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Section 1: 10-Q (LM 10-Q 9.30.2017)

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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, 2017
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
391028898_imageleggmasona07.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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth 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
 
Emerging growth company
 
 
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ____

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.
91,937,502 shares of common stock as of the close of business on November 6, 2017.


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, 2017
 
March 31, 2017
ASSETS
 
 
 
 
Current Assets
 
 
 
 
Cash and cash equivalents
 
$
654,234

 
$
733,709

Cash and cash equivalents of consolidated investment vehicles
 
2,475

 
651

Restricted cash
 
21,547

 
16,046

Receivables:
 
 
 
 
Investment advisory and related fees
 
439,859

 
433,192

Other
 
62,274

 
70,527

Investment securities
 
394,829

 
423,619

Investment securities of consolidated investment vehicles
 
104,259

 
49,901

Other
 
70,711

 
74,102

Other current assets of consolidated investment vehicles
 
1,368

 

Total Current Assets
 
1,751,556

 
1,801,747

Fixed assets, net
 
151,995

 
159,662

Intangible assets, net
 
4,000,511

 
4,034,380

Goodwill
 
1,931,351

 
1,924,889

Deferred income taxes
 
204,787

 
202,843

Other
 
145,929

 
156,907

Other assets of consolidated investment vehicles
 
9,536

 
9,987

TOTAL ASSETS
 
$
8,195,665

 
$
8,290,415

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 

LIABILITIES
 
 

 
 

Current Liabilities
 
 

 
 

Accrued compensation
 
$
391,295

 
$
486,679

Accounts payable and accrued expenses
 
173,739

 
181,793

Contingent consideration
 
18,982

 
22,316

Other
 
114,366

 
117,863

Other current liabilities of consolidated investment vehicles
 
636

 
736

Total Current Liabilities
 
699,018

 
809,387

Deferred compensation
 
99,303

 
87,757

Deferred income taxes
 
347,079

 
329,229

Contingent consideration
 
2,180

 
14,494

Other
 
133,275

 
138,737

Long-term debt, net
 
2,221,839

 
2,221,867

TOTAL LIABILITIES
 
3,502,694

 
3,601,471

Commitments and Contingencies (Note 8)
 
 
 
 
REDEEMABLE NONCONTROLLING INTERESTS
 
698,774

 
677,772

STOCKHOLDERS' EQUITY
 
 
 
 
Common stock, par value $.10; authorized 500,000,000 shares; issued 91,892,245 shares for September 2017 and 95,726,628 shares for March 2017
 
9,189

 
9,573

Additional paid-in capital
 
2,242,115

 
2,385,726

Employee stock trust
 
(21,726
)
 
(24,057
)
Deferred compensation employee stock trust
 
21,726

 
24,057

Retained earnings
 
1,789,298

 
1,694,859

Accumulated other comprehensive loss, net
 
(74,431
)
 
(106,784
)
Total stockholders' equity attributable to Legg Mason, Inc.
 
3,966,171

 
3,983,374

Nonredeemable noncontrolling interest
 
28,026

 
27,798

TOTAL STOCKHOLDERS' EQUITY
 
3,994,197

 
4,011,172

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
 
$
8,195,665

 
$
8,290,415

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,
 
 
2017
 
2016
 
2017
 
2016
OPERATING REVENUES
 
 
 
 
 
 
 
 
Investment advisory fees:
 
 
 
 
 
 
 
 
Separate accounts
 
$
253,128

 
$
233,328

 
$
503,174

 
$
460,181

Funds
 
393,035

 
377,079

 
775,263

 
740,542

Performance fees
 
40,821

 
41,970

 
122,358

 
59,429

Distribution and service fees
 
80,668

 
94,545

 
159,574

 
185,927

Other
 
686

 
1,448

 
1,811

 
2,456

Total Operating Revenues
 
768,338

 
748,370

 
1,562,180

 
1,448,535

OPERATING EXPENSES
 
 
 
 
 
 
 
 
Compensation and benefits
 
367,951

 
368,330

 
781,258

 
726,955

Distribution and servicing
 
123,634

 
128,868

 
245,983

 
253,531

Communications and technology
 
51,299

 
51,281

 
101,602

 
104,013

Occupancy
 
25,171

 
30,558

 
49,579

 
63,700

Amortization of intangible assets
 
6,082

 
6,271

 
12,421

 
11,974

Impairment charges
 

 

 
34,000

 

Contingent consideration fair value adjustments
 

 
(7,000
)
 
(16,550
)
 
(25,000
)
Other
 
49,782

 
42,429

 
102,263

 
112,174

Total Operating Expenses
 
623,919

 
620,737

 
1,310,556

 
1,247,347

OPERATING INCOME
 
144,419

 
127,633

 
251,624

 
201,188

NON-OPERATING INCOME (EXPENSE)
 
 
 
 
 
 
 
 
Interest income
 
1,572

 
1,545

 
3,040

 
3,393

Interest expense
 
(29,077
)
 
(27,925
)
 
(58,343
)
 
(52,490
)
Other income, net
 
7,289

 
9,975

 
18,677

 
16,560

Non-operating income of consolidated investment vehicles, net
 
2,094

 
5,206

 
3,091

 
8,434

Total Non-Operating Income (Expense)
 
(18,122
)
 
(11,199
)
 
(33,535
)
 
(24,103
)
INCOME BEFORE INCOME TAX PROVISION
 
126,297

 
116,434

 
218,089

 
177,085

Income tax provision
 
38,673

 
29,902

 
66,928

 
45,213

NET INCOME
 
87,624

 
86,532

 
151,161

 
131,872

Less: Net income attributable to noncontrolling interests
 
11,960

 
20,091

 
24,577


31,979

NET INCOME ATTRIBUTABLE TO LEGG MASON, INC.
 
$
75,664

 
$
66,441

 
$
126,584

 
$
99,893

 
 
 
 
 
 
 
 
 
NET INCOME PER SHARE ATTRIBUTABLE TO LEGG MASON, INC. SHAREHOLDERS:
 
 
 
 
 
 
 
 
Basic
 
$
0.78

 
$
0.63

 
$
1.30

 
$
0.94

Diluted
 
0.78

 
0.63

 
1.29

 
0.94

 
 
 
 
 
 
 
 
 
DIVIDENDS DECLARED PER SHARE
 
$
0.28

 
$
0.22

 
$
0.56

 
$
0.44

See Notes to Consolidated Financial Statements

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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,
 
 
2017
 
2016
 
2017
 
2016
NET INCOME
 
$
87,624

 
$
86,532

 
$
151,161

 
$
131,872

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
21,442

 
4,167

 
32,113

 
(13,023
)
Unrealized gains (losses) on interest rate swap:
 
 
 
 
 
 
 
 
Unrealized gains (losses) on interest rate swap, net of tax provision (benefit) of $181 and $(1,708) in 2016, respectively
 

 
289

 

 
(2,718
)
Reclassification adjustment for losses included in net income, net of tax benefit of $1,505 and $1,708 in 2016, respectively
 

 
2,394

 

 
2,718

Net unrealized gains (losses) on interest rate swap
 

 
2,683

 



Changes in defined benefit pension plan
 
121

 
(14,054
)
 
240

 
(19,159
)
Total other comprehensive income (loss)
 
21,563

 
(7,204
)
 
32,353

 
(32,182
)
COMPREHENSIVE INCOME
 
109,187

 
79,328

 
183,514

 
99,690

Less: Comprehensive income attributable to noncontrolling interests
 
10,483

 
18,152

 
22,767

 
32,038

COMPREHENSIVE INCOME ATTRIBUTABLE TO LEGG MASON, INC.
 
$
98,704

 
$
61,176

 
$
160,747

 
$
67,652

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,
 
 
2017
 
2016
STOCKHOLDERS' EQUITY ATTRIBUTABLE TO LEGG MASON, INC.
 
 
 
 
COMMON STOCK
 
 
 
 
Beginning balance
 
$
9,573

 
$
10,701

Stock options exercised
 
32

 
12

Deferred compensation employee stock trust
 
1

 
1

Stock-based compensation
 
89

 
37

Employee tax withholdings by settlement of net share transactions
 
(34
)
 
(36
)
Shares repurchased and retired
 
(472
)
 
(617
)
Ending balance
 
9,189

 
10,098

ADDITIONAL PAID-IN CAPITAL
 
 
 
 

Beginning balance
 
2,385,726

 
2,693,113

Stock options exercised
 
9,304

 
3,442

Deferred compensation employee stock trust
 
285

 
254

Stock-based compensation
 
38,994

 
43,773

Performance-based restricted share units related to the acquisition of Clarion Partners
 

 
11,121

Employee tax withholdings by settlement of net share transactions
 
(13,017
)
 
(11,766
)
Shares repurchased and retired
 
(179,177
)
 
(201,056
)
Redeemable noncontrolling interest reclassification for affiliate management equity plans
 

 
(3,632
)
Ending balance
 
2,242,115

 
2,535,249

EMPLOYEE STOCK TRUST
 
 
 
 

Beginning balance
 
(24,057
)
 
(26,263
)
Shares issued to plans
 
(286
)
 
(255
)
Distributions and forfeitures
 
2,617

 
1,067

Ending balance
 
(21,726
)
 
(25,451
)
DEFERRED COMPENSATION EMPLOYEE STOCK TRUST
 
 
 
 

Beginning balance
 
24,057

 
26,263

Shares issued to plans
 
286

 
255

Distributions and forfeitures
 
(2,617
)
 
(1,067
)
Ending balance
 
21,726

 
25,451

RETAINED EARNINGS
 
 
 
 

Beginning balance
 
1,694,859

 
1,576,242

Net Income Attributable to Legg Mason, Inc.
 
126,584

 
99,893

Dividends declared
 
(54,177
)
 
(46,039
)
Reclassifications to noncontrolling interest for:
 
 
 
 
EnTrustPermal combination
 

 
(15,500
)
Net increase in estimated redemption value of affiliate management equity plans and affiliate noncontrolling interests
 
(2,295
)
 
(1,721
)
Adoption of new stock-based compensation guidance
 
24,327

 

Ending balance
 
1,789,298

 
1,612,875

ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS), NET
 
 
 
 

Beginning balance
 
(106,784
)
 
(66,493
)
Changes in defined benefit pension plan
 
240

 
(19,159
)
Foreign currency translation adjustment
 
32,113

 
(13,023
)
Ending balance
 
(74,431
)
 
(98,675
)
TOTAL STOCKHOLDERS’ EQUITY ATTRIBUTABLE TO LEGG MASON, INC.
 
3,966,171


4,059,547

NONREDEEMABLE NONCONTROLLING INTEREST
 
 
 
 
Beginning balance
 
27,798

 
22,202

Net income attributable to noncontrolling interests
 
4,291

 
3,707

Distributions
 
(4,063
)
 
(2,723
)
Ending balance
 
28,026

 
23,186

TOTAL STOCKHOLDERS’ EQUITY
 
$
3,994,197

 
$
4,082,733

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,
 
 
2017
 
2016
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
 
Net Income
 
$
151,161

 
$
131,872

Adjustments to reconcile Net Income to net cash provided by operations:
 
 
 
 
Impairments of intangible assets
 
34,000

 

Depreciation and amortization
 
36,634

 
40,342

Accretion and amortization of securities discounts and premiums, net
 
1,670

 
2,097

Stock-based compensation, including $15,200 related to Clarion Partners affiliate management equity plan in 2016
 
39,531

 
54,981

Net unrealized gains on investments
 
(10,800
)
 
(21,382
)
Net (gains) losses and earnings on investments
 
(7,037
)
 
3,391

Net gains of consolidated investment vehicles
 
(3,091
)
 
(8,434
)
Deferred income taxes
 
51,194

 
30,307

Contingent consideration fair value adjustments
 
(16,550
)
 
(25,000
)
Other
 
(272
)
 
500

Decrease (increase) in assets:
 
 
 
 
Investment advisory and related fees receivable
 
(4,978
)
 
(17,298
)
Net sales of trading and other investments
 
32,520

 
25,002

Other receivables
 
9,207

 
(4,030
)
Other assets
 
11,456

 
(11,290
)
Assets of consolidated investment vehicles
 
(32,924
)
 
56,672

Increase (decrease) in liabilities:
 
 
 
 
Accrued compensation
 
(96,720
)
 
(102,908
)
Deferred compensation
 
11,386

 
22,092

Accounts payable and accrued expenses
 
(9,301
)
 
(3,423
)
Other liabilities
 
(21,237
)
 
(37,733
)
Other liabilities of consolidated investment vehicles
 
(100
)
 
2,101

CASH PROVIDED BY OPERATING ACTIVITIES
 
$
175,749

 
$
137,859











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Table of Contents

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


 
 
Six Months Ended September 30,
 
 
2017
 
2016
CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
 

Payments for fixed assets
 
$
(15,846
)
 
$
(18,684
)
Business investments and acquisitions, net of cash acquired of $33,547 in 2016
 
(2,250
)
 
(1,009,928
)
Contingent payment from prior sale of business
 
2,561

 

Change in restricted cash
 
(5,103
)
 
436

Returns of capital and proceeds from sales and maturities of investments
 
5,506

 
2,436

CASH USED IN INVESTING ACTIVITIES
 
(15,132
)
 
(1,025,740
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
 
Repurchases of common stock
 
(179,649
)
 
(201,673
)
Dividends paid
 
(47,639
)
 
(44,103
)
Distributions to affiliate noncontrolling interests
 
(27,076
)
 
(13,061
)
Net subscriptions/(redemptions) attributable to noncontrolling interests
 
19,624


(39,469
)
Employee tax withholdings by settlement of net share transactions
 
(13,051
)
 
(11,802
)
Issuances of common stock for stock-based compensation
 
9,622

 
3,709

Proceeds from issuance of long-term debt
 

 
500,000

Net decrease in short-term borrowings
 

 
(40,000
)
Debt issuance costs
 

 
(17,639
)
Payment of contingent consideration
 

 
(6,587
)
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
 
(238,169
)
 
129,375

EFFECT OF EXCHANGE RATES ON CASH
 
(1,923
)
 
248

NET DECREASE IN CASH AND CASH EQUIVALENTS
 
(79,475
)
 
(758,258
)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
 
733,709

 
1,329,126

CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
654,234

 
$
570,868

SUPPLEMENTAL DISCLOSURE
 
 
 
 
Cash paid for:
 
 
 
 
Income taxes, net of refunds of $9,505 and $754, respectively
 
$
7,277

 
$
11,025

Interest
 
56,670

 
45,485

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, 2017
(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, including amounts for Contingent consideration fair value adjustments in the Consolidated Statements of Income, cash flows and changes in equity.

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 Non-Operating Income (Expense) and reflected in Net income 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. 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, the products with “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, 2017, March 31, 2017, and September 30, 2016, 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

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Under consolidation accounting 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. Market-based fees are those fees which are both customary and commensurate with the level of effort required for the services provided. 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.

Legg Mason concluded it was the primary beneficiary of three foreign mutual fund VIEs as of each September 30, 2017 and March 31, 2017, and of six foreign mutual fund VIEs as of September 30, 2016, which were consolidated and designated as CIVs, because it held significant financial interests in these funds. Legg Mason also concluded it was the primary beneficiary of two sponsored investment fund VIEs, and one employee-owned fund that it sponsors, as of each September 30, 2017, March 31, 2017, and September 30, 2016, which were also consolidated and designated as CIVs.

On July 26, 2017, Legg Mason entered into four total return swap arrangements with financial intermediaries with respect to one Legg Mason sponsored exchange traded fund ("ETF") which resulted in investments in the ETF by those intermediaries in the aggregate amount of $23,096. Similarly, on June 6, 2017, Legg Mason entered into four total return swap arrangements with financial intermediaries with respect to another Legg Mason sponsored ETF, which resulted in investments in the ETF by those financial intermediaries in the aggregate amount of $20,253. See Note 12 for additional information regarding the total return swaps. Under the terms of the total return swaps, Legg Mason absorbs all gains and losses on the underlying ETF investments of these financial intermediaries, and therefore has variable interests in each of the two related funds, and is deemed to be the primary beneficiary. As such, each of the two underlying sponsored investment funds were consolidated and designated CIVs as of September 30, 2017.

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

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 Contingent consideration fair value adjustments 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 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. Changes in the expected settlement values are recognized over the settlement period as adjustments 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

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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 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.

Derivative Instruments
As noted above, on July 26, 2017, Legg Mason entered into four total return swap arrangements with financial intermediaries with respect to one Legg Mason sponsored ETF for an aggregate notional amount of $23,096 which resulted in investments in the ETF by each of those financial intermediaries. Similarly, on June 6, 2017, Legg Mason entered into four total return swap arrangements with financial intermediaries with respect to another Legg Mason sponsored ETF for an aggregate notional amount of $20,253, which resulted in investments in that ETF by each of those financial intermediaries. As of September 30, 2017, the aggregate notional amounts related to these total return swap arrangements totaled $44,464. The total return swap arrangements qualify as derivative instruments and are not designated for hedge accounting. In connection with the arrangements, Legg Mason also executed futures contracts to partially hedge the market risk related to the total return swap arrangements.

See Notes 4, 12, and 13 for additional information.

Stock-Based Compensation
Effective April 1, 2017, Legg Mason adopted updated accounting guidance on stock-based compensation accounting. The updated guidance simplifies several aspects of accounting for stock-based compensation including the income tax consequences, and clarifies classification criteria for awards as either equity or liabilities, and the classification of related amounts in statements of cash flows. The updated guidance requires all excess tax benefits and deficiencies associated with stock-based compensation to be recognized as discrete items in the Income tax provision in the Consolidated Statements of Income in the reporting period in which they occur, thereby increasing the volatility of the Income tax provision as a result of fluctuations in Legg Mason's stock price. Legg Mason adopted this amendment on a modified retrospective basis, and recorded a cumulative-effect adjustment of $24,327 as an increase to both deferred tax assets and Retained earnings on the Consolidated Balance Sheet as of April 1, 2017. These tax benefits were not previously recognized due to Legg Mason's cumulative tax loss position. In addition, Legg Mason recorded a related discrete Income tax expense of $214 and $1,120 during the three and six months ended September 30, 2017, respectively, for vested stock awards with a grant date exercise price higher than the related vesting date stock price, as this aspect of the guidance was adopted on a prospective basis. Upon adoption of the updated guidance, Legg Mason elected to prospectively account for forfeitures as they occur, which did not have a material impact on the Consolidated Financial Statements. Also, cash flows related to income tax deductions in excess of or less than the related stock-based compensation expense will be classified as Cash Flows from Operating Activities in the Consolidated Statements of Cash Flows.

Accumulated Other Comprehensive Loss, Net
There were no significant amounts reclassified from Accumulated other comprehensive loss, net, to the Consolidated Statements of Income, except as follows. During the three months and six months ended September 30, 2017, $121 and $240, respectively, of previously unrecognized losses on a defined benefit pension plan were reclassified and expensed as further described in Note 3, and during the three and six months ended September 30, 2016, $3,899 and $4,426, respectively, realized on the settlement of an interest rate swap was reclassified and expensed, as further described in Note 7.

Income Taxes
Noncontrolling interests in EnTrustPermal Group Holdings, LLC ("EnTrustPermal"), Clarion Partners, LLC ("Clarion Partners") and Royce & Associates ("Royce") are structured as partnerships that pass an allocable portion of tax attributes

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and obligations 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 a reduction in the effective tax rate of 2.8 percentage points and 6.7 percentage points for the three months ended September 30, 2017 and 2016, respectively, and 3.6 percentage points and 4.4 percentage points for the six months ended September 30, 2017 and 2016, respectively.

In connection with the adoption of updated accounting guidance on stock-based compensation accounting discussed above, Legg Mason recorded a discrete income tax expense of approximately $214 and $1,120 during the three and six months ended September 30, 2017, respectively, which increased the effective tax rate by 0.2 percentage point and 0.5 percentage points, 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.

Recent Accounting Developments
In August 2017, the Financial Accounting Standards Board ("FASB") updated the guidance on accounting for derivative hedging. The updated guidance more closely aligns the results of cash flow and fair value hedging designations with risk management activities through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results in the financial statements.  The new guidance also simplifies the application of hedge accounting.  The updated guidance is effective for Legg Mason in fiscal 2020, unless adopted earlier.  Legg Mason only uses accounting hedge designation from time-to-time and would only be impacted if derivative transactions were designated for hedging.

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 for Legg Mason in fiscal 2020. Legg Mason expects to recognize right of use assets and liabilities upon its adoption of the new standard and is continuing to evaluate the full impact of its adoption.

In May 2014, the FASB updated the guidance on revenue recognition. The updated guidance provides a single, comprehensive revenue recognition model for all contracts with customers, improves comparability and removes inconsistencies in revenue recognition practices across entities, industries, jurisdictions, and capital markets. The guidance also requires comprehensive disclosures about the nature, timing, and uncertainty of revenue and cash flows arising from contracts with customers, including significant judgments made in applying the guidance. 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. Legg Mason has reviewed its revenue contracts, and is monitoring relevant implementation guidance. Legg Mason does not anticipate any significant changes to current revenue recognition practices, except as discussed below. Legg Mason may be required to recognize longer-term performance and incentive fees subject to clawback when clawback is not reasonably possible. This is earlier than under its current revenue recognition process, which defers recognition until all contingencies are resolved. Additionally, Legg Mason is evaluating whether certain separate account commissions currently expensed when paid meet the criteria for capitalization and amortization. Legg Mason is also evaluating whether revenue-related costs currently presented on a gross basis will be recorded net, or vice versa. The evaluation of the effect of this guidance is ongoing, and Legg Mason has not determined the ultimate impact of the adoption or the transition method to be used upon adoption, which is effective for Legg Mason on April 1, 2018.



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3. Acquisitions

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
 
Clarion Partners
 
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

(1) 

 

 

 

Total consideration
 
540,000

 
642,597

 
238,739

 
277,788

 
24,370

Fair value of noncontrolling interests
 
247,700

(1) 
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)
Post combination EnTrustPermal noncontrolling interest of $403,200 also included a fair value reclassification of $15,500 from retained earnings at the time of the acquisition.

EnTrust Capital
On May 2, 2016, Legg Mason acquired EnTrust Capital ("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 of the combined entity, after appropriate discounts for lack of marketability and control.


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The fair value of the acquired amortizable intangible asset management contracts had 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, respectively, during the three and six months ended September 30, 2016.

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 did not have a material impact on Net Income Attributable to Legg Mason, Inc.

In connection with the combination of EnTrust and Permal, Legg Mason incurred total charges for restructuring and transition costs of $89,001 through September 30, 2017, which includes $1,358 and $3,920, respectively, recognized during the three and six months ended September 30, 2017. These costs were primarily comprised of charges for employee termination benefits, including severance and retention incentives, which were recorded as Compensation and benefits, in the Consolidated Statements of Income, and real estate related charges, which were recorded as Occupancy, in the Consolidated Statements of Income. While the combination is substantially complete, Legg Mason expects to incur additional costs totaling $2,000 to $3,000 during the remainder of fiscal 2018 and fiscal 2019.


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The table below presents a summary of changes in the restructuring and transition-related liability from December 31, 2015 through September 30, 2017, 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
 
22,891

 
11,075

(1)
33,966

Payments
 
(29,211
)
 
(12,408
)
 
(41,619
)
Balance as of March 31, 2017
 
3,323

 
6,551

 
9,874

Accrued charges
 
1,379

 
437

 
1,816

Payments
 
(4,560
)
 
(2,664
)
 
(7,224
)
Balance as of September 30, 2017
 
$
142

 
$
4,324

 
$
4,466

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

 
$
1,143

 
$
1,734

   Year ended March 31, 2017
 
4,423

 
3,396

 
7,819

   Six months ended September 30, 2017
 
2,100

 
4

 
2,104

Total
 
$
7,114

 
$
4,543

 
$
11,657

 
 
 
 
 
 
 
Cumulative charges incurred through September 30, 2017
 
$
62,965

 
$
26,036

 
$
89,001

(1) Includes lease loss reserve for space permanently abandoned of $9,069 for the year ended March 31, 2017, 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 to employees as compensation, 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
%


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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.

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 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, for the initial period of the acquisitions as if each acquisition had occurred on 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, excludes projected cost savings, 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, 2016
 
Six Months Ended September 30, 2016
Revenues
 
$
748,370

 
$
1,465,886

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

 
143,587

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

 
$
1.35

Diluted
 
0.71

 
1.35


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 a continuing corporate 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 credit facility, as well as existing cash resources. In addition, contingent consideration may be due March 31, 2018, of up to $83,174 (using

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the foreign exchange rate as of September 30, 2017, 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 transaction also provided for a potential contingent payment as of March 31, 2017, however no such payment was due based on relevant net revenue targets.

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 of RARE Infrastructure, after appropriate discounts for lack of marketability and control.

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 was principally attributable to synergies expected to arise with RARE Infrastructure.

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%

During the three months ended June 30, 2017, the amortizable intangible asset management contracts asset and the trade name indefinite-life intangible asset were impaired by $32,000 and $2,000, respectively. See Note 6 for additional information.

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, 2017, the fair value of the contingent consideration liability was $2,180, a decrease of $15,264 from March 31, 2017. During the three months ended June 30, 2017, reductions in projected AUM and revenues attributable in part to a large outflow during the quarter resulted in a $15,250 reduction in the estimated contingent consideration liability, recorded as a credit to Contingent consideration fair value adjustments in the Consolidated Statement of Income. The remaining decrease during the six months ended September 30, 2017 of $14 is attributable to changes in the exchange rate, which is included in Accumulated other comprehensive loss, net, as Foreign currency translation adjustment, net of accretion. The total contingent consideration liability was included in non-current Contingent consideration in the Consolidated Balance Sheet as of September 30, 2017. As of March 31, 2017, the contingent

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consideration liability totaled $17,444, of which $7,791 was included in current Contingent consideration in the Consolidated Balance Sheet, with the remaining $9,653 included in non-current Contingent consideration. The contingent consideration liability was recorded at an entity with an Australian dollar functional currency, such that related changes in the exchange rate do not impact net income.

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, a contingent consideration payment may be due March 31, 2018, following the third anniversary of closing, of up to approximately $435,884 (using the foreign exchange rate as of September 30, 2017 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, 2018, as specified in the share purchase agreement. The agreement also provided for potential first and second anniversary contingent payments as of March 31, 2016 and 2017, respectively, however no such payments were 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, 2017, the fair value of the contingent consideration liability was $12,858, an increase of $840 from March 31, 2017, which was attributable to changes in the exchange rate, which is included in Accumulated other comprehensive loss, net, as Foreign currency translation adjustment. The contingent consideration liability was included in current Contingent consideration in the Consolidated Balance Sheet as of September

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30, 2017 and March 31, 2017, and recorded at an entity with a British pound functional currency, such that related changes in the exchange rate do not impact net income.

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 65% equities (Level 1), 34% bonds (Level 2) and 1% cash (Level 1) as of September 30, 2017, and 65% equities (Level 1) and 35% bonds (Level 2) as of March 31, 2017. Assumptions used to determine the expected return on plan assets targets a 60% / 40% 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, 2017. The most recent actuarial valuation was performed as of May 31, 2013, which was updated through the acquisition and at subsequent balance sheet dates through March 31, 2017. 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 and benefits expense over the recovery period of 15 years. During the three and six months ended September 30, 2017, $121 and $240, respectively, of such previously unrecognized losses were expensed under the corridor approach.
 
The resulting net benefit obligation, comprised as follows, is included in the September 30, 2017 and March 31, 2017, Consolidated Balance Sheets as Other non-current liabilities:
 
 
September 30, 2017
 
March 31, 2017
Fair value of plan assets (at 5.4% expected weighted-average long-term return)
 
$
64,071

 
$
59,623

Benefit obligation (at 2.7% discount rate)
 
(101,999
)
 
(97,137
)
Unfunded status (excess of benefit obligation over plan assets)
 
$
(37,928
)
 
$
(37,514
)

For the three months ended September 30, 2017 and 2016, a net periodic benefit cost of $26 and $10, respectively, and for the six months ended September 30, 2017 and 2016, a net periodic benefit cost of $51 and $38, respectively, was included in Compensation and benefits expense in the Consolidated Statements of Income. Net actuarial losses of $17,619 and $16,681 were included in Accumulated other comprehensive loss, net, in the Consolidated Balance Sheets at September 30, 2017 and March 31, 2017, 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.

In connection with a review by the Pensions Regulator in the U.K. ("the Regulator") of the pension plan's current structure and funding status, Martin Currie, the trustees of the pension and the Regulator have agreed to a revised plan structure, including the redomiciliation of the plan in the U.K., additional guarantees and, following the application of any contingent consideration payments toward the pension deficit, provisions for accelerated funding of a portion of any remaining benefit obligation in certain circumstances. Absent funding from contingent consideration payments, Martin Currie does not expect to contribute any additional amounts in fiscal 2018 to the plan in excess of the $1,919 contributed during the three months ended June 30, 2017.

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.


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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 $2,500 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. Goodwill is principally attributable to synergies expected to arise with QS Investors.

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%

As of September 30, 2017, the fair value of the contingent consideration liability was $3,624, a decrease of $1,217 from March 31, 2017. During the three months ended June 30, 2017, a reduction in projected net revenue resulted in a $1,300 reduction in the estimated contingent consideration liability, recorded as a credit to Contingent consideration fair value adjustments in the Consolidated Statement of Income. The reduction was offset in part by an increase of $83 attributable to accretion. The contingent consideration liability was included in current Contingent consideration in the Consolidated Balance Sheet as of September 30, 2017 and non-Current Contingent consideration in the Consolidated Balance Sheet as of March 31, 2017.
 

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 potential contingent payment of up to $3,000 based on certain metrics within the first year after the acquisition. No contingent payment was due based on relevant 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 working capital to Financial Guard, to be paid over the two-year period following the acquisition, of which $2,500 has been paid as of September 30, 2017. As March 31, 2017, no contingent consideration liability was recorded in the Consolidated Balance Sheet.

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 ETF 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

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economic interests of Precidian, along with customary preferred equity protections. At its sole option during the 48 months following the initial investment or, if earlier, within nine months of the SEC's approval of Precidian's application to operate its active shares product. 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.

Legg Mason accounts for its investment in Precidian, which is included in Other assets in the Consolidated Balance Sheets as of September 30, 2017 and March 31, 2017, under the equity method of accounting.

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 and NAV, 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.

The fair values of financial assets and (liabilities) of the Company were determined using the following categories of inputs:
 
 
As of September 30, 2017
 
 
Quoted prices in active markets
(Level 1)
 
Significant other observable inputs
(Level 2)
 
Significant unobservable inputs
(Level 3)
 
Investments measured at NAV
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
Cash equivalents:(1)
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
322,454

 
$

 
$

 
$

 
$
322,454

Time deposits and other
 

 
12,179

 

 

 
12,179

Total cash equivalents
 
322,454

 
12,179

 

 

 
334,633

Trading investments of proprietary fund products and other trading investments:(2)
 
 
 
 
 
 
 
 
 
 

Seed capital investments
 
110,637

 
69,475

 

 
4,166

 
184,278

Other(3)
 
19,434

 
2,581

 

 
11

 
22,026

Trading investments relating to long-term incentive compensation plans(4)
 
179,821

 

 

 
103

 
179,924

Equity method investments relating to long-term incentive compensation plans(5)
 

 

 
1,393

 
7,208

 
8,601

Total current investments(6)
 
309,892

 
72,056

 
1,393

 
11,488

 
394,829

Equity method investments in partnerships and LLCs:(5)(7)
 
 
 
 
 
 
 
 
 
 
Seed capital investments(6)
 

 

 
851

 
22,646

 
23,497

Seed capital investments in real estate funds
 

 

 
27,382

 

 
27,382

Other
 

 

 

 
13,598

 
13,598

Investments in partnerships and LLCs:(7)
 
 
 
 
 
 
 
 
 


Seed capital investments
 

 

 

 
3,371

 
3,371

Investments related to long-term incentive compensation plans
 

 

 
9,367

 

 
9,367

Other
 

 
99

 
485

 

 
584

Derivative assets(7)(8)
 
5,109

 

 

 

 
5,109

Other investments(7)
 

 

 
114

 

 
114

Total
 
$
637,455

 
$
84,334

 
$
39,592

 
$
51,103

 
$
812,484

Liabilities:
 
 
 
 
 
 
 
 
 
 
Contingent consideration liabilities(9)
 
$

 
$

 
$
(21,162
)
 
$

 
$
(21,162
)
Derivative liabilities(8)
 
(3,167
)
 

 

 

 
(3,167
)
Total
 
$
(3,167
)
 
$

 
$
(21,162
)
 
$

 
$
(24,329
)

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As of March 31, 2017
 
 
Quoted prices in active markets
(Level 1)
 
Significant other observable inputs
(Level 2)
 
Significant unobservable inputs
(Level 3)
 
Investments measured at NAV
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
Cash equivalents:(1)
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
403,585

 
$

 
$

 
$

 
$
403,585

Time deposits and other
 

 
35,835

 

 

 
35,835

Total cash equivalents
 
403,585

 
35,835

 

 

 
439,420

Trading investments of proprietary fund products and other trading investments:(2)
 
 
 
 
 
 
 
 
 
 
Seed capital investments
 
141,025

 
75,275

 

 
4,373

 
220,673

Other(3)
 
39,177

 
2,724

 

 
11

 
41,912

Trading investments relating to long-term incentive compensation plans(4)
 
150,576

 

 

 
327

 
150,903

Equity method investments relating to proprietary fund products and long-term incentive compensation plans:(5)
 
 
 
 
 
 
 
 
 


Seed capital investments
 

 
2,502

 

 

 
2,502

Investments related to long-term incentive compensation plans
 

 

 
1,337

 
6,292

 
7,629

Total current investments(6)
 
330,778


80,501

 
1,337

 
11,003

 
423,619

Equity method investments in partnerships and LLCs:(5)(7)
 
 
 
 
 
 
 
 
 
 
Seed capital investments(6)
 

 

 
752

 
22,712

 
23,464

Seed capital investments in real estate funds
 

 

 
26,909

 

 
26,909

Other
 

 

 
1,646

 
15,617

 
17,263

Investments in partnerships and LLCs:(7)
 
 
 
 
 
 
 
 
 
 
Seed capital investments
 

 

 

 
3,440

 
3,440

Investments related to long-term incentive compensation plans
 

 

 
9,315

 

 
9,315

Other
 

 
99

 
1,825

 

 
1,924

Derivative assets(7)(8)
 
2,718

 

 

 

 
2,718

Other investments(7)
 

 

 
113

 

 
113

Total
 
$
737,081

 
$
116,435

 
$
41,897

 
$
52,772

 
$
948,185

Liabilities:
 
 
 
 
 
 
 
 
 
 
Contingent consideration liabilities(9)
 
$

 
$

 
$
(36,810
)
 
$

 
$
(36,810
)
Derivative liabilities(8)
 
(4,522
)
 

 

 

 
(4,522
)
Total
 
$
(4,522
)
 
$

 
$
(36,810
)
 
$

 
$
(41,332
)
(1)
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.
(2)
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, 2017, and approximately 79% and 21% equity and debt securities, respectively, as of March 31, 2017.
(3)
Includes $6,753 and $26,854 in noncontrolling interests associated with consolidated seed investment products as of September 30, 2017 and March 31, 2017, respectively.
(4)
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.
(5)
Certain of Legg Mason's equity method investments are investment companies that record underlying investments at fair value. Therefore, the fair value of these investments 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. Other equity method investments not measured at fair value on a recurring basis are excluded from the tables above.
(6)
Excludes $40,775 and $28,300 of seed capital as of September 30, 2017, and March 31, 2017, respectively, which is related to Legg Mason's investments in CIVs. See Note 13.
(7)
Amounts are included in Other non-current assets in the Consolidated Balance Sheets for each of the periods presented.
(8)
See Note 12.
(9)
See Note 3 and Note 9.


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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 $279,303 and $305,288, as of September 30, 2017 and March 31, 2017, respectively, which are substantially comprised of investments in 54 funds and 57 funds, respectively, that are individually greater than $1,000, and together comprise over 90% of the total seed capital investments at each period end.

As further discussed in Notes 2, 12, and 13, on July 26, 2017, Legg Mason entered into four total return swap arrangements with financial intermediaries with respect to one Legg Mason sponsored ETF for an aggregate notional amount of $23,096 which resulted in the investment in the ETF by each of these financial intermediaries. Similarly, on June 6, 2017, Legg Mason entered into four total return swap arrangements with financial intermediaries with respect to another Legg Mason sponsored ETF for an aggregate notional amount of $20,253 which resulted in the investment in that ETF by each of those financial intermediaries. Under the terms of the total return swap arrangements, Legg Mason receives all the investment gains and losses on the underlying investments and therefore is required to consolidate each of the sponsored investment funds, which were designated as CIVs.

See Notes 2 for information regarding the determination of whether investments in proprietary fund products represent VIEs and consolidation.
The net realized and unrealized gain for investment securities classified as trading was $12,633, and $15,765 for the three months ended September 30, 2017 and 2016, respectively, and $22,802, and $25,352 for the six months ended September 30, 2017 and 2016, respectively.
The net unrealized gains relating to trading investments still held as of the reporting dates were $8,072 and $13,017 for the three months ended September 30, 2017 and 2016, respectively, and $10,140 and $17,156 for the six months ended September 30, 2017 and 2016, respectively.

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The changes in financial assets and (liabilities) measured at fair value using significant unobservable inputs (Level 3) for three and the six months ended September 30, 2017 and 2016, are presented in the tables below:
 
 
Balance as of June 30, 2017
 
Purchases
 
Sales
 
Redemptions/ Settlements/ Other
 
Transfers
 
Realized and unrealized gains/(losses), net
 
Balance as of September 30, 2017
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity method investments relating to long-term incentive compensation plans
 
$
1,349

 
$
11

 
$

 
$
(11
)
 
$

 
$
44

 
$
1,393

Equity method investments in partnerships and LLCs:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Seed capital investments
 
813

 

 

 

 

 
38

 
851

Seed capital investments in real estate funds
 
27,182

 
1,756

 

 
(2,131
)
 

 
575

 
27,382

Other proprietary fund products
 
1,646

 

 

 
(1,646
)