusion of potentially issuable common shares
will decrease the net loss per share. Since this would be
antidilutive, such shares are excluded from the calcula-
tion. Basic and diluted earnings per share for the fiscal
year ended March 31, 2009 include all vested shares of
restricted stock related to Legg Mason’s deferred com-
pensation plans.
On December 1, 2005, Legg Mason issued 13.346632
shares of non-voting convertible preferred stock in con-
nection with the acquisition of CAM. The non-voting
convertible preferred shares are entitled to receive the
same dividends (on an as-converted basis) as those paid on
common stock and convert automatically upon transfer
to an entity that is not an affiliate of Citigroup into an
aggregate of 13.3 million shares of our common stock. As
of March 31, 2009 and 2008, there were zero and 0.36
shares of non-voting convertible preferred stock outstand-
ing, respectively.
The following table presents the computations of basic and diluted EPS:
Weighted average basic shares outstanding
Potential common shares:
Employee stock options
Shares related to deferred compensation
Shares issuable upon conversion of senior notes
Shares issuable upon payment of contingent consideration
Total weighted average diluted shares
Income (loss) from continuing operations
Interest expense on contingent convertible senior notes, net of tax
Income (loss) from continuing operations
Gain on sale of discontinued operations, net of tax
Net income (loss)
Net income (loss) per Share:
Basic
Income (loss) from continuing operations
Gain on sale of discontinued operations
Diluted
Income (loss) from continuing operations
Gain on sale of discontinued operations
2009
140,669
Years Ended March 31,
2008
142,018
2007
141,112
—
—
—
—
140,669
$(1,947,928)
—
(1,947,928)
—
$(1,947,928)
$
$
$
$
(13.85)
—
(13.85)
(13.85)
—
(13.85)
1,664
51
—
243
143,976
$267,610
—
267,610
—
$267,610
$
$
$
$
1.88
—
1.88
1.86
—
1.86
2,646
87
134
407
144,386
$646,246
84
646,330
572
$646,902
$
$
$
$
4.58
—
4.58
4.48
—
4.48
78
The diluted EPS calculation for the fiscal year ended
March 31, 2009 excludes 6,629 potential common shares
that are antidilutive due to the net loss for the fiscal year.
A summary of Legg Mason’s accumulated other com-
prehensive income (loss) as of March 31, 2009 and 2008
is as follows:
Options to purchase 2,780 shares for the fiscal year ended
March 31, 2008 and 1,086 shares for the fiscal year ended
March 31, 2007, were not included in the computation of
diluted earnings per share because the presumed proceeds
from exercising such options, including related income tax
benefits, exceed the average price of the common shares
for the fiscal year and therefore the options are deemed
antidilutive. Diluted earnings per share for the fiscal years
ended March 31, 2008 and 2007 also include unvested
shares of restricted stock, except for 707 and 526 shares,
respectively, which were deemed antidilutive. Also at
March 31, 2009 and 2008, warrants issued in connection
with the convertible note hedge transactions described in
Note 7 are excluded from the calculation of diluted earn-
ings per share because the effect would be antidilutive. In
May 2008, Legg Mason issued 23 million Equity Units
that include purchase warrants providing for the issuance
of between 17.0 and 20.4 million shares of Legg Mason
common stock by June 2011, as more fully described in
Note 7. Currently, the purchase warrants are antidilutive
because the market price of Legg Mason stock is less than
the maximum conversion price of $67.56.
15. ACCUMULATED OTHER
COMPREHENSIVE INCOME (LOSS)
Accumulated other comprehensive income includes cumu-
lative foreign currency translation adjustments, net of tax
gains and losses on interest rate swap, and net of tax gains
and losses on investment securities. The change in the
accumulated translation adjustments for fiscal 2009 and
2008 primarily resulted from the impact of changes in
the Brazilian real, the British pound, the Polish zloty, the
Australian dollar and the Japanese yen in relation to the
U.S. dollar on the net assets of Legg Mason’s subsidiar-
ies in Brazil, the United Kingdom, Poland, Australia and
Japan, for which the real, the pound, the zloty, the dollar
and the yen are the functional currencies, respectively.
Foreign currency
translation adjustments
$(2,886)
$83,827
2009
2008
Unrealized holding loss
on interest rate swap,
net of tax benefit of $0
and $666, respectively
Unrealized gains on
investment securities,
net of tax provision of
$68 and $29, respectively
Total
—
(938)
102
$(2,784)
41
$82,930
16. VARIABLE INTEREST ENTITIES
In the normal course of its business, Legg Mason spon-
sors and is the manager of various types of investment
vehicles that are considered VIEs. For its services, Legg
Mason is entitled to receive management fees and may be
eligible, under certain circumstances, to receive additional
subordinate management fees or other incentive fees.
Legg Mason did not sell or transfer assets to any of the
VIEs. Legg Mason’s exposure to risk in these entities is
generally limited to any equity investment it has made or
is required to make and any earned but uncollected man-
agement fees. Uncollected management fees from these
VIEs were not material at March 31, 2009 and 2008.
Legg Mason has not issued any investment performance
guarantees to these VIEs or their investors.
During fiscal 2009 and 2008, Legg Mason had vari-
able interests in certain liquidity funds to which it has
provided various forms of credit and capital support as
described in Note 17. After evaluating both the contrac-
tual and implied variable interests in these funds, as of
and during the years ended March 31, 2009 and 2008, it
has been determined that Legg Mason is not the primary
beneficiary of these funds.
79
As of March 31, 2009, Legg Mason was the primary bene-
ficiary of one sponsored investment fund VIE due to high
corporate ownership level which resulted in consolidation.
This VIE had total assets and total equity of $48.2 mil-
lion as of March 31, 2009. Legg Mason’s investment in
this VIE was $26.3 million, which represents the maxi-
mum risk of loss. The assets of this VIE are primarily
comprised of investments. As of March 31, 2008, Legg
Mason was not required to consolidate any VIEs that
were material to its consolidated financial statements.
As of March 31, 2009 and 2008, for VIEs in which Legg Mason holds a significant variable interest or is the sponsor
and holds a variable interest, but for which it was not the primary beneficiary, Legg Mason’s carrying value, the related
VIEs assets and liabilities and maximum risk of loss were as follows:
VIE Assets That
the Company
Does Not
Consolidate
$ 7,548,539
5,116,004
18,241,540
$30,906,083
For the Year Ended March 31, 2009
VIE Liabilities Equity Interests
That the
on the
Company Does Consolidated
Not Consolidate Balance Sheet
$ 121,338
4,786,604
3,381
$4,911,323
$
—
—
34,458
$34,458
Maximum
Risk of Loss*
$41,500
1,566
52,019
$95,085
VIE Assets That
the Company
Does Not
Consolidate
$ 95,214,043
5,608,533
40,771,666
$141,594,242
For the Year Ended March 31, 2008
Equity Interests
VIE Liabilities
on the
That the
Company Does
Consolidated
Not Consolidate Balance Sheet
$1,064,722
5,299,633
1,250
$6,365,605
$
—
—
42,419
$42,419
Maximum
Risk of Loss*
$1,966,000
628
61,602
$2,028,230
Money market funds
CDOs/CLOs
Other sponsored investment funds
Total
Money market funds
CDOs/CLOs
Other sponsored investment funds
Total
*
Includes capital support to liquidity funds, equity interests the Company has made or is required to make and any earned but uncollected management fees.
The assets of these VIEs are primarily comprised of cash
and cash equivalents and investments and the liabilities
are primarily comprised of various expense accruals.
17. LIQUIDITY FUND SUPPORT
Due to continued stress in the liquidity markets, certain
asset backed securities previously held by liquidity funds
that a Legg Mason subsidiary manages were in default
or had been restructured after a default. Although the
Company was not required to provide support to its
funds, Legg Mason elected to do so to maintain the con-
fidence of its clients, maintain its reputation in the mar-
ketplace, and in certain cases, to support the AAA/Aaa
credit ratings of funds. If clients were to lose confidence in
the Company, they could potentially withdraw funds in
favor of investments offered by competitors, resulting in a
reduction in Legg Mason’s assets under management and
investment advisory and other fees.
80
During fiscal 2009 and 2008, Legg Mason entered
into and amended various arrangements to provide
support to certain of its liquidity funds. During fiscal
2009, Legg Mason sold, or the funds sold, all securi-
ties issued by SIVs held in its money market funds, on
its balance sheet, and supported through a TRS with
a major bank. The par value, support amounts, col-
lateral and income statement impact for the fiscal years
ended March 31, 2009 and 2008, for all support that
remained outstanding as of the end of each period and
sale transactions that occurred during the period were
as follows:
Description
Capital Support Agreements—
Non-asset Backed Securities
Purchase of Non-bank Sponsored SIV(4)
Sale of Non-bank Sponsored SIV(4)
Total
Par
Value
n/m
—
—
Description
Letters of Credit
Capital Support Agreements—
Asset Backed Securities
Total Return Swap
Purchase of Non-bank Sponsored SIV(4,5)
Purchase of Canadian Conduit Securities
Total
Par
Value
$1,192,000
2,163,000
890,000
82,000
94,000
$4,421,000
Year Ended March 31, 2009
Cash
Collateral(1)
Pre Tax
Charge(2)
Support
Amount
After Tax
Charge(3)
$ 41,500
—
—
$ 41,500
$ 41,500
—
—
$ 41,500
$
20,906
965
2,261,365
$2,283,236
$
12,289
2,144
1,362,146
$1,376,579
Year Ended March 31, 2008
Cash
Collateral(1)
$286,250
Pre Tax
Charge(2)
$ 235,468
Support
Amount
$ 485,000
After Tax
Charge(3)
$ 97,866
415,000
890,000
82,000
94,000
$1,966,000
415,000
139,480
—
—
$840,730
316,185
18,042
162
37,419
$ 607,276
195,149
4,454
40
16,218
$ 313,727
n/m—not meaningful
(1) Included in restricted cash on the Consolidated Balance Sheet.
(2) Pre tax charges include reductions in the value of underlying securities, in addition to $181,183 relating to reimbursements to two funds for a portion of losses they incurred in
selling SIV securities and $2,863 principally relating to transaction costs which were substantially offset by a gain on a foreign exchange forward contract and interest payments
received on underlying securities, and are included in fund support in Other non-operating income (expense) on the Consolidated Statements of Operations.
(3) After tax and after giving effect to operating expense adjustments.
(4) Securities issued by SIVs.
(5) Support amount for securities purchased from funds reflects amount paid to fund less subsequent principal repayments.
81
The following table provides a summary of changes (in millions) in liquidity fund support, including securities pur-
chased from the funds by Legg Mason, for the fiscal years ended March 31, 2009 and 2008:
Capital
Support
Capital
Support Agreements–
Agreements– Non-asset
Letters of Asset Backed Backed
Securities
Securities
Credit
$ —
485
—
—
485
257
—
—
—
(742)
—
—
$
—
415
—
—
415
395
635
—
—
(1,430)
(15)
—
$ —
—
—
—
—
27
15
—
—
—
—
—
Purchase
& Sale of
Non-bank Purchase of
Sponsored Canadian
Conduit
Securities
SIV
Securities
$
—
—
82
—
$ —
—
98
(4)
82
—
—
2,973
(2,932)
—
(82)
(41)
94
—
—
—
(76)
—
—
(18)
Total
$
—
1,790
180
(4)
1,966
679
650
2,973
(3,363)
(2,172)
(537)
(154)
Total
Return
Swap
$ —
890
—
—
890
—
—
—
(355)
—
(440)
(95)
$ —
$
—
$ 42
$ —
$
—
$ —
$
42
Support amount as of
March 31, 2007
New support agreements
Purchases
Other(1)
Support amount as of
March 31, 2008
New support agreements
Amended support agreements
Purchases
Sales
Terminations of
support agreements
Maturities
Other(1)
Support amount as of
March 31, 2009
(1) Includes principal and interest payments received related to purchased securities and securities subject to the TRS, in addition to currency gains (losses) on Canadian
conduit securities
Letter of Credit
During fiscal 2008, Legg Mason provided support to three
liquidity funds in the form of LOCs issued by two third
party banks for an aggregate amount of approximately
$485 million to support investments in asset backed com-
mercial paper issued by two SIVs. During fiscal 2009,
Legg Mason provided additional support to liquidity
funds in the form of two LOCs issued by a third party
bank for an aggregate amount of approximately $257 mil-
lion to support investments in asset backed commercial
paper issued by two SIVs. Under the terms of the LOC
agreements, the LOCs could be drawn in certain cir-
cumstances, including upon the fund’s realizing a loss
on disposition or restructuring of the position, upon the
agreement’s termination if unpaid amounts remained on
certain of the fund’s SIV-issued securities, or in certain cir-
cumstances upon ratings downgrades of the issuing bank.
As part of the LOC arrangements, Legg Mason agreed
to reimburse to the banks any amounts that were drawn
on the LOCs. As of the date the LOCs were issued, Legg
Mason established a derivative liability for the fair value of
its guarantee to reimburse the banks any amounts drawn
under the LOCs. Due to the sale of all securities issued by
SIVs held by the liquidity funds during fiscal 2009, the
LOCs were terminated in accordance with their terms, no
amounts were drawn thereunder, and no derivative liability
was reported as of March 31, 2009. At March 31, 2008,
Legg Mason reported derivative liabilities of $235.5 mil-
lion for these LOCs.
Capital Support Agreements—Asset Backed Securities
During fiscal 2008, Legg Mason entered into six CSAs
with two liquidity funds to support investments in asset
backed securities issued by SIVs. Under the terms of
one of the CSAs, the Company agreed to provide up
to $15 million in contributions to the fund if the fund
recognized a loss from certain investments or continued
to hold the underlying securities at the expiration of the
one-year term of the agreement, and at the applicable
time, the fund’s net asset value was less than a specified
threshold. Under the terms of five of the CSAs, the
82
Company agreed to provide up to $400 million of con-
tributions to the fund if the fund recognized a loss on the
sale of, or certain other events relating to, securities issued
by two SIVs. Contributions made by the Company under
any of its CSAs will not result in Legg Mason acquiring
an ownership or other interest in the fund. During fiscal
2009, Legg Mason amended five of the CSAs entered into
in fiscal 2008 to increase the maximum contributions that
the Company would make thereunder by $525 million,
from $400 million to $925 million.
During fiscal 2009, Legg Mason also entered into seven
new CSAs, aggregating $395 million, with four liquid-
ity funds to support investments in asset backed securi-
ties issued by four SIVs. All but one of these CSAs were
amended during the year to provide up to $110 million
of additional support. Under the amended terms of six of
the CSAs and the original terms of one of the CSAs, the
Company agreed to provide up to the maximum contri-
bution amount to the funds if the funds recognized a loss
on the sale of, or certain other events relating to, securities
issued by the four SIVs.
Due to maturities of supported securities and the sale of
all securities issued by SIVs held by the liquidity funds
during fiscal 2009, all CSAs which supported asset backed
securities issued by SIVs were terminated in accordance
with their terms, no contributions were made thereunder,
and no derivative liability was reported as of March 31,
2009. At March 31, 2008, Legg Mason reported a deriva-
tive liability of $316.2 million related to CSAs.
Capital Support Agreements—Non-Asset
Backed Securities
During the year ended March 31, 2009, Legg Mason also
entered into four CSAs, aggregating $27 million, to sup-
port investments in non-asset backed securities held in
four liquidity funds. Two of these CSAs were amended
during the year to provide up to $15 million of additional
support. Under the amended terms of two of the CSAs
and the original terms of two of the CSAs, Legg Mason
agreed to provide up to the maximum contribution
amount to the funds if the funds recognize a loss from
investments in certain non-asset backed securities or con-
tinue to hold the underlying securities at the expiration
of the one-year terms of the agreements, and at the appli-
cable time, the funds net asset value is less than a specified
threshold. These four CSAs include a recovery clause in
which the funds are required to reimburse Legg Mason
for all contributions made upon the expiration of the CSA
to the extent that the funds subsequently receive payments
from the issuer of the underlying securities or upon the
sale or other disposition thereof that exceed the amortized
cost of the underlying securities. As of March 31, 2009,
Legg Mason reported a derivative liability of $20.6 mil-
lion related to these CSAs.
Total Return Swap
During fiscal year 2008, Legg Mason entered into a TRS
arrangement with a major bank (“the Bank”) pursuant to
which the Bank purchased securities issued by three SIVs
from a Dublin-domiciled liquidity fund managed by a sub-
sidiary of Legg Mason. The $890 million of securities in face
amount of commercial paper were purchased by the Bank
for cash at an aggregate amount of $832 million, which rep-
resented an estimate of value determined for collateral pur-
poses. In addition, Legg Mason reimbursed the fund for the
$59.5 million difference between the fund’s carrying value,
including accrued interest, and the amount paid. The securi-
ties had a market value of $886 million at March 31, 2008,
which after expected financing costs, exceeded the amount
paid by the Bank by $45.7 million. This difference was
accounted for as a derivative asset included in Other current
assets on the Consolidated Balance Sheet as of March 31,
2008, and represented the amount Legg Mason expected to
recover from the Bank upon maturity or sale of the underly-
ing securities. Under the TRS, Legg Mason agreed to pay
to the Bank any losses (including losses incurred through a
sale of the securities or through principal not being repaid
at maturity) the Bank incurs from its ownership of the
securities and a return on the purchase price paid for the
securities equal to the one-month LIBOR rate plus 1%, and
the Bank agreed to pay to Legg Mason any principal and
interest it received on the securities in excess of the price it
paid for the securities. During fiscal year 2009, $440 mil-
lion of securities supported by the TRS matured and were
paid in full and $95 million in principal amount of securi-
ties supported by the TRS was paid. The TRS arrangement
terminated in November 2008. Legg Mason amended the
TRS to extend its expiration to November 2009 and, due
to maturities of, and principal payments on, the underlying
securities, decrease the total amount of securities covered
by the TRS from $890 million to $355 million. The TRS
was terminated in fiscal 2009 upon the sale of the underly-
ing securities.
Non-Bank Sponsored SIV
During fiscal 2008, Legg Mason purchased for cash an
aggregate of $132 million in principal amount of non-
bank sponsored SIV securities from a liquidity fund.
83
During January 2008 and May 2008, approximately
$50 million and $82 million, respectively, in principal
amount of the securities matured and were paid in full.
Canadian Conduit Securities
During fiscal 2008, Legg Mason acquired for cash an aggre-
gate of $98 million in principal amount of conduit securities
issued by Canadian asset backed commercial paper issuers
from a fund managed by a Legg Mason subsidiary. These
securities were sold in fiscal 2009, as described below.
During fiscal 2009, Legg Mason purchased for $2.9 bil-
lion in cash, including $24 million of accrued interest,
$3.0 billion in principal amount of non-bank sponsored
SIV securities from six liquidity funds that were previously
supported under twelve CSAs and seven LOCs. Upon the
purchase of these securities, the twelve CSAs aggregating
$1.4 billion and seven LOCs aggregating $742 million
were terminated in accordance with their terms. The
Company subsequently sold the $3.0 billion of purchased
securities along with $355 million of securities previously
supported by the TRS and the $76 million of Canadian
conduit securities held on its balance sheet, to third parties
for $655 million, excluding transaction costs. Legg Mason
also paid $181.2 million to reimburse two funds for a por-
tion of losses they incurred in selling unsupported SIV
securities. As a result of the sale and reimbursement to the
funds, which completely eliminated the Company’s expo-
sure to securities issued by SIVs, the Company incurred a
realized loss of $2.3 billion ($1.4 billion, net of taxes and
operating expense adjustments) in fiscal 2009.
18. BUSINESS SEGMENT INFORMATION
Legg Mason is a global asset management company that
provides investment management and related services
to a wide array of clients. We operate in one reportable
business segment, Asset Management. Asset Management
provides investment advisory services to institutional
and individual clients and to company sponsored invest-
ment funds. The primary sources of revenue in Asset
Management are investment advisory, distribution and
administrative fees, which typically are calculated as a
percentage of the AUM and vary based upon factors such
as the type of underlying investment product and the type
of services that are provided. In addition, performance
fees may be earned on certain investment advisory con-
tracts for exceeding performance benchmarks.
In connection with changes to our executive management
during fiscal 2009 and a desire to expand multi-channel
distribution capabilities and to better align our resources
to access new growth opportunities, we realigned our
management responsibilities. As a result, we have replaced
our three former operating segments (divisions), Managed
Investments, Institutional and Wealth Management,
which were based on the primary products offered and cli-
ents served of our asset managers, with two new divisions,
Americas and International, which are primarily based
on the geographic location of the advisor or the domi-
cile of fund families we manage. The Americas Division
consists of our U.S.-domiciled fund families, the separate
account businesses of our U.S.-based investment affiliates
and the domestic distribution organization. Similarly, the
International Division consists of our fund complexes,
distribution teams and investment affiliates located outside
the U.S., primarily in the United Kingdom. We believe
this structure will provide greater focus and allow us to
maximize distribution efforts and more efficiently take
advantage of growth opportunities locally and abroad.
Presentation of all previously reported amounts have been
conformed to the new management structure.
The table below reflects our revenues and long-lived assets by geographic region (in thousands) as of March 31, 2009:
OPERATING REVENUES
United States
United Kingdom
Other International
Total
INTANGIBLE ASSETS, NET AND GOODWILL
United States
United Kingdom
Other International
Total
84
2009
2008
2007
$2,290,474
747,257
319,636
$3,357,367
$3,606,678
1,052,007
450,863
$5,109,548
$3,217,182
972,419
444,485
$4,634,086
$4,816,712
1,255,816
574,023
$6,646,551
$3,169,370
765,811
408,494
$4,343,675
$5,045,791
1,181,976
630,482
$6,858,249
quARTERLy FINANCIAL DATA
(Dollars in thousands, except per share amounts)
(Unaudited)
Fiscal 2009(1)
Operating Revenues
Operating Expenses(2)
Operating Income (Loss)
Other Income (Expense)(3)
Income (Loss) from Operations before Income Tax
Benefit and Minority Interests
Income tax benefit
Income (Loss) from Operations before Minority Interests
Minority interests, net of tax
Net Income (Loss)
Net Income (Loss) per Share:
Basic
Diluted
Cash dividend per share
Stock price range:
High
Low
Assets Under Management:
End of period
Average
Quarter Ended
Mar. 31
$ 617,211
662,546
(45,335)
(637,820)
Dec. 31
$ 719,988
1,792,993
(1,073,005)
(1,189,917)
Sept. 30
$ 966,137
745,924
220,213
(380,031)
Jun. 30
$1,054,031
825,084
228,947
(278,909)
(683,155)
(361,354)
(321,801)
(3,280)
(159,818)
(55,813)
(104,005)
254
$(325,081) $(1,487,823) $(103,751)
(2,262,922)
(774,951)
(1,487,971)
148
$
(2.29) $
(2.29)
0.24
(10.55) $
(10.55)
0.24
(0.74)
(0.74)
0.24
25.53
10.37
38.74
11.09
47.82
26.56
$
$
(49,962)
(18,735)
(31,227)
(46)
(31,273)
(0.22)
(0.22)
0.24
65.50
43.37
$ 632,404
657,430
$ 698,241
745,084
$ 841,933
898,390
$ 922,767
948,529
(1) Due to rounding of quarterly results, total amounts for each fiscal year may differ immaterially from the annual results.
(2) The quarters ending March 31, 2009 and December 31, 2008 include $82,870 and $1,225,100, respectively, of impairment charge related to intangibles assets.
(3) The quarters ending March 31, 2009, December 31, 2008, September 30, 2008, and June 30, 2008 include $606,426, $1,085,296, $324,639 and $266,875, respectively,
of charges resulting from providing support to liquidity funds.
As of May 20, 2009, the closing price of Legg Mason’s common stock was $18.78.
Fiscal 2008(1)
Operating Revenues
Operating Expenses(2)
Operating Income
Other Income (Expense)(3)
Income from Operations before Income Tax
Provision (Benefit) and Minority Interests
Income tax provision (benefit)
Income from Operations before Minority Interests
Minority interests, net of tax
Net Income (Loss)
Net Income per Share:
Basic
Diluted
Cash dividend per share
Stock price range:
High
Low
Assets Under Management:
End of period
Average
Quarter Ended
Mar. 31
$1,069,123
931,519
137,604
(530,492)
Dec. 31
$1,186,644
844,653
341,991
(94,999)
Sept. 30
$1,172,351
893,933
278,418
5,779
Jun. 30
$1,205,968
913,805
292,163
13,407
(392,888)
(137,488)
(255,400)
(51)
$ (255,451)
246,992
92,319
154,673
(91)
$ 154,582
284,197
106,574
177,623
(159)
$ 177,464
305,570
114,590
190,980
35
$ 191,015
$
$
(1.81)
(1.81)
0.24
75.32
51.51
1.09
1.07
0.24
88.20
68.35
$
$
1.25
1.23
0.24
1.34
1.32
0.24
103.09
76.80
106.36
92.82
$ 950,122
975,317
$ 998,476
1,013,644
$1,011,628
994,695
$ 992,419
984,931
(1) Due to rounding of quarterly results, total amounts for each fiscal year may differ immaterially from the annual results.
(2) The quarter ending March 31, 2008 includes a $151,000 impairment charge related to acquired asset management contracts.
(3) The quarters ending March 31, 2008 and December 31, 2007 include $516,193 and $91,083, respectively, of charges resulting from providing support to liquidity funds.
85
ExECuTIVE oFFICERS
Mark R. Fetting
Chairman, President and
Chief Executive Officer
Charles J. Daley, Jr.
Senior Vice President, Chief
Financial Officer and Treasurer
CoRpo RATE DATA
Executive Offices(1)
100 Light Street
Baltimore, Maryland 21202
(410) 539-0000
www.leggmason.com
(1) After July 31, 2009, the Company’s
address will be 100 International Drive,
Baltimore, Maryland 21202.
SEC Certifications
The certifications by the Chief
Executive Officer and the Chief
Financial Officer of Legg Mason,
Inc., required under Section 302 of
the Sarbanes-Oxley Act of 2002,
have been filed as exhibits to Legg
Mason’s Annual Report on Form
10-K for fiscal 2009.
Ronald R. Dewhurst
Senior Executive Vice President
Jeffrey A. Nattans
Senior Vice President
David R. Odenath
Senior Executive Vice President
Joseph A. Sullivan
Senior Executive Vice President
NYSE Certification
In 2008, the Chief Executive Officer
of Legg Mason, Inc. submitted an
unqualified annual certification to
the NYSE regarding the Company’s
compliance with the NYSE corporate
governance listing standards.
Form 10-K
Legg Mason’s Annual Report on
Form 10-K for fiscal 2009, filed
with the Securities and Exchange
Commission and containing audited
financial statements, is available upon
request without charge by writing
to the Corporate Secretary at the
Executive Offices of the Company.
Copies can also be obtained by accessing
our website at www.leggmason.com
Independent Registered
Public Accounting Firm
PricewaterhouseCoopers LLP
100 E. Pratt Street
Baltimore, Maryland 21202
(410) 783-7600
www.pwc.com
Transfer Agent
American Stock Transfer &
Trust Company
59 Maiden Lane
New York, New York 10038
(866) 668-6550
www.amstock.com
Common Stock
Shares of Legg Mason, Inc. common
stock are listed and traded on the New
York Stock Exchange (symbol: LM).
As of March 31, 2009, there were 1,785
shareholders of record of the Company’s
common stock.
ToTAL R ETuRN pERF oRMANCE
The graph below compares the cumulative total stockholder return on Legg Mason’s common stock for the last five fiscal
years with the cumulative total return of the S&P 500 Stock Index and the SNL Asset Manager Index over the same period
(assuming the investment of $100 in each on March 31, 2004). The SNL Asset Manager Index consists of 34 asset
management firms.
250
200
e
u
l
a
V
x
e
d
n
I
150
100
50
0
Legg Mason, Inc.
S&p 500 Stock Index
SNL Asset Manager Index
p E R I o D E N D I N g
Index
03/31/04 03/31/05 03/31/06 03/31/07 03/31/08 03/31/09
Legg Mason, Inc.
100.00 127.40
205.63 155.85
93.75
27.80
S&p 500 Stock Index
100.00 106.69
119.20 133.31 126.54
78.34
SNL Asset Manager Index
100.00 116.74
164.38 184.31 165.52
87.98
Source: SNL Financial LC, Charlottesville, VA
Source: S&P 500 Stock Index return rates obtained from www.standardandpoors.com
03/31/04
03/31/05
03/31/06
03/31/07
03/31/08
03/31/09
86
Our commitment
to the global community
Legg Mason believes that we have a duty to act
responsibly and take pride in the world we live in.
We believe that by investing in our communities,
we invest in our futures. Through the sponsorship
of employee volunteerism efforts and Legg Mason
Charitable Foundation’s philanthropic giving, we
support community initiatives by investing time
and money in areas that promote community
well-being—from improving education, reducing
poverty, providing food and shelter, encouraging
diversity and the arts, to advancing sustainability
and more. Our corporate citizenship efforts touch
all types of causes and reach locales both inside
the United States and abroad. More than ever, we
are committed to serving our global communities.
Follow legg Mason news and events at leggmason.com