Toggle SGML Header (+)


Section 1: 10-Q (10-Q)

Document
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q
(Mark One)
[x]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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
36503070_imageleggmasona04.jpg
LEGG MASON, INC.
(Exact name of registrant as specified in its charter)
 
 
 
MARYLAND
 
52-1200960
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
100 International Drive - Baltimore, MD
 
21202
(Address of principal executive offices)
 
(Zip code)
 
 
 
(410) 539-0000
(Registrant’s telephone number, including area code)
 
 
(Former name, former address and former fiscal year, if changed since last report)
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 for such shorter period that the registrant was required to submit and post such files). 
Yes
X
 
No
 
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 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
 
(Do not check if a smaller reporting company)
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
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
101,006,739 shares of common stock as of the close of business on October 27, 2016.


Table of Contents

TABLE OF CONTENTS
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



Table of Contents

PART I. FINANCIAL INFORMATION

Item 1.      Financial Statements


LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(Unaudited)
 
 
September 30, 2016
 
March 31, 2016
ASSETS
 
 
 
 
Current Assets
 
 
 
 
Cash and cash equivalents
 
$
570,868

 
$
1,329,126

Cash and cash equivalents of consolidated investment vehicles
 
2,835

 
297

Restricted cash
 
18,688

 
19,580

Receivables:
 
 
 
 
Investment advisory and related fees
 
425,948

 
334,922

Other
 
58,891

 
74,694

Investment securities
 
446,610

 
515,335

Investment securities of consolidated investment vehicles
 
66,564

 
48,715

Other
 
71,072

 
55,405

Other current assets of consolidated investment vehicles
 

 
6,970

Total Current Assets
 
1,661,476

 
2,385,044

Fixed assets, net
 
165,765

 
163,305

Intangible assets, net
 
4,089,766

 
3,146,485

Goodwill
 
1,958,654

 
1,479,516

Deferred income taxes
 
209,334

 
206,797

Other
 
161,113

 
139,215

Other assets of consolidated investment vehicles
 
8,442

 
84

TOTAL ASSETS
 
$
8,254,550

 
$
7,520,446

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 

LIABILITIES
 
 

 
 

Current Liabilities
 
 

 
 

Accrued compensation
 
$
353,216

 
$
430,736

Accounts payable and accrued expenses
 
199,331

 
201,572

Short-term borrowings
 

 
40,000

Contingent consideration
 
11,315

 
26,396

Other
 
110,834

 
138,301

Other current liabilities of consolidated investment vehicles
 
6,649

 
4,548

Total Current Liabilities
 
681,345

 
841,553

Deferred compensation
 
87,698

 
65,897

Deferred income taxes
 
301,215

 
260,386

Contingent consideration
 
40,738

 
58,189

Other
 
162,761

 
141,886

Long-term debt
 
2,221,896

 
1,740,985

TOTAL LIABILITIES
 
3,495,653

 
3,108,896

Commitments and Contingencies (Note 9)
 
 
 
 
REDEEMABLE NONCONTROLLING INTERESTS
 
676,164

 
175,785

STOCKHOLDERS' EQUITY
 
 
 
 
Common stock, par value $.10; authorized 500,000,000 shares; issued 100,982,945 shares for September 2016 and 107,011,664 shares for March 2016
 
10,098

 
10,701

Additional paid-in capital
 
2,535,249

 
2,693,113

Employee stock trust
 
(25,451
)
 
(26,263
)
Deferred compensation employee stock trust
 
25,451

 
26,263

Retained earnings
 
1,612,875

 
1,576,242

Accumulated other comprehensive loss, net
 
(98,675
)
 
(66,493
)
Total stockholders' equity attributable to Legg Mason, Inc.
 
4,059,547

 
4,213,563

Nonredeemable noncontrolling interest
 
23,186

 
22,202

TOTAL STOCKHOLDERS' EQUITY
 
4,082,733

 
4,235,765

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
 
$
8,254,550

 
$
7,520,446

See Notes to Consolidated Financial Statements

3

Table of Contents

LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share amounts)
(Unaudited)

 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
OPERATING REVENUES
 
 
 
 
 
 
 
 
Investment advisory fees:
 
 
 
 
 
 
 
 
Separate accounts
 
$
233,328

 
$
205,155

 
$
460,181

 
$
413,259

Funds
 
377,079

 
359,871

 
740,542

 
744,216

Performance fees
 
41,970

 
7,902

 
59,429

 
26,555

Distribution and service fees
 
94,545

 
99,602

 
185,927

 
196,462

Other
 
1,448

 
556

 
2,456

 
1,244

Total Operating Revenues
 
748,370

 
673,086

 
1,448,535


1,381,736

OPERATING EXPENSES
 
 
 
 
 
 
 
 
Compensation and benefits
 
368,330

 
282,433

 
726,955

 
597,485

Distribution and servicing
 
128,868

 
138,930

 
253,531

 
288,218

Communications and technology
 
51,281

 
49,845

 
104,013

 
98,522

Occupancy
 
30,558

 
25,716

 
63,700

 
51,703

Amortization of intangible assets
 
6,271

 
670

 
11,974

 
1,327

Other
 
35,429

 
42,462

 
87,174

 
86,908

Total Operating Expenses
 
620,737

 
540,056

 
1,247,347

 
1,124,163

OPERATING INCOME
 
127,633

 
133,030

 
201,188

 
257,573

OTHER NON-OPERATING INCOME (EXPENSE)
 
 
 
 
 
 
 
 
Interest income
 
1,545

 
1,229

 
3,393

 
2,546

Interest expense
 
(27,925
)
 
(13,280
)
 
(52,490
)
 
(25,229
)
Other income (expense), net
 
9,975

 
(28,110
)
 
16,560

 
(22,399
)
Other non-operating income (expense) of consolidated investment vehicles, net
 
5,206

 
(2,303
)
 
8,434

 
(1,896
)
Total Other Non-Operating Income (Expense)
 
(11,199
)
 
(42,464
)
 
(24,103
)
 
(46,978
)
INCOME BEFORE INCOME TAX PROVISION
 
116,434

 
90,566

 
177,085

 
210,595

Income tax provision
 
29,902

 
27,647

 
45,213

 
52,737

NET INCOME
 
86,532

 
62,919

 
131,872

 
157,858

Less: Net income (loss) attributable to noncontrolling interests
 
20,091

 
(1,400
)
 
31,979


(1,009
)
NET INCOME ATTRIBUTABLE TO LEGG MASON, INC.
 
$
66,441

 
$
64,319

 
$
99,893

 
$
158,867

 
 
 
 
 
 
 
 
 
NET INCOME PER SHARE ATTRIBUTABLE TO LEGG MASON, INC. SHAREHOLDERS:
 
 
 
 
 
 
 
 
Basic
 
$
0.63

 
$
0.58

 
$
0.94

 
$
1.43

Diluted
 
0.63

 
0.58

 
0.94

 
1.42

 
 
 
 
 
 
 
 
 
DIVIDENDS DECLARED PER SHARE
 
$
0.22

 
$
0.20

 
$
0.44

 
$
0.40

See Notes to Consolidated Financial Statements

4

Table of Contents

LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
(Unaudited)

 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
NET INCOME
 
$
86,532

 
$
62,919

 
$
131,872

 
$
157,858

Other comprehensive income:
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
4,167

 
(37,176
)
 
(13,023
)
 
(16,512
)
Unrealized losses on interest rate swap:
 
 
 
 
 
 
 
 
Unrealized gains (losses) on interest rate swap, net of tax provision (benefit) of $181 and $(1,708), respectively
 
289

 

 
(2,718
)
 

Reclassification adjustment for losses included in net income, net of tax benefit of $1,505 and $1,708, respectively
 
2,394

 

 
2,718

 

Net unrealized losses on interest rate swap
 
2,683

 

 

 

Net actuarial gains (losses) on defined benefit pension plan
 
(14,054
)
 
1,922

 
(19,159
)
 
2,990

Total other comprehensive loss
 
(7,204
)
 
(35,254
)
 
(32,182
)
 
(13,522
)
COMPREHENSIVE INCOME
 
79,328

 
27,665

 
99,690

 
144,336

Less: Comprehensive income (loss) attributable to noncontrolling interests
 
18,152

 
(1,400
)
 
32,038

 
(1,009
)
COMPREHENSIVE INCOME ATTRIBUTABLE TO LEGG MASON, INC.
 
$
61,176

 
$
29,065

 
$
67,652

 
$
145,345

See Notes to Consolidated Financial Statements

5

Table of Contents

LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(Dollars in thousands)
(Unaudited)
 
 
Six Months Ended September 30,
 
 
2016
 
2015
STOCKHOLDERS' EQUITY ATTRIBUTABLE TO LEGG MASON, INC.
 
 
 
 
COMMON STOCK
 
 
 
 
Beginning balance
 
$
10,701

 
$
11,147

Stock options exercised
 
12

 
22

Deferred compensation employee stock trust
 
1

 
1

Stock-based compensation
 
37

 
11

Employee tax withholdings by settlement of net share transactions
 
(36
)
 
(40
)
Shares repurchased and retired
 
(617
)
 
(320
)
Ending balance
 
10,098

 
10,821

ADDITIONAL PAID-IN CAPITAL
 
 
 
 

Beginning balance
 
2,693,113

 
2,844,441

Stock options exercised
 
3,442

 
6,073

Deferred compensation employee stock trust
 
254

 
250

Stock-based compensation
 
43,773

 
35,881

Performance-based Legg Mason restricted share units related to the acquisition of Clarion Partners
 
11,121

 

Additional tax benefit on Equity Unit exchange in fiscal 2010
 

 
9,173

Employee tax withholdings by settlement of net share transactions
 
(11,766
)
 
(21,138
)
Shares repurchased and retired
 
(201,056
)
 
(157,658
)
Redeemable noncontrolling interest reclassification for affiliate management equity plans
 
(3,632
)
 

Ending balance
 
2,535,249

 
2,717,022

EMPLOYEE STOCK TRUST
 
 
 
 

Beginning balance
 
(26,263
)
 
(29,570
)
Shares issued to plans
 
(255
)
 
(251
)
Distributions and forfeitures
 
1,067

 
2,143

Ending balance
 
(25,451
)
 
(27,678
)
DEFERRED COMPENSATION EMPLOYEE STOCK TRUST
 
 
 
 

Beginning balance
 
26,263

 
29,570

Shares issued to plans
 
255

 
251

Distributions and forfeitures
 
(1,067
)
 
(2,143
)
Ending balance
 
25,451

 
27,678

RETAINED EARNINGS
 
 
 
 

Beginning balance
 
1,576,242

 
1,690,055

Net Income Attributable to Legg Mason, Inc.
 
99,893

 
158,867

Dividends declared
 
(46,039
)
 
(44,162
)
Reclassifications to noncontrolling interest for:
 
 
 
 
EnTrustPermal combination
 
(15,500
)
 

Net increase in estimated redemption value of affiliate management equity plans
 
(1,721
)
 
(826
)
Ending balance
 
1,612,875

 
1,803,934

ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS), NET
 
 
 
 

Beginning balance
 
(66,493
)
 
(60,742
)
Net actuarial gains (losses) on defined benefit pension plan
 
(19,159
)
 
2,990

Foreign currency translation adjustment
 
(13,023
)
 
(16,512
)
Ending balance
 
(98,675
)
 
(74,264
)
TOTAL STOCKHOLDERS’ EQUITY ATTRIBUTABLE TO LEGG MASON, INC.
 
4,059,547


4,457,513

Nonredeemable noncontrolling interest
 
23,186

 

TOTAL STOCKHOLDERS’ EQUITY
 
$
4,082,733

 
$
4,457,513

See Notes to Consolidated Financial Statements

6

Table of Contents

LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)

 
 
Six Months Ended September 30,
 
 
2016
 
2015
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
 
Net Income
 
$
131,872

 
$
157,858

Adjustments to reconcile Net Income to net cash provided by operations:
 
 
 
 
Depreciation and amortization
 
40,342

 
27,534

Accretion and amortization of securities discounts and premiums, net
 
2,097

 
424

Stock-based compensation, including $15,200 related to the Clarion Partners affiliate management equity plan in April 2016
 
54,981

 
37,041

Net unrealized (gains) losses on investments
 
(21,382
)
 
39,024

Net (gains) losses and earnings on investments
 
3,391

 
(22,336
)
Net (gains) losses of consolidated investment vehicles
 
(8,434
)
 
1,896

Deferred income taxes
 
30,307

 
46,749

Contingent consideration fair value adjustments
 
(25,000
)
 

Other
 
500

 
701

Decrease (increase) in assets:
 
 
 
 
Investment advisory and related fees receivable
 
(17,298
)
 
37,970

Net sales (purchases) of trading and other investments
 
25,002

 
(12,373
)
Other receivables
 
(4,030
)
 
(10,884
)
Other assets
 
(11,290
)
 
16,892

Other assets of consolidated investment vehicles
 
56,672

 
(4,925
)
Increase (decrease) in liabilities:
 
 
 
 
Accrued compensation
 
(102,908
)
 
(134,114
)
Deferred compensation
 
22,092

 
12,123

Accounts payable and accrued expenses
 
(3,423
)
 
(18,376
)
Other liabilities
 
(37,733
)
 
(23,355
)
Other liabilities of consolidated investment vehicles
 
2,101

 
(141
)
CASH PROVIDED BY OPERATING ACTIVITIES
 
$
137,859

 
$
151,708











7

Table of Contents

LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(Dollars in thousands)
(Unaudited)


 
 
Six Months Ended September 30,
 
 
2016
 
2015
CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
 
Payments for fixed assets
 
$
(18,684
)
 
$
(19,858
)
Business acquisitions, net of cash acquired of $33,547
 
(1,009,928
)
 

Change in restricted cash
 
436

 
18,438

Proceeds from sales and maturities of investments
 
2,436

 
9,465

CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
 
(1,025,740
)
 
8,045

CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
 
Net decrease in short-term borrowings
 
(40,000
)
 

Payment of contingent consideration
 
(6,587
)
 
(22,765
)
Proceeds from issuance of long-term debt
 
500,000

 

Debt issuance costs
 
(17,639
)
 

Issuances of common stock for stock-based compensation
 
3,709

 
6,346

Employee tax withholdings by settlement of net share transactions
 
(11,802
)
 
(21,178
)
Repurchases of common stock
 
(201,673
)
 
(157,978
)
Dividends paid
 
(44,103
)
 
(40,383
)
Net subscriptions/(redemptions) and distributions attributable to noncontrolling interests
 
(52,530
)
 
33,141

CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
 
129,375

 
(202,817
)
EFFECT OF EXCHANGE RATES ON CASH
 
248

 
(7,553
)
NET DECREASE IN CASH AND CASH EQUIVALENTS
 
(758,258
)
 
(50,617
)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
 
1,329,126

 
669,552

CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
570,868

 
$
618,935

SUPPLEMENTAL DISCLOSURE
 
 
 
 
Cash paid for:
 
 
 
 
Income taxes, net of refunds of $(754) and $(2,018), respectively
 
$
11,025

 
$
17,125

Interest
 
45,485

 
24,551

See Notes to Consolidated Financial Statements

8

Table of Contents

LEGG MASON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts or unless otherwise noted)
September 30, 2016
(Unaudited)

1. Interim Basis of Reporting

The accompanying unaudited interim consolidated financial statements of Legg Mason, Inc. and its subsidiaries (collectively “Legg Mason”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and the applicable rules and regulations of the Securities and Exchange Commission (the "SEC"). The interim consolidated financial statements have been prepared using the interim basis of reporting and, as such, reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of the results for the periods presented. The preparation of interim consolidated financial statements requires management to make assumptions and estimates that affect the amounts reported in the interim consolidated financial statements and accompanying notes. Actual amounts could differ from those estimates and the differences could have a material impact on the interim consolidated financial statements. Terms such as “we,” “us,” “our,” and “Company” refer to Legg Mason.

The nature of Legg Mason's business is such that the results of any interim period are not necessarily indicative of the results of a full year. Certain disclosures included in the Company's annual report are not required to be included on an interim basis in the Company's quarterly reports on Form 10-Q. The Company has condensed or omitted these disclosures. Certain amounts in prior period financial statements have been reclassified to conform to the current period presentation.

The information contained in the interim consolidated financial statements should be read in conjunction with Legg Mason's latest Annual Report on Form 10-K filed with the SEC.

2. Significant Accounting Policies

Consolidation
In the normal course of its business, Legg Mason sponsors and manages various types of investment products. For its services, Legg Mason is entitled to receive management fees and may be eligible, under certain circumstances, to receive additional subordinated management fees or other incentive fees. Legg Mason's exposure to risk in these entities is generally limited to any equity investment it has made or is required to make, and any earned but uncollected management fees. Legg Mason did not sell or transfer investment assets to any of these investment products. In accordance with financial accounting standards, Legg Mason consolidates certain sponsored investment products, some of which are designated and reported as consolidated investment vehicles (“CIVs”). The consolidation of sponsored investment products, including those designated as CIVs, has no impact on Net Income Attributable to Legg Mason, Inc. and does not have a material impact on Legg Mason's consolidated operating results. The change in the value of all consolidated sponsored investment products is recorded in Other Non-Operating Income (Expense) and reflected in Net income (loss) attributable to noncontrolling interests.

Certain of the investment products Legg Mason sponsors and manages are considered to be variable interest entities ("VIEs") (as further described below) while others are considered to be voting rights entities (“VREs”) subject to traditional consolidation concepts based on ownership rights. Sponsored investment products that are considered VREs are consolidated if Legg Mason has a controlling financial interest in the investment vehicle, absent substantive investor rights to replace the manager of the entity (kick-out rights). Legg Mason may fund the initial cash investment in certain VRE investment products to generate an investment performance track record in order to attract third-party investors in the product. Legg Mason's initial investment in a new product typically represents 100% of the ownership in that product. As further discussed below, these “seed capital investments” are consolidated as long as Legg Mason maintains a controlling financial interest in the product, but they are not designated as CIVs by Legg Mason unless the investment is longer-term. As of September 30, 2016, March 31, 2016, and September 30, 2015, no consolidated VREs were designated as CIVs.

A VIE is an entity which does not have adequate equity to finance its activities without additional subordinated financial support; or the equity investors, as a group, do not have the normal characteristics of equity investors for a potential controlling financial interest. Legg Mason must consolidate any VIE for which it is deemed to be the primary beneficiary.

9

Table of Contents

Updated Consolidation Accounting Guidance
Effective April 1, 2016, Legg Mason adopted updated consolidation accounting guidance on a modified retrospective basis. Under the updated guidance, if limited partners or similar equity holders in a sponsored investment vehicle structured as a limited partnership or a similar entity do not have either substantive kick-out or substantive participation rights over the general partner, the entities are VIEs. As a sponsor and manager of an investment vehicle, Legg Mason may be deemed a decision maker under the accounting guidance. If the fees paid to a decision maker are market-based, such fees are not considered variable interests in a VIE. Additionally, if employee interests in a sponsored investment vehicle are not made to circumvent the consolidation guidance and are not financed by the sponsor, they are not included in the variable interests assessment, and are not included in the primary beneficiary determination.

A decision maker is deemed to be a primary beneficiary of a VIE if it has the power to direct activities that most significantly impact the economic performance of the VIE and the obligation to absorb losses or receive benefits from variable interests that could be significant to the VIE. In determining whether it is the primary beneficiary of a VIE, Legg Mason considers both qualitative and quantitative factors such as the voting rights of the equity holders, guarantees, and implied relationships. If a fee paid to a decision maker is not market-based, it will be considered in the primary beneficiary determination.

The adoption of this accounting guidance resulted in certain sponsored investment products that are foreign mutual fund trusts that were previously accounted for as VREs to be evaluated as VIEs, and the consolidation of nine funds as of June 30, 2016, which were also designated as CIVs. Under the updated accounting guidance, Legg Mason also concluded it was the primary beneficiary of one sponsored investment fund VIE managed by EnTrust Capital ("EnTrust"), which was also consolidated and designated a CIV. The adoption also resulted in the deconsolidation of 13 employee-owned funds, as Legg Mason no longer has a variable interest in those funds.

As of September 30, 2016, Legg Mason no longer held a significant financial interest in four foreign mutual funds, and therefore concluded it was no longer the primary beneficiary. As a result, these four funds were not consolidated as of September 30, 2016. In addition, during the quarter ended September 30, 2016, Legg Mason concluded that it was the primary beneficiary of one additional foreign mutual fund trust, which was consolidated and designated as a CIV.

Legg Mason also concluded it was the primary beneficiary of one sponsored investment fund VIE, which was consolidated (and designated as a CIV) as of September 30, 2016. This sponsored investment fund was also consolidated under prior accounting guidance, as further discussed below.

The adoption of the updated accounting guidance did not have a material impact on the Consolidated Balance Sheet as of September 30, 2016.

Prior Consolidation Accounting Guidance
Under prior accounting guidance, for most sponsored investment fund VIEs deemed to be investment companies, including money market funds, Legg Mason determined it was the primary beneficiary of a VIE if it absorbed a majority of the VIE's expected losses, or received a majority of the VIE's expected residual returns, if any. Legg Mason's determination of expected residual returns excluded gross fees paid to a decision maker if certain criteria relating to the fees were met. In determining whether it was the primary beneficiary of a VIE, Legg Mason considered both qualitative and quantitative factors such as the voting rights of the equity holders, economic participation of all parties (including how fees were earned and paid to Legg Mason), related party ownership, guarantees, and implied relationships.

For other sponsored investment funds that do not meet the investment company criteria, Legg Mason determined it was the primary beneficiary of a VIE if it had both the power to direct the activities of the VIE that most significantly impact the entity's economic performance and the obligation to absorb losses, or the right to receive benefits, that could be significant to the VIE.

Legg Mason concluded it was the primary beneficiary of one sponsored investment fund VIE, that was consolidated as of March 31, 2016, and September 30, 2015, despite significant third-party investments in this product. Also, as of both March 31, 2016, and September 30, 2015, Legg Mason concluded it was the primary beneficiary of 14 employee-owned funds it sponsors which were consolidated and designated as CIVs. As discussed above, effective April 1, 2016, under new accounting guidance, all but one of those employee-owned funds no longer qualified as VIEs, and 13 of those employee-owned funds were therefore deconsolidated.


10

Table of Contents

As of September 30, 2015, Legg Mason had a variable interest in three collateralized loan obligations ("CLOs"). Legg Mason concluded it was not the primary beneficiary of these CLOs, which were not consolidated, as it held no equity interest in these investment products and the level of fees they were expected to pay to Legg Mason was insignificant.

See Notes 4 and 13 for additional information related to VIEs.

Fair Value Measurements
Legg Mason's financial instruments are measured and reported at fair value and are classified and disclosed in one of the following categories (the "fair value hierarchy"):

Level 1 — Financial instruments for which prices are quoted in active markets, which, for Legg Mason, include investments in publicly traded mutual funds with quoted market prices and equities listed in active markets and certain derivative instruments.

Level 2 — Financial instruments for which prices are quoted for similar assets and liabilities in active markets, prices are quoted for identical or similar assets in inactive markets, or prices are based on observable inputs, other than quoted prices, such as models or other valuation methodologies.

Level 3 — Financial instruments for which values are based on unobservable inputs, including those for which there is little or no market activity.

As a result of the acquisition of Clarion Partners, LLC ("Clarion Partners") in April 2016, Legg Mason holds investments in real estate fund partnerships and limited liability companies, which are classified as Level 3. The fair values of investments in real estate funds are prepared giving consideration to the income, cost and sales comparison approaches of estimating property value. The income approach estimates an income stream for a property and discounts this income plus a reversion (presumed sale) into a present value at a risk adjusted rate. Yield rates and growth assumptions utilized in this approach are derived from market transactions as well as other financial and industry data. The discount rate and the exit capitalization rate are significant inputs to these valuations. These rates are based on the location, type and nature of each property, and current and anticipated market conditions. The cost approach estimates the replacement cost of the building less physical depreciation plus the land value. The sales comparison approach compares recent transactions to the appraised property. Adjustments are made for dissimilarities which typically provide a range of value. Many factors are also considered in the determination of fair value including, but not limited to, the operating cash flows and financial performance of the properties, property types and geographic locations, the physical condition of the asset, prevailing market capitalization rates, prevailing market discount rates, general economic conditions, economic conditions specific to the market in which the assets are located, and any specific rights or terms associated with the investment. Because of the inherent uncertainties of valuation, the values may materially differ from the values that would be determined by negotiations held between parties in a sale transaction.

See Note 4 for additional information regarding fair value measurements.

Contingent Consideration Liabilities
In connection with business acquisitions, Legg Mason may be required to pay additional future consideration based on the achievement of certain designated financial metrics. Legg Mason estimates the fair value of these potential future obligations at the time a business combination is consummated and records a Contingent consideration liability in the Consolidated Balance Sheet.

Legg Mason accretes contingent consideration liabilities to the expected payment amounts over the related earn-out terms until the obligations are ultimately paid, resulting in Interest expense in the Consolidated Statements of Income. If the expected payment amounts subsequently change, the contingent consideration liabilities are (reduced) or increased in the current period, resulting in a (gain) or loss, which is reflected within Other operating expense in the Consolidated Statements of Income. See Notes 3 and 9 for additional information regarding contingent consideration liabilities.

Noncontrolling Interests
Noncontrolling interests include affiliate minority interests, third-party investor equity in consolidated sponsored investment products, and vested affiliate management equity plan interests. For CIVs and other consolidated sponsored investment products with third-party investors, the related noncontrolling interests are classified as redeemable noncontrolling interests

11

Table of Contents

if investors in these funds may request withdrawals at any time. Also included in redeemable noncontrolling interests are vested affiliate management equity plan and affiliate minority interests for which the holder may, at some point, request settlement of their interests. Redeemable noncontrolling interests are reported in the Consolidated Balance Sheets at their estimated settlement values. When settlement is not expected to occur until a future date, changes in the expected settlement value are recognized over the settlement period as an adjustment to retained earnings. Nonredeemable noncontrolling interests include vested affiliate management equity plan interests that do not permit the holder to request settlement of their interests. Nonredeemable noncontrolling interests are reported in the Consolidated Balance Sheets at their issuance value, together with undistributed net income allocated to noncontrolling interests.

Legg Mason estimates the settlement value of noncontrolling interests as their fair value. For consolidated sponsored investment products, where the investor may request withdrawal at any time, fair value is based on market quotes of the underlying securities held by the investment products. For affiliate minority interests and management equity plan interests, fair value reflects the related total business enterprise value, after appropriate discounts for lack of marketability and control. There may also be features of these equity interests, such as dividend subordination, that are contemplated in their valuations. The fair value of option-like management equity plan interests also relies on Black-Scholes option pricing model calculations.

Net income (loss) attributable to noncontrolling interests in the Consolidated Statements of Income includes the share of net income of the respective subsidiary allocated to the minority interest holders.

See Note 11 for additional information regarding noncontrolling interests.

Accumulated Other Comprehensive Loss, Net
There were no significant amounts reclassified from Accumulated other comprehensive loss, net, to the Consolidated Statements of Income for the three and six months ended September 30, 2016 or 2015, except for $237 and $764 realized on the settlement and termination of an interest rate swap for the three and six months ended September 30, 2016, respectively, as further described in Note 7.

Income Tax Provision
Noncontrolling interests in EnTrustPermal Group Holdings, LLC ("EnTrustPermal"), Clarion Partners, and Royce & Associates ("Royce") are structured as partnerships that pass related tax attributes to the related noncontrolling interest holders. As such, the consolidated financial statements do not generally include any tax provision/benefit associated with the net income allocated to these noncontrolling interests, which caused the effective tax rate to be reduced by 6.7 percentage points and 4.4 percentage points for the three and six months ended September 30, 2016, respectively.

In September 2016, the U.K. Finance Act 2016 was enacted, which reduced the main U.K. corporate tax rate effective on April 1, 2020 from 18% to 17%. The reduction in the U.K. corporate tax rate resulted in a tax benefit of $4,055, recognized in the three months ended September 30, 2016, as a result of the revaluation of certain existing deferred tax assets and liabilities at the new rate, which reduced the effective tax rate by 3.5 percentage points and 2.3 percentage points for the three and six months ended September 30, 2016, respectively. During the three months ended September 30, 2016, Legg Mason also recognized income tax benefits of $2,200 as a result of reserve adjustments related to the conclusion of certain tax examinations, which reduced the effective tax rate by 1.9 percentage points and 1.2 percentage points for the three and six months ended September 30, 2016, respectively.

During the three months ended September 30, 2015, Legg Mason recognized income tax benefits of $7,026 as a result of reserve adjustments related to the conclusion of certain tax examinations, and during the three months ended June 30, 2015, Legg Mason recognized an income tax benefit of $17,527 as a result of an increase in the value of deferred tax assets due to changes in the New York City tax code. These tax benefits reduced the effective income tax rate by 7.8 percentage points and 11.7 percentage points for the three and six months ended September 30, 2015, respectively.

Recent Accounting Developments
In August 2016, the Financial Accounting Standards Board ("FASB") updated the guidance on the classification of certain cash receipts and cash payments in the statement of cash flows. The updated guidance addresses the reporting classification of several specific cash flow items, including debt prepayment or extinguishment costs, contingent consideration payments, and distributions received from equity method investees, with the objective of reducing diversity in practice where no specific guidance exists, or current guidance is unclear. The updated guidance will be effective in fiscal 2019, with the option for early adoption. Legg Mason is currently evaluating the impact of its adoption.

12

Table of Contents


In February 2016, the FASB updated the guidance on accounting for leases. The updated guidance requires that a lessee shall recognize the assets and liabilities that arise from lease transactions. A lessee will recognize a right-of-use asset to use the underlying asset and a liability representing the lease payments. The updated guidance also requires an evaluation at the inception of a service or other contract, to determine whether the contract is or contains a lease. The guidance will be effective in fiscal 2020. Legg Mason is evaluating the impact of its adoption.

In May 2014, the FASB updated the guidance on revenue recognition. The updated guidance improves comparability and removes inconsistencies in revenue recognition practices across entities, industries, jurisdictions, and capital markets. In March 2016, the FASB further updated the revenue guidance on determining whether to report revenue on a gross versus net basis. The updated guidance clarifies how entities evaluate principal versus agent aspects of the revenue recognition guidance issued in May 2014. The evaluation will require entities to identify all goods or services to be provided to the customer, and determine whether they obtain control of the good or service before it is transferred to the customer, where control would suggest a principal relationship, which would be accounted for on a gross basis. These updates are effective for Legg Mason in fiscal 2019. Legg Mason is evaluating the impact of its adoption.



13

Table of Contents

3. Acquisitions

The following table presents a summary of the acquisition-date fair values of the assets acquired and liabilities assumed for each of Legg Mason's significant recent acquisitions:
 
 
EnTrust Capital(1)
 
Clarion Partners(1)
 
RARE Infrastructure Limited
 
Martin Currie (Holdings) Limited
 
QS Investors Holdings, LLC
Acquisition Date
 
May 2,
2016
 
April 13, 2016
 
October 21, 2015
 
October 1, 2014
 
May 31,
 2014
 
 
 
 
 
 
 
 
 
 
 
Purchase price
 
 
 
 
 
 
 
 
 
 
Cash
 
$
400,000

 
$
631,476

 
$
213,739

 
$
202,577

 
$
11,000

Estimated contingent consideration
 

 

 
25,000

 
75,211

 
13,370

Performance-based Legg Mason restricted share units
 

 
11,121

 

 

 

Minority equity interest transferred
 
140,000

(2) 

 

 

 

Total Consideration
 
540,000

 
642,597

 
238,739

 
277,788

 
24,370

Fair value of noncontrolling interests
 
247,700

(2) 
105,300

 
62,722

 

 

Total
 
787,700

 
747,897

 
301,461

 
277,788

 
24,370

Identifiable assets and liabilities
 
 
 
 
 
 
 
 
 
 
Cash
 
8,236

 
25,307

 
9,667

 
29,389

 
441

Investments
 
16,220

 
22,285

 

 

 
3,281

Receivables
 
20,820

 
53,657

 
6,612

 

 
2,699

Indefinite-life intangible fund management contracts
 
262,300

 
505,200

 
122,755

 
135,321

 

Indefinite-life trade name
 
7,400

 
23,100

 
4,766

 
7,130

 

Amortizable intangible asset management contracts
 
65,500

 
102,800

 
67,877

 
15,234

 
7,060

Fixed assets
 
4,479

 
8,255

 
673

 
784

 
599

Other current assets (liabilities), net
 
1,030

 
(25,585
)
 
(10,605
)


 

Liabilities, net
 
(8,823
)
 
(10,579
)
 
(3,948
)
 
(4,388
)
 
(6,620
)
Pension liability
 

 

 

 
(32,433
)
 

Deferred tax liabilities
 

 
(36,788
)
 
(58,619
)
 
(31,537
)
 

Total identifiable assets and liabilities
 
377,162

 
667,652

 
139,178

 
119,500

 
7,460

Goodwill
 
$
410,538

 
$
80,245

 
$
162,283

 
$
158,288

 
$
16,910

(1)
Subject to measurement period adjustments, including for amounts ultimately realized.
(2)
Post combination EnTrustPermal noncontrolling interest of $403,200 also includes a fair value reclassification of $15,500 from retained earnings.

EnTrust Capital
On May 2, 2016, Legg Mason acquired EnTrust and combined it with The Permal Group, Ltd. ("Permal"), Legg Mason's existing hedge fund platform, to form EnTrustPermal. EnTrust, an alternative asset management firm headquartered in New York, had $9,600,000 in assets under management ("AUM") and approximately $2,000,000 in assets under advisement and committed capital at closing, and largely complementary investment strategies, investor base, and business mix to Permal. The transaction included a cash payment of $400,000, which was funded with borrowings under Legg Mason's revolving credit facility, as well as a portion of the proceeds from the issuance of $450,000 of 4.75% Senior Notes due 2026 (the "2026 Notes") and $250,000 of 6.375% Junior Subordinated Notes due 2056 (the "6.375% 2056 Notes") in March 2016. As a result of the combination, Legg Mason owns 65% of the new entity, EnTrustPermal, with the remaining 35% owned by EnTrust's co-founder and managing partner. The noncontrolling interests can be put by the holder or called by Legg Mason for settlement at fair value subject to various conditions, including the passage of time. The fair value of the noncontrolling interests in the Consolidated Balance Sheet reflects the total business enterprise value, after appropriate discounts for lack of marketability and control of the combined entity.

During the three months ended September 30, 2016, Legg Mason revised the determination of the fair values of certain tangible and intangible assets acquired and liabilities assumed and the amount of goodwill recognized in connection with

14

Table of Contents

the acquisition of EnTrust, which was accounted for as a business combination. As a result of additional information obtained about the facts and circumstances that existed as of the acquisition date, the fair value of the indefinite-life intangible fund management contracts recognized was reduced by $190,500, with an offsetting increase in goodwill, and the fair value of the amortizable intangible asset management contracts recognized was increased by $30,000, with an offsetting decrease in goodwill. The increase in the fair value of the amortizable intangible asset management contracts did not have a material impact on Amortization of intangible assets recorded in the Consolidated Income Statement for the three months ended September 30, 2016. In addition, a working capital adjustment resulted in the recognition of an additional liability of $8,904, with an offsetting increase in goodwill.

The fair value of the acquired amortizable intangible asset management contracts has a useful life of approximately eight years at acquisition. Purchase price allocated to intangible assets and goodwill is expected to be deductible for U.S. tax purposes over a period of 15 years. Goodwill is principally attributable to synergies expected to arise with EnTrust.

Management estimated the fair values of the indefinite-life intangible fund management contracts, indefinite-life trade name, and amortizable intangible asset management contracts based upon discounted cash flow analyses, using unobservable market data inputs, which are Level 3 measurements. The significant assumptions used in these analyses at acquisition, including projected annual cash flows, projected AUM growth rates and discount rates, are summarized as follows:
 
 
Projected Cash Flow Growth
 
Discount Rate
Indefinite-life intangible fund management contracts
 
(1)% to 5% (weighted-average: 4%)
 
14.5%
Indefinite-life trade name

 
6% to 14% (weighted-average: 6%)
 
14.5%
 
 
 
 
 
 
 
Projected AUM Growth / (Attrition)
 
Discount Rate
Amortizable intangible asset management contracts
 
10% / (13)%
 
13.5%

Costs incurred in connection with the acquisition of EnTrust were $299 and $7,031 during the three and six months ended September 30, 2016, respectively.

The financial results of EnTrust included in Legg Mason's consolidated financial results for the three and six months ended September 30, 2016, include revenues of $26,540 and $45,266, respectively, and currently did not have a material impact on Net Income Attributable to Legg Mason, Inc.

In connection with the combination, Legg Mason expects to incur total restructuring and transition-related charges of approximately $92,000 to $95,000, primarily comprised of charges for employee termination benefits, including severance and retention incentives, and real estate related charges. Total charges for restructuring and transition costs of $79,959 have been recognized through September 30, 2016, which includes $12,400 and $36,663 for the three and six months ended September 30, 2016, respectively. These costs are primarily recorded as Compensation and benefits in the Consolidated Statement of Income. Legg Mason expects that substantially all of the $12,000 to $15,000 of remaining anticipated costs associated with the combination will be incurred during the remainder of fiscal 2017.


15

Table of Contents

The table below presents a summary of changes in the restructuring and transition-related liability from December 31, 2015 through September 30, 2016, and cumulative charges incurred to date:
 
 
Compensation
 
Other
 
Total
Balance as of December 31, 2015
 
$

 
$

 
$

Accrued charges
 
31,581

 
9,981

(1)
41,562

Payments
 
(21,938
)
 
(2,097
)
 
(24,035
)
Balance as of March 31, 2016
 
9,643

 
7,884

 
17,527

Accrued charges
 
19,667

 
11,460

(1)
31,127

Payments
 
(13,012
)
 
(9,086
)
 
(22,098
)
Balance as of September 30, 2016
 
$
16,298

 
$
10,258

 
$
26,556

Non-cash charges(2)
 
 
 
 
 
 
   Year ended March 31, 2016
 
$
591

 
$
1,143

 
$
1,734

   Six months ended September 30, 2016
 
2,140

 
3,396

 
5,536

Total
 
$
2,731

 
$
4,539

 
$
7,270

 
 
 
 
 
 
 
Cumulative charges incurred through September 30, 2016
 
$
53,979

 
$
25,980

 
$
79,959

(1)
Includes lease loss reserve for space permanently abandoned of $9,069 for the six months ended September 30, 2016, and $7,212 for the year ended March 31, 2016.
(2)
Includes stock-based compensation expense and accelerated fixed asset depreciation.

Clarion Partners
On April 13, 2016, Legg Mason acquired a majority equity interest in Clarion Partners, a diversified real estate asset management firm headquartered in New York. Clarion Partners managed approximately $41,500,000 in AUM on the date of acquisition. Legg Mason acquired an 82% ownership interest in Clarion Partners for a cash payment of $631,476 (including a payment for cash delivered of $36,772 and co-investments of $16,210), which was funded with a portion of the proceeds from the issuance of the 2026 Notes and the 6.375% 2056 Notes in March 2016. The Clarion Partners management team retained 18% of the outstanding equity in Clarion Partners. The Clarion Partners management team also retained rights to the full amount of performance fee revenues earned on historic AUM in place as of the closing of the acquisition. Performance fees earned on this historic AUM are fully passed through, per the terms of the acquisition agreement, and recorded as compensation expense. Legg Mason expects the full pass through of performance fees to phase out approximately five years post-closing. The firm's previous majority owner sold its entire ownership interest in the transaction. The noncontrolling interests held by the management team can be put by the holders or called by Legg Mason for settlement at fair value subject to various conditions, including the passage of time. The fair value of the noncontrolling interests reflects the total business enterprise value, after appropriate discounts for lack of marketability and control.

Upon the acquisition, Legg Mason also granted certain key employees of Clarion Partners a total of 716 performance-based Legg Mason restricted share units with an aggregate fair value of $11,121, which vest upon Clarion Partners achieving a certain level of EBITDA, as defined in the award agreements, within a designated period after the closing of the acquisition. The aggregate value of the award was included in the purchase price and was determined as of the grant date using a Monte Carlo pricing model with the following assumptions:
Long-term EBITDA growth rate
 
6.0
%
Risk-free interest rate
 
2.3
%
Expected volatility:
 
 
   Legg Mason
 
38.0
%
   Clarion Partners
 
30.0
%

In connection with the transaction, Legg Mason also implemented an affiliate management equity plan for the management team of Clarion Partners, which resulted in a non-cash charge of $15,200 in the three months ended June 30, 2016. See Note 8 for additional information related to the Clarion Partners management equity plan.


16

Table of Contents

As a result of additional information obtained about the facts and circumstances that existed as of the acquisition date, the fair value of the deferred tax liabilities recognized was reduced by$14,044, with an offsetting increase in goodwill.

The fair value of the acquired amortizable intangible asset management contracts had an average useful life of approximately 10 years at acquisition. Approximately 82% of the purchase price allocated to intangible assets and goodwill is expected to be deductible for U.S. tax purposes over a period of 15 years. Goodwill is principally attributable to synergies expected to arise with Clarion Partners.

Management estimated the fair values of the indefinite-life intangible fund management contracts, indefinite-life trade name, and amortizable intangible asset management contracts based upon discounted cash flow analyses, using unobservable market data inputs, which are Level 3 measurements. The significant assumptions used in these analyses at acquisition, including projected annual cash flows, projected AUM growth rates and discount rates, are summarized as follows:
 
 
Projected Cash Flow Growth
 
Discount Rate
Indefinite-life intangible fund management contracts
 
6% to 20% (weighted-average: 6%)
 
13.5%
Indefinite-life trade name
 
5% to 17% (weighted-average: 6%)
 
13.5%
 
 
 
 
 
 
 
Projected AUM Growth / (Attrition)
 
Discount Rate
Amortizable intangible asset management contracts:
 
7% / (10)%
 
13.4%

In addition to the previously discussed charge of $15,200 incurred in connection with the implementation of the Clarion Partners management equity plan, during the three and six months ended September 30, 2016, there were $358 and $10,741, respectively, of costs incurred in connection with the acquisition of Clarion Partners.

The financial results of Clarion Partners included in Legg Mason's consolidated financial results for the three and six months ended September 30, 2016, include revenues of $84,082 and $140,773, respectively, and currently did not have a material impact to Net Income Attributable to Legg Mason, Inc.

Pro Forma Financial Information
The following unaudited pro forma financial information presents the combined financial results of Legg Mason, Clarion Partners, and EnTrust, as though the acquisitions had occurred as of April 1, 2015. The unaudited pro forma financial information reflects certain adjustments for amortization expense related to the fair value of acquired intangible assets, acquisition- and transition-related costs, interest expense related to debt incurred to finance the acquisitions, and the income tax impact of the pro forma adjustments. The unaudited pro forma financial information is for informational purposes only and is not necessarily indicative of the financial results that would have been achieved had the acquisitions actually occurred at the beginning of the first period presented.
 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
Revenues
 
$
748,370

 
$
751,962

 
$
1,465,886

 
$
1,543,748

Net Income Attributable to Legg Mason, Inc.
 
75,336

 
53,852

 
143,587

 
108,642

Net Income Per Share Attributable to Legg Mason, Inc. Shareholders:
 
 
 
 
 
 
 
 
Basic
 
0.72

 
0.49

 
1.35

 
0.98

Diluted
 
0.71

 
0.48

 
1.35

 
0.97


RARE Infrastructure Limited
On October 21, 2015, Legg Mason acquired a majority equity interest in RARE Infrastructure Limited ("RARE Infrastructure"). RARE Infrastructure specializes in global listed infrastructure security investing, is headquartered in Sydney, Australia, and had approximately $6,800,000 in AUM at the closing of the transaction. Under the terms of the related transaction agreements, Legg Mason acquired a 75% ownership interest in the firm, the firm's management team retained a 15% equity interest and The Treasury Group, a continuing minority owner, retained 10%. The acquisition required an initial cash payment of $213,739 (using the foreign exchange rate as of October 21, 2015 for the 296,000 Australian dollar payment), which was funded with approximately $40,000 of net borrowings under the Company's previous revolving

17

Table of Contents

credit facility, as well as existing cash resources. In August 2015, Legg Mason executed a currency forward contract to economically hedge the risk of movement in the exchange rate between the U.S. dollar and the Australian dollar in which the initial cash payment was denominated. This currency forward contract was closed in October 2015. See Note 12 for additional information regarding derivatives and hedging. In addition, contingent consideration may be due March 31, 2017 and 2018, aggregating up to $81,231 (using the foreign exchange rate as of September 30, 2016, for the maximum 106,000 Australian dollar amount per the related agreements), dependent on the achievement of certain net revenue targets, and subject to potential catch-up adjustments extending through March 31, 2019.

The noncontrolling interests can be put by the holders or called by Legg Mason for settlement at fair value, except for the non-management portion of the noncontrolling interests, which are callable at a pre-agreed formula, as specified in the agreements. The fair value of the noncontrolling interests reflects the total business enterprise value, after appropriate discounts for lack of marketability and control.

Management estimated the fair values of the indefinite-life intangible fund management contracts, indefinite-life trade name, and amortizable intangible asset management contracts based upon discounted cash flow analyses, using unobservable market data inputs, which are Level 3 measurements. The significant assumptions used in these analyses at acquisition, including projected annual cash flows, projected AUM growth rates and discount rates, are summarized as follows:
 
 
Projected Cash Flow Growth
 
Discount Rate
Indefinite-life intangible fund management contracts and indefinite-life trade name
 
Up to 10% (weighted-average: 7%)
 
16.5%
 
 
 
 
 
 
 
Projected AUM Growth / (Attrition)
 
Discount Rate
Amortizable intangible asset management contracts
 
7% / (8)%
 
16.5%

The fair value of the acquired amortizable intangible asset management contracts had a useful life of 12 years at acquisition. Purchase price allocated to intangible assets and goodwill is not deductible for Australian tax purposes. Goodwill is principally attributable to synergies expected to arise with RARE Infrastructure.

The fair value of the contingent consideration was estimated using Monte Carlo simulation in a risk-neutral framework with various observable inputs, as well as, with various unobservable data inputs which are Level 3 measurements. The simulation considered variables, including AUM growth and performance fee levels. Consistent with risk-neutral framework, projected AUM and performance fees were dampened by a measure of risk referred to as 'market price of risk' to account for its market risk or systematic risk before calculating the earn-out payments. These earn-out payments were then discounted commensurate with their timing. A summary of various assumption values follows:
AUM growth rates
 
Weighted-average: 7%
Performance fee growth rates
 
Weighted-average: 3%
Projected AUM and performance fee market price of risk
 
6.5%
AUM volatility
 
20.0%
Earn-out payment discount rate
 
1.9%

Significant increases (decreases) in projected AUM or performance fees would result in a significantly higher (lower) contingent consideration liability fair value.

The contingent consideration liability established at closing had an acquisition date fair value of $25,000 (using the foreign exchange rate as of October 21, 2015). As of September 30, 2016, the fair value of the contingent consideration liability was $20,499, a decrease of $6,646 from March 31, 2016. During the three months ended September 30, 2016, a reduction in projected AUM and performance fees resulted in a $7,000 reduction in the estimated contingent consideration liability, recorded as a credit to Other operating expense in the Consolidated Statement of Income. The reduction was offset in part by an increase of $354 attributable to changes in the exchange rate, which is included in Accumulated other comprehensive loss, net, as Foreign currency translation adjustment, and accretion. The contingent consideration liability is recorded at an entity with an Australian dollar functional currency, such that related changes in the exchange rate do not impact net income. Of the total contingent consideration liability, $3,747 relates to the first anniversary payment and is included in current

18

Table of Contents

Contingent consideration in the Consolidated Balance Sheet, with the remainder included in non-current Contingent consideration.

The Company has not presented pro forma combined results of operations for this acquisition because the results of operations as reported in the accompanying Consolidated Statements of Income would not have been materially different.

Martin Currie (Holdings) Limited
On October 1, 2014, Legg Mason acquired all outstanding equity interests of Martin Currie (Holdings) Limited ("Martin Currie"), an international equity specialist based in the United Kingdom. The acquisition required an initial payment of $202,577 (using the foreign exchange rate as of October 1, 2014 for the £125,000 contract amount), which was funded from existing cash. In addition, contingent consideration payments may be due March 31 following the second and third anniversaries of closing, aggregating up to approximately $421,840 (using the foreign exchange rate as of September 30, 2016 for the maximum £325,000 contract amount), inclusive of the payment of certain potential pension and other obligations, and dependent on the achievement of certain financial metrics at March 31, 2017, and 2018, as specified in the share purchase agreement. The agreement provided for a potential first anniversary payment due as of March 31, 2016, however no such payment was due based on relevant financial metrics.

The fair value of the amortizable intangible asset management contracts asset is being amortized over a period of 12 years. Goodwill is principally attributable to synergies expected to arise with Martin Currie. These acquired intangible assets and goodwill are not deductible for U.K. tax purposes.

Management estimated the fair values of the indefinite-life intangible fund management contracts, indefinite-life trade name, and amortizable intangible asset management contracts based upon discounted cash flow analyses, using unobservable market data inputs, which are Level 3 measurements. The significant assumptions used in these analyses at acquisition, including projected annual cash flows, projected AUM growth rates and discount rates, are summarized as follows:
 
 
Projected Cash Flow Growth
 
Discount Rate
Indefinite-life intangible fund management contracts and indefinite-life trade name
 
Up to 25% (weighted-average: 11%)
 
15.0%
 
 
 
 
 
 
 
Projected AUM Growth / (Attrition)
 
Discount Rate
Amortizable intangible asset management contracts
 
6% / (17)%
 
15.0%

The fair value of the contingent consideration was measured using Monte Carlo simulation with various unobservable market data inputs, which are Level 3 measurements. The simulation considered variables, including AUM growth, performance fee levels and relevant product performance. Projected AUM, performance fees and earn-out payments were discounted as appropriate. A summary of various assumption values follows:
AUM growth rates
 
Weighted-average: 14%
Performance fee growth rates
 
Weighted-average: 15%
Discount rates:
 
 
   Projected AUM
 
13.0%
   Projected performance fees
 
15.0%
   Earn-out payments
 
1.3%
AUM volatility
 
18.8%

Significant future increases (decreases) in projected AUM or performance fees would result in a significantly higher (lower) contingent consideration liability fair value.

The contingent consideration liability established at closing had an acquisition date fair value of $75,211 (using the foreign exchange rate as of October 1, 2014). Actual payments to be made may also include amounts for certain potential pension and other obligations that are accounted for separately. As of September 30, 2016, the fair value of the contingent consideration liability was $19,797, a decrease of $21,425 from March 31, 2016. During the three months ended June 30, 2016, a reduction in projected AUM and performance fees resulted in an $18,000 reduction in the estimated contingent consideration liability, recorded as a credit to Other operating expense in the Consolidated Statement of Income. The remaining decrease of $3,425

19

Table of Contents

related to the exchange rate, which is included in Accumulated other comprehensive loss, net, as Foreign currency translation adjustment, net of accretion, also impacted the contingent consideration liability. The contingent consideration liability is recorded at an entity with a British pound functional currency, such that related changes in the exchange rate do not impact net income. Of the total contingent consideration liability as of September 30, 2016, $5,568 relates to the second anniversary payment and is included in current Contingent consideration in the Consolidated Balance Sheet, with the remainder included in non-current Contingent consideration in the Consolidated Balance Sheet.

Martin Currie Defined Benefit Pension Plan
Martin Currie sponsors a retirement and death benefits plan, a defined benefit pension plan with assets held in a separate trustee-administered fund. Plan assets are measured at fair value and comprised of 58% equities (Level 1), 40% bonds (Level 2) and 2% cash (Level 1) as of September 30, 2016, and 60% equities (Level 1) and 40% bonds (Level 2) as of March 31, 2016. Assumptions used to determine the expected return on plan assets targets a 55% / 45% equity/bond allocation with reference to the 15-year FTSE U.K. Gilt yield for equities and U.K. long-dated bond yields for bonds. Plan liabilities are measured on an actuarial basis using the projected unit method and discounted at a rate equivalent to the current rate on a high quality bond in the local U.K. market and currency. There were no significant concentrations of risk in plan assets as of September 30, 2016. The most recent actuarial valuation was performed as of May 31, 2013, which was updated through the acquisition and at subsequent balance sheet dates. Accrual of service credit under the plan ceased on October 3, 2014. Legg Mason uses the corridor approach to account for this plan. Under the corridor approach, actuarial gains and losses on plan assets and liabilities are deferred and reported as Other comprehensive income (loss). However, if at the beginning of the next fiscal year, the actuarial gains and losses exceed 10% of the greater of the fair value of the plan assets or the plan benefit obligation, the excess will be amortized as Compensation expense over the recovery period.

The resulting net benefit obligation, comprised as follows, is included in the September 30, 2016 and March 31, 2016, Consolidated Balance Sheets as Other non-current liabilities:
 
 
September 30, 2016
 
March 31, 2016
Fair value of plan assets (at 5.4% and 5.2%, respectively, expected weighted-average long-term return)
 
$
60,554

 
$
57,253

Benefit obligation (at 2.4% and 3.6%, respectively, discount rate)
 
(108,047
)
 
(90,010
)
Unfunded status (excess of benefit obligation over plan assets)
 
$
(47,493
)
 
$
(32,757
)
 
 
A net periodic benefit cost of $10 and $38, for the three and six months ended September 30, 2016, respectively, and $21 and $47, for the three and six months ended September 30, 2015, respectively, was included in Compensation and benefits expense in the Consolidated Statements of Income. Net actuarial losses of $25,980 and $6,821 were included in Accumulated other comprehensive loss, net, in the Consolidated Balance Sheets at September 30, 2016 and March 31, 2016, respectively.
 
 
The contingent consideration payments may provide some funding of the net plan benefit obligation, through a provision of the share purchase agreement requiring certain amounts to be paid to the plan. Any contingent consideration payments to the plan are based on determination of the plan benefit obligation under local technical provisions utilized by the plan trustees.

The Pensions Regulator in the U.K. ("the Regulator"), is reviewing the pension plan's current structure and funding status, which could result in additional guarantees or accelerated funding. Absent funding from contingent consideration payments or any requirement from the Regulator for additional payments or guarantees, Martin Currie does not expect to contribute any additional amounts in fiscal 2017 to the plan in excess of the $2,152 contributed during the three months ended June 30, 2016.

The contingent consideration provisions of the share purchase agreement also require a designated percentage of the earn-out payments, net of any pension contribution, to be allocated to fund an incentive plan for Martin Currie's management. No payments to employees under the arrangement will be made until the end of the earn-out period. The estimated payment (adjusted quarterly) is being amortized over the earn-out term.


20

Table of Contents

Other
In December 2015, Martin Currie acquired certain assets of PK Investment Management, LLP ("PK Investments"), a London based equity manager, for an initial cash payment of $4,981 and an estimated contingent payment of $2,499 due on December 31, 2017. The amount of any ultimate contingent payment will be based on certain financial metrics. The initial cash payment was funded with existing cash resources. In connection with the acquisition, Legg Mason recognized indefinite-life intangible fund management contracts and goodwill of $6,619 and $827, respectively.

QS Investors Holdings, LLC
Effective May 31, 2014, Legg Mason acquired all of the outstanding equity interests of QS Investors, a customized solutions and global quantitative equities provider. The initial purchase price was a cash payment of $11,000, funded from existing cash. In August 2016, Legg Mason paid contingent consideration of $6,587 for the second anniversary payment. Additional contingent consideration of up to $20,000 for the fourth anniversary payment, and up to $3,400 for a potential catch-up adjustment for the second anniversary payment shortfall, may be due in July 2018, dependent on the achievement of certain net revenue targets.

The fair value of the amortizable intangible asset management contracts had a useful life of 10 years at acquisition. Purchase price allocated to goodwill is expected to be deductible for U.S. tax purposes over a period of 15 years.

Management estimated the fair values of the amortizable intangible asset management contracts based upon a discounted cash flow analysis, and the contingent consideration expected to be paid and discounted, based upon probability-weighted revenue projections, using unobservable market data inputs, which are Level 3 measurements. The significant assumptions used in these analyses at acquisition including projected annual cash flows, revenues and discount rates, are summarized as follows:
 
 
Projected Cash Flow Attrition, Net
 
Discount Rate
Amortizable intangible asset management contracts
 
(10.0)%
 
15.0%
 
 
 
 
 
 
 
Projected Revenue Growth Rates
 
Discount Rates
Contingent consideration
 
0% to 10% (weighted-average: 6%)
 
1.2% / 2.1%

Goodwill is principally attributable to synergies expected to arise with QS Investors.

As of September 30, 2016, the fair value of the contingent consideration liability was $7,258, which is included in non-current Contingent consideration in the Consolidated Balance Sheet. The decrease of $6,491 from March 31, 2016, reflects the payment discussed above, offset in part by accretion.

Financial Guard, LLC
On August 17, 2016, Legg Mason acquired 82% of the equity interests in Financial Guard, LLC ("Financial Guard"), an online registered investment advisor and technology-enabled wealth management and investment advice platform. The acquisition required an initial cash payment, which was funded with existing cash resources, and a contingent payment based on certain metrics. In connection with the acquisition, Legg Mason recognized certain business assets and goodwill of $11,995. Legg Mason also committed to contribute up to $5,000 of additional capital to Financial Guard, to be paid over the two year period following the acquisition.

Precidian Investments, LLC
On January 22, 2016, Legg Mason 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 Funds marketplace.

The transaction required a cash payment, which was funded from existing cash resources. Under the terms of the transaction, Legg Mason acquired series B preferred units of Precidian that entitle Legg Mason to approximately 20% of the voting and economic interests of Precidian, along with customary preferred equity protections. At its sole option during the 48 months following the initial investment, Legg Mason may, subject to satisfaction of certain closing conditions and upon payment of further consideration, convert its preferred units to 75% of the common equity of Precidian on a fully diluted basis.


21

Table of Contents

Legg Mason accounts for its investment in Precidian, which is included in Other assets in the Consolidated Balance Sheet as of September 30, 2016 and March 31, 2016, under the equity method of accounting.

Fauchier Partners Management, Limited
On March 13, 2013, Permal acquired all of the outstanding share capital of Fauchier Partners Management, Limited ("Fauchier"), a European based manager of funds-of-hedge funds. The initial purchase price was a cash payment of $63,433, which was funded from existing cash resources. In May 2015, Legg Mason paid contingent consideration of $22,765 for the second anniversary payment. Additional contingent consideration of up to approximately $25,959 (using the exchange rate as of September 30, 2016 for the £20,000 maximum contract amount), may be due on or about the fourth anniversary of closing, dependent on achieving certain levels of revenue, net of distribution costs.

As of September 30, 2016 and March 31, 2016, no contingent consideration liability was included in the Consolidated Balance Sheets, as no additional contingent consideration is expected to be paid.

4. Investments and Fair Values of Assets and Liabilities

The disclosures below include details of Legg Mason's financial assets and financial liabilities that are measured at fair value, excluding the financial assets and financial liabilities of CIVs. See Note 13, Variable Interest Entities and Consolidation of Investment Vehicles, for information related to the assets and liabilities of CIVs that are measured at fair value.

Effective April 1, 2016, Legg Mason adopted updated accounting guidance on fair value measurement which removed both the requirement to categorize within the fair value hierarchy and the requirement to provide related sensitivity disclosures for all investments for which fair value is measured using net asset value ("NAV") as a practical expedient. The amount of these investments is disclosed separately in the following tables as a reconciling item between investments included in the fair value hierarchy and investments reported in the Consolidated Balance Sheets. The updated guidance was adopted on a retrospective basis, therefore, the investment amounts for which fair value is measured using NAV as a practical expedient have been removed from the fair value hierarchy for all periods presented.


22

Table of Contents

The fair values of financial assets and (liabilities) of the Company were determined using the following categories of inputs:
 
 
As of September 30, 2016
 
 
Quoted prices in active markets
(Level 1)
 
Significant other observable inputs
(Level 2)
 
Significant unobservable inputs
(Level 3)
 
Investments measured at NAV(1)
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
Cash equivalents:(2)
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
243,835

 
$

 
$

 
$

 
$
243,835

Time deposits and other
 

 
22,839

 

 

 
22,839

Total cash equivalents
 
243,835

 
22,839

 

 

 
266,674

Trading investments of proprietary fund products and other trading investments:(3)
 
 
 
 
 
 
 
 
 
 

Seed capital investments
 
157,241

 
88,284

 

 
4,243

 
249,768

Other(4)
 
35,523

 
3,126

 

 
11

 
38,660

Trading investments relating to long-term incentive compensation plans(5)
 
144,468

 

 

 
781

 
145,249

Equity method investments relating to proprietary fund products and long-term incentive compensation plans:(6)
 
 
 
 
 
 
 
 
 


Seed capital investments
 

 
4,317

 

 

 
4,317

Investments related to long-term incentive compensation plans
 

 
5,963

 
2,653

 

 
8,616

Total current investments(7)
 
337,232

 
101,690

 
2,653

 
5,035

 
446,610

Equity method investments in partnerships and LLCs:(6)(8)
 
 
 
 
 
 
 
 
 
 
Seed capital investments(7)
 

 

 
552

 
39,616

 
40,168

Seed capital investments in real estate funds
 

 

 
25,722

 

 
25,722

Investments in partnerships and LLCs:(8)
 
 
 
 
 
 
 
 
 


Seed capital investments
 

 

 

 
3,417

 
3,417

Investments related to long-term incentive compensation plans
 

 

 
7,501

 

 
7,501

Other proprietary fund products
 

 
96

 
3,827

 

 
3,923

Derivative assets(8)(9)
 
277

 

 

 

 
277

Other investments(8)
 

 

 
245

 
35

 
280

Total
 
$
581,344

 
$
124,625

 
$
40,500

 
$
48,103

 
$
794,572

Liabilities:
 
 
 
 
 
 
 
 
 
 
Contingent consideration liabilities(10)
 
$

 
$

 
$
(52,053
)
 
$

 
$
(52,053
)
Derivative liabilities(8)
 
(5,744
)
 

 

 

 
(5,744
)
Total
 
$
(5,744
)
 
$

 
$
(52,053
)
 
$

 
$
(57,797
)


23

Table of Contents

 
 
As of March 31, 2016
 
 
Quoted prices in active markets
(Level 1)
 
Significant other observable inputs
(Level 2)
 
Significant unobservable inputs
(Level 3)
 
Investments measured at NAV(1)
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
Cash equivalents:(2)
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
1,057,916

 
$

 
$

 
$

 
$
1,057,916

Time deposits and other
 

 
35,265

 

 

 
35,265

Total cash equivalents
 
1,057,916

 
35,265

 

 

 
1,093,181

Trading investments of proprietary fund products and other trading investments:(3)
 
 
 
 
 
 
 
 
 
 
Seed capital investments
 
205,608

 
102,021

 
3

 
18,304

 
325,936

Other(4)
 
65,112

 
2,331

 

 
21

 
67,464

Trading investments relating to long-term incentive compensation plans(5)
 
105,568

 

 

 
996

 
106,564

Equity method investments relating to proprietary fund products and long-term incentive compensation plans:(6)
 
 
 
 
 
 
 
 
 


Seed capital investments
 
1,329

 
7,575

 

 

 
8,904

Investments related to long-term incentive compensation plans
 

 
6,467

 

 

 
6,467

Total current investments(7)
 
377,617


118,394

 
3

 
19,321

 
515,335

Equity method investments in partnerships and LLCs:(6)(8)
 
 
 
 
 
 
 
 
 
 
Seed capital investments
 

 

 
627

 
19,812

 
20,439

Other proprietary fund products
 

 

 

 
9,434

 
9,434

Investments in partnerships and LLCs:(8)
 
 
 
 
 
 
 
 
 
 
Investments related to long-term incentive compensation plans
 

 

 
7,501

 

 
7,501

Other proprietary fund products
 

 

 
4,807

 
3,124

 
7,931

Derivative assets(8)(9)
 
1,051

 
7,599

 

 

 
8,650

Other investments(8)
 

 

 
83

 

 
83

Total
 
$
1,436,584

 
$
161,258

 
$
13,021

 
$
51,691

 
$
1,662,554

Liabilities:
 
 
 
 
 
 
 
 
 
 
Contingent consideration liabilities(10)
 
$

 
$

 
$
(84,585
)
 
$

 
$
(84,585
)
Derivative liabilities(9)
 
(18,079
)
 

 

 

 
(18,079
)
Total
 
$
(18,079
)
 
$

 
$
(84,585
)
 
$

 
$
(102,664
)
(1)
Reflects certain investments measured at fair value using NAV (or its equivalent) as a practical expedient. These investments have not been classified in the fair value hierarchy.
(2)
Cash equivalents include highly liquid investments with original maturities of 90 days or less. Cash investments in actively traded money market funds are classified as Level 1.  Cash investments in time deposits and other are measured at amortized cost, which approximates fair value because of the short time between purchase of the instrument and its expected realization, and are classified as Level 2.
(3)
Trading investments of proprietary fund products and other trading investments consist of approximately 72% and 28% equity and debt securities, respectively, as of September 30, 2016, and approximately 68% and 32% equity and debt securities, respectively, as of March 31, 2016.
(4)
Includes $23,197 and $54,392 in noncontrolling interests associated with consolidated seed investment products as of September 30, 2016 and March 31, 2016, respectively.
(5)
Primarily mutual funds where there is minimal market risk to the Company as any change in value is primarily offset by an adjustment to compensation expense and related deferred compensation liability.
(6)
Legg Mason's equity method investments that are investment companies record underlying investments at fair value. Therefore, fair value is measured using Legg Mason's share of the investee's underlying net income or loss, which is predominately representative of fair value adjustments in the investments held by the equity method investee.
(7)
Excludes $34,272 and $13,641 of seed capital as of September 30, 2016, and March 31, 2016, respectively, which is related to Legg Mason's investments in CIVs. See Note 13.
(8)
Amounts are included in Other non-current assets in the Consolidated Balance Sheets for each of the periods presented.
(9)
See Note 12.
(10)
See Note 3 and Note 9.

Proprietary fund products include seed capital investments made by Legg Mason to fund new investment strategies and products. Legg Mason had seed capital investments in proprietary fund products, which totaled $357,664 and $368,920, as

24

Table of Contents

of September 30, 2016 and March 31, 2016, respectively, which are substantially comprised of investments in 65 funds and 63 funds, respectively, that are individually greater than $1,000, and together comprise over 90% of the total seed capital investments at each period end.

See Notes 2 and 13 for information regarding the determination of whether investments in proprietary fund products represent VIEs and consolidation.
The net realized and unrealized gain (loss) for investment securities classified as trading was $15,765 and $(31,460) for the three months ended September 30, 2016 and 2015, respectively, and $25,352 and $(27,431) for the six months ended September 30, 2016 and 2015, respectively.
The net unrealized gains (losses) relating to trading investments still held as of the reporting dates were $13,017 and $(32,755) for the three months ended September 30, 2016 and 2015, respectively, and $17,156 and $(43,165) for the six months ended September 30, 2016 and 2015, respectively.

25

Table of Contents

The changes in financial assets and (liabilities) measured at fair value using significant unobservable inputs (Level 3) for the three and six months ended September 30, 2016 and 2015, are presented in the tables below:
 
 
Balance as of June 30, 2016
 
Purchases
 
Sales
 
Redemptions/ Settlements/ Other
 
Transfers
 
Realized and unrealized gains/(losses), net
 
Balance as of September 30, 2016
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading investments of seed capital investments in proprietary fund products
 
$

 
$

 
$

 
$

 
$

 
$

 
$

Equity method investments relating to long-term incentive compensation plans
 
2,587

 
406

 

 
(406
)
 

 
66

 
2,653

Equity method investments in partnerships and LLCs:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Seed capital investments
 
644

 

 

 

 

 
(92
)
 
552

Seed capital investments in real estate funds
 
24,513

 
1,036

 

 
(307
)
 

 
480

 
25,722

Investments in partnerships and LLCs:
 
 
 
 
 
 
 
 
 
 
 
 
 


Investments related to long-term incentive compensation plans
 
7,501