Item 1. Business.
General
Legg Mason, Inc. (the "Company") is a holding company which, through its subsidiaries, is engaged in securities brokerage and trading, investment management of Company-sponsored mutual funds and individual and institutional accounts, investment banking for corporations and municipalities, sale of insurance and annuity products, commercial mortgage banking and provision of other financial services.
The Company's principal broker-dealer subsidiary is Legg Mason Wood Walker, Incorporated ("Legg Mason Wood Walker"), a full service regional broker-dealer and investment banking firm operating primarily in the Eastern and Mid-South regions of the United States. Another broker-dealer subsidiary, Howard, Weil, Labouisse, Friedrichs Incorporated ("Howard Weil"), engages in public finance in the Mid-South region as well as energy-related investment banking and institutional brokerage.
Investment advisory subsidiaries of the Company, and their respective assets under management as of March 31, 1995, include Legg Mason Fund Adviser, Inc., which serves as investment adviser to or manager of Company-sponsored mutual funds, with assets of approximately $4.1 billion; Western Asset Management Company, which manages fixed-income assets for institutional accounts, with approximately $12.5 billion under management; Batterymarch Financial Management, Inc., which manages emerging markets, international and U.S. equity portfolios for institutional clients, with approximately $4.9 billion under management; Legg Mason Capital Management, Inc., which serves as investment adviser to individual and institutional accounts, with approximately $740 million under management; Gray, Seifert & Co., Inc., which serves as investment adviser to wealthy individual, family group, endowment and foundation accounts, with approximately $680 million under management; The Fairfield Group, Inc., which serves as investment adviser to mutual funds (with assets of approximately $310 million) structured to meet the investment needs of banks and bank trust departments.
The Company's principal real estate finance subsidiaries are Legg Mason Real Estate Services, Inc. (formerly named Latimer & Buck, Inc.) and Dorman & Wilson, Inc. which are primarily engaged in commercial mortgage banking and commercial loan servicing.
In the fiscal year ended March 31, 1995, the Company's total revenues were derived approximately 51% from individual investor brokerage accounts, including interest on margin accounts, 6% from institutional investor brokerage accounts, 24% from investment advisory services, and the balance from transactions as principal with
other dealers, investment banking, mortgage banking and other activities.
The Company was incorporated in Maryland in 1981 to serve as a holding company for Legg Mason Wood Walker and other subsidiaries. The predecessor company to Legg Mason Wood Walker was formed in 1970 under the name Legg Mason & Co., Inc. to combine the operations of Legg & Co., a Maryland-based broker-dealer formed in 1899, and Mason & Company, Inc., a Virginia-based broker-dealer formed in 1962. The Company's subsequent growth has occurred through internal expansion as well as through its acquisitions of Wood Walker & Co., a New York broker-dealer, in 1973; Mason & Lee, Incorporated, a Virginia broker-dealer, in 1981; C. C. Collings and Company, Inc. and A. E. Masten & Co., Incorporated, two Pennsylvania broker-dealers, in 1984; Hill & Co., an Ohio broker-dealer, in 1985; Western Asset Management Company and Warren W. York & Co., a Pennsylvania broker-dealer, in 1986; Howard Weil in 1987; Latimer & Buck, Inc. in 1990; Dorman & Wilson, Inc. in 1991; The Fairfield Group, Inc. in April 1993; Gray, Seifert & Co., Inc. in April 1994; and Batterymarch Financial Management in January 1995.
Unless the context otherwise requires, all references in this Report to the Company include Legg Mason, Inc. and its predecessors and subsidiaries.
Registrations and Exchange Memberships
Legg Mason Wood Walker and Howard Weil are registered as broker-dealers with the Securities and Exchange Commission ("SEC"), are members of the New York Stock Exchange, Inc. ("NYSE"), the New York Futures Exchange, Inc., the National Association of Securities Dealers, Inc. ("NASD") and the Securities Investors Protection Corporation ("SIPC"), and are registered as futures commission merchants with the Commodity Futures Trading Commission. In addition, Legg Mason Wood Walker is a member of the Philadelphia Stock Exchange, Inc.
Brokerage Offices
The following table reflects, as of March 31, 1995, certain information with respect to the Company's securities brokerage offices.
Revenues by Source
The following table sets forth certain information regarding the revenues of the Company by source.
(1) Principal transactions (securities transactions in which the Company buys for or sells from its own inventory) are classified as "Customer Related" when such transactions are effected with a customer of the Company (whether an individual or institutional investor) and as "Dealer Related" when such transactions are effected with another dealer. (2) Principally selling concessions from underwriting participations and fees from managed offerings. (3) Includes revenues from mortgage servicing and loan originations (1993: $12,198; 1994: $14,908; 1995: $14,603) and real estate appraisal and consulting fees (1993: $3,776; 1994: $3,094; 1995: $2,805); and retirement account fees (1993: $2,205; 1994: $1,922; 1995: $2,391).
Retail Securities Business
For the fiscal years ended March 31, 1993, 1994 and 1995, revenues derived from securities transactions for individual investors (excluding interest on margin accounts) constituted approximately 82%, 84% and 88%, respectively, of total revenues from securities transactions and 50%, 50% and 45%, respectively, of the Company's total revenues. Management believes that such services will continue to be the Company's primary source of revenues in the foreseeable future, although the percentage of total revenues may decrease primarily as a result of increases in investment advisory revenues. Retail commissions are charged on both exchange and over-the-counter ("OTC") transactions in accordance with a schedule which the Company has formulated and may change from time to time. Discounts from the schedule are granted in certain cases. The Company also offers certain account arrangements under which a single fee is charged based on a percentage of the assets held in a customer's account and no commissions are charged on a transaction by transaction basis. When OTC transactions are executed by the Company as a dealer, the Company receives, in lieu of commissions, mark-ups or mark-downs that are included in "Revenues by Source" as customer-related principal transactions. The Company has dealer-sales agreements with several major distributors that offer mutual fund shares through broker-dealers. In addition, the Company sells shares of Company-sponsored mutual funds. See "Company-Sponsored Mutual Funds."
Margin Accounts, Interest Income and Free Credit Balances
Customers' securities transactions are effected on either a cash or a margin basis. In a margin account, the customer pays less than the full cost of the securities purchased and the broker-dealer makes a loan for the balance of the purchase price secured by the securities purchased or other securities owned by the investor. The amount of the loan is subject to the margin regulations (Regulation T) of the Board of Governors of the Federal Reserve System, NYSE margin requirements, and the Company's internal policies, which in some instances are more stringent than Regulation T or NYSE requirements. In permitting a customer to purchase securities on margin, the Company is subject to the risk that a market decline could reduce the value of its collateral below the amount of the customer's indebtedness and that the customer might be unable otherwise to repay the indebtedness.
Interest is charged on amounts borrowed by customers (debit balances) to finance their margin transactions. The rate of interest charged to customers is the brokers' call money rate (the interest rate on bank loans to brokers collateralized by securities) plus an additional amount that varies depending upon the size of the customer's debit balance and level of account activity. For the fiscal years ended March 31, 1993, 1994 and 1995, interest income derived from these sources constituted approximately 3%, 3% and 5%, respectively, of the Company's total revenues. Interest is also
earned on securities owned by the Company and on operating and segregated cash balances.
Free credit balances (excess funds kept by customers in their brokerage accounts), equity capital and bank lines of credit are the primary sources of funds to finance customers' margin account borrowings. Legg Mason Wood Walker pays interest on certain free credit balances in customers' accounts when the customer has indicated that the funds will be used for reinvestment at a future date. The rate of interest on these customer balances has generally been below money market fund rates. In fiscal 1995, Legg Mason Wood Walker paid interest on approximately 76% of customer free credit balances.
Institutional Business
The Company is engaged in executing securities transactions for institutional investors such as banks, mutual funds, insurance companies and pension and profit-sharing plans. Such investors normally purchase and sell securities in large quantities which require special marketing and trading expertise. The Company believes that a significant portion of its institutional brokerage commissions is received as a consequence of provision to institutions of research opinions and services regarding specific corporations and industries and other matters affecting the securities markets. See "Research."
Transactions are executed by the Company acting as broker or as principal. The Company permits discounts from its commission schedule to its institutional customers. The size of such discounts varies with the size of particular transactions and other factors. For the fiscal years ended March 31, 1993, 1994 and 1995, revenues derived from securities transactions for institutional investors constituted approximately 18%, 16% and 12%, respectively, of total revenues from securities transactions and 11%, 10% and 6%, respectively, of the Company's total revenues.
Principal Transactions
The Company is an active market maker and distributor of municipal bonds, particularly bonds issued by municipalities located in the Mid-Atlantic and Mid-South regions. The Company also makes primary markets in equity securities that are traded OTC, particularly securities of companies located in the Mid-Atlantic and Mid-South regions.
As of March 31, 1995, the Company made markets in equity securities of approximately 460 corporations, including corporations for which the Company has acted as a managing or co-managing underwriter. The Company has 23 traders involved in trading corporate equity and debt securities, 14 in trading municipal securities, and 9 in trading government securities.
The Company's market-making activities are also conducted with other dealers through a network of direct wires, and with institutional and individual customers of its branch office system. In making markets in equity and debt securities, the Company maintains positions in such securities to service its customers and accordingly exposes its own capital to the risk of fluctuations in market value. While the Company seeks to avoid substantial market risk, and may engage in hedging transactions to minimize risk, it does, nonetheless, realize profits and losses from market fluctuations. Trading profits (or losses) depend upon the skills of the employees engaged in market making, the amount of capital allocated to positions in securities and the general level of activity and trend of prices in the securities markets.
Investment Banking
Corporate and Municipal Finance
The Company participates as an underwriter in public offerings of corporate debt and equity issues as well as municipal securities, generally as a member of underwriting syndicates managed by others. The Company also serves as manager or co-manager of corporate equity and municipal offerings, generally involving issuers located in the Mid-Atlantic and Mid-South regions.
The following tables set forth, for the periods indicated, (i) the total number and dollar amount of corporate stock and bond and municipal bond offerings managed or co-managed by the Company, and (ii) the total number and dollar amount of its underwriting participations in those offerings and in offerings managed by others.
As the above tables indicate, the number and size of corporate and municipal offerings managed or underwritten by the Company increased sharply in 1991, 1992 and 1993, largely because of favorable conditions in the equity and debt markets, and refinancings resulting from substantial declines in interest rates. The 1992 and 1993 increases included a substantial volume of closed-end fund offerings and the 1993 increase included a substantial volume of real estate investment trust offerings. In 1994, higher interest rate levels resulted in industry-wide declines in the volume and size of corporate and municipal securities offerings.
Underwriting involves both economic and regulatory risks. An underwriter may incur losses if it is unable to resell the securities it is committed to purchase, or if it is forced to liquidate its commitments at less than the agreed purchase price. In addition, an underwriter is subject to substantial potential liability for material misstatements or omissions in prospectuses and other communications with respect to underwritten offerings. See "Item 3. Legal Proceedings." Furthermore, because underwriting commitments require a charge against net capital, the Company's broker-dealer subsidiaries could find it necessary to limit their underwriting participations to remain in compliance with regulatory net capital requirements. See "Net Capital Requirements."
Other Investment Banking Activities
The Company's investment banking activities also include private debt and equity placements and initiation and advice with respect to merger and acquisition transactions, as well as provision of financial advisory services to corporate and municipal clients.
The Company sells interests in both private and public limited partnership investments and in the past has originated real estate securities partnership offerings, although activities in this area have not been significant for several years. In self-originated offerings, subsidiaries of the Company serve as general partners of limited partnerships sponsored by the Company, which may subject the Company to the potential liabilities that can arise as a result of such service.
At March 31, 1995, the Company had 72 professionals engaged in investment banking activities, including 34 in municipal finance, 37 in corporate finance and 3 in limited partnership investment activities.
Company-Sponsored Mutual Funds
The Company sponsors and serves as distributor for fifteen Legg Mason mutual funds, including five equity funds, seven taxable and tax-exempt fixed-income funds and three taxable and tax-exempt money market funds. Legg Mason Fund Adviser, Inc., Western Asset Management Company, Batterymarch Financial Management, Inc. and Legg
Mason Capital Management, Inc., wholly-owned subsidiaries of the Company, serve as investment adviser to or manager of these funds. The Company anticipates that it will sponsor additional funds in the future and that such funds will be advised by investment advisory subsidiaries of the Company.
As of March 31, 1994 and 1995, the aggregate net assets of all Company-sponsored mutual funds were approximately $3.7 billion and $4.1 billion, respectively.
For the fiscal years ended March 31, 1993, 1994 and 1995, the Company received approximately $12.3 million, $16.8 million and $21.0 million, respectively, in asset-based sales charges from its sponsored mutual funds.
Investment Advisory Services
Legg Mason Fund Adviser, Inc. serves as investment adviser to or manager of the Company-sponsored mutual funds as described above.
Western Asset Management Company specializes in the management of fixed-income assets for institutional clients. At March 31, 1994 and 1995, Western had approximately $10.5 billion and $12.5 billion, respectively, under management (not including assets in Company-sponsored mutual funds for which it serves as investment adviser).
Batterymarch Financial Management, Inc., acquired in January 1995, manages emerging markets, international, and U.S. equity portfolios for institutional clients. At March 31, 1995, Batterymarch managed assets with a value of approximately $4.9 billion.
Gray, Seifert & Co., Inc., acquired in April 1994, manages securities portfolios for wealthy individuals and family groups, endowments, and foundations. At March 31, 1994 and 1995, Gray Seifert managed assets with a value of approximately $670 million and $680 million, respectively.
The Company has revenue sharing agreements with Western, Batterymarch, and Gray Seifert and certain of their key officers pursuant to which a specified percentage of the subsidiary's revenues is distributed to Legg Mason, Inc., and the balance of the revenues is retained by the subsidiary to pay its operating expenses, including salaries and bonuses, with specific expense and compensation allocations being determined by the subsidiary's management.
Legg Mason Capital Management, Inc. manages securities portfolios of individual and institutional clients. At March 31, 1994 and 1995, this subsidiary managed assets with values of approximately $615 million and $740 million, respectively, including approximately $75 million and $55 million, respectively, of the Company's funds
invested in short-term securities (not including assets in Company-sponsored mutual funds for which it serves as investment adviser).
The Fairfield Group, Inc., acquired in April 1993, offers several investment vehicles structured to meet the specialized investment needs of banks and bank trust departments. These include the Navigator taxable and tax-free money market funds, with combined assets of approximately $560 million and $310 million at March 31, 1994 and 1995, respectively, and Navigator REPO/LINE, a service which invested approximately $1.6 billion and $1.3 billion at March 31, 1994 and 1995, respectively, of short-term cash in repurchase agreements collateralized by U.S. government and government agency securities.
The Company's advisory activities also include wrap-fee programs in which the Company's customer pays a single asset-based fee that covers all execution and advisory services, including advisory services provided by the Company's investment advisory affiliates and selected independent advisory firms. In addition, the Company provides asset allocation and advisor performance and selection consultation services.
Mortgage Banking and Real Estate Services
Legg Mason Real Estate Services, Inc. ("LMRES"), formerly named Latimer & Buck, Inc., is engaged in the commercial mortgage banking, loan servicing and pension fund advisory businesses. In its mortgage banking business, LMRES originates, structures, places and services commercial mortgages on income-producing properties for insurance companies, pension funds and other investors. In its pension fund advisory business, LMRES manages mortgage portfolios on behalf of two state pension funds. LMRES' headquarters are located in Philadelphia, Pennsylvania, and it has offices located in the Mid-Atlantic and Southeastern regions of the United States.
Dorman & Wilson, Inc. is a mortgage banking firm engaged in commercial mortgage banking and loan servicing. Headquartered in White Plains, New York, Dorman & Wilson has offices in New York and New Jersey.
As of March 31, 1994 and 1995, the combined commercial mortgage servicing portfolios of LMRES and Dorman & Wilson totaled approximately $12.0 and $10.8 billion, respectively.
Legg Mason Realty Group, Inc., with offices in Baltimore, Washington, D.C. and Philadelphia, provides market feasibility, consulting and appraisal services regarding residential, retail, commercial and industrial real estate to a diverse clientele.
Insurance and Financial Planning
Approximately 725 of the Company's investment executives are licensed to sell insurance. Legg Mason Financial Services, Inc., a wholly-owned subsidiary of the Company, acts as general agent for several life insurance companies and sells fixed and variable annuities and insurance. The Company also offers comprehensive financial planning services to individuals.
Other Services
At March 31, 1995, the Company served as a non-bank custodian for approximately 96,000 IRA's, 2,600 Keogh Plans, and 8,200 Simplified Employee Pension Plans.
The Company effects the purchase and sale of options and commodities contracts on behalf of clients.
In March 1993, the Company established the Legg Mason Trust Company, a state chartered, non-depository bank, to provide services as a trustee for trusts established by the Company's individual and employee benefit plan clients. The Company provides brokerage and advisory services for a significant portion of the assets held in the Trust Company's accounts.
Research
The Company employs 26 analysts who develop investment recommendations and market information with respect to companies and industries. Legg Mason Wood Walker's research emphasizes the identification of securities of financially sound, well managed companies that appear to be undervalued in relation to their long-term earning power or the value of underlying assets. Legg Mason refers to this investment strategy as the "Value Approach" to investing. Howard Weil's analysts concentrate on the oil and gas exploration, pipeline and service industries. The Company's research services are supplemented by research services purchased from outside consultants.
The Company's clients do not pay for research services directly, although the Company is often compensated for its research services by institutional clients through the direction of brokerage transactions to the Company for execution. The Company believes that its research activities are extremely important in attracting and retaining individual and institutional brokerage and investment advisory clients.
Operations
Administrative and operations personnel are responsible for the processing of securities transactions; receipt, identification and delivery of funds and securities; internal financial controls; office services; custody of customers' securities and the handling of
margin accounts. At March 31, 1995, the Company had approximately 250 full-time employees performing such functions.
There is considerable fluctuation during any year and from year to year in the volume of transactions the Company must process. During the fiscal years ended March 31, 1993, 1994 and 1995, the Company processed approximately 1,721,000, 2,146,000 and 2,056,000 securities transactions, respectively. The Company records transactions and posts its books on a daily basis. Operations personnel monitor day-to-day operations to determine compliance with applicable laws, rules and regulations. Failure to keep current and accurate books and records can render the Company liable to disciplinary action by governmental and self-regulatory authorities.
Legg Mason Wood Walker clears all of its own securities transactions as a participant in various depositories. It executes transactions in listed securities on the NYSE and other exchanges through the Pershing Division of Donaldson, Lufkin & Jenrette Securities Corporation. Pershing also processes orders and floor reports, matches trades and transmits execution reports and records data pertinent to trades in listed securities. All over-the-counter and foreign securities transactions are compared by Legg Mason Wood Walker through its participation in various clearing corporations.
The Company believes that its internal controls and safeguards are adequate, although fraud and misconduct by customers and employees and the possibility of theft of securities are risks inherent in the securities industry. As required by the NYSE and certain other authorities, the Company carries a fidelity bond covering loss or theft of securities as well as forgery of checks and drafts and embezzlement and misplacement of securities. The bond provides total coverage of $30,000,000 (subject to a $1,000,000 deductible per claim).
Employees
At March 31, 1995, the Company had approximately 2,900 employees. None of the Company's employees is covered by a collective bargaining agreement. The Company considers its relations with its employees to be satisfactory. However, competition for experienced financial services personnel, especially investment executives and investment management professionals, is keen and from time to time the Company may experience a loss of valuable personnel.
The Company recognizes the importance of hiring and training investment executives. The Company trains new investment executives who are required to take examinations given by the NYSE, the NASD and various states in order to be registered and qualified. The Company also requires ongoing training for investment executives.
Competition
The Company is engaged in an extremely competitive business. Its competition includes, with respect to one or more aspects of its business, numerous national, regional and local broker-dealer and investment advisory firms, and commercial banks and thrift institutions. Many of these organizations have substantially greater personnel and financial resources than the Company. Discount brokerage firms oriented to the retail market, including firms affiliated with commercial banks and thrift institutions, are devoting substantial funds to advertising and direct solicitation of customers in order to increase their share of commission dollars and other securities-related income. In many instances, the Company is competing directly with such organizations. The Company also competes for investment funds with banks, insurance companies and investment companies. The principal competitive factors relating to the Company's business are the quality of advice and services provided to investors and the price of those services.
Competition in the Company's business periodically has been affected by significant developments in the securities industry. See "Factors Affecting the Company and the Securities Industry -- Industry Changes and Competitive Factors."
Regulation
The securities industry in the United States is subject to extensive regulation under both Federal and state laws. The SEC is the Federal agency charged with administration of the Federal securities laws. Much of the regulation of broker-dealers has been delegated to self-regulatory authorities, principally the NASD and the securities exchanges. These self-regulatory organizations conduct periodic examinations of member broker-dealers in accordance with rules they have adopted and amended from time to time, subject to approval by the SEC. Securities firms are also subject to regulation by state securities commissions in those states in which they do business.
Broker-dealers are subject to regulations that cover all aspects of the securities business, including sales methods, trading practices among broker-dealers, uses and safekeeping of customers' funds and securities, capital structure and financial soundness of securities firms, recordkeeping and the conduct of directors, officers and employees. Additional legislation, changes in rules promulgated by the SEC and self-regulatory authorities, or changes in the interpretation or enforcement of existing laws and rules, may directly affect the mode of operation and profitability of broker-dealers. The SEC, self-regulatory authorities and state securities commissions may conduct administrative proceedings that can result in censure, fine, suspension or expulsion of a broker-dealer, its officers or employees. Such administrative proceedings, whether or not resulting in adverse findings, can require substantial expenditures and can have an adverse
impact on the reputation of a broker-dealer. The principal purpose of regulation and discipline of broker-dealers is the protection of customers and the securities markets, rather than protection of creditors and stockholders of the regulated entity.
The Company's investment advisory subsidiaries and the Company-sponsored mutual funds are also subject to extensive Federal and state regulation by the SEC and state securities commissions.
The Company's broker-dealer subsidiaries are required by Federal law to belong to the SIPC. When the SIPC fund falls below a certain amount, members are required to pay annual assessments. The Company's broker-dealer subsidiaries are currently contributing .00073% of their adjusted gross revenues to the fund. The SIPC fund provides protection for securities held in customer accounts up to $500,000 per customer, with a limitation of $100,000 on claims for cash balances. The Company purchases insurance that provides additional protection for securities of up to $24,500,000 per customer.
Net Capital Requirements
Every registered broker-dealer doing business with the public is subject to the Uniform Net Capital Rule (Rule 15c3-1) promulgated by the SEC. The Rule, which is designed to measure the financial soundness and liquidity of broker-dealers, specifies minimum net capital requirements. Since the Company is not itself a registered broker-dealer, it is not directly subject to the Uniform Net Capital Rule. However, its broker-dealer subsidiaries are subject to the Rule, and a provision of the Rule requires that a broker-dealer notify the SEC prior to the withdrawal of equity capital by a parent company if the withdrawal would exceed the greater of $500,000 or 30 percent of the broker-dealer's excess net capital.
Rule 15c3-1 provides that a broker-dealer doing business with the public shall not permit its aggregate indebtedness to exceed 15 times its net capital (the "primary method") or, alternatively, that it not permit its net capital to be less than 2% of its aggregate debit items (primarily receivables from customers and broker-dealers) computed in accordance with such Rule (the "alternative method"). Legg Mason Wood Walker and Howard Weil use the alternative method of calculation. As of March 31, 1995, these broker-dealer subsidiaries had aggregate net capital of $89.6 million, which exceeded the minimum net capital requirements by $82.1 million.
In computing net capital under the Rule, various adjustments are made to net worth with a view to excluding assets not readily convertible into cash and to provide a conservative statement of other assets, such as a firm's position in securities. To that end, a deduction is made against the market value of securities to reflect the possibility of a market decline prior to their disposition. For every dollar that net capital is reduced, by means of such deductions
or otherwise (for example, through operating losses or capital distributions), the maximum aggregate debit items which a firm may carry is reduced. Thus, net capital rules, which are unique to the securities industry, impose financial restrictions upon the Company's business that are more severe than those imposed on other types of businesses.
Under NYSE Rule 326, Legg Mason Wood Walker as a member organization that carries customer accounts, would be required to reduce its business activities if its net capital, as defined, was less than 4% of aggregate debit items, as defined, and would be precluded from expanding its business if its net capital was less than 5% of aggregate debit items.
Compliance with applicable net capital rules could limit operations of the Company's broker-dealer subsidiaries, particularly operations such as underwriting and trading activities that require use of significant amounts of capital. A significant operating loss or an extraordinary charge against net capital could adversely affect the ability of the broker-dealers to expand or even maintain their present levels of business.
Outstanding Subordinated Liabilities
Legg Mason Wood Walker has incurred subordinated liabilities ("Subordinated Liabilities") which it is permitted to treat as capital for the purposes of the Uniform Net Capital Rule and NYSE Rules 325 and 326. The Subordinated Liabilities instruments issued by Legg Mason Wood Walker provide that such liabilities shall be subordinated in right of payment to the prior payment in full, or provision for such payment, of all obligations to all other present and future creditors of Legg Mason Wood Walker (except for other Subordinated Liabilities similarly subordinated). At March 31, 1995, Legg Mason Wood Walker had a $5.0 million Subordinated Liability outstanding, due to Legg Mason, Inc. The Subordinated Liability may, with the prior written consent of the NYSE, be prepaid in whole or in part at any time after such Subordinated Liability has been outstanding for more than one year. Legg Mason Wood Walker may not pay or permit the payment or withdrawal of any Subordinated Liability if, after giving effect to such payment or withdrawal, its net capital would be less than 5% (6% in the case of the Subordinated Liability due to Legg Mason, Inc.) of aggregate debit items. See Note 14 of Notes to Consolidated Financial Statements in Item 8 of this Report.
Factors Affecting the Company and the Securities Industry
The securities industry is characterized by frequent change, the effects of which have been difficult to predict. In addition to an evolving regulatory environment, the industry has been subject to radical changes in pricing structure, alternating periods of contraction and expansion and intense competition from within and outside the industry.
Fluctuating Securities Volume and Prices
The securities industry is subject to substantial fluctuations in volume and price levels of securities transactions. These fluctuations can occur on a daily basis as well as over longer periods as a result of national and international economic and political events, and broad trends in business and finance. Reduced volume and prices generally result in lower brokerage and investment banking revenues, as well as losses from trading as principal and from underwriting. Profitability is adversely affected in periods of reduced volume because fixed costs remain relatively unchanged. To the extent that purchases of securities are permitted to be made on margin, securities firms also are subject to risks inherent in extending credit, especially during periods of rapidly declining markets, in that a market decline could reduce collateral value below the amount of a customer's indebtedness. In the past, heavy trading volume has caused clearance and processing problems for many securities firms, and this could occur in the future. In addition, there is risk of loss from errors that can occur in the execution and settlement process. See "Operations."
Industry Changes and Competitive Factors
Considerable consolidation has occurred in the securities industry as numerous securities firms have either ceased operations or been acquired by other securities firms, in many cases resulting in firms with greater financial resources than firms such as the Company. In addition, a number of substantial companies not previously engaged in the securities business have made investments in and acquired securities firms. Increasing competitive pressures in the securities industry require regional securities firms to offer to their customers many of the financial services that are provided by much larger securities firms that have substantially greater resources than the Company. A sizeable number of new investment advisory firms and mutual funds have been established in recent years, increasing competition in that area of the Company's activities.
Fixed minimum commissions for securities transactions were eliminated in 1975, resulting in substantial discounts of commissions earned from institutional customers and in the establishment of an increasing number of firms, including affiliates of banks and thrift institutions, that offer discount brokerage services to retail customers. These firms generally effect transactions at lower commission rates on an "execution only" basis, without offering other services such as investment advice and research that are provided by "full-service" brokerage firms such as the Company. In addition, some discount brokerage firms have increased the range of services that they offer. Continued increases in the number of discount brokerage firms and services provided by such firms may adversely affect the Company.
Certain institutions, notably commercial banks and thrift institutions, have become a competitive factor in the securities industry by offering certain investment banking and corporate and individual financial services traditionally provided only by securities firms. The Federal Reserve Board has approved applications of major commercial banks to underwrite and deal in certain types of securities that such banks had not been permitted to underwrite and deal in previously, subject to limitations on the resulting underwriting volume and market share. Commercial banks, generally, are expanding their securities activities, as well as their activities relating to the provision of financial services. Also, major corporations have acquired large securities firms. While it presently is not possible to predict the type and extent of competitive services that banks and other institutions ultimately may offer or the extent to which administrative or legislative barriers will be repealed or modified, to the extent that such services are offered on a large scale, securities firms such as the Company that are heavily oriented to individual retail customers may be adversely affected.
Regulation
The business of the Company and its subsidiaries in the securities industry is subject to regulation by various regulatory authorities that are charged with protecting the interests of broker-dealers' customers. See "Regulation."
Effect of Net Capital Requirements
The SEC and the NYSE have stringent rules with respect to the net capital requirements of securities firms. A significant operating loss or extraordinary charge against net capital may adversely affect the ability of the Company's broker-dealer subsidiaries to expand or even maintain their present levels of business. See "Net Capital Requirements."
Litigation
Many aspects of the Company's business involve substantial risks of liability. In the normal course of business, the Company's subsidiaries have been named as defendants or co-defendants in lawsuits seeking substantial damages. There has been an increased incidence of litigation in the securities industry in recent years, including customer claims as well as class action suits seeking substantial damages. See "Item 3. Legal Proceedings."
Item 2.

Item 2. Properties.
The Company leases a substantial portion of its office space. The Company's headquarters are located in an office building in which the Company is the major tenant. The Company currently occupies approximately 101,000 square feet in that building for a term expiring
in February 1998. Annual base rent for the current leased space is approximately $2.4 million.
The Company's administrative and operations personnel are located in an office building owned by the Company. The building, located in Baltimore, consists of a total of 162,000 square feet, of which approximately 103,000 square feet is occupied by the Company and 48,000 square feet is leased to unrelated tenants.
Information concerning location of the Company's sales offices is contained in Item 1 of this Report. See Note 8 of Notes to Consolidated Financial Statements in Item 8 of this Report.
Item 3.

Item 3. Legal Proceedings.
Taxable Municipal Bond Litigation
From April 1990 through January 1991, a number of purported class actions were filed in various federal courts naming Howard, Weil, Labouisse, Friedrichs Incorporated as one of the defendants in connection with seven different public offerings involving a total of $1.55 billion in taxable municipal bonds issued by six state financing authorities. The seven offerings were made in the period from July through November 1986. Howard Weil was one of the co-managing underwriters in the offerings, each of which had Drexel Burnham Lambert Incorporated as the senior managing underwriter. All of these actions, which generally are based on similar factual and legal allegations, as discussed below, were transferred by the Judicial Panel on Multidistrict Litigation to the United States District Court for the Eastern District of Louisiana (the "MDL Court") for coordinated and consolidated pre-trial proceedings under the caption In Re Taxable Municipal Bond Securities Litigation. Pursuant to a pre-trial order of the MDL Court, the various actions have been consolidated and a single complaint has been filed to cover all actions relating to each of the public offerings. In addition, a single complaint has been filed to cover the allegations made under RICO with respect to all of the offerings. The following schedule sets forth with respect to each offering the identification and amount of the offering, including the percentage underwritten by Howard Weil, and the title of the consolidated action in the MDL Court.
Generally, each action alleges, among other things, that the official statement by which the public offering was made contained misrepresentations and omissions in violation of federal and state securities laws, common law fraud, negligent misrepresentation and RICO. The complaints generally allege misstatements and omissions regarding, among other things, (i) the likelihood that the proceeds of each offering that were placed in a guaranteed investment contract ("GIC") issued by Executive Life Insurance Company would remain invested in the GIC rather than being used to purchase, and collateralize the bonds with, agricultural or multifamily housing loans; (ii) an alleged scheme between Drexel Burnham Lambert Incorporated, the senior managing underwriter of the offering, and Executive Life relating to retention of the proceeds in the GIC; (iii) Executive Life's substantial investment of its funds in junk bonds; and (iv) the possibility that the GICs would not be treated as
insurance products entitled to pro rata treatment with other Executive Life insurance products in the event of an Executive Life insolvency. In each action, the plaintiff class purportedly consists of all persons who purchased the bonds either in the initial offering or in the open market through April 1990. Following the deterioration of the junk bond market in early 1990, the ratings of both Executive Life and the bonds that had been issued in the seven offerings were downgraded and the bonds experienced substantial market price declines. In addition, the bonds have defaulted in interest payments as a result of Executive Life having been placed in conservatorship in April 1991 and ceasing payments on the GICs, and the amount of future payments of principal and interest is dependent upon successful resolution of the pending conservatorship. The various complaints seek actual and punitive damages in unspecified amounts, pre and post judgment interest, as well as costs and attorneys' fees. If any of these actions were determined adversely to Howard Weil, substantial liabilities could result, with a significant adverse effect on Howard Weil's financial condition and operations.
During 1992, the MDL Court issued orders denying the motions to dismiss of Howard Weil and the other principal defendants with respect to virtually all counts of the complaint. In September 1993, all class plaintiffs except Washington National Life Insurance Company of New York, a putative class representative in the case relating to the Nebraska Investment Finance Authority bonds, voluntarily dismissed the plaintiffs' joint complaint covering allegations made under RICO. Howard Weil and other defendants filed a motion for summary judgment with respect to Washington National's RICO claim. This motion was granted. In August 1993, Howard Weil and other defendants filed motions for summary judgment with respect to the issue of whether plaintiffs' claims under Rule 10b-5 should be dismissed in any case in which plaintiffs did not actually rely on the official statements that are alleged to have been false and misleading. These motions are pending.
In February 1995, the MDL Court preliminarily approved the principal terms of a proposed settlement of the class actions as set forth in a settlement agreement among the defendants and the representatives of the putative plaintiff class. The settlement agreement will require Howard Weil, as one of the underwriter defendants, to contribute approximately $3.6 million toward a total settlement amount of $25.6 million. A settlement notice has been sent to putative class members and a settlement hearing before the MDL Court is scheduled for July 31, 1995.
In January 1991, an action captioned Magnolia Life Insurance Company v. Howard, Weil, Labouisse, Friedrichs Incorporated was commenced in the 14th Judicial District Court, Parish of Calcasieu, State of Louisiana, alleging misrepresentation by Howard Weil in the sale to Magnolia in April 1988 of approximately $830,000 of taxable municipal bonds issued by the Louisiana Agricultural Finance Authority
("LAFA"). These bonds had been part of the bonds issued in the 1986 LAFA public offering described above. The plaintiff alleges that Howard Weil misrepresented to it that the bonds were secured by government guaranteed loans. In September 1991, the plaintiff filed a motion for summary judgment. This motion is pending. A stay of this proceeding by the MDL Court was lifted in December 1994 permitting the case to proceed to discovery and ultimate resolution.
Nasdaq Market-Makers Antitrust Litigation
Legg Mason Wood Walker and approximately thirty other broker-dealer firms have been named as defendants in a number of purported class actions filed in various federal courts alleging violation of federal antitrust laws. The first of these actions was filed in May 1994, and in October 1994 the actions were consolidated in the United States District Court for the Southern District of New York under the caption In re Nasdaq Market-Makers Antitrust Litigation. The consolidated complaint alleges that the defendants violated the antitrust laws by conspiring to raise, fix and maintain the "spreads" on certain securities traded on Nasdaq by refusing to quote bids and asks in so-called "odd-eighths." The actions purport to be brought on behalf of all persons who purchased or sold these securities on Nasdaq during the approximately five year period preceding commencement of the litigation. The plaintiffs seek treble damages in an unspecified amount, injunctive relief, and attorneys' fees and costs. In February 1995, the defendants filed a motion to dismiss the actions. The decision on the motion is pending.
Following the commencement of the antitrust litigation, the Antitrust Division of the United States Department of Justice and the Securities and Exchange Commission commenced investigations relating to the allegations in the litigation. Legg Mason Wood Walker, together with other broker-dealer firms, has received requests for information from both government agencies.
In addition to the matters described above, the Company's subsidiaries have been named as defendants or co-defendants in various other lawsuits alleging substantial damages. Some of these proceedings relate to public offerings of securities in which one or more subsidiaries of the Company participated as a member of the underwriting syndicate. The Company is also aware of litigation against certain underwriters of offerings in which one or more subsidiaries of the Company was a participant, but where the subsidiary is not now a defendant. In these latter cases, it is possible that a subsidiary may be called upon to contribute to settlements or judgments. While the ultimate resolution of pending litigation cannot be predicted with certainty, in the opinion of management, after consultation with legal counsel, pending litigation will not have a material adverse effect on the consolidated financial statements of the Company.
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 4A. Executive Officers of the Company.
Information (not included in the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders) regarding certain executive officers of the Company is as follows:
F. Barry Bilson, age 42, was elected Vice President-Finance of the Company in June 1984. He served as Controller of the Company from October 1983 until September 1988, and as Controller of Legg Mason Wood Walker from April 1981 to September 1988. From December 1978 to March 1981, he was Assistant Controller of the Coatings Division of Dutch Boy, Inc. Mr. Bilson is a certified public accountant.
Theodore S. Kaplan, age 52, became Senior Vice President and General Counsel of the Company in April 1993. From 1970 until he joined the Company, he was engaged in the private practice of law with the firm of Weinberg and Green. Prior to 1970, Mr. Kaplan served as an attorney in the Office of the General Counsel and Division of Corporation Finance of the Securities and Exchange Commission.
Eileen M. O'Rourke, age 37, became Controller of the Company and of Legg Mason Wood Walker in September 1988 and was elected Vice President-Finance of the Company in March 1989, having served as Assistant Controller since December 1984. Mrs. O'Rourke is a certified public accountant and was an audit manager with Peat Marwick Main & Co. prior to joining the Company in 1984.
Timothy C. Scheve, age 37, has been Treasurer of the Company and of Legg Mason Wood Walker since January 1992. He became a Vice President of the Company in August 1993 and a Senior Vice President of Legg Mason Wood Walker in August 1994. Mr. Scheve has served in various financial and administrative capacities since joining the Company in 1984. Mr. Scheve was a management consultant with Price Waterhouse & Co. prior to joining the Company.
Elisabeth N. Spector, age 47, became a Senior Vice President of the Company and Legg Mason Wood Walker in January 1994. She has general responsibilities in business and financial strategy. From November 1989 until she joined the Company, Ms. Spector was employed by the Resolution Trust Corporation, where, among other things, she served as the initial Director of the RTC's Capital Markets Division. From 1975 to November 1989 she was an investment banker with Merrill Lynch & Co., Inc.
Edward A. Taber III, age 51, became an Executive Vice President of the Company in September 1992. He is responsible for supervising the Company's investment management activities. From 1973 until he joined the Company, Mr. Taber held various positions with T. Rowe Price Associates, Inc., an investment management firm, last
serving as Director of that firm's taxable fixed income division. Prior to 1973, Mr. Taber served as the Treasurer and Chief Financial Officer of the Federal Home Loan Bank of Boston. Mr. Taber is a Director of the Legg Mason Value Trust, Inc., the Legg Mason Total Return Trust, Inc., the Legg Mason Special Investment Trust, Inc., a trustee of the Legg Mason Tax-Free Income Fund, President and a director of the Legg Mason Income Trust, Inc., the Legg Mason Global Trust, Inc., and the Legg Mason Investors Trust, Inc., and Vice President of the Worldwide Value Fund, Inc.
PART II
Item 5.

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Shares of Legg Mason, Inc. common stock are listed and traded on the New York Stock Exchange (symbol LM). As of March 31, 1995, there were 1,385 shareholders of record of the Company's common stock. Information with respect to the Company's dividends and stock prices is as follows:
Item 6.

Item 6. Selected Financial Data.
Item 7.

Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition.
Legg Mason, Inc. and its subsidiaries ("the Company") are principally engaged in providing securities brokerage, investment advisory, investment banking and mortgage banking services to individuals, institutions, corporations and municipalities. The Company's profitability is sensitive to a variety of factors including the volume of trading in securities, the volatility and general level of market prices, and the demand for investment banking and mortgage banking services.
During the fiscal year ended March 31, 1995, interest rate levels rose sharply, adversely impacting the Company's investment banking and securities brokerage revenues. In contrast, the prior year's results were the most successful in the Company's history and were achieved in a very favorable corporate and municipal finance environment.
The Company's investment advisory activities and their contribution to operating results have grown significantly, through both internal growth and acquisition, over the past ten years. During fiscal 1995, the Company acquired Batterymarch Financial Management, Inc. ("Batterymarch") and Gray, Seifert & Co. ("Gray Seifert"), as described in Note 2 of Notes to Consolidated Financial Statements. Batterymarch, acquired in January 1995, manages approximately $5 billion in emerging markets, international and U.S. equity portfolios for institutional clients. Gray Seifert, acquired in April 1994, manages $680 million in equity and balanced accounts for individuals and family groups, endowments and foundations. With these two additions, assets under management for institutions, Company-sponsored mutual funds and private accounts managed by the Company's subsidiaries were $24.6 billion at March 31, 1995, up 47% from $16.7 billion a year earlier and from $526 million ten years ago. Earnings from investment advisory services tend to be more stable than those from securities brokerage and investment banking activities because they are less affected by changes in securities market conditions.
Results of any individual period should not be considered representative of future profitability. Many of the Company's activities have fixed operating costs which do not decline with reduced levels of volume. While the Company attempts to reduce costs, particularly during periods of low volume, it does not, as a general rule, attempt to do so through personnel reduction. Accordingly, sustained periods of unfavorable market conditions may adversely affect profitability.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, items in the Consolidated Statements of Earnings as percentages of total revenues and the increase (decrease) by item as a percentage of the amount for the previous period:
In fiscal 1995, revenues, net earnings and earnings per share declined from record levels reached in the prior fiscal year. Revenues were $371.6 million, a 7% decrease from revenues of $397.5 million in fiscal 1994. Net earnings were $16.3 million, down 55% from net earnings of $36.0 million in the prior fiscal year. Primary earnings per share declined 56% to $1.30 from $2.98.
Revenues derived from securities transactions for individual investors constituted approximately 50% of the Company's total revenues in fiscal 1995, and the Company believes this will continue to be the largest single source of its revenues in the foreseeable future.
Revenues
Commissions
Commissions fell 15% to $120.7 million in fiscal 1995, principally as a result of lower sales of non-affiliated mutual funds and listed and over-the-counter securities. Commission revenues were adversely affected by rising interest rates and investor caution, particularly on the part of individual investors.
In fiscal 1994, commissions rose 21% to $141.4 million from levels in fiscal 1993, principally because of increases in sales of listed securities, non-affiliated mutual funds, variable annuities and over-the-counter securities. During most of fiscal 1994, commission revenues benefited from an active and rising stock market, attributable in part to investors seeking higher investment returns than those available on money market accounts and other short-term investments.
Principal Transactions
Revenues from principal transactions rose 10% to $59.5 million in fiscal 1995, principally as a result of increased sales of municipal and corporate debt securities, offset in part by lower sales of mortgage-backed securities. Higher sales of municipal securities in the secondary markets substantially offset sharp declines in municipal new issue volume. Sales of corporate debt securities benefited from the Company's expansion of its taxable fixed-income marketing capabilities.
In fiscal 1994, principal transactions fell 2% to $53.9 million because of lower sales of taxable fixed-income securities and a decline in profits on firm-owned securities positions, substantially offset by increased sales of over-the-counter securities.
Investment Advisory and Related Fees
Investment advisory and related fees rose 35% in fiscal 1995 to $88.3 million, principally as a result of the addition of fees earned by Batterymarch and Gray Seifert and growth in assets under management in Company-sponsored mutual funds and the Company's fixed-income advisory subsidiary. Excluding fees earned by Batterymarch and Gray Seifert, investment advisory and related fees rose 19% in fiscal 1995. Fees from assets under management and from fee-based brokerage accounts accounted for 24% of total revenues in fiscal 1995, up from 16% in the prior year.
In fiscal 1994, investment advisory and related fees rose 29% because of growth in assets under management in Company-sponsored mutual funds and the Company's fixed-income advisory subsidiary, as well as growth in various types of fee-based brokerage accounts.
The graph here depicts the growth in Investment Advisory and Related Fees Revenue and Assets Under Management for the five fiscal periods ended March 31, 1995.
Investment Banking
Investment banking revenues declined 56% to $34.7 million in fiscal 1995 from record levels achieved in the prior fiscal year as significantly higher interest rates led to industry-wide declines in corporate and municipal securities offerings.
In fiscal 1994, investment banking revenues rose 19% to $79.3 million as a result of selling concessions and management fees earned on a substantially higher level of corporate underwritings, particularly co-managed offerings of real estate investment trusts and closed-end fund issuances. Low interest rates and higher securities valuations were important factors in the growth of investment banking revenues during fiscal 1994.
Other Revenues
Other revenues rose 6% to $29.1 million, primarily because of increased account maintenance fees and rental income from an office building purchased in fiscal 1995.
In fiscal 1994, other revenues rose 21%, primarily because of increased mortgage banking loan origination fees and the addition of certain fees earned by The Fairfield Group subsequent to its acquisition in April 1993.
Expenses
Compensation and Benefits
Compensation and benefits fell 5% to $217.0 million in fiscal 1995, as lower commission and profitability-based compensation was partially offset by personnel additions in certain
product and support areas and in twelve new branch office locations.
In fiscal 1994, compensation and benefits rose 18% to $229.0 million, reflecting higher sales compensation on increased commission-based revenues, personnel additions, and higher profitability-based compensation.
A substantial part of compensation expense fluctuates in proportion to the level of business activity. Other compensation costs, primarily salaries and benefits, are fixed and may not decline with reduced levels of volume. Therefore, profitability may be adversely affected by sustained periods of unfavorable market conditions or slow revenue growth in acquired businesses or new product areas.
Occupancy and Equipment Rental
Occupancy and equipment rental rose 11% to $29.8 million because of the inclusion of expenses of Batterymarch and Gray Seifert and higher depreciation and data processing expenses related to branch office and product area expansion.
In fiscal 1994, occupancy and equipment rental rose 15% to $26.9 million, principally because of increased transaction-related data processing costs and higher rental payments at corporate headquarters and certain branch office locations.
Communications
Communications costs rose 13% to $25.9 million in fiscal 1995, principally reflecting increased quote services for branch offices and product areas, and higher printing and paper expenses.
In fiscal 1994, communications costs rose 14%, reflecting increases in telephone and transaction-related variable expenses attributable to increased business activity.
Floor Brokerage and Clearing Fees
Floor brokerage and clearing fees fell 13% to $5.0 million in fiscal 1995, following a 4% increase in fiscal 1994, reflecting changes in securities transaction volume.
Other Expense
Other expense rose 28% and 17% in fiscal 1995 and 1994, respectively, because of increased litigation-related expenses (including a $2.0 million current year charge for the proposed settlement of a class action lawsuit discussed in Note 8 of Notes to Consolidated Financial Statements) and higher promotional and programming expense. In addition, fiscal 1995 includes the expenses of Batterymarch and Gray Seifert subsequent to their acquisitions.
Interest Revenue and Expense
Interest revenue increased 31% to $39.3 million in fiscal 1995, primarily as a result of higher interest rates earned on substantially larger customer margin account balances and stock loan conduit activity, offset in part by a reduction in interest earned on proprietary securities positions. Interest expense increased 11% to $17.1 million because of higher interest rates paid on customer credit and conduit stock loan balances, offset in part by a decline in interest paid on short-term borrowings.
In fiscal 1994, interest revenue increased 25% to $30.0 million, as a result of increased stock loan conduit activity, larger customer margin account balances and investment of proceeds of the Company's $68.0 million convertible subordinated debenture offering completed in April 1993. These increases were partially offset by lower interest earnings on proprietary fixed-income securities positions. Interest expense increased 32% to $15.4 million, primarily because of debt service on the convertible subordinated debentures and increased stock loan conduit activity.
As a result of substantially larger customer margin account balances and higher interest rates, the Company's net interest margin increased to 56.4% in fiscal 1995 from 48.7% in fiscal 1994.
The graph here depicts Interest Revenue and Interest Expense for the five fiscal periods ended March 31, 1995.
Income Taxes
Income taxes fell 51% to $11.4 million in fiscal 1995 because of lower pre-tax earnings. The Company's effective tax rate increased to 41.3% from 39.1% as a result of federal tax law changes and higher effective state income tax rates.
In fiscal 1994, income taxes increased 23% because of higher pre-tax earnings. The Company's effective tax rate increased to 39.1% from 38.3% as a result of higher corporate income tax rates following the enactment of the 1993 Omnibus Budget Reconciliation Act.
LIQUIDITY AND CAPITAL RESOURCES
The Company's assets are primarily liquid, consisting mainly of cash and assets readily convertible into cash. These assets are financed primarily by free credit balances, equity capital, convertible debentures, bank lines of credit and other payables.
During the year ended March 31, 1995, cash and cash equivalents increased $17.1 million. Cash flows from operating activities provided $62.3 million, primarily attributable to a reduction in regulatory deposits and to fiscal 1995 net earnings, adjusted for depreciation and amortization, offset in part by increased customer receivables. The Company invested cash of $26.7 million, principally related to the acquisition of Batterymarch, offset in part by a net decrease in resale agreements and investment securities. Cash flows from financing activities used $18.5 million primarily to repay short-term borrowings.
During fiscal 1995, the Company acquired Batterymarch utilizing $54.1 million in cash. See Note 2 of Notes to Consolidated Financial Statements regarding future payments that may be required in the business combination.
The Company's broker-dealer subsidiaries are subject to the requirements of the SEC's net capital rule which is designed to measure the general financial soundness and liquidity of broker-dealers. At March 31, 1995, the brokerage subsidiaries had aggregate net capital of $90.7 million, which exceeded minimum net capital requirements by $82.9 million.
The principal sources of the Company's funds are its investment advisory and broker-dealer subsidiaries. The amount of the broker-dealers' net assets that may be distributed is subject to restrictions under applicable net capital rules. In addition, the Company has a revolving bank line of credit in the amount of $50.0 million, none of which is currently outstanding, and the Company's subsidiaries have lines of credit, aggregating $96.0 million, pursuant to which they may borrow on a short-term demand
basis generally at prevailing broker call rates. Management believes that funds available from operations and its lines of credit are sufficient to meet its present and reasonably foreseeable capital needs, although the Company may augment its capital funds for continued expansion by internal growth and acquisition.
The Company borrows and lends securities in the normal course of business to facilitate the settlement of its customer and proprietary transactions. In addition, the Company engages in conduit securities borrowing and lending activities in which it acts as an agent to facilitate settlement for other institutions. In both firm and conduit transactions, the Company deposits or receives cash, generally equal to 102% of the market value of securities exchanged, and monitors the adequacy of collateral levels on a daily basis.
EFFECTS OF INFLATION
The Company's assets are not significantly affected by inflation because they are primarily monetary, consisting of cash, resale agreements, securities and receivables. However, the rate of inflation affects various expenses, including employee compensation, occupancy, and communications, which may not be readily recoverable in charges for services provided by the Company.
RECENT ACCOUNTING DEVELOPMENT
Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," was issued by the Financial Accounting Standards Board in March 1995. The Company expects to adopt the provisions of Statement No. 121 beginning in fiscal 1996. Based on the Company's current evaluation, the impact of adoption will not be material to the Company's financial position or results of operations.
Item 8.

Item 8. Financial Statements and Supplementary Data.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders, Legg Mason, Inc.
We have audited the accompanying consolidated statements of financial condition of Legg Mason, Inc. and Subsidiaries as of March 31, 1995 and 1994, and the related consolidated statements of earnings, changes in stockholders' equity and cash flows for each of the three years in the period ended March 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Legg Mason, Inc. and Subsidiaries as of March 31, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended March 31, 1995, in conformity with generally accepted accounting principles.
/s/COOPERS & LYBRAND L.L.P.
Baltimore, Maryland May 2, 1995
CONSOLIDATED STATEMENTS OF EARNINGS (Dollars in thousands except per share amounts)
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Dollars in thousands except share amounts)
CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousand except per share amounts)
1. Summary of Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Legg Mason, Inc. ("Parent") and its wholly-owned subsidiaries. All material intercompany balances and transactions have been eliminated. Where appropriate, prior years' financial statements have been reclassified to conform with the 1995 presentation.
Cash and Cash Equivalents
Cash equivalents are highly liquid investments with original maturities of less than 90 days, other than those held for sale in the ordinary course of business.
Resale Agreements
The Company invests in short-term resale agreements collateralized by U.S. government and agency securities. The market value of the underlying collateral as determined daily, plus accrued interest thereon, must exceed the face amount of the transaction. It is the Company's policy to have such underlying collateral deposited in the Company's accounts at its custodian banks. Resale agreements are carried at the amounts at which the securities will be subsequently resold as specified in the agreements, plus accrued interest.
Securities
Securities transactions are recorded on a settlement date basis which does not differ materially from a trade date basis. Commission revenues and related expenses for unsettled transactions are recorded on a trade date basis. Securities owned by the Company's broker-dealer subsidiaries, both for trading and investing, are valued at market and resulting unrealized gains and losses are reflected in earnings.
The Company adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities," in fiscal 1995. Accordingly, investment securities of the Parent and its non-broker-dealer subsidiaries held as available-for-sale are valued at market and resulting unrealized gains and losses are reflected in stockholders' equity.
Depreciation and Amortization
Property and equipment are reported at cost, net of accumulated depreciation and amortization of $32,193 and $28,025 at March 31, 1995 and 1994, respectively.
Depreciation and amortization are determined by use of the straight line method over the estimated useful life of the asset or the remaining life of the lease. Maintenance and repair costs are expensed as incurred.
Intangible Assets
Intangible assets consist principally of goodwill, asset management and mortgage servicing contracts, attributable to business combinations. Intangibles are amortized using straight line and accelerated methods over periods ranging from three to forty years. Accumulated amortization at March 31, 1995 and 1994 was $41,794 and $36,714, respectively.
The Company periodically reviews its accounting for goodwill and other intangible assets, considering such factors as historical profitability and projected operating cash flows, to determine that the assets are realizable and the amortization periods are appropriate.
Investment Advisory and Related Fees
The Company earns investment advisory fees on assets in accounts managed by its subsidiaries, distribution fees on assets in Company-sponsored equity and bond mutual funds, and asset based fees on various types of single-fee brokerage accounts.
Earnings Per Share
Primary earnings per share are computed by dividing net earnings by the weighted average number of shares outstanding and dilutive common stock equivalents. The Company's common stock equivalents are shares of common stock issuable under various stock option plans.
Fully diluted earnings per share assumes both the exercise of dilutive common stock equivalents and conversion of subordinated debentures.
The weighted average number of shares is as follows:
2. BUSINESS COMBINATIONS
On January 5, 1995, the Company acquired the assets of Batterymarch Financial Management ("Batterymarch"), an investment advisory firm that manages equity portfolios for institutional clients. The Company paid $54,141 cash at closing. A supplemental closing payment of $5,859 is due on or before January 1996 if Batterymarch reaches a specified annualized revenue level in any month during calendar 1995. An additional payment, due in early 1998 and based on Batterymarch's achievement of specified revenue levels for calendar 1997, could increase the total consideration up to $120,000. If the amount of the 1998 payment exceeds $40,000, the Company may pay all or any portion of the excess in the form of shares of the Company's common stock.
The acquisition was accounted for under the purchase method of accounting; accordingly, the total purchase price was allocated to the net assets acquired, principally goodwill and asset management contracts, based on estimated fair market values. The results of operations have been included in the consolidated financial statements from the date of acquisition.
The Company acquired Gray Seifert and Co. ("Gray Seifert") and The Fairfield Group ("Fairfield"), in April 1994 and 1993, respectively, through the issuance of common stock. Gray Seifert provides investment advisory services to individuals, endowments and foundations. Fairfield is a provider of mutual fund advisory and other services to banks and bank trust departments. The acquisitions were accounted for as poolings of interests, but were not material to the Company's results of operations and financial position. Accordingly, the results of operations of Gray Seifert and Fairfield have been included from the dates of acquisition.
3. RECEIVABLE FROM AND PAYABLE TO CUSTOMERS
Receivable from and payable to customers represent balances arising from cash and margin transactions. Securities owned by customers are held as collateral for the receivable balances. Included in payable to customers are free credit balances of approximately $269,825 as of March 31, 1995, and $261,803 as of March 31, 1994. The Company pays interest on certain customer free credit balances held for reinvestment purposes.
4. SECURITIES, AT MARKET
Securities positions consist of the following at March 31:
5. INVESTMENT SECURITIES
The Company's investment securities, including the type and maturity range for available-for-sale securities, are as follows:
The proceeds of debt securities held as available-for-sale which matured or were sold during fiscal 1995 were $35,882, with a gross realized loss of $124.
At March 31,1994, prior to adoption of SFAS 115, investment securities were carried at unamortized cost of $29,754 and had a market value of $30,368.
6. SHORT-TERM BORROWINGS
The Company has a revolving credit agreement which permits it to borrow up to $50,000, repayable generally over five years, at floating rates. Under the terms of the agreement, the Company is required, among other things, to maintain consolidated net worth plus subordinated liabilities of not less than $252,011 plus 50% of consolidated annual net earnings subsequent to March 31, 1995. Together with certain subsidiaries, the Company has jointly entered into revolving credit agreements which permit it to borrow up to $40,000, repayable within 30 days. In addition, subsidiaries of the Company have bank lines of credit of $96,000, which are generally subject to termination at either party's discretion. No borrowings were outstanding under these agreements at March 31, 1995.
Short-term borrowings at March 31, 1994, primarily loans from banks, totalled $15,546.
Interest payments were $17,190 in 1995, $12,704 in 1994 and $10,941 in 1993.
7. SUBORDINATED LIABILITIES
The Company's subordinated liabilities at March 31, 1995 and 1994 are as follows:
The 5.25% and 7% debentures are convertible at any time prior to maturity into common stock of the Company at per share conversion prices of $25.80 and $21.76, respectively. The conversion prices are subject to adjustment in certain events.
The Company may redeem the debentures prior to maturity, in whole or in part, subject to certain conditions. The 5.25% debentures are redeemable at 103.28% of the principal on May 1, 1996, and thereafter at prices declining annually to 100% on or after May 1, 2001. At March 31, 1995, the 7% debentures are redeemable at 101.4%, declining to 100% on or after June 15, 1996.
The 7% debentures require annual sinking fund payments of $1,500 beginning June 15, 1997 calculated to retire 61% of the debentures prior to maturity.
8. COMMITMENTS AND CONTINGENCIES
The Company leases office facilities and equipment under non-cancellable operating leases which expire on varying dates through 2005. Certain leases provide for renewal options and contain escalation clauses providing for increased rentals. As of March 31, 1995, the minimum annual aggregate rentals are as follows:
Total rental expense, including cancellable equipment leases, was $23,510, $27,761 and $24,768 for 1995, 1994 and 1993, respectively.
The Company leased office space from a partnership in which the Company and some of its officers, stockholders and directors had a combined controlling interest through July 1994, at which time the Company acquired the property for $5,000. Rent expense includes payments of $240 in 1995, $811 in 1994, and $690 in 1993 to the aforementioned partnership.
The Company enters into when-issued and underwriting commitments. Had the open transactions relating to these commitments as of March 31, 1995 been closed, the effect on the consolidated financial statements of the Company would not have been material.
The Company and its subsidiaries have been named as defendants in various legal actions arising primarily from securities and investment banking activities, including certain class actions which primarily allege violations of securities laws and seek unspecified damages which could be substantial. While the ultimate resolution of these actions cannot be currently determined, in the opinion of management, after consultation with legal counsel, the actions will be resolved with no material adverse effect on the consolidated financial statements of the Company.
Fiscal 1995 earnings include a charge of $2,000 ($950 after tax) relating to the proposed settlement of class action litigation arising from taxable municipal bond offerings underwritten in 1986 by one of the Company's subsidiaries. The settlement is subject to final court approval, to be considered at
a hearing scheduled for July 1995. "Item 3. Legal Proceedings" of this Report contains additional information concerning this matter.
9. EMPLOYEE BENEFITS
The Company, through its subsidiaries, maintains various defined contribution plans covering substantially all employees. Discretionary contributions charged to operations amounted to $3,417, $7,241 and $6,181 in 1995, 1994 and 1993, respectively. In addition, employees can make voluntary contributions under certain plans.
10. INCOME TAXES
The Company and its subsidiaries file a consolidated federal income tax return. The provision for income taxes consists of:
A reconciliation of the difference between the effective income tax rate and the statutory federal income tax rate follows:
Components of the Company's deferred tax assets and liabilities are as follows:
At March 31, 1995 and 1994, the deferred tax valuation allowance was primarily for benefits related to net operating losses which expire from 2000 to 2010.
Income tax payments were $12,047 in 1995, $26,114 in 1994, and $19,529 in 1993.
11. CAPITAL STOCK
At March 31, 1995, the authorized numbers of common and preferred shares were 20,000,000 and 4,000,000, respectively, of which 4,220,540 common shares were reserved for issuance upon conversion of the Company's convertible subordinated debentures. In addition, at March 31, 1995 and 1994, there were 2,157,456 and 2,239,870 shares of common stock reserved for issuance under the Company's stock option plans.
On September 24, 1993, the Company paid a 5-for-4 stock split to shareholders of record on September 8, 1993. All references in the consolidated financial statements to the number of common shares and per share amounts have been adjusted retroactively to reflect the 5-for-4 stock split, except for the number of issued common shares presented in the consolidated financial statements.
12. STOCK PLANS
Options under the Company's employee stock option plans have been granted at prices not less than 100% of the fair market
value of the shares on the date of grant. Options granted are generally exercisable in cumulative 20% increments over five years and have a term of not more than ten years from the date of grant.
Transactions under the plans during the three years ending March 31, 1995 are summarized below:
The Company has also adopted the "Legg Mason 1988 Non-Employee Director Option Plan." Options granted under the plan are immediately exercisable at a price equal to the fair market value of the shares on the date of grant. Options issuable under the plan, limited to 175,000 shares in aggregate, have a term of not more than ten years from the date of grant. At March 31, 1995, options on 69,000 shares have been granted, of which 64,000 are currently outstanding. The Company makes no charge to income with respect to its stock option plans.
The Company has an Employee Stock Purchase Plan covering substantially all employees. Shares of common stock are purchased in the open market on behalf of participating employees, subject to a 625,000 total share limit under the plan. Purchases are made through payroll deductions with the Company matching 5% of the employees' contributions. Charges to earnings were not significant with respect to this plan.
13. OFF-BALANCE SHEET RISK AND CONCENTRATION OF CREDIT
In the normal course of business, the Company executes, settles and finances customer and proprietary securities transactions. These activities expose the Company to off-balance sheet risk in the event that customers or other parties fail to satisfy their obligations.
In accordance with industry practice, securities transactions are recorded on settlement date, generally five business days after trade date. Should a customer or broker fail to deliver cash or securities as agreed, the Company may be required to purchase or sell securities at unfavorable market prices.
The Company extends credit to customers, collateralized by cash and securities, and subject to regulatory and internal requirements. Customer margin transactions include sales of securities not yet purchased, option contracts and commodity futures contracts. The Company continually monitors margin requirements and requests customers to deposit additional collateral or reduce positions when necessary. Such transactions expose the Company to risk in the event that margin requirements are insufficient to fully cover customer losses.
The Company borrows and lends securities to finance transactions and facilitate the settlement process, utilizing both firm proprietary positions and customer margin securities held as collateral. The Company deposits or receives cash generally equal to 102% of the market value of securities exchanged and monitors the adequacy of collateral levels on a daily basis. The Company periodically borrows from banks on a collateralized basis utilizing firm and customer margin securities in compliance with Securities and Exchange Commission rules. Should the counterparty fail to return customer securities pledged, the Company is subject to the risk of acquiring the securities at prevailing market prices in order to satisfy its customer obligations. The Company sells securities it does not currently own, and is obligated to subsequently purchase such securities at prevailing market prices. The Company is exposed to risk of loss if securities prices increase prior to closing the transactions.
14. REGULATORY REQUIREMENTS
The Company's broker-dealer subsidiaries are subject to the Securities and Exchange Commission's Uniform Net Capital Rule. The rule provides that equity capital may not be withdrawn or cash dividends paid if resulting net capital would fall below specified levels. As of March 31, 1995, the broker-dealer subsidiaries had aggregate net capital, as defined, of $90,711 which exceeded required net capital by $82,949.
The Company's principal broker-dealer subsidiary must maintain a separate account for the exclusive benefit of customers in accordance with Securities and Exchange Commission Rule 15c3-3, as determined by periodic computations. The rule allows the broker-dealer to maintain the required amounts in cash or qualified securities.
15. BUSINESS SEGMENT INFORMATION
The Company, through its subsidiaries, operates predominantly in a single business segment-the securities industry. Within this segment, the Company is primarily engaged in securities brokerage, investment advisory and investment banking activities.
QUARTERLY FINANCIAL DATA* (Dollars in thousands except per share amounts) (Unaudited)
Item 9.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
PART III
Item 10.

Item 10. Directors and Executive Officers of the Registrant.
The information required by this item is contained under the caption "Election of Directors" on pages 1 through 4 of the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders and the caption "Compliance With Section 16(a) of the Securities Exchange Act of 1934" on page 13 of such proxy statement. Such information is incorporated herein by reference to the proxy statement. See Part I, Item 4A of this Report for information regarding certain executive officers of the Company.
Item 11.

Item 11. Executive Compensation.
The information required by this item is contained under the caption "Executive Compensation" on pages 6 and 7 of the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders. Such information is incorporated herein by reference to the proxy statement.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this item is contained under the caption "Security Ownership of Management and Principal Stockholders" on page 5 of the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders. Such information is incorporated herein by reference to the proxy statement.
Item 13.

Item 13. Certain Relationships and Related Transactions.
The information required by this item is contained under the caption "Certain Transactions" on page 10 of the Company's definitive proxy statement for the 1995 Annual Meeting of Stockholders. Such information is incorporated herein by reference to the proxy statement.
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) Documents filed as a part of the report:
1. The following consolidated financial statements are included in Item 8 of this Report:
2. Financial Statement Schedules (included on pages S-1 to S-5 of this Report):
Report of Independent Accountants on Financial Statement Schedules
Schedule I - Condensed Financial Statement of Registrant
All other schedules to the consolidated financial statements for which provision is made in the accounting regulations of the Securities and Exchange Commission are not applicable or are not required and therefore have been omitted.
*These exhibits are management contracts or compensatory plans or arrangements.
(b) No reports on Form 8-K were filed during the quarter ended March 31, 1995.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
LEGG MASON, INC.
By: /s/ Raymond A. Mason Raymond A. Mason, Chairman of the Board, President and Chief Executive Officer
Date: June 28, 1995
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.