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Section 1: 10-K (10-K)

SEC Document
Table of Contents

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
UNITED STATES
 
 
 
 
 
SECURITIES AND EXCHANGE COMMISSION
 
 
 
 
 
 
 
 
 
 
 
 
 
Washington, D.C. 20549
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
FORM 10-K
 
 
 
(Mark One)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
[X]
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
 
 
 
 
ACT OF 1934
 
 
 
 
For the fiscal year ended March 31, 2016
 
 
 
 
or
 
 
 
[ ]
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
 
 
 
 
EXCHANGE ACT OF 1934
 
 
 
 
For the transition period from
 
 
to
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commission File Number 1-8529
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
LEGG MASON, INC.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Exact name of registrant as specified in its charter)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Maryland
 
 
 
 
 
 
52-1200960
 
 
 
 
 
(State or other jurisdiction of
 
 
 
 
 
 
(I.R.S. Employer
 
 
 
 
 
 incorporation or organization)
 
 
 
 
 
 
Identification No.)
 
 
 
 
 
100 International Drive
 
 
 
 
 
 
21202
 
 
 
 
 
Baltimore, MD
 
 
 
 
 
 
(Zip Code)
 
 
 
 
 
(Address of principal executive offices)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Registrant's telephone number, including area code:
(410) 539-0000
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Securities registered pursuant to Section 12(b) of the Act:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Name of each exchange on
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Title of each class
 
 
 
 
 
 
which registered
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock, $.10 par value
 
 
 
 
 
New York Stock Exchange
 
 
 
 
 
 
Securities registered pursuant to Section 12(g) of the Act: NONE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes
[X]
No
[ ]
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
Yes
[ ]
No
[X]
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes
[X]
No
[ ]
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or such shorter period that the registrant was required to submit and post such files). 
Yes
[X]
No
[ ]
 
 
 
 
 
 
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K.
 
[X]
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting
company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
(Check one)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Large accelerated filer
[X]
 
 
 
 
 
 
 
 
 
Accelerated filer
 
[ ]
 
 
 
 
 
 
 
Non-accelerated filer
 
[ ]
 
 
 
 
 
 
 
 
 
Smaller reporting company
[ ]
 
 
 
 
 
 
 
(Do not check if a smaller reporting company)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes
[ ]
No
[X]
 
 
As of September 30, 2015 the aggregate market value of the registrant's voting stock, consisting of the registrant's common stock, held by
non-affiliates was $4,446,042,065.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of May 17, 2016, the number of shares outstanding of the registrant's common stock was 105,402,210.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
DOCUMENTS INCORPORATED BY REFERENCE
 
 
 
 
Portions of the registrant's definitive proxy statement for its Annual Meeting of Stockholders to be held on July 26, 2016 are incorporated by
reference into Part III of this Report.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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TABLE OF CONTENTS
 
 
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Table of Contents

FORWARD-LOOKING STATEMENTS.
We have made in this Report on Form 10-K, 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, including information relating to anticipated growth in revenues, margins or earnings per share, anticipated changes in our business or in the amount of our client assets under management (“AUM”) or assets under advisement (“AUA”), 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 caution readers that any forward-looking information provided by or on behalf of Legg Mason is not a guarantee of future performance.

Actual results may differ materially from those in 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 this 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 factors, such as: the total value and composition of our AUM; the mix of our AUM among our affiliates, asset classes, client type and geography; the revenue yield of our AUM; the volatility and general level of securities prices and interest rates; the relative investment performance of company-sponsored investment funds and other asset management products 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 administrative 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 fluctuation 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; increases in distribution expenses; variations in expenses and capital costs, including depreciation, amortization and other non-cash charges incurred by us to maintain our administrative 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.











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PART I
ITEM 1. BUSINESS.
General
Legg Mason is a global asset management company. Acting through our subsidiaries, we provide investment management and related services to institutional and individual clients, company-sponsored mutual funds and other pooled investment vehicles. We offer these products and services directly and through various financial intermediaries. We provide our asset management services through a number of asset managers, each of which generally markets its products and services under its own brand name and, in many cases, distributes retail products and services through a centralized global distribution platform.

Legg Mason, Inc. was incorporated in Maryland in 1981 to serve as a holding company for its various subsidiaries. The predecessor companies to Legg Mason trace back to Legg & Co., a Maryland-based broker-dealer formed in 1899. Our subsequent growth occurred primarily through internal expansion and the acquisition of asset management and broker-dealer firms. In December 2005, Legg Mason completed a transaction in which it sold its primary broker-dealer businesses to concentrate on the asset management industry.

Additional information about Legg Mason is available on our website at http://www.leggmason.com. We make available, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and our proxy statements. Investors can find this information under the “Investor Relations” section of our website. These reports are available through our website as soon as reasonably practicable after we electronically file the material with, or furnish it to, the Securities and Exchange Commission (“SEC”). In addition, the Legg Mason, Inc. Corporate Governance Principles, our Code of Conduct for all employees and directors, and the charters for the committees of our Board of Directors are also available on our corporate website at http://www.leggmason.com under the “About - Corporate Governance” section. A copy of any of these materials may also be obtained, free of charge, by sending a written request to Corporate Secretary, Legg Mason, Inc., 100 International Drive, Baltimore, MD 21202. As required, and within the time frames required, by the SEC or the New York Stock Exchange (“NYSE”), we will post on our website any amendments to the Code of Conduct and any waiver of the Code of Conduct applicable to any executive officer, director, chief financial officer, principal accounting officer or controller. The information on our website is not incorporated by reference into this Report.

Unless the context otherwise requires, all references in this Report to “we,” “us,” “our” and “Legg Mason” include Legg Mason, Inc. and its predecessors and subsidiaries, and the term “asset managers” refers to the asset management businesses operated by our subsidiaries. References to “fiscal year 2016” or other fiscal years refer to the 12-month period ended March 31st of the year specified.

Business Developments During the Fiscal Year Ended March 31, 2016

During fiscal year 2016, in addition to the normal course operation of our business, we continued to improve our affiliate portfolio through strategic acquisitions and issued additional debt to finance those acquisitions. We also implemented a management equity plan at one of our affiliates in order to better align the interests of the affiliate’s management team with those of our shareholders.

Acquisitions

On October 21, 2015, we acquired a majority equity interest in RARE Infrastructure Ltd. (“RARE Infrastructure”). RARE Infrastructure specializes in global listed infrastructure investing, is headquartered in Sydney, Australia, and had approximately $6.3 billion in AUM as of March 31, 2016. Legg Mason holds a 75% ownership interest in the firm, the firm's management team retained a 15% equity stake and a previous minority owner retained 10%. The acquisition of RARE Infrastructure fills gaps in our liquid alternatives products line-up.

On January 21, 2016, we entered into an agreement to acquire an 82% equity interest in Clarion Partners, a diversified real estate asset management firm based in New York. As of April 30, 2016, Clarion Partners managed approximately $41.5

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billion in AUM across the real estate risk/return spectrum. The Clarion Partners management team retained 18% of the outstanding equity in Clarion Partners. The acquisition of Clarion Partners fills gaps in our illiquid alternative product offerings. The transaction with Clarion Partners was completed on April 13, 2016.

On January 22, 2016, we entered into an agreement to combine the Permal Group, our existing hedge fund of funds platform, with EnTrust Capital ("EnTrust"), a leading alternative asset management firm headquartered in New York with approximately $10 billion in AUM as of March 31, 2016, and largely complementary investment strategies, investor base, and business mix to Permal. As a result of the combination, we own 65% of the combined entity, branded EnTrustPermal, and 35% is owned by EnTrustPermal's chief executive officer. The combination of the businesses of EnTrust and Permal will create a new global alternatives solutions firm. The transaction with EnTrust was completed on May 2, 2016.

On January 22, 2016, we acquired a minority equity position in Precidian Investments, LLC ("Precidian"), a firm specializing in creating innovative products and solutions and solving market structure issues, particularly with regard to the exchange-traded fund (“ETF”) marketplace. Under the terms of the transaction, we acquired preferred units of Precidian that entitle us to approximately 20% of the voting and economic interests of Precidian, along with customary preferred equity protections. At our sole option during the 48 months following the initial investment, we may, subject to satisfaction of certain closing conditions, convert our preferred units to 75% of the common equity of Precidian on a fully diluted basis. The investment in Precidian expands our ETF capabilities and provides the opportunity to partner with Precidian to create new products and offerings.

Management Equity Plan

On March 1, 2016, we implemented a management equity plan and revised revenue sharing arrangement with our subsidiary, Royce & Associates (“Royce”). Under the terms of the management equity plan, Royce’s management team was issued equity interests in Royce which allow the holders to receive quarterly distributions of a portion of Royce's net income. Our prior revenue sharing arrangement with Royce was replaced with a new arrangement which reduced the percentage of Royce net revenues reserved to pay expenses (including bonus awards) and increased the percentage of revenues payable to us. The management equity plan and new revenue sharing arrangement help to align the interests of Royce’s management with our interests and provide continued incentives to grow revenues and control operating expenses.

Financings

On December 29, 2015, we entered into a Credit Agreement (the "Credit Agreement") pursuant to which we have available a multi-currency revolving credit facility in an amount of $1 billion (as amended from time to time, the “Revolving Facility”). We borrowed $40 million on the Revolving Facility on December 29, 2015 to repay the outstanding $40 million balance on our previous revolving credit facility, which was terminated. On May 4, 2016, we borrowed $460 million under the Revolving Facility in order to replenish cash used to pay for the acquisitions of EnTrust and Clarion Partners. We will use the remainder of the available borrowings under the Revolving Facility to fund working capital needs and for general corporate purposes.

On March 14, 2016, we completed the issuance and sale of $250 million aggregate principal amount of 6.375% Junior Subordinated Notes due 2056 (the “2056 Notes”). On March 22, 2016, we completed the issuance and sale of $450 million aggregate principal amount of 4.750% Senior Notes due 2026 (the “2026 Notes”). The net proceeds of both offerings, together with borrowings under our Revolving Facility, were used to finance the purchase prices of the acquisitions of EnTrust and Clarion Partners and to pay fees and expenses related to those transactions.

See “Item 8. Financial Statements and Supplementary Data” for the revenues, net income and assets of Legg Mason, which operates in a single reportable business segment. See Note 16 of Notes to Consolidated Financial Statements in Item 8 of this Report for our revenues generated in, and our long-lived assets (consisting primarily of intangible assets and goodwill) located in, each of the principal geographic regions in which we conduct business. See Note 7 of Notes to Consolidated Financial Statements in Item 8 of this Report for our deferred tax assets in the U.S. and in all other countries, in aggregate.


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Business Overview

Acting through our subsidiaries, we provide investment management and related services to institutional and individual clients, company-sponsored investment funds and retail separately managed account programs. Operating from asset management offices located in the United States, the United Kingdom and a number of other countries worldwide, our businesses provide a broad array of investment management products and services. We offer these products and services directly and through various financial intermediaries. Our investment advisory services include discretionary and non-discretionary management of separate investment accounts in numerous investment styles for institutional and individual investors. Our investment products include proprietary mutual funds ranging from money market and other liquidity products to fixed income, equity and alternative funds managed in a wide variety of investment styles. We also offer other domestic and offshore funds to both retail and institutional investors and funds-of-hedge funds.

Our subsidiary asset managers primarily earn revenues by charging fees for managing the investment assets of clients. Fees are typically calculated as a percentage of the value of AUM; accordingly, the fee income of each of our asset managers will typically increase or decrease as its average AUM increases or decreases. In addition, the fees on our AUM vary with the type of account managed, the amount of assets in the account, the asset manager and the type of client. Increases in AUM generally result from inflows of additional assets from new and existing clients and from appreciation in the value of client assets (including investment income earned on client assets). Conversely, decreases in AUM generally result from client redemptions and declines in the value of client assets. Our AUM may also increase as a result of business acquisitions, or decrease as a result of dispositions.

We may earn performance fees from certain accounts if the investment performance of the assets in the account meets or exceeds a specified benchmark, high water mark or hurdle rate during a measurement period. For the fiscal years ended March 31, 2016, 2015 and 2014, of our $2.7 billion, $2.8 billion and $2.7 billion in total revenues, $42.0 million, $83.5 million and $107.1 million, respectively represented performance fees. As of March 31, 2016, approximately 7% of our total AUM was in accounts that were eligible to pay performance fees.

As of March 31 of each of the last three fiscal years, we had the following aggregate AUM (in billions, except percentages):
 
 
Assets
Under
Management
 
Equity
Assets
 
% of Total in
Equity Assets
 
Fixed
Income
Assets
 
% of Total in
Fixed Income
Assets
 
Liquidity
Assets
 
% of Total
in Liquidity
Assets
2016
 
$
669.6

 
$
180.5

 
27
%
 
$
376.8

 
56
%
 
$
112.3

 
17
%
2015
 
702.7

 
199.4

 
28

 
376.1

 
54

 
127.2

 
18

2014
 
701.8

 
186.4

 
27

 
365.2

 
52

 
150.2

 
21

From time to time, our reported equity or fixed income assets under management may exclude assets that we are retained to manage on a short-term or temporary basis. Beginning in fiscal year 2017, we will report Alternative Assets as part of our AUM classifications. We currently define Alternative Assets as all AUM managed by Clarion Partners, EnTrustPermal, RARE Infrastructure or Permal Capital Management.

We believe that market conditions and our investment performance are critical elements in our attempts to grow our AUM and business. When securities markets are increasing, our AUM will tend to increase because of market performance, resulting in additional asset management revenues. Similarly, if we can produce positive investment results, our AUM will tend to increase as a result of our asset managers’ investment performance. In addition, favorable market conditions or strong relative investment performance can result in increased inflows in assets from existing and new clients. Conversely, in periods when securities markets are weak or declining, or when we have produced poor investment performance, absolute or relative to benchmarks or peers, it is likely to be more difficult to grow our AUM and business and, in such periods, our AUM and business may decline.


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We generally manage the accounts of our clients pursuant to written investment management or sub-advisory contracts between one of our asset managers and the client (or a financial intermediary acting on behalf of the client). These contracts usually specify, among other things, the management fees to be paid to the asset manager and the investment strategy for the account, and are generally terminable by either party on relatively short notice. Typically, investment management contracts may not be assigned (including as a result of transactions, such as a direct or indirect change of control of the asset manager, if it would constitute an assignment under the Investment Advisers Act of 1940 or other applicable regulatory requirements) without the prior consent of the client. When the asset management client is a U.S. registered mutual fund or closed-end fund (whether or not one of our asset managers has sponsored the fund), the fund's board of directors generally must annually approve the investment management contract, and any material changes to the contract, and the fund’s board of directors and fund shareholders must approve any assignment of the contract (including as a result of transactions that would constitute an assignment under the Investment Company Act of 1940).

We conduct the majority of our business through our asset managers. Our asset managers are individual businesses, each of which generally focuses on a portion of the asset management industry in terms of the types of assets managed (primarily equity or fixed income), the types of products and services offered, the investment styles utilized, the distribution channels used, and the types and geographic locations of its clients. Each asset manager is housed in one or more different subsidiaries, all of the voting equity of which, as of March 31, 2016, is directly or indirectly owned by Legg Mason except for Royce, which is 17% owned by its management team, RARE Infrastructure, which is 15% owned by its management team and 10% owned by another shareholder and one joint venture that we own with a former employee.

Each of our primary asset managers is generally operated as a separate business, in many cases with certain distribution functions being provided by the parent company and other affiliates, that typically markets its products and services under its own brand name. Consistent with this approach, we have in place revenue sharing arrangements with certain of our asset managers: Brandywine Global Investment Management, ClearBridge Investments, RARE Infrastructure, Royce & Associates, and Western Asset Management Company, and/or certain of their key officers. Pursuant to these revenue sharing arrangements, a specified percentage of the asset manager's revenues, net of certain third party distribution expenses, is required to be distributed to the equity owners of the business and the balance of the revenues (or net revenues) is retained to pay operating expenses, including salaries and bonuses, but excluding certain expenses such as amortization of acquired intangible assets and excluding income taxes. Specific compensation allocations are determined by the asset manager's management, subject to corporate management approval in certain cases. Although, without renegotiation, the revenue sharing arrangements impede our ability to increase our profit margins from these businesses, we believe the agreements are important because they help us retain and attract talented employees. In addition, the revenue sharing arrangements provide management of these asset managers with incentives to (i) grow the asset managers' revenues, since management is able to participate in the revenue growth through the portion that is retained; and (ii) control operating expenses, which will increase the portion of the revenues retained that is available to fund growth initiatives and for incentive compensation. In addition, the management teams of Royce and RARE Infrastructure have significant equity interests in the applicable company, which helps to align the interests of the management of those two affiliates with the interests of our shareholders.

Asset Managers

Our asset managers provide a wide range of investment advisory services to separately managed account clients, including institutional clients such as pension and other retirement plans, corporations, insurance companies, endowments and foundations and governments, as well as retail clients such as high net worth individuals and families, and retail separately managed account programs. In addition, our asset managers also manage or sub-advise various groups of proprietary and non-proprietary U.S. mutual funds registered under the Investment Company Act of 1940, as amended, including equity, fixed income, liquidity and balanced funds. Certain of our asset managers also manage or sub-advise numerous international mutual funds that are domiciled and distributed in countries around the globe.

Western Asset Management Company is a leading global fixed income asset manager for institutional clients. Headquartered in Pasadena, California, Western Asset Management's operations include investment operations in New York City, the United Kingdom, Japan, Brazil, Australia and Singapore. Western Asset Management offers a broad range of products spanning the yield curve and encompassing the world's major bond markets, including a suite of limited duration and core products, emerging market and high yield portfolios, municipal portfolios and a variety of sector-oriented and global products. Among the services Western Asset Management provides are management of separate accounts and U.S. mutual funds, one real estate investment trust, closed-end funds, international funds and other structured investment products. As of March 31, 2016, Western Asset Management managed assets with a value of $428.9 billion.

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ClearBridge Investments is an equity asset management firm based in New York City that also has an office in Baltimore, Maryland. ClearBridge Investments provides asset management services to certain of the equity funds (including balanced funds and closed-end funds) in the Legg Mason Funds, to retail separately managed account programs, to certain of our international funds and, primarily through separate accounts, to institutional clients. ClearBridge Investments also sub-advises non-proprietary U.S. mutual funds that are sponsored by third parties. ClearBridge Investments offers a diverse array of investment styles and disciplines, designed to address a range of investment objectives. Significant ClearBridge Investments investment styles include low volatility, high active shares and income solutions. In managing assets, ClearBridge Investments generally utilizes a bottoms-up, research intensive, fundamental approach to security selection that seeks to identify companies with the potential to provide solid economic returns relative to their risk-adjusted valuations. As of March 31, 2016, ClearBridge Investments managed assets with a value of $96.0 billion.

Brandywine Global Investment Management is a global asset management firm headquartered in Philadelphia, Pennsylvania with offices also in the United Kingdom, Canada and Singapore. Brandywine Global provides investment advisory services primarily to separately managed accounts for institutional clients in a range of fixed income, including global and international fixed income, and equity investment strategies. Brandywine Global also provides investment advisory services to high net worth clients through separately managed account programs, including various non-proprietary wrap accounts sponsored by third parties. In addition, Brandywine Global manages nine of our proprietary U.S. mutual funds and a number of our international funds. Brandywine Global pursues a value investing approach in its management of both equity and fixed income assets. As of March 31, 2016, Brandywine Global managed assets with a value of $70.2 billion.

QS Investors is a customized solutions and global quantitative equities investment firm providing asset management and advisory services to a diverse array of institutional clients. Headquartered in New York City, QS Investors has developed approaches to integrating quantitative and behavioral investment insights and dynamically weighting opportunities in response to changing conditions in the economy and the market. QS Investors offers a broad spectrum of strategies which includes actively managed U.S. and Global equities, Liquid Alternatives, and Customized Solutions. Following our acquisition of QS Investors in May 2014, two of our wholly-owned subsidiaries, Batterymarch and LMGAA, were integrated into QS Investors. As of March 31, 2016, QS Investors managed approximately $18.1 billion of AUM.

Royce is the investment advisor to all of The Royce Funds, a proprietary range of equity U.S. mutual funds and to certain of our international funds. In addition, Royce manages other pooled and separately managed accounts, primarily for institutional clients. Headquartered in New York City, Royce generally invests in smaller company stocks, using a value approach. Royce’s stock selection process generally seeks to identify companies with strong balance sheets and the ability to generate free cash flow. Royce pursues securities that are priced below its estimate of the issuer’s current worth. As of March 31, 2016, Royce managed assets with a value of $17.7 billion.

Permal Group Limited is a leading global funds-of-hedge funds management firm with its investment teams located in London, New York City and Paris and additional offices in Boston, Dubai, Hong Kong, Singapore and Nassau. Permal Group manages products which include both directional and absolute return strategies, and are available through multi-manager and single manager funds, separately managed accounts and structured products sponsored by several large financial institutions. Permal Group selects from among thousands of investment managers and investment firms in designing portfolios that are intended to meet a wide variety of specific investment objectives, including global, regional, class and sector specific offerings. In managing its directional offerings, Permal Group's objective is to participate significantly in strong markets, preserve capital in down or volatile markets and outperform market indices over a full market cycle with reduced risk and volatility. In managing its absolute return strategies, Permal Group seeks to achieve positive investment returns in all market conditions with low correlation to the overall equity markets. As of March 31, 2016, Permal managed assets with a value of $16.4 billion. On May 2, 2016, we completed a transaction which combined the Permal Group with EnTrust Capital. We own 65% of the combined firm, EnTrustPermal.

Martin Currie is an international equity specialist headquartered in Edinburgh, Scotland. It manages active equity portfolios for a global client base of financial institutions, charities, foundations, endowments, pension funds, family offices, government agencies and investment funds. Following our acquisition of Martin Currie, our Melbourne-based Australian equities investment team, which specializes in Australian equity products, Australian property trusts and asset allocation products, was combined into Martin Currie. As of March 31, 2016, Martin Currie, including the Australian equities investment team, managed approximately $11.5 billion in AUM.

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RARE Infrastructure is a global listed infrastructure investing specialist, which we acquired in October 2015. Legg Mason holds a 75% ownership interest in the firm, the firm's management team retained a 15% equity stake and a previous minority owner retained 10%. Headquartered in Sydney, Australia, RARE Infrastructure had approximately $6.3 billion in AUM as of March 31, 2016.

We and one of our former employees each own 50% of a joint venture that serves as investment manager of two equity U.S. mutual funds, the Legg Mason Opportunity Trust and the Miller Income Opportunity Trust, within the Legg Mason Funds family. We include all of the assets managed by the joint venture, which totaled $2.1 billion at March 31, 2016, in our AUM.

Legg Mason Poland engages in portfolio management, servicing and distribution of both separate account management services and local funds in Poland. Based in Warsaw, the firm provides portfolio management services primarily for equity assets to institutions, including corporate pension plans and insurance companies, and, through funds distributed through banks and insurance companies and individual investors. As of March 31, 2016, Legg Mason Poland managed assets with a value of $1.1 billion.

In April 2016, we acquired Clarion Partners. We hold an 82% equity interest in Clarion Partners, while the Clarion Partners management team holds the remaining 18% of outstanding equity. Clarion Partners managed approximately $41.5 billion in AUM as of April 30, 2016.

United States Mutual Funds

Our U.S. mutual funds primarily consist of two groups of proprietary mutual and closed-end funds (the “Legg Mason Funds” and the "Royce Funds"). The Legg Mason Funds invest in a wide range of domestic and international equity and fixed income securities utilizing a number of different investment styles, and also include several money market funds. The Royce Funds invest primarily in smaller-cap company stocks using a value investment approach.

The Legg Mason Funds consist of 128 mutual funds and 32 closed-end funds in the United States, all of which are primarily managed or sub-advised by Brandywine Global, ClearBridge Investments, Permal, QS Investors, Western Asset Management, Martin Currie, RARE Infrastructure and our joint venture with a former employee. The mutual funds and closed-end funds within the Legg Mason Funds include 69 equity funds (including balanced funds) that invest in a wide spectrum of equity securities utilizing numerous investment styles, including large- and mid-cap growth funds and international funds. The fixed income and liquidity mutual funds and closed-end funds within the Legg Mason Funds include 91 funds that offer a wide variety of investment strategies and objectives, including income funds, investment grade funds and municipal securities funds. As of March 31, 2016 and 2015, the Legg Mason Funds included $147.5 billion and $157.2 billion in assets, respectively, in their mutual funds and closed-end funds, of which approximately 34% and 37%, respectively, were equity assets, approximately 37% and 35%, respectively, were fixed income assets and approximately 29% and 28%, respectively, were liquidity assets.

The Royce Funds consist of 20 mutual funds and three closed-end funds, most of which invest primarily in smaller-cap company or micro-cap company stocks using a value approach. The funds differ in their approach to investing in smaller companies and the universe of securities from which they can select. As of March 31, 2016 and 2015, The Royce Funds included $16.0 billion and $26.9 billion in assets, respectively, substantially all of which were equity assets. The Royce Funds are distributed through non-affiliated fund supermarkets, Legg Mason Global Distribution, non-affiliated wrap programs, and direct distribution. In addition, two of the portfolios in The Royce Funds are distributed only through insurance companies.

International Funds

Outside the United States, we manage, support and distribute numerous proprietary funds across a wide array of global fixed income, liquidity and equity investment strategies. Our international funds include a broad range of cross border funds that are domiciled in Ireland and are sold in a number of countries across Asia, Europe and Latin America. Our international funds also include local fund ranges that are domiciled in the United Kingdom, Australia, Japan, Singapore and Poland and offered to investors in the country of domicile. Our international funds are distributed and serviced by Legg Mason Global Distribution, as discussed below. Our international funds, which include equity, fixed income, liquidity and

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balanced funds are primarily managed or sub-advised by Brandywine Global, ClearBridge Investments, Permal, QS Investors, Martin Currie, RARE Infrastructure, Royce and Western Asset Management. In the aggregate, we sponsored and managed 208 and 187 of these international funds, respectively at March 31, 2016 and 2015, which at those dates had an aggregate of approximately $105.9 billion and $119.8 billion in assets, respectively, of which approximately 17% and 14%, respectively, were equity assets, approximately 22% and 20%, respectively were fixed income assets and approximately 61% and 66%, respectively, were liquidity assets. The information above does not include the funds-of-hedge funds sponsored and managed by Permal, or the Brazil-domiciled funds managed by Western Asset Management.

Retail Separately Managed Account Programs

We are a leading provider of asset management services to retail separately managed account programs, commonly known as managed account or wrap programs. These programs typically allow securities brokers or other financial intermediaries to offer their clients the opportunity to choose from a number of asset management services pursuing different investment strategies provided by one or more asset managers, and generally charge an all-inclusive fee that covers asset management, trade execution, asset allocation and custodial and administrative services. We provide investment management services through more than 100 retail separately managed account programs sponsored by various financial institutions.

Distribution

Our centralized global distribution group, Legg Mason Global Distribution, operates two divisions, the U.S. Distribution Group and the International Distribution Group. The U.S. Distribution Group markets, distributes and supports our U.S. mutual funds and retail separately managed account programs. The International Distribution Group markets, distributes and supports our international funds. In general, our U.S. and international sales and marketing teams are housed in separate subsidiaries from our asset managers.

In addition, each of our asset managers has its own sales and marketing teams that distribute its products and services, primarily, in most cases, to institutional investors or high net worth individuals and families. The institutional sales and marketing teams of our asset managers distribute asset management services to potential clients, both directly and through consultants. Consultants play a large role in institutional asset management by helping clients select and retain asset managers. Institutional asset management clients and their consultants tend to be highly sophisticated and investment performance-driven.    

U.S. Distribution

The U.S. Distribution Group of Legg Mason Global Distribution employs a team of U.S. based sales, marketing and support staff that market, distribute and support our U.S. mutual funds, including the Legg Mason Funds and the Royce Funds. Our mutual fund wholesalers distribute the Legg Mason Funds through a number of third-party distributors. While we have worked to diversify our distribution network, historically, many of the Legg Mason Funds were principally sold through the retail brokerage business of Citigroup. The retail business created by the combination of Morgan Stanley's brokerage unit and Citigroup's Smith Barney unit into Morgan Stanley Wealth Management remains a significant intermediary selling the Legg Mason Funds.

The U.S. Distribution Group distributes institutional share classes of the Legg Mason Funds to institutional clients and also distributes variable annuity sub-advisory services provided by our asset managers to insurance companies (including advisory services provided to certain of the Legg Mason Funds that are specifically designed for purchase through variable annuity contracts and variable life insurance policies offered by participating insurance companies). Our institutional liquidity funds are primarily distributed by Western Asset Management's sales team. The Royce Funds are distributed by Royce’s sales team in addition to the U.S. Distribution Group.

In addition to distributing funds, the wholesalers in Legg Mason Global Distribution also market and support our retail separately managed account program services. These services are provided through programs sponsored by a variety of financial institutions.

    

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International Distribution

The International Distribution Group of Legg Mason Global Distribution employs a team of sales, marketing and support staff that markets, distributes and supports our international funds to individual and institutional investors across Asia, Europe and the Americas. The International Distribution Group has sales teams operating out of distribution offices in 16 cities in 13 countries and distributing our cross border international funds globally and our international local fund ranges in their respective countries. The goal of our International Distribution Group is to be a global partner for firms that utilize or distribute asset management products around the world, but also to be viewed as a local partner through an understanding of the nuances and needs of each local market that they cover. These distributors seek to develop deep distribution relationships with retail banks, private banks, asset managers, fund platforms, pension plans and insurance plans. Our international distribution offices also work with our asset managers on a case-by-case basis to take advantage of preferences for local distributors or to meet regulatory requirements in distributing products and services into their local markets.

Legg Mason Investments is the largest business component within the International Distribution Group. It is responsible for the distribution and servicing of cross border and local fund ranges across Europe, the Americas and Asia. Legg Mason Investments has offices in locations including London, Paris, Milan, Zurich, Frankfurt, Madrid, Singapore, Hong Kong, Taipei, Miami, Santiago and New York. Our distribution efforts are not limited to the locations where we have offices, as Legg Mason Investments distributes cross border funds in more than 30 countries around the world. This global presence provides Legg Mason Investments with the capabilities to provide a platform of sales, service, marketing and products that can cater to the different distribution dynamics in each of the three regions that it covers. Client coverage is local, coordinated across regions, and encompasses multiple distribution channels including broker-dealers, funds-of-funds, asset managers, independent financial advisers, banks, fund platforms, insurance companies and other distribution partners. The extent to which each channel takes precedence in any one market is governed by local market dynamics.

In addition to Legg Mason Investments, Legg Mason Global Distribution includes separate distribution operations in Australia and Japan. In Australia, our distribution operations distribute local and cross border funds sub-advised by our asset managers primarily to retail investors, pension plans, fund-of-funds managers, insurance companies and government funds/agencies. In Japan, our distribution operations distribute domestic investment funds, cross border funds and institutional separate accounts primarily to the retail market, which includes retail banks, private banks, asset managers, funds platforms and insurance companies.

Permal's products and services are sold outside the United States to non-U.S. high net worth investors through a network of financial intermediaries by Permal's distribution operations as well as through our International Distribution Group. Permal's relationships with its financial intermediaries have resulted in wide international distribution of Permal's products and services. In addition, Permal distributes its products and services to U.S. and international institutions through Permal's internal distribution teams.

Employees

At March 31, 2016, 2015 and 2014, we had 3,066, 2,982 and 2,843 employees, respectively. None of our employees are covered by a collective bargaining agreement. We consider our relations with our employees to be satisfactory. However, competition for experienced asset management personnel is intense and from time to time we may experience a loss of valuable personnel. We recognize the importance to our business of hiring, training and retaining skilled professionals.

Competition

We are engaged in an extremely competitive business and are subject to substantial competition in all aspects of our business. Our competition includes, with respect to one or more aspects of our business, numerous international and domestic asset management firms and broker-dealers, mutual fund complexes, hedge funds, commercial banks, insurance companies, other investment companies and other financial institutions. Many of these organizations offer products and services that are similar to, or compete with, those we offer, and many of these organizations have substantially more personnel and greater financial resources than we have. Some of these competitors have proprietary products and distribution channels that make it more difficult for us to compete with them. In addition, many of our competitors have long-standing and established relationships with distributors and clients. The principal competitive factors relating to our business are the quality of advice and services provided to investors, the performance records of that advice and service, the reputation of

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the company providing the services, the price of the services, the products and services offered and distribution relationships and compensation offered to distributors.

Competition in our business periodically has been affected by significant developments in the asset management industry. See “Item 1A. Risk Factors - Risks Related to our Asset Management Business - Competition in the Asset Management Industry Could Reduce our Revenues and Net Income.”

Regulation

The asset management industry in the United States is subject to extensive regulation under both federal and state securities and other laws. The SEC is the federal agency charged with administration of the federal securities laws. Our distribution activities also may be subject to regulation by federal agencies, self-regulatory organizations and state securities commissions in those states in which we conduct business. In addition, asset management firms are subject to regulation by various foreign governments, securities exchanges, central banks and regulatory bodies, particularly in those countries where they have established offices. Due to the extensive laws and regulations to which we are subject, we must devote substantial time, expense and effort to remaining vigilant about, and addressing, legal and regulatory compliance matters. Moreover, regulatory changes in one jurisdiction often affect our business operations in other jurisdictions.

Virtually all aspects of our business are subject to various laws and regulations around the world, some of which are summarized below. These laws and regulations are primarily intended to protect investment advisory clients and investors in registered and unregistered investment companies. Under these laws and regulations, agencies that regulate investment advisers, investment funds and other individuals and entities have broad administrative powers, including the power to limit, restrict or prohibit the regulated entity or person from conducting business if it fails to comply with such laws and regulations. Regulators also have a variety of informal enforcement mechanisms available that could have a significant impact on our business. Possible sanctions for significant compliance failures include the suspension of individual employees, limitations on engaging in certain lines of business for specified periods of time, revocation of investment adviser and other registrations, censures and fines. A regulatory proceeding, regardless of whether it results in a sanction, can require substantial expenditures and can have an adverse effect on our reputation or business.

Regulatory Reform

We are subject to numerous regulatory reform initiatives around the world. Any such initiative, or any new laws or regulations or changes in enforcement of existing laws or regulations, could materially and adversely impact us by leading to business disruptions, requiring us to change certain business practices and exposing us to additional costs (including compliance and legal costs). The rules governing the regulation of financial institutions and their holding companies and subsidiaries are very detailed and technical. Accordingly, the discussion below is general in nature, does not purport to be complete and is current only as of the date of this report.

Dodd-Frank Wall Street Reform and Consumer Protection Act

In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law in the United States. The Dodd-Frank Act requires the adoption of extensive regulations and numerous regulatory decisions, many of which have been adopted and others of which will be forthcoming. As the impact of these rules will become evident over time, it is not yet possible to predict the ultimate effects that the Dodd-Frank Act or subsequent implementing regulations and decisions will have on us.

Systemically Important Financial Institution Review

On July 31, 2014, the Financial Stability Oversight Council (“FSOC”) principals directed the staff to undertake a more focused analysis of industry-wide products and activities to assess potential risks associated with the asset management industry, and on December 18, 2014 the FSOC issued a Request for Information related to this analysis. On April 18, 2016, the FSOC released a statement providing an update on its review of asset management products and activities and their potential risks to U.S. financial stability. The statement outlines FSOC’s recent analysis of risks focused on the following areas: (i) liquidity and redemption; (ii) leverage; (iii) operational functions; (iv) securities lending; and (v) resolvability and transition planning. The statement also includes the FSOC’s views on ways to mitigate potential financial instability risk relating to such areas.

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In addition, on January 8, 2014, the Financial Stability Board (“FSB”) and the International Organization of Securities Commissions (“IOSCO”) issued a consultative document on proposed methodologies to identify nonbank/noninsurance global systemically important financial institutions (“G-SIFI”). A second FSB-IOSCO consultation is expected to be released in the near future.

Under the Dodd-Frank Act, we could be designated a systemically important financial institution (“SIFI”) and become subject to direct supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). If we or any other asset manager were designated a SIFI or G-SIFI, we could become subject to enhanced prudential, capital, supervisory and other requirements, such as risk-based capital requirements, leverage limits, liquidity requirements, resolution plan and credit exposure report requirements, concentration limits, a contingent capital requirement, enhanced public disclosures, short-term debt limits and overall risk management requirements. Requirements such as these, which were designed to regulate banking institutions, would likely need to be modified to be applicable to an asset manager. No proposals have been made indicating how such measures would be adapted for asset managers.

Money Market Fund Reform

On July 23, 2014, the SEC adopted final rules on money market fund reform (the “2014 Rules”), which are designed to reform the regulatory structure governing money market funds and to address the perceived systemic risks that such funds present. The 2014 Rules require any institutional prime money market fund and any institutional municipal (or tax-exempt) money market fund that is registered under the Investment Company Act of 1940 to utilize market-based valuations to calculate a floating net asset value (“NAV”) rather than using the amortized cost method for valuing securities maturing in more than 60 days to seek to maintain a stable NAV. The 2014 Rules also provide for new tools for the funds’ boards designed to address unanticipated changes in the demand for liquidity, or liquidity shocks, including liquidity fees and redemption gates. Institutional prime and institutional municipal money market funds and retail money market funds must comply with liquidity fees and redemption gate requirements, but these are optional for U.S. Government money market funds. Approximately 16% of our AUM as of March 31, 2016, consisted of assets in money market funds, of which institutional prime or institutional municipal money market funds (including offshore funds that feed into such money market funds) comprised approximately 80% of that total. While various changes prompted by the 2014 Rules have phased in over time, final implementation of all reforms must be completed by October 14, 2016. The potential impact of the rules that affect the structure of the funds on our business remains untested.

Securities and Exchange Commission Review of Asset Managers and Mutual Funds

Our business may also be impacted by additional regulatory initiatives by the SEC. In December 2014, the Chair of the SEC recommended that the SEC enhance its oversight of asset managers by (i) expanding and updating data requirements with which asset managers must comply, (ii) improving fund level controls, including those related to liquidity levels and the nature of specific instruments and (iii) ensuring that asset management firms have appropriate transition plans in place to deal with market stress events or situations where an investment adviser is no longer able to serve its clients. In May 2015, the SEC issued proposed amendments to Form ADV, the form filed by an investment adviser to register with the SEC as an investment adviser, to require that a registered investment adviser provide additional and more detailed information about itself and the separately managed accounts (i.e., non-pooled investment vehicles) that it advises, including information on the types of assets held in client accounts and the use of derivatives and borrowings in client accounts. Also in May 2015, the SEC proposed new rules (as well as amendments to existing rules) to modernize the reporting and disclosure of information by registered investment companies. Although the proposed changes have not been finalized, any additional SEC oversight or the introduction of any new reporting, disclosure or control requirements could expose us to additional compliance costs and may require us to change how we operate our business.

Regulation of Derivatives

The SEC, the Internal Revenue Service (“IRS”) and the Commodity Futures Trading Commission (“CFTC”) each continue to review the use of futures, swaps and other derivatives by mutual funds. Such reviews could result in regulations that further limit the use of such products by mutual funds. If adopted, these limitations could require us to change certain mutual fund business practices or to register additional entities with the CFTC, which could result in additional costs and/or restrictions. We also report certain information about a number of our private funds to the SEC and certain information to the CFTC, under systemic risk reporting requirements adopted by both agencies. These reporting obligations have required,

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and will continue to require, investments in people and systems to assure timely and accurate reporting. The rules and regulations applicable to offshore funds, accounts and counterparties will require us to build and implement new compliance monitoring procedures to address the enhanced level of oversight to which we will be subject. These rule changes also introduce new requirements for centrally clearing certain swap, and eventually security-based swap, transactions and for executing certain swap, and eventually security-based swap, transactions on or through CFTC or SEC-registered trading venues. Jurisdictions outside the United States in which we operate also have adopted and implemented, or are in the process of considering, adopting or implementing more pervasive regulation of many elements of the financial services industry, which could further impact us and the broader markets. This includes the implementation of mandated central clearing of swaps in the European Union (“EU”) and the implementation of trade reporting, documentation, central clearing and other requirements in various jurisdictions globally.

Use of Derivatives by US Registered Investment Companies - SEC Proposed Rule

On December 11, 2015 the SEC proposed a new exemptive rule designed to provide an updated and more comprehensive approach to the regulation of US mutual funds’ use of derivatives. The proposed rule would permit mutual funds, ETFs, closed-end funds, and companies that have elected to be treated as business development companies under the Act to enter into derivatives transactions and financial commitment transactions, notwithstanding the prohibitions and restrictions on the issuance of senior securities under the Act, provided that the funds comply with the conditions of the proposed rule. A fund that relies on the proposed rule in order to enter into derivatives transactions would be required to: comply with one of two alternative portfolio limitations designed to impose a limit on the amount of leverage the fund may obtain through derivatives transactions and other senior securities transactions; manage the risks associated with the fund’s derivatives transactions by maintaining an amount of certain assets, defined in the proposed rule as “qualifying coverage assets,” designed to enable the fund to meet its obligations under its derivatives transactions; and, depending on the extent of its derivatives usage, establish a formalized derivatives risk management program. A fund that relies on the proposed rule in order to enter into financial commitment transactions would be required to maintain qualifying coverage assets equal in value to the fund’s full obligations under those transactions. The potential impact of the new rule, which is still subject to change and is likely to have a lengthy transition period prior to implementation, on the funds and/or our business is unclear.

Proposed SEC Liquidity Management Rule covering US Registered Open-End Funds, including ETFs

On September 22, 2015, the SEC proposed a new rule (and amendments to existing rules) designed to promote effective liquidity risk management throughout the open-end fund industry, thereby reducing the risk that funds will be unable to meet redemption obligations and mitigating dilution of the interests of fund shareholders. The proposed amendments also seek to enhance disclosure regarding fund liquidity and redemption practices. The proposed new rule would require each registered open-end fund, including open-end ETFs (but not including money market funds), to establish a liquidity risk management program. The Commission also proposed amendments to existing rule 22c-1 to permit a fund, under certain circumstances, to use “swing pricing,” the process of adjusting the net asset value of a fund’s shares to effectively pass on the costs stemming from shareholder purchase or redemption activity to the shareholders associated with that activity. The potential impact of the new and amended rules, which are still subject to change and are likely to have a lengthy transition period prior to implementation, on the funds and/or our business is unclear.

Benchmark Reform

In 2013, the IOSCO published principles for regulatory oversight of financial benchmarks, with standards applying to methodologies for benchmark calculation, and transparency and governance issues in the benchmarking process. Regulators in some of the jurisdictions in which we operate are analyzing the application of these principles, with a draft European Regulation published in September 2013. In July 2014, the FSB published a report aimed at reforming major interest rate benchmarks. These regulations may result in business disruptions or strictly control the activities of financial services firms.

Alternative Investment Fund Managers Directive

Our European business is impacted by the EU Alternative Investment Fund Managers Directive (“AIFMD”), which became effective on July 21, 2011. The AIFMD regulates managers of, and service providers to, a broad range of alternative investment funds (“AIFs”) domiciled within and (depending on the precise circumstances) outside the EU. The AIFMD also regulates the marketing of all AIFs inside the European Economic Area (“EEA”). The AIFMD is being implemented in

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stages, which run through 2018. Compliance with the AIFMD’s requirements restrict alternative investment fund marketing and impose additional compliance and disclosure obligations regarding remuneration, capital requirements, leverage, valuation, stakes in EU companies, depositaries, the domicile of custodians and liquidity management on us. We have incurred, and expect to continue to incur, additional expenses related satisfying these new compliance and disclosure obligations and the associated risk management and reporting requirements.

Markets in Financial Instrument Directives

We are subject to numerous regulatory reform initiatives in Europe. The United Kingdom and other European jurisdictions in which we operate have implemented the Markets in Financial Instruments Directive (“MiFID”) rules into national legislation, and have begun to implement MiFID 2. MiFID 2 builds upon many of the initiatives introduced through MiFID, which focused primarily on equities, to encourage trading across all asset classes to migrate onto open and transparent markets. MiFID 2, which will come into full effect in January 2018, will be implemented through a number of more detailed directives, regulations and standards to be made by the European Commission and by the European Securities and Markets Authority (“ESMA”). It is expected that MiFID 2 will have significant and wide-ranging impacts on EU securities and derivatives markets, including (i) enhanced investor protection and governance standards, (ii) rules regarding the ability of portfolio management firms to receive and pay for investment research relating to all asset classes, (iii) enhanced regulation of algorithmic trading, (iv) the movement of trading in certain shares and derivatives onto regulated execution venues, (v) the extension of pre- and post-trade transparency requirements to wider categories of financial instruments, (vi) restrictions on the use of so-called dark pool trading, (vii) the creation of a new type of trading venue called the Organized Trading Facility for non-equity financial instruments, (viii) commodity derivative position limits and reporting requirements, (ix) a move away from vertical silos in execution, clearing and settlement, (x) an enhanced role for ESMA in supervising EU securities and derivatives markets and (xi) new requirements regarding non-EU investment firms’ access to EU financial markets. Implementation of these measures will have direct and indirect impacts on us and certain of our affiliates.

Undertakings for Collective Investment in Transferable Securities

The EU has adopted directives on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (“UCITS”) with respect to depositary functions, remuneration policies and sanctions. UCITS V, which became effective in September 2014, seeks to align the depositary regime, remuneration rules and sanctioning powers of regulators under UCITS with the requirements of the AIFMD. UCITS V is required to be incorporated into the national law of each EU member state by second quarter of 2016. In addition, in August 2014 ESMA revised the guidelines it published in 2012 on ETFs and other UCITS funds. The guidelines introduced new collateral management requirements for UCITS funds concerning collateral received in the context of derivatives using Efficient Portfolio Management (“EPM”) techniques (including securities lending) and over-the-counter derivative transactions. These rules, which are now in effect, required us to make a series of changes to collateral management arrangements applicable to the EPM of UCITS fund ranges and will cause us to incur additional expenses associated with new risk management and reporting requirements.

Extension of Retail Distribution Review

The United Kingdom and other European jurisdictions in which we operate have recently implemented rules regarding retail distribution review (the “RDR”) aimed at enhancing consumer protections, overhauling mutual fund fee structures and increasing professionalism in the retail investment sector. In order to achieve this, RDR requires advisory firms to explicitly disclose and separately charge clients for their services and clearly describe their services as either independent or restricted. It also requires individual advisers to adhere to consistent professional standards, including a code of ethics. Similarly, MiFID 2 will contain a ban on certain advisers recovering commissions and other nonmonetary benefits from fund managers. These rules, if implemented, may lead to changes to the fees and commissions we are able to charge to our clients, as well as to our client servicing and distribution models.

Existing U.S. Regulation

Our U.S. asset managers are registered as investment advisors with the SEC, as are several of our international asset managers, and are also required to make notice filings in certain states. We and certain of our affiliates are also currently subject to regulation by the SEC, the Department of Labor (the “DOL”), the Federal Reserve, the Financial Industry Regulatory Authority (“FINRA”), the National Futures Association (“NFA”), the CFTC and other government agencies and

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regulatory bodies. Certain of our affiliates are also subject to various anti-terrorist financing, privacy, anti-money laundering regulations and economic sanctions laws and regulations established by various agencies.
    
The Investment Advisers Act of 1940 imposes numerous obligations on registered investment advisers such as certain of our asset managers, including record-keeping, operational and marketing requirements, disclosure obligations and prohibitions on fraudulent activities. The Investment Company Act of 1940 imposes stringent governance, compliance, operational, disclosure and related obligations on registered investment companies and their investment advisers and distributors. The SEC is authorized to institute proceedings and impose sanctions for violations of the Investment Advisers Act of 1940 and the Investment Company Act of 1940, ranging from fines and censure to termination of an investment adviser’s registration. Investment advisers also are subject to certain state securities laws and regulations. Non-compliance with the Investment Advisers Act of 1940, the Investment Company Act of 1940 or other federal and state securities laws and regulations could result in investigations, sanctions, disgorgement, fines and reputational damage.

Our trading and investment activities for client accounts are regulated under the Securities Exchange Act of 1934 (the “Exchange Act”), as well as the rules of various U.S. and non-U.S. securities exchanges and self-regulatory organizations, including laws governing trading on inside information, market manipulation and a broad number of technical requirements and market regulation policies in the United States and globally.    

Our broker-dealer subsidiaries are subject to regulations that cover all aspects of the securities business. Much of the regulation of broker-dealers has been delegated to self-regulatory organizations, principally FINRA. These self-regulatory organizations have adopted extensive regulatory requirements relating to matters such as sales practices, compensation and disclosure, and 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. The SEC, self-regulatory organizations and state securities commissions may conduct administrative proceedings that can result in censure, fine, suspension or expulsion of a broker-dealer, its officers or registered employees. These administrative proceedings, whether or not resulting in adverse findings, can require substantial expenditures and can have an adverse impact on the reputation or business of a broker-dealer. The principal purpose of regulation and discipline of broker-dealers is the protection of clients and the securities markets, rather than protection of creditors and stockholders of the regulated entity.

In addition, our asset managers also may be subject to the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), and related regulations, particularly insofar as they act as a “fiduciary” under ERISA with respect to benefit plan clients. ERISA and related provisions of the Internal Revenue Code impose duties on persons who are fiduciaries under ERISA, and prohibit certain transactions involving the assets of ERISA plan clients and certain transactions by the fiduciaries (and several other related parties) to the plans. The Department of Labor, which administers ERISA, has been increasingly active in proposing and adopting regulations affecting the asset management industry. On April 6, 2016, the Department of Labor issued a final fiduciary rule expanding the circumstances in which advice furnished to retirement investors will be treated as fiduciary in nature as well as related prohibited transaction class exemptions. The fiduciary rule and exemptions are focused on financial intermediaries who provide advice to institutional and retail retirement plan clients, including the third-party distributors who market and sell Legg Mason Funds and separately managed account program services, and mandate increased disclosure of financial intermediary compensation and mitigation of conflicts of interest. We and our asset managers may be adversely impacted by the fiduciary rule and exemptions to the extent that they lead to changes in financial intermediary and retirement plan investment preferences and increased pressure on product fees and expenses.

Existing International Regulation

In our international business, we have fund management, asset management, broker-dealer and distribution subsidiaries domiciled in a number of jurisdictions, including Australia, Brazil, Japan, Hong Kong, Ireland, Poland, Singapore, Taiwan and the United Kingdom that are subject to extensive regulation under the laws of, and to supervision by, governmental authorities and regulatory agencies in each of these jurisdictions. Our international subsidiaries are also authorized or licensed to offer their products and services in several other countries around the world, and thus are subject to the laws of, and to supervision by, governmental authorities in these additional countries. In addition, a subsidiary of Permal is a Bahamas bank regulated by the Central Bank of the Bahamas. In some instances, our international subsidiaries are also affected by U.S. laws and regulations that have extra-territorial application. Our offshore proprietary funds are subject to the laws and regulatory bodies of the jurisdictions in which they are domiciled and, for funds listed on exchanges, to the rules of the applicable exchanges. Certain of our funds domiciled in Ireland are also registered for public sale in several

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countries around the world and are subject to the laws of, and supervision by, the governmental authorities of those countries. All of these non-U.S. governmental authorities generally have broad supervisory and disciplinary powers, including, among others, the power to set minimum capital requirements, to temporarily or permanently revoke the authorization to carry on regulated business, to suspend registered employees, and to invoke censures and fines for both the regulated business and its registered employees.

The Financial Conduct Authority (“FCA”) currently regulates certain of our affiliates in the United Kingdom. Authorization by the FCA is required to conduct certain financial services related business in the United Kingdom under the Financial Services and Markets Act 2000. The FCA’s rules adopted under that Act govern capital resources requirements, senior management arrangements, conduct of business, interaction with clients, and systems and controls. The FCA monitors our compliance with its requirements through a combination of proactive engagement, event-driven and reactive supervision and thematic based reviews. Breaches of the FCA’s rules may result in a wide range of disciplinary actions.

In addition, certain of our affiliates must comply with the pan-European regulatory regime established by MiFID, which became effective on November 1, 2007 and regulates the provision of investment services and activities throughout the wider EEA. MiFID, the scope of which is being enhanced through MiFID 2, sets out detailed requirements governing the organization and conduct of business of investment firms and regulated markets. It also includes pre- and post-trade transparency requirements for equity markets and extensive transaction reporting requirements.

Certain of our affiliates are subject to an EU regulation on OTC derivatives, central counterparties and trade repositories, which was adopted in August 2012 and which requires (i) the central clearing of standardized OTC derivatives, (ii) the application of risk-mitigation techniques to non-centrally cleared OTC derivatives and (iii) the reporting of all derivative contracts from February 2014.

In Australia, our affiliates are subject to various Australian federal and state laws and certain subsidiaries are regulated by the Australian Securities and Investments Commission (“ASIC”). ASIC is Australia’s corporate, markets and financial services regulator and is responsible for promoting investor, creditor and consumer protection.

Net Capital Requirements

We have three small, non-clearing broker-dealer subsidiaries that primarily distribute our funds and other asset management products. These broker-dealer subsidiaries are subject to net capital rules that mandate that they maintain certain levels of capital. In addition, certain of our subsidiaries that operate outside the United States are subject to net capital or liquidity requirements in the jurisdictions in which they operate. For example, in addition to requirements in other jurisdictions, our United Kingdom-based subsidiaries and our Singapore-based subsidiaries are subject to the net capital requirements of the FCA and the Monetary Authority of Singapore, respectively.



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ITEM 1A. RISK FACTORS.
Our business, and the asset management industry in general, is subject to numerous risks, uncertainties and other factors that could negatively affect our business or results of operations. These risks, uncertainties and other factors, including the ones discussed below and those discussed elsewhere herein and in our other filings with the SEC, could cause actual results to differ materially from any forward-looking statements that we or any of our employees may make.

Risks Related to our Asset Management Business

Poor Investment Performance Could Lead to a Loss of Assets Under Management and a Decline in Revenues

We believe that investment performance is one of the most important factors for the maintenance and growth of our AUM. Poor investment performance, either on an absolute or relative basis, could impair our revenues and growth because:

existing clients might withdraw funds in favor of better performing products, which would result in lower investment advisory and other fees;
our ability to attract funds from existing and new clients might diminish; and
negative absolute investment performance will directly reduce our managed assets.

In addition, in the ordinary course of our business we may reduce or waive investment management fees, or limit total expenses, on certain products or services for particular time periods to manage fund expenses, or for other reasons, and to help retain or increase managed assets. If our revenues decline without a commensurate reduction in our expenses, our net income will be reduced. From time to time, several of our key equity and fixed income asset managers generated poor investment performance, on a relative basis or an absolute basis, in certain products or accounts that they managed, which contributed to a significant reduction in their AUM and revenues and a reduction in performance fees, and several of our asset managers currently face these issues, particularly in connection with shorter-term performance. We face periodic performance issues with certain of our products, and there is typically a lag before improvements in investment performance produce a positive effect on asset flows. There can be no assurances as to when, or if, investment performance issues will cease to negatively influence our AUM and revenues.

Assets Under Management May Be Withdrawn, Which May Reduce our Revenues and 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 relationships with us, reduce the aggregate amount of AUM, or shift their funds to other types of accounts with different rate structures for any number of reasons, including investment performance, changes in prevailing interest rates, changes in investment preferences of clients, 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 or other personnel and financial market performance. This risk is underscored by the fact that we have one international client that represents approximately 7% (primarily liquidity assets) of our total AUM that generates approximately 2% of our operating revenues. In addition, in a declining securities market, the pace of mutual fund redemptions and withdrawal of assets from other accounts could accelerate. Poor investment performance generally or relative to other investment management firms tends to result in decreased purchases of fund shares, increased redemptions of fund shares, and the loss of institutional or individual accounts.

We have experienced net outflows of equity AUM for the last ten fiscal years due in part to investment performance issues. During fiscal years 2016 and 2015, we had $26.1 billion and $5.7 billion of net client outflows, respectively. Fiscal year 2016 outflows included $14.9 billion, $10.8 billion, and $0.4 billion of liquidity, equity, and fixed income net client outflows, respectively. Fiscal year 2015 net outflows included $22.2 billion in liquidity outflows and $2.7 billion in equity outflows, which were partially offset by $19.2 billion in fixed income inflows.


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    If we Are Unable to Maintain our Fee Levels or If our Asset Mix Changes, our Revenues and Margins Could Be Reduced

Our profit margins and net income are dependent in significant part on our ability to maintain current fee levels for the products and services that our asset managers offer. There has been a trend toward lower fees in some segments of the asset management industry, and no assurances can be given that we will be able to maintain our current fee structure. Competition could lead to our asset managers reducing the fees that they charge their clients for products and services. See “Competition in the Asset Management Industry Could Reduce our Revenues and Net Income.” In addition, our asset managers may be required to reduce their fee levels, or restructure the fees they charge, because of, among other things, regulatory initiatives or proceedings that are either industry-wide or specifically targeted, or court decisions. A reduction in the fees that our asset managers charge for their products and services will reduce our revenues and could reduce our net income. These factors also could inhibit our ability to increase fees for certain products.

Our AUM can generate very different revenues per dollar of managed assets based on factors such as the type of asset managed (equity assets generally produce greater revenues than fixed income assets), the type of client (institutional clients generally pay lower fees than other clients), the type of asset management product or service provided and the fee schedule of the asset manager providing the service. A shift in the mix of our AUM from higher revenue-generating assets to lower revenue-generating assets may result in a decrease in our revenues even if our aggregate level of AUM remains unchanged or increases. A decrease in our revenues, without a commensurate reduction in expenses, will reduce our net income. We experienced a shift in the mix of our AUM during fiscal year 2016, during which our equity AUM decreased to $180.5 billion (27% of our total AUM) on March 31, 2016 from $199.4 billion (28% of our total AUM) on March 31, 2015. In addition, average AUM operating revenue yields, excluding performance fees, decreased to 38.2 basis points in fiscal year 2016 from 38.9 basis points in fiscal year 2015 due to a less favorable product mix with lower yielding products comprising a higher percentage of our total average AUM for fiscal year 2016 as compared to fiscal year 2015. There can be no assurance that we will achieve a more favorable product mix in future fiscal years.

Our Mutual Fund Management Contracts May Not Be Renewed, Which May Reduce our Revenues and Net Income

A substantial portion of our revenue comes from managing U.S. mutual funds. We generally manage these funds pursuant to management contracts with the funds that must be renewed and approved by the funds' boards of directors annually. A majority of the directors of each mutual fund are independent from us. Although the funds' boards of directors have historically approved each of our management contracts, there can be no assurance that the board of directors of each fund that we manage will continue to approve the funds’ management contracts each year, or will not condition its approval on the terms of the management contract being revised in a way that is adverse to us. If a mutual fund management contract is not renewed, or is revised in a way that is adverse to us, it could result in a reduction in our revenues and, if our revenues decline without a commensurate reduction in our expenses, our net income will be reduced.

Unavailability of Appropriate Investment Opportunities Could Hamper our Investment Performance or Growth

An important component of investment performance is the availability of appropriate investment opportunities for new client funds. If any of our asset managers are not able to find sufficient investments for new client assets in a timely manner, the asset manager's investment performance could be adversely affected. Alternatively, if one of our asset managers does not have sufficient investment opportunities for new funds, it may elect to limit its growth by reducing the rate at which it receives new funds. Depending on, among other factors, prevailing market conditions, the asset manager's investment style, regulatory and other limits and the market sectors and types of opportunities in which the asset manager typically invests (such as less capitalized companies and other more thinly traded securities in which relatively smaller investments are typically made), the risks of not having sufficient investment opportunities may increase when an asset manager increases its AUM, particularly when the increase occurs very quickly. If our asset managers are not able to identify sufficient investment opportunities for new client funds, their investment performance or ability to grow may be reduced.


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Changes in Securities Markets and Prices May Affect our Revenues and Net Income

A large portion of our revenue is derived from investment advisory contracts with clients. Under these contracts, the investment advisory fees we receive are typically based on the market value of assets under management. Accordingly, a decline in the prices of securities generally may cause our revenues and income to decline by:

causing the value of our AUM to decrease, which would result in lower investment advisory and other fees;
causing our clients to withdraw funds in favor of investments they perceive offer greater opportunity or lower risk, which would also result in lower investment advisory and other fees; or
decreasing the performance fees earned by our asset managers.
    
There are often substantial fluctuations in price levels in the securities markets. These fluctuations can occur on a daily basis and over longer periods as a result of a variety of factors, including national and international economic and political events, broad trends in business and finance, and interest rate movements. Reduced securities market prices generally may result in reduced revenues from lower levels of AUM and loss or reduction in advisory, incentive and performance fees. Periods of reduced market prices may adversely affect our profitability because fixed costs remain relatively unchanged. Because we operate in one industry, the business cycles of our asset managers may occur contemporaneously. Consequently, the effect of an economic downturn may have a magnified negative effect on our business.

In addition, as of March 31, 2016, a substantial portion of our invested assets consisted of securities and other seed capital investments. A decline in the value of equity, fixed income or other alternative securities could lower the value of these investments and result in declines in our non-operating income and net income. Increases or decreases in the value of these investments could increase the volatility of our earnings.

Changes in Interest Rates Could Have Adverse Effects on our Assets Under Management

Increases in interest rates from their historically low present levels may adversely affect the net asset values of our AUM. In addition, in a rising interest rate environment, institutional investors may shift liquidity assets that we manage in pooled investment vehicles to direct investments in the types of assets in which the pooled vehicles invest in order to realize higher yields than those available in money market and other products or strategies holding lower-yielding instruments. Furthermore, increases in interest rates may result in reduced prices in equity markets. Conversely, decreases in interest rates could lead to outflows in fixed income or liquidity assets that we manage as investors seek higher yields. Any of these effects could lower our AUM and revenues and, if our revenues decline without a commensurate reduction in our expenses, our net income will be reduced.

The current historically low interest rate environment affects the yields of money market funds, which are based on the income from the underlying securities less the operating costs of the funds. With short-term interest rates at or near zero, the operating expenses of money market funds may become greater than the income from the underlying securities, which reduces the yield of the money market funds to very low levels. In addition, bank deposits may become more attractive to investors and money market funds could experience redemptions, which could decrease our revenues and net income. We are monitoring the industry wide low yields of money market funds, which may result in negative yields, particularly in Europe, which could have a significant adverse effect on the industry in general and our liquidity business in particular. During the past four fiscal years, we voluntarily waived certain fees or assumed expenses of money market funds for competitive reasons, such as to maintain competitive yields, which reduces our advisory fee income and net income. These fee waivers for competitive reasons resulted in approximately $70 million in reduced investment advisory revenues in fiscal year 2016, and have continued into the present fiscal year.

Competition in the Asset Management Industry Could Reduce our Revenues and Net Income

The asset management industry in which we are engaged is extremely competitive and we face substantial competition in all aspects of our business. We compete with numerous international and domestic asset management firms and broker-dealers, mutual fund complexes, hedge funds, commercial banks, insurance companies, other investment companies and other financial institutions. Many of these organizations offer products and services that are similar to, or compete with, those offered by our asset managers and have substantially more personnel and greater financial resources than we do. Some of these competitors have proprietary products and distribution channels that make it more difficult for us to compete with them. In addition, many of our competitors have long-standing and established relationships with

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distributors and clients. From time to time, our asset managers also compete with each other for clients and assets under management. Our ability to compete may be adversely affected if, among other things, our asset managers lose key employees or, as has been the case for certain of the products managed by our asset managers, under-perform in comparison to relevant performance benchmarks or peer groups.

The asset management industry has experienced from time to time the entry of many new firms, as well as significant consolidation as numerous asset management firms have either been acquired by other financial services firms or ceased operations. In many cases, this has resulted in firms with greater financial resources than we have. In addition, a number of heavily capitalized companies, including commercial banks and foreign entities have made investments in and acquired asset management firms. Access to mutual fund distribution channels has also become increasingly competitive. All of these factors could make it more difficult for us to compete, and no assurance can be given that we will be successful in competing and growing our AUM and business. If clients and potential clients decide to use the services of competitors, it could reduce our revenues and growth rate, and if our revenues decrease without a commensurate reduction in our expenses, our net income will be reduced. In this regard, there are a number of asset classes and product types that are not well covered by our current products and services. When these asset classes or products are in favor with investors, we will miss the opportunity to gain the assets under management that are being invested in these assets and face the risk of our managed assets being withdrawn in favor of competitors who provide services covering these classes or products. For example, to the extent there is a trend in the asset management business in favor of passive products such as index and certain types of exchange-traded funds, it favors our competitors who provide those products over active managers like our asset managers. In addition, our asset managers are not typically the lowest cost provider of asset management services. To the extent that we compete on the basis of price in any of our businesses, we may not be able to maintain our current fee structure in that business, which could adversely affect our revenues and net income. In the retail separately managed account program business, there has been a trend toward more open programs that involve more asset managers who provide only investment models which the financial institution sponsor's employees use to allocate assets. A number of the programs for which we provide services have followed this trend, and additional programs could do so in the future. This trend could result in AUM retention issues due to additional competition within the programs, particularly for products with performance issues, and reduced management fees, which are typical results of providing investment models rather than advisory services.

Our business is asset management. As a result, we may be more affected by trends and issues affecting the asset management industry, such as industry-wide regulatory issues and inquiries, publicity about, and public perceptions of the industry and asset management industry market cycles, than other financial services companies that have more diversified businesses.

We May Support Money Market Funds to Maintain Their Stable Net Asset Values, or Other Products we Manage, Which Could Affect our Revenues or Operating Results

Approximately 16% of our AUM as of March 31, 2016, consisted of assets in money market funds. Money market funds seek to preserve a stable net asset value. The money market funds our asset managers manage have always maintained this stable net asset value. However, there is no guarantee that this stable net asset value will be achieved in the future. Market conditions could lead to severe liquidity or security pricing issues, which could impact their net asset values. If the net asset value of a money market fund managed by our asset managers were to fall below its stable net asset value, we would likely experience significant redemptions in AUM and reputational harm, which could have a material adverse effect on our revenues or net income.

If a money market fund's stable net asset value comes under pressure, we may elect, as we have done in the past, to provide credit, liquidity, or other support to the fund. We may also elect to provide similar or other support, including by providing liquidity to a fund, to other products we manage for any number of reasons. We are not legally required to support any money market fund or other product and there can be no assurance that any support would be sufficient to avoid an adverse impact on any product or investors in any product. A decision to provide support may arise from factors specific to our products or from industry-wide factors. If we elect to provide support, we could incur losses from the support we provide and incur additional costs, including financing costs, in connection with the support. These losses and additional costs could be material, and could adversely affect our earnings. If we were to take such actions we may also restrict our corporate assets, limiting our flexibility to use these assets for other purposes, and may be required to raise additional capital. In addition, certain proposed regulatory reforms could adversely impact the operating results of our money market funds. See “Item 1. Business - Regulation - Regulatory Reform - Money Market Fund Reform.”


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Failure to Comply With Contractual Requirements or Guidelines Could Result in Liability and Loss of Assets Under Management, Both of Which Could Cause our Net Income to Decline

The asset management contracts under which we manage client assets, including contracts with investment funds, often specify guidelines or contractual requirements that we are obligated to observe in providing asset management services. A failure to comply with these guidelines or requirements could result in damage to our reputation, liability to the client or the client reducing its assets under our management, any of which could cause our revenues and net income to decline. This risk is increased by the trend toward customized, specialized mandates seen by many of our asset managers, which tends to result in more complex mandates that are more difficult to administer.

The Soundness of Other Financial Institutions Could Adversely Affect our Business

Volatility in the markets has highlighted the interconnection of the global markets and demonstrated how the deteriorating financial condition of one institution may materially and adversely impact the performance of other institutions. Legg Mason, and the funds and accounts that we manage, has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial industry. We, and the funds and accounts we manage, may be exposed to credit, operational or other risk in the event of a default by a counterparty or client, or in the event of other unrelated systemic failures in the markets.

Performance-Based Fee Arrangements May Increase the Volatility of our Revenues

A portion of our total revenues is derived from performance fees. Our asset managers earn performance fees under certain client agreements if the investment performance in the portfolio meets or exceeds a specified benchmark. If the investment performance does not meet or exceed the investment return benchmark for a particular period, the asset manager will not generate a performance fee for that period and, if the benchmark is based on cumulative returns, the asset manager's ability to earn performance fees in future periods may be impaired. As of March 31, 2016, approximately 7% of our AUM was in accounts or products that are eligible to earn performance fees. We earned $42.0 million, $83.5 million and $107.1 million in performance fees during fiscal years 2016, 2015 and 2014, respectively. An increase or decrease in performance fees, or in performance-based fee arrangements with our clients, could create greater fluctuations in our revenues.

We Rely Significantly on Third Parties to Distribute Mutual Funds and Certain Other Products

Our ability to market and distribute mutual funds and certain other investment products that we manage is significantly dependent on access to third-party financial intermediaries that distribute these products. These distributors are generally not contractually required to distribute our products, and typically offer their clients various investment products and services, including proprietary products and services, in addition to and in competition with our products and services. Relying on third-party distributors also exposes us to the risk of increasing costs of distribution, as we compensate them for selling our products and services in amounts that are agreed between them and us but which, in many cases, are largely determined by the distributor. There has been a recent trend of increasing fees paid to certain distributors in the asset management business, and our distribution costs have increased as a result. While we have worked to diversify our distribution network, historically, many of the Legg Mason Funds were principally sold through the retail brokerage business of Citigroup. The retail business created by the combination of Morgan Stanley's brokerage unit and Citigroup's Smith Barney unit into Morgan Stanley Wealth Management remains a significant intermediary selling the Legg Mason Funds. While the third-party distributors are compensated for distributing our products and services, there can be no assurances that we will be successful in distributing our products and services through them. In addition, mergers and other corporate transactions among distributors may affect our distribution relationships. For example, we are not able to predict the long-term effect of the Morgan Stanley Wealth Management business on our ability to continue to successfully distribute our funds and other products through it, or the costs of doing so. If we are unable to distribute our products and services successfully, it will adversely affect our revenues and net income, and any increase in distribution-related expenses could adversely affect our net income.


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Our Funds-of-Hedge Funds Business Entails a Number of Additional Risks

Permal operates a portion of its business in the international funds-of-hedge funds business. The funds-of-hedge funds business typically involves clients being charged fees on two levels - at the funds-of-funds level and at the underlying funds level. These fees may include management fees and performance fees. There can be no assurance that Permal will not be forced to change its fee structures by competitive or other pressures or that Permal's fee structures will not hamper its growth. Furthermore, Permal, consistent with other funds-of-hedge funds managers, has experienced a trend in recent years of outflows in business from retail high net worth clients and inflows from institutional clients, which has negatively impacted Permal’s revenues and profits. On May 2, 2016, we completed a transaction which combines Permal with EnTrust, a leading independent hedge fund investor and alternative asset manager headquartered in New York. There can be no assurance that the combined EnTrustPermal will be able to continue to transition the historical Permal business into the institutional business, or that this transition will not further affect the revenues or profits of EnTrustPermal. In addition, EnTrustPermal may generate significant performance fees from time to time, which could increase the volatility of our revenues. See “Performance-Based Fee Arrangements May Increase the Volatility of our Revenues.” Because Permal operates in the funds-of-hedge funds business globally, it is exposed to a number of regulatory authorities and requirements in different jurisdictions.

Risks Related to our Company

Our Leverage May Affect our Business and May Restrict our Operating Results

At March 31, 2016, on a consolidated basis, we had approximately $1.8 billion in total indebtedness, and total stockholders' equity of $4.2 billion, and our goodwill and other intangible assets were $1.5 billion and $3.1 billion, respectively. After drawing $460 million on our revolving credit facility in May 2016, in connection with the acquisitions of EnTrust and Clarion Partners, we had $500 million of additional borrowing capacity available under our revolving credit facility, subject to certain conditions and compliance with the covenants in our credit agreement. As a result of this substantial indebtedness, we are currently required to use a portion of our cash flow to service interest on our debt, which will limit the cash flow available for other business opportunities. In addition, these servicing obligations will increase in the future as the principal payments on this debt become due or if we incur additional indebtedness.

Our ability to make scheduled payments of principal, to pay interest, or to refinance our indebtedness and to satisfy our other debt obligations will depend upon our future operating performance, which may be affected by general economic, financial, competitive, legislative, regulatory, business and other factors beyond our control and by a variety of factors specific to our business.

The level of our indebtedness could:

limit our ability to obtain additional debt financing in the future or to borrow under our existing credit facilities (our principal bank debt facility requires that (i) our ratio of net debt (total debt less unrestricted cash in excess of working capital) to Consolidated EBITDA (as defined therein) not exceed (a) 3.5 to 1 at any time for the period from March 31, 2016 through and including September 30, 2016, (b) 3.25 to 1 at any time for the period from October 1, 2016, through and including December 31, 2016 and (c) 3 to 1 at any other time., and (ii) our ratio of Consolidated EBITDA to total cash interest payments on certain Indebtedness (as defined therein) exceeds 4.0 to 1);
limit cash flow available for general corporate purposes due to the ongoing cash flow requirements for debt service;
limit our flexibility, including our ability to react to competitive and other changes in the industry and economic conditions; and
place us at a competitive disadvantage compared to our competitors that have less debt.

As of March 31, 2016, under the terms of our bank credit agreement our ratio of net debt to Consolidated EBITDA was 1.3 to 1 (excluding cash held on that date to fund the acquisitions of Clarion Partners and EnTrust) and our ratio of Consolidated EBITDA to interest expense was 13.0 to 1, and, therefore, Legg Mason was in compliance with its bank financial covenants. If our net income significantly declines for any reason, it may be difficult to remain in compliance with these covenants. Similarly, to the extent that we spend our available cash for purposes other than repaying debt or acquiring businesses that increase our EBITDA, we will increase our net debt to Consolidated EBITDA ratio. Although there are

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actions that we may take if our financial covenant compliance becomes an issue, there can be no assurance that Legg Mason will remain in compliance with its bank debt covenants.

Our access to credit on reasonable terms is also partially dependent on our credit ratings. If our credit ratings are downgraded, it will likely become more difficult and costly for us to access the credit markets or otherwise incur new debt.

Upon the occurrence of various events, such as a change of control, some or all of our outstanding debt obligations may come due prior to their maturity dates and may require payments in excess of their outstanding amounts, which in certain circumstances may be significant.

We May Engage in Strategic Transactions That Could Create Risks

As part of our business strategy, we regularly review, are currently reviewing, and from time to time have discussions with respect to potential strategic transactions, including potential acquisitions, dispositions, consolidations, joint ventures or similar transactions and “lift-outs” of portfolio management teams, some of which may be material. There can be no assurance that we will find suitable candidates for strategic transactions at acceptable prices, have sufficient capital resources to accomplish our strategy, or be successful in entering into agreements for desired transactions. In addition, these transactions typically involve a number of risks and present financial, managerial and operational challenges, including:

adverse effects on our reported earnings per share in the event acquired intangible assets or goodwill become impaired;
existence of unknown liabilities or contingencies that arise after closing; and
potential disputes with counterparties.

Acquisitions, related transactions and completed acquisitions, including the acquisitions of RARE Infrastructure, Clarion Partners and EnTrust and the combination of EnTrust with Permal to form EnTrustPermal, pose the risk that any business we acquire may lose customers or employees or could underperform relative to expectations. We could also experience financial or other setbacks if transactions encounter unanticipated problems, including problems related to execution or integration. Following the completion of an acquisition, we may have to rely on the seller to provide administrative and other support, including financial reporting and internal controls, to the acquired business for a period of time. There can be no assurance that the seller will do so in a manner that is acceptable to us.

Strategic transactions typically are announced publicly even though they may remain subject to numerous closing conditions, contingencies and approvals and there is no assurance that any announced transaction will actually be consummated. The failure to consummate an announced transaction could have an adverse effect on us. Future transactions may also further increase our leverage or, if we issue equity securities to pay for acquisitions, dilute the holdings of our existing stockholders.

If our Reputation is Harmed, we Could Suffer Losses in our Business, Revenues and Net Income

Our business depends on earning and maintaining the trust and confidence of clients and other market participants, and the resulting good reputation is critical to our business. Our reputation is vulnerable to many threats that can be difficult or impossible to control, and costly or impossible to remediate. Regulatory inquiries, employee misconduct and rumors, among other things, can substantially damage our reputation, even if they are baseless or satisfactorily addressed. Regulatory sanctions or adverse litigation results can also cause substantial damage to our reputation. Any damage to our reputation could impede our ability to attract and retain clients and key personnel, and lead to a reduction in the amount of our AUM, any of which could have a material adverse effect on our revenues and net income.

Failure to Properly Address Conflicts of Interest Could Harm our Reputation, Business and Results of Operations
    
As we have expanded the scope of our businesses and our client base, we must continue to address conflicts between our interests and those of our clients. In addition, the SEC and other regulators have increased their scrutiny of potential conflicts of interest. We have procedures and controls that are reasonably designed to address these issues. However, appropriately dealing with conflicts of interest is complex and difficult and if we fail, or appear to fail, to deal appropriately with conflicts of interest, we could face reputational damage, litigation or regulatory proceedings or penalties, any of which may adversely affect our revenues or net income.

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Loss of Key Personnel Could Harm our Business

We are dependent on the continued services of a number of our key asset management personnel and our management team, including our Chief Executive Officer. The loss of any of such personnel without adequate replacement could have a material adverse effect on us. Moreover, since certain of our asset managers operate with lean management teams and contribute significantly to our revenues and net income, the loss of even a small number of key personnel at these businesses could have a disproportionate impact on our overall business. Additionally, we need qualified managers and skilled employees with asset management experience in order to operate our business successfully. The market for experienced asset management professionals is extremely competitive and is increasingly characterized by the movement of employees among different firms. Due to the competitive market for asset management professionals and the success of some of our employees, our costs to attract and retain key employees are significant and will likely increase over time. From time to time, we may work with key employees to revise revenue sharing arrangements and other employment-related terms to reflect current circumstances, including in situations where a revenue sharing arrangement may result in insufficient revenues being retained by the subsidiary. In addition, since the investment track record of many of our products and services is often attributed to a small number of individual employees, and sometimes one person, the departure of one or more of these employees could cause the business to lose client accounts or managed assets, which could have a material adverse effect on our results of operations and financial condition. If we are unable to attract and retain qualified individuals or our costs to do so increase significantly, our operations and financial results would be materially adversely affected.

Our Business is Subject to Numerous Operational Risks

We face numerous operational risks related to our business on a day-to-day basis. Among other things, we must be able to consistently and reliably obtain securities pricing information, process trading activity, process client and investor transactions and provide reports and other customer service to our clients, investors and distributors. Failure to keep current and accurate books and records can render us subject to disciplinary action by governmental and self-regulatory authorities, as well as to claims by our clients. A portion of our software is licensed from and supported by outside vendors upon whom we rely to prevent operating system failure. A suspension or termination of these licenses or the related support, upgrades and maintenance could cause system delays or interruption. If any of our financial, portfolio accounting or other data processing systems, or the systems of third parties on whom we rely, do not operate properly or are disabled or if there are other shortcomings or failures in our internal processes, people or systems, or those of third parties on whom we rely, we could suffer an impairment to our liquidity, a financial loss, a disruption of our businesses, liability to clients, regulatory problems or damage to our reputation. These systems may fail to operate properly or become disabled as a result of events that are wholly or partially beyond our control, including a disruption of electrical or communications services or our inability to occupy one or more offices. In addition, our operations are dependent upon information from, and communications with, third parties, and operational problems at third parties may adversely affect our ability to carry on our business.

We depend on our headquarters, the offices of our subsidiaries, our operations centers and third-party providers for the continued operation of our business. The failure to maintain an infrastructure commensurate with the size and scope of our business, a disaster or a disruption in the infrastructure that supports our asset managers, or an event disrupting the ability of our employees to perform their job functions, including terrorist attacks or a disruption involving electrical communications, transportation or other services used by us or third parties with whom we conduct business, directly affecting our headquarters, the offices of our subsidiaries, our operations centers or the travel of our sales, client service and other personnel, may have a material adverse impact on our ability to continue to operate our business without interruption or impede the growth of our business. Although we have disaster recovery and business continuity programs in place, there can be no assurance that these will be sufficient to mitigate the harm that may result from such a disaster or disruption. If we fail to keep business continuity plans up-to-date or if such plans, including secure back-up facilities and systems, are improperly implemented or deployed during a disruption, our ability to operate could be adversely impacted or our ability to comply with regulatory obligations leading to reputational harm, regulatory fines and sanctions. In addition, insurance and other safeguards might only partially reimburse us for our losses.


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Failure to implement effective information and cyber security policies, procedures and capabilities could disrupt operations and cause financial losses

Our operations rely on the effectiveness of our information and cyber security policies, procedures and capabilities to provide secure processing, storage and transmission of confidential and other information in our computer systems, networks and mobile devices and on the computer systems, networks and mobile devices of third parties on which we rely. Although we take protective measures and endeavor to modify them as circumstances warrant, our computer systems, software, networks and mobile devices, and those of third parties on whom we rely, may be vulnerable to cyber-attacks, sabotage, unauthorized access, computer viruses, worms or other malicious code, and other events that have a security impact. An externally caused information security incident, such as a hacker attack, virus or worm, or an internally caused issue, such as failure to control access to sensitive systems, could materially interrupt business operations or cause disclosure or modification of sensitive or confidential client or competitive information and could result in material financial loss, loss of competitive position, regulatory actions, breach of client contracts, reputational harm or legal liability. If one or more of such events occur, it potentially could jeopardize our or our clients', employees' or counterparties' confidential and other information processed and stored in, and transmitted through, our or third party computer systems, networks and mobile devices, or otherwise cause interruptions or malfunctions in our, our clients', our counterparties' or third parties' operations. As a result, we could experience material financial loss, loss of competitive position, regulatory actions, breach of client contracts, reputational harm or legal liability, which, in turn, could cause a decline in our earnings. We may be required to spend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against fully or not fully covered through any insurance that we maintain.

We May Incur Charges Related to Leased Facilities

We continue to be exposed to the risk of incurring charges related to subleases or vacant space for several of our leased offices. As of March 31, 2016, our future commitments from third parties under non-cancellable subleases were approximately $141 million, which in total, net of reserves, effectively offsets obligations under our leases for the properties. As of March 31, 2016, our total future lease commitments for office space that we vacated and are seeking to sublease were approximately $32 million, of which we reserved approximately $15 million through lease charges to our earnings during the fiscal year ended March 31, 2016. Under generally accepted accounting principles, at the time a sublease is entered into or space is deemed permanently abandoned, we must incur a charge equal to the present value of the amount by which the commitments under the lease exceeds the amount due, or amount expected to be received, under a sublease. As a result, in a period of declining commercial lease markets, we are exposed to the risk of incurring charges relating to any premises we are seeking to sublease resulting from longer periods to identify sub-tenants and reduced market rent rates leading to new sub-tenants paying less in rent than we are paying under our lease. Also, if a sub-tenant defaults on its sublease, we would likely incur a charge for the rent that we will incur during the period that we expect would be required to sublease the premises and any reduction in rent that current market rent rates lead us to expect a new sub-tenant will pay. This risk is underscored by the fact that one sub-tenant represents approximately half of the future sublease rent commitments described above. There can be no assurance that we will not recognize additional lease-related charges, which may be material to our results of operations.

Potential Impairment of Goodwill and Intangible Assets Could Increase our Expenses and Reduce our Assets

Determining goodwill and intangible assets, and evaluating them for impairment, requires significant management estimates and judgment, including estimating value and assessing life in connection with the allocation of purchase price in the acquisition creating them. Our goodwill and intangible assets may become impaired as a result of any number of factors, including losses of investment management contracts or declines in the value of managed assets. Any impairment of goodwill or intangibles could have a material adverse effect on our results of operations. For example, during the quarter ended December 31, 2015, we incurred aggregate impairment charges of $371 million ($297 million, net of taxes) relating to the Permal/Fauchier funds-of-hedge funds contracts and Permal trade name. Changes in the assumptions underlying projected cash flows from the assets or reporting unit, resulting from market conditions, reduced AUM or other factors, could result in an impairment of any of these assets.

The domestic mutual fund contracts asset acquired in the 2005 acquisition of the CAM business of $2.1 billion and the Permal funds-of-hedge funds contracts assets of $334 million account for approximately 70% and 10%, respectively, of our indefinite-life intangible assets, while the goodwill in our reporting unit aggregates $1.5 billion. As of March 31, 2016,

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we also have $618 million of other indefinite-life intangible assets, which includes indefinite-life mutual funds contract assets of $130 million and $120 million recorded at fair value in connection with the acquisitions of RARE Infrastructure Limited in October 2015 and Martin Currie (Holdings) Limited in October 2014, respectively.

The carrying value of the Permal funds-of-hedge funds contracts asset has recently been written down to fair value as a result of the aforementioned impairment during the quarter ended December 31, 2015, while the carrying value of the domestic mutual fund contracts asset was written down to fair value as a result of an impairment during the fiscal year ended March 31, 2013. As a result, decreases in our cash flow projections or increases in the discount rates, resulting from actual results, or changes in assumptions due to market conditions, reduced AUM, less favorable operating margins, lower yielding asset mixes, and other factors, may result in further impairment of these assets. There can be no assurances that continued market uncertainty or asset outflows, or other factors, will not produce an additional impairment in either asset, particularly for the Permal funds-of-hedge funds contracts asset.

Cash flows through December 31, 2015, from our domestic mutual fund contracts compared favorably to the growth assumptions related to the domestic mutual fund contracts assets impairment testing at December 31, 2014, but the related carrying value remains sensitive to changes in the actual results or assumptions noted above. Therefore, market decreases, outflows or other changes in actual results or the assumptions noted above may result in an impairment of the domestic mutual fund contracts assets. As of December 31, 2015, the date of our most recent annual testing, the estimated fair value of the domestic mutual fund contracts asset exceeded the related carrying value by approximately $1.0 billion. Assuming all other factors remain the same, our actual results and/or changes in assumptions for the domestic mutual fund contracts cash flow projections over the long term would have to deviate by more than 30%, or the discount rate would have to increase from 13.0% to more than 16.5% for the asset to be deemed impaired. The estimated fair value of our reporting unit exceeds its aggregate carrying value by a material amount at December 31, 2015. However, changes in the assumptions underlying projected cash flows from the reporting unit or its EBITDA multiple, resulting from market conditions, reduced AUM or other factors, could still result in an impairment of goodwill.

There can be no assurances that continued market uncertainty or asset outflows, or other factors, will not produce an additional impairment. See “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates - Intangible Assets and Goodwill.”

Our Deferred Tax Assets May Not Be Fully Realizable

As of March 31, 2016, we had approximately $712 million in U.S. federal deferred tax assets, which represent tax benefits that we expect to realize in future periods. Under accounting rules, we are required to recognize a charge to earnings to reduce our deferred tax assets if it is determined that any future tax benefits are not likely to be realized before they expire. Deferred tax assets generated in U.S. jurisdictions resulting from net operating losses generally expire 20 years after they are generated. Those resulting from foreign tax credits generally expire 10 years after they are generated. In order to realize these future tax benefits, we estimate that we must generate approximately $3.2 billion in future U.S. earnings, of which $740 million must be foreign sourced earnings, before the benefits expire. There can be no assurances that we will achieve this level of earnings before some portion of these tax benefits expires. In addition, our belief that we will likely be able to realize these future tax benefits is based in part upon our estimates of the timing of other differences in revenue and expense recognition between tax returns and financial statements and our understanding of the application of tax regulations, which may prove to be incorrect for any number of reasons, including future changes in tax or accounting regulations. Further, our estimates and assumptions do not contemplate certain possible future changes in the ownership of Legg Mason stock, which, under the U.S. Internal Revenue Code (the “Code”), could limit our utilization of net operating loss and foreign tax credit benefits. Under the relevant Code provisions, an “ownership change” occurs if there is a cumulative net increase in the aggregate ownership of Legg Mason stock by “5% shareholders” (as defined in the Code) of more than 50 percent of the total outstanding shares of Legg Mason stock during a rolling three-year period. An ownership change would prospectively establish an annual limitation on the amount of pre-change net operating loss and foreign tax credit carryforwards we could utilize to reduce our tax liability. The amount of the limitation would generally equal the amount of our market capitalization immediately prior to the ownership change multiplied by the long-term tax-exempt interest rate in effect at that time. Such an ownership change would impact the timing or amount of net operating loss or foreign tax credit benefits we ultimately realize before they expire. If we are required to recognize a charge to earnings to reduce our deferred tax assets, the charge may be material to our earnings or financial condition.


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We Are Exposed to a Number of Risks Arising From our International Operations

Our asset managers operate in a number of jurisdictions outside of the United States on behalf of international clients. We have offices in numerous countries and many cross border and local proprietary funds that are domiciled outside the United States. Our international operations require us to comply with the legal requirements of various foreign jurisdictions, expose us to the political consequences of operating in foreign jurisdictions and subject us to expropriation risks, expatriation controls and potential adverse tax consequences which, among other things, make it more difficult to repatriate to the United States the cash that we generate outside the U.S. At March 31, 2016, our total liquid assets, which include cash, cash equivalents and certain current investment securities, were $1.7 billion, approximately $700 million of which was used to fund the acquisitions of Clarion Partners in April 2016 and EnTrust in May 2016. The remaining $1.0 billion of liquid assets included approximately $378 million of cash and investments held by our foreign subsidiaries, some of which, if repatriated, may be subject to material tax effects. Furthermore, despite controls and other actions reasonably designed to mitigate these risks, our international operations expose us to risks arising from Legg Mason's potential responsibility for actions of third party agents and other representatives of our business operating outside our primary jurisdictions of operation. Our foreign business operations are also subject to the following risks:

difficulty in managing, operating and marketing our international operations;
fluctuations in currency exchange rates which may result in substantial negative effects on AUM and revenues in our U.S. dollar-based financial statements; and
significant adverse changes in foreign political, economic, legal and regulatory environments.

Legal and Regulatory Risks

Regulatory Matters May Negatively Affect our Business and Results of Operations

Our business is subject to regulation by various regulatory authorities around the world that are charged with protecting the interests of our clients. We could be subject to civil liability, criminal liability, or sanction, including revocation of our subsidiaries' registrations as investment advisers, revocation of the licenses of our employees, censures, fines, or temporary suspension or permanent bar from conducting business, if we violate such laws or regulations. Any such liability or sanction could have a material adverse effect on our financial condition, results of operations, reputation, and business prospects. In addition, the regulatory environment in which we operate frequently changes and has seen significant increased regulation in recent years. Our profitability could be materially and adversely affected by modification of the rules and regulations that impact the business and financial communities in general, including changes to the laws governing taxation, antitrust regulation and electronic commerce. In particular, we have incurred, and will continue to incur, significant additional costs as a result of regulatory changes affecting U.S. mutual funds and changes to European mutual fund regulation.

We may be adversely affected as a result of new or revised legislation or regulations or by changes in the interpretation or enforcement of existing laws and regulations. The challenges associated with consistently interpreting regulations issued in multiple countries may add to such risks. For example, we note that the U.S. federal government has made, and has proposed further, significant changes to the regulatory structure of the financial services industry, and we expect to spend time and resources to comply with these regulatory changes. For a summary of the laws, regulations and regulators to which we are subject, see “Item 1 - Business - Regulation.”

Instances of criminal activity and fraud by participants in the asset management industry, disclosures of trading and other abuses by participants in the financial services industry and significant governmental intervention and investment in the financial markets and financial firms have led the U.S. government and regulators to increase the rules and regulations governing, and oversight of, the U.S. financial system. This activity has resulted in changes to the laws and regulations governing the asset management industry and more aggressive enforcement of the existing laws and regulations. For example, the Dodd-Frank Act provides for a comprehensive overhaul of the financial services regulatory environment and requires the adoption of extensive regulations and many regulatory decisions to be implemented. Certain provisions of the Dodd-Frank Act will, and other provisions may, require us to change or impose new limitations on the manner in which we conduct business, will or may increase regulatory compliance burdens, and may have unintended adverse consequences on the liquidity or structure of the financial markets. The ongoing revisions to the laws and regulations governing our business, and their counterparts internationally, are an ongoing process. The cumulative effect of these actions may result in increased expenses, or lower management or other fees, and therefore adversely affect the revenues or profitability of our business.


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Our Business Involves Risks of Being Engaged in Litigation and Liability That Could Increase our Expenses and Reduce our Net Income

Many aspects of our business involve substantial risks of liability. In the normal course of business, our asset managers are from time to time named as defendants or co-defendants in lawsuits, or are involved in disputes that involve the threat of lawsuits, seeking substantial damages. We are also involved from time to time in governmental and self-regulatory organization investigations and proceedings, including the regulatory proceedings discussed in Note 8 of Notes to Consolidated Financial Statements. In addition, we are involved in a tax dispute in Brazil arising from matters relating to the tax deductibility of goodwill amortization with respect to the Brazilian business of our subsidiary, Western Asset Management. While the assessments have been withdrawn for a portion of the years that were subject to the dispute, the amount at issue in the years still subject to the assessment is over $14 million. It may take another five years or more to achieve final resolution of this matter as it potentially could go through multiple levels of appeal. During that time the current $14 million amount in dispute could increase to approximately $35 million due to additional interest and penalty accruals and denial of future year deductions. While there can be no assurance of the timing or outcome of this dispute, or that we will receive additional favorable judgments in connection with this matter, we and our local advisors believe that our tax position is correct and it is more likely than not that we will not be required to pay the taxes in question or any related interest and penalties.

In addition, the investment funds that our asset managers manage are subject to actual and threatened lawsuits and governmental and self-regulatory organization investigations and proceedings, any of which could harm the investment returns or reputation of the applicable fund or result in our asset managers being liable to the funds for any resulting damages. There has been an increased incidence of litigation and regulatory investigations in the asset management industry in recent years, including customer claims as well as class action suits seeking substantial damages. Any litigation can increase our expenses and reduce our net income.

Insurance May Not Be Available on a Cost Effective Basis to Protect us From Liability

We face the inherent risk of liability related to litigation from clients, third-party vendors or others and actions taken by regulatory agencies. To help protect against these potential liabilities, we purchase insurance in amounts, and against risks, that we consider appropriate, where such insurance is available at prices we deem acceptable. There can be no assurance, however, that a claim or claims will be covered by insurance or, if covered, will not exceed the limits of available insurance coverage, that any insurer will remain solvent and will meet its obligations to provide us with coverage or that insurance coverage will continue to be available with sufficient limits at a reasonable cost. Insurance costs are impacted by market conditions and the risk profile of the insured, and may increase significantly over relatively short periods. In addition, certain insurance coverage may not be available or may only be available at prohibitive costs. Renewals of insurance policies may expose us to additional costs through higher premiums or the assumption of higher deductibles or co-insurance liability.



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ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
ITEM 2. PROPERTIES.
We lease all of our office space. Our headquarters and certain other functions are located in an office building in Baltimore, Maryland, in which we currently hold under lease approximately 372,000 square feet, of which approximately 159,000 square feet has been subleased to third parties. We are currently seeking to secure additional tenants to sublease an additional 27,000 square feet.

Our asset managers and other subsidiaries are housed in office buildings in 35 cities in 18 countries around the world. The largest of the leases include:

ClearBridge Investments, Western Asset Management and our distribution and administrative services subsidiaries currently occupy approximately 130,000 square feet in an office building located in New York, New York in which we hold under lease approximately 193,000 square feet. The remaining 63,000 square feet has been subleased to a third party;
Western Asset Management’s headquarters is housed in an office building in Pasadena, California in which we occupy approximately 190,000 square feet; and
our distribution and administrative services subsidiaries occupy approximately 79,000 square feet in an office building located in Stamford, Connecticut in which we hold under lease approximately 138,000 square feet. 47,000 square feet has been subleased to a third party. We are seeking to secure additional tenants to sublease the remaining 12,000 square feet.

See Note 8 of Notes to Consolidated Financial Statements in Item 8 of this Report for a discussion of our lease obligations.


ITEM 3. LEGAL PROCEEDINGS.

Our current and former subsidiaries have been the subject of customer complaints and have also been named as defendants in various legal actions arising primarily from asset management, securities brokerage and investment banking activities, including certain class actions, which primarily allege violations of securities laws and seek unspecified damages, which could be substantial. For example, we are aware of litigation against certain underwriters of offerings in which one or more of our former subsidiaries was a participant, but where the former subsidiary is not now a defendant. In these latter cases, it is possible that we may be called upon to contribute to settlements or judgments. In the normal course of our business, our current and former subsidiaries have also received subpoenas and are currently involved in governmental and self-regulatory agency inquiries, investigations and, from time to time, proceedings. While the ultimate resolution of any threatened or pending litigation, regulatory investigations and other matters cannot be currently determined, in the opinion of our management, after consultation with legal counsel, due in part to the preliminary nature of certain of these matters, we are currently unable to estimate the amount or range of potential losses from these matters, and our financial condition, results of operations and cash flows could be materially affected during a period in which a matter is ultimately resolved. See Note 8 of Notes to Consolidated Financial Statements in Item 8 of this Report.

ITEM 4. MINE SAFETY DISCLOSURES.

Not Applicable.



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ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.
Information (not included in our definitive proxy statement for the 2015 Annual Meeting of Stockholders) regarding certain of our executive officers is as follows:

Thomas K. Hoops, age 51, was appointed Executive Vice President and Head of Business and Product Development in January 2014. From March 2000 through January 2014, Mr. Hoops held a variety of positions at Wells Fargo Corporation and its predecessors, most recently as Head of Affiliated Managers at Wells Fargo Asset Management. Prior to joining Wells Fargo / Wachovia, he was a Managing Director at a boutique investment bank which specialized in M&A advisory services for emerging growth and middle-market companies and their owners. He began his career as a credit analyst at First Union National Bank in Charlotte.

Terence Johnson, age 43, was appointed Head of Global Distribution in March 2013 and elected Executive Vice President in April 2013.  Since October 2012, he had been serving as interim Head of Global Distribution, overseeing U.S. Distribution, International Distribution, Global Product Development, Marketing, and Administration and Operations of the division.  Prior to that, Mr. Johnson headed International Distribution at Legg Mason.  Mr. Johnson joined Legg Mason in December 2005 from Citigroup Asset Management following its acquisition by Legg Mason.

Thomas C. Merchant, age 48, was appointed General Counsel in March 2013 and elected Executive Vice President in April 2013.  Mr. Merchant continues to serve as Corporate Secretary, a position he has held since 2008.  Mr. Merchant oversees Legg Mason's legal and compliance departments. Mr. Merchant previously served as Corporate General Counsel and Deputy General Counsel.  Mr. Merchant joined Legg Mason as Associate General Counsel in 1998.

Peter H. Nachtwey, age 60, was elected Chief Financial Officer and Senior Executive Vice President of Legg Mason in January 2011 when he joined the firm. From July 2007 through December 2010, Mr. Nachtwey served as Chief Financial Officer of The Carlyle Group, an alternative investment management firm, where he had responsibility for all of the financial and a number of the operational functions at the firm. Prior to The Carlyle Group, Mr. Nachtwey spent more than 25 years at Deloitte & Touche, LLP, an accounting firm, most recently as Managing Partner of the Investment Management practice.

Ursula Schliessler, age 57, was appointed Chief Administrative Officer in March 2015 and elected Executive Vice President in April 2015. Ms. Schliessler oversees Legg Mason's technology, human resources, risk management, internal audit and global fund accounting. Prior to her appointment as Chief Administrative Officer, Ms. Schliessler served as Head of Global Distribution Business Management for Legg Mason, managing day to day operations and aligning strategic initiatives to support the growth of Legg Mason's retail business. Ms. Schliessler has been in senior roles with Legg Mason or predecessor firms since 1988, with a brief interruption between 2007 and 2010.


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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Shares of Legg Mason, Inc. common stock are listed and traded on the New York Stock Exchange (symbol LM). As of March 31, 2016, there were approximately 1,300 holders of record of Legg Mason common stock. Information with respect to our dividends and stock prices is as follows:
 
 
Quarter ended
 
 
Mar. 31
 
Dec. 31
 
Sept. 30
 
June 30
Fiscal Year 2016
 
 
 
 
 
 
 
 
Cash dividend declared per share
 
$
0.20

 
$
0.20

 
$
0.20

 
$
0.20

Stock price range:
 
 
 
 
 
 
 
 
High
 
39.97

 
46.41

 
52.61

 
55.88

Low
 
24.93

 
37.84

 
40.60

 
50.39

Fiscal Year 2015
 
 
 
 
 
 
 
 
Cash dividend declared per share
 
$
0.16

 
$
0.16

 
$
0.16

 
$
0.16

Stock price range:
 
 
 
 
 
 
 
 
High
 
59.19

 
57.15

 
52.00

 
51.80

Low
 
52.16

 
45.78

 
45.68

 
43.25

We expect to continue paying cash dividends. However, the declaration of dividends is subject to the discretion of our Board of Directors. In determining whether to declare dividends, or how much to declare in dividends, our Board will consider factors it deems relevant, which may include our results of operations and financial condition, our financial requirements, general business conditions and the availability of funds from our subsidiaries, including all restrictions on the ability of our subsidiaries to provide funds to us. On April 26, 2016, our Board of Directors declared a regular, quarterly dividend of $0.22 per share, increasing the regular, quarterly dividend rate paid on shares of our common stock during the prior fiscal quarter.
Purchases of our Common Stock
The following table sets out information regarding our purchases of Legg Mason common stock during the quarter ended March 31, 2016:
Period
 
(a)
Total number
of shares
purchased (1)
 
(b)
Average price
paid per share (2)
 
(c)
Total number of
shares purchased
as part of
publicly announced
plans or programs(3)
 
(d)
Approximate dollar value that may
yet be purchased
under the plans
or programs(3)
January 1, 2016 Through January 31, 2016
 
669

 
$
39.08

 

 
$
830,611,864

February 1, 2016 Through February 29, 2016
 
2,501

 
30.16

 

 
830,611,864

March 1, 2016 Through March 31, 2016
 
776,042

 
34.33

 
776,042

 
803,973,237

Total
 
779,212

 
$
34.32

 
776,042

 


 
 
 
 
 
 
 
 
 
(1)
Includes shares of vesting restricted stock, and shares received on vesting of restricted stock units, surrendered to Legg Mason to satisfy related income tax withholding obligations of employees via net share transactions.
(2)
Amounts exclude fees.
(3)
On January 27, 2015, our Board of Directors approved a share repurchase authorization for up to $1 billion for additional repurchases of common stock. There is no expiration attached to this share repurchase authorization.

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ITEM 6. SELECTED FINANCIAL DATA.
(Dollars in thousands, except per share amounts or unless otherwise noted)
 
 
Years ended March 31,
 
 
2016
 
2015
 
2014
 
2013
 
2012
OPERATING RESULTS
 
 
 
 
 
 
 
 
 
 
Operating Revenues
 
$
2,660,844

 
$
2,819,106

 
$
2,741,757

 
$
2,612,650

 
$
2,662,574

Operating expenses, excluding impairment
 
2,239,013

 
2,320,887

 
2,310,864

 
2,313,149

 
2,323,821

Impairment of intangible assets and goodwill
 
371,000

 

 

 
734,000

 

Operating Income (Loss)
 
50,831

 
498,219

 
430,893

 
(434,499
)
 
338,753

Other non-operating expense, net, including $107,074 debt extinguishment loss in July 2014 and $68,975 in May 2012
 
(68,806
)
 
(136,114
)
 
(13,726
)
 
(73,287
)
 
(54,006
)
Other non-operating income (expense) of consolidated investment vehicles, net
 
(7,243
)
 
5,888

 
2,474

 
(2,821
)
 
18,336

Income (Loss) before Income Tax Provision (Benefit)
 
(25,218
)
 
367,993

 
419,641

 
(510,607
)
 
303,083

Income tax provision (benefit)
 
7,692

 
125,284

 
137,805

 
(150,859
)
 
72,052

Net Income (Loss)
 
(32,910
)
 
242,709

 
281,836

 
(359,748
)
 
231,031

Less: Net income (loss) attributable to noncontrolling interests
 
(7,878
)
 
5,629

 
(2,948
)
 
(6,421
)
 
10,214

Net Income (Loss) Attributable to Legg Mason, Inc.
 
$
(25,032
)
 
$
237,080

 
$
284,784

 
$
(353,327
)
 
$
220,817

 
 
 
 
 
 
 
 
 
 
 
PER SHARE
 
 
 
 
 
 
 
 
 
 
Net Income (Loss) per Share Attributable to Legg Mason, Inc. Shareholders:
 
 
 
 
 
 
 
 
 
 
Basic
 
$
(0.25
)
 
$
2.06

 
$
2.34

 
$
(2.65
)
 
$
1.54

Diluted
 
$
(0.25
)
 
$
2.04

 
$
2.33

 
$
(2.65
)
 
$
1.54

Weighted-Average Number of Shares Outstanding: (1)
 
 
 
 
 
 
 
 
 
 
Basic
 
107,406

 
112,019

 
121,941

 
133,226

 
143,292

Diluted
 
107,406

 
113,246

 
122,383

 
133,226

 
143,349

Dividends Declared
 
$
0.80

 
$
0.64

 
$
0.52

 
$
0.44

 
$
0.32

BALANCE SHEET
 
 
 
 
 
 
 
 
 
 
Total Assets(2)
 
$
7,520,446

 
$
7,064,834

 
$
7,103,203

 
$
7,264,582

 
$
8,547,381

Long-term debt(2)
 
1,740,985

 
1,048,946

 
1,031,118

 
1,139,876

 
1,128,526

Total Stockholders' Equity Attributable to Legg Mason, Inc.
 
4,213,563

 
4,484,901

 
4,724,724

 
4,818,351

 
5,677,291

FINANCIAL RATIOS AND OTHER DATA
 
 
 
 
 
 
 
 
 
 
Adjusted Income (3)
 
$
370,271

 
$
378,751

 
$
417,805

 
$
347,169

 
$
397,030

Adjusted Income per diluted share (3)
 
$
3.36

 
$
3.26

 
$
3.41

 
$
2.61

 
$
2.77

Operating Margin
 
1.9
%
 
17.7
%
 
15.7
%
 
(16.6
)%
 
12.7
%
Operating Margin, as Adjusted (4)
 
18.6
%
 
23.0
%
 
22.0
%
 
17.5
 %
 
22.3
%
Adjusted EBITDA(5)
 
$
621,722

 
$
686,499

 
$
617,092

 
$
555,725

 
$
585,275

Total debt to total capital (6)
 
29.9
%
 
19.1
%
 
18.0
%
 
19.2
 %
 
19.6
%
Assets under management (in millions)
 
$
669,615

 
$
702,724

 
$
701,774

 
$
664,609

 
$
643,318

Full-time employees
 
3,066

 
2,982

 
2,843

 
2,975

 
2,979

(1)
Excludes weighted-average unvested restricted shares deemed to be participating securities for the years ended March 31, 2016 and 2015. Basic and diluted shares are the same for periods with a Net Loss Attributable to Legg Mason, Inc. See Note 12 of Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplemental Data.
(2)
For the year ended March 31, 2016, Legg Mason elected to early adopt updated accounting guidance which requires unamortized debt issuance costs to be presented in the balance sheet as a direct deduction from the carrying value of the associated long-term debt liability. This guidance was adopted on a retrospective basis. Therefore, for years prior to fiscal 2016, unamortized debt issuance costs have been reclassified from Other assets to Long-term debt in the Consolidated Balance Sheets. See Note 1 of Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplemental Data.
(3)
Adjusted Income is a non-GAAP performance measure. 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 convertible debt less deferred income taxes on goodwill and indefinite-life intangible asset impairment, if any. We also adjust for certain non-core items, such as intangible asset impairments, the impact of fair value adjustments of contingent consideration liabilities, if any, 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. The calculation of Adjusted Income per diluted share includes weighted-average unvested restricted shares. See Supplemental Non-GAAP Information in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
(4)
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, amortization related to intangible assets, transition-related costs of streamlining our business model, if any, income (loss) of consolidated investment vehicles, the impact of fair value adjustments of contingent consideration liabilities, if any, 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 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
(5)
Adjusted EBITDA is a non-GAAP liquidity measure we define as cash provided by operations plus (minus) allocation of debt redemption payments, interest expense, net of accretion and amortization of debt discounts and premiums, current income tax expense, net gains on investment securities, the net change in other assets and liabilities and other. This definition results in a metric that is the same amount as EBITDA used in covenants in our revolving credit facility agreement. See Supplemental Non-GAAP Information in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
(6)
Calculated based on total gross debt as a percentage of total capital (total stockholders' equity attributable to Legg Mason, Inc. plus total gross debt) as of March 31.

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ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

EXECUTIVE OVERVIEW

Legg Mason, Inc., a holding company, with its subsidiaries (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 financial intermediaries. We have operations principally in the U.S. and the U.K. and also have offices in Australia, Bahamas, Brazil, Canada, Chile, China, Dubai, France, Germany, Italy, Japan, Poland, Singapore, Spain, Switzerland and Taiwan. All references to fiscal 2016, 2015 or 2014, refer to our fiscal year ended March 31 of that year. Terms such as "we," "us," "our," and "Company" refer to Legg Mason.

Our operating revenues primarily consist of investment advisory fees from separate accounts and funds, and distribution and service fees. Investment advisory fees are generally calculated as a percentage of the assets of the investment portfolios that we manage. In addition, performance fees may be earned under certain investment advisory contracts for exceeding performance benchmarks or hurdle rates. 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 products and services, for providing other support services to investment portfolios, or for providing non-discretionary advisory services, and are generally calculated as a percentage of the assets in an investment portfolio or as a percentage of new assets added to an investment portfolio. Our revenues, therefore, are dependent upon the level of our assets under management ("AUM") and assets under advisement ("AUA") and fee rates, and thus are affected by factors such as securities market conditions, our ability to attract and maintain AUM and key investment personnel, and investment performance. Our AUM varies in large part from period to period due to inflows and outflows of client assets as well as market performance and changes in foreign exchange rates. 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 investment objectives, liquidity needs, investment horizon and amount of assets managed, our relationships with distributors and the external economic environment, including market conditions.

The fees that we charge for our investment services vary based upon factors such as the type of underlying investment product, the amount of AUM, the asset management affiliate that provides the services, and the type of services (and investment objectives) that are provided. Fees charged for equity asset management services are generally higher than fees charged for fixed income or liquidity asset management services. Accordingly, our revenues and average operating revenue yields will be affected by the composition of our AUM, with changes in the relative level of equity assets and alternatives typically more significantly impacting our revenues and average operating revenue yields. Average operating revenue yields are calculated as the ratio of annualized investment advisory fees, distribution and service fees, and other revenues, less performance fees, to average AUM. In addition, in the ordinary course of our business, we may reduce or waive investment management fees, or limit total expenses, on certain products or services for particular time periods to manage fund expenses, or for other reasons, and to help retain or increase managed assets. We have revenue sharing arrangements in place for most of our asset management affiliates, under which specified percentages of the affiliates' revenues are required to be distributed to us and the balance of the revenues is retained by the affiliates to pay their operating expenses, including compensation expenses, but excluding certain expenses and income taxes. Under these arrangements, our asset management affiliates retain different percentages of revenues to cover their costs. As such, our Net Income (Loss) Attributable to Legg Mason, Inc., operating margin and compensation as a percentage of operating revenues are impacted based on which affiliates and products generate our AUM, and a change in AUM at one affiliate or with respect to one product or class of products can have a dramatically different effect on our revenues and earnings than an equal change at another affiliate or in another product or class of products. In addition, from time to time, we may agree to changes in revenue sharing and other arrangements 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-compensation related operating expense levels at revenue share-based affiliates, and our overall profitability. The next largest component of our cost structure is distribution and servicing expense, which consists primarily of fees paid to third-party distributors for selling

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our asset management products and services and are largely variable in nature. Certain other operating costs are typically consistent from period to period, such as occupancy, depreciation and amortization, and fixed contract commitments for market data, communication and technology services, and usually do not decline with reduced levels of business activity or, conversely, usually do not rise proportionately with increased business activity.

Our financial position and results of operations are materially affected by the overall trends and conditions of global financial markets. 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, as well as changes in foreign currency exchange rates, among other things. Periods of unfavorable market conditions are likely to have an adverse effect on our profitability. In addition, the diversification of services and products offered, investment performance, access to distribution channels, reputation in the market, attraction and retention of key employees and client relations are significant factors in determining whether we are successful in the attraction and retention of clients. In the last few years, the industry has seen flows into products for which we do not currently garner significant market share. For a further discussion of factors that may affect our results of operations, refer to Item 1A. Risk Factors included herein.

The financial services business in which we are engaged is extremely competitive. Our competition includes numerous global, national, regional and local asset management firms, commercial banks, insurance companies and other financial services companies. The industry has been impacted by continued economic uncertainty, the constant introduction of new products and services, and the consolidation of financial services firms through mergers and acquisitions. The industry in which we operate is also subject to extensive regulation under federal, state, and foreign laws. Like most firms, we have been and will continue to be impacted by regulatory and legislative changes. Responding to these changes and keeping abreast of regulatory developments, has required, and will continue to require, us to incur costs that impact our profitability.

Our strategic priorities are 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 initiatives on which management currently focuses in evaluating our performance and financial condition.

 
Strategic Priorities
 
 
Initiatives
Ÿ
Products
 
Ÿ
Create an innovative portfolio of investment products and promote revenue growth by developing new products and leveraging the capabilities of our affiliates
 
 
 
Ÿ
Identify and execute strategic acquisitions to increase product offerings, strengthen our affiliates, and fill gaps in products and services
 
 
 
 
 
Ÿ
Performance
 
Ÿ
Deliver compelling and consistent performance against both relevant benchmarks and the products and services of our competitors
 
 
 
 
 
Ÿ
Distribution
 
Ÿ
Evaluate and reallocate resources within and to our distribution platform to continue to maintain and enhance our leading distribution function with the capability to offer solutions to relevant investment challenges and grow market share worldwide
 
 
 
 
 
Ÿ
Productivity
 
Ÿ
Operate with a high level of effectiveness and improve ongoing efficiency
 
 
 
Ÿ
Manage expenses
 
 
 
Ÿ
Align economic relationships with affiliate management teams, including retained affiliate management equity and the implementation of affiliate management equity plan agreements
 
 
 
 
 

The strategic priorities discussed above are designed to drive improvements in our net flows, earnings, cash flows, AUM and other key metrics, including operating margin.  Certain of these key metrics are discussed in our annual results discussion to follow.


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In connection with these strategic priorities (principally products and productivity):

On May 2, 2016, we completed the transaction to combine The Permal Group, Limited ("Permal"), our existing hedge fund platform, with EnTrust Capital ("EnTrust"). EnTrust is a leading alternative asset management firm headquartered in New York with approximately $10 billion in AUM and $2 billion in AUA and committed capital. We own 65% of the combined entity, which is branded EnTrustPermal.

The combination of the businesses of EnTrust and Permal creates a new global alternatives firm with over $26 billion in AUM and total client assets (including AUA and committed capital) of approximately $30 billion. In connection with the restructuring of Permal for the combination with EnTrust, we expect to incur up to $100 million of total restructuring and transition-related costs, of which $43.3 million was incurred during the year ended March 31, 2016. Approximately $40 million to $50 million of the anticipated remaining costs associated with the restructuring are expected to be incurred in the year ending March 31, 2017. We expect to achieve approximately $35 million in annual savings from the cost structures of the two businesses. See Notes 2 and 18 of Notes to Consolidated Financial Statements for additional information.

On April 13, 2016, we acquired an 82% majority equity interest in Clarion Partners, a diversified real estate asset management firm based in New York. Clarion Partners managed approximately $41.5 billion in AUM as of April 30, 2016. See Note 18 of Notes to Consolidated Financial Statements for additional information.

In March 2016, we completed the implementation of a management equity plan with the management of Royce & Associates ("Royce"). We incurred a non-cash charge of $21.4 million upon the issuance of management equity plan units in fiscal 2016. See Note 11 of Notes to Consolidated Financial Statements for additional information regarding the Royce management equity plan.

In March 2016, we issued $450 million of Senior Notes due 2026, and $250 million of Junior Subordinated Notes due 2056, the net proceeds of which were used to finance the acquisitions of EnTrust and Clarion Partners. See Note 6 of Notes to Consolidated Financial Statements for additional information.

On January 22, 2016, we acquired a 20% minority equity position in Precidian Investments, LLC ("Precidian"), a firm specializing in creating innovative products and solutions and solving market structure issues, particularly with regard to the exchange-traded fund ("ETF") marketplace. See Note 2 of Notes to Consolidated Financial Statements for additional information.

In December 2015, we launched four new ETF products on the NASDAQ Stock Exchange. These outcome-oriented index-based ETF funds are managed by our wholly-owned asset management affiliate QS Investors Holdings, LLC ("QS Investors").

On October 21, 2015, we acquired a 75% majority interest in RARE Infrastructure Limited ("RARE Infrastructure"). RARE Infrastructure specializes in global listed infrastructure investing, is headquartered in Sydney, Australia, and had approximately $6.8 billion in AUM at closing. See Note 2 of Notes to Consolidated Financial Statements for additional information.
    
Net Loss Attributable to Legg Mason, Inc. for the year ended March 31, 2016, was $25.0 million, or $0.25 per diluted share, as compared to Net Income Attributable to Legg Mason, Inc. of $237.1 million, or $2.04 per diluted share for the year ended March 31, 2015.  In addition to the $43.3 million of expenses related to the restructuring of Permal for the combination with EnTrust and the $21.4 million charge related to the Royce management equity plan, as discussed above, the year ended March 31, 2016, included pre-tax impairment charges of $371.0 million, or $2.76 per diluted share, related to Permal indefinite-life intangible assets, inclusive of the related intangible asset from Fauchier Partners Management Limited ("Fauchier"). The year ended March 31, 2015, included a pre-tax, non-operating charge of $107.1 million, or $0.59 per diluted share, related to the refinancing of our previously outstanding 5.5% Senior Notes, as well as $35.8 million in expenses related to the integration of two of our existing affiliates, Batterymarch Financial Management, Inc. ("Batterymarch") and Legg Mason Global Asset Management, LLC ("LMGAA") into QS Investors. Average AUM and total revenues decreased in fiscal 2016, as compared to fiscal 2015, as further discussed below.


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Total AUM decreased during the year ended March 31, 2016, due to the negative impact of market performance and other and net client outflows in both long-term and liquidity AUM, which were offset in part by the acquisition of RARE Infrastructure in October 2015.

The following discussion and analysis provides additional information regarding our financial condition and results of operations.

BUSINESS ENVIRONMENT AND RESULTS OF OPERATIONS

During fiscal 2016, while the U.S. economic environment was characterized by continued growth and improving fundamentals, the business environment was strongly influenced by overall markets, which remained sensitive to increasing concerns over economic and political conditions in other countries, as well as the U.S. Federal Reserve Board's decision to increase the target federal funds rate in December 2015 for the first time since 2006.

Both U.S. and international equity markets experienced significant volatility during fiscal 2016. Despite recovering a significant portion of the losses experienced as a result of this volatility, all three major U.S. equity market indices decreased during fiscal 2016, after increasing for the past two fiscal years, while bond indices were mixed, as illustrated in the table below:
 
 
% Change for the year ended March 31:
Indices(1)
 
2016
 
2015
 
2014
Dow Jones Industrial Average(2)
 
(0.5
)%
 
8.0
 %
 
12.9
 %
S&P 500(2)
 
(0.4
)%
 
10.4
 %
 
19.3
 %
NASDAQ Composite Index(2)
 
(0.6
)%
 
16.7
 %
 
28.5
 %
Barclays Capital U.S. Aggregate Bond Index
 
2.0
 %
 
5.7
 %
 
(0.1
)%
Barclays Capital Global Aggregate Bond Index
 
4.6
 %
 
(3.7
)%
 
1.9
 %
(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.
(2)
Excludes the impact of the reinvestment of dividends and stock splits.

In December 2015, the Federal Reserve Board increased the target federal funds rate for the first time since 2006, from 0.25% to 0.50%. While the economic outlook for the U.S. has remained more positive in recent years, the financial environment in which we operate continues to reflect a heightened level of sensitivity as we move into fiscal 2017.

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The following table sets forth, for the periods indicated, amounts in the Consolidated Statements of Income (Loss) as a percentage 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,
 
2016
Compared
 
2015
Compared
 
 
2016
 
2015
 
2014
 
to 2015
 
to 2014
Operating Revenues
 
 
 
 
 
 
 
 
 
 
Investment advisory fees
 
 
 
 
 
 
 
 
 
 
Separate accounts
 
31.0
 %
 
29.2
%
 
28.4
%
 
0.2
%
 
6.0
 %
Funds
 
53.0

 
54.8

 
54.7

 
(8.8
)
 
2.9

Performance fees
 
1.6

 
3.0

 
3.9

 
(49.7
)
 
(22.0
)
Distribution and service fees
 
14.3

 
12.8

 
12.7

 
5.6

 
3.9

Other
 
0.1

 
0.2

 
0.3

 
(60.7
)
 
(32.1
)
Total Operating Revenues
 
100.0

 
100.0

 
100.0

 
(5.6
)
 
2.8

Operating Expenses
 
 
 
 
 
 
 
 
 
 
Compensation and benefits
 
45.3

 
43.7

 
44.1

 
(2.3
)
 
1.9

Distribution and servicing
 
20.5

 
21.1

 
22.6

 
(8.3
)
 
(3.9
)
Communications and technology
 
7.4

 
6.5

 
5.8

 
8.5

 
15.5

Occupancy
 
4.6

 
3.9

 
4.2

 
11.8

 
(4.8
)
Amortization of intangible assets
 
0.2

 
0.1

 
0.4

 
89.7

 
(78.9
)
Impairment of intangible assets
 
13.9

 

 

 
n/m

 
n/m

Other
 
6.1

 
7.0

 
7.2

 
(17.9
)
 
1.3

Total Operating Expenses
 
98.0

 
82.3

 
84.3

 
12.5

 
0.4

Operating Income (Loss)
 
2.0

 
17.7

 
15.7

 
(89.8
)
 
15.6

Other Non-Operating Income (Expense)
 
 
 
 
 
 
 
 
 
 
Interest income
 
0.2

 
0.3

 
0.2

 
(24.3
)
 
17.2

Interest expense
 
(1.8
)
 
(2.1
)
 
(1.9
)
 
(16.8
)
 
10.2

Other income (expense), net
 
(1.0
)
 
(3.0
)
 
1.2

 
(69.5
)
 
n/m

Other non-operating income (expense) of consolidated investment vehicles, net
 
(0.3
)
 
0.2

 
0.1

 
n/m

 
n/m

Total other non-operating expense
 
(2.9
)
 
(4.6
)
 
(0.4
)
 
(41.6
)
 
n/m

Income (Loss) before Income Tax Provision (Benefit)
 
(0.9
)
 
13.1

 
15.3

 
n/m

 
(12.3
)
Income tax provision (benefit)
 
0.3

 
4.5

 
5.0

 
n/m

 
(9.1
)
Net Income (Loss)
 
(1.2
)
 
8.6

 
10.3

 
n/m

 
(13.9
)
Less: Net income (loss) attributable to noncontrolling interests
 
(0.3
)
 
0.2

 
(0.1
)
 
n/m

 
  n/m
Net Income (Loss) Attributable to Legg Mason, Inc.
 
(0.9
)%
 
8.4
%
 
10.4
%
 
n/m

 
(16.8
)%
n/m-not meaningful
(1)
Calculated based on the change in actual amounts between fiscal years as a percentage of the prior year amount.



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ASSETS UNDER MANAGEMENT AND ASSETS UNDER ADVISEMENT

Assets Under Management
Our AUM is primarily managed across the following asset classes:
Equity
 
Fixed Income
 
Liquidity
 
 
 
 
 
 
 
 
Ÿ
Large Cap Growth
 
Ÿ
U.S. Intermediate Investment Grade
 
Ÿ
U.S. Managed Cash
Ÿ
Large Cap Value
 
Ÿ
U.S. Credit Aggregate
 
Ÿ
U.S. Municipal Cash
Ÿ
Small Cap Core
 
Ÿ
Global Opportunistic Fixed Income
 
 
 
Ÿ
Equity Income
 
Ÿ
Global Government
 
 
 
Ÿ
Large Cap Core
 
Ÿ
U.S. Municipal
 
 
 
Ÿ
International Equity
 
Ÿ
Global Fixed Income
 
 
 
Ÿ
Infrastructure Value
 
Ÿ
U.S. Long Duration
 
 
 
Ÿ
Small Cap Value
 
Ÿ
U.S. Limited Duration
 
 
 
Ÿ
Sector Equity
 
Ÿ
U.S. High Yield
 
 
 
Ÿ
Mid Cap Core
 
Ÿ
Emerging Markets
 
 
 
Ÿ
Emerging Markets Equity
 
 
 
 
 
 
Ÿ
Global Equity
 
 
 
 
 
 

The components of the changes in our AUM (in billions) for the years ended March 31, were as follows:
 
 
2016
 
2015
 
2014
Beginning of period
 
$
702.7

 
$
701.8

 
$
664.6

Net client cash flows
 
 
 
 
 
 
Investment funds, excluding liquidity funds(1)
 
 

 
 

 
 

Subscriptions
 
50.3

 
72.1

 
52.1

Redemptions
 
(62.3
)
 
(61.2
)
 
(58.1
)
Separate account flows, net
 
0.8

 
5.6

 
2.2

Total long-term flows
 
(11.2
)
 
16.5

 
(3.8
)
Liquidity fund flows, net
 
(15.1
)
 
(21.3
)
 
11.8

Separate account flows, net
 
0.2

 
(0.9
)
 
0.3

Total liquidity flows
 
(14.9
)
 
(22.2
)
 
12.1

Total net client cash flows
 
(26.1
)
 
(5.7
)
 
8.3

Market performance and other (2)
 
(15.3
)
 
20.1

 
35.1

Impact of foreign exchange
 
1.4

 
(18.5
)
 
(4.9
)
Acquisitions (dispositions), net (3)
 
6.9

 
5.0

 
(1.3
)
End of period
 
$
669.6

 
$
702.7

 
$
701.8

(1)
Subscriptions and redemptions reflect the gross activity in the funds and include assets transferred between funds and between share classes.
(2)
Other is primarily the reclassification of $0.5 billion and $12.8 billion of client assets from AUM to AUA for fiscal 2016 and 2015, respectively, and the reinvestment of dividends.
(3)
Includes $6.8 billion related to the acquisition of RARE Infrastructure and $0.1 billion related to the acquisition of PK Investments, LLP ("PK Investments") during the year ended March 31, 2016; and $9.5 billion related to the acquisition of Martin Currie (Holdings) Limited ("Martin Currie") and $5.0 billion related to the acquisition of QS Investors, offset in part by $9.5 billion related to the disposition of Legg Mason Investments Counsel and Trust ("LMIC"), for the year ended March 31, 2015.

AUM at March 31, 2016, was $669.6 billion, a decrease of $33.1 billion, or 4.7%, from March 31, 2015.  Total net client outflows were $26.1 billion, consisting of net client outflows from the liquidity and long-term asset classes of $14.9 billion and $11.2 billion, respectively. Net long-term asset outflows were comprised of equity and fixed income net outflows of $10.8 billion and $0.4 billion, respectively. Equity net outflows were primarily in products managed by Royce, for which outflows are expected to continue for the near-term, and ClearBridge Investments, LLC (“ClearBridge”), offset in part by equity net inflows at QS Investors. Fixed income net outflows were primarily in products managed by Western Asset Management Company ("Western Asset") and Permal, offset in part by fixed income net inflows at Brandywine Global

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Investment Management, LLC ("Brandywine"). We generally earn higher fees and profits on equity AUM, and outflows 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. Market performance and other was $(15.3) billion and the positive impact of foreign currency exchange rate fluctuations was $1.4 billion. Acquisitions of $6.9 billion primarily relate to the acquisition of RARE Infrastructure in October 2015.

AUM at March 31, 2015, was $702.7 billion, an increase of $0.9 billion, or 0.1%, from March 31, 2014.  Total net client outflows were $5.7 billion, as net client outflows of $22.2 billion from the liquidity asset class were substantially offset by $16.5 billion of net client inflows into long-term asset classes. In fiscal 2015, we experienced net inflows into long-term asset classes for the only time since fiscal 2007. Net long-term asset inflows were comprised of fixed income net inflows of $19.2 billion offset in part by equity net outflows of $2.7 billion. Fixed income net inflows were primarily in products managed by Brandywine and Western Asset. Equity net outflows were primarily in products managed by Royce and QS Investors and were partially offset by equity inflows at ClearBridge and Brandywine. Market performance and other totaled $20.1 billion, as the positive impact of market performance and other of $32.9 billion was offset in part by the reclassification of $12.8 billion of client assets from AUM to AUA in the first quarter of fiscal 2015, as further discussed below. The negative impact of foreign currency exchange rate fluctuations was $(18.5) billion. Acquisitions (dispositions), net, totaled $5.0 billion, with $9.5 billion related to the acquisition of Martin Currie and $5.0 billion related to the acquisition of QS Investors, offset in part by $9.5 billion related to the disposition of LMIC.

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 relationships 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, including investment performance, changes in prevailing interest rates, changes in our reputation in the marketplace, changes in management or control of clients or third-party distributors with whom we have relationships, loss of key investment management personnel or financial market performance.

AUM by Asset Class
AUM by asset class (in billions) for the years ended March 31 were as follows:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
% Change
 
 
2016
 
% of
Total
 
2015
 
% of
Total
 
2014
 
% of
Total
 
2016 Compared to 2015
 
2015 Compared to 2014
 Equity
 
$
180.5

 
27
%
 
$
199.4

 
28
%
 
$
186.4

 
27
%
 
(9
)%
 
7
 %
Fixed Income
 
376.8

 
56

 
376.1

 
54

 
365.2

 
52

 

 
3

Total long-term assets
 
557.3

 
83

 
575.5

 
82

 
551.6

 
79

 
(3
)
 
4

Liquidity
 
112.3

 
17

 
127.2

 
18

 
150.2

 
21

 
(12
)
 
(15
)
Total
 
$
669.6

 
100
%
 
$
702.7

 
100
%
 
$
701.8

 
100
%
 
(5
)
 


Average AUM by asset class (in billions) for the years ended March 31 were as follows:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
% Change
 
 
2016
 
% of
Total
 
2015
 
% of
Total
 
2014
 
% of
Total
 
2016 Compared to 2015
 
2015 Compared to 2014
 Equity
 
$
189.2

 
28
%
 
$
195.4

 
28
%
 
$
172.8

 
26
%
 
(3
)%
 
13
%
Fixed Income
 
372.5

 
54

 
367.1

 
52

 
358.7

 
54

 
1

 
2

Total long-term assets
 
561.7

 
82

 
562.5

 
80

 
531.5

 
80

 

 
6

Liquidity
 
123.1

 
18

 
140.0

 
20

 
135.9

 
20

 
(12
)
 
3

Total
 
$
684.8

 
100
%
 
$
702.5

 
100
%
 
$
667.4

 
100
%
 
(3
)
 
5



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Table of Contents

The component changes in our AUM by asset class (in billions) for the fiscal years ended March 31, 2016, 2015 and 2014, were as follows:
 
 
Equity
 
Fixed
Income
 
Total
Long-Term
 
Liquidity
 
Total
March 31, 2013
 
$
161.8

 
$
365.1

 
$
526.9

 
$
137.7

 
$
664.6

Investment funds, excluding liquidity funds
 
 

 
 

 
 
 
 

 
 

Subscriptions
 
27.0

 
25.1

 
52.1

 

 
52.1

Redemptions (1)
 
(30.1
)
 
(28.0
)
 
(58.1
)