Legg Mason Inc.
Annual Report 2013

Plain-text annual report

Forward 2013 Annual Report together “ We can’t change the direction of the wind, but we can adjust the sails.” — I n d I a n P r o v e r b Western Asset Management is one of the world’s leading fixed income managers. With a focus on long-term fun- damental value investing, the firm has nine offices around the globe and deep experience across the range of fixed income sectors. Founded in 1971, Western Asset’s approach emphasizes team man- agement, intensive proprietary research and robust risk management. For more than 40 years, Royce & Associates has utilized a disciplined, value-oriented approach in managing smaller- company portfolios. Known primarily through its family of mutual funds, The Royce Funds, Royce is committed to the same investment principles that have served it well since 1972. ClearBridge Investments is a well-established global equity manager focusing on proprietary research and fundamen- tal investing. With over 45 years of experience building portfolios for clients seeking income solutions, high active share or managed volatil- ity, long-tenured portfolio managers provide strong leadership in a centralized investment structure. Permal Group is a pioneer in multi-manager, multi- strategy alternative investing. Established in 1973, the firm has offices in 10 international financial centers and extensive networks of experienced managers and relationships around the globe. Permal is rec- ognized for investments in new and established hedge fund managers across strategies, asset classes and regions. Founded in 1986, Brandywine Global is committed to pur- suing value investing in equity and fixed income markets, in the U.S. and around the globe. Historically an institutionally- focused firm, with offices in the U.S., Europe and Asia, Brandywine Global combines the agility of a boutique asset manager with the stability and resources of an industry leader. Batterymarch Financial Management is a global quantitative equity spe- cialist whose core and solutions-based strat- egies are characterized by rigorous bottom-up stock selection, inte- grated risk control and cost-efficient trading. Batterymarch is known for pioneering the use of fundamentally- based, quantitative techniques and its early entrance into interna- tional and emerging market investing. Legg Mason Global Equities Group is a collection of three spe- cialty firms dedicated to the global equities asset class, including Esemplia Emerging Markets, Legg Mason Australian Equities and Legg Mason Poland. As with all of our manag- ers, each affiliate oper- ates with investment autonomy pursuing its own unique investment style and process. Legg Mason Investment Counsel provides highly tailored investment and trust strategies for affluent individuals, families and institutions through an iterative and collaborative approach with its clients. In addi- tion to its core invest- ment capabilities, the firm has specializations in socially responsive investing, philan- thropy and trust and family office services. Legg Mason Global Asset Allocation draws on global expertise and deep intellec- tual curiosity to build innovative portfolios of diversified assets aimed at achieving a variety of investment goals. The firm offers a broad range of asset allocation capabilities to meet the needs of institutional and retail investors, combining asset allocation exper- tise with dynamic risk management solutions. As a global asset management firm with over $664 billion in managed assets, Legg Mason unites some of the industry’s leading investment managers under a single banner. Our diverse family of specialized managers is dedicated to creat- ing sustainable value for their clients through active strategies, unique investment processes and an independent approach to research and analysis. Our managers leverage the Legg Mason-led retail global distribu- tion network to further deliver their investment solutions across geographies and channels, guided by client priorities. San Francisco Pasadena Montreal Boston Stamford New York Philadelphia Wilmington Baltimore Toronto Cincinnati Naples Miami Nassau São Paulo Santiago London Luxembourg Paris Frankfurt Geneva Milan Madrid Warsaw Tokyo Shanghai Dubai Hong Kong Taipei Investment Centers (17) Distribution Locations (23) Singapore Melbourne Investment Driven Client CenteredJoseph A. Sullivan, President and Chief Executive Officer Letter from Joseph A. Sullivan, President and Chief Executive Officer Dear Fellow Shareholders I am honored to be writing to you for the first time since being elected Legg Mason’s new President and CEO this past February and am grateful for the trust and confidence that our Board and you have placed in me. I am very proud to be leading a firm with a long and rich history and a future filled with opportunity. At Legg Mason, our goal is straightforward: we strive to be the best asset management firm in the world...for our clients, our shareholders and our employees...and in that order. By focusing first on clients, we will deliver investment performance that builds the loyalty of current clients and attracts new ones. In turn, the oper- ating performance that results will reward our shareholders appropriately. In so doing, we will continue to make Legg Mason a firm of great opportunity for our employees and of which we can be justifiably proud. As a company, we have chosen and are committed to active investment management through an independent, multi-affiliate model combined with world-class distribution. This model, well executed, is a unique value propo- sition for shareholders and will differentiate us favorably in the marketplace. We are a firm with demonstrated ability to manage assets, robust global distribution and the scale, diversity and determination to succeed. 1Legg MasonThe Board’s Perspective The past year has seen the culmination of Achieving this success going forward is wholly dependent a process of reassessment, restructure and on combining the many competitive strengths of our model renewal for Legg Mason. to deliver, together, the results that clients and sharehold- ers expect. We are never better as a company than when Given the challenges of the post financial crisis we come together to perform for our clients and it is that environment, reassessment of the fundamen- focus—moving forward, together, in serving our clients— tal beliefs that support our business model that will drive Legg Mason to realize its potential and distin- was required. Our conclusion—the unique guish the company among many in an increasingly competi- combination of investment focus and product tive marketplace. flexibility provided by our multi-affiliate busi- ness model, when combined with our global In this letter, I will highlight the company’s results for the distribution capability, presents significant 2013 fiscal year, discuss our ongoing operating priorities, opportunities for our clients and our sharehold- review our progress against those priorities and look ahead ers that distinguish Legg Mason in the asset to the future of Legg Mason, a future I’m confident you will management industry. agree is bright. However, the financial markets and investor Our clients look to us for insight and ideas to address their requirements and expectations have changed need for both the security and growth of their investment significantly from the pre-crisis era. These portfolios in this low rate, low growth economic environment changes require a leaner organization and more and beyond. This opportunity to serve and perform for our focused and strategic leadership. Our man- clients is also a responsibility that we take very seriously. agement processes have been restructured to And we recognize that we must earn this opportunity, this improve their effectiveness and efficiency, and privilege, daily. we have a new leadership team under CEO Joe Sullivan. Fiscal Year Highlights Our fiscal year results showed important signs of improve- Your Board and the management team have ment and progress and while we are encouraged, we know reaffirmed the fundamental principles that have served Legg Mason clients and share- holders well in the past. As your represen- that we must and can perform still better. We finished our fiscal year with the lowest level of quarterly tatives, we are committed to renewing the long-term outflows in over five years and our global retail growth of our business and creating value for distribution group achieved its best fiscal year of net flows our shareholders. W. Allen Reed Chairman of the Board since 2007. Our investment performance continues to be strong, with at least 80% of our strategy AUM, excluding liquidity assets, beating their respective benchmarks for the 1-, 3-, 5- and 10-year periods ended March 31, 2013. And, our strong cash generation enabled us to deleverage our balance sheet by $350 million, repurchase 16.2 million shares of Legg Mason stock and increase dividends by 38%, returning over $480 million to shareholders during the fiscal year, while finishing the year with a cash position of over $930 million. 2Legg MasonOur Operating Priorities and Progress As we move forward, we are focused on four operating pri- First, offering products that meet the needs of investors: we must continually review and evolve our product orities that we believe will best serve our clients and share- lineup to meet the requirements and preferences of holders and will most competitively position our franchise our clients. for growth: Products, Investment Performance, Distribution and Productivity. We commissioned a Global Income Survey to gain a deeper understanding of the income needs and preferences of global Our performance this past fiscal year, in the context of these retail investors. This survey yielded a number of interesting priorities, is highlighted as follows: insights, including the fact that these investors are more Financial Highlights (dollars in thousands, except per share amounts) Years Ended March 31, OPERATING RESULTS Operating revenues Operating income (loss) Income (loss) from continuing operations before income tax provision (benefit) Net income (loss) attributable to Legg Mason, Inc.(1) Adjusted income (loss)(2) PER COMMON SHARE Net income (loss), diluted(1) Adjusted income (loss)(2) Dividends declared Book Value FINANCIAL CONDITION Total assets Total stockholders’ equity 2013 2012 2011 2010 2009 $2,612,650 $2,662,574 $2,784,317 $2,634,879 $ 3,357,367 (434,499) (510,607) (353,327) 347,169 338,753 303,083 220,817 397,030 386,808 365,197 253,923 439,248 321,183 329,656 204,357 381,258 (669,180) (3,188,197) (1,967,918) (1,191,389) $ (2.65) $ 1.54 $ 1.63 $ 1.32 $ (13.99) 2.61 0.44 38.44 2.77 0.32 40.59 2.83 0.20 38.41 2.45 0.12 35.94 (8.47) 0.96 31.87 $7,269,660 $8,555,747 $8,707,756 $8,622,632 $ 9,232,299 4,818,351 5,677,291 5,770,384 5,841,724 4,598,625 (1) Fiscal 2013 includes non-cash impairment charges related to intangible assets, net of income tax benefits, of $508,252 or $3.81 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. (2) Adjusted income (loss) 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. 3Legg Masonwilling than ever before to consider global and equity income solutions to meet their income needs. This past year, we launched over 20 new products that raised over $2.6 billion in assets under management as of fiscal year end, and we continue to invest seed capital and other resources to develop and bring additional innovative products to market. Examples of firm-wide product launches this year include a CLO product and mortgage REIT at Western Asset, income-related products and an energy MLP managed by ClearBridge Investments, global and sovereign fixed income products within Brandywine Global and a Permal multi-strat- egy fund of hedge funds product. Our recently completed acquisition of Fauchier Partners with Permal is another exam- ple of how we intend to seek new sources of product, asset diversification and revenue growth. Fauchier is a leading European-based manager in the fund of hedge funds space, with an institutionally focused European and Asian Pacific client base and expertise in equity hedged and event driven strategies, all of which are highly complementary to Permal’s capabilities. Combined, in a transaction we expect to be accretive in the first year, Permal and Fauchier further expand our product suite and client base as one of the largest fund of hedge funds manag- ers in the world. Second, delivering compelling investment performance: we must consistently deliver for our clients perfor- mance that differentiates itself in an increasingly competitive marketplace. For the critical three-year time period ending March 31, 2013, 81% of strategy AUM, excluding liquidity, including all of Legg Mason’s investment affiliates beat their respective benchmarks. Additionally, the percentage of our strategy AUM, excluding liquidity, beating benchmark was 80% for the 1-year, 84% for the 5-year and 87% for the 10-year periods ending March 31, 2013. Legg Mason Global Income Survey With many investors rethinking their approach to income and asset diver- sification, we conducted a special research study of affluent investors in 13 countries for our Global Income Survey: Bridging the gap in income investing. To read about our key find- ings, visit http://www.leggmason.com/ globalthoughtleadership 4Legg MasonWestern Asset, our largest affiliate, Permal and Brandywine increasing asset retention. These efforts contributed to the Global continued to deliver strong investment results and group’s best year of net flows in over five years with gross were recognized for their strong performance track records: sales increasing by 15% to $57 billion during fiscal year 2013 and strong improvement in the group’s net contribution to • Western Asset was named manager of the year in the Legg Mason’s earnings. fixed income core category by Institutional Investor; Importantly, net flows increased year over year in nine out • a Permal diversified multi-manager fund was named the of the ten sales channels in which we offer products in the best performing specialist fund of hedge funds over ten United States and five out of the six regions in which we years by Hedge Fund Review; and operate outside of the United States. We continue to believe that, while significant opportunities for improvement remain, • Brandywine Global received accolades from Institutional our distribution platform...through its broad global footprint... Investor and Morningstar for their global fixed income represents a unique competitive strength for Legg Mason. performance. ClearBridge Investments, our largest equity affiliate, also ating productivity: quite simply, operating effectiveness delivered strong performance, resulting in their best net flow and efficiency are competitive imperatives in our indus- performance since 2005. try and for Legg Mason. And fourth, managing our business with a focus on oper- We remain focused with our affiliates on improving upon A significant component of our ability to deliver shareholder areas of investment underperformance and importantly, we value is a disciplined and ongoing focus on expenses and are working aggressively to bring those products with strong efficiency, which this past year included the consolidation of investment performance to a broader set of clients. certain corporate functions and real estate that will result in a long-term benefit to our shareholders. We have also com- Third, distributing our products effectively across menced a bottom-up review of ways that we can further lever- channels and geographies: the standard for our institu- age our operating functions to continue to reallocate resources tional and retail distribution teams is nothing short of toward our critical priorities, including product innovation, world class. enhanced client service and an expanded global footprint. Our distribution and client service philosophy for both institu- tional and retail clients begins and ends with the needs and preferences of our clients. Our investment affiliates serve Capital Deployment and Investing for Future Growth We are pleased that our capital strength and consistent institutional clients, who prefer direct coverage and access cash generation enabled us to reduce shares outstanding by to our portfolio teams, and have worked hard to enhance 12% and raise dividends by 38%, returning over $480 mil- their capabilities and global reach, through investments and lion to our shareholders since our prior fiscal year ended improvements in technology and infrastructure. March 31, 2012. Our centralized global retail distribution group, which col- Since 2010, we have reduced shares outstanding by 23% laborates with our affiliates to serve retail client advisors, and returned $1.4 billion to shareholders in the form of has refocused its strategy to place greater emphasis on repurchases and dividends. In May of 2012, we further improving sales productivity, expanding market share and enhanced our financial flexibility by refinancing $1.25 billion 5Legg Masonof convertible senior notes due in 2015 with longer maturity We must add investment capabilities where we have product debt, reducing outstanding debt by $350 million. gaps, improve our revenue diversification and flows and Importantly, our cash position, which totaled over $930 mil- focus on European equities and alternative investments. lion at the end of our fiscal year, provides resources to buffer market volatility, while also capturing opportunities to expand While we’re committed to our core business model, it can be broaden our capabilities outside the United States, with a and strengthen our business. Looking Ahead The past several years have been a difficult period for Legg improved. We are in discussions with our affiliates to create affil- iate equity plans to help attract and retain investment talent and better align the long-term interests of our affiliates with those of our shareholders. We recently initiated just such a plan with Mason. In responding to the multiple challenges we have Permal and we expect additional affiliate equity plans to follow. faced, we have taken deliberate and aggressive actions to reduce our cost structure, divest and/or combine some of our We are focused on strengthening our global retail distribution smaller investment affiliates and modify leadership throughout capability through greater affiliate collaboration and by invest- the company, including at the highest levels. ing in more client-facing professionals and increased support As a result, Legg Mason’s competitive position is strong and areas of growing demand, such as income-oriented product we are now poised for growth. solutions, alternatives and specialized fixed income products, for them. We seek to further develop targeted solutions in consistent with the appetite of retail investors globally. We have a unique combination of independent investment affiliates and a robust global distribution platform to lever- During the past several years, our focused business model, age our affiliate investment capabilities. Our independent, disciplined investment processes and global scale have helped multi-affiliate model supports investment autonomy, promotes us maintain our fundamental strength as a firm. But moving creativity and innovation and, we believe, should lead to supe- ahead, to effectively compete, our focus must be on gaining rior long-term investment performance over time. Our firm market share and diversifying our revenue stream to provide is diversified by asset class and investment style, geography consistent earnings, sustaining and improving our investment and client type. We operate globally in 31 cities with over performance to increase flows, and maintaining an efficient 435 investment professionals and more than 500 members cost structure to drive greater profitability. of our global distribution team located throughout the world. We have a strong foundation for success...and now, we must deliver on the opportunities before us. Appreciation and Closing Before closing, I would like to acknowledge with sincere grati- tude the significant contributions made by Denny Beresford and Change is constant and accelerating within our industry...and Nick St. George, both of whom will be retiring from our Board we embrace it. In fact, we view this change as an opportunity of Directors this year, after a combined 41 years of service to to further distinguish ourselves for current and future clients our shareholders. We join all of our shareholders in thanking by anticipating, adapting and responding to business and mar- Denny and Nick for their guidance, leadership and dedication to ket opportunities as they unfold. our firm and wish them both continued future success. 6Legg MasonOver the past year, we have taken thoughtful and meaningful steps to improve Legg Mason for long-term success but more work remains. As we think about the future, we are both excited and optimis- tic about what lies ahead. We know that the markets will be challenging and that the industry will continue to change and evolve. We also know that the challenges before our clients are significant and it is our primary goal to listen to them, understand their needs and work to develop solutions that meet their financial hopes and objectives. I am very proud of our many talented and highly professional employees who have been so unwavering in their dedication to our clients during this past year of transition. We now enter a new year of challenge and opportunity, better positioned, with new momentum and a clear commitment to growth. We are very grateful for your continued trust and confidence, as we work tirelessly to deliver performance for clients and results for shareholders and move Legg Mason forward, together! Joseph A. Sullivan President and Chief Executive Officer “ At Legg Mason, our goal is straightforward: we strive to be the best asset management firm in the world...for our clients, our shareholders and our employees...and in that order.” Executive Committee Legg Mason’s Executive Committee is com- posed of (left to right) Pete Nachtwey, Chief Financial Officer; Terry Johnson, Head of Global Distribution; Joe Sullivan, Chief Executive Officer; Jennifer Murphy, Chief Administrative Officer; and Tom Merchant, General Counsel. 7U.S. Investment Management Awards Western Asset Management Western Asset was named manager of the year in the fixed income core category by Institutional Investor, which recognizes managers who “stood out in the eyes of the investor community for their exceptional performance, risk management and service.” “ Our mission…To remain a leader in diversified fixed income investment management with integrated global operations, exercising uncompromising standards of excellence and ethics in all aspects of our business.” Established in 1971, Western Asset is one of the world’s largest and leading managers of fixed income investments, with nearly $460 billion of assets under management. With a combined staff of 867 employees, Western Asset offers a broad range of fixed income investment services representing a global array of currencies, investment strategies and mar- kets. Western Asset has 133 products, managed globally, in 17 currencies. Clients domiciled outside of the United States represented 27% of Western Asset’s total assets under man- agement at year-end. Over the past 15 years, under the leadership of CEO Jim Hirschmann, Western Asset has successfully executed its strategic plan that has guided the company for many years and remains the model for growth today: • Deliver superior risk adjusted investment performance results versus benchmark and peers; • Continue to reinvest and allocate resources to develop and attract top talent and to support increasingly complex customized solutions; • Strive to achieve industry best practices across all areas of the firm; • Continue to provide virtually any fixed income solution in any currency; and, • Continue to expand and develop globally while preserving its culture of teamwork. 8Legg MasonLocated in New York City and founded by President and Co-Chief Investment Officer, Chuck Royce, the company uses a bottom-up value approach, primarily seeking companies with strong balance sheets and above-average returns on invested capital that are trading at substantial discounts to their intrinsic value. Royce manages approximately $37 billion of assets through open-end mutual funds, variable annuity funds and closed-end funds, as well as institutional accounts and limited partnerships. Wealth of Experience: Royce & Associates is committed to the same investment principles that have served it well for 40 years. Chuck Royce enjoys one of the longest tenures of any active mutual fund manager. Royce’s investment staff also includes Co-Chief Investment Officer W. Whitney George, 18 portfolio managers, five assistant portfolio managers and analysts, and nine traders. Multiple Funds, Common Focus: Royce’s goal is to offer both individual and institutional investors the best available micro-cap, small-cap and mid-cap portfolios. They have cho- sen to concentrate on smaller-company investing by providing investors with a range of funds that take full advantage of this large and diverse sector. Consistent Discipline: Royce’s approach emphasizes paying close attention to risk and maintaining the same discipline, regardless of market movements and trends. The price they pay for a security must be significantly below their appraisal This year, Royce & Associates, our small-cap manager, celebrated the 40th anniversary of its flagship portfolio Royce Pennsylvania Mutual Fund. Manager Chuck Royce has successfully navigated the many changes in the small-cap marketplace by adhering to a disciplined, value-oriented approach. Total Invested Assets by Geography U.S. Equity—83% Rest of the World Equity—9% of its current worth. This requires a thorough analysis of the European Equity—3% financial and business dynamics of an enterprise, as though Cash—5% they were purchasing the entire company. Co-Ownership of Funds: It is important that Royce’s employees and shareholders share a common financial goal. The officers, employees and their families currently have approximately $160 million invested in The Royce Funds and are often among the largest individual shareholders. 9Legg MasonClearBridge Investments is an active global equity manager with more than $65 billion in assets under management. With a legacy dating back over 45 years, ClearBridge’s long-tenured portfolio managers and fundamental research team focus on building equity portfolios for clients that target three primary investment objectives: income solutions, high active share and managed volatility. At ClearBridge Investments, all equity strategies start with the same fundamental principle: the key to long-term success is selecting high-quality companies through rigorous fundamen- tal research and analysis. Driven by the insight and expertise of portfolio managers and analysts, ClearBridge’s time-tested investment process has guided the firm throughout its history. Strengthened by advanced trading and risk management sys- tems, ClearBridge’s disciplined, methodical approach is designed to achieve consistent top-tier performance over the long term. ClearBridge operates with investment independence from its headquarters in New York and offices in San Francisco and Wilmington. The firm has 177 employees, including 28 portfolio managers, 25 research analysts and 9 traders. ClearBridge port- folio managers are among the most seasoned in the industry, having an average of 25 years of investment experience and 19 years at the firm. ClearBridge Investments and Legg Mason Japan collaborated earlier this year to promote the launch of the LM U.S. High Dividend Equity Fund. A confer- ence was held in Tokyo for over 200 distributors and included a presentation on the U.S. energy MLP marketplace by ClearBridge. Assets by Product Type High Active Share—43% Managed Volatility—32% Income Solutions—25% 10Legg MasonWith 40 years of experience and long track records across invest- ment strategies and markets, Permal Group is a leading global alternative asset manager offering investment solutions through established funds and more customized investment portfolios. Permal has developed extensive networks of experienced managers and relationships around the globe, and today there is a global investment team based in New York and London, with investment hubs in Singapore and Paris. There are additional offices in Dubai, Hong Kong, Nassau, Paris, Tokyo and Shanghai. Permal’s clients include sovereign wealth funds, pension funds, endowments, foundations, insurance companies, family offices, private banks and high net worth individuals. Alongside its long-term performance track record, Permal is widely regarded for its capabilities in fundamental analysis and highly sophisticated analytic and risk management tools, as well as its ability to structure and manage highly diversified portfolios of specialized managers. A core element of Permal’s invest- ment offering is its leading buyside managed account platform (Permal MAP), consisting of pari passu and product engineered vehicles, covering a wide variety of investment strategies and offering investors greater flexibility, control, transparency and often lower costs. Multi-Manager Funds’ Assets by Strategy Global Macro—33% Fixed Income—20% Global Long/Short—18% Event Driven—18% Equity Long—2% Relative Value Arbitrage—2% Natural Resources—2% Cash/Other—5% A Permal diversified multi-manager fund was named the best specialist fund of hedge funds over 10 years by Hedge Fund Review, which recognizes funds that “delivered out- standing risk-adjusted returns across a variety of individual strategies.” 11Legg MasonBrandywine Global won a 2013 Morningstar Hong Kong Fund Award in the Global Bond Category. The awards recognize “retail funds that added the most value for investors within the context of their relevant peer group in 2012 and over the longer term.” Since its founding in 1986, Brandywine Global has pursued a singular investment approach—value investing. Its assets under management today include an array of fixed income, equity and multi-asset class portfolios that invest in U.S., international, and global markets on behalf of over 400 institutional clients. With over $46 billion in assets under management, Brandywine Global’s growth has been fueled primarily by an increasing pres- ence in international markets, with 43% of assets managed on behalf of non-U.S. domiciled clients. Its institutional client base includes public funds, corporations, educational institutions, Taft-Hartley plans and health care organizations. Brandywine Global has 183 employees, including 44 invest- ment professionals, located in Philadelphia, San Francisco, London and Singapore. Brandywine Global works consistently to strengthen its funda- mental and quantitative research capabilities and broaden their application to new securities and new markets. The company’s mission is to deliver superior investment solutions and perfor- mance by listening to its clients; hiring, supporting and retaining the industry’s best people; encouraging independent thinking by sponsoring an open marketplace for ideas; promoting a cul- ture of integrity and partnership; and finding value, throughout the world, that others have not yet recognized. In May 2013, Brandywine Global hosted a conference for over 100 clients and consul- tants with the theme: Where Some See Risk, Others See Opportunity. Francis Scotland, director of global macro research, discussed market trends and the global eco- nomic climate. Assets by Strategy Fixed Income—79% Diversified Equity—9% Large Cap Equity—9% Small/Mid Cap Equity—3% 12Legg Mason“ Batterymarch’s mission is to provide consistent long-term value by exceeding client expectations in both performance and service. We are committed to fostering a culture that rewards creative, collaborative thinking and leverages new technology to maximize the effectiveness of our entire organization.” 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 Boston-based firm utilizes an adaptive, bottom-up process that combines the wisdom and experience of fundamental investors with the power and efficiency of quantitative tools. As a global equity manager of both institutional separate accounts and subadvised funds, Batterymarch invests in approximately 50 countries, with products that span the full range of equity asset classes. The company customizes its investment strategies to capture the intricacies of individual regions, countries and sectors and to provide investment solu- tions to address client identified concerns. All of Batterymarch’s investment strategies are collaborative and team driven, and incorporate rigorous stock selection, effective risk control and cost-efficient trading. Batterymarch has 84 employees, including 25 investment professionals. Its clients represent a broad spectrum of investors, including corporate pension plans, public funds, foundations and endowments, Taft-Hartley plans, investment companies and sovereign wealth funds. More than half of Batterymarch’s over $12 billion in assets under management represent global, international or emerging markets accounts, and 31% is man- aged for clients domiciled outside the United States. A Range of Products to Meet Client Objectives Core • Global • International • US Large Cap Higher Alpha Solutions-Based • Global Unconstrained • Global TAA • International Small Cap • Global Market Neutral • US Small Cap • Global Yield Hunter • US Large Cap Enhanced Index • Global Emerging Markets • Managed Volatility • US MidCap • Canada • GEM Smaller Companies • Inflation Sensitive • Asia ex-Japan • ESG • Asia ex-Japan Absolute Return 13Legg MasonThe Legg Mason Global Equities Group is a collection of reflective of the diversity of its people, a number of whom three specialty firms dedicated to the global equities asset were either born and/or have lived and worked in the emerg- class. As with all our managers, each affiliate operates with ing markets for a considerable period of their lives. investment autonomy, pursuing its own unique investment philosophy and process. Legg Mason Australian Equities is a specialist Australian equities fund manager with an extensive range of investment Esemplia Emerging Markets is a dedicated global emerging strategies, including core, value, property securities, small markets asset management firm. It has a core active funda- companies, equity and real income, tactical asset allocation mental-based approach to investing and manages a range of and multi-sector funds. With a 39-year history, Legg Mason long only and alternative investment strategies. Esemplia has Australian Equities has an experienced and stable investment offices and manages money for clients out of London and team that combines fundamental research and quantitative Hong Kong. The company has a unique boutique-like culture analysis with market expertise. Its clients include government Warsaw London agencies, institutional funds and retail investors. Legg Mason Poland is one of the longest established asset managers in Poland, investing in Polish and Central European securities, including bonds, equities and money markets. Legg Mason Poland utilizes a fundamental bottom-up approach to investing with an emphasis on efficient risk Hong Kong control. The firm’s clients are mostly affluent and institutional investors, including pension funds, insurance companies, foundations and local governments. Melbourne Legg Mason Australian Equities was named Asset Allocator of the Year at the 2013 Money Management/Lonsec Fund Manager of the Year Awards. The firm was recognized for the “combi- nation of a highly regarded investment team and a robust investment process.” 14Legg MasonLegg Mason Investment Counsel provides highly tailored investment and trust strategies for affluent individuals, fam- ilies and institutions. Through an iterative and collaborative approach with its clients, the firm focuses on understanding goals and needs before building individualized strategies. Integral to its core investment capabilities and to help clients pursue their financial goals, the firm also has specializations in socially responsive investing, philanthropy, trust and family office services, as well as estate and tax planning. Legg Mason Investment Counsel’s dedicated team of 21 portfolio managers and trust officers average over 27 years of expe- rience. The firm also employs 14 analysts whose work is for the benefit of the firm’s clients only. Legg Mason Investment Counsel operates from offices in Baltimore, Cincinnati, New York and Philadelphia. Assets by Investment Type U.S./Global Balanced—48% U.S./Global Equity—29% Fixed Income—23% Legg Mason Global Asset Allocation (LMGAA) provides strategic asset allocation, tactical asset allocation and custom risk management solutions, creating multi-manager/multi- asset class solutions aimed at achieving a variety of client investment goals. Based in New York, the firm draws on global expertise and deep intellectual curiosity to offer a broad range of asset allocation capabilities that meet the needs of institutional and retail investors, combining asset allocation expertise with dynamic risk management solutions and the depth of resources of one of the world’s largest investment management firms. LMGAA’s investment process combines conceptual creativity with quantitative discipline, with an emphasis on managing downside risk. LMGAA’s products and strategies are deliverable across multiple vehicles, including mutual funds, variable insurance trusts, institutional separate accounts and cross-border mutual funds. Investment Process Overview Strategic Asset Allocation Manager Selection Attribution and Measurement Tactical Asset Allocation Dynamic Risk Management 15Legg MasonBoard of Directors Standing left to right Seated left to right John E. Koerner III Managing Member, Koerner Capital, LLC Nicholas J. St. George Private Investor W. Allen Reed Private Investor; Retired CEO, GM Asset Management Corporation (Chairman of the Board, Lead Independent Director, Chairman of Finance Committee) Dennis M. Kass Private Investor; Retired CEO, Jennison Associates Cheryl Gordon Krongard Private Investor; Former CEO, Rothschild Asset Management Joseph A. Sullivan President and CEO, Legg Mason, Inc. Dennis R. Beresford Professor, University of Georgia; Former Chairman of Financial Accounting Standards Board Kurt L. Schmoke Vice President and General Counsel, Howard University; Former Mayor of Baltimore Nelson Peltz Chief Executive Officer and Founding Partner, Trian Fund Management, L.P. (Chairman of Nominating & Corporate Governance Committee) Barry W. Huff Retired Vice Chairman, Deloitte (Chairman of Audit Committee) John T. Cahill Executive Chairman, Kraft Foods Group, Inc. (Chairman of Compensation Committee) Margaret Milner Richardson Private Consultant and Investor; Former U.S. Commissioner of Internal Revenue Harold L. Adams Chairman Emeritus, RTKL Associates, Inc. Robert E. Angelica Private Investor; Former Chairman and CEO, AT&T Investment Management Corporation (Chairman of Risk Committee) Not pictured John V. Murphy Former CEO, OppenheimerFunds Inc. John H. Myers Senior Advisor, Angelo, Gordon & Co.; Former CEO, GE Asset Management Our New Directors Dennis Kass joined the Legg Mason Board in April 2013. Mr. Kass’s previous positions have included serving as Chairman and CEO of Jennison Associates from 2003 to 2012 and more than a decade with J.P. Morgan’s Investment Management unit, including as Vice Chairman of J.P. Morgan Fleming Asset Management. John Murphy joined the Legg Mason Board in June 2013. Mr. Murphy’s previous positions include serving as Chairman and Chief Executive Officer of OppenheimerFunds Inc. as part of more than 18 years with Oppenheimer and its corporate parent, MassMutual Financial Group, in a variety of senior roles. John Myers joined the Legg Mason Board in June 2013. Mr. Myers is cur- rently a senior advisor to Angelo, Gordon & Co. Mr. Myers’ previous positions include almost 10 years as President and Chief Executive Officer of GE Asset Management as part of more than almost 40 years with General Electric Company and its subsidiaries. 16Legg MasonSelected Financial Data (Dollars in thousands, except per share amounts or unless otherwise noted) OPERATING RESULTS Operating revenues 2013 2012 2011 2010 2009 Years Ended March 31, $2,612,650 $2,662,574 $2,784,317 $2,634,879 $ 3,357,367 Operating expenses, excluding impairment 2,313,149 2,323,821 2,397,509 2,313,696 Impairment of intangible assets and goodwill Operating income (loss) Other non-operating expense Other non-operating income (expense) of consolidated investment vehicles, net Fund support Income (loss) before income tax provision (benefit) Income tax provision (benefit) Net income (loss) Less: Net income (loss) attributable to noncontrolling interests 734,000 (434,499) (73,287) (2,821) — (510,607) (150,859) (359,748) — 338,753 (54,006) 18,336 — 303,083 72,052 231,031 — 386,808 (23,315) 1,704 — 365,197 119,434 245,763 — 321,183 (32,027) 17,329 23,171 329,656 118,676 210,980 2,718,577 1,307,970 (669,180) (243,577) 7,796 (2,283,236) (3,188,197) (1,223,203) (1,964,994) (6,421) 10,214 (8,160) 6,623 2,924 Net income (loss) attributable to Legg Mason, Inc. $ (353,327) $ 220,817 $ 253,923 $ 204,357 $(1,967,918) PER SHARE Net income (loss) per share attributable to Legg Mason, Inc. common shareholders: Basic Diluted Weighted-average shares outstanding: Basic Diluted(1) Dividends declared BALANCE SHEET Total assets Long-term debt Total stockholders’ equity FINANCIAL RATIOS AND OTHER DATA Adjusted income (loss)(2) Adjusted income (loss) per diluted share(2) Operating margin Operating margin, as adjusted(3) Total debt to total capital(4) $ (2.65) $ 1.54 $ 1.63 $ 1.33 $ (13.99) $ (2.65) $ 1.54 $ 1.63 $ 1.32 $ (13.99) 133,226 133,226 143,292 143,349 155,321 155,484 153,715 155,362 140,669 140,669 $ 0.44 $ 0.32 $ 0.20 $ 0.12 $ 0.96 $7,269,660 $8,555,747 $8,707,756 $8,622,632 $ 9,232,299 1,144,954 4,818,351 1,136,892 1,201,868 1,170,334 5,677,291 5,770,384 5,841,724 2,740,190 4,598,625 $ 347,169 $ 2.61 $ 397,030 $ 439,248 $ 381,258 $(1,191,389) $ 2.77 $ 2.83 $ 2.45 $ (8.47) (16.6)% 16.8% 19.2% 12.7% 21.3% 19.6% 13.9% 23.2% 20.1% 12.2% 20.7% 19.6% (19.9)% 23.9% 39.4% Assets under management (in millions) $ 664,609 $ 643,318 $ 677,646 $ 684,549 $ 632,404 Full-time employees 2,975 2,979 3,395 3,550 3,890 (1) Basic shares and diluted shares are the same for periods with a net loss. (2) Adjusted income (loss) is a non-GAAP performance measure. We define Adjusted income (loss) as Net income (loss) attributable to Legg Mason, Inc., plus amortization and deferred taxes related to intangible assets and goodwill, and imputed interest and tax benefits on contingent convertible debt less deferred income taxes on goodwill and indefinite-life intangible asset impairment, if any. We also adjust for non-core items, such as intangible asset impairments, the impact of tax rate adjustments on certain deferred tax liabilities related to indefinite-life intangible assets, and loss on extinguishment of contingent convert- ible debt. See Supplemental Non-GAAP Information in Management’s Discussion and Analysis of Financial Condition and Results of Operations. (3) Operating margin, as adjusted, is a non-GAAP performance measure we calculate by dividing (i) Operating income (loss), adjusted to exclude the impact on compensation expense of gains or losses on investments made to fund deferred compensation plans, the impact on compensation expense of gains or losses on seed capital investments by our affiliates under revenue sharing agreements, transition-related costs of streamlining our business model, income (loss) of consolidated investment vehicles, and impairment charges by (ii) our Operating revenues, adjusted to add back net investment advisory fees eliminated upon consolidation of investment vehicles, less distribution and servicing expenses which we use as an approximate measure of revenues that are passed through to third parties, which we refer to as “Operating revenues, as adjusted.” See Supplemental Non-GAAP Information in Management’s Discussion and Analysis of Financial Condition and Results of Operations. (4) Calculated based on total debt as a percentage of total capital (total stockholders’ equity plus total debt) as of March 31. 17 Legg MasonManagement’s Discussion and Analysis of Financial Condition and Results of Operations 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 (“U.S.”) and the United Kingdom (“U.K.”) and also have offices in Australia, Bahamas, Brazil, Canada, Chile, China, Dubai, France, Germany, Italy, Japan, Luxembourg, Poland, Singapore, Spain, Switzerland and Taiwan. All references to fiscal 2013, 2012 or 2011, refer to our fiscal year ended March 31 of that year. Terms such as “we,” “us,” “our,” and “Company” refer to Legg Mason. In connection with a realignment of our executive manage- ment team during fiscal 2011, we no longer manage our business in two divisions and, during fiscal 2012, eliminated the previous separation of the Americas and International divisions and combined them into one operating segment, Global Asset Management. We believe this structure allows us to function as a global organization with a single purpose. As a result of this change, we no longer present assets under management (“AUM”) or revenues by division. 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 invest- ment advisory contracts for exceeding performance benchmarks. The largest portion of our performance fees is earned based on 12-month performance periods that end in differing quarters during the year, with a portion based on quarterly performance periods. Distribution and service fees are received for distributing investment prod- ucts 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 AUM and fee rates, and thus are affected by factors such as securities market conditions, our ability to attract and maintain AUM and key investment person- nel, and investment performance. Our AUM primarily vary from period to period due to inflows and outflows of client assets as well as 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 absolute and relative to benchmarks or competitive products) of our products and services, the fees we charge for our investment services, the client or potential client’s situation, including invest- ment objectives, liquidity needs, investment horizon and amount of assets managed, our relationships with distribu- tors 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 underlying invest- ment product, the amount of assets under management, the asset management affiliate that provides the services, and the type of services (and investment objectives) that are provided. Fees charged for equity asset manage- ment services are generally higher than fees charged for fixed income and liquidity asset management services. Accordingly, our revenues and average AUM advisory revenue yields will be affected by the composition of our AUM, with changes in the relative level of equity assets more significantly impacting our revenues and average AUM advisory revenue yields. Average AUM advisory revenue yields are calculated as the ratio of annualized investment advisory fees, excluding performance fees, to average AUM. In addition, in the ordinary course of our business, we may reduce or waive investment manage- ment 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. We have in place revenue sharing agreements with most of our asset management affiliates, under which specified percentages of the affili- ates’ revenues are required to be distributed to us and the balance of the revenues is retained to pay operating expenses, including compensation expenses, but exclud- ing certain expenses and income taxes. Under these agreements, our asset management affiliates retain dif- ferent percentages of revenues to cover their costs. As such, our Net Income (Loss) Attributable to Legg Mason, Inc., operating margin and compensation as a percent- age of operating revenues are impacted based on which affiliates generate our revenues, and a change in AUM at one affiliate can have a dramatically different effect on our revenues and earnings than an equal change at another affiliate. In addition, from time to time we may agree to changes in revenue sharing agreements and other arrange- ments with our asset management personnel, which may impact our compensation expenses and profitability. 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, non-com- pensation related operating expense levels at revenue 18 Legg Masonshare-based affiliates, and profits. The next largest com- ponent of our cost structure is distribution and servicing expense, which are primarily fees paid to third-party dis- tributors for selling our asset management products and services and are largely variable in nature. Certain other operating costs are quasi-fixed in nature, such as occu- pancy, depreciation and amortization, and fixed contract commitments for market data, communication and tech- nology 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 materi- ally affected by the overall trends and conditions of the financial markets, particularly in the United States, but also in the other countries in which we operate. Results of any individual period should not be considered representative of future results. Our profitability is sensitive to a variety of factors, including the amount and composition of our AUM, and the volatility and general level of securities prices and interest rates, among other things. Periods of unfavorable market conditions are likely to adversely affect our profitability. In addition, the diversification of services and products offered, investment performance, access to distribution channels, reputation in the market, attracting and retaining key employees and client relations are signifi- cant factors in determining whether we are successful in attracting and retaining clients. In the last few years, the Strategic Priorities Recent Initiatives industry has seen flows into products for which we do not currently garner significant market share. In addition, the economic downturn of fiscal 2008 and 2009 contributed to a significant contraction in our business and we have not recovered to pre-downturn levels. 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 impacted by continued economic uncertainty, and in prior years, by the consolidation of financial services firms through mergers and acquisitions. The industry in which we operate is also subject to exten- sive regulation under federal, state, and foreign laws. Like most firms, we have been impacted by regulatory and legislative changes. Responding to these changes has required, and will continue to require, us to incur costs that continue to impact our profitability. Our strategy is focused on four primary areas listed below. Management keeps these strategic priorities in mind when it evaluates our operating performance and financial condition. Consistent with this approach, we have also presented in the table below the most important matters on which management currently focuses in evaluating our performance and financial condition. Product expansion • Promote revenue growth through new product development, leveraging the capabilities of our affiliates • Identify and execute strategic acquisitions to increase product offerings and fill gaps in products and services Investment performance • Deliver compelling and consistent performance against both relevant benchmarks and the products and services of our competitors for 1-year, 3-year, 5-year, and 10-year periods Distribution focus • Evaluation and reallocation of resources within and to our distribution platform to continue to build a top distribution function with the capability to offer solutions to relevant investment challenges Operating efficiency • Management of expenses • Restructuring of affiliate arrangements Net Loss Attributable to Legg Mason, Inc. for fiscal 2013 was $353.3 million, or $2.65 per diluted share, as com- pared to Net Income Attributable to Legg Mason, Inc. of $220.8 million, or $1.54 per diluted share, for fiscal 2012. The current year loss is primarily attributable to $734.0 mil- lion, or $3.81 per diluted share, of non-cash impairment charges related to intangible assets and a $69.0 million, or $0.34 per diluted share, non-operating charge from the extinguishment of debt. Average AUM, and total revenues, remained relatively flat in fiscal year 2013, as compared to fiscal year 2012. Strong overall performance and the improvement of our global distribution function contributed to a continued reduction in outflows. The modest outflows were mostly offset by increases in AUM due to market performance, an acquisi- tion, and new product launches in fiscal 2013. 19 Legg MasonThe following discussion and analysis provides additional information regarding our financial condition and results of operations. BUSINESS ENVIRONMENT AND RESULTS OF OPERATIONS The business environment in fiscal 2013 was marked by uneven growth and a continued heightened sensitivity to economic news. Major economic events and news of the year included uneven domestic growth, periodic develop- ments in the ongoing European sovereign debt crisis, the fiscal cliff, sequestration, and the actions of the Federal Reserve to maintain low interest rates, including beginning a third round of quantitative easing and the continued sup- port of the secondary mortgage market. These events led to a challenging financial environment, both globally and in the United States. However, during fiscal 2013 most U.S. indices produced positive returns, with record highs in the equity markets in March 2013. While the economic out- look has remained more positive than in recent years, the financial environment in which we operate still reflects a heightened level of sensitivity as we move into fiscal 2014. All three major U.S. equity market indices, as well as the Barclays Capital U.S. Aggregate Bond Index and Barclays Capital Global Aggregate Bond Index, increased over the past two fiscal years, as illustrated in the table below: Indices(1) Dow Jones Industrial Average S&P 500 NASDAQ Composite Index Barclays Capital U.S. Aggregate % Change for the Year Ended March 31, 2013 10.34% 11.41% 5.69% 2012 7.24% 6.23% 11.16% Bond Index 3.77% 7.71% Barclays Capital Global Aggregate Bond Index 1.26% 5.26% (1) Indices are trademarks of Dow Jones & Company, McGraw-Hill Companies, Inc., NASDAQ Stock Market, Inc., and Barclays Capital, respectively, which are not affiliated with Legg Mason. 20 Legg MasonThe following table sets forth, for the periods indicated, amounts in the Consolidated Statements of Income (Loss) 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 Period to Period Change(1) Years Ended March 31, 2013 2012 2011 2013 Compared to 2012 2012 Compared to 2011 28.0% 29.1% 29.3% (5.8)% (4.9)% Operating Revenues Investment advisory fees Separate accounts Funds Performance fees Distribution and service fees Other Total operating revenues Operating Expenses Compensation and benefits Transition-related compensation Total compensation and benefits Distribution and servicing Communications and technology Occupancy Amortization of intangible assets Impairment of intangible assets Other Total operating expenses Operating Income (Loss) Other Income (Expense) Interest income Interest expense Other Other non-operating income (expense) of consolidated investment vehicles Total other income (expense) Income (Loss) before Income Tax Provision (Benefit) Income tax provision (benefit) Net Income (Loss) Less: Net income (loss) attributable to noncontrolling interests 55.3 3.8 12.6 0.3 56.0 1.9 12.8 0.2 53.4 3.5 13.6 0.2 100.0 100.0 100.0 45.5 — 45.5 23.0 5.7 6.6 0.5 28.1 7.2 116.6 (16.6) 0.3 (2.4) (0.7) (0.1) (2.9) (19.5) (5.7) (13.8) (0.3) 41.7 1.3 43.0 24.4 6.2 5.8 0.7 — 7.2 87.3 12.7 0.4 (3.3) 0.8 0.8 (1.3) 11.4 2.7 8.7 0.4 41.0 1.6 42.6 25.6 5.8 5.0 0.8 — 6.3 86.1 13.9 0.3 (3.3) 2.1 0.1 (0.8) 13.1 4.3 8.8 (0.3) Net Income (Loss) Attributable to Legg Mason, Inc. (13.5)% 8.3% 9.1% n/m—not meaningful (1) Calculated based on the change in actual amounts between fiscal years as a percentage of the prior year amount. (3.0) 99.1 (3.1) 37.3 (1.9) 7.1 n/m 3.9 (7.6) (9.1) 11.1 (28.4) n/m (1.2) 31.1 n/m (33.9) (28.2) n/m n/m n/m n/m n/m n/m n/m n/m 0.3 (48.8) (10.1) (16.0) (4.4) (2.7) (23.1) (3.5) (8.9) 1.7 12.3 (14.6) n/m 8.0 (3.1) (12.4) 24.2 (5.0) (62.9) n/m n/m (17.0) (39.7) (6.0) n/m (13.0)% 21 Legg MasonFISCAL 2013 COMPARED WITH FISCAL 2012 Assets Under Management Our AUM is primarily managed across the following asset classes: Equity Fixed Income • Large Cap Growth • Small Cap Core • Large Cap Value • Equity Income • Mid Cap Core • Global Emerging Market Equity • Global Equity • International Equity • U.S. Intermediate Investment Grade • Global Government • U.S. Municipal • U.S. Long Duration • Global Opportunistic Fixed Income • U.S. Credit Aggregate • U.S. Limited Duration • Global Fixed Income • U.S. Government Intermediate • Government/Credit Liquidity • U.S. Managed Cash • U.S. Municipal Cash 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(1) Subscriptions Redemptions Separate account flows, net Liquidity fund flows, net Net client cash flows Market performance and other(2) Acquisitions (dispositions), net 2013 $643.3 2012 $677.6 44.9 (49.0) (27.4) 19.8 (11.7) 34.2 (1.2) 46.9 (51.1) (35.9) 12.6 (27.5) 17.1 (23.9) End of period $664.6 $643.3 (1) Subscriptions and redemptions reflect the gross activity in the funds and include assets transferred between funds and between share classes. (2) Includes impact of foreign exchange, reinvestment of dividends, and other. AUM at March 31, 2013, was $664.6 billion, an increase of $21.3 billion, or 3%, from March 31, 2012. The increase in AUM was attributable to market performance and other of $34.2 billion, including the negative impact of foreign cur- rency exchange fluctuations of $8.3 billion, and $5.4 billion related to the acquisition of Fauchier Partners Management Limited (“Fauchier”). These increases were offset in part by net client outflows of $11.7 billion and dispositions of $6.6 bil- lion. The dispositions were in liquidity assets which resulted from the amendment of historical Smith Barney brokerage programs providing for investment in liquidity funds that our asset managers manage. Long-term asset classes accounted for the net client outflows, with $20.4 billion and $11.0 bil- lion in equity and fixed income outflows, respectively, partially offset by liquidity inflows of $19.7 billion. Equity out- flows were primarily experienced by products managed at Batterymarch Financial Management, Inc. (“Batterymarch”), Royce & Associates (“Royce”), The Permal Group, Ltd. (“Permal”), and Legg Mason Capital Management LLC (“LMCM”). Due in part to investment performance issues, we have experienced net annual outflows in our equity asset class since fiscal 2007. The majority of fixed income outflows were in products managed by Western Asset Management Company (“Western Asset”), includ- ing $6.4 billion in outflows from a single, low fee global sovereign mandate. We expect to continue to experience outflows from this mandate of approximately $500 million per month during fiscal 2014. Fixed income outflows were offset in part by inflows at Brandywine Global Investment Management, LLC (“Brandywine”). We have experienced outflows in our fixed income asset class in all but two quarters since the fourth quarter of fiscal 2008. We gener- ally earn higher fees and profits on equity AUM, and out- flows in the equity asset class will more negatively impact our revenues and Net Income (Loss) Attributable to Legg Mason, Inc. than would outflows in other asset classes. We experienced liquidity outflows of approximately $13 bil- lion from a sovereign wealth client during the month ended April 30, 2013, however, we do not expect this outflow to have a material impact on our revenues or net income. Our investment advisory and administrative contracts are generally terminable at will or upon relatively short notice, and investors in the mutual funds that we manage may redeem their investments in the funds at any time without prior notice. Institutional and individual clients can terminate their relation- ships with us, reduce the aggregate amount of assets under management, or shift their funds to other types of accounts with different rate structures for any number of reasons, includ- ing 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. 22 Legg MasonAUM by Asset Class AUM by asset class (in billions) for the years ended March 31 were as follows: Equity Fixed Income Liquidity Total 2013 $161.8 365.1 137.7 $664.6 % of Total 24% 55 21 100% 2012 $163.4 356.1 123.8 $643.3 % of Total % Change 26% (1)% 55 19 3 11 100% 3% The component changes in our AUM by asset class (in billions) for the fiscal year ended March 31, 2013, were as follows: March 31, 2012 Investment funds, excluding liquidity funds Subscriptions Redemptions Separate account flows, net Liquidity fund flows, net Net client cash flows Market performance and other Acquisitions (dispositions), net March 31, 2013 Equity $163.4 Fixed Income Liquidity $356.1 $123.8 Total $643.3 18.9 (26.4) (12.9) — (20.4) 13.4 5.4 26.0 (22.6) (14.4) — (11.0) 20.0 — — — (0.1) 19.8 19.7 0.8 (6.6) 44.9 (49.0) (27.4) 19.8 (11.7) 34.2 (1.2) $161.8 $365.1 $137.7 $664.6 Average AUM by asset class (in billions) for the years ended March 31 were as follows: Equity Fixed Income Liquidity Total 2013 $152.1 364.5 128.9 $645.5 % of Total 24% 56 20 100% 2012 $168.4 359.8 116.6 $644.8 % of Total % Change 26% (10)% 56 18 1 11 100% —% AUM by Distribution Channel We have two principal distribution channels, Global Distribution and Affiliate/Other, through which we sell a variety of invest- ment products and services. Global Distribution, which consists of our centralized global distribution operations, principally sells U.S. and international mutual funds and other commingled vehicles, retail separately managed account programs, and sub-advisory accounts for insurance companies and similar clients. Affiliate/Other consists of the distribution operations within our asset managers and principally sells institutional separate accounts and liquidity (money market) funds. The component changes in our AUM by distribution channel (in billions) for the year ended March 31, 2013, were as follows: March 31, 2012 Net client cash flows, excluding liquidity funds Liquidity fund flows, net Net client cash flows Market performance and other Acquisitions/(dispositions), net March 31, 2013 Global Distribution Affiliate/Other $220.6 $422.7 2.2 — 2.2 9.3 — (33.7) 19.8 (13.9) 24.9 (1.2) Total $643.3 (31.5) 19.8 (11.7) 34.2 (1.2) $232.1 $432.5 $664.6 23 Legg MasonFor the years ended March 31, 2013 and 2012, our overall effective fee rate across all asset classes and distribution channels was 34 and 35 basis points, respectively. Fees for managing equity assets are generally higher, averaging approximately 75 basis points for each of the years ended March 31, 2013 and 2012. This compares to fees for man- aging fixed income assets, which averaged approximately 25 basis points for each of the years ended March 31, 2013 and 2012, and liquidity assets, which averaged under 10 basis points (reflecting the impact of current advisory fee waivers due to the low interest rate environment) for each of the years ended March 31, 2013 and 2012. Equity assets are primarily managed by ClearBridge, Royce, Batterymarch, and Permal; fixed income assets are primar- ily managed by Western Asset and Brandywine; and liquid- ity assets are primarily managed by Western Asset. Fee rates for assets distributed through Legg Mason Global Distribution, which are predominately retail in nature, aver- aged approximately 50 basis points for each of the years ended March 31, 2013 and 2012, while fee rates for assets distributed through the Affiliate/Other channel averaged approximately 20 basis points for each of the years ended March 31, 2013 and 2012. The decline in higher yielding equity assets has impacted our revenues, as further dis- cussed below. Investment Performance Overall investment performance of our assets under man- agement in the year ended March 31, 2013, was generally positive compared to relevant benchmarks. For the year ended March 31, 2013, most U.S. indices produced positive returns. The best performing was the S&P 400 Mid Cap Index, returning 17.8% for the year ended March 31, 2013. These returns were achieved in an economic environment characterized by uneven domestic growth and heightened sensitivity to economic news which included improving unemployment and housing figures, the anticipation and implementation of the sequestration, con- cerns surrounding the fiscal cliff, and periodic developments in the continuing European sovereign debt crisis. In the fixed income markets, the Federal Reserve affirmed its commitment to hold the federal funds rate at historic lows, by beginning a third round of quantitative easing and continuing support of the secondary mortgage market. These actions were taken to keep interest rates low and stimulate economic growth, and resulted in a downward shift in the yield curve over the year. The lowest yielding fixed income sector for the year was U.S. government bonds, as measured by the Barclays U.S. Government Bond Index returning 3.0%. The best performing fixed income sector for the year was high yield bonds as measured by the Barclays U.S. High Yield Bond Index returning 13.1% as of March 31, 2013. The following table presents a summary of the percentages of our AUM by strategy(1) that outpaced their respective benchmarks as of March 31, 2013 and 2012, for the trailing 1-year, 3-year, 5-year, and 10-year periods: Total (includes liquidity) Equity: Large cap Small cap Total equity As of March 31, 2013 As of March 31, 2012 1-year 84% 65% 13% 3-year 85% 68% 15% 5-year 88% 88% 27% 10-year 91% 1-year 62% 3-year 81% 5-year 70% 10-year 87% 80% 62% 66% 49% 43% 63% 66% 88% 78% 89% (includes other equity) 48% 50% 62% 71% 53% 52% 66% 80% Fixed income: U.S. taxable U.S. tax-exempt Global taxable Total fixed income 96% 100% 89% 94% 94% 100% 94% 94% 91% 100% 95% 93% 90% 100% 98% 94% 66% 2% 38% 51% 95% 2% 93% 87% 61% 2% 70% 60% 89% 1% 97% 84% 24 Legg MasonThe following table presents a summary of the percentages of our U.S. mutual fund assets(2) that outpaced their Lipper category averages as of March 31, 2013 and 2012, for the trailing 1-year, 3-year, 5-year, and 10-year periods: As of March 31, 2013 As of March 31, 2012 1-year 3-year 5-year 10-year 1-year 3-year 5-year 10-year 59% 57% 70% 64% 67% 66% 78% 74% Total long-term (excludes liquidity) Equity: Large cap Small cap Total equity 90% 27% (includes other equity) 56% Fixed income: U.S. taxable U.S. tax-exempt Global taxable Total fixed income 74% 50% 71% 64% 79% 16% 44% 92% 57% 74% 76% 77% 48% 59% 85% 86% 95% 87% 40% 68% 53% 90% 84% 54% 85% 78% 44% 51% 63% 48% 93% 45% 98% 57% 56% 73% 71% 76% 91% 96% 84% 91% 70% 81% 81% 82% 91% 87% 87% 83% 82% 83% 83% (1) For purposes of investment performance comparisons, strategies are an aggregation of discretionary portfolios (separate accounts, investment funds, and other products) into a single group that represents a particular investment objective. In the case of separate accounts, the investment performance of the account is based upon the performance of the strategy to which the account has been assigned. Each of our asset managers has its own specific guidelines for including portfolios in their strategies. For those managers which manage both separate accounts and investment funds in the same strategy, the per- formance comparison for all of the assets is based upon the performance of the separate account. As of March 31, 2013 and 2012, 90% and 91% of total AUM is included in strategy AUM, respectively, although not all strategies have three-, five-, and ten- year histories. Total strategy AUM includes liquidity assets. Certain assets are not included in reported performance comparisons. These include: accounts that are not managed in accordance with the guidelines outlined above; accounts in strategies not marketed to potential clients; accounts that have not yet been assigned to a strategy; and certain smaller products at some of our affiliates. Past performance is not indicative of future results. For AUM included in institutional and retail separate accounts and investment funds included in the same strategy as separate accounts, performance comparisons are based on gross-of-fee performance. For investment funds (including fund-of-hedge funds) which are not managed in a separate account format, performance comparisons are based on net-of-fee performance. These performance com- parisons do not reflect the actual performance of any specific separate account or investment fund; individual separate account and investment fund performance may differ. Certain prior year amounts have been updated to conform to the current year presentation. (2) Source: Lipper Inc. includes open-end, closed-end, and variable annuity funds. As of March 31, 2013 and 2012, the U.S. long-term mutual fund assets rep- resented in the data accounted for 19% and 18%, respectively, of our total AUM. The performance of our U.S. long-term mutual fund assets is included in the strategies. 25 Legg Mason The following table presents a summary of the absolute and relative performance compared to the applicable benchmark for a representative sample of funds within our AUM, net of management and other fees as of the end of the period presented, for the 1-year, 3-year, 5-year, and 10-year periods, and from each fund’s inception. The table below includes a representative sample of funds from each significant subclass of our investment strategies (i.e., large cap equity, small cap equity, etc.). The funds within this group are representative of the performance of significant investment strategies we offer, that as of March 31, 2013, constituted an aggregate of approximately $393 billion, or approximately 59%, of our AUM. The only meaningful exclusions are our funds-of-hedge funds strategies, which involve privately placed hedge funds, and represent only 3% of our total assets under management as of March 31, 2013, for which investment per- formance is not made publicly available. Providing investment returns of funds provides a relevant representation of our performance while avoiding the many complexities relating to factors such as multiple fee structures, bundled pricing, and asset level break points, that would arise in reporting performance for strategies or other product aggregations. Fund Name/Index Equity Large Cap Inception Date Performance Type(1) Annualized Absolute & Relative Total Return (%) vs. Benchmark 1-year 3-year 5-year 10-year Inception ClearBridge Appreciation Fund 3/10/1970 Absolute 14.80% 11.78% 5.77% 8.45% 10.26% S&P 500 Relative 0.83% (0.89)% (0.04)% (0.08)% 0.02% ClearBridge All Cap Value Fund 11/12/1981 Absolute 15.65% 9.15% 3.72% 7.96% 11.69% Russell 3000 Value Relative (3.06)% (3.55)% (1.32)% (1.37)% 0.04% Legg Mason Capital Management Value Trust 4/16/1982 Absolute 12.55% 7.65% 0.67% 3.64% 6.68% S&P 500 Relative (1.42)% (5.02)% (5.14)% (4.90)% 2.19% ClearBridge Aggressive Growth Fund 10/24/1983 Absolute 20.02% 16.86% Russell 3000 Growth Relative 9.60% 3.67% ClearBridge Large Cap Value Fund 12/31/1988 Absolute 15.94% 12.51% 8.25% 0.81% 5.84% 9.14% 12.05% 0.30% 2.51% 9.03% 9.48% Russell 1000 Value Relative (2.83)% (0.23)% 0.99% (0.14)% (0.65)% ClearBridge Equity Income Fund 11/6/1992 Absolute 16.20% 13.86% 5.81% 8.46% 8.35% Russell 3000 Value Relative (2.51)% 1.16% 0.76% (0.87)% (1.38)% ClearBridge Large Cap Growth Fund 8/29/1997 Absolute 16.52% 11.22% 7.07% 7.79% 10.20% Russell 1000 Growth Relative 6.44% (1.84)% (0.24)% (0.83)% (1.68)% Legg Mason Brandywine Diversified Large Cap Value Fund Russell 1000 Value Small Cap 9/7/2010 Absolute Relative 14.68% (4.08)% n/a n/a n/a n/a n/a n/a 17.74% 1.26% Royce Pennsylvania Mutual 6/30/1967 Absolute 12.63% 12.03% 7.28% 12.17% 11.97% Russell 2000 Royce Premier Fund Russell 2000 Relative (3.68)% (1.42)% (0.96)% 0.65% n/a 12/31/1991 Absolute 6.47% 11.80% 7.91% 13.77% 12.19% Relative (9.83)% (1.66)% (0.33)% 2.25% 2.81% Royce Total Return Fund 12/15/1993 Absolute 16.28% 12.70% 7.18% 10.46% 11.15% Russell 2000 Royce Low-Priced Stock Russell 2000 Royce Special Equity Russell 2000 Fixed Income U.S. Taxable Relative (0.03)% (0.75)% (1.06)% (1.06)% 2.70% 12/15/1993 Absolute (5.04)% 4.42% 4.31% 10.78% 11.51% Relative (21.34)% (9.04)% (3.93)% (0.74)% 3.05% 5/1/1998 Absolute 13.02% 11.75% 10.14% 10.76% 9.60% Relative (3.28)% (1.71)% 1.90% (0.76)% 3.13% Western Asset Core Bond Fund 9/4/1990 Absolute Barclays US Aggregate Relative 5.17% 1.39% 7.22% 1.70% 7.76% 2.30% 5.64% 7.55% 0.61% 0.67% 26 Legg MasonFund Name/Index Inception Date Performance Type(1) Annualized Absolute & Relative Total Return (%) vs. Benchmark 1-year 3-year 5-year 10-year Inception Western Asset Short Term Bond Fund 11/11/1991 Absolute Citi Treasury Gov’t/Credit 1-3 YR Relative Western Asset Adjustable Rate Income 6/22/1992 Absolute Citi T-Bill 6-Month Relative Western Asset Corporate Bond Fund 11/6/1992 Absolute Barclays US Credit Relative Western Asset Intermediate Bond Fund 7/1/1994 Absolute Barclays Intermediate Gov’t/Credit Relative Western Asset Core Plus Fund 7/8/1998 Absolute Barclays US Aggregate Relative Western Asset Inflation Index Plus Bond 3/1/2001 Absolute 2.42% 1.29% 3.97% 3.84% 9.25% 2.25% 5.37% 1.84% 6.73% 2.95% 5.80% 3.24% 1.60% 3.59% 3.45% 8.38% 3.04% 2.14% 4.02% 0.68% (0.94)% (0.74)% 2.30% 1.81% 7.38% 1.84% 3.11% 0.03% (0.12)% 4.96% 6.93% 0.53% (0.14)% (1.00)% (0.08)% 6.15% 1.40% 7.66% 2.13% 8.02% 6.59% 1.97% 8.63% 3.16% 5.65% 5.52% 6.50% 1.03% 0.62% 6.61% 6.93% 1.58% 1.12% 6.15% 6.91% Barclays US TIPS Relative 0.12% (0.55)% (0.24)% (0.17)% (0.19)% Western Asset High Yield Fund 9/28/2001 Absolute 14.63% 11.30% 10.56% 9.08% 8.61% Barclays US Corp High Yield Relative Western Asset Total Return Unconstrained 7/6/2006 Absolute 1.51% 5.86% 5.22% 0.06% (1.08)% (1.04)% (1.24)% Barclays US Aggregate Relative 2.09% (0.30)% Western Asset Mortgage Defined Opportunity Fund Inc. 2/24/2010 Absolute 31.77% 20.13% BOFAML Floating Rate Home Loan Index Relative 15.30% 12.23% 6.47% 1.00% n/a n/a n/a n/a n/a n/a 5.97% (0.07)% 20.14% 12.31% U.S. Tax-Exempt Western Asset Managed Municipals Fund 3/4/1981 Absolute Barclays Municipal Bond Global Taxable Relative 6.82% 1.58% 7.01% 0.78% 6.92% 0.82% 5.71% 8.28% 0.71% 0.56% Legg Mason Australian Bond Trust 6/30/1983 Absolute UBS Australian Composite Bond Index Relative 9.12% 2.09% 9.02% 1.07% Western Asset Global High Yield Bond Fund 2/22/1995 Absolute 14.42% 10.40% 8.96% 1.14% 9.67% 6.70% 6.56% 0.60% 0.61% 8.43% 8.08% Barclays Global High Yield Relative 1.44% (0.78)% (1.65)% (2.50)% (1.90)% Legg Mason Core Plus Global Bond Trust 2/28/1995 Absolute 11.49% 10.24% 8.94% 6.28% 6.20% Barclays Global Aggregate (AUD Hedged) Relative Western Asset Emerging Markets Debt 10/17/1996 Absolute 2.85% 8.31% 0.93% (0.09)% (1.33)% (1.04)% 9.41% 9.53% 10.99% 11.36% JPM EMBI Global Relative (2.13)% (1.14)% (0.28)% 0.40% 1.07% Western Asset Global Multi Strategy Fund 8/31/2002 Absolute 5.98% 5.56% 6.17% 7.19% 8.05% 50% Bar. Global Agg./ 5% Bar. HY 2%/25% JPM EMBI + Relative (0.26)% (2.10)% (1.10)% (0.87)% (0.72)% Legg Mason Brandywine Global Fixed Income 9/30/2003 Absolute Citi World Gov’t Bond Relative 5.03% 5.70% 7.08% 3.22% Legg Mason Brandywine Global Opportunities Bond Citi World Gov’t Bond Liquidity 11/1/2006 Absolute 9.30% 10.33% Relative 9.97% 6.47% 6.11% 3.34% 8.30% 5.53% n/a n/a n/a n/a 6.00% 0.93% 8.31% 3.23% Western Asset Institutional Cash Reserves Ltd. 12/31/1989 Absolute Citi 3-Month T-Bill Relative 0.18% 0.10% 0.19% 0.10% 0.67% 0.37% 1.98% 3.72% 0.32% 0.32% (1) Absolute performance is the actual performance (i.e., rate of return) of the fund. Relative performance is the difference (or variance) between the perfor- mance of the fund or strategy and its stated benchmark. 27 Legg MasonBusiness Model Streamlining Initiative In May 2010, we announced an initiative to streamline our business model to drive increased profitability and growth that primarily involved transitioning certain shared services to our investment affiliates which are closer to the actual client relationships. The initiative resulted in over $140 million in annual cost savings, substantially all of which are cash savings. These cost savings consist of (i) over $80 million in compensation and benefits cost reductions from eliminating positions in certain corporate shared services functions as a result of transitioning such functions to the affiliates, and charging affiliates for other centralized services that will continue to be provided to them without any corresponding adjustment in revenue sharing or other compensation arrangements; (ii) approxi- mately $50 million in non-compensation costs from eliminating and streamlining activities in our corporate and distribution business units, including savings associated with consolidating office space; and (iii) approximately $10 million from our global distribution group sharing in affiliate revenues from retail assets under management without any corresponding adjustment in revenue sharing or other compensation arrangements. The initiative involved $127.5 million in transition-related costs that primarily included charges for employee termina- tion benefits and incentives to retain employees during the transition period. The transition-related costs also included charges for consolidating leased office space, early con- tract terminations, accelerated depreciation of fixed assets, asset disposals and professional fees. During the years ended March 31, 2012 and 2011, transition-related costs totaled $73.1 million and $54.4 million, respectively. All transition-related costs were accrued as of the completion of the initiative on March 31, 2012. We achieved total cost savings from the initiative of approximately $140 million and $97 million as of March 31, 2013 and 2012, respec- tively, when compared to similar expenses prior to the commencement of the streamlining initiative. A portion of the estimated transition-related savings were incremental to fiscal 2012, and are explained, where applicable, in the results of operations discussion to follow. See Note 15 of Notes to Consolidated Financial Statements for additional information on our business streamlining initiative. consolidated sponsored investment funds and the change in the value of these investments, which is recorded in Other non-operating income (expense), is reflected in our Net Income (Loss), net of amounts allocated to noncontrolling interests. See Notes 1 and 17 of Notes to Consolidated Financial Statements for additional informa- tion regarding the consolidation of investment vehicles. Operating Revenues Total operating revenues for the year ended March 31, 2013, were $2.6 billion, a decrease of 1.9% from $2.7 bil- lion in the year ended March 31, 2012, despite average AUM remaining essentially flat. This decrease was pri- marily due to the impact of a reduction in average AUM advisory revenue yields, from 35.2 basis points in the year ended March 31, 2012, to 33.7 basis points in the year ended March 31, 2013. The reduction in average AUM advisory revenue yields was the result of a less favorable average asset mix, with equity assets, which generally earn higher fees than fixed income and liquidity assets, comprising a lower percentage of our total average AUM for the year ended March 31, 2013, as compared to the year ended March 31, 2012. This decrease was offset in part by a $49.1 million increase in performance fees. Investment advisory fees from separate accounts decreased $45.2 million, or 5.8%, to $730.3 million. Of this decrease, $41.5 million was the result of lower aver- age equity assets managed by Batterymarch, LMCM and Legg Mason Global Equities Group (“LMGE”), and $12.3 million was due to the divestiture of an affiliate in February 2012. These decreases were offset in part by an increase of $9.6 million due to higher average fixed income assets managed by Brandywine. Investment advisory fees from funds decreased $45.3 mil- lion, or 3.0%, to $1.4 billion. Of this decrease, $52.9 mil- lion was due to lower average assets managed by Permal, and $48.7 million was due to lower average equity assets managed by Royce, LMCM and LMGE. These decreases were offset in part by a $39.1 million increase as a result of higher average fixed income assets managed by Western Asset and Brandywine, and a $16.7 million increase as a result of higher average equity assets at ClearBridge. RESULTS OF OPERATIONS In accordance with financial accounting standards on con- solidation, we consolidate and separately identify certain sponsored investment vehicles, the most significant of which is a collateralized loan obligation entity (“CLO”). The consolidation of these investment vehicles has no impact on Net Income (Loss) Attributable to Legg Mason, Inc. and does not have a material impact on our consolidated operating results. We also hold investments in certain Of our total AUM as of March 31, 2013 and 2012, approxi- mately 6% was in accounts that were eligible to earn performance fees. Performance fees increased $49.1 mil- lion to $98.6 million, primarily due to $32.0 million of fees received by Western Asset related to the wind-down of its participation in the U.S. Treasury’s Public-Private Investment Program (“PPIP”). Higher fees earned on assets managed at Permal and Brandywine also contrib- uted to the increase. 28 Legg MasonDistribution and service fees decreased $10.5 million, or 3.1%, to $330.5 million, as the result of the decline in aver- age fee rates received on mutual fund AUM subject to distribution and service fees. Operating Expenses Total operating expenses for the year ended March 31, 2013 were $3.0 billion, an increase of 31.1% from $2.3 billion in the prior year. The increase in total operating expenses was primarily the result of $734.0 million of intangible asset impairment charges recorded during the current year, as further discussed below. Operating expenses for the years ended March 31, 2013 and 2012 incurred at the investment management affiliate level comprised approximately 70% of total operating expenses in each year, excluding the impairment charges, which are deemed to be corporate expenses. The remaining operating expenses are com- prised of corporate and distribution costs. The components of total compensation and benefits (in millions) for the years ended March 31 were as follows: Salaries and incentives Benefits and payroll taxes Transition-related costs Management transition compensation costs Other Years Ended March 31, 2013 2012 $ 924.5 $ 895.0 204.5 — 17.9 41.6 196.7 34.6 — 18.0 Total compensation and benefits $1,188.5 $1,144.3 Total compensation and benefits increased 3.9% to $1.2 billion; • Salaries and incentives increased $29.5 million, principally due to an increase of $38.5 million in incentive-based compensation at investment affili- ates, primarily resulting from costs associated with the modification of employment and other arrange- ments, most significantly with the management of Permal, and the impact of reductions in other non- compensation related operating expenses at revenue share based affiliates, which create an offsetting increase in compensation per the applicable revenue share agreements. Additional salary and incentive costs of $12.2 million, resulting from market-based compensation increases among retained staff and new hires to support ongoing growth initiatives, also contributed to the increase. These increases were offset in part by a $23.7 million decrease in corporate salaries primarily due to headcount reductions result- ing from our business streamlining initiative. • Benefits and payroll taxes increased $7.8 million, primarily as a result of an increase in non-cash amor- tization expense and other costs associated with certain deferred compensation plans. • Transition-related costs decreased $34.6 million, due to the completion of our business streamlining initia- tive in March 2012. • Management transition compensation costs in the current year were associated with our Chief Executive Officer stepping down in September 2012 and the subsequent reorganization of our executive committee. These costs were primarily comprised of $7.5 million of cash severance and $6.4 million of net non-cash accelerated vesting of stock based awards. Also included in this line item was $3.0 mil- lion of non-cash amortization expense related to retention awards granted to certain executives and key employees. • Other compensation and benefits increased $23.6 million, primarily due to an increase in revenue- share based incentive obligations resulting from net market gains on assets invested for deferred com- pensation plans and seed capital investments, which were offset by corresponding increases in Other non-operating income (expense). Compensation as a percentage of operating revenues increased to 45.5% from 43.0% in the prior year, due to the impact of reductions in other non-compensation related operating expenses at revenue share based affili- ates, the impact of the modification of employment and other arrangements, as well as the impact of quasi-fixed compensation costs of administrative and distribution per- sonnel which do not typically vary with revenues. These increases were offset in part by the impact of transition- related compensation recorded in the prior year, as well as the impact of lower corporate compensation costs, princi- pally attributable to our business streamlining initiative. Distribution and servicing expenses decreased 7.6% to $600.6 million, driven by a $53.8 million decrease due to a reduction in average AUM in certain products for which we pay fees to third-party distributors. Communications and technology expense decreased 9.1% to $149.6 million, driven by the impact of $8.4 million in transition-related costs recognized in the prior year, as well as $4.4 million in cost savings as a result of our business streamlining initiative. Occupancy expense increased 11.1% to $171.9 million, pri- marily due to real estate related charges totaling $52.8 mil- lion, recorded during fiscal 2013 related to further space 29 Legg Masonconsolidation which will result in savings of approximately $10.0 million per year, prospectively. This increase was off- set in part by the impact of $11.9 million of lease reserves recorded in the prior year, as well as the acceleration of $10.3 million of depreciation in the prior year, both primar- ily related to certain office space permanently vacated as a part of our business streamlining initiative. The increase was also offset in part by $6.0 million in cost savings, also as a result of our business streamlining initiative. Amortization of intangible assets decreased 28.4% to $14.0 million, primarily due to certain management con- tracts becoming fully amortized during fiscal 2012. Impairment of intangible assets was $734.0 million in the year ended March 31, 2013. The impairment charges relate to our domestic mutual fund contracts asset, Permal funds-of-hedge fund contracts asset, and Permal trade name. The impairment charges resulted from a number of current trends and factors, including (i) a decrease in near-term margin projections; (ii) an increase in the rate used to discount projected future cash flows primarily due to company specific factors including continued market and regulatory influences, continued stock price uncertainty and the search for a permanent Chief Executive Officer, which was ongoing as of our December 31, 2012, impairment testing date; (iii) recent outflows and related reductions in assets under man- agement; and (iv) a reduction in the near-term projected growth rates. These changes resulted in a reduction of the projected cash flows and our overall assessment of fair value of the assets, such that the domestic mutual fund contracts asset, Permal funds-of-hedge funds contracts asset, and Permal trade name asset, declined below their carrying values, and accordingly were impaired by $396.0 million, $321.0 million, and $17.0 mil- lion, respectively. See Critical Accounting Policies and Note 5 of Notes to Consolidated Financial Statements for further discussion of the impairment charges. Other expenses decreased $2.2 million, or 1.2%, to $188.4 million, primarily due to a $4.1 million reduction in charges for trading errors. A $2.5 million decrease in expense reimbursements paid to certain mutual funds, and the impact of $1.7 million of transition-related costs recognized in the prior year, also contributed to the decrease. These decreases were offset in part by a $5.0 million increase in litigation-related expenses as a result of certain regulatory investigations. See Note 8 of Notes to Consolidated Financial Statements for further discussion of these investigations. A $1.8 million increase in professional fees, primarily related to initiatives with Permal, including the acquisition of Fauchier during fiscal 2013, also offset the decrease. Non-Operating Income (Expense) Interest income decreased 33.9% to $7.6 million, driven by a $2.6 million decrease due to lower yields earned on investment balances and a $1.8 million decrease due to lower average investment balances. Interest expense decreased 28.2% to $62.9 million, primar- ily as a result of the refinancing of the 2.5% Convertible Senior Notes (the “Notes”) in May 2012. Other non-operating income (expense) decreased $40.1 million, to an expense of $18.0 million, from income of $22.1 million in the prior year. This decrease was primarily a result of the $69.0 million loss on debt extinguishment recognized in connection with the repurchase of the Notes in May 2012. The impact of an $8.6 million gain related to an assigned bankruptcy claim, and a $7.5 million gain on the sale of a small affili- ate, both recognized in the prior year, also contributed to the decrease. These decreases were offset in part by a $22.7 million increase in net market gains on seed capital investments and assets invested for deferred compensa- tion plans, which are offset by corresponding increases in compensation discussed above, as well as a $20.8 mil- lion increase in net market gains on corporate invest- ments in proprietary fund products, which are not offset in compensation. Other non-operating income (expense) of consolidated investment vehicles (“CIVs”) decreased $21.2 million to an expense of $2.8 million, from income of $18.3 mil- lion in the prior year, primarily due to net market losses on investments of certain CIVs, as well as the impact of market gains recognized in the prior year period related to a previously consolidated CIV that was redeemed in the prior year. Income Tax Provision (Benefit) The benefit for income taxes was $150.9 million com- pared to a provision of $72.1 million in the prior year. In July 2011, The U.K. Finance Act 2011 was enacted, which reduced the main U.K. corporate tax rate from 27% to 26% effective April 1, 2011, and from 26% to 25% effective April 1, 2012. In July 2012, The U.K. Finance Act 2012 was enacted, further reducing the main U.K. corporate tax rate to 24% effective April 1, 2012 and 23% effective April 1, 2013. The impact of the tax rate changes on certain existing deferred tax assets and liabilities resulted in a tax benefit of $18.1 million in the current year. The prior year also included a similar U.K. tax benefit of $18.3 million on the revaluation of deferred tax assets and liabilities, and the impact was more sub- stantial due to the higher level of pre-tax income in that fiscal year. 30 Legg MasonThe effective benefit rate was 29.5% for the year ended March 31, 2013, compared to an effective tax rate of 23.8% in the prior year. Changes in the U.K. tax rate impacted the effective tax (benefit) rate by 3.5 percentage points in the year ended March 31, 2013, and 6.0 percent- age points in the prior year. The impact of CIVs reduced the effective tax (benefit) rate by 0.5 and 0.8 percentage points for the years ended March 31, 2013 and 2012, respectively. Otherwise, the change in the effective tax rate was primarily related to a lower tax benefit associated with the intangible asset impairment charge recorded in fiscal 2013, due to the lower statutory rates in the jurisdic- tions where certain intangible assets were held, partially offset by adjustments to reserves and the impact of cer- tain tax planning initiatives recorded in fiscal 2012. Net Income (Loss) Attributable to Legg Mason, Inc. Net Loss Attributable to Legg Mason, Inc. for the year ended March 31, 2013, totaled $353.3 million, or $2.65 per diluted share, compared to Net Income Attributable to Legg Mason, Inc. of $220.8 million, or $1.54 per diluted share, in the prior year. The decrease was primarily attrib- utable to the impact of the pre-tax impairment charges of $734.0 million ($508.3 million, net of income tax benefits, or $3.81 per diluted share), recorded in the current year, related to our indefinite-life intangible assets, as well as the $69.0 million pre-tax loss ($44.8 million, net of income tax benefits, or $0.34 per diluted share) on debt extin- guishment recognized in connection with the repurchase of the Notes in May 2012. Real estate related charges of $52.8 million also contributed to the decrease. These decreases were offset in part by the impact of transition- related costs recorded in the prior year, and the impact of increased cost savings in the current year, both in connec- tion with our business streamlining initiative. These items were previously discussed above. Supplemental Non-GAAP Financial Information As supplemental information, we are providing performance measures that are based on methodologies other than generally accepted accounting principles (“non-GAAP”) for “Adjusted Income” and “Operating Margin, As Adjusted” that management uses as benchmarks in evaluating and comparing our period-to-period operating performance. Adjusted Income decreased to $347.2 million, or $2.61 per diluted share, for the year ended March 31, 2013, from $397.0 million, or $2.77 per diluted share, in the prior year. Operating Margin, as Adjusted, for the years ended March 31, 2013 and 2012, was 16.8% and 21.3%, respec- tively. Operating Margin, as Adjusted for the year ended March 31, 2013 was reduced by 3.5 percentage points due to real estate related charges and management transition compensation costs recorded during fiscal 2013. Adjusted Income We define “Adjusted Income” as Net Income (Loss) Attributable to Legg Mason, Inc., plus amortization and deferred taxes related to intangible assets and goodwill, and imputed interest and tax benefits on contingent con- vertible debt less deferred income taxes on goodwill and indefinite-life intangible asset impairment, if any. We also adjust for non-core items that are not reflective of our eco- nomic performance, such as intangible asset impairments, the impact of tax rate adjustments on certain deferred tax liabilities related to indefinite-life intangible assets, and loss on extinguishment of contingent convertible debt. We believe that Adjusted Income provides a useful rep- resentation of our operating performance adjusted for non-cash acquisition related items and other items that facilitate comparison of our results to the results of other asset management firms that have not issued/extin- guished contingent convertible debt or made significant acquisitions. We also believe that Adjusted Income is an important metric in estimating the value of an asset man- agement business. Adjusted Income only considers adjustments for certain items that relate to operating performance and compa- rability, and therefore, is most readily reconcilable to Net Income (Loss) Attributable to Legg Mason, Inc. deter- mined under GAAP. This measure is provided in addition to Net Income (Loss) Attributable to Legg Mason, Inc., but is not a substitute for Net Income (Loss) Attributable to Legg Mason, Inc. and may not be comparable to non- GAAP performance measures, including measures of adjusted earnings or adjusted income, of other companies. Further, Adjusted Income is not a liquidity measure and should not be used in place of cash flow measures deter- mined under GAAP. We consider Adjusted Income to be useful to investors because it is an important metric in measuring the economic performance of asset manage- ment companies, as an indicator of value, and because it facilitates comparison of our operating results with the results of other asset management firms that have not issued/extinguished contingent convertible debt or made significant acquisitions. In calculating Adjusted Income, we add the impact of the amortization of management contract assets and impair- ment of indefinite-life intangible assets, both of which arise from acquisitions, to Net Income (Loss) Attributable to Legg Mason, Inc. to reflect the fact that these non-cash expenses distort comparisons of our operating results with the results of other asset management firms that have not engaged in significant acquisitions. Deferred taxes on indefinite-life intangible assets and goodwill include actual tax benefits from amortization deductions 31 Legg Masonthat are not realized under GAAP absent an impairment charge or the disposition of the related business. Because we fully expect to realize the economic benefit of the cur- rent period tax amortization, we add this benefit to Net Income (Loss) Attributable to Legg Mason, Inc. in the cal- culation of Adjusted Income. However, because of our net operating loss carry-forward, we will receive the benefit of the current tax amortization over time. Conversely, we subtract the non-cash income tax benefits on goodwill and indefinite-life intangible asset impairment charges and United Kingdom tax rate adjustments on excess book basis on certain acquired indefinite-life intangible assets, if applicable, that have been recognized under GAAP. We also add back non-cash imputed interest and the extin- guishment loss on contingent convertible debt adjusted for amounts allocated to the conversion feature, as well as adding the actual tax benefits on the imputed inter- est that are not realized under GAAP. These adjustments reflect that these items distort comparisons of our operat- ing results to prior periods and the results of other asset management firms that have not engaged in significant acquisitions, including any related impairments, or issued/ extinguished contingent convertible debt. Should a disposition, impairment charge or other non-core item occur, its impact on Adjusted Income may distort actual changes in the operating performance or value of our firm. Accordingly, we monitor these items and their related impact, including taxes, on Adjusted Income to ensure that appropriate adjustments and explanations accompany such disclosures. Although depreciation and amortization of fixed assets are non-cash expenses, we do not add these charges in calcu- lating Adjusted Income because these charges are related to assets that will ultimately require replacement. A reconciliation of Net Income (Loss) Attributable to Legg Mason, Inc. to Adjusted Income (in thousands except per share amounts) is as follows: Net Income (Loss) Attributable to Legg Mason, Inc. Plus (less): Amortization of intangible assets Loss on extinguishment of 2.5% senior notes Impairment of intangible assets Deferred income taxes on intangible assets: Impairment charges Tax amortization benefit U.K. tax rate adjustment Imputed interest on convertible debt (2.5% senior notes) Adjusted Income Net Income (Loss) per diluted share Attributable to Legg Mason, Inc. common shareholders Plus (less): Amortization of intangible assets Loss on extinguishment of 2.5% senior notes Impairment of intangible assets Deferred income taxes on intangible assets: Impairment charges Tax amortization benefit U.K. tax rate adjustment Imputed interest on convertible debt (2.5% senior notes) For the Years Ended March 31, 2013 2012 $(353,327) $220,817 14,019 54,873 734,000 (225,748) 135,588 (18,075) 5,839 19,574 — — — 135,830 (18,268) 39,077 $ 347,169 $397,030 $ (2.65) $ 1.54 0.11 0.41 5.51 (1.69) 1.02 (0.14) 0.04 0.14 — — — 0.95 (0.13) 0.27 Adjusted Income per diluted share $ 2.61 $ 2.77 32 Legg MasonOperating Margin, as Adjusted We calculate “Operating Margin, as Adjusted,” by divid- ing (i) Operating Income (Loss), adjusted to exclude the impact on compensation expense of gains or losses on investments made to fund deferred compensation plans, the impact on compensation expense of gains or losses on seed capital investments by our affiliates under revenue sharing agreements, transition-related costs of streamlining our business model, income (loss) of CIVs, and impairment charges by (ii) our operating revenues, adjusted to add back net investment advisory fees eliminated upon consolida- tion of investment vehicles, less distribution and servicing expenses which we use as an approximate measure of revenues that are passed through to third parties, which we refer to as “Operating Revenues, as Adjusted.” The compensation items, other than transition-related costs, are removed from Operating Income (Loss) in the calcula- tion because they are offset by an equal amount in Other non-operating income (expense), and thus have no impact on Net Income (Loss) Attributable to Legg Mason, Inc. Transition-related costs, impairment charges and income (loss) of CIVs are removed from Operating Income (Loss) in the calculation because these items are not reflective of our core asset management operations. We use Operating Revenues, as Adjusted in the calculation to show the oper- ating margin without distribution and servicing expenses, which we use to approximate our distribution revenues that are passed through to third parties as a direct cost of selling our products, although distribution and servicing expenses may include commissions paid in connection with the launching of closed-end funds for which there is no cor- responding revenue in the period. Operating Revenues, as Adjusted, also include our advisory revenues we receive from CIVs that are eliminated in consolidation under GAAP. We believe that Operating Margin, as Adjusted, is a useful measure of our performance because it provides a mea- sure of our core business activities excluding items that have no impact on Net Income (Loss) Attributable to Legg Mason, Inc. and because it indicates what our operating margin would have been without the distribution rev- enues that are passed through to third parties as a direct cost of selling our products, transition-related costs and impairment charges, and the impact of the consolidation of certain investment vehicles described above. The con- solidation of these investment vehicles does not have an impact on Net Income (Loss) Attributable to Legg Mason, Inc. This measure is provided in addition to our operating margin calculated under GAAP, but is not a substitute for calculations of margins under GAAP and may not be com- parable to non-GAAP performance measures, including measures of adjusted margins of other companies. The calculation of Operating margin and Operating margin, as adjusted, is as follows (dollars in thousands): Operating Revenues, GAAP basis Plus (less): Operating revenues eliminated upon consolidation of investment vehicles Distribution and servicing expense excluding consolidated investment vehicles Operating Revenues, as Adjusted Operating Income (Loss), GAAP basis Plus (less): Gains (losses) on deferred compensation and seed investments Transition-related costs Impairment of intangible assets Operating income and expenses of consolidated investment vehicles Operating Income, as Adjusted Operating Margin, GAAP basis Operating Margin, as Adjusted For the Years Ended March 31, 2013 2012 $2,612,650 $2,662,574 2,397 (600,582) $2,014,465 $ (434,499) 3,094 (649,679) $2,015,989 $ 338,753 36,497 — 734,000 2,959 13,809 73,066 — 3,702 $ 338,957 $ 429,330 (16.6)% 16.8 12.7% 21.3 33 Legg MasonFISCAL 2012 COMPARED WITH FISCAL 2011 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(1) Subscriptions Redemptions Separate account flows, net Liquidity fund flows, net Net client cash flows Market performance and other(2) Dispositions End of period 2012 $677.6 2011 $684.5 46.9 (51.1) (35.9) 12.6 (27.5) 17.1 (23.9) 49.5 (44.3) (52.1) (14.2) (61.1) 56.3 (2.1) $643.3 $677.6 (1) Subscriptions and redemptions reflect the gross activity in the funds and include assets transferred between funds and between share classes. (2) Includes impact of foreign exchange, reinvestment of dividends, and other. AUM at March 31, 2012, was $643.3 billion, a decrease of $34.3 billion, or 5%, from March 31, 2011. The decrease in AUM was attributable to net client outflows of $27.5 bil- lion and dispositions of $23.9 billion, which were partially offset by market performance and other of $17.1 billion, including the negative impact of foreign currency exchange fluctuations. The majority of dispositions were in liquidity assets, $19.9 billion, which resulted from the amendment of historical Smith Barney brokerage programs discussed below. There were also $4.0 billion in dispositions from the divestiture of two small affiliates. Long-term asset classes accounted for the net client outflows, with $21.3 billion and $18.6 billion in equity and fixed income outflows, respectively, partially offset by liquidity inflows of $12.4 billion. Equity outflows were primarily expe- rienced by products managed at LMCM, ClearBridge, Batterymarch and Royce. The majority of fixed income outflows were in products managed by Western Asset, including $12.7 billion in outflows from a single, low fee global sovereign mandate. The amendment of certain historical Smith Barney broker- age programs during the first quarter of fiscal 2012, as previously discussed, resulted in a reduction of $19.9 bil- lion in liquidity AUM during the year ended March 31, 2012. As a significant portion of the management fees generated by these assets were being waived prior to the disposition, the disposition of this liquidity AUM resulted in a reduction in operating revenue of $52.3 million, net of related fee waivers, in the year ended March 31, 2012, as compared to the year ended March 31, 2011. The disposi- tion of this AUM also resulted in reductions in distribu- tion and servicing expenses of $41.4 million in the year ended March 31, 2012, as compared to the year ended March 31, 2011. AUM by Asset Class AUM by asset class (in billions) as of March 31 were as follows: Equity Fixed income Liquidity Total 2012 $163.4 356.1 123.8 $643.3 % of Total 26% 55 19 100% 2011 $189.6 356.6 131.4 $677.6 % of Total % Change 28% (14)% 53 19 — (6) 100% (5)% The component changes in our AUM by asset class (in billions) for the fiscal year ended March 31, 2011, were as follows: March 31, 2011 Investment funds, excluding liquidity funds Subscriptions Redemptions Separate account flows, net Liquidity fund flows, net Net client cash flows Market performance and other Dispositions March 31, 2012 34 Equity $189.6 Fixed Income Liquidity $356.6 $131.4 Total $677.6 21.7 (30.4) (12.6) — (21.3) (2.1) (2.8) 25.2 (20.7) (23.1) — (18.6) 19.3 (1.2) — — (0.2) 12.6 12.4 (0.1) (19.9) 46.9 (51.1) (35.9) 12.6 (27.5) 17.1 (23.9) $163.4 $356.1 $123.8 $643.3 Legg MasonAverage AUM by asset class (in billions) for the years ended March 31 were as follows: Equity Fixed Income Liquidity Total 2012 $168.4 359.8 116.6 $644.8 % of Total 26% 56 18 100% 2011 $173.8 361.6 133.8 $669.2 % of Total % Change 26% (3)% 54 20 — (13) 100% (4)% AUM by Distribution Channel The component changes in our AUM by distribution channel (in billions) for the fiscal year ended March 31, 2012, were as follows: March 31, 2011 Net client cash flows, excluding liquidity funds Liquidity fund flows, net Net client cash flows Market performance and other Dispositions March 31, 2012 Global Distribution Affiliate/Other $220.3 $457.3 (2.3) — (2.3) 2.6 — (37.8) 12.6 (25.2) 14.5 (23.9) Total $677.6 (40.1) 12.6 (27.5) 17.1 (23.9) $220.6 $422.7 $643.3 For the years ended March 31, 2012 and 2011, our overall effective fee rate across all asset classes and distribution channels was 35 and 34 basis points, respectively. Fees for managing equity assets are generally higher, averaging approximately 75 basis points for each of the years ended March 31, 2012 and 2011. This compares to fees for manag- ing fixed income assets, which averaged approximately 25 basis points for each of the years ended March 31, 2012 and 2011, and liquidity assets, which averaged under 10 basis points (reflecting the impact of current advisory fee waivers due to the low interest rate environment) for each of the years ended March 31, 2012 and 2011. Fee rates for assets distributed through Legg Mason Global Distribution, which are predominately retail in nature, averaged approximately 50 basis points for each of the years ended March 31, 2012 and 2011, while fee rates for assets distributed through the Affiliate/Other channel averaged approximately 20 basis points for each of the years ended March 31, 2012 and 2011. The decline in higher yielding equity assets has impacted our revenues, as further discussed below. Investment Performance Overall investment performance of our assets under man- agement in the year ended March 31, 2012, was generally positive compared to relevant benchmarks. The equity markets ended a difficult year on a positive note, responding favorably to improving unemployment figures, the conclusion of bank stress tests resulting in certain banks increasing dividends, and reduced fears of a European debt fallout. As a result, most U.S. indices produced positive returns for our fiscal 2012. The most notable was the NASDAQ Composite returning 11.2% for the year ended March 31, 2012. In the fixed income markets, improved economic data suggested that the recovery was strengthening. Flights-to- safety ebbed as the European debt crisis eased allowing U.S. Treasury rates to climb from historically low levels. The yield curve steepened over the year as economic releases from the Federal Reserve Board painted an increasingly optimistic picture and talk of a third round of quantitative easing diminished. The worst performing fixed income sector for the year was high yield bonds, as measured by the Barclays High Yield Index returning 6.5%. The best performing fixed income sector for the year was Treasury Inflation Protected Securities (TIPS), as measured by the Barclays U.S. TIPS Index returning 12.2% as of March 31, 2012. 35 Legg MasonThe following table presents a summary of the percentages by strategy(1) that outpaced their respective benchmarks as of March 31, 2012 and 2011, for the trailing 1-year, 3-year, 5-year, and 10-year periods: Total (includes liquidity) 1-year 62% 3-year 81% 5-year 70% 10-year 87% 1-year 76% 3-year 79% 5-year 74% 10-year 84% As of March 31, 2012 As of March 31, 2011 Equity: Large cap Small cap Total equity 66% 49% 43% 63% 66% 88% 78% 89% 40% 68% 61% 75% 55% 89% 63% 99% (includes other equity) 53% 52% 66% 80% 47% 59% 60% 77% Fixed income: U.S. taxable U.S. tax-exempt Global taxable Total fixed income 66% 2% 38% 51% 95% 2% 93% 87% 61% 2% 70% 60% 89% 1% 97% 84% 93% 3% 81% 82% 83% 3% 91% 80% 77% 2% 73% 70% 83% 3% 94% 81% The following table presents a summary of the percentages of our U.S. mutual fund assets(2) that outpaced their Lipper category averages as of March 31, 2012 and 2011, for the trailing 1-year, 3-year, 5-year, and 10-year periods: As of March 31, 2012 As of March 31, 2011 1-year 3-year 5-year 10-year 1-year 3-year 5-year 10-year Total long-term (excludes liquidity) 67% 66% 78% 74% 56% 74% 70% 67% Equity: Large cap Small cap Total equity 78% 44% 51% 63% 48% 93% 45% 98% 39% 72% 63% 76% 31% 91% 21% 98% (includes other equity) 57% 56% 73% 71% 58% 70% 68% 60% Fixed income: U.S. taxable U.S. tax-exempt Global taxable Total fixed income 76% 91% 96% 84% 91% 70% 81% 81% 82% 91% 91% 87% 83% 82% 87% 83% 79% 6% 80% 52% 85% 77% 94% 83% 78% 82% 41% 78% 80% 90% 88% 85% (1) For purposes of investment performance comparisons, strategies are an aggregation of discretionary portfolios (separate accounts, investment funds, and other products) into a single group that represents a particular investment objective. In the case of separate accounts, the investment performance of the account is based upon the performance of the strategy to which the account has been assigned. Each of our asset managers has its own specific guidelines for including portfolios in their strategies. For those managers which manage both separate accounts and investment funds in the same strategy, the per- formance comparison for all of the assets is based upon the performance of the separate account. As of March 31, 2012 and 2011, 91% of total AUM is included in strategy AUM in each period, although not all strategies have three-, five-, and ten-year histories. Total strategy AUM includes liquidity assets. Certain assets are not included in reported performance comparisons. These include: accounts that are not managed in accordance with the guidelines outlined above; accounts in strategies not marketed to potential clients; accounts that have not yet been assigned to a strategy; and certain smaller products at some of our affiliates. Past performance is not indicative of future results. For AUM included in institutional and retail separate accounts and investment funds included in the same strategy as separate accounts, performance comparisons are based on gross-of-fee performance. For investment funds (including fund-of-hedge funds) which are not managed in a separate account format, performance comparisons are based on net-of-fee performance. These performance com- parisons do not reflect the actual performance of any specific separate account or investment fund; individual separate account and investment fund performance may differ. Certain prior year amounts have been updated to conform to the current year presentation. (2) Source: Lipper Inc. includes open-end, closed-end, and variable annuity funds. As of March 31, 2012 and 2011, the U.S. long-term mutual fund assets rep- resented in the data accounted for 18% and 17%, respectively, of our total AUM. The performance of our U.S. long-term mutual fund assets is included in the marketed composites. 36 Legg Mason RESULTS OF OPERATIONS Operating Revenues Total operating revenues for the year ended March 31, 2012, were $2.7 billion, a decrease of 4.4% from $2.8 bil- lion in the prior year, primarily due to a 4% decrease in average AUM and a $47.2 million decrease in performance fees. This decrease was offset in part by an increase in average AUM revenue yields, from 34.4 basis points in the year ended March 31, 2011, to 35.2 basis points in the year ended March 31, 2012, resulting from a more favorable average asset mix. The disposition of liquidity AUM related to the Morgan Stanley Wealth Management (“MSWM”) relationship resulted in a reduction in operat- ing revenues of $52.3 million, net of related fee waivers, in fiscal 2012, as compared to fiscal 2011, as a significant portion of the management fees generated by these assets were being waived prior to the disposition. Investment advisory fees from separate accounts decreased $40.1 million, or 4.9%, to $775.5 million. Of this decrease, $25.9 million was primarily the result of lower average equity assets managed by LMCM, Batterymarch, ClearBridge and Legg Mason Investment Counsel & Trust Company (“LMIC”), and $8.0 million was primarily due to the divestiture of a Singapore-based asset manager in fiscal 2011. These decreases were offset in part by an increase of $6.7 million due to higher average fixed income assets managed by Brandywine. Investment advisory fees from funds remained essen- tially flat at $1.5 billion for both periods. Higher average equity assets managed by Royce and ClearBridge, and higher average fixed income assets, primarily managed at Western Asset, resulted in an increase of $41.3 million and $41.1 million, respectively. These increases were offset by a decrease of $51.3 million, net of related fee waivers, due to lower average liquidity assets managed at Western Asset, primarily as a result of the previously discussed disposition of liquidity AUM related to our MSWM relationship, as well as a $31.5 million decrease as a result of lower average equity assets managed by LMCM and Permal. Of our total AUM as of March 31, 2012 and 2011, approxi- mately 6% for each period was in accounts that were eligible to earn performance fees. Performance fees decreased 48.8%, or $47.2 million, to $49.5 million dur- ing the year ended March 31, 2012, primarily as a result of lower fees earned on assets managed at Permal and Western Asset, offset slightly by an increase in perfor- mance fees earned on assets managed at Brandywine. Distribution and service fees decreased $38.2 million, or 10.1%, to $341.0 million, primarily due to the disposition of the liquidity AUM related to the MSWM relationship, as well as a decline in average mutual fund AUM subject to distribution and service fees. Operating Expenses Total operating expenses for the year ended March 31, 2012, were $2.3 billion, a decrease of 3.1% from $2.4 bil- lion in the prior year. Operating expenses for the year ended March 31, 2012, incurred at the investment manage- ment affiliate level comprised approximately 70% of total operating expenses. The remaining operating expenses are comprised of corporate and distribution costs. The components of total compensation and benefits (in millions) for the years ended March 31 were as follows: Years Ended March 31, 2012 2011 Salaries and incentives $ 895.0 $ 905.8 Benefits and payroll taxes Transition-related costs Other 196.7 34.6 18.0 194.7 45.0 39.9 Total compensation and benefits $1,144.3 $1,185.4 Total compensation and benefits decreased 3.5% to $1.1 billion; • Salaries and incentives decreased $10.8 million, primarily due to a $40.6 million decrease in corpo- rate salaries and incentives, primarily resulting from headcount reductions in connection with our busi- ness streamlining initiative, and a $40.3 million net decrease in salaries and incentives at revenue-share based affiliates. These decreases were offset in part by an increase in incentives of $51.0 million resulting from changes in an expense reimbursement arrange- ment with Western Asset, as well as additional costs of $20.5 million associated with market-based com- pensation increases among retained staff and new employees, primarily in our global distribution group, to support ongoing growth initiatives. • Benefits and payroll taxes increased $2.0 million, primarily due to an $11.2 million increase in non- cash amortization expense associated with certain deferred compensation awards at revenue-share based affiliates. This increase was offset in part by a $9.2 million decrease in corporate benefits expense, primarily due to headcount reductions resulting from our business streamlining initiative. • Transition-related costs decreased $10.4 million. These costs represent accruals for severance and retention costs related to our business streamlining initiative. • Other compensation and benefits decreased $21.9 mil- lion, primarily due to a decrease in revenue-share 37 Legg Masonbased incentive obligations resulting from net market losses on assets invested for seed capital invest- ments and deferred compensation plans, which were offset by corresponding increases in Other non-oper- ating income (expense). Compensation as a percentage of operating revenues increased to 43.0% from 42.6% in the prior fiscal year, primarily due to the impact of the change in the expense reimbursement arrangement with Western Asset, as well as market-based compensation increases among retained staff and new employees. These increases were offset in part by the impact of lower corporate compensation costs, primarily attributable to our business streamlining initiative, the impact of compensation decreases related to reduced market gains on assets invested for deferred compensa- tion plans and seed capital investments, and the decrease in transition-related compensation. Distribution and servicing expenses decreased 8.9% to $649.7 million, principally driven by a $41.4 million decrease due to the previously discussed disposition of liquidity AUM related to the MSWM relationship, as well as a $6.9 million decrease in servicing expenses as a result of our business streamlining initiative. A $5.8 mil- lion decline in structuring fees related to closed-end fund launches also contributed to the decrease. Communications and technology expense increased 1.7% to $164.7 million, driven by increases, principally in data processing costs, market data costs, and consulting fees, totaling $12.2 million, primarily due to transition-related costs incurred as a result of our business streamlining initiative. These increases were offset in part by $9.3 mil- lion in cost savings as a result of our streamlining changes, including reduced depreciation of technology hardware and software and consulting fees. Occupancy expense increased 12.3% to $154.8 mil- lion, primarily due to a $14.7 million net increase in lease reserves recorded in fiscal 2012, primarily related to per- manently abandoning certain office space as part of our business streamlining initiative. In addition, there was a $10.3 million increase as a result of the acceleration of depreciation related to space permanently abandoned in fiscal 2012, also related to our business streamlining initia- tive. These increases were offset in part by the impact of the write-off of a $4.1 million real estate escrow deposit in the prior year and a $3.3 million reduction in depreciation on furniture and leasehold improvements, both resulting from our business streamlining initiative. Amortization of intangibles decreased 14.6% to $19.6 mil- lion, primarily due to the full amortization of certain man- agement contracts during fiscal 2012. Other expenses increased $14.1 million, or 8.0%, to $190.7 million, primarily as a result of an increase in expense reimbursements paid to certain mutual funds dur- ing the current year under expense cap arrangements. Non-Operating Income (Expense) Interest income increased 24.2% to $11.5 million, driven by higher yields earned on investment balances. Interest expense decreased 5.0% to $87.6 million, pri- marily as a result of the retirement of our Equity Units during fiscal 2012, which reduced interest expense by $4.1 million. Other non-operating income decreased $37.5 million to $22.1 million, primarily as a result of $56.0 million in net market losses on investments in proprietary fund products, which were partially offset by corresponding compensation decreases discussed above, and $11.8 mil- lion due to reduced gains on assets invested for deferred compensation plans, which were substantially offset by corresponding compensation decreases described above. These decreases were offset in part by an $11.3 million increase in dividend income, which was partially offset by a corresponding compensation increase under revenue- sharing agreements, a gain of $8.6 million related to an assigned bankruptcy claim, and a gain of $7.5 million on the sale of a small affiliate. Other non-operating income of CIVs increased $16.6 mil- lion to $18.3 million, due to net market gains on invest- ments of certain CIVs. Income Tax Provision The provision for income taxes was $72.1 million com- pared to $119.4 million in the prior year. During fiscal 2012, The U.K. Finance Act 2011 (the “Act”) was enacted. The Act reduced the main U.K. corporate income tax rate from 27% to 26% effective April 1, 2011, and to 25% effective April 1, 2012. The impact of the tax rate changes on the revaluation of certain existing deferred tax liabilities resulted in a tax benefit of $18.3 million in the current year. The prior year also included a similar tax benefit of $8.9 million on the revaluation of deferred tax liabilities. In addition, the restructuring of our Australian business, partially offset by adjustments to the net value of certain deferred tax assets, resulted in a net tax benefit of $10.1 million in the current year. The effective tax rate was 23.8% compared to 32.7% in the prior year. Changes in the U.K. tax rate impacted the effective tax rate by 6.0 38 Legg Masonand 2.5 percentage points in the years ended March 31, 2012 and 2011, respectively. In addition, the restructuring of our Australian business, partially offset by adjustments to the net value of certain deferred tax assets, impacted the effective tax rate by 3.3 percentage points in the cur- rent year. Net Income Attributable to Legg Mason, Inc. Net Income Attributable to Legg Mason, Inc. for the year ended March 31, 2012, totaled $220.8 million, or $1.54 per diluted share, compared to $253.9 million, or $1.63 per diluted share, in the prior year. The decrease in Net Income was primarily due to an increase in incentive compensation from changes in an expense reimburse- ment arrangement with Western Asset, the impact of net market losses on proprietary fund products and assets invested for deferred compensation plans which are not offset in compensation and benefits, and the net impact of decreased operating revenues. These decreases were off- set in part by the impact of cost savings due to our busi- ness streamlining initiative, and the impact of tax benefits associated with the restructuring of a foreign subsidiary and U.K. tax rate changes. These items were previously discussed in “Results of Operations” above. Supplemental Non-GAAP Financial Information Adjusted Income decreased to $397.0 million, or $2.77 per diluted share, for the year ended March 31, 2012, from $439.2 million, or $2.83 per diluted share, in the prior year primarily due to the decrease in Net Income, previously discussed, excluding the impact of U.K. tax rate adjustments. Operating Margin, as Adjusted, for the years ended March 31, 2012 and 2011, was 21.3% and 23.2%, respectively. Adjusted Income A reconciliation of Net Income Attributable to Legg Mason, Inc. to Adjusted Income (in thousands except per share amounts) is as follows: Net Income Attributable to Legg Mason, Inc. Plus (less): Amortization of intangible assets Deferred income taxes on intangible assets: Tax amortization benefit U.K. tax rate adjustment Imputed interest on convertible debt (2.5% senior notes) Adjusted Income Net Income per diluted share Attributable to Legg Mason, Inc. common shareholders Plus (less): Amortization of intangible assets Deferred income taxes on intangible assets: Tax amortization benefit U.K. tax rate adjustment Imputed interest on convertible debt (2.5% senior notes) Adjusted Income per diluted share For the Years Ended March 31, 2012 2011 $220,817 $253,923 19,574 22,913 135,830 (18,268) 39,077 134,602 (8,878) 36,688 $397,030 $439,248 $ 1.54 $ 1.63 0.14 0.95 (0.13) 0.27 0.15 0.87 (0.06) 0.24 $ 2.77 $ 2.83 39 Legg MasonOperating Margin, as Adjusted The calculation of Operating margin and Operating margin, as adjusted, is as follows (dollars in thousands): Operating Revenues, GAAP basis Plus (less): Operating revenues eliminated upon consolidation of investment vehicles Distribution and servicing expense excluding consolidated investment vehicles Operating Revenues, as Adjusted Operating Income, GAAP basis Plus (less): Gains (losses) on deferred compensation and seed investments Transition-related costs Operating income and expenses of consolidated investment vehicles For the Years Ended March 31, 2012 2011 $2,662,574 $2,784,317 3,094 4,133 (649,679) (712,779) $2,015,989 $ 338,753 $2,075,671 $ 386,808 13,809 73,066 3,702 36,274 54,434 4,704 $ 429,330 $ 482,220 12.7% 21.3 13.9% 23.2 no recourse to our general credit beyond the level of our investment, if any, so we do not consider these liabilities to be our obligations. Our assets consist primarily of intangible assets, good- will, cash and cash equivalents, investment securities, and investment advisory and related fee receivables. Our assets have been principally funded by equity capital, long- term debt and the results of our operations. At March 31, 2013, our cash and cash equivalents, total assets, long- term debt and stockholders’ equity were $0.9 billion, $7.0 billion, $1.1 billion and $4.8 billion, respectively. Total assets and total liabilities of the CIVs at March 31, 2013, were $285 million and $221 million, respectively. Cash and cash equivalents are primarily invested in liquid domestic and non-domestic money market funds that hold principally domestic and non-domestic bank time deposits, bank and corporate commercial paper and bonds, and gov- ernment and agency securities. We have not recognized any losses on these investments. Our monitoring of cash and cash equivalents mitigates the potential that material risks may be associated with these balances. Operating Income, as Adjusted Operating Margin, GAAP basis Operating Margin, as Adjusted LIqUIDITy AND CAPITAL RESOURCES The primary objective of our capital structure is to appro- priately support our business strategies and to provide needed liquidity at all times, including maintaining required capital in certain subsidiaries. Liquidity and the access to liquidity is important to the success of our ongoing opera- tions. Our overall funding needs and capital base are con- tinually reviewed to determine if the capital base meets the expected needs of our businesses. 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. The consolidation of variable interest entities discussed above does not impact our liquidity and capital resources. We have no rights to the benefits from, nor do we bear the risks associated with, the assets and liabilities of the CIVs beyond our investments in and investment advisory fees generated from these vehicles, which are eliminated in consolidation. Additionally, creditors of the CIVs have 40 Legg MasonThe following table summarizes our Consolidated Statements of Cash Flows for the years ended March 31 (in millions): Cash flows provided by operating activities Cash flows provided by/(used in) investing activities Cash flows used in financing activities Effect of exchange rate changes Net change in cash and cash equivalents Cash and cash equivalents, beginning of period Cash and cash equivalents, end of period 2013 $ 303.3 (11.0) (735.9) (5.7) (449.3) 1,382.3 $ 933.0 2012 2011 $ 496.8 $ 412.1 2.3 (481.8) (10.9) 6.4 1,375.9 $1,382.3 (44.4) (468.5) 10.8 (90.0) 1,465.9 $1,375.9 Cash inflows provided by operating activities during fiscal 2013 were $303.3 million, primarily related to net sales of trading and other current investments and results of operations, adjusted for non-cash items, offset in part by the allocation of extinguished debt repayment and pay- ments for accrued compensation. Cash outflows used in investing activities during fiscal 2013, were $11.0 million, primarily related to payments related to the acquisition of Fauchier and payments made for fixed assets, offset in part by net activity related to CIVs. Cash outflows used in financing activities during fiscal 2013 were $735.9 mil- lion, primarily related to the repayment of long-term debt of $1,049.2 million, the repurchase of 16.2 million shares of our common stock for $425.5 million, the $250.0 mil- lion repayment of short-term debt, and dividends paid of $55.3 million, offset in part by the proceeds from the sub- sequent long-term debt issuances of $1,143.2 million. Cash inflows provided by operating activities during fis- cal 2012 were $496.8 million, primarily related to Net Income, adjusted for non-cash items. Cash inflows provided by investing activities during fiscal 2012, were $2.3 million, primarily related to $20.2 million of net activity related to CIVs and a release of restricted cash required for market hedge arrangements, offset in part by payments made for fixed assets. Cash outflows used in financing activities during fiscal 2012, were $481.8 mil- lion, primarily due to the repurchase of 13.6 million shares of our common stock for $400.3 million and dividends paid of $43.6 million. Cash inflows provided by operating activities during fis- cal 2011 were $412.1 million, primarily attributable to Net Income, adjusted for non-cash items. Cash outflows used in investing activities during fiscal 2011 were $44.4 mil- lion, primarily attributable to payments made for fixed assets. Cash outflows used in financing activities during fiscal 2011 were $468.5 million, primarily attributable to the repurchase of 14.6 million of our common shares for $445 million. Financing Transactions The table below reflects our primary sources of financing (in thousands) as of March 31, 2013: Type Total at March 31, 2013 Amount Outstanding at March 31, 2013 2012 Interest Rate 5.5% Senior Notes $650,000 $650,000 Five-year Amortizing Term Loan Revolving Credit Agreement 500,000 500,000 2.5% Convertible Senior Notes Previous Revolving Credit Agreement — — 500,000 — — — N/A N/A N/A 5.50% LIBOR + 1.5% LIBOR + 1.5% + 0.20% annual commitment fee Maturity May 2019 June 2017 June 2017 1,127,009 2.50% Repurchased June 2012 250,000 LIBOR + 2.625% Terminated June 2012 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 was used for general corporate purposes, including the purchase of structured investment vehicle securities from our liquidity funds. The Notes were repurchased in May 2012, as further discussed below. Prior to the repurchase of the Notes, we were accreting the carrying value of the Notes to the principal amount at maturity using an interest rate of 6.5% (the effective borrowing rate for non-convertible debt at the time of issuance) over its expected life of seven years, resulting in additional interest expense for fiscal 2013, 2012 and 2011, of approximately $5.8 million, $39.1 million 41 Legg Masonand $36.7 million, respectively. In connection with this financing, we entered into economic hedge transactions that increased the effective conversion price of the Notes. These hedge transactions had a net cost to us of $83 mil- lion, which we paid from the proceeds of the Notes. These transactions closed on January 31, 2008. Capital Plan In May 2012, we announced a capital plan that included refinancing the Notes. The refinancing was effected through the issuance of $650 million of 5.5% senior notes, the net proceeds of which, together with cash on hand and $250 million of remaining borrowing capacity under a then existing revolving credit facility, were used to repurchase all $1.25 billion of the Notes. The terms of the repurchase included the repayment of the Notes at par plus accrued interest, a prepayment fee of $6.3 million, and the issuance of warrants to the holders of the Notes. The warrants provide for the purchase, in the aggregate and subject to adjustment, of 14.2 million shares of our common stock, on a net share settled basis, at an exercise price of $88 per share. The warrants expire in June 2017 and can be settled, at our election, in either shares of com- mon stock or cash. Also pursuant to the capital plan, in June 2012, we entered into an unsecured credit agreement which provides for an undrawn $500 million revolving credit facility and a $500 million term loan. The proceeds of the term loan were used to repay the $500 million of outstanding bor- rowings under the previous revolving credit facility, which was then terminated. The $500 million revolving credit facility may be increased by an aggregate amount up to $250 million, subject to the approval of the lenders, and expires June 2017. This revolv- ing credit facility is available to fund working capital needs and for general corporate purposes. There were no borrow- ings outstanding under this facility as of March 31, 2013. The $500 million term loan entered into in conjunction with the unsecured credit agreement noted above can be repaid at any time and is due in four annual installments of $50 million, beginning in June 2013, with the remainder to be repaid at maturity in June 2017. The $650 million 5.5% senior notes are due May 2019 and were sold at a discount of $6.8 million, which is being amortized to interest expense over the seven-year term. The financial covenants under our bank agreements include: maximum net debt to EBITDA ratio of 2.5 to 1 and minimum EBITDA to interest expense ratio of 4.0 to 1. Debt is defined to include all obligations for borrowed money, excluding non-recourse debt of CIVs, and capi- tal leases. Under these net debt covenants, our debt is reduced by the amount of our unrestricted cash in excess of the greater of subsidiary cash or $375 million. EBITDA is defined as consolidated net income (loss) plus/minus tax expense (benefit), interest expense, depreciation and amortization, amortization of intangibles, any extraordinary expense or losses, and any non-cash charges, as defined in the agreements. As of March 31, 2013, our net debt to EBITDA ratio was 1.4 to 1 and EBITDA to interest expense ratio was 11.6 to 1, and, therefore, we have maintained compliance with the applicable covenants. In addition, the 5.5% senior notes are subject to certain nonfinancial covenants, including provisions relating to dispositions of certain assets, which could require a percentage of any related proceeds to be applied to accelerated repayments. If our net income (loss) significantly declines, or if we spend our available cash, it may impact our ability to main- tain compliance with the financial covenants. If we deter- mine that our compliance with these covenants may be under pressure, we may elect to take a number of actions, including reducing our expenses in order to increase our EBITDA, using available cash to repay all or a portion of our outstanding debt subject to these covenants or seek- ing to negotiate with our lenders to modify the terms or to restructure our debt. We anticipate that we will have avail- able cash to repay 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 modification or restructuring of our debt would likely result in additional fees or interest payments. Our outstanding bank debt agreement is currently impacted by the ratings of two rating agencies. The interest rate and annual commitment fee on our revolving line of credit is based on the higher credit rating of the two rating agen- cies. In June 2011, our rating by one of these agencies was downgraded one notch below the other. Should the other agency downgrade our rating, absent an upgrade from the former agency, our interest costs will rise modestly. In addi- tion, under the terms of the 5.5% senior notes, the interest rate paid on these notes will increase modestly if our credit ratings are reduced below investment grade. In connection with the extinguishment of the Notes, the hedge transactions (purchased call options and warrants) executed in connection with the initial issuance of the Notes were also terminated. Also in connection with the capital plan, our board of direc- tors authorized $1.0 billion for additional purchases of our common stock, $730 million of which remained available as of March 31, 2013, and the completion of the purchase 42 Legg Masonof the then remaining $155 million of our common stock previously authorized, which occurred in the quarter ended June 30, 2012. The capital plan authorizes using up to 65% of cash generated from future operations, beginning in fiscal 2013, to purchase shares of our common stock. Other Transactions On March 13, 2013, we completed the acquisition of all of the outstanding share capital of Fauchier, a leading European based manager of funds-of-hedge funds, from BNP Paribas Investment Partners, S.A. The transaction included an initial cash payment of $63.4 million, which was funded from existing cash resources. In addition, contingent consideration of up to approximately $23.0 mil- lion and approximately $30.0 million, utilizing exchange rates as of March 31, 2013, may be due on the second and fourth anniversaries of closing, respectively, dependent on achieving certain financial targets and subject to a catch up adjustment. The contingent consideration liability had an acquisition date fair value of approximately $21.6 million. In May 2010, we terminated the exchangeable share arrangement related to the acquisition of Legg Mason Canada Inc., in accordance with its terms. In this transac- tion, 1.1 million shares, representing all remaining out- standing exchangeable shares, were exchanged for shares of our common stock on a one-for-one basis. Certain of our asset management affiliates maintain vari- ous credit facilities for general operating purposes. Certain affiliates are also subject to the capital requirements of various regulatory agencies. All such affiliates met their respective capital adequacy requirements during the peri- ods presented. See Notes 2 and 6 of Notes to Consolidated Financial Statements for additional information related to the Fauchier acquisition and our capital plan, respectively. Future Outlook We expect that over the next 12 months cash generated from our operating activities will be adequate to support our operating and investing cash needs, and planned share repurchases. We currently intend to utilize our other available resources for any number of potential activities, including, but not limited to, seed capital investments in new products, repurchase of shares of our common stock, acquisitions, repayment of outstanding debt, or payment of increased dividends. working capital requirements. As previously discussed, and in accordance with our capital plan, we intend to utilize up to 65% of cash generated from future operations to purchase shares of our common stock. We do not currently expect to raise additional debt or equity financing over the next 12 months. However, there can be no assurances of these expectations as our projections could prove to be incorrect, events may occur that require additional liquidity, such as an acquisition opportunity or an opportunity to refinance indebtedness, or market conditions might significantly worsen, affecting our results of operations and generation of available cash. If these events result in our operations and available cash being insufficient to fund liquidity needs, we would likely seek to manage our available resources by taking actions such as reducing future share repurchases, additional cost-cutting, reducing our expected expenditures on investments, selling assets (such as investment securi- ties), repatriating earnings from foreign subsidiaries, or mod- ifying arrangements with our affiliates and/or employees. Should these types of actions prove insufficient, or should a large acquisition or refinancing opportunity arise, we may seek to raise additional equity or debt. At March 31, 2013, our total cash and cash equivalents of $933 million included $415 million held by foreign sub- sidiaries. Some of the amounts held by foreign subsidiar- ies may be subject to material repatriation tax effects. During the year ended March 31, 2013, we repatriated approximately $390 million of foreign cash and we plan to repatriate up to another $325 million over the next several years, in order to increase our cash available in the U.S. for general corporate purposes. We anticipate an incremental tax cost of approximately $18 million with respect to this repatriation and have adjusted our tax reserve accordingly. No further repatriation of accumulated prior period foreign earnings is currently planned. However, if circumstances change, we will provide for and pay any applicable addi- tional U.S. taxes in connection with repatriation of these funds. It is not practical at this time to determine the income tax liability that would result from any further repa- triation of accumulated foreign earnings. Credit and Liquidity Risk Cash and cash equivalent deposits involve certain credit and liquidity risks. We maintain our cash and cash equiva- lents with a number of high quality financial institutions or funds and from time to time may have concentrations with one or more of these institutions. The balances with these financial institutions or funds and their credit quality are monitored on an ongoing basis. As described above, we currently project that our cash flows from operating activities will be sufficient to fund our liquidity needs. As of March 31, 2013, we had over $550 million in cash and cash equivalents in excess of our Off-Balance Sheet Arrangements Off-balance sheet arrangements, as defined by the Securities and Exchange Commission (“SEC”), include 43 Legg Masoncertain contractual arrangements pursuant to which a company has an obligation, such as certain contingent obligations, certain guarantee contracts, retained or con- tingent interest in assets transferred to an unconsolidated 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 reasonably likely to have, a material current or future effect on our financial condition, results of operations, liquidity or capital resources. We generally do not enter into off-balance sheet arrangements, as defined, other than those described in the Contractual Obligation section that follows and Consolidation discussed in Critical Accounting Policies and Notes 1 and 17 of Notes to Consolidated Financial Statements. Contractual and Contingent Obligations We have contractual obligations to make future payments, principally in connection with our long-term debt, non-can- celable lease agreements, acquisition agreements and service agreements. See Notes 6 and 8 of Notes to Consolidated Financial Statements for additional disclosures related to our commitments. The following table sets forth these contractual obligations (in millions) by fiscal year, and excludes contractual obligations of CIVs, as we are not responsible or liable for these obligations: 2014 2015 2016 2017 2018 Thereafter Total Contractual Obligations Long-term borrowings by contract maturity(1) $ 50.4 $ 50.5 $ 50.0 $ 50.0 $300.0 $ 650.0 $1,150.9 Interest on long-term borrowings and credit facility commitment fees(1) 44.9 Minimum rental and service commitments Total Contractual Obligations Contingent Obligation 132.5 227.8 43.9 121.2 215.6 43.0 106.6 199.6 42.2 95.3 37.2 86.7 53.6 422.6 264.8 964.9 187.5 423.9 1,126.2 2,380.6 Payments related to business acquisition(2) — 23.0 — 30.0 — — 53.0 Total Contractual and Contingent Obligations(3)(4)(5)(6) $227.8 $238.6 $199.6 $217.5 $423.9 $1,126.2 $2,433.6 (1) Excludes long-term borrowings of the consolidated CLO of $207.8 million and interest on these long-term borrowings, as applicable. (2) The amount of contingent payments reflected for any year represents the maximum amount that could be payable, using exchange rates as of March 31, 2013, at the earliest possible date under the terms of the business purchase agreement. The contingent obligation had an acquisition date fair value of $21.6 million. (3) The table above does not include approximately $37.4 million in capital commitments to investment partnerships in which Legg Mason is a limited partner. These obligations will be funded, as required, through the end of the commitment periods through fiscal 2021. (4) The table above does not include amounts for uncertain tax positions of $51.5 million (net of the federal benefit for state tax liabilities), because the timing of any related cash outflows cannot be reliably estimated. (5) The table above does not include redeemable noncontrolling interests, primarily related to CIVs, of $21.0 million, because the timing of any related cash outflows cannot be reliably estimated. (6) The table above excludes commitments arising from any potential awards under the proposed Permal management equity plan for its key employees. MARKET RISK We maintain an enterprise risk management program to oversee and coordinate risk management activities of Legg Mason and its subsidiaries. Under the program, cer- tain 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 (Loss) The majority of our revenue is calculated from the market value of our AUM. Accordingly, a decline in the value of the underlying securities will cause our AUM, and thus our revenues, 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. In the ordinary course of our business, we may also 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. Performance fees may be earned on certain investment advisory contracts for exceeding performance benchmarks, and strong markets tend to increase these fees. 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 dispropor- tionately impact our revenues. In addition, under revenue sharing agreements, certain of our affiliates retain different percentages of revenues to cover their costs, including compensation. Our net income (loss), profit margin and compensation as a percentage of operating revenues are impacted based on which affiliates generate our revenues, and a change in AUM at one subsidiary can have a dramat- ically different effect on our revenues and earnings than an equal change at another subsidiary. 44 Legg MasonTrading and Non-Trading Assets Our trading and non-trading assets are comprised of investment securities, including seed capital in sponsored mutual funds and products, limited partnerships, limited liability companies and certain other investment products. Trading and other current investments, excluding CIVs, at March 31, 2013 and 2012, subject to risk of security price fluc- tuations are summarized (in thousands) below. Investment securities, excluding CIVs: Trading investments relating to long-term incentive compensation plans Trading proprietary fund products and other investments Equity method investments relating to long-term incentive compensation plans, proprietary fund products and other investments Total current investments, excluding CIVs 2013 2012 $ 86,583 228,156 56,341 $371,080 $111,257 222,585 78,277 $412,119 Approximately $39.2 million and $80.0 million of trad - ing and other current investments related to long-term incentive compensation plans as of March 31, 2013 and 2012, 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 (loss) or liquidity. However, it will have an impact on our compensation expense with a corresponding offset in other non-operating income (expense). Trading and other current investments of $91.1 million and $86.2 million at March 31, 2013 and 2012, respectively, relate to other long-term incentive plans for which the related liabilities do not completely offset due to vesting provisions. Therefore, fluctuations in the market value of these trading investments will impact our compensa- tion expense, non-operating income (expense) and net income (loss). Approximately $240.8 million and $245.9 million of trading and other current investments at March 31, 2013 and 2012, respectively, are investments in proprietary fund products and other investments for which fluctuations in market value will impact our non-operating income (expense). Of these amounts, the fluctuations in market value of approxi- mately $13.8 million and $12.6 million of proprietary fund products as of March 31, 2013 and 2012, respectively, have offsetting compensation expense under revenue share agreements. The fluctuations in market value of approxi- mately $71.9 million and $11.8 million in proprietary fund products as of March 31, 2013 and 2012, respectively, are substantially offset by gains (losses) on market hedges and therefore do not materially impact Net Income (Loss) Attributable to Legg Mason, Inc. Investments in proprietary fund products are not liquidated before the related fund establishes a track record, has other investors, or a deci- sion is made to no longer pursue the strategy. Non-trading assets, excluding CIVs, at March 31, 2013 and 2012, subject to risk of security price fluctuations are summa- rized (in thousands) below. Investment securities, excluding CIVs: Available-for-sale Investments in partnerships, LLCs and other Equity method investments in partnerships and LLCs Other investments Total non-trading assets, excluding CIVs 2013 2012 $ 12,400 31,143 68,780 99 $112,422 $ 11,913 34,965 169,201 112 $216,191 Equity method investments in partnerships and LLCs at March 31, 2012, included approximately $89.3 million of investments related to our involvement with the PPIP. Fluctuations in the market value of these investments had offsetting compensation expense under revenue- sharing agreements. Our investments related to the PPIP were fully redeemed during fiscal 2013, upon liquidation of the fund. Investment securities of CIVs totaled $24.8 million and $31.6 million as of March 31, 2013 and 2012, respec- tively, and investments of CIVs totaled $210.6 million and $294.9 million as of March 31, 2013 and 2012, respec- tively. As of March 31, 2013 and 2012, we held equity investments in the CIVs of $39.1 million and $38.9 mil- lion, respectively. Fluctuations in the market value of investments of CIVs in excess of our equity investment 45 Legg Masonwill not impact Net Income (Loss) Attributable to Legg Mason, Inc. However, it may have an impact on other non-operating income (expense) of CIVs with a corre- sponding offset in Net income (loss) attributable to non- controlling interests. Valuation of trading and non-trading investments is described below within Critical Accounting Policies under the heading “Valuation of Financial Instruments.” See Notes 1 and 14 of Notes to Consolidated Financial Statements for further discussion of derivatives. The following is a summary of the effect of a 10% increase or decrease in the market values of our financial instruments subject to market valuation risks at March 31, 2013: Investment securities, excluding CIVs: Trading investments relating to long-term incentive compensation plans Trading proprietary fund products and other investments $ 86,583 228,156 $ 95,241 250,972 $ 77,925 205,340 Equity method investments relating to long-term incentive compensation plans, Carrying Value Fair Value Assuming a 10% Increase(1) Fair Value Assuming a 10% Decrease(1) proprietary fund products and other investments Total current investments, excluding CIVs Investments in CIVs Available-for-sale investments Investments in partnerships, LLCs and other Equity method investments in partnerships and LLCs Other investments Total investments subject to market risk 56,341 371,080 39,056 12,400 31,143 68,780 99 61,975 408,188 42,962 13,640 34,257 75,658 109 50,707 333,972 35,150 11,160 28,029 61,902 89 $522,558 $574,814 $470,302 (1) Gains and losses related to certain investments in deferred compensation plans and proprietary fund products are directly offset by a corresponding adjust- ment to compensation expense and related liability. In addition, investments in proprietary fund products of approximately $71.9 million have been eco- nomically hedged to limit market risk. As a result, a 10% increase or decrease in the unrealized market value of our financial instruments subject to market valuation risks would result in a $33.1 million increase or decrease in our pre-tax earnings as of March 31, 2013. Also, as of March 31, 2013 and 2012, cash and cash equiv- alents included $485.8 million and $893.7 million, respec- tively, of money market funds. Foreign Exchange Sensitivity We operate primarily in the United States, but provide services, earn revenues and incur expenses outside the United States. Accordingly, fluctuations in foreign exchange rates for currencies, principally in the United Kingdom, Brazil, Japan, Canada, Singapore, Australia, and those denominated in the euro, may impact our compre- hensive income (loss) and net income (loss). Certain of our affiliates have entered into forward contracts to man- age 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 net income (loss) or liquidity. Interest Rate Risk Exposure to interest rate changes on our outstanding debt is partially mitigated as our $650 million of 5.5% senior notes are at fixed interest rates. At March 31, 2013, approximately $500 million of our outstanding floating rate debt is subject to fluctuations in interest rates and will have an impact on our non-operating income (loss) and net income (loss). As of March 31, 2013, we estimate that a 1% change in interest rates would result in a net annual change to interest expense of $5 million. See Note 6 of Notes to Consolidated Financial Statements for additional disclosures regarding debt. CRITICAL ACCOUNTING POLICIES AND ESTIMATES 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 information. Certain critical accounting policies require us to make esti- mates and assumptions that affect the amounts of assets, liabilities, revenues and expenses reported in the financial statements. Due to their nature, estimates involve judg- ment based upon available information. Therefore, actual results or amounts could differ from estimates and the difference could have a material impact on the consoli- dated financial statements. 46 Legg MasonWe consider the following to be our critical accounting policies that involve significant estimates or judgments. Consolidation Effective April 1, 2010, we adopted revised accounting guidance, Accounting Standards Codification (“ASC”) Topic 810, “Consolidation,” (Statement of Financial Accounting Standards No. 167, “Amendments to Financial Accounting Standards Board Interpretation No. 46(R)”) (“SFAS No. 167”), relating to the consolidation of variable interest enti- ties (“VIEs”) which includes a new approach for determin- ing who should consolidate a VIE, changes to when it is necessary to reassess who should consolidate a VIE, and changes in the assessment of which entities are VIEs. The application of the revised accounting guidance has been deferred for certain investment funds, including money market funds. Investment funds that qualify for the deferral continue to be assessed for consolidation under prior guid- ance, Financial Accounting Standards Board Interpretation No. 46(R), “Consolidation of Variable Interest Entities—an interpretation of ARB No. 51” (“FIN 46(R)”). In the normal course of our business, we sponsor and are the manager of various types of investment vehicles. Certain of these investment vehicles are considered to be VIEs while others are considered to be voting rights entities (“VREs”) subject to traditional consolidation concepts based on ownership rights. For our services, we are entitled to receive management fees and may be eligible, under certain circumstances, to receive additional subordinate management fees or other incentive fees. Our exposure to risk in these entities is generally limited to any equity investment we have made or are required to make and any earned but uncollected management fees. Uncollected management fees from these VIEs were not material at March 31, 2013. We have not issued any investment performance guarantees to these VIEs, VREs or their investors. Investment vehicles that are considered VREs are consolidated if we have a controlling financial interest in the investment vehicle, absent substantive investor rights to replace the manager of the entity (kick- out rights). Financial Accounting Standards Board Interpretation No. 46(R) (Accounting Standards Update 2010-10, “Amendments to Statement 167 for Certain Investment Funds”) For most sponsored investment funds, including money market funds, we determine whether we are the pri- mary beneficiary of a VIE if we absorb a majority of the VIE’s expected losses, or receive a majority of the VIE’s expected residual returns, if any. Our determination of expected residual returns excludes gross fees paid to a decision maker if certain criteria are met. In determining whether we are the primary beneficiary of a VIE, we con- sider both qualitative and quantitative factors such as the voting rights of the equity holders, economic participa- tion of all parties, including how fees are earned and paid to us, related party ownership, guarantees and implied relationships. In determining the primary beneficiary, we must make assumptions and estimates about, among other things, the future performance of the underlying assets held by the VIE, including investment returns, cash flows, and credit and interest rate risks. In determining whether a VIE is significant for disclosure purposes, we consider the same factors used for determination of the primary beneficiary. Statement of Financial Accounting Standards No. 167 (Accounting Standards Codification Topic 810, “Consolidation”) We sponsor and are the manager for collateralized debt obligation entities (“CDOs”) and CLOs that do not qualify for the deferral, and are assessed under the revised accounting guidance, as follows. We determine whether we have a variable interest in a VIE by considering if, among other things, we have the obligation to absorb losses, or the right to receive benefits, that are expected to be significant to the VIE. We consider the management fee structure, including the seniority level of our fees, the current and expected economic performance of the entity, as well as other provisions included in the governing docu- ments that might restrict or guarantee an expected loss or residual return. If we have a significant variable interest, we determine whether we are the primary beneficiary of the VIE if we have both the power to direct the activities of the VIE that most significantly impact the entity’s eco- nomic performance and the obligation to absorb losses, or the right to receive benefits, that potentially could be significant to the VIE. In evaluating whether we have the obligation to absorb losses, or the right to receive benefits, that could poten- tially be significant to the VIE, we consider factors regarding the design, terms, and characteristics of the investment vehicles, including the following qualitative fac- tors: if we have involvement with the investment vehicle beyond providing management services; if we hold equity or debt interests in the investment vehicle; if we have transferred any assets to the investment vehicle; if the potential aggregate fees in future periods are insignificant relative to the potential cash flows of the investment vehi- cle; and if the variability of the expected fees in relation to the potential cash flows of the investment vehicle is more than insignificant. Legg Mason must consolidate any VIE for which it is deemed to be the primary beneficiary. 47 Legg MasonSee Note 17 of Notes to Consolidated Financial Statements for additional discussion of CIVs and other VIEs. Revenue Recognition The vast majority of our revenues are calculated as a percentage 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 securities for which market quotations are readily available, the market value of such securities; and (ii) with respect to other secu- rities and assets, fair value as determined in good faith. For most of our mutual funds and other pooled products, their 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 estab- lished policies to ensure consistency in the application 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 clients. Equity securities under management for which market 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 relationships between securi- ties. 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 independent pricing services, fund accounting agents, custodians and bro- kers. 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 underly- ing securities in the portfolio within each asset class. Regardless of the valuation process or pricing source, we have established controls reasonably designed to assess the reasonableness 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, unobservable inputs. Management fees on AUM where fair values are based on unobservable inputs are not material. As of March 31, 2013, equity, fixed income and liquidity AUM values aggregated $161.8 bil- lion, $365.1 billion and $137.7 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 the value of our AUM. Economic events and financial market turmoil 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, 2013, less than 1% 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 approxi- mate fair value, except our long-term debt. Trading invest- ments, 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 (Loss) or Other Comprehensive Income (Loss), depending on the underlying purpose of the instrument. For equity investments where we do not control the investee, and where we are not the primary beneficiary of a variable interest entity, but can exert significant influence over the financial and operating policies of the investee, we follow the equity method of accounting. The evaluation of whether we exert control or significant influence over the financial and operational policies of an investee requires significant judgment based on the facts and circumstances surrounding each individual investment. Factors considered in these evaluations may include investor voting or other rights, any influence we may have on the governing board of the investee, the 48 Legg Masonlegal rights of other investors in the entity pursuant to the fund’s operating documents and the relationship between us and other investors in the entity. Substantially all of our equity method investees are investment companies which record their underlying investments at fair value. Therefore, under the equity method of accounting, our share of the investee’s underlying net income or loss predominantly represents fair value adjustments in the investments held by the equity method investee. Our share of the investee’s net income or loss is based on the most current information available and is recorded as a net gain (loss) on investments within non-operating income (expense). The accounting guidance for fair value measurements and disclosures defines fair value and establishes a framework for measuring fair value. The accounting guidance 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 participants on the measurement date. A fair value measurement should reflect all of the assumptions that market partici- pants would use in pricing the asset or liability, including assumptions about the risk inherent in a particular valua- tion technique, the effect of a restriction on the sale or use of an asset, and the risk of non-performance. 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 market prices. We evaluate our non-trading Investment securities 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. For investments in illiquid or privately-held securities for which market prices or quotations are not readily available, the determination of fair value requires us to 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. As of March 31, 2013 and 2012, excluding investments in CIVs, we owned approximately $0.1 million and $11.9 million, respectively, of financial investments that were valued on our assumptions or estimates and unobservable inputs. At March 31, 2013 and 2012, we also have approximately $99.9 million and $204.2 million, respectively, of other investments, such as investment partnerships, that are included in Other noncurrent assets on the Consolidated Balance Sheets, of which approximately $68.8 million and $169.2 million, respectively, are accounted for under the equity method. The remainder is accounted for under the cost method, which considers if factors indicate there may be an impairment in the value of these invest- ments. In addition, as of March 31, 2013 and 2012, we had $56.3 million and $78.3 million, respectively, of equity method investments that are included in Investment secu- rities on the Consolidated Balance Sheets. The accounting guidance for fair value measurements establishes a hierarchy that prioritizes the inputs for valua- tion 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 low- est 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. This category also includes CLO loans and derivative liabili- ties of a CIV. Level 3—Financial instruments for which values are based on unobservable inputs, including those for which there is little or no market activity. This cat- egory includes investments in partnerships, limited liability companies, private equity funds and CLO debt of a CIV. 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 measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety. 49 Legg MasonProprietary fund products and certain investments held by CIVs are valued at net asset value (“NAV”) determined by the fund administrator. These funds are typically invested in exchange traded investments 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 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, including certain investments held by CIVs, management must estimate the value of the securi- ties using a variety of methods and resources, including the most current available financial information for the invest- ment and the industry to which it applies in order to deter- mine fair value. These valuation processes for illiquid and privately-held securities inherently require management’s judgment and are therefore classified in Level 3. The fair values of CLO loans and bonds are determined based on prices from well-recognized third-party pricing services that utilize available market data and are there- fore classified as Level 2. Legg Mason has established controls designed to assess the reasonableness of the prices provided. The fair value of CLO debt is valued using a discounted cash flow methodology. Inputs used to deter- mine the expected cash flows include assumptions about forecasted default and recovery rates that a market partici- pant would use in determining the fair value of the CLO’s underlying collateral assets. Given the significance of the unobservable inputs to the fair value measurement, the CLO debt valuation is classified as Level 3. Exchange traded options are valued using the last sale price or in the absence of a sale, the last offering price. Options traded over the counter are valued using dealer supplied valu- ations. Options are classified as Level 1. Futures contracts are valued at the last settlement price at the end of each day on the exchange upon which they are traded and are classified as Level 1. Index and single name credit default swaps and interest rate swaps previously held were valued based on valu- ations furnished by pricing services and classified as Level 2. As a practical expedient, we rely on the NAVs of certain investments as their fair value. The NAVs that have been provided by investees are derived from the fair values of the underlying investments as of the reporting date. As of March 31, 2013, approximately 2% of total assets (10% of financial assets measured at fair value) and 9% of total liabilities meet the definition of Level 3. Excluding the assets and liabilities of CIVs, approximately 1% of total assets (8% of financial assets measured at fair value) and no 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, 2013, are as follows (in thousands): Amortizable asset management contracts Indefinite-life intangible assets Trade names Goodwill $ 22,327 3,102,435 52,800 1,269,165 $4,446,727 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 take into consideration estimates and assumptions including profit margins, growth or attrition rates for acquired con- tracts 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 client 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 representing the degree of risk inherent in the asset, as more fully described below. 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 50 Legg Mason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, including changes in economic arrange- ments with our affiliates that will impact future operating results. If a triggering event has occurred, we perform tests, which include critical reviews of all significant assumptions, to determine if any intangible assets or goodwill are impaired. At a minimum, we perform these tests for indefinite-life intangible assets and goodwill annu- ally at December 31. We performed an impairment test of the Permal funds-of- hedge funds contracts indefinite-life intangible asset as of December 12, 2012, because a modification of our employ- ment contracts and other arrangements with the manage- ment of Permal that was completed on that day constituted a triggering event. Our test indicated that the funds-of- hedge funds contracts asset was impaired, thereby trigger- ing impairment tests of our other indefinite-life intangible assets and goodwill. As a result of these impairment tests, updated through our annual test date of December 31, 2012, our Permal funds-of-hedge funds contracts and trade name indefinite-life intangible assets and our domestic mutual fund contracts indefinite-life intangible assets were each determined to be partially impaired, resulting in aggre- gate pre-tax operating charges of $734 million. Neither goodwill nor any other intangible assets were deemed to be impaired. Details of our intangible assets and goodwill and the related impairment tests follow. No impairment in the value of amortizable intangible assets was recognized during the year ended March 31, 2013, as our estimates of the related future cash flows exceeded the asset carrying values. We also determined that no triggering events had occurred as of March 31, 2013, therefore, no additional indefinite-life intangible asset and goodwill impairment testing was necessary. Amortizable Intangible Assets Intangible assets subject to amortization are considered for impairment at each reporting period using an undis- counted cash flow analysis. Significant assumptions 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 vari- ance in any one period must be considered in conjunction with other assumptions that impact projected cash flows. The estimated remaining useful lives of amortizable intan- gible assets currently range from one to six years with a weighted-average life of approximately 2.8 years. Indefinite-Life Intangible Assets For intangible assets with lives that are indeterminable or indefinite, fair value is determined from a market partici- pant’s perspective based on projected discounted cash flows, taking into account the values market participants would pay in a taxable transaction to acquire the respec- tive assets. We have two primary types of indefinite-life intangible assets: proprietary fund contracts and, to a lesser extent, trade names. We determine the fair value of our intangible assets based upon discounted projected cash flows, which take into consideration estimates of future fees, profit margins, growth rates, taxes, and discount rates. An asset is deter- mined to be impaired if the current implied fair value is less than the recorded carrying value of the asset. The determination of the fair values of our indefinite-life intan- gible assets is highly dependent on these estimates and changes in these inputs could result in a material impair- ment of the related carrying values. If an asset is impaired, the difference between the current 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 determined to exist. 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 restrictions. Similarly, cash flows generated by new funds added to the fund group are included when determining the fair value of the intangible asset. 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 cli- ent flows and projected market performance. To estimate the projected cash flows, projected growth rates by affili- ate are used to project their assets under management. Cash flow growth rates consider estimates of both AUM flows and market expectations by asset class (equity, fixed income and liquidity) and by investment manager based upon, among other things, historical experience and expectations of future market and investment perfor- mance from internal and external sources. Currently, our 51 Legg Masonmarket growth assumptions are 6% for equity, 3% for fixed income, and 0% for liquidity products, with a general assumption of 2% organic growth for all products, subject to exceptions for organic growth in near-term periods. The starting point for these assumptions is our corporate planning process that includes three-year AUM projec- tions from the management of each operating affiliate that consider the specific business circumstances of each affili- ate, with near-year flow assumptions for certain affiliates adjusted, as appropriate, to reflect a market participant view. Beyond year three, the estimates move towards our general organic growth assumption of 2%, as appropri- ate for each affiliate and asset class, through year 20. The resulting cash flow growth rate for year 20 is held constant and used to further project cash flows through year 40. Based on projected AUM by affiliate and asset class, affili- ate advisory fee rates are applied to determine projected revenues. The domestic mutual fund contracts projected revenues are applied to a weighted-average margin for the applicable affiliates that manage the AUM. Margins are based on arrangements currently in place at each affiliate. Projected operating income is further reduced by an appro- priate tax rate to calculate the projected cash flows. We believe our growth assumptions are reasonable given our consideration of multiple inputs, including internal and external sources, although our assumptions are subject to change based on fluctuations in our actual results and market conditions. Our assumptions are also subject to change due to, among other factors, poor investment performance by one or more of our advisory affiliates, the withdrawal of AUM by clients, changes in business cli- mate, adverse regulatory actions, or loss of key personnel. We consider these risks in the development of our growth assumptions and discount rates, discussed further below. Further, actual cash flows in any one period may vary from the projected cash flows without resulting in an impair- ment charge because a variance in any one period must be considered in conjunction with other assumptions that impact projected cash flows. Our process includes comparison of actual results to prior growth projections. However, differences between actual results and our prior projections are not necessarily indica- tive of a need to reassess our estimates given that our dis- counted projected cash flow analyses include projections well beyond three years and variances in the near-years may be offset in subsequent years; fair value assess- ments are point-in-time; and the consistency of a fair value assessment with other indicators of value that reflect expectations of market participants at that point-in-time is critical evidence of the soundness of the estimate of value. In subsequent periods, we consider the differences in actual results from our prior projections in considering the reasonableness of the growth assumptions used in our current impairment testing. Discount rates are based on appropriately weighted esti- mated costs of debt and equity capital using a market par- ticipant perspective. We estimate the cost of debt based on published debt rates. We estimate the cost of equity capital based on the Capital Asset Pricing Model, which considers the risk-free interest rate, peer-group betas, and company and equity risk premiums. The equity risk is fur- ther adjusted to consider the relative risk associated with each Legg Mason indefinite-life intangible asset and our reporting unit. The discount rates are also calibrated based on an assessment of relevant market values. Continued market uncertainty and the resulting impact on Legg Mason’s stock price and our search for a permanent CEO, which was ongoing during our impairment testing process, increase the relative risk associated with all aspects of our business, resulting in higher discount rates in the current year for our evaluation of each of Legg Mason’s indefinite- life intangible assets and the reporting unit. Consistent with standard valuation practices for taxable transactions, the projected discounted cash flow analysis also factors in a tax benefit value. This tax benefit repre- sents the discounted tax savings a third party that pur- chased an asset on a given valuation date would receive from future tax deductions for the amortization of the pur- chase price over 15 years. The Permal funds-of-hedge funds contracts of $626 mil- lion account for approximately 20% of our indefinite-life intangible assets. As noted above, the modification of employment contracts and other arrangements with the management of Permal constituted a triggering event as of December 12, 2012. Further, Permal has experienced recent outflows and increased risk associated with its business. The past several years have seen declines in the traditional high net worth client fund-of-hedge funds business, Permal’s historical focus, which Permal has offset to some extent with new institutional business. As a result of these factors, actual results generally compare unfavorably to the growth assumptions for the Permal funds-of-hedge funds contracts used in the asset impair- ment testing at December 31, 2011 and 2010. As a result, in our December 2012 testing, the near-term growth assumptions for these contracts were reduced, which, together with the impact of decreased margins in near- years resulting from the modifications of the employment arrangements, led to decreased projected cash flows from the business. Further, fund-of-hedge fund managers are subject to unique market and regulatory influences, adding additional uncertainty to our estimates. 52 Legg MasonBased upon our projected discounted cash flow analy- ses, the carrying value of the Permal funds-of-hedge funds contracts asset exceeded its fair value, resulting in impairment charges of $321 million for the excess. Cash flows on the Permal funds-of-hedge funds contracts are assumed to have an average annual growth rate of approx- imately 8%. However, given current experience, projected cash flows reflect no net AUM flows trending to moderate inflows in years 1 and 2, respectively. The projected cash flows from the Permal funds-of-hedge funds contracts are discounted at 16.0%, reflecting the Permal and Legg Mason specific factors noted above. Investment performance, including its expected impact on future asset flows, is a significant factor in our growth projections for the Permal funds-of-hedge funds contracts. Our market performance projections are supported by the fact that Permal’s two largest funds that comprise over half of the contracts asset AUM have 10-year average returns exceeding 6%. Our market projections are further supported by industry statistics. The domestic mutual fund contracts acquired in the Citigroup Asset Management (“CAM”) transaction of $2,106 million account for approximately 65% of our indefinite-life intangible assets. As of December 31, 2012, approximately $127 billion of AUM, primarily managed by ClearBridge and Western Asset, are associated with this asset, with approximately 40% in long-term fixed income AUM and 30% in each of equity AUM and liquidity AUM. Although our domestic mutual fund contracts overall have maintained strong recent market performance, previously disclosed uncertainties regarding market conditions and asset flows and more recent assessments of related risk, including risks related to potential regulatory changes in the liquidity business, are reflected in our projected discounted cash flow analyses. As a result of the impact of these factors on our projected discounted cash flow analyses, the related carrying value exceeded its fair value, resulting in an impairment charge of $396 million for the excess. For our impairment test, cash flows from the domestic mutual fund contracts are assumed to have annual growth rates that average approximately 6%, but given current uncertainties, reflect no net AUM flows trending to moderate inflows in years 1 and 2, respec- tively. Projected cash flows of the domestic mutual fund contracts are discounted at 14.5%, reflecting the business and Legg Mason specific factors noted above. We believe that investment performance also has a signifi- cant influence on our domestic mutual fund contract long- term flows, and that recent improvements in performance will favorably impact our flows, as long as performance is strong. In aggregate, 76% of our domestic mutual fund long-term AUM was in funds that had outpaced their three-year Lipper category average at December 31, 2012, the date through which the testing was completed, which compares to 33% at September 30, 2008. Generally, there tends to be a four to five-year lag before improved invest- ment performance results in increased asset flows. In addition, we believe a recent reorganization of our distri- bution platform, which provides an improved focus on the growth of our business, has also favorably impacted our flows. The improvement in investment performance has assisted distribution personnel in selling more products. As a result of improved performance and the reorganiza- tion of the distribution platform, our U.S. distribution group had net inflows for the nine months through September 30, 2012, with the quarter ended June 30, 2012 having the highest net inflows since March 2007. Year-to-date results generally compare slightly favorably to the growth assumptions related to the domestic mutual fund con- tracts asset impairment testing at December 31, 2011. In the past several years, however, such actual to projection comparisons are less favorable, and flows in the last sev- eral months have been less consistent and are considered in our current estimates. Trade names account for 2% of indefinite-life intangible assets and are primarily related to Permal. We tested these intangible assets using assumptions similar to those described above for indefinite-life contracts. The Permal trade name carrying value exceeded its estimated fair value, resulting in a $17 million impairment for the excess. The resulting fair value of the other trade name signifi- cantly exceeded the related carrying amount. Goodwill Goodwill is evaluated at the reporting unit level and is con- sidered for impairment when the carrying amount of the reporting unit exceeds the implied fair value of the report- ing unit. In estimating the implied fair value of the report- ing unit, we use valuation techniques based on discounted projected cash flows and EBITDA multiples, similar to techniques employed in analyzing the purchase price of an acquisition. In December 2010, we announced a realign- ment of our executive management team, which during fiscal 2012, resulted in the combination of our Americas and International divisions into one operating segment, Global Asset Management. Internal management report- ing has been modified consistent with this realignment such that discrete financial information regularly received by the chief operating decision maker, our Chief Executive Officer, is at the consolidated Global Asset Management business level. As a result, the former Americas and International operating segments are no longer our report- ing units, and subsequently, goodwill is recorded and 53 Legg Masonevaluated at one Global Asset Management reporting unit level. Our Global Asset Management reporting unit consists of the operating businesses of our asset man- agement affiliates and our centralized global distribution operations. In our most recent impairment testing process, all consolidated assets and liabilities were allocated to our single Global Asset Management reporting unit, except deferred tax assets arising from net operating losses not related to any assets or liabilities of the reporting unit. Similarly, the projected operating results of the reporting unit include our holding company corporate costs and overhead, including costs associated with executive man- agement, finance, human resources, legal and compliance, internal audit and other central corporate functions. results of our two estimates of value for the reporting unit (the discounted cash flow and EBITDA multiple analyses) are compared and any significant difference is assessed to determine the reasonableness of each value and whether any adjustment to either result is warranted. Once the values are accepted, the appropriately weighted average of the two reporting unit valuations (the discounted cash flow and EBITDA multiple analyses) is used as the implied fair value of our Global Asset Management reporting unit, which at December 31, 2012, exceeds the carrying value by approximately $660 million. Considering the relative merits of the details involved in each valuation process, we used an equal weighting of the two values for the December 2012 testing. Goodwill principally originated from the acquisitions of CAM, Permal and Royce. The value of the reporting unit is based in part, on projected consolidated net cash flows, including all cash flows of assets managed in our mutual funds, closed-end funds and other proprietary funds, in addition to separate account assets of our managers. Significant assumptions used in assessing the implied fair value of the reporting unit under the discounted cash flow method are consistent with the methodology discussed above for indefinite-life intangible assets. Also, at the reporting unit level, future corporate costs are estimated and consolidated with the projected operating results of all our affiliates. 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 con- sidered in conjunction with other assumptions that impact projected cash flows. For the reporting unit discounted projected cash flow analysis, projected cash flows, on an aggregate basis across all asset classes, are assumed to have an average annual growth rate of approximately 8%. Discount rates are based on appropriately weighted esti- mated costs of debt using a market participant perspec- tive, also consistent with the methodology discussed above for indefinite-life intangible assets. For our impair- ment test during the quarter ended December 31, 2012, the projected cash flows were discounted at 15.0% to determine their present value, reflecting the company/ asset specific factors noted above. We also perform a market-based valuation of our reporting unit value, which applies an average of EBITDA multiples paid in change of control transactions for peer companies to our EBITDA. The observed average EBITDA multiple utilized was 9.5x, from ten asset management transac- tions dated October 2009 through December 2012. The We further assess the accuracy of the reporting unit value determined from these valuation methods by compar- ing their results to our market capitalization to determine an implied control premium. The reasonableness of this implied control premium is tested by comparing it to control premiums that have been paid in relevant actual change of control transactions, as further discussed below. This assessment provides evidence that our under- lying assumptions in our analyses of our reporting unit fair value are reasonable. In calculating our market capitalization for these purposes, market volatility can have a significant impact on our capi- talization, and if appropriate, we may consider the aver- age market prices of our stock for a period of up to two months before the test date to determine market capital- ization. A control premium arises from the fact that in an acquisition, there is typically a premium paid over current market prices of publicly traded companies that relates to the ability to control the operations of an acquired com- pany. Further, assessments of control premiums in the asset management industry are difficult because many acquisitions involve privately held companies, or involve only portions of a public company, such that no control premium can be calculated. Asset manager transactions are often valued on EBITDA multiples which, absent unusual circumstances, have generally been consistently priced in a range of 8x to 13x EBITDA over the past sev- eral years. Recent market evidence regarding control premiums sug- gests values of 11% to 99% as realistic and common, and we believe such premiums to be a reasonable range of estimation for our equity value. Our market evidence is from a published source for the two years ended December 31, 2011 and includes 56 transactions from the banking and finance and brokerage and investment con- sulting industry groups with an average control premium value of 43%. As noted above, control premium values 54 Legg Masonspecific to public asset manager transactions are limited. However, since 2000, 17 public asset manager transac- tions available to us had control premium values ranging from 20% to 154%, and averaged 55%. We consider the specific circumstances of our company to determine whether there are specific differences for our situation that make these market control premiums not applicable. We also exclude from our consideration outlying values and transactions with known unique circumstances. Based on our analysis and consideration, we believe the implied control premium of 48% determined by our reporting unit value estimation at December 31, 2012, is reasonable in relation to the range of observed relevant market control premium values. Subsequent to our December 31, 2012 analysis, the market price of Legg Mason common stock has appreciated by more than 20% as of March 31, 2013, which would reduce our implied control premium assum- ing all other values remain constant. Stock-Based Compensation Our stock-based compensation plans include stock options, employee stock purchase plans, market-based performance share awards, restricted stock awards and deferred compensation payable in stock. Under our stock compensation plans, we issue equity awards to directors, officers, and key employees. In accordance with the applicable accounting guidance, compensation expense for the years ended March 31, 2013, 2012 and 2011, includes compensation cost for all non-vested share-based awards at their grant date fair value amortized over the respective vesting periods on the straight-line method. Also, under the accounting guidance, cash flows related to income tax deductions in excess of or less than the stock-based compensation expense are classified as financing cash flows. expected life of the options. We estimate volatility equally weighted between the historical prices of our stock over a period equal to the expected life of the option and the implied volatility of market listed options at the date of grant. The expected life is the estimated length of time an option will be 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 We 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 filing positions with each jurisdic- tion. Due to the inherent complexities arising from con- ducting business and being taxed in a substantial number of jurisdictions, we must make certain estimates and judg- ments 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. We granted 1.0 million, 0.8 million, and 0.7 million stock options in fiscal 2013, 2012 and 2011, respectively. For additional information on share-based compensation, see Note 11 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 would 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 exer- cise price require estimates or assumptions. We calculate the dividend yield based upon the average of the histori- cal quarterly dividend payments over a term equal to the Substantially all of our deferred tax assets relate to U.S. and U.K. taxing jurisdictions. As of March 31, 2013, U.S. federal deferred tax assets aggregated $771 million, realization of which is expected to require $4.2 billion of future U.S. earnings, approximately $332 million of which must be in the form of foreign source income. Deferred tax assets generated in U.S. jurisdictions resulting from net operating losses generally expire 20 years after they are generated and those resulting from foreign tax credits generally expire 10 years after they are generated. Based on estimates of future taxable income, using assumptions consistent with those used in our goodwill impairment testing, it is more likely than not that current federal tax benefits relat- ing to net operating losses are realizable and no valuation allowance is necessary at this time. With respect to those resulting from foreign tax credits, it is more likely than not that tax benefits relating to the utilization of $36.3 million 55 Legg Masonforeign tax credits as credits will not be realized and an additional valuation allowance of $17.1 million was recorded in fiscal 2013 with respect thereto. In addition, a valuation allowance was established in prior years for the substantial portion of our deferred tax assets relating to U.K. taxing jurisdictions. While tax planning may enhance our posi- tions, the realization of current tax benefits is not depen- dent on any significant tax strategies. As of March 31, 2013, U.S. state deferred tax assets aggregated $173 million. Due to state tax planning which will allow for the utilization of net operating losses gener- ated in certain jurisdictions, we recognized a net valuation allowance release of $2.0 million during fiscal 2013. Due to the uncertainty of future state apportionment factors and future effective state tax rates, the value of state net oper- ating loss benefits ultimately realized may vary. A net valuation allowance release of $3.5 million in fiscal 2013 primarily related to the full release of the valuation allowance on deferred tax assets related to Australia and Singapore offset by an establishment of a valuation allow- ance against certain U.K. deferred tax assets. To the extent our analysis of the realization of deferred tax assets relies on deferred tax liabilities, we have considered the tim- ing, nature and jurisdiction of reversals, as well as, future increases relating to the tax amortization of goodwill and indefinite-life intangible assets. In the event we determine all or any portion of our deferred tax assets that are not already subject to a valuation allowance are not realizable, we will be required to establish a valuation allowance by a charge to the income tax provision in the period in which that determination is made. Depending on the facts and cir- cumstances, the charge could be material to our earnings. 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 other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes will be due. 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 2013 Annual Report, and from time to time may otherwise make in our public filings, press releases and statements by our management, “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, includ- ing information relating to anticipated growth in revenues, margins or earnings per share, anticipated changes in our business or in the amount of our client AUM, anticipated future performance of our business, including expected earnings per share in future periods, anticipated future investment performance of our affiliates, 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 cau- tion 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 forward- 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 filings, press releases and statements by our management. Due to such risks, uncertainties and other factors, we caution each person receiving such forward-looking information 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 date on which such statement is made or to reflect the occurrence of unanticipated events. Our future revenues may fluctuate due to numerous fac- tors, such as: the total value and composition of our AUM; the mix of our AUM among our affiliates; the revenue yield of our AUM; the volatility and general level of securities prices and interest rates; the relative investment perfor- mance of company-sponsored investment funds and other asset management products both in absolute terms and relative to competing offerings and market indices; investor sentiment and confidence; general economic conditions; our ability to maintain investment management and admin- istrative fees at current levels; competitive conditions in our business; the ability to attract and retain key personnel and the effects of acquisitions, including prior acquisitions. Our future operating results are also dependent upon the level of operating expenses, which are subject to fluctua- tion for the following or other reasons: variations in the level of compensation 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 56 Legg Masonnon-cash charges incurred by us to maintain our admin- istrative infrastructure; 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 substantial 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” pre- viously discussed. 57 Legg MasonReport of Management on 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 account- ing principles generally accepted in the United States of America. Legg Mason’s internal control over financial 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 transac- tions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles gen- erally 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 regard- ing 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 misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inade- quate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of Legg Mason’s internal control over financial reporting as of March 31, 2013, 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, 2013, 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, 2013, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report appearing herein, which expresses an unqualified opinion on the effectiveness of Legg Mason’s internal control over financial reporting as of March 31, 2013. Joseph A. Sullivan President, Chief Executive Officer and Director Peter H. Nachtwey Senior Executive Vice President and Chief Financial Officer 58 Legg MasonReport of Independent Registered Public 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 income (loss), comprehensive income (loss), changes in stockholders’ equity and cash flows present fairly, in all material respects, the financial position of Legg Mason, Inc. and its subsidiaries (“the Company”) at March 31, 2013 and March 31, 2012, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 2013 in con- formity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2013, based on cri- teria 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 maintain- ing 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 control over finan- cial 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 perform 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 state- ments included examining, on a test basis, evidence supporting the amounts and disclosures in the financial 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 policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transac- tions 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 detection of unauthor- ized 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 misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inade- quate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Baltimore, Maryland May 24, 2013 59 Legg MasonConsolidated Balance Sheets (Dollars in thousands) ASSETS Current Assets Cash and cash equivalents Cash and cash equivalents of consolidated investment vehicles Restricted cash Receivables: Investment advisory and related fees Other Investment securities Investment securities of consolidated investment vehicles Deferred income taxes Other Other assets of consolidated investment vehicles Total Current Assets Fixed assets, net Intangible assets, net Goodwill Investments of consolidated investment vehicles Deferred income taxes Other Other assets of consolidated investment vehicles 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 Other Other current liabilities of consolidated investment vehicles Total Current Liabilities Deferred compensation Deferred income taxes Other Other liabilities of consolidated investment vehicles Long-term debt Long-term debt of consolidated investment vehicles Total Liabilities Commitments and Contingencies (Note 8) Redeemable Noncontrolling Interests Stockholders’ Equity Common stock, par value $.10; authorized 500,000,000 shares; issued 125,341,361 shares in 2013 and 139,874,034 shares in 2012 Additional paid-in capital Employee stock trust Deferred compensation employee stock trust Retained earnings Appropriated retained earnings for consolidated investment vehicle Accumulated other comprehensive income, net Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity See Notes to Consolidated Financial Statements. 60 March 31, 2013 2012 $ 933,036 46,541 8,812 350,726 72,392 371,080 24,792 85,257 48,239 1,987 1,942,862 201,819 3,177,562 1,269,165 210,553 279,361 187,274 1,064 $7,269,660 $ 351,965 214,803 — 50,438 74,940 10,320 702,466 56,809 161,298 204,446 2,930 1,094,516 207,835 2,430,300 $1,382,263 26,139 2,167 333,777 100,060 412,119 31,575 117,391 51,977 326 2,457,794 239,411 3,856,866 1,275,045 294,853 142,706 287,653 1,419 $8,555,747 $ 409,759 195,808 250,000 1,278 114,840 4,097 975,782 57,339 242,567 167,544 3,872 1,135,614 271,707 2,854,425 21,009 24,031 12,534 3,449,190 (32,623) 32,623 1,304,259 4,829 47,539 4,818,351 $7,269,660 13,987 3,864,216 (32,419) 32,419 1,715,395 12,221 71,472 5,677,291 $8,555,747 Legg MasonConsolidated Statements of Income (Loss) (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 Transition-related compensation Total Compensation and benefits Distribution and servicing Communications and technology Occupancy Amortization of intangible assets Impairment of intangible assets Other Total Operating Expenses OPERATING INCOME (LOSS) OTHER NON-OPERATING INCOME (EXPENSE) Interest income Interest expense Other income (expense), net, including $68,975 debt extinguishment loss in 2013 Other non-operating income (loss) of consolidated investment vehicles, net Total Other Non-Operating Income (Expense) INCOME (LOSS) BEFORE INCOME TAX PROVISION (BENEFIT) Income tax provision (benefit) NET INCOME (LOSS) Less: Net income (loss) attributable to noncontrolling interests Years Ended March 31, 2013 2012 2011 $ 730,326 $ 775,534 $ 815,633 1,446,066 1,491,325 1,486,615 98,568 330,480 7,210 49,499 340,966 5,250 96,661 379,161 6,247 2,612,650 2,662,574 2,784,317 1,188,470 1,109,671 1,140,305 — 34,638 45,048 1,188,470 1,144,309 1,185,353 600,644 149,645 171,941 14,019 734,000 188,430 649,739 164,712 154,816 19,574 — 712,839 161,969 137,861 22,913 — 190,671 176,574 3,047,149 2,323,821 2,397,509 (434,499) 338,753 386,808 7,590 (62,919) (17,958) (2,821) (76,108) (510,607) (150,859) (359,748) (6,421) 11,481 (87,584) 22,097 18,336 9,246 (92,157) 59,596 1,704 (35,670) (21,611) 303,083 72,052 231,031 10,214 365,197 119,434 245,763 (8,160) NET INCOME (LOSS) ATTRIBUTABLE TO LEGG MASON, INC. $ (353,327) $ 220,817 $ 253,923 NET INCOME (LOSS) PER SHARE ATTRIBUTABLE TO LEGG MASON, INC. COMMON SHAREHOLDERS Basic Diluted See Notes to Consolidated Financial Statements. $ (2.65) $ 1.54 $ 1.63 $ (2.65) $ 1.54 $ 1.63 61 Legg MasonConsolidated Statements of Comprehensive Income (Loss) (Dollars in thousands) NET INCOME (LOSS) Other comprehensive income (loss): Foreign currency translation adjustment Unrealized gains (losses) on investment securities: Unrealized holding gains (losses), net of tax provision (benefit) of $(1), $132 and $(22), respectively Reclassification adjustment for losses included in net income (loss) Net unrealized gains (losses) on investment securities Total other comprehensive income (loss) COMPREHENSIVE INCOME (LOSS) Less: Comprehensive income (loss) attributable to noncontrolling interests Years Ended March 31, 2013 2012 2011 $(359,748) $231,031 $245,763 (23,945) (22,098) 35,159 (1) 13 12 198 11 209 (33) 8 (25) (23,933) (383,681) (6,421) (21,889) 209,142 10,214 35,134 280,897 (8,160) COMPREHENSIVE INCOME (LOSS) ATTRIBUTABLE TO LEGG MASON, INC. $(377,260) $198,928 $289,057 See Notes to Consolidated Financial Statements. 62 Legg MasonConsolidated Statements of Changes in Stockholders’ Equity (Dollars in thousands) COMMON STOCK Beginning balance Stock options and other stock-based compensation Deferred compensation employee stock trust Deferred compensation, net Exchangeable shares Equity Units exchanged Employee tax withholdings by net share transactions Shares repurchased and retired 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 Exchangeable shares Equity Units exchanged Employee tax withholdings by net share transactions Shares repurchased and retired Allocation from 2.5% Convertible Senior Notes repurchase, net of tax 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 Net income (loss) attributable to Legg Mason, Inc. Dividends declared Ending balance APPROPRIATED RETAINED EARNINGS FOR CONSOLIDATED INVESTMENT VEHICLE Beginning balance Cumulative effect of change in accounting principle Net income (loss) reclassified to appropriated retained earnings Ending balance ACCUMULATED OTHER COMPREHENSIVE INCOME, NET Beginning balance Net unrealized holding gains (losses) on investment securities Foreign currency translation adjustment Ending balance Years Ended March 31, 2013 2012 2011 $ 13,987 8 8 192 — — (41) (1,620) 12,534 $ 15,022 17 7 124 — 183 (6) (1,360) 13,987 $ 16,144 64 7 152 110 — — (1,455) 15,022 — — — — — — 2,760 (2,760) — 3,864,216 5,198 1,803 44,246 — — (11,303) (423,855) (31,115) 3,449,190 (32,419) (1,811) 1,607 (32,623) 32,419 1,811 (1,607) 32,623 4,111,095 16,508 2,020 32,193 — 102,831 (1,525) (398,906) — 3,864,216 (34,466) (2,027) 4,074 (32,419) 34,466 2,027 (4,074) 32,419 4,447,612 31,674 2,673 34,619 2,650 35,877 — (444,010) — 4,111,095 (33,095) (2,136) 765 (34,466) 33,095 2,136 (765) 34,466 1,715,395 (353,327) (57,809) 1,304,259 1,539,984 220,817 (45,406) 1,715,395 1,316,981 253,923 (30,920) 1,539,984 12,221 — (7,392) 4,829 71,472 12 (23,945) 47,539 10,922 — 1,299 12,221 93,361 209 (22,098) 71,472 — 24,666 (13,744) 10,922 58,227 (25) 35,159 93,361 TOTAL STOCKHOLDERS’ EqUITy $4,818,351 $5,677,291 $5,770,384 See Notes to Consolidated Financial Statements. 63 Legg MasonConsolidated Statements of Cash Flows (Dollars in thousands) CASH FLOWS FROM OPERATING ACTIVITIES Net Income (Loss) 2.5% Convertible Senior Notes: Allocation of repurchase payment Loss on extinguishment Adjustments to reconcile Net Income (Loss) to net cash provided by operations: Impairment of intangible assets Depreciation and amortization Imputed interest for 2.5% Convertible Senior Notes Accretion and amortization of securities discounts and premiums, net Stock-based compensation Net gains on investments Net losses (gains) of consolidated investment vehicles Deferred income taxes Other Decrease (increase) in assets: Investment advisory and related fees receivable Net sales (purchases) of trading and other current investments Other receivables Other assets Other assets of consolidated investment vehicles Increase (decrease) in liabilities: Accrued compensation Deferred compensation Accounts payable and accrued expenses Other liabilities Other liabilities of consolidated investment vehicles CASH PROVIDED By OPERATING ACTIVITIES CASH FLOWS FROM INVESTING ACTIVITIES Payments for fixed assets Business acquisition, net of cash acquired Proceeds from sale of assets Change in restricted cash Purchases of investment securities Proceeds from sales and maturities of investment securities Purchases of investments by consolidated investment vehicles Proceeds from sales and maturities of investments by consolidated investment vehicles Years Ended March 31, 2013 2012 2011 $ (359,748) $ 231,031 $ 245,763 (216,038) 68,975 734,000 87,848 5,839 3,295 58,983 (43,684) 5,358 (157,355) 1,725 (11,045) 189,347 (9,712) (1,605) (14,378) (54,964) (530) 8,690 3,112 5,219 — — — 93,795 39,077 4,552 48,735 (1,714) (6,711) 49,192 (12,191) 31,790 (40,020) 1,432 1,810 53,720 42,763 (35,148) (11,147) 28,135 (22,332) — — — 102,748 36,688 4,539 56,245 (58,851) 3,959 80,272 5,393 (13,794) (55,540) 1,962 (20,923) 25,880 75,970 (44,825) (251) (49,954) 16,859 303,332 496,769 412,140 (38,351) (55,277) — (7,245) (5,787) 5,272 (98,374) 188,739 (31,822) (32,904) — 3,060 11,221 (6,493) 6,197 — — — (8,430) 9,077 (141,727) (173,261) 161,894 161,047 CASH PROVIDED By (USED IN) INVESTING ACTIVITIES $ (11,023) $ 2,330 $ (44,471) 64 Legg MasonConsolidated Statements of Cash Flows (continued) (Dollars in thousands) Repayment of 2.5% Convertible Senior Notes, net of operating allocation (1,040,212) (1,014) CASH FLOWS FROM FINANCING ACTIVITIES Repayment of short-term borrowings Third-party distribution financing, net Repayment of long-term debt Repayment of long-term debt of consolidated investment vehicles Proceeds from issuance of long-term debt Debt issuance costs Issuance of common stock Repurchase of common stock, including net shares Dividends paid Net repayments of consolidated investment vehicles Net (redemptions/distributions paid to)/subscriptions received from noncontrolling interest holders CASH USED IN FINANCING ACTIVITIES EFFECT OF EXCHANGE RATES 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 SUPPLEMENTAL DISCLOSURE Cash paid for: Years Ended March 31, 2013 2012 2011 $ (250,000) $ — $ — — — (1,639) (3,515) — — — — — — — — (9,006) (75,561) 1,143,246 (10,289) 1,986 4,538 14,440 (436,818) (401,797) (445,465) (55,250) — (43,602) (18,309) (26,813) (7,025) (3,993) (21,596) 1,551 (735,897) (481,780) (468,466) (5,639) (10,974) (449,227) 6,345 10,827 (89,970) 1,382,263 1,375,918 1,465,888 $ 933,036 $1,382,263 $1,375,918 Income taxes, net of refunds of $(2,313), $(12,034), and $(12,090), respectively $ 32,318 $ 24,552 $ 39,524 Interest See Notes to Consolidated Financial Statements. 40,262 41,039 46,620 65 Legg MasonNotes to Consolidated Financial Statements (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 providing asset management and related financial services to indi- viduals, 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 Note 17 for a further discussion of VIEs. All material intercompany balances and transactions have been eliminated. Where appropriate, prior years financial statement amounts reflect reclassifications of certain less significant items to conform to the current year presentation. All references to fiscal 2013, 2012 or 2011, 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 and the applicable rules and regulations of the Securities and Exchange Commission (the “SEC”), which require management to make assumptions and estimates that affect the amounts reported in the financial statements and accompanying notes, including revenue recognition, valuation of finan- cial instruments, intangible assets and goodwill, stock- based compensation, income taxes, and consolidation. 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. Consolidation Legg Mason applies Accounting Standards Codification (“ASC”) Topic 810, “Consolidation,” (Statement of Financial Accounting Standards No. 167, “Amendments to Financial Accounting Standards Board Interpretation No. 46(R)”) (“SFAS No. 167”), relating to the consolidation of VIEs, which includes guidance for determining who should consolidate a VIE, when it is necessary to reassess who should consolidate a VIE, and for the assessment of which entities are VIEs. However, certain investment funds, including money market funds, qualify for a deferral of the application of SFAS No. 167 and continue to be assessed for consolidation under prior guidance, ASC Topic 810, “Consolidation,” (Financial Accounting Standards Board Interpretation No. 46(R), “Consolidation of Variable Interest Entities—an interpretation of ARB No. 51”) (“FIN 46(R)”). In the normal course of its business, Legg Mason spon- sors and is the manager of various types of investment vehicles. Certain of these investment vehicles are consid- ered to be VIEs while others are considered to be voting rights entities (“VREs”) subject to traditional consolidation concepts based on ownership rights. 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 or VREs. 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 uncol- lected management fees. Uncollected management fees from these VIEs were not material at March 31, 2013 and 2012. Legg Mason has not issued any investment perfor- mance guarantees to these VIEs, VREs or their investors. Investment vehicles that are considered VREs are consoli- dated if Legg Mason has a controlling financial interest in the investment vehicle, absent substantive investor rights to replace the manager of the entity (kick-out rights). Financial Accounting Standards Board Interpretation No. 46(R) (Accounting Standards Update 2010-10, “Amendments to Statement 167 for Certain Investment Funds”) For most sponsored investment funds, including money market funds, which qualify for the deferral of the revised accounting guidance, Legg Mason determines it is the primary beneficiary of a VIE if it absorbs a majority of the VIE’s expected losses, or receives a majority of the VIE’s expected residual returns, if any. Legg Mason’s determina- tion of expected residual returns excludes gross fees paid to a decision maker. It is unlikely that Legg Mason will be the primary beneficiary for VIEs created to manage assets for clients which qualify for the deferral unless Legg Mason’s ownership interest in the VIE, including interests of related parties, is substantial, unless Legg Mason may earn significant performance fees from the VIE or unless Legg Mason is considered to have a material implied vari- able interest. In determining whether it is the primary beneficiary of a VIE which qualifies for the deferral, 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 and paid to Legg Mason, related party ownership, guaran- tees and implied relationships. In determining the primary beneficiary, Legg Mason must make assumptions and 66 Legg Masonestimates about, among other things, the future perfor- mance of the underlying assets held by the VIE, including investment returns, cash flows, and credit and interest rate risks. In determining whether a VIE is significant for disclosure purposes, Legg Mason considers the same fac- tors used for determination of the primary beneficiary. be used by Legg Mason, nor is Legg Mason obligated for the debt. The consolidation of the CLO had no impact on Net Income Attributable to Legg Mason, Inc.’s com- mon shareholders. See Note 17 for additional information related to the application of the amended VIE consolida- tion model and the required disclosures. Statement of Financial Accounting Standards No. 167 (Accounting Standards Codification Topic 810, “Consolidation”) Legg Mason sponsors and is the manager for collateral- ized debt obligation entities (“CDOs”) and collateralized loan obligations (“CLOs”) that do not qualify for the defer- ral, and are assessed under the revised accounting guid- ance, as follows. Legg Mason determines whether it has a variable interest in a VIE by considering if, among other things, it has the obligation to absorb losses, or the right to receive benefits, that are expected to be significant to the VIE. Legg Mason also considers the management fee structure, including the seniority level of its fees, the cur- rent and expected economic performance of the entity, as well as other provisions included in the governing docu- ments that might restrict or guarantee an expected loss or residual return. If Legg Mason has a significant variable interest, it determines it is the primary beneficiary of the VIE if it has both the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and the obligation to absorb losses, or the right to receive benefits, that potentially could be signifi- cant to the VIE. In evaluating whether it has the obligation to absorb losses, or the right to receive benefits, that potentially could be significant to the VIE, Legg Mason considers factors regarding the design, terms, and characteristics of the investment vehicles, including, but not limited to, the following qualitative factors: if Legg Mason has involvement with the investment vehicle beyond provid- ing management services; if Legg Mason holds equity or debt interests in the investment vehicle; if Legg Mason has transferred any assets to the investment vehicle; if the potential aggregate fees in future periods are insignificant relative to the potential cash flows of the investment vehi- cle; and if the variability of the expected fees in relation to the potential cash flows of the investment vehicle is more than insignificant. Under both the revised accounting guidance and prior guidance, Legg Mason must consolidate VIEs for which it is deemed to be the primary beneficiary. As of March 31, 2013 and 2012, Legg Mason’s Consolidated Balance Sheets reflect $224,193 and $291,853, respectively, in assets, and $207,835 and $271,707, respectively, in debt issued by a CLO, despite the fact that the assets cannot Cash and Cash Equivalents Cash equivalents are highly liquid investments with original maturities of 90 days or less. Restricted Cash Restricted cash primarily represents long-term escrow deposits and cash collateral required for market hedge arrangements. This cash is not available to Legg Mason for general corporate use. Financial Instruments Substantially all financial instruments are reflected in the financial statements at fair value or amounts that approxi- mate fair value, except Legg Mason’s long-term debt. For equity investments where Legg Mason does not control the investee, and where it is not the primary beneficiary of a VIE, but can exert significant influence over the financial and operating policies of the investee, Legg Mason follows the equity method of accounting. The evaluation of whether Legg Mason can exert control or significant influence over the financial and operational policies of an investee requires significant judgment based on the facts and circumstances surrounding each individual investment. Factors considered in these evalu- ations may include investor voting or other rights, any influence Legg Mason may have on the governing board of the investee, the legal rights of other investors in the entity pursuant to the fund’s operating documents and the relationship between Legg Mason and other investors in the entity. Substantially all of Legg Mason’s equity method investees are investment companies which record their underlying investments at fair value. Therefore, under the equity method of accounting, Legg Mason’s share of the investee’s underlying net income or loss predominantly represents fair value adjustments in the investments held by the equity method investee. Legg Mason’s share of the investee’s net income or loss is based on the most current information available and is recorded as a net gain (loss) on investments within non-operating income (expense). A significant portion of earnings (losses) attributable to Legg Mason’s equity method investments has offset- ting compensation expense adjustments under revenue sharing agreements and deferred compensation arrange- ments, therefore, fluctuations in the market value of these investments will not have a material impact on Net Income (Loss) Attributable to Legg Mason, Inc. 67 Legg MasonLegg Mason also holds debt and marketable equity invest- ments 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 stock- holders’ equity, noncontrolling interests, and comprehen- sive income (loss), 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, including those held by consolidated investment vehicles (“CIVs”), are classified as trading securities. These invest- ments are recorded at fair value and unrealized gains and losses are included in current period earnings. Realized gains and losses for all investments are included in current period earnings. Equity and fixed income securities classified as trading or available-for-sale are valued using closing market prices for listed instruments or broker price quotations, when avail- able. Fixed income securities may also be valued using val- uation models and estimates based on spreads to actively traded benchmark debt instruments with readily available market prices. 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 amount of impairment that relates to credit losses is recognized as a charge to income. As of March 31, 2013, 2012 and 2011, the amount of temporary unrealized losses for investment securities not recognized in income was not material. For investments in illiquid or privately-held securities for which market prices or quotations may not be readily avail- able, including certain investments held by CIVs, manage- ment 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. In addition to the financial instruments described above and the derivative instruments and CLO loans, bonds and debt, described below, other financial instruments that are carried at fair value or amounts that approximate fair value include Cash and cash equivalents and Short-term borrow- ings. The fair values of Long-term debt at March 31, 2013 and 2012, aggregated $1,206,166 and $1,214,245, respec- tively. The carrying value of the five-year term loan approx- imates fair value because the debt is a credit facility with a variable interest rate based on a short-term rate. These fair values were estimated using publicly quoted market prices or discounted cash flow analyses, as appropriate, and were classified as Level 2 in the fair value hierarchy as described below. Derivative Instruments The fair values of derivative instruments are recorded as assets or liabilities on the Consolidated Balance Sheets. Legg Mason has used foreign exchange forwards and interest rate swaps to hedge the risk of movement in exchange rates or interest rates on financial assets on a limited basis. Also, Legg Mason has used futures con- tracts on index funds to hedge the market risk of certain seed capital investments. In addition, certain CIVs use derivative instruments. However, there is no risk to Legg Mason in relation to the derivative assets and liabilities of the CIVs in excess of its investment in the funds, if any. Legg Mason has not designated any financial instru- ments for hedge accounting, as defined in the account- ing literature, during the periods presented. The gains or losses on derivative instruments not designated for hedge accounting are included as Other income (expense) or Other non-operating income (expense) in the Consolidated Statements of Income (Loss), with the exception of gains and losses on derivative instruments of CIVs, which are recorded as Other non-operating income (expense) of consolidated investment vehicles, net, in the Consolidated Statements of Income (Loss). Fair Value Measurements Accounting guidance for fair value measurements defines fair value and establishes a framework for measuring fair value. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liabil- ity in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Under accounting guidance, 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. The objective of fair value accounting 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 requires the use of judg- ment to ascertain if a formerly active market has become inactive and in determining fair values when markets have become inactive. This accounting guidance also relates to 68 Legg Masonother-than-temporary impairments and is intended to bring greater consistency to the timing of impairment recogni- tion. 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 guid- ance also requires timely disclosures regarding expected cash flows, credit losses, and an aging of securities with unrealized losses. Fair value accounting guidance also establishes a hier- archy 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 are measured and reported at fair value and are classified and disclosed in one of the following 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 mar- kets; prices are quoted for identical or similar assets in inactive markets; or prices are based on observ- able inputs, other 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. This category also includes CLO loans and derivative liabilities of a CIV. Level 3—Financial instruments for which values are based on unobservable inputs, including those for which there is little or no market activity. This cat- egory includes investments in partnerships, limited liability companies, private equity funds and CLO debt of a CIV. 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 in which a fair value measurement falls in its entirety is determined based on the lowest level input that is significant to the fair value measurement in its entirety. Proprietary fund products and certain investments held by CIVs are valued at net asset value (“NAV”) determined by the applicable fund administrator. These funds are typically invested in exchange traded investments with observ- able 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 deter- minations 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, including certain investments held by CIVs, management must esti- mate the value of the securities using a variety of meth- ods 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 there- fore classified in Level 3. The fair values of CLO loans and bonds are determined based on prices from well-recognized third-party pricing services that utilize available market data and are there- fore classified as Level 2. Legg Mason has established controls designed to assess the reasonableness of the prices provided. The fair value of CLO debt is valued using a discounted cash flow methodology. Inputs used to deter- mine the expected cash flows include assumptions about forecasted default and recovery rates that a market partici- pant would use in determining the fair value of the CLO’s underlying collateral assets. Given the significance of the unobservable inputs to the fair value measurement, the CLO debt valuation is classified as Level 3. Exchange traded options are valued using the last sale price or, in the absence of a sale, the last offering price. Options traded over the counter are valued using dealer supplied valuations. Options are classified as Level 1. Futures contracts are valued at the last settlement price at the end of each day on the exchange upon which they are traded and are classified as Level 1. As a practical expedient, Legg Mason relies on the NAV of certain investments as their fair value. The NAVs that have been provided by investees are derived from the fair val- ues of the underlying investments as of the reporting date. Any transfers between categories are measured at the beginning of the period. See Note 3 for additional information regarding fair value measurements. Fair Value Option Legg Mason has elected the fair value option for certain eligible assets and liabilities, including corporate loans and debt, of a CLO it is consolidating (see Note 17). 69 Legg MasonManagement believes that the use of the fair value option eliminates certain timing differences and better matches the changes in fair value of assets and liabilities related to the CLO. Unrealized gains and losses on assets and liabilities for which the fair value option has been elected are reported in earnings. The decision to elect the fair value option is determined on an instrument by instru- ment basis, must be applied to an entire instrument, and is irrevocable once elected. Assets and liabilities which are measured at fair value pursuant to the fair value option are included in the assets and liabilities of consolidated invest- ment vehicles in the Consolidated Balance Sheets. At this time, the Company has not elected to apply the fair value option to any of its other financial instruments. Appropriated Retained Earnings Upon the election of the fair value option for eligible assets and liabilities of the CLO described above, Legg Mason recorded a cumulative effect adjustment to Appropriated retained earnings for consolidated investment vehicle on the Consolidated Balance Sheets equal to the difference between the fair values of the CLO’s assets and liabilities. This difference is recorded as “Appropriated retained earnings” because the investors in the CLO, not Legg Mason shareholders, will ultimately realize any benefits or losses associated with the CLO. Changes in the fair values of the CLO assets and liabilities are recorded as Net income (loss) attributable to noncontrolling interests in the Consolidated Statements of Income (Loss) and Appropriated retained earnings for consolidated invest- ment vehicle in the Consolidated Balance Sheets. Fixed Assets Fixed assets primarily consist of equipment, software and leasehold improvements. Equipment consists pri- marily of communications and technology hardware and furniture and fixtures. Software includes both purchased software and internally developed software. Fixed assets are reported at cost, net of accumulated depreciation and amortization. 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 improve- ments 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 Legg Mason’s intangible assets consist principally of asset management contracts, contracts to manage propri- etary 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 manage- ment 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 classified 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 gener- ate cash flows indefinitely. Goodwill represents the excess cost of a business acquisition over the fair value of the net assets acquired. Indefinite-life intangible assets and goodwill are not amor- tized for book purposes. Given the relative significance of intangible assets and goodwill to the Company’s con- solidated 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 personnel, significant business dispositions, or other events, including changes in economic arrangements with our affiliates that will impact future operating results. If a triggering event has occurred, the Company will per- form tests, which include critical reviews of all significant assumptions, to determine if any intangible assets or goodwill are impaired. At a minimum, the Company per- forms these tests annually at December 31, for indefinite- life intangible assets and goodwill, considering factors such as projected cash flows and revenue multiples, to determine whether the value of the assets is impaired and the indefinite-life assumptions are appropriate. If an asset is impaired, the difference between the value of the asset reflected on the financial statements and its current fair value is recognized as an expense in the period in which the impairment is determined. The fair values of intan- gible assets subject to amortization are reviewed at each reporting period using an undiscounted cash flow analy- sis. For intangible assets with indefinite lives, fair value is determined from a market participant’s perspective based on projected discounted cash flows, which take into con- sideration estimates of future fees, profit margins, growth rates, taxes, and discount rates. Goodwill is evaluated at 70 Legg Masonthe reporting unit level, and is considered for impairment when the carrying value of the reporting unit exceeds the implied fair value of the reporting unit. In estimating the fair value of the reporting unit, Legg Mason uses valua- tion techniques principally based on discounted projected cash flows and EBITDA multiples, similar to techniques employed in analyzing the purchase price of an acquisition. Goodwill is deemed to be recoverable at the reporting unit level, which is also the operating segment level that Legg Mason defines as the Global Asset Management segment. This results from the fact that the chief operat- ing decision maker, Legg Mason’s Chief Executive Officer, regularly receives discrete financial information at the consolidated Global Asset Management business level and does not regularly receive discrete financial informa- tion, such as operating results, at any lower level, such as the asset management affiliate level. Prior to fiscal 2012, Legg Mason’s reporting units were its Americas and International divisions. Allocations of goodwill for manage- ment restructures, acquisitions and dispositions are based on relative fair values of the respective businesses restruc- tured, added to or sold from the divisions. See Note 5 for additional information regarding intangible assets and goodwill and Note 16 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 trans- lated at average exchange rates during the period. The gains or losses resulting from translating foreign currency financial statements into U.S. dollars are included in stock- holders’ equity and comprehensive income (loss). Gains or losses resulting from foreign currency transactions are included in Net Income (Loss). 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 Sheets and is recognized over the period earned. Performance fees may be earned on certain investment advisory contracts for exceeding performance benchmarks on a relative or absolute basis, depending on the prod- uct, and are recognized at the end of the performance measurement period. Accordingly, neither advanced bill- ings nor performance fees are subject to reversal. The largest portion of performance fees are earned based on 12-month performance periods that end in differing quar- ters during the year, with a portion also based on quarterly performance periods. Of Legg Mason’s total AUM at each period ended as of March 31, 2013, 2012 and 2011, approximately 6% was in accounts that were eligible to earn performance fees. Legg Mason has responsibility for the valuation of AUM, substantially all of which is based on observable 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 market- ing 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 invest- ment 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, distribu- tion and servicing expense is accrued for the amounts owed to third parties, including finders’ fees and refer- ral fees paid to unaffiliated broker-dealers or introducing parties. Distribution and servicing expense also includes payments to third parties for certain shareholder adminis- trative services and sub-advisory fees paid to unaffiliated asset managers. Deferred Sales Commissions Commissions paid to financial intermediaries in connection with sales of certain classes of company-sponsored mutual funds are capitalized as deferred sales commissions. The asset is amortized over periods not exceeding six years, which represent the periods during which commissions 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 service fee 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 71 Legg Masonand other events and circumstances that may indicate an impairment in value has occurred. If these factors indicate an impairment in value, management compares the car- rying value to the estimated undiscounted cash flows expected to be generated by the asset over its remaining 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, 2013, 2012 and 2011, no impairment charges were recorded. Deferred sales commissions, included in Other non-current assets in the Consolidated Balance Sheets, were $8,259 and $9,510 at March 31, 2013 and 2012, 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 state- ments. Deferred income tax assets are subject to a valu- ation 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 and other carryforward benefits, busi- ness combinations, amortization of intangible assets and accrued compensation. Under applicable accounting guidance, a tax benefit should only be recognized if it is more likely than not that the position will be sustained based on its technical mer- its. 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. 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 7 for additional information regarding income taxes. 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, market-based performance shares payable in com- mon stock and deferred compensation payable in stock. Under its stock compensation plans, Legg Mason issues equity awards to directors, officers, and other key employees. In accordance with the applicable accounting guidance, compensation expense 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 market-based performance grants, which would be valued with a Monte Carlo option-pricing model. See Note 11 for additional information regarding stock- based compensation. Earnings Per Share Basic earnings per share attributable to Legg Mason, Inc. common shareholders (“EPS”) is calculated by dividing Net Income (Loss) Attributable to Legg Mason, Inc. by the weighted-average number of shares outstanding. The calculation of weighted-average shares includes common shares, shares exchangeable into common stock and certain unvested share-based payment awards that are considered participating securities because they contain nonforfeitable rights to dividends. 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 12 for additional discussion of EPS. Restructuring Costs In May 2010, Legg Mason’s management committed to a plan to streamline its business model as further described in Note 15. The streamlining initiative was completed as of March 31, 2012. The costs associated with this initia- tive primarily related to employee termination benefits, incentives to retain employees during the transition period, charges for consolidating leased office space, and contract termination costs. Termination benefits, includ- ing severance and retention incentives, were recorded as Transition-related compensation in the Consolidated Statements of Income (Loss). These compensation items required employees to provide future service and were therefore expensed ratably over the required ser- vice period. Contract termination and other costs were expensed when incurred. Capital Plan In May 2012, Legg Mason implemented a capital plan for the refinancing/restructuring of debt, the completion of the existing share repurchase authorization, and the authorization of further share repurchases. As a result, Net Income (Loss) Attributable to Legg Mason, Inc. for the year ended March 31, 2013, includes a pre-tax loss on debt extinguishment of $68,975 and a net reduction 72 Legg Masonin outstanding debt obligations of $350,000. See Notes 6 and 12 for further details. employees that will entitle them to participate in 15% of the future growth in value of the Permal business. Other Developments On December 12, 2012, the Company modified its employ- ment and other arrangements with the management of its investment management affiliate The Permal Group, Ltd (“Permal”). These modifications included the Company investing in the Permal business in part by sharing certain compensation and other costs that result in lower margins from the business at current revenue levels in exchange for higher margins at significantly increased revenue levels. In addition, the Company and Permal are engaged in imple- menting a profits interest management equity plan for key Noncontrolling Interests Noncontrolling interests related to CIVs are classified as redeemable noncontrolling interests if investors in these funds may request withdrawals at any time. There are no nonredeemable noncontrolling interests as of March 31, 2013, 2012 and 2011. As noted above, Net income (loss) attributable to noncontrolling interests in the Consolidated Statements of Income (Loss) also includes Net income (loss) reclassified to appropriated retained earnings for consolidated investment vehicle in the Consolidated Balance Sheets. Net income (loss) attributable to noncontrolling interests for the years ended March 31, 2013, 2012 and 2011, included the following amounts: Net income attributable to redeemable noncontrolling interests Net Income (loss) reclassified to appropriated retained earnings for consolidated investment vehicle Total 2013 $ 971 (7,392) $(6,421) 2012 $ 8,915 1,299 $10,214 2011 $ 5,584 (13,744) $ (8,160) Redeemable noncontrolling interests as of and for the years ended March 31, 2013, 2012 and 2011, included the follow- ing amounts: Balance, beginning of period Net income attributable to redeemable noncontrolling interests Net (redemptions/distributions paid to)/subscriptions received from noncontrolling interest holders Balance, end of period 2013 $24,031 971 (3,993) $21,009 2012 $ 36,712 8,915 (21,596) $ 24,031 2011 $29,577 5,584 1,551 $36,712 Recent Accounting Developments In December 2011, the Financial Accounting Standards Board (“FASB”) updated the guidance on disclosures for offsetting assets and liabilities to require both gross and net information about instruments and transactions, including derivatives, repurchase and reverse repurchase and other arrangements that are eligible for offset in the balance sheet. The disclosures will be effective for Legg Mason in fiscal 2014, and are not expected to have a material impact on Legg Mason’s consolidated financial statements. In July 2012, the FASB updated the guidance on the annual indefinite-lived intangible asset tests for impair- ment. The update permits companies to assess qualitative factors to determine if it is more likely than not that the fair value of the intangible asset is less than its carrying amount as a basis for determining whether it is necessary to perform the currently required quantitative fair value assessment. This update will be effective for Legg Mason in fiscal 2014. This update is not expected to have a mate- rial effect on Legg Mason’s recorded indefinite-lived assets, and Legg Mason is still evaluating its adoption. In January 2013, the FASB updated the guidance on a parent’s accounting for a cumulative translation adjust- ment upon the sale, transfer, or liquidation of a foreign subsidiary entity. The update states that a cumulative translation adjustment should be released into earnings only if an entity ceases to have a controlling financial interest in a foreign subsidiary or a group of assets within a foreign subsidiary, and the sale or transfer results in the complete or substantially complete liquidation of the foreign entity. This update will be effective for Legg Mason in fiscal 2014. This update is not expected to have a material effect on Legg Mason’s cumulative translation adjustment and Legg Mason is still evaluating the impact of its adoption. 73 Legg Mason2. ACqUISITIONS On March 13, 2013, Permal, a wholly-owned subsidiary of Legg Mason, completed the acquisition of all of the out- standing share capital of Fauchier Partners Management, Limited (“Fauchier”), a leading European based manager of funds-of-hedge funds, from BNP Paribas Investment Partners, S.A. in accordance with a Sale and Purchase Agreement (“SPA”) entered into in December 2012. This transaction significantly expands Permal’s institutional business, creating a global institutional capability across geographies and client profiles. At the time of acquisition Fauchier managed assets of approximately $5,400,000. The initial purchase price was a cash payment of $63,433, which was funded from existing cash resources. In addition, contingent consideration of up to approximately $23,000 and approximately $30,000, using exchange rates as of March 31, 2013, may be due on the second and fourth anni- versaries of closing, respectively, dependent on achieving certain financial targets and subject to a catch up adjust- ment. The contingent consideration liability established at closing had an acquisition date fair value of $21,566, which represents the present value of the contingent con- sideration expected to be paid and is included in Other liabilities in the Consolidated Balance Sheet. Any changes in estimates for the fair value of the contingent consider- ation will be recorded as Other non-operating income (loss) in the Consolidated Statements of Income (Loss). A summary of the fair values of the assets acquired and liabilities assumed are as follows: Cash(1) Receivables(1) Amortizable asset management contracts Indefinite-life fund management contracts Goodwill(1) Other current liabilities, net(1) Contingent consideration Deferred tax liability Total net assets acquired $ 8,156 12,174 2,865 65,126 28,983 (16,667) (21,566) (15,638) $ 63,433 (1) Subject to adjustment for amounts ultimately realized, as provided for in the SPA. The fair value of the amortizable asset management con- tracts are being amortized over a period of 6 years. None of the acquired intangible assets or goodwill are deductible for local tax purposes. Management estimated the fair values of the indefinite-life fund management contracts based upon discounted cash flow analyses and the contingent consideration expected to be paid based upon revenue projections, using unobservable mar- ket data inputs, which are Level 3 measurements. As is typical with the acquisition of a portion of a business from a larger financial services firm with other related operations, Legg Mason expects some initial contraction in the acquired business. The significant assumptions used in these analyses included projected cash flows, revenues and discount rates, summa- rized as follows: Indefinite-life fund management contracts (35)% to 11% (weighted-average - 6%) Projected Cash Flow Growth Rates Contingent consideration Projected Revenue Growth Rates (23)% to 3% (weighted-average - (6)%) Discount Rate 16.0% Discount Rate 2.0% The Company has not presented pro forma combined results of operations for this acquisition because the results of operations as reported in the accompanying Consolidated Statements of Income would not have been materially different. The post-acquisition financial results of Fauchier included in Legg Mason’s consolidated financial results for the year ended March 31, 2013 were not sig- nificant. Legg Mason incurred acquisition costs of $1,380, which is included in Other operating expenses in the Consolidated Statement of Income (Loss). 3. INVESTMENTS AND FAIR VALUES OF ASSETS AND LIABILITIES The disclosures below include details of Legg Mason’s assets and liabilities that are measured at fair value, excluding the assets and liabilities of CIVs. See Note 17, Variable Interest Entities and Consolidation of Investment Vehicles, for information related to the assets and liabilities of CIVs that are measured at fair value. 74 Legg MasonLegg Mason has investments in debt and equity securi- ties that are generally classified as trading as described in Note 1. Investments as of March 31, 2013 and 2012, are as follows: securities and equity securities. Gross unrealized gains and (losses) for investments classified as available-for-sale were $230 and $(188), respectively, as of March 31, 2013, and $551 and $(184), respectively, as of March 31, 2012. Investment securities: Current investments Available-for-sale Other(1) Total 2013 2012 $371,080 12,400 99 $383,579 $412,119 11,913 112 $424,144 (1) Includes investments in private equity securities that do not have readily determinable fair values. The net unrealized and realized gain (loss) for investment securities classified as trading was $18,260, $(6,063) and $28,355 for fiscal 2013, 2012 and 2011, respectively. 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: Available-for-sale: Proceeds Gross realized gains Years Ended March 31, 2013 2012 2011 $5,272 22 $6,197 6 $4,012 7 Gross realized losses (43) (25) (19) Legg Mason’s available-for-sale investments consist of mortgage backed securities, U.S. government and agency Legg Mason had no investments classified as held-to- maturity as of March 31, 2013 and 2012. The fair values of financial assets and (liabilities) of the Company were determined using the following categories of inputs: quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Value as of March 31, 2013 ASSETS: Cash equivalents(1): Money market funds Time deposits and other Total cash equivalents Current investments: Trading investments relating to long-term incentive compensation plans(2) Trading proprietary fund products and other investments(3) Equity method investments relating to long-term incentive compensation plans, proprietary fund products and other investments(4)(5) Total current investments Available-for-sale investment securities(6) Investments in partnerships, LLCs and other(6) Equity method investments in partnerships and LLCs(4)(6) Derivative assets: Currency and market hedges Other investments(6) LIABILITIES: Derivative liabilities: $485,776 $ — $ — $ 485,776 — 485,776 177,471 177,471 86,583 158,846 12,600 258,029 2,034 761 1,518 1,939 — — 69,064 43,741 112,805 10,354 2,620 924 — — — — — 246 — 246 12 27,762 66,338 — 99 177,471 663,247 86,583 228,156 56,341 371,080 12,400 31,143 68,780 1,939 99 $750,057 $304,174 $94,457 $1,148,688 Currency and market hedges $ (781) $ — $ — $ (781) 75 Legg MasonQuoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Value as of March 31, 2012 ASSETS: Cash equivalents(1): Money market funds Time deposits Total cash equivalents Current investments: Trading investments relating to long-term incentive compensation plans(2) Trading proprietary fund products and other investments(3) Equity method investments relating to long-term incentive compensation plans, proprietary fund products and other investments(4)(5) Total current investments Available-for-sale investment securities(6) Investments in partnerships, LLCs and other(6) Equity method investments in partnerships and LLCs(4)(6) Derivative assets: Currency and market hedges Other investments(6) LIABILITIES: Derivative liabilities: $ 893,738 $ — $ — $ 893,738 — 893,738 111,257 143,002 88,289 88,289 — 79,583 11,565 54,934 265,824 134,517 2,091 851 1,415 84 — 9,810 5,351 1,348 — — — — — — 11,778 11,778 12 28,763 166,438 — 112 88,289 982,027 111,257 222,585 78,277 412,119 11,913 34,965 169,201 84 112 $1,164,003 $239,315 $207,103 $1,610,421 Currency and market hedges $ (886) $ — $ — $ (886) (1) Cash equivalents include highly liquid investments with original maturities of 90 days or less. Cash investments in actively traded money market funds are measured at NAV and are classified as Level 1. Cash investments in time deposits and other are measured at amortized cost, which approximates fair value because of the short time between the purchase of the instrument and its expected realization, and are classified as Level 2. (2) Primarily mutual funds where there is minimal market risk to the Company as any change in value is primarily offset by an adjustment to compensation expense and related deferred compensation liability. (3) Trading proprietary fund products and other investments primarily represent mutual funds that are invested approximately 49% and 51% in equity and debt securities, respectively, as of March 31, 2013, and were invested approximately 52% and 48% in equity and debt securities, respectively, as of March 31, 2012. (4) Substantially all of Legg Mason’s equity method investments are investment companies which record their underlying investments at fair value. Fair value is measured using Legg Mason’s share of the investee’s underlying net income or loss, which is predominately representative of fair value adjustments in the investments held by the equity method investee. (5) Includes investments under the equity method (which approximates fair value) relating to long-term incentive compensation plans of $43,741 and $54,934 as of March 31, 2013 and March 31, 2012, respectively, and proprietary fund products and other investments of $12,600 and $23,343 as of March 31, 2013 and March 31, 2012, respectively, which are classified as Investment securities on the Consolidated Balance Sheets. (6) Amounts are included in Other non-current assets on the Consolidated Balance Sheets for each of the periods presented. Substantially all of the above financial instruments where valuation methods rely on other than observable market inputs as a significant input utilize the equity method, the cost method, or NAV practical expedient discussed below, such that measurement uncertainty has little relevance. 76 Legg MasonThe changes in financial assets measured at fair value using significant unobservable inputs (Level 3) for the years ended March 31, 2013 and 2012, are presented in the tables below: Value as of March 31, 2012 Purchases Sales Redemptions/ Settlements/ Other Transfers Realized and Unrealized Gains/ (Losses), Net Value as of March 31, 2013 ASSETS: Trading proprietary fund products and other investments $ — $ 246 $ — $ — $ — $ — $ 246 Equity method investments in proprietary fund products Investments in partnerships, LLCs and other Equity method investments in partnerships and LLCs 11,778 28,763 — — — (11,705) (970) (1,014) 166,438 2,827 (2,268) (117,411) Other investments 124 — — — — — — — (73) — 983 27,762 16,752 (13) 66,338 111 $207,103 $3,073 $(3,238) $(130,130) $ — $17,649 $94,457 Value as of March 31, 2011 Purchases Sales Settlements/ Other Transfers Realized and Unrealized Gains/ (Losses), Net Value as of March 31, 2012 ASSETS: Trading proprietary fund products and other investments $ 11,378 $ — $(11,906) $ — $ — $ 528 $ — Equity method investments in proprietary fund products Investments in partnerships, LLCs and other Equity method investments in partnerships and LLCs 12,167 — 22,167 6,932 — — — (578) 153,931 25,883 (6,387) (14,168) Other investments 282 — — (159) — — — — (389) 11,778 242 28,763 7,179 166,438 1 124 $199,925 $32,815 $(18,293) $(14,905) $ — $7,561 $207,103 Realized and unrealized gains and losses recorded for Level 3 investments are included in Other Non-Operating Income (Expense) on the Consolidated Statements of Income (Loss). The change in unrealized gains (losses) for Level 3 invest- ments still held at the reporting date was $(1,229) and $5,495 for the years ended March 31, 2013 and 2012, respectively. There were no significant transfers between Level 1 and Level 2 during the years ended March 31, 2013 and 2012. 77 Legg MasonAs a practical expedient, Legg Mason relies on the NAV of certain investments as their fair value. The NAVs that have been provided by the investees have been derived from the fair values of the underlying investments as of the respective reporting dates. The following table summarizes, as of March 31, 2013, the nature of these investments and any related liquidation restrictions or other factors which may impact the ultimate value realized: Fair Value Determined Using NAV As of March 31, 2013 March 31, 2013 $38,811(1) March 31, 2012 $ 51,251(2) Unfunded Commitments Remaining Term n/a n/a 24,716 25,460 $20,000 n/a Category of Investment Investment Strategy Funds-of-hedge funds Hedge funds Global macro, fixed income, long/short equity, natural resources, systematic, emerging market, European hedge Fixed income—developed market, event driven, fixed income—hedge, relative value arbitrage, European hedge Private equity funds Long/short equity Fixed income, residential and commercial mortgage-backed securities Private fund(4) Other Total Various 2,408 2,450 $89,698(6) $196,411(6) $25,235 23,763(3) — 27,927(3) 89,323 5,235 Up to 7 years n/a n/a n/a Various(5) n/a—not applicable (1) 49% monthly redemption; 51% quarterly redemption, of which 38% is subject to two-year lock-up, which expires in June 2013. (2) 63% monthly redemption; 37% quarterly redemption, of which 36% is subject to two-year lock-up, which expires in June 2013. (3) Liquidations are expected over the remaining term. (4) Legg Mason’s investment was fully redeemed in the quarter ended December 31, 2012 upon liquidation of the fund. (5) Of this balance, 4% has a remaining term of less than one year and 96% has a remaining term of 20 years. (6) Comprised of approximately 32% and 68% of Level 2 and Level 3 assets, respectively, as of March 31, 2013 and 13% and 87% of Level 2 and Level 3 assets, respectively, as of March 31, 2012. There are no current plans to sell any of these investments held as of March 31, 2013. 4. FIXED ASSETS The following table reflects the components of fixed assets as of March 31: Equipment Software Leasehold improvements Total cost Less: accumulated depreciation and amortization Fixed assets, net 2013 2012 $ 152,065 $ 155,173 227,739 205,760 222,260 242,566 602,064 603,499 (400,245) (364,088) $ 201,819 $ 239,411 Depreciation and amortization expense related to fixed assets was $73,829, $74,221 and $79,835 for fiscal 2013, 2012 and 2011, respectively, and includes accelerated depre- ciation and amortization of $21,020 in fiscal 2013, related to an initiative to reduce space requirements, and $10,256 in fiscal 2012, related to our business streamlining initiative. INTANGIBLE ASSETS AND GOODWILL 5. Goodwill and indefinite-life intangible assets are not amor- tized, 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 value of the assets exceeds the book value. Intangible assets subject to amortization are considered for impairment at each reporting period. If the fair value is less than the book value, Legg Mason will record an impairment charge. 78 Legg MasonThe following table reflects the components of intangible assets as of: March 31, 2013 March 31, 2012 Amortizable asset management contracts Cost $ 208,651 $ 206,411 Accumulated amortization (186,324) (172,974) Net 22,327 33,437 Indefinite-life intangible assets U.S. domestic mutual fund management contracts Permal/Fauchier funds-of-hedge fund management contracts Other fund management contracts Trade names Intangible assets, net 2,106,351 2,502,351 692,133 303,951 52,800 947,000 304,278 69,800 3,155,235 3,823,429 $3,177,562 $3,856,866 As part of Legg Mason’s annual impairment testing pro- cess, and considering aspects of the modifications to Permal compensation and other related arrangements discussed in Note 1, on December 12, 2012, and as updated through December 31, 2012, the Company con- cluded that the carrying value of two significant indefinite- life fund management contract intangible assets and a trade name asset exceeded their respective fair values, and the assets were impaired by an aggregate amount of $734,000. The impairment charges resulted from a number of trends and factors, including (i) a decrease in near-term margin projections; (ii) an increase in the rate used to discount projected future cash flows primarily due to company specific factors including continued market and regulatory influences, continued stock price uncer- tainty and the search for a permanent Chief Executive Officer, which was ongoing during the impairment test- ing process; (iii) recent outflows and related reductions in assets under management; and (iv) a reduction in near- term projected growth rates. These changes resulted in a reduction of the projected cash flows and Legg Mason’s overall assessment of fair value of the assets, such that the domestic mutual fund management contracts asset, Permal funds-of-hedge fund management contracts asset, and Permal trade name declined below their carry- ing values, and accordingly were impaired by $396,000, $321,000, and $17,000, respectively. Management estimated the fair values of these assets based upon discounted cash flow analyses using unobservable market data inputs, which are Level 3 mea- surements. The significant assumptions used in these cash flow analyses included projected cash flows and dis- count rates, summarized as follows: Projected Cash Flow Growth Rates Range Weighted- Average Discount Rates Domestic mutual funds contracts asset 3% to 9% 6% 14.5% Permal funds-of-hedge funds contracts and trade name assets (1)% to 17% 8% 16.0% Projected cash flow growth rates for these assets are most dependent on product investment performance, client AUM flows, and market conditions. Discount rates are influenced by changes in market conditions, as well as interest rates and other factors. Decreases in the projected cash flow growth rates and/or increases in the discount rates could result in lower fair value measurements and potential additional impairments that could be material. There were no impairments to other indefinite-life intan- gible assets, amortizable management contracts intan- gible assets, or goodwill, as of December 31, 2012. Legg Mason also determined that no triggering events occurred as of March 31, 2013 that would require further impair- ment testing. Changes in indefinite-life intangible assets, other than the impairments noted above and the Fauchier business acqui- sition further discussed in Note 2, relate to the impact of foreign currency translation. As of March 31, 2013, amortizable asset management contracts are being amortized over a weighted-average remaining life of 2.8 years. Estimated amortization expense for each of the next five fiscal years is as follows: 2014 2015 2016 2017 2018 Thereafter Total $12,320 3,405 3,148 2,484 485 485 $22,327 79 Legg MasonThe change in the carrying value of goodwill is summarized below: Balance as of March 31, 2011 Impact of excess tax basis amortization Other, including changes in foreign exchange rates Balance as of March 31, 2012 Impact of excess tax basis amortization Business acquisition (see Note 2) Other, including changes in foreign exchange rates Gross Book Value Accumulated Impairment Net Book Value $2,473,552 $(1,161,900) $1,311,652 (21,694) (14,913) — — (21,694) (14,913) $2,436,945 $(1,161,900) $1,275,045 (21,573) 28,983 (13,290) — — — (21,573) 28,983 (13,290) Balance as of March 31, 2013 $2,431,065 $(1,161,900) $1,269,165 Legg Mason also recognizes the tax benefit of the amortization of excess tax basis related to the Citigroup Asset Management (“CAM”) acquisition. In accordance with accounting guidance for income taxes, the tax benefit is recorded as a reduction of goodwill and deferred tax liabilities as the benefit is realized. 6. SHORT-TERM BORROWINGS AND LONG-TERM DEBT The disclosures below include details of Legg Mason’s debt, excluding the debt of CIVs. See Note 17, Variable Interest Entities and Consolidation of Investment Vehicles, for information related to the debt of CIVs. The accreted value of long-term debt consists of the following: 5.5% senior notes Five-year amortizing term loan Other term loans 2.5% convertible senior notes Subtotal Less: current portion Total Current Accreted Value $ 644,077 500,000 877 — 1,144,954 50,438 $1,094,516 March 31, 2013 Unamortized Discount $5,923 — — — 5,923 — $5,923 Maturity Amount $ 650,000 500,000 877 — 1,150,877 50,438 $1,100,439 March 31, 2012 Accreted Value $ — — 9,883 1,127,009 1,136,892 1,278 $1,135,614 In January 2008, Legg Mason sold $1,250,000 of 2.5% Convertible Senior Notes (the “Notes”) due 2015. In May 2012, Legg Mason announced a capital plan that included the refinancing of the Notes, as further discussed below. The refinancing was effected through the issuance of $650,000 of 5.5% senior notes, the net proceeds of which, together with cash on hand and $250,000 of additional borrowing under a then existing revolving credit facility, were used to repurchase the entire $1,250,000 face amount of the Notes. Also, pursuant to the capital plan, in June 2012, Legg Mason entered into an unsecured credit agreement which provides for an undrawn $500,000 revolving credit facility and a $500,000 term loan, also further discussed below. The proceeds of the term loan were used to repay the $500,000 of outstanding borrowings under the previous revolving credit facility, which was then terminated. As of March 31, 2012, there was $250,000 outstanding under the previous revolving credit facility, which had a then effective interest rate of 2.9%. The $500,000 revolving credit facility may be increased by an aggregate amount of up to $250,000, subject to the approval of the lenders, and expires in June 2017. The revolving credit facility has an interest rate of LIBOR plus 150 basis points and an annual commitment fee of 20 basis points. The interest rate may change in the future based on changes in Legg Mason’s credit ratings. This revolving credit facility is available to fund working capital needs and for general corporate purposes. There were no borrowings outstanding under this facility as of March 31, 2013. The revolving credit facility and term loan have standard financial covenants, including a maximum net debt to EBITDA ratio (as defined in the documents) of 2.5 to 1 and minimum EBITDA to interest ratio (as defined in the 80 Legg Masondocuments) of 4.0 to 1. As of March 31, 2013, Legg Mason’s net debt to EBITDA ratio was 1.4 to 1 and EBITDA to inter- est expense ratio was 11.6 to 1, and therefore, Legg Mason has maintained compliance with the applicable covenants. Five-year Amortizing Term Loan The $500,000 term loan entered into in conjunction with the unsecured credit agreement noted above can be repaid at any time and will be due in four annual installments of $50,000, beginning in June 2013, with the remainder to be repaid at maturity in June 2017. The term loan bears interest at LIBOR plus 150 basis points, which may change in the future based on changes in Legg Mason’s credit ratings. The effective interest rate as of March 31, 2013 was 1.7%. 5.5% Senior Notes The $650,000 5.5% Senior Notes (the “Senior Notes”) due May 2019, were sold at a discount of $6,754, which is being amortized to interest expense over the seven- year term. The Senior Notes are subject to certain nonfinancial covenants, including provisions relating to dispositions of certain assets, which could require a per- centage of any related proceeds to be applied to acceler- ated repayments. The Senior Notes can be redeemed at any time prior to their scheduled maturity, in part or in aggregate, at the greater of the related principal amount at that time or the sum of the remaining scheduled pay- ments discounted at the Treasury rate (as defined) plus 0.50%, together with any related accrued and unpaid interest. In February 2013, the Senior Notes were regis- tered to trade in public markets, consistent with the terms of a registration rights agreement signed in connection with the issuance. In addition, under the terms of the 5.5% senior notes, the interest rate paid on these notes will increase modestly if Legg Mason’s credit ratings are reduced below investment grade. 2.5% Convertible Senior Notes and Related Hedge Transactions Prior to the repurchase of the Notes in May 2012, as previ- ously discussed, Legg Mason was accreting the carrying value of the Notes to the principal amount at maturity using an interest rate of 6.5% (the effective borrowing rate for non-convertible debt at the time of issuance) over its expected life of seven years, resulting in interest expense of $5,839, $39,077 and $36,688 for the years ended March 31, 2013, 2012 and 2011, respectively. The Notes were convertible, if certain conditions were met, at an initial conversion rate of 11.3636 shares of Legg Mason common stock per one thousand dollar principal amount of Notes (equivalent to a conversion price of approximately $88 per share), or a maximum of 14,205 shares, subject to adjustment. Unconverted notes would mature at par in January 2015. Upon conversion of a one thousand dollar principal amount note, the holder would receive cash in an amount equal to one thousand dollars or, if less, the con- version value of the note. If the conversion value exceeded the principal amount of the Note at conversion, Legg Mason would also deliver, at its election, cash or common stock or a combination of cash and common stock for the conversion value in excess of one thousand dollars. In connection with the sale of the Notes, in January 2008, Legg Mason entered into convertible note hedge transac- tions with respect to its common stock (the “Purchased Call Options”) with financial institution counterparties (“Hedge Providers”). The Purchased Call Options were exercisable solely in connection with any conversions of the Notes in the event that the market value per share of Legg Mason common stock at the time of exercise was greater than the exercise price of the Purchased Call Options, which was 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, 14,205 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 were not part of the terms of the Notes and did not affect the holders’ rights under the Notes. These hedging transactions had a net cost of approximately $83,000, which was paid from the proceeds of the Notes and recorded as a reduction of additional paid-in capital. These transactions effectively increased the conversion price of the Notes to $107.46 per share of common stock. Legg Mason had contractual rights, and, at execution of the related agreements, had the ability to settle its obli- gations under the conversion feature of the Notes, the Purchased Call Options and warrants, with Legg Mason common stock. Accordingly, these transactions were accounted for as equity, with no subsequent adjustment for changes in the value of these obligations. The terms of the repurchase of the Notes in May 2012 noted above included their repayment at par plus accrued interest, a prepayment fee of $6,250, and a non-cash exchange of warrants (the “Warrants”) to the holders of the Notes that replicated and extended the contin- gent conversion feature of the Notes. The cash payment of $1,256,250 to repurchase the Notes was allocated between their liability and equity components based on a liability fair value of $1,193,971, determined using a then current market interest rate of 4.1%, resulting in a loss on debt extinguishment of $68,975, including $7,851 of accelerated deferred issue costs. The remaining balance of the cash payment was allocated to the equity component of the Notes for a $62,279 reduction of additional paid-in 81 Legg MasonIn connection with the extinguishment of the Notes, the hedge transactions (Purchased Call Options and warrants) executed in connection with the initial issuance of the Notes were also terminated. Other Term Loans In fiscal 2006, a subsidiary of Legg Mason entered into a $12,803 term loan agreement to finance an aircraft. The outstanding balance at March 31, 2012 was $8,568 and was paid in full during fiscal 2013. As of March 31, 2013, the aggregate maturities of long- term debt, based on their contractual terms, are as follows: capital, offset by related tax benefits of $31,446. The $1,193,971 amount of cash repurchase payment allocated to the liability component of the Notes upon their extin- guishment exceeds the initial allocated value at issuance of $977,933, requiring the Consolidated Statements of Cash Flows for the year ended March 31, 2013 to include an allo- cation of the $216,038 excess to operating activities. The Warrants issued to the holders of the Notes in con- nection with the repurchase of the Notes provide for the purchase, in the aggregate and subject to adjustment, of 14,205 shares of Legg Mason common stock, on a net share settled basis, at an exercise price of $88 per share. Upon exercise of the Warrants, Legg Mason will be required to deliver to the holders of the Warrants, at its election, either shares of its common stock or cash, in an amount based on the excess of the market price per share of its common stock over the exercise price of the Warrants. The Warrants expire in July 2017. Legg Mason has had the option to settle its obligations under the Warrants with Legg Mason common stock. Accordingly, the Warrants are accounted for as equity. 2014 2015 2016 2017 2018 Thereafter Total INCOME TAXES 7. The components of income (loss) before income tax provision (benefit) are as follows: Domestic Foreign Total The components of income tax expense (benefit) are as follows: Federal Foreign State and local Total income tax provision (benefit) Current Deferred Total income tax provision (benefit) 2013 $(264,342) (246,265) $(510,607) 2012 $257,866 45,217 $303,083 2013 $ (74,185) (85,677) 9,003 $(150,859) $ 6,496 (157,355) $(150,859) 2012 $54,179 (7,850) 25,723 $72,052 $22,860 49,192 $72,052 82 $ 50,438 50,439 50,000 50,000 300,000 650,000 $1,150,877 2011 $230,334 134,863 $365,197 2011 $ 75,290 18,788 25,356 $119,434 $ 39,162 80,272 $119,434 Legg MasonA reconciliation of the difference between the effective income tax (benefit) rate and the statutory federal income tax (benefit) rate is as follows: Tax provision (benefit) at statutory U.S. federal income tax rate State income taxes, net of federal income tax benefit(1) Effect of foreign tax rates(1) Effect of loss on Australian restructuring Changes in U.K. tax rates on deferred tax assets and liabilities Net (income) loss attributable to noncontrolling interests Other, net(1) Effective income tax (benefit) rate 2013 (35.0)% 2012 35.0% 1.5 3.8 — (3.5) 0.5 3.2 5.4 (1.8) (6.0) (6.0) (0.8) (2.0) 2011 35.0% 4.9 (5.4) — (2.5) 0.8 (0.1) (29.5)% 23.8% 32.7% (1) State income taxes include changes in valuation allowances, net of the impact on deferred tax assets of changes in state apportionment factors and plan- ning strategies. The effect of foreign tax rates also includes changes in valuation allowances. Other includes changes in federal valuation allowances. See schedule below for the change in valuation allowances by jurisdiction. During the quarter ended September 30, 2010, the U.K. Finance (No. 2) Act 2010 was enacted, which reduced the main U.K. corporate tax rate from 28% to 27%. In July 2011, The U.K. Finance Act 2011 (the “Act”) was enacted. The Act fur- ther reduced the main U.K. corporate tax rate from 27% to 26% effective April 1, 2011, and from 26% to 25% effective April 1, 2012. In July 2012, The U.K. Finance Act 2012 was enacted, further reducing the main U.K. corporate tax rate to 24% effective April 1, 2012 and 23% effective April 1, 2013. The reductions in the U.K. corporate tax rate resulted in tax benefits of $18,075, $18,268 and $8,878, recognized in fiscal 2013, 2012 and 2011, respectively, as a result of the revalua- tion of deferred tax assets and liabilities at the new rates. In addition, during the year ended March 31, 2012, Legg Mason recorded $18,254 of tax benefits related to a restructuring of our Australian business. 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 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 Convertible debt obligations Foreign tax credit carryforward Federal benefit of uncertain tax positions Mutual fund launch costs Net unrealized losses from investments Other Deferred tax assets Valuation allowance Deferred tax assets after valuation allowance 2013 2012 $ 107,411 $ 125,797 73,181 449,806 41,256 — 115,819 21,165 24,324 4,447 5,086 62,410 397,013 46,244 4,951 59,871 17,602 14,476 5,327 18,119 842,495 (115,815) 751,810 (102,722) $ 726,680 $ 649,088 83 Legg MasonDEFERRED TAX LIABILITIES Basis differences, principally for intangible assets and goodwill Depreciation and amortization Other Deferred tax liabilities Net deferred tax asset 2013 2012 $134,873 386,959 1,528 523,360 $203,320 $196,611 431,280 3,667 631,558 $ 17,530 Certain tax benefits associated with Legg Mason’s employee stock plans are recorded directly in Stockholders’ Equity. No tax benefit was recorded to equity in fiscal 2013, 2012 or 2011, due to the net operat- ing loss position of the Company. As of March 31, 2013, an additional $6,700 of net operating loss will be recog- nized as an increase in Stockholders’ Equity when ulti- mately realized. In connection with the completion and filing of its fiscal 2010 federal tax return in December 2010, Legg Mason recorded a net additional tax benefit of approximately $36,000 in fiscal 2011 with respect to the Equity Unit extinguishment that occurred in fiscal 2010. The tax benefit increased Additional paid-in capital in a manner consistent with the fiscal 2010 allocation of the extin- guishment payment. Legg Mason has various loss carryforwards that may pro- vide future tax benefits. Related valuation allowances are established in accordance with accounting guidance for income taxes, if it is management’s opinion 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 U.K. taxing jurisdictions. As of March 31, 2013, U.S. federal deferred tax assets aggregated $770,933, realization of which is expected to require approximately $4,200,000 of future U.S. earnings, approximately $331,606 of which must be in the form of foreign source income. Based on estimates of future taxable income, using assumptions consistent with those used in Legg Mason’s goodwill impairment testing, it is more likely than not that current federal tax benefits relating to net operating losses are realizable and no valuation allowance is necessary at this time. With respect to those resulting from foreign tax credits, it is more likely than not that tax benefits relating to the utilization of $36,319 of foreign tax credits as credits will not be realized and an additional valu- ation allowance of $17,066 was provided in fiscal 2013. In addition, a valuation allowance was established in prior years for the substantial portion of our deferred tax assets relating to U.K. taxing jurisdictions. While tax planning may enhance Legg Mason’s tax positions, the realization of these current tax benefits is not dependent on any signifi- cant tax strategies. As of March 31, 2013, U.S. state deferred tax assets aggregated approximately $172,704. Due to state tax plan- ning which will allow for the utilization of NOLs generated in certain jurisdictions the Company recognized a net valu- ation allowance release of $2,046. Due to the uncertainty of future state apportionment factors and future effective state tax rates, the value of state net operating loss ben- efits ultimately realized may vary. A net valuation allowance release of approximately $3,500 in fiscal 2013 was primarily related to the full release of the valuation allowance on deferred tax assets related to Australia and Singapore offset by an establishment of a valuation allowance against certain U.K. deferred tax assets. To the extent the analysis of the realization of deferred tax assets relies on deferred tax liabilities, Legg Mason has considered the timing, nature and juris- diction of reversals, as well as, future increases relating to the tax amortization of goodwill and indefinite-life intangible assets. 84 Legg MasonThe following deferred tax assets and valuation allowances relating to carryforwards have been recorded at March 31, 2013 and 2012, respectively. Deferred tax assets U.S. federal net operating losses U.S. federal capital losses U.S. federal foreign tax credits U.S. charitable contributions U.S. state net operating losses(1)(2) U.S. state capital losses Non-U.S. net operating losses Non-U.S. capital losses Total deferred tax assets for carryforwards Valuation allowances U.S. federal capital losses U.S. federal foreign tax credits U.S. charitable contributions U.S. state net operating losses U.S. state capital losses Non-U.S. net operating losses Non-U.S. capital losses Valuation allowances for carryforwards Non-U.S. other deferred assets Total valuation allowances Expires Beginning after Fiscal Year 2029 2015 2015 2013 2015 2015 2027 n/a 2013 2012 $266,659 $219,984 74 115,819 5,401 161,136 34,960 22,011 6,222 74 59,871 4,709 151,762 39,046 26,704 7,124 $612,282 $509,274 $ 74 $ 74 23,608 1,597 25,951 34,960 15,899 6,222 108,311 7,504 6,542 — 23,911 39,046 22,956 7,124 99,653 3,069 $115,815 $102,722 (1) Substantially all of the U.S. state net operating losses carryforward through fiscal 2029. (2) Due to potential for change in the factors relating to apportionment of income to various states, the Company’s effective state tax rates are subject to fluctuation which will impact the value of the Company’s deferred tax assets, including net operating losses, and could have a material impact on the future effective tax rate of the Company. Legg Mason had total gross unrecognized tax benefits of approximately $72,650, $90,831 and $77,653 as of March 31, 2013, 2012 and 2011, respectively. Of these totals, approximately $46,340, $62,400 and $53,500, 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. During fiscal 2013, as a result of the expiration of statutes of limitation and the completion of tax authority examinations, unrecognized benefits of $16,842 were realized. A reconciliation of the beginning and ending amount of unrecognized gross tax benefits for the years ended March 31, 2013, 2012 and 2011, 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 statutes of limitations Balance, end of year 2013 $ 90,831 11,726 8,439 (13,083) (25,205) (58) 2012 $77,653 9,822 10,668 (3,575) (3,185) (552) 2011 $51,027 1,361 34,959 (6,107) (2,667) (920) $ 72,650 $90,831 $77,653 85 Legg MasonAlthough management cannot predict with any degree of certainty the timing of ultimate resolution of matters under review by various taxing jurisdictions, it is reasonably pos- sible that the Company’s gross unrecognized tax benefits balance may change within the next twelve months by up to $11,400 as a result of the expiration of statutes of limita- tion and the completion of tax authorities’ exams. The Company accrues interest related to unrecognized tax benefits in interest expense and recognizes penalties in other operating expense. During the years ended March 31, 2013, 2012 and 2011, the Company recognized approxi- mately $5,500, $1,300, and $3,000, respectively, which was substantially all interest. At March 31, 2013, 2012 and 2011, Legg Mason had approximately $14,000, $10,000, and $9,000, respectively, accrued for interest and penalties on tax contingencies in the Consolidated Balance Sheets. Legg Mason is under examination by the Internal Revenue Service, the Inland Revenue Service, and other tax authori- ties in various states. The following 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 2009 for U.S. federal; after fiscal 2012 for the United Kingdom; after fiscal 2004 for the state of California; after fiscal 2005 for the state of New York; and after fis- cal 2009 for the states of Connecticut, Maryland and Massachusetts. The Company does not anticipate making any significant cash payments with the settlement of these audits in excess of amounts that have been reserved. During the year ended March 31, 2013, Legg Mason repatriated approximately $394,000 of foreign cash, and plans to repatriate up to another $325,000, over the next several years in order to make the cash available in the U.S. for general corporate purposes. Legg Mason anticipates an incremental tax cost of approximately $18,000 with respect to this repatriation and has adjusted the tax reserve accordingly. No further repatriation of accumulated prior period foreign earnings is currently planned. However, if circumstances change, Legg Mason will provide for and pay any applicable additional U.S. taxes in connection with repatriation of these funds. It is not practical at this time to determine the income tax liability that would result from any further repatriation of accumulated foreign earnings. Except as noted above, Legg Mason intends to perma- nently 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 perma- nently 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. 8. 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 2026. 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, 2013, the minimum annual aggregate rentals under operating leases and service agreements are as follows: 2014 2015 2016 2017 2018 Thereafter Total $132,524 121,176 106,623 95,369 86,669 422,581 $964,942 The minimum rental commitments shown above have not been reduced by $151,664 for minimum sublease rentals to be received in the future under non-cancelable subleases, of which approximately half is due from one counterparty. If a sub-tenant defaults on a sublease, Legg Mason may incur operating charges to adjust the exist- ing liability of $31,321 to reflect expected future sublease rentals at reduced amounts, as a result of the current com- mercial real estate market. The above minimum rental commitments include $877,807 in real estate and equipment leases and $87,135 in service and maintenance agreements. Included in the table above is $75,894 in commitments related to space that has been vacated, but for which sub- leases are being pursued. A lease liability was adjusted in fiscal 2013 and 2012, to reflect the present value of the excess existing lease obligations over the estimated sublease income and related costs, including any newly vacated or subleased space. The lease liability takes into consideration various assumptions, including the amount of time it will take to secure a sublease agreement and prevailing rental rates in the applicable real estate markets. As of March 31, 2013, the liability related to vacant space for which a sublease is being pursued aggregated $35,592, but is subject to adjustment based on circumstances in the real estate markets that may require a change in assump- tions or the actual terms of a sublease that is ultimately secured. In addition to accelerated depreciation and amor- tization discussed in Note 4, these and other related costs incurred during fiscal 2013, driven by an initiative to reduce 86 Legg Masonspace requirements, and during fiscal 2012, related to the business streamlining initiative, aggregated $28,788 and $13,375, respectively, and are included in Occupancy expense in the Consolidated Statements of Income. The following table reflects rental expense under all oper- ating leases and servicing agreements. 2013 2012 2011 Rental expense $138,488 $140,285 $137,072 Less: sublease income 14,750 14,310 10,848 Net rent expense $123,738 $125,975 $126,224 certain class actions, which primarily allege violations of securities laws and seek unspecified damages, which could be substantial. In the normal course of its business, Legg Mason has also received subpoenas and is currently involved in governmental and self-regulatory agency inqui- ries, investigations and, from time to time, proceedings involving asset management activities. In accordance with guidance for accounting for contingencies, Legg Mason has established provisions for estimated losses from pend- ing complaints, legal actions, investigations and proceed- ings when it is probable that a loss has been incurred and a reasonable estimate of loss can be made. 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 with- out 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 landlord, including those used for tenant improvements. As of March 31, 2013 and 2012, Legg Mason had com- mitments to invest approximately $37,410 and $36,653, respectively, in limited partnerships that make private investments. These commitments are expected to be funded as required through the end of the respective investment periods ranging through fiscal 2021. In connection with the acquisition of Fauchier, as further discussed in Note 2, contingent consideration of up to approximately $23,000 and approximately $30,000, using exchange rates as of March 31, 2013, may be due on the second and fourth anniversaries of closing, respectively, which is dependent upon the achievement of certain financial targets and subject to a catch up adjustment. The contingent consideration liability had an acquisition date fair value of $21,566. In the normal course of business, Legg Mason enters into contracts that contain a variety of representations and warranties and that provide general indemnifications, which are not considered financial guarantees by relevant accounting guidance. 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 In a transaction with Citigroup in December 2005, Legg Mason transferred to Citigroup the subsidiaries that con- stituted its Private Client/Capital Markets (“PC/CM”) businesses, thus transferring the entities that would have primary liability for most of the customer complaint, litiga- tion and regulatory liabilities and proceedings arising from those businesses. However, as part of that transaction, Legg Mason agreed to indemnify Citigroup for most cus- tomer 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 mat- ters cannot be determined based on current information, after consultation with legal counsel, management believes that any accrual or range of reasonably possible losses as of March 31, 2013 and 2012, is not material. Similarly, although Citigroup transferred to Legg Mason the entities that would be primarily liable for most customer complaint, litigation and regulatory liabilities and proceedings of the CAM busi- ness, 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. One of Legg Mason’s asset management subsidiaries was named as the defendant in a lawsuit filed by a former insti- tutional client in late August 2011. The complaint alleges breach of contract and breach of fiduciary duty arising from investments in the former client’s account allegedly being inconsistent with the account’s objectives, and seeks dam- ages in excess of $90,000. Legg Mason believes that the claims are without merit and intends to defend the matter vigorously. Discovery in the case is ongoing, and a pre- trial conference is currently scheduled for October 2013. Because of the continued preliminary status of the matter, Legg Mason cannot estimate the possible loss or range of loss from this matter, if any. In addition, although Legg Mason believes that this matter would likely be covered by insurance policies that may substantially mitigate the amount of any eventual loss, as is not unusual with litiga- tion at this point in the process, there can be no assurance the action will not have a material effect on Legg Mason’s financial position, results of operations or cash flows. 87 Legg MasonAdditionally, there are two matters subject to regula- tory investigations involving one of Legg Mason’s asset management subsidiaries regarding its compliance with applicable legal requirements with respect to investments made for certain client accounts. Legg Mason is continu- ing discussions to resolve the matters, subsequent to the fiscal year-end. As a result of these discussions, Legg Mason has agreed in principle, subject to agreement on final terms and documentation, to settle these two mat- ters for approximately $20,000, which was accrued as of March 31, 2013, the majority of which is covered by expected insurance proceeds. Any ultimate loss on these matters beyond amounts covered by insurance policies will be substantially mitigated by reductions in compensa- tion under revenue share arrangements. Other than the specific matters discussed above, Legg Mason cannot estimate the reasonably possible loss or range of loss associated with matters of litigation, includ- ing those described above as customer complaints, legal actions, inquiries, proceedings and investigations. The inability to provide a reasonably possible amount or range of losses is not because there is uncertainty as to the ultimate outcome of a matter, but because liability and damage issues have not developed to the point where Legg Mason can conclude that there is both a reasonable possibility of a loss and a meaningful amount or range of possible losses. There are numerous aspects to customer complaints, legal actions, inquiries, proceedings and investigations that prevent Legg Mason from estimating a related amount or range of reasonably possible losses. These aspects include, among other things, the nature of the matters; that significant relevant facts are not known, are uncertain or are in dispute; and that damages sought are not specified, are uncertain, unsupportable or unex- plained. In addition, for legal actions, discovery may not yet have started, may not be complete or may not be con- clusive, and meaningful settlement discussions may not have occurred. Further, for regulatory matters, investiga- tions may run their course without any clear indication of wrongdoing or fault until their conclusion. In management’s opinion, an adequate accrual has been made as of March 31, 2013, to provide for any probable losses that may arise from matters for which the Company could reasonably estimate an amount. Legg Mason’s finan- cial condition, results of operations and cash flows could be materially affected during a period in which a matter is ultimately resolved. In addition, the ultimate costs of litiga- tion-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 indemnifi- cation, contribution or insurance reimbursement. As of March 31, 2013 and 2012, Legg Mason’s liability for losses and contingencies was $20,300 and $200, respectively. During fiscal 2013, 2012 and 2011, Legg Mason recorded litigation related charges of approximately $5,200, $1,000, and $2,500, respectively (net of recover- ies of $15,200 in fiscal 2013). During fiscal 2013, 2012 and 2011, the liability was reduced for settlement payments of approximately $300, $1,300, and $23,500, respectively. 9. EMPLOyEE BENEFITS Legg Mason, through its subsidiaries, maintains vari- ous defined contribution plans covering substantially all employees. Through these plans, 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 match of employee 401(k) contributions. Matches range from 50% to 100% of employee 401(k) contributions, up to a maximum of the lesser of up to 6% of employee compensation or a specified amount up to $15 per year. Corporate profit sharing and matching contributions, together with contributions made under subsidiary plans, totaled $25,868, $22,336 and $22,739 in fiscal 2013, 2012 and 2011, respectively. In addition, employees can make voluntary contributions under certain plans. 10. CAPITAL STOCK At March 31, 2013, the authorized numbers of common and preferred shares were 500,000 and 4,000, respec- tively. At March 31, 2013 and 2012, there were 11,948 and 13,932 shares of common stock, respectively, reserved for issuance under Legg Mason’s equity plans. As of March 31, 2010, 1,099 common shares were reserved for exchangeable shares issued in connection with the acqui- sition of Legg Mason Canada Inc. Exchangeable shares were exchangeable at any time by the holder on a one-for- one basis into shares of Legg Mason’s common stock and were included in basic shares outstanding. In May 2010, all outstanding exchangeable shares were converted into shares of Legg Mason common stock. In May 2012, as part of a capital plan, Legg Mason’s Board of Directors authorized $1,000,000 for additional purchases of Legg Mason common stock, as well as the completion of the repurchase of the then remaining approximate $155,000 of Legg Mason common stock previously authorized. There is no expiration date attached to this new authorization. During fiscal 2013, Legg Mason purchased and retired 16,199 shares of its common stock for $425,475 through open market purchases, which completed the repurchase of its common stock under the previous authorization, and began purchases under the new authorization. During fis- cal 2012, Legg Mason purchased and retired 13,597 shares of its common stock for $400,266 through open market 88 Legg Masonpurchases. The remaining balance of the authorized stock buyback is approximately $730,000. In May 2008, Legg Mason issued $1,150,000 of Equity Units, each unit consisting of a 5% interest in one thou- sand dollar 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. During fiscal 2010, Legg Mason issued approxi- mately 18,596 shares through the Equity Unit tender offer in exchange for 91% of the outstanding Equity Units. During fiscal 2012, Legg Mason issued 1,830 shares of Legg Mason common stock upon the exercise of the purchase contracts from the remaining Equity Units and the senior notes from the Equity Units were retired in a remarketing. As discussed in Note 6, warrants issued in connection with the repurchase of the Notes could result in the issu- ance of a maximum of 14,205 shares of Legg Mason common stock, subject to adjustment, if certain condi- tions are met. Changes in common stock and shares exchangeable into common stock for the three years ended March 31, 2013, 2012 and 2011, respectively, are as follows: COMMON STOCK Beginning balance Shares issued for: Stock option exercises and other stock-based compensation Deferred compensation trust Deferred compensation Exchangeable shares Shares repurchased and retired Net share transactions Equity Units exchange Ending balance SHARES EXCHANGEABLE INTO COMMON STOCK Beginning balance Exchanges Ending balance Years Ended March 31, 2013 2012 2011 139,874 150,219 161,439 80 71 1,925 — 172 68 1,246 — 638 75 1,520 1,099 (16,199) (13,597) (14,552) (410) — (64) 1,830 — — 125,341 139,874 150,219 — — — — — — 1,099 (1,099) — Dividends declared per share were $0.44, $0.32 and $0.20 for fiscal 2013, 2012 and 2011, respectively. Dividends declared but not paid at March 31, 2013, 2012 and 2011, were $14,185, $11,493 and $8,990, respectively, and are included in Other current liabilities. 11. STOCK-BASED COMPENSATION Legg Mason’s stock-based compensation includes stock options, employee stock purchase plans, restricted stock awards and units, market-based performance shares payable in common stock, and deferred com- pensation payable in stock. Effective July 26, 2011, the number of shares authorized to be issued under Legg Mason’s active equity incentive stock plan was increased by 6,500 to 41,500. Shares available for issu- ance under the active equity incentive stock plan as of March 31, 2013, were 11,273. 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 four to five years and expire within eight to ten years from the date of grant. Compensation expense relating to stock options for the years ended March 31, 2013, 2012, and 2011 was $10,979, $14,076, and $19,926, respectively. The related income tax benefit for the years ended March 31, 2013, 2012, and 2011 was $4,293, $5,539, and $7,718, respectively. 89 Legg MasonStock option transactions under Legg Mason’s equity incentive plans during the years ended March 31, 2013, 2012 and 2011, respectively, are summarized below: Options outstanding at March 31, 2010 Granted Exercised Canceled/forfeited Options outstanding at March 31, 2011 Granted Exercised Canceled/forfeited Options outstanding at March 31, 2012 Granted Exercised Canceled/forfeited Options outstanding at March 31, 2013 Number of Shares Weighted-Average Exercise Price Per Share 6,054 729 (634) (730) 5,419 810 (117) (488) 5,624 966 (25) (1,204) 5,361 $57.75 33.12 21.85 48.94 59.82 33.99 25.32 48.80 57.78 23.72 21.80 51.87 $53.13 The total intrinsic value of options exercised during the years ended March 31, 2013, 2012 and 2011, was $168, $398, and $6,977, respectively. At March 31, 2013, the aggregate intrinsic value of options outstanding was $12,649. The following information summarizes Legg Mason’s stock options outstanding at March 31, 2013: Exercise Price Range $ 12.65–$ 25.00 25.01– 35.00 35.01– 94.00 94.01– 100.00 100.01– 134.97 Option Shares Outstanding Weighted-Average Exercise Price Per Share Weighted-Average Remaining Life (in years) 971 2,649 84 462 1,195 5,361 $ 23.03 31.86 61.02 95.14 107.98 6.8 4.7 0.3 1.3 1.1 At March 31, 2013, 2012 and 2011, options were exercisable on 3,254, 3,334, and 2,860 shares, respectively, and the weighted-average exercise prices were $69.07, $73.60, and $77.20, respectively. Stock options exercisable at March 31, 2013, have a weighted-average remaining contractual life of 2.6 years. At March 31, 2013, the aggregate intrinsic value of options exercisable was $3,555. The following information summarizes Legg Mason’s stock options exercisable at March 31, 2013: Exercise Price Range $ 12.65–$ 25.00 25.01– 35.00 35.01– 94.00 94.01– 100.00 100.01– 134.97 90 Option Shares Exercisable Weighted-Average Exercise Price Per Share 81 1,432 84 462 1,195 3,254 $ 17.32 31.59 61.02 95.14 107.98 Legg MasonThe following information summarizes unvested stock options under Legg Mason’s equity incentive plans for the year ended March 31, 2013: Shares unvested at March 31, 2012 Granted Vested Canceled/forfeited Shares unvested at March 31, 2013 Number of Shares Weighted-Average Grant Date Fair Value 2,290 966 (874) (275) 2,107 $14.00 9.47 15.17 12.35 $11.65 Unamortized compensation cost related to unvested options at March 31, 2013, was $17,167 and is expected to be recognized over a weighted-average period of 1.6 years. Legg Mason uses an equally weighted combination of both implied and historical volatility to measure expected volatility for calculating Black-Scholes option values. Cash received from exercises of stock options under Legg Mason’s equity incentive plans was $660, $2,851, and $12,094 for the years ended March 31, 2013, 2012 and 2011, respectively. The tax benefit expected to be realized for the tax deductions from these option exercises totaled $45, $47, and $2,645 for the years ended March 31, 2013, 2012 and 2011, respectively. The weighted-average fair value of stock option grants dur- ing the years ended March 31, 2013, 2012 and 2011, using the Black-Scholes option pricing model, was $9.47 and $13.13, and $14.32 per share, respectively. The following weighted-average assumptions were used in the model for grants in fiscal 2013, 2012, and 2011: Expected dividend yield Risk-free interest rate 2013 1.44% 0.81% 2012 1.39% 1.95% 2011 1.39% 2.37% Expected volatility 51.80% 47.16% 52.64% Expected life (in years) 5.02 5.12 5.18 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 4,500 total share limit under the plan. Purchases are made through payroll deductions and Legg Mason provides a 10% con- tribution towards purchases, which is charged to earn- ings. During the fiscal years ended March 31, 2013, 2012 and 2011, approximately 107, 107, and 102 shares, respec- tively, were purchased in the open market on behalf of participating employees. In fiscal 2013, 2012 and 2011, Legg Mason recognized $238, $267, and $286, respec- tively, in compensation expense related to the stock pur- chase plan. On January 28, 2008, the Legg Mason Compensation Committee approved grants to senior officers of 120 market-based performance shares. During fiscal 2013 the remaining 100 shares from this award were forfeited resulting in no outstanding balance as of March 31, 2013. 91 Legg MasonRestricted stock and restricted stock unit transactions during the years ended March 31, 2013, 2012 and 2011, respec- tively, are summarized below: Unvested shares at March 31, 2010 Granted Vested Canceled/forfeited Unvested shares at March 31, 2011 Granted Vested Canceled/forfeited Unvested shares at March 31, 2012 Granted Vested Canceled/forfeited Unvested shares at March 31, 2013 Number of Shares Weighted-Average Grant Date Value 1,605 1,867 (617) (218) 2,637 1,370 (1,075) (59) 2,873 2,185 (1,177) (143) 3,738 $34.80 33.02 38.62 30.42 33.01 33.48 31.49 32.68 33.83 24.04 31.22 58.30 $27.99 The restricted stock and restricted stock unit awards were non-cash transactions. In fiscal 2013, 2012 and 2011, Legg Mason recognized $46,351, $32,826, and $35,770, respectively, in compensation expense and related tax benefits of $17,697, $12,705, and $13,854, respectively, for restricted stock and restricted stock unit awards. Unamortized compensation cost related to unvested restricted stock and restricted stock unit awards for 3,738 shares not yet recognized at March 31, 2013, was $66,854 and is expected to be recognized over a weighted-average period of 1.6 years. In connection with the change in Legg Mason’s Chief Executive Officer in September 2012, 325 shares of restricted stock were granted to certain executives and key employees, with an aggregate value of $8,400. In March 2013, the vesting of 85 of these shares was accel- erated. The remaining shares vest on March 31, 2014. Compensation expense for the year ended March 31, 2013 includes approximately $6,400 of accelerated stock-based net compensation costs associated with the departure of three Legg Mason executive officers during fiscal 2013, of which $1,400 relates to the accelerated vesting of shares in March 2013. Legg Mason also has an equity plan for non-employee directors. 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, direc- tors could also elect to receive stock options. Options granted under the old plan are immediately 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. In fiscal 2013, 2012 and 2011, Legg Mason rec- ognized expense of $1,250, $1,375, and $1,425, respec- tively, for awards under this plan. Shares, options, and restricted stock units issuable under the equity plan are limited to 625 shares in aggregate, of which 328 shares were issued under the plan as of March 31, 2013. As of March 31, 2013, 2012 and 2011 non-employee direc- tors held 112, 184 and 220, stock options, respectively, which are included in the outstanding options presented in the table above. As of March 31, 2013, 2012 and 2011 non-employee directors held 91, 74 and 62 restricted stock units, respectively, which vest on the grant date and are, therefore, not included in the unvested shares of restricted stock and restricted stock units in the table above. During the years ended March 31, 2013 and 2012, non-employee directors did not exercise any stock options and no restricted stock units were distributed. During the year ended March 31, 2011, non-employee directors exercised 9 stock options. In the fiscal year ended March 31, 2011, 7 restricted stock units were distributed for non-employee directors. During the years ended March 31, 2013, 2012 and 2011 non-employee directors were granted 17, 12 and 17 restricted stock units and 35, 31 and 31 shares of common stock, respec- tively. In the fiscal years ended March 31, 2013, 2012 and 2011, there were 72, 36 and 59 stock options canceled or forfeited, respectively. During fiscal 2012, Legg Mason established a long-term incentive plan (the “LTIP”) under its equity incentive plan, which provides an additional element of compensation that is based on performance. Under the LTIP, executive officers were granted cash value performance units in 92 Legg Masonthe June 2011 quarter and the September 2012 quarter that will vest at the end of their performance periods on March 31, 2014 and March 31, 2015, respectively, based upon Legg Mason’s cumulative adjusted earnings per share over the respective periods. Awards granted under the LTIP may be settled in cash and/or shares of Legg Mason common stock, at the discretion of Legg Mason. The estimated payout amounts of the awards, if any, are expensed over the future vesting periods based on a prob- ability assessment of the expected outcome under the LTIP provisions. 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 con- tributions and dividends. There are 378 additional shares reserved for future issuance under the plan. In fiscal 2013, 2012 and 2011, Legg Mason recognized $165, $191, and $263, respectively, in compensation expense related to this plan. During fiscal 2013, 2012 and 2011, Legg Mason issued 71, 68, and 77 shares, respectively, under the plan with a weighted-average fair value per share at the grant date of $23.07, $27.05, and $28.38, respectively. 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 trusts and the corresponding liability related to the deferred compensation plans are presented as com- ponents of stockholders’ equity as Employee stock trust and Deferred compensation employee stock trust, respec- tively. Shares held by the trusts at March 31, 2013, 2012 and 2011, were 726, 690 and 706, respectively. As part of the Company’s streamlining initiative, as further discussed in Note 15, the employment of certain recipi- ents of stock option and restricted stock awards has been terminated. The termination benefits extended to these employees included accelerated vesting of any portion of their equity incentive awards that would not have vested by January 1, 2012, under the original terms of the awards. During fiscal 2011, the portion of the awards subject to accelerated vesting was revalued and was expensed over the new vesting period, the impact of which is included above. Also in connection with the restructuring initiative, the departure of an executive officer in December 2010 resulted in the accelerated vesting of a portion of cer- tain equity incentive awards, the impact of which is also included above. In May 2013, Legg Mason awarded options to purchase 500 shares of Legg Mason, Inc. common stock at an exer- cise price of $31.46 to its President and Chief Executive Officer. The award had a grant date fair value of $5,525 and is subject to vesting requirements, the majority of which contain market-based hurdles, as well as a require- ment that certain shares received upon exercise are retained for a two year period. 12. EARNINGS PER SHARE Basic EPS is calculated by dividing Net Income (Loss) Attributable to Legg Mason, Inc. by the weighted-aver- age number of shares outstanding. The calculation of weighted-average shares includes common shares and unvested restricted shares deemed to be participating securities. Diluted EPS is similar to basic EPS, but adjusts for the effect of potentially issuable common shares, except when inclusion is antidilutive. For periods where a net loss attributable to Legg Mason, Inc. is reported, the inclusion of potentially issuable common shares will decrease the net loss per share. Since this would be anti- dilutive, such shares are excluded from the calculation. In May 2012, as part of a capital plan, Legg Mason’s Board of Directors authorized $1,000,000 for additional purchases of Legg Mason common stock, as well as the comple- tion of the repurchase of the then remaining approximate $155,000 of Legg Mason common stock previously autho- rized. The capital plan authorizes using up to 65% of cash generated from future operations, beginning in fiscal 2013, to purchase shares of Legg Mason common stock. During the years ended March 31, 2013 and 2012, Legg Mason purchased and retired 16,199 and 13,597 shares of its common stock, respectively, for $425,475 and $400,266, through open market purchases. The fiscal 2013 purchases completed the repurchase of its com- mon stock under the previous authorization and includes approximately $270,000 of purchases under the new authorization. During fiscal 2011, Legg Mason purchased and retired 14,552 shares of its common stock for $445,465, through accelerated share repurchase agree- ments and open market purchases. These repurchases reduced weighted-average shares outstanding by 8,449, 9,716, and 9,088 shares for the years ended March 31, 2013, 2012, and 2011, respectively. The par value of the shares repurchased is charged to common stock, with the excess of the purchase price over par first charged against additional paid-in capital, with the remaining balance, if any, charged against retained earnings. During the year ended March 31, 2013 and 2012, Legg Mason issued 2,185 and 1,370 shares of restricted stock, respectively, primarily related to its annual incentive 93 Legg Masonawards and retention awards. Of the shares issued in fis- cal 2013 and 2012, 1,807 and 1,153 shares, respectively, are included in weighted-average shares outstanding. In June 2011, Legg Mason issued 1,830 shares of com- mon stock upon the exercise of purchase contracts on the remaining outstanding Equity Units. Of these shares, 1,380 shares are included in weighted-average shares out- standing for the year ended March 31, 2012. The following table presents the computations of basic and diluted EPS: Weighted-average basic shares outstanding Potential common shares: Employee stock options Weighted-average diluted shares Net income (loss) Less: Net income (loss) attributable to noncontrolling interests Net income (loss) attributable to Legg Mason, Inc. Net income (loss) per share attributable to Legg Mason, Inc. common shareholders Basic Diluted(1) (1) Diluted shares are the same as basic shares for periods with a net loss. The diluted EPS calculation for the year ended March 31, 2013 excludes 5,730 potential common shares that are antidilutive due to the net loss for the fiscal year. Further, the diluted EPS calculation for the years ended March 31, 2013, 2012 and 2011, excludes any potential common shares issuable under the 2.5% Convertible Senior Notes extinguished in May 2012, or the Warrants exchanged for the Note conversion feature, because the market price of Legg Mason common stock had not exceeded the price at which conversion/exercise would be dilutive using the treasury stock method. Also at March 31, 2012 and 2011, warrants issued in connection with the convertible note hedge transactions associated with the issuance of the 2.5% Convertible Senior Notes are excluded from the cal- culation of diluted earnings per share because the effect would be antidilutive. Options to purchase 5,239 and 5,204 shares for the fis- cal years ended March 31, 2012 and 2011, respectively, Years Ended March 31 2013 133,226 2012 143,292 — 133,226 $(359,748) (6,421) $(353,327) 57 143,349 $231,031 10,214 $220,817 2011 155,321 163 155,484 $245,763 (8,160) $253,923 $ (2.65) $ (2.65) $ 1.54 $ 1.54 $ 1.63 $ 1.63 were not included in the computation of diluted earnings per share because the presumed proceeds from exercis- ing such options, including related income tax benefits, exceed the average price of the common shares for the period and therefore the options are deemed antidilutive. 13. ACCUMULATED OTHER COMPREHENSIVE INCOME Accumulated other comprehensive income includes cumu- lative foreign currency translation adjustments and net of tax, gains and losses on investment securities. The change in the accumulated translation adjustments for fiscal 2013 and 2012, primarily resulted from the impact of changes in the Brazilian real, the Japanese yen, the British pound, the Australian dollar, and the Polish zloty in relation to the U.S. dollar on the net assets of Legg Mason’s subsidiaries in Brazil, Japan, the United Kingdom, Australia and Poland, for which the real, the yen, the pound, the Australian dollar, and the zloty are the functional currencies, respectively. A summary of Legg Mason’s accumulated other comprehensive income as of March 31, 2013 and 2012, is as follows: Foreign currency translation adjustment Unrealized gains on investment securities, net of tax provision of $187 and $179, respectively Total 94 2013 $47,259 280 $47,539 2012 $71,204 268 $71,472 Legg MasonThere were no significant amounts reclassified from Accumulated other comprehensive income to the Consolidated Statements of Income (Loss) for the years ended March 31, 2013, 2012 or 2011. 14. DERIVATIVES AND HEDGING The disclosures below detail Legg Mason’s derivatives and hedging activities excluding the derivatives and hedging activities of CIVs. See Note 17, Variable Interest Entities and Consolidation of Investment Vehicles, for information related to the derivatives and hedging of CIVs. Legg Mason uses currency forwards to economically hedge the risk of movements in exchange rates, primarily between the U.S. dollar, euro, Japanese yen, Singapore dollar, British pound, Chinese yuan, and South Korean won. In the Consolidated Balance Sheets, Legg Mason nets the fair value of certain foreign currency forwards executed with the same counterparty where Legg Mason has both the legal right and intent to settle the contracts on a net basis. Legg Mason also uses market hedges on certain seed capital investments by entering into futures contracts to sell index funds that benchmark the hedged seed capital investments. Open futures contracts required cash collateral of $7,131 and $1,919 as of March 31, 2013 and 2012, respectively. The following table presents the fair values as of March 31, 2013 and 2012, of derivative instruments not designated for accounting purposes as hedging instruments, classified as Other assets and Other liabilities: Currency forward contracts Futures contracts Total 2013 2012 Liabilities Assets Liabilities $101 680 $781 $38 46 $84 $685 201 $886 Assets $1,496 443 $1,939 The following table presents gains (losses) recognized on derivative instruments for the years ended March 31, 2013, 2012, and 2011: Income Statement Classification Gains Losses Gains Losses Gains Losses 2013 2012 2011 Currency forward contracts for: Operating activities Other expense $3,650 $(1,858) $ 5,604 $(3,159) $4,943 $ (6,094) Seed capital investments Other non-operating income (expense) 1,090 (380) 431 (351) 123 (355) Futures contracts for seed capital investments Other non-operating income (expense) 1,914 (5,597) 5,684 (4,560) 1,652 (7,146) Total $6,654 $(7,835) $11,719 $(8,070) $6,718 $(13,595) 15. RESTRUCTURING In May 2010, Legg Mason announced a plan to stream- line its business model to drive increased profitability and growth that primarily involved transitioning certain shared services to its investment affiliates which are closer to actual client relationships. This plan involved headcount reductions in operations, technology, and other administrative areas, which were partially offset by headcount increases at the affiliates, and enabled Legg Mason to eliminate a portion of its corporate office space that was primarily dedicated to operations and technology employees. The initiative was completed as of March 31, 2012. Total transition-related costs were $127,500, including non-cash charges of $30,841, through completion of the plan in March 2012. Of the total transition-related costs incurred, $79,686 were related to charges for employee termination benefits and retention incentives during the transition period, and were recorded in Transition- related compensation in the Consolidated Statements of Income (Loss). The remainder represents other costs, including charges for consolidating leased office space, early contract terminations, asset disposals, and pro- fessional fees, which were recorded in the appropriate operating expense classifications. Charges for transition- related costs were $73,066 and $54,434 for the years ended March 31, 2012 and 2011, respectively, which primarily represent costs for lease loss accruals and fixed asset accelerated depreciation related to space perma- nently abandoned, as well as costs for severance and retention incentives. 95 Legg MasonThe table below presents a summary of changes in the transition-related liability from March 31, 2011 through March 31, 2013: Balance as of March 31, 2011 Accrued charges Payments Balance as of March 31, 2012 Payments and other Balance as of March 31, 2013 Severance and Retention Incentives $ 23,211 29,096 (51,140) 1,167 (1,167) Lease Loss Accruals and Other $ 5,835 25,916(1) (16,121) 15,630 (10,744) Total $ 29,046 55,012 (67,261) 16,797 (11,911) $ — $ 4,886 $ 4,886 (1) Includes lease loss accruals of $17,983 for space permanently abandoned. 16. BUSINESS SEGMENT INFORMATION Legg Mason is a global asset management company that provides investment management and related services to a wide array of clients. Due to a realignment of its executive management team, beginning in fiscal 2012, the previous separation of the Americas and International divisions has been eliminated and the company operates in one report- able business segment, Global Asset Management. Global Asset Management provides investment advisory services to institutional and individual clients and to company-spon- sored investment funds. The primary sources of revenue in Global Asset Management are investment advisory, distribution and administrative fees, which typically are cal- culated 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 under certain investment advisory contracts for exceeding performance benchmarks. Revenues by geographic location are primarily based on the geographic location of the advisor or the domicile of fund families managed by Legg Mason. The table below reflects our revenues and long-lived assets by geographic region as of March 31: OPERATING REVENUES United States United Kingdom Other International Total INTANGIBLE ASSETS, NET AND GOODWILL United States United Kingdom Other International Total 2013 2012 2011 $1,800,539 $1,806,990 $1,919,680 387,966 424,145 448,863 406,721 512,313 352,324 $2,612,650 $2,662,574 $2,784,317 $3,139,050 $3,548,628 $3,565,019 895,767 411,910 1,108,297 474,986 1,136,386 487,022 $4,446,727 $5,131,911 $5,188,427 17. VARIABLE INTEREST ENTITIES AND CONSOLIDATION OF INVESTMENT VEHICLES Legg Mason is the investment manager for CDOs/CLOs that are considered VIEs under revised accounting guid- ance, since investors in these structures lack unilateral decision making authority. These investment vehicles were created for the sole purpose of issuing collateralized instruments that offer investors the opportunity for returns that vary with the risk level of their investment. Legg Mason’s management fee structure for these investment vehicles typically includes a senior management fee, and may also include subordinated and incentive management fees. Legg Mason holds no equity interest in any of these investment vehicles and did not transfer or sell any assets to any of these investment vehicles. In accordance with the methodology described in Note 1 above, Legg Mason concluded that it had a variable interest in only two of these investment vehicles, which are CLOs, and is the primary beneficiary of one of the two CLOs, because although Legg Mason holds no equity interest in either of these investment vehicles, it had both the power to control and had a significant variable interest in one CLO because of its expected subordinated fees. As of March 31, 2013 and 2012, the balances related to this CLO 96 Legg Masonwere consolidated on the Company’s consolidated finan- cial statements. The collateral assets of this VIE are pri- marily comprised of investments in corporate loans, and to a lesser extent, bonds. The assets of the CLO cannot be used by Legg Mason and gains and losses related to these assets have no impact on Net Income (Loss) Attributable to Legg Mason, Inc. The liabilities of this VIE are primarily comprised of debt and the CLO’s debt holders have no recourse to the general credit or assets of Legg Mason. The other CLO is not consolidated, as its level of expected subordinated fees is insignificant. In addition, Legg Mason was the primary beneficiary of one sponsored investment fund VIE, and also held a controlling financial interest in one sponsored invest- ment fund VRE, both of which were consolidated as of March 31, 2013, 2012 and 2011. Effective December 31, 2011, a controlling financial interest of $20,814 in a second sponsored investment fund VRE, which was consolidated by Legg Mason as of March 31, 2011 was redeemed. Accordingly, the fund was deconsolidated by Legg Mason and the fund’s balance sheet amounts have been excluded from Legg Mason’s consolidated balance sheet as of March 31, 2012 and later, but partial income statement and cash flow amounts for the fund have been included in Legg Mason’s consolidated income and cash flow state- ments for the year ended March 31, 2012. Legg Mason’s investment in CIVs as of March 31, 2013 and 2012, was $39,056 and $38,919, respectively, which represents its maximum risk of loss, excluding uncollected advisory fees. The assets of these CIVs are primarily comprised of invest- ment securities. Investors and creditors of these CIVs have no recourse to the general credit or assets of Legg Mason beyond its investment in these funds. The following tables reflect the impact of CIVs on the Consolidated Balance Sheets as of March 31, 2013 and 2012, respec- tively, and the Consolidated Statements of Income (Loss) for the years ended March 31, 2013, 2012 and 2011 respectively: Consolidating Balance Sheets Current assets Non-current assets Total assets Current liabilities Long-term debt of CIVs Other non-current liabilities Total liabilities Redeemable non-controlling interests Total stockholders’ equity Total liabilities and equity Current assets Non-current assets Total assets Current liabilities Long-term debt of CIVs Other non-current liabilities Total liabilities Redeemable non-controlling interests Total stockholders’ equity Total liabilities and equity Balance before Consolidation of CIVs $1,908,932 5,115,181 $7,024,113 $ 692,261 — 1,517,069 2,209,330 1,355 4,813,428 $7,024,113 Balance before Consolidation of CIVs $2,439,161 5,801,681 $8,240,842 $ 971,803 — 1,603,064 2,574,867 996 5,664,979 $8,240,842 March 31, 2013 CIVs $ 73,320 211,617 $284,937 $ 10,539 207,835 2,930 221,304 — 63,633 $284,937 Eliminations Consolidated Totals $(39,390) — $(39,390) $ (334) — — (334) 19,654 (58,710) $(39,390) $1,942,862 5,326,798 $7,269,660 $ 702,466 207,835 1,519,999 2,430,300 21,009 4,818,351 $7,269,660 March 31, 2012 CIVs $ 58,040 296,272 $354,312 $ 4,467 271,707 3,872 280,046 — 74,266 $354,312 Eliminations Consolidated Totals $(39,407) — $(39,407) $ (488) — — (488) 23,035 (61,954) $(39,407) $2,457,794 6,097,953 $8,555,747 $ 975,782 271,707 1,606,936 2,854,425 24,031 5,677,291 $8,555,747 97 Legg MasonConsolidating Statements of Income (Loss) Total operating revenues Total operating expenses Operating income (loss) Total other non-operating income (expense) Income (loss) before income tax provision (benefit) Income tax provision (benefit) Net income (loss) Less: Net income (loss) attributable to noncontrolling interests Fiscal year Ended March 31, 2013 Balance before Consolidation of CIVs $2,615,047 3,046,587 (431,540) (72,177) (503,717) (150,859) (352,858) 469 CIVs $ — 2,965 (2,965) (2,864) (5,829) — (5,829) — Eliminations As Reported $(2,397) (2,403) 6 (1,067) (1,061) — (1,061) (6,890) $2,612,650 3,047,149 (434,499) (76,108) (510,607) (150,859) (359,748) (6,421) Net income (loss) attributable to Legg Mason, Inc. $ (353,327) $(5,829) $ 5,829 $ (353,327) Total operating revenues Total operating expenses Operating income (loss) Total other non-operating income (expense) Income (loss) before income tax provision (benefit) Income tax provision (benefit) Net income (loss) Less: Net income (loss) attributable to noncontrolling interests Fiscal Year Ended March 31, 2012 Balance before Consolidation of CIVs CIVs Eliminations As Reported $2,665,668 2,323,213 342,455 (49,236) 293,219 72,052 221,167 350 $ — 3,709 (3,709) 18,336 14,627 — 14,627 — $ (3,094) (3,101) $2,662,574 2,323,821 7 (4,770) (4,763) — (4,763) 9,864 338,753 (35,670) 303,083 72,052 231,031 10,214 Net income (loss) attributable to Legg Mason, Inc. $ 220,817 $14,627 $(14,627) $ 220,817 Total operating revenues Total operating expenses Operating income (loss) Total other non-operating income (expense) Income (loss) before income tax provision (benefit) Income tax provision (benefit) Net income (loss) Less: Net income (loss) attributable to noncontrolling interests Fiscal Year Ended March 31, 2011 Balance before Consolidation of CIVs $2,788,450 2,396,938 391,512 (17,931) 373,581 119,434 254,147 224 CIVs $ — 4,704 (4,704) 1,704 (3,000) — (3,000) — Eliminations As Reported $(4,133) (4,133) — (5,384) (5,384) — (5,384) (8,384) $2,784,317 2,397,509 386,808 (21,611) 365,197 119,434 245,763 (8,160) Net income (loss) attributable to Legg Mason, Inc. $ 253,923 $(3,000) $ 3,000 $ 253,923 Other non-operating income (expense) includes interest income, interest expense and net gains (losses) on investments and long-term debt determined on an accrual basis. The consolidation of CIVs has no impact on Net Income (Loss) Attributable to Legg Mason, Inc. 98 Legg MasonThe fair value of the financial assets and (liabilities) of CIVs were determined using the following categories of inputs as of March 31, 2013: ASSETS: Trading investments: Hedge funds Investments: CLO loans CLO bonds Private equity funds Total investments LIABILITIES: CLO debt Derivative liabilities ASSETS: Trading investments: Hedge funds Investments: CLO loans CLO bonds Private equity funds Total investments LIABILITIES: CLO debt Derivative liabilities quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Value as of March 31, 2013 $2,076 $ 3,268 $ 19,448 $ 24,792 — — — — $2,076 $ — — $ — 172,519 11,052 — 183,571 $186,839 $ — (2,930) $ (2,930) — — 26,982 26,982 172,519 11,052 26,982 210,553 $ 46,430 $ 235,345 $(207,835) — $(207,835) $(207,835) (2,930) $(210,765) As of March 31, 2012 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Value as of March 31, 2012 $1,016 $ 6,443 $ 24,116 $ 31,575 — — — — $1,016 $ — — $ — 260,690 9,092 — 269,782 $276,225 $ — (3,872) $ (3,872) — — 25,071 25,071 260,690 9,092 25,071 294,853 $ 49,187 $ 326,428 $(271,707) — $(271,707) $(271,707) (3,872) $(275,579) 99 Legg MasonExcept for the CLO debt, substantially all of the above financial instruments where valuation methods rely on other than observable market inputs as a significant input utilize the NAV practical expedient, such that measurement uncertainty has little relevance. The following table provides a summary of qualitative information relating to the valuation of CLO debt: Value as of March 31, 2013 $(207,835) Valuation Technique Discounted cash flow Value as of March 31, 2012 $(271,707) Valuation Technique Discounted cash flow Unobservable Input Range (Weighted-Average) Discount rate Default rate 1.1%–11.0% (2.3%) 3.0%– 4.0% (3.5%) Constant prepayment rate 25.0% Unobservable Input Range (Weighted-Average) Discount rate Default rate 1.7%–24.5% (3.8%) 2.5%– 4.0% (3.4%) Constant prepayment rate 15.0% Significant increases (decreases) in any of these inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, both the constant rate of prepayment and default rate are driven by market conditions related to interest rates, credit ratings, and other factors. Each of the inputs noted could move independently depend- ing on specific market conditions, making it possible for varying market conditions to drive changes in these inputs with a positive, negative, or zero correlation. The changes in assets and (liabilities) of CIVs measured at fair value using significant unobservable inputs (Level 3) for the years ended March 31, 2013 and 2012 are presented in the table below: ASSETS: Hedge funds Private equity funds LIABILITIES: CLO debt Total realized and unrealized gains (losses), net Value as of March 31, 2012 Purchases Sales Settlements/ Other Transfers Realized and Unrealized Gains/ (Losses), Net Value as of March 31, 2013 $ 24,116 25,071 $ 49,187 $1,980 2,622 $4,602 $(6,602) $ — (2,030) — $(8,632) $ — $ — — $ — $ (46) $ 19,448 1,319 26,982 $ 1,273 $ 46,430 $(271,707) $ — $ — $75,798 $ — $(11,926) $(207,835) $(10,653) ASSETS: Hedge funds Value as of March 31, 2011 Purchases Sales Transfers In Transfers Out Realized and Unrealized Gains, Net Value as of March 31, 2012 $ 34,272 $17,018 $(32,058) $3,302 $(3,316) $ 4,898 $ 24,116 Private equity funds 17,879 4,889 (762) — — 3,065 25,071 $ 52,151 $21,907 $(32,820) $3,302 $(3,316) $ 7,963 $ 49,187 LIABILITIES: CLO debt $(278,320) $ — $ — $ — $ — $ 6,613 $(271,707) Total realized and unrealized gains, net $14,576 100 Legg MasonRealized and unrealized gains and losses recorded for Level 3 assets and liabilities of CIVs are included in Other non- operating income (expense) of CIVs on the Consolidated Statements of Income (Loss). Total unrealized gains (losses) for Level 3 investments and liabilities of CIVs relating only to those assets and liabilities still held at the reporting date were $(11,842) and $7,297 for the years ended March 31, 2013 and 2012, respectively. There were no transfers between Level 1 and Level 2 during either of the years ended March 31, 2013 and 2012. The NAV values used as a practical expedient by CIVs have been provided by the investees and have been derived from the fair values of the underlying investments as of the respective reporting dates. The following table summarizes, as of March 31, 2013 and March 31, 2012, the nature of these investments and any related liquidation restrictions or other fac- tors which may impact the ultimate value realized: Category of Investment Hedge funds Investment Strategy Global macro, fixed income, long/short equity, systematic, emerging market, U.S. and European hedge Fair Value Determined Using NAV As of March 31, 2013 March 31, 2013 March 31, 2012 Unfunded Commitments Remaining Term $24,792(1) $31,575(2) n/a n/a Private equity funds Long/short equity Total 26,982(3) 25,071(3) $51,774 $56,646 $5,549 $5,549 6 years n/a—not applicable (1) 11% daily redemption; 8% monthly redemption; 2% quarterly redemption; and 79% are subject to three to five year lock-up or side pocket provisions. (2) 5% daily redemption; 6% monthly redemption; 5% quarterly redemption; and 84% are subject to three to five year lock-up or side pocket provisions. (3) Liquidations are expected over the remaining term. There are no current plans to sell any of these investments held as of March 31, 2013. Legg Mason has elected the fair value option for certain eligible assets and liabilities, including corporate loans and debt, of the consolidated CLO. Management believes that the use of the fair value option eliminates certain timing differences and better matches the changes in fair value of assets and liabilities related to the CLO. The following table presents the fair value and unpaid principal balance of CLO loans, bonds and debt carried at fair value under the fair value option as of March 31, 2013 and March 31, 2012: CLO loans and bonds Unpaid principal balance Unpaid principal balance in excess of fair value Fair value Unpaid principal balance of loans that are more than 90 days past due and also in nonaccrual status Unpaid principal balance in excess of fair value for loans that are more than 90 days past due and also in nonaccrual status Fair value of loans more than 90 days past due and in nonaccrual status CLO debt Principal amounts outstanding Excess unpaid principal over fair value Fair value March 31, 2013 March 31, 2012 $186,839 (3,268) $183,571 $277,156 (7,374) $269,782 $ — $ 2,963 — $ — $225,161 (17,326) $207,835 (1,023) $ 1,940 $300,959 (29,252) $271,707 101 Legg MasonDuring the years ended March 31, 2013 and 2012, total net gains (losses) of $(8,455) and $2,054, respectively, were recognized in Other non-operating income (loss) of CIVs in the Consolidated Statements of Income (Loss) related to assets and liabilities for which the fair value option was elected. CLO loans and CLO debt measured at fair value have floating interest rates, therefore, substantially all of the estimated gains and losses included in earnings for the years ended March 31, 2013 and 2012, were attributable to instrument specific credit risk. The CLO debt bears interest at variable rates based on LIBOR plus a pre-defined spread, which ranges from 25 basis points to 400 basis points. All outstanding debt matures on July 15, 2018. The CLO commenced its wind-down in July 2012, such that proceeds from securi- ties cannot be reinvested and are applied to reduce the debt outstanding in the quarter subsequent to receipt, after other required payments. Total derivative liabilities of CIVs of $2,930 and $3,872 as of March 31, 2013 and 2012, respectively, are recorded in Other liabilities of CIVs. Gains and (losses) of $942 and $(1,223), respectively, for the fiscal year ended March 31, 2013, and $54,603 and $(47,697), respectively, for the fis- cal year ended March 31, 2012, related to derivative liabili- ties of CIVs are included in Other non-operating income (loss) of CIVs. There is no risk to Legg Mason in relation to the derivative assets and liabilities of the CIVs in excess of its investment in the funds, if any. As of March 31, 2013 and 2012, for VIEs in which Legg Mason holds a variable interest or is the sponsor and holds a vari- able interest, but for which it was not the primary beneficiary, Legg Mason’s carrying value and maximum risk of loss were as follows: CLOs Real Estate Investment Trust Other sponsored investment funds Total CLO Public-Private Investment Program(2) Other sponsored investment funds Total As of March 31, 2013 Equity Interests on the Consolidated Balance Sheet Maximum Risk of Loss(1) $ — 989 43,104 $44,093 $ 496 2,644 87,121 $90,261 As of March 31, 2012 Equity Interests on the Consolidated Balance Sheet Maximum Risk of Loss(1) $ — 282 54,161 $54,443 $ 442 282 93,521 $94,245 (1) Includes equity investments the Company has made or is required to make and any earned but uncollected management fees. (2) Upon liquidation of the fund, Legg Mason’s investment was fully redeemed in the quarter ended December 31, 2012. The Company’s total AUM of unconsolidated VIEs was $17,090,267 and $17,534,840 as of March 31, 2013 and 2012, respectively. The assets of these VIEs are primarily comprised of cash and cash equivalents and investment securities, and the liabilities are primarily comprised of debt and vari- ous expense accruals. These VIEs are not consolidated because Legg Mason does not absorb a majority of each VIE’s expected losses or does not receive a majority of each VIE’s expected residual returns. 102 Legg Masonquarterly Financial Data (Dollars in thousands, except per share amounts) (Unaudited) Fiscal 2013(1) Operating Revenues Operating Expenses Operating Income (Loss) Other Non-Operating Income (Expense) Income (Loss) before Income Tax Provision (Benefit) Income tax provision (benefit) Net Income (Loss) Less: Net income (loss) attributable to noncontrolling interests Mar. 31 $667,763 624,750 43,013 5,633 48,646 17,955 30,691 1,487 quarter Ended Dec. 31 $ 673,900 1,307,223 (633,323) (5,441) (638,764) (180,214) (458,550) (4,680) Sept. 30 $640,295 560,561 79,734 17,758 97,492 16,397 81,095 298 June 30 $630,692 554,615 76,077 (94,058) (17,981) (4,997) (12,984) (3,526) Net Income (Loss) Attributable to Legg Mason, Inc. $ 29,204 $ (453,870) $ 80,797 $ (9,458) Net Income (Loss) per Share Attributable to Legg Mason, Inc. common shareholders: Basic Diluted Cash dividend per share Stock price range: High Low Assets Under Management: End of period Average $ 0.23 $ (3.45) $ 0.60 $ (0.07) 0.23 0.11 32.59 25.43 (3.45) 0.11 26.63 23.88 0.60 0.11 27.14 23.31 (0.07) 0.11 28.47 22.36 $664,609 657,357 $ 648,879 648,354 $650,700 639,389 $631,823 635,463 (1) Due to rounding of quarterly results, total amounts for fiscal year may differ immaterially from the annual results. As of May 21, 2013, the closing price of Legg Mason‘s common stock was $36.13. Fiscal 2012(1) Operating Revenues Operating Expenses Operating Income Other Non-Operating Income (Expense) Income before Income Tax Provision (Benefit) Income tax provision (benefit) Net Income Less: Net income attributable to noncontrolling interests Mar. 31 $648,591 576,379 72,212 37,781 109,993 33,184 76,809 740 Quarter Ended Dec. 31 $626,978 567,655 59,323 (11,575) 47,748 12,607 35,141 7,009 Sept. 30 $669,897 563,045 106,852 (51,075) 55,777 (1,606) 57,383 719 June 30 $717,108 616,742 100,366 (10,801) 89,565 27,867 61,698 1,746 Net Income attributable to Legg Mason, Inc. $ 76,069 $ 28,132 $ 56,664 $ 59,952 Net Income per Share attributable to Legg Mason, Inc. common shareholders: Basic Diluted Cash dividend per share Stock price range: High Low Assets Under Management: End of period Average $ 0.54 $ 0.20 $ 0.39 $ 0.40 0.54 0.08 29.49 23.75 0.20 0.08 29.56 22.61 0.39 0.08 34.32 24.11 0.40 0.08 37.82 30.86 $643,318 634,916 $626,960 622,004 $611,794 643,296 $662,533 670,761 (1) Due to rounding of quarterly results, total amounts for fiscal year may differ immaterially from the annual results. 103 Legg MasonExecutive Officers Corporate Data Joseph A. Sullivan President and Chief Executive Officer Peter H. Nachtwey Senior Executive Vice President and Chief Financial Officer EXECUTIVE OFFICES 100 International Drive Baltimore, Maryland 21202 (410) 539-0000 www.leggmason.com TRANSFER AGENT American Stock Transfer & Trust Company 59 Maiden Lane New York, New York 10038 (866) 668-6550 www.amstock.com Terence Johnson Executive Vice President and Head of Global Distribution Thomas C. Merchant Executive Vice President and General Counsel Jennifer Murphy Executive Vice President and Chief Administrative Officer FORM 10-K Legg Mason’s Annual Report on Form 10-K for fiscal 2013, filed with the Securities COMMON STOCK Shares of Legg Mason, Inc. common and Exchange Commission and containing stock are listed and traded on the New audited financial statements, is available York Stock Exchange (symbol: LM). upon request without charge by writing to As of March 31, 2013, there were 1,360 the Corporate Secretary at the Executive Offices of the Company. shareholders of record of the Company’s common stock. 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 Total Return Performance 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, 2008). The SNL Asset Manager Index consists of 34 asset management firms. E U L A V x E D N I 150 125 100 75 50 25 0 03/31/08 03/31/09 03/31/10 03/31/11 03/31/12 03/31/13 Legg Mason, Inc. snL asset Manager Index s&P 500 104 P E R I O D E N D I N G INDEX 03/31/08 03/31/09 03/31/10 03/31/11 03/31/12 03/31/13 Legg Mason, Inc. 100.00 29.65 53.69 67.99 53.23 62.31 SNL Asset Manager Index 100.00 53.16 98.11 114.82 112.23 144.15 S&P 500 100.00 61.91 92.72 107.23 116.39 132.64 Source: SNL Financial LC, Charlottesville, VA © 2013 www.snl.com Legg Mason Legg Mason was named among 2012’s Best Corporate Citizens in the financials/insurance/ real estate sector by Corporate Responsibility Magazine. Volunteerism: Enriching and participating in our communities. At Legg Mason, we strive to enrich our surrounding communities through employee volunteerism, including mentoring programs and our community-based Days of Caring program. We are proud to have been awarded the SIFMA Diversity Leadership Award this year for our work partnering with community-based nonprofit organizations and their boards to provide opportunities for employees to better serve their communities. Diversity and Inclusion: Appreciating and leverag- ing our differences. Legg Mason is proud to be a com- pany that promotes respect, inclusion and participation in a team-focused environment. We value collaboration and its impact on achieving creative solutions and new perspectives. Corporate Citizenship At Legg Mason, we affirm our commitment to corporate citi- zenship each day—through philanthropic giving, environmental awareness, volunteerism efforts and diversity and inclusion in our workplace. Our employees are actively engaged in our cor- porate citizenship efforts which touch a wide range of causes and reach locales both inside the United States and abroad. We have always believed that by investing in our communi- ties, we invest in our futures. Philanthropy: Supporting and strengthening our communities. Legg Mason’s long history of supporting community efforts and initiatives philanthropically through the Legg Mason Charitable Foundation focuses on our efforts over the long term and making our communities strong and vibrant for generations to come. Environment: Protecting and improving our world. We are committed to advancing sustainability and environ- mental initiatives. Our online Sustainability Report details our efforts and dedication to making continued progress towards a more sustainable future. L e g g M a s o n 2 0 1 3 A n n u a l R e p o r t Independent Expertise. Singular Focus. Legg Mason, Inc. 100 International Drive Baltimore, MD 21202 (410) 539-0000 www.leggmason.com 

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