Filed with the SEC from Sep 13 to Sep 19:
Gain Capital Holdings (GCAP)
Discovery Equity Partners disclosed that it owns 1,826,900 shares (5.2%) after it bought 234,896 shares from Aug. 6 through Sept. 13 at prices from $4.49 to $4.99 per share. Discovery said it acquired the shares because it believes "that the trading prices of the common stock do not adequately reflect the potential value of the Company's underlying business and assets." The investment group added that it has had discussions with management regarding Gain's "operations, strategic direction, and valuation in the public market" and reiterated its "desire for the Company to pursue all appropriate strategic and financial alternatives to increase shareholder value."
We are a global provider of online trading services, specializing in global over-the-counter, or OTC, markets, including spot foreign exchange, or forex, and precious metals, as well as â€ścontracts-for-difference â€ť, or CFDs, which are investment products with returns linked to the performance of an underlying commodity, index or security. We have customers residing in more than 140 countries worldwide and conduct business from our offices in New York City, Bedminster, New Jersey, London, Tokyo, Sydney, Beijing, Hong Kong, Seoul and Singapore.
We service retail investors through our FOREX.com brand and institutional investors through our GAIN GTX offering. We also offer retail customers the ability to trade exchange-traded products through our wholly-owned subsidiary, GAIN Securities. We have invested considerable resources in developing our retail and institutional trading platforms and tools to allow our customers to trade and manage their accounts. While our retail and institutional businesses use separate platforms, we are able to leverage our combined scale and trading volume in our relationships with our wholesale trading partners, bank liquidity providers, and other service providers. In addition, we believe the two platforms complement each other, which allows us to cross-sell our services and to leverage our facilities and the technology we develop. Our customers can trade through web-based, downloadable and mobile trading platforms and have access to innovative trading tools to assist them with research, automated trading and account management.
Our Retail Business
Through FOREX.com we provide our retail customers around the world with access to a variety of global OTC financial markets, including forex, precious metals and CFDs on commodities and indices. Because of U.S. regulatory requirements, neither we nor our subsidiaries offer CFDs in the United States or to U.S. residents. We provide our customers with what we believe to be one of the most robust online forex and CFD trading services in the industry, allowing customers to monitor multiple markets around the world simultaneously and to execute trades quickly and at a low cost from a single trading account. Today, we provide liquidity in 77 OTC markets, including 58 currency pairs, 10 equity indices, and 9 commodities. Since our retail products are offered OTC, we act as a counterparty for our customersâ€™ transactions. Our retail business represented 96.9% of our consolidated net revenue for the year ended December 31, 2011.
We have been developing our FOREX.com retail offering for more than a decade, and have grown to support over 350,000 accounts worldwide as of the year ended December 31, 2011. Due to the global nature of our business, we have invested considerable resources to make our products and services available in multiple languages, which today includes English, German, Chinese, Japanese, Russian and Arabic and to allow our customers to fund their accounts in six different currencies.
In April 2011, we significantly added to our retail business through the acquisition of the customer account balances and effective customer agreements of Deutsche Bank AGâ€™s dbFX retail foreign exchange business. The agreement also provided for the referral of retail forex clients from Deutsche Bank to us over the two-year period following the closing of the transaction.
As an OTC forex and CFD broker, when a retail customer executes a trade with us, the trade may be naturally hedged against an offsetting trade from another customer, hedged through an offsetting trade with one of our wholesale trading partners or may become part of our net exposure portfolio. For naturally hedged trades, we receive the entire bid/offer spread we offer our customers on the two offsetting transactions. For immediately offset trades, we earn the difference between the retail bid/offer spread we offer our customers and the wholesale bid/offer spread we receive from our wholesale trading partners. Customer trades in our net exposure portfolio are managed pursuant to our risk-management policies and procedures, including risk limits established by the Risk Committee of our Board of Directors, and we receive the net gains or losses generated through the management of our net exposure.
We believe that our proprietary trading technology has and will continue to provide us with a significant competitive advantage because we have the ability to adapt quickly to our customersâ€™ changing needs and rapidly incorporate new products and features.
Competitive pricing and fast, accurate trade execution
We have leveraged our extensive experience in the global OTC markets to develop highly automated processes, which allows us to deliver tight bid/offer spreads generally reflective of currently available pricing in the markets we trade, and to execute our customersâ€™ trades quickly and efficiently.
We have relationships with a large number of the most prominent forex liquidity providers, which we believe allows us to offer our customers more competitive pricing with tighter bid/offer spreads than many of our competitors. In addition, we have developed a proprietary pricing engine, which electronically aggregates quotes from our liquidity sources based on the midpoint price between the available â€śbest bidâ€ť and â€śbest offerâ€ť and allows us to provide our customers with real-time quotes without reliance on third-party pricing providers.
Our trading processes enable us to execute trades, in most cases, in under a second. We have established a set of standards we use to measure execution quality and we publish execution statistics on a quarterly basis. The FOREX.com execution scorecard, which is available on our website, demonstrates our ability to provide fast, accurate trade executions, as well as our commitment to transparency in our business. In 2011, we handled over 39 million trade requests and executed 99.9% of trades in less than one second, with an average execution speed of .07 seconds. We believe we are the only firm in our industry to voluntarily publish a monthly execution scorecard with the level of detail that we provide.
Sophisticated risk management
Because we are exposed to market and credit risk in connection with our retail trading activities, robust risk management capabilities is a high priority.
Our risk management policies and procedures have been developed to enable us to effectively manage our exposure to market risk, particularly in connection with the management of our net exposure. Our net exposure is evaluated each second and is continuously rebalanced throughout the trading day, thereby minimizing the risk we will be adversely affected by changes in the market prices of the products we hold. This real-time rebalancing of our portfolio enables us to curtail risk and to be profitable in both up market and down market scenarios. For the year ending December 31, 2011, approximately 97.1% of our average daily retail trading volume was either naturally hedgedâ€”when one customer executing a trade in a currency pair is offset by a trade made by another customerâ€”or hedged by us with one of our wholesale forex trading partners.
Our risk management policies and procedures are established and reviewed regularly by the Risk Committee of our Board of Directors. While many of our risk management processes are automated and we calculate margin requirements for each of our customers on a real-time basis across all products, our risk-management policies also require quantitative analyses by product, as well as assessment of a range of market inputs, including trade size, price and market liquidity. Our risk-management procedures require our team of senior traders to monitor risk exposure on a continuous basis and update senior management both informally over the course of the trading day and formally through real-time, intraday and end of day reporting. We do not take proprietary directional market positions and therefore do not initiate market positions for our own account in anticipation of future movements in the relative prices of products we offer.
Because we allow our customers to trade notional amounts greater than the funds they have on deposit with us through the use of leverage, management of credit risk is a key focus for us. The maximum leverage available to retail traders is set by the regulator in each jurisdiction. For example, the maximum leverage available to retail accounts in the United States is 50-to-1 (e.g. the initial margin requirement would be approximately $2,000 in order to execute a notional trade amount of 100,000 for the Euro/Dollar (EUR/USD) currency pair), 25-to-1 in Japan and up to 200-to-1 in the United Kingdom and Australia. We manage customer credit risk through a combination of making available trading tools that allow our customers to avoid taking on excessive risk and automatic processes that close customer positions in the event the market moves against them. For example, our customer trading platforms provide a real-time margin monitoring tool to enable customers to know when they are approaching their margin limits so that they may take action ahead of any liquidation event. Customers also have the option of employing lower leverage. If a customerâ€™s equity falls below what is required to support that position, we will automatically liquidate positions to bring the customerâ€™s account into margin compliance.
Demonstrated white label capabilities
We have significant experience in successfully negotiating and maintaining white label partnerships. White label partners are firms that enter into an arrangement with us whereby we provide all of the front- and back-office services necessary for them to provide online retail forex trading to their customers under their own brands. Our typical white label partner is a either a financial services firm seeking to provide their retail customers with online forex trading services quickly and cost-effectively or an online broker, such as a broker-dealer or Futures Commission Merchant, or FCM, seeking to expand the number of financial products they offer to their customers. We enter into white label partnerships in order to expand into new markets where we have not obtained the regulatory authorizations necessary to provide our trading services directly to retail customers or to gain access to a partnerâ€™s existing client base. We compensate our white label partners with either a commission based on the trading volume generated by their customers or a share of net revenue generated by their customers. These relationships allow us to take advantage of market opportunities that would be costly and time-consuming to access by other means. Through our white label partners, we generated 14.5% of our retail trading volume for the year ended December 31, 2011. We believe we are well-positioned to capture new partnership opportunities given our successful track record of supporting partners globally.
Our retail customers consist of self-directed traders, who execute trades on their own behalf, and managed account customers who have engaged an intermediary to make trading decisions on their behalf.
The majority of our retail customers are self-directed traders. The typical self-directed customer is generally comfortable making trading decisions and has prior experience trading online, typically in more traditional asset classes, such as equities. Generally, our self-directed customers seek a high return on capital and are interested in investing in alternative asset classes, which typically have a higher risk/reward profile, but can serve as a diversification tool. For the year ended December 31, 2011, self-directed customers represented approximately 93.5% of our retail trading volume.
Our managed account customers make up a smaller portion of our retail customer base. The intermediaries engaged by our managed account customers, which we refer to as authorized traders, include professional money managers, which trade a significant amount of aggregated customer funds, and individuals that trade for a small number of customer accounts. For the year ended December 31, 2011, authorized traders collectively represented approximately 6.5% of our retail trading volume.
Sales and Marketing
In connection with our retail business, we employ a mixture of online and traditional marketing programs, such as advertising on third-party websites, search engine marketing, email marketing, as well as television advertising. In addition, we position senior members of our research team as expert industry resources, resulting in regular appearances on major financial news outlets.
Our principal lead-generation tool is to offer prospective customers access to free registered practice trading accounts for a 30-day trial period. From a prospective customerâ€™s point of view, we believe the registered practice trading account serves two important functions. First, it serves as an educational tool, providing the prospective customers with the opportunity to try trading in a risk-free environment, without committing any capital. Second, it allows the prospective customer to evaluate our trading platform, tools and services. During this trial period, our customer service team is available to assist and educate the prospective customers.
We also attract customers by building awareness of our company, and the retail forex trading industry in general, through various education initiatives. Our educational resources currently include a variety of video tutorials, articles and other materials, along with interactive webinars and a comprehensive web-based training course coupled with access to experienced instructors. In keeping with our education focus, FOREX.com co-sponsors a 30-minute CNBC program developed to educate self-directed traders about the forex market. The program debuted in March 2011.
We also actively forge partnerships with introducing brokers in order to expand our customer base. We work with a variety of different types of introducing brokers, ranging from small, specialized firms that specifically identify and solicit customers interested in forex trading, to larger, more established financial services firms seeking to enhance their customer base by offering a broader array of financial products. Introducing brokers direct customers to us in return for either a commission on each referred customerâ€™s trading volume or a share of net revenue generated by each referred customerâ€™s trading activity.
Our Institutional Business
We offer institutional customers access to forex trading, primarily through our GAIN GTX offering, which we launched in 2010. GAIN GTX utilizes a highly innovative, next generation electronic communications network, or ECN, which provides deep liquidity and true peer to peer trading capabilities through our unique centrally-cleared prime brokerage model, along with advanced algorithmic trading capabilities. We have made a significant investment in the development of proprietary enhancements to the GAIN GTX platform to provide our customers with innovative trading tools, such as basket trading, highly customized reporting and custom margin monitoring. In 2011, we launched a specialty execution desk within our GAIN GTX business to facilitate the execution of more complex transactions for our clients covering all aspects of the forex markets, including swaps, NDFs and options. For the year ended December 31, 2011, net revenue from our institutional business represented 2.4% of our total consolidated revenue.
Through GAIN GTX we provide institutional customers fully anonymous and equal access to the same executable pricing across all major currency pairs. GAIN GTX clients use their existing credit line with a prime broker to trade on the liquidity of other participants, including banks, hedge funds and other clients. GAIN GTX provides a marketplace where participants, including banks, market makers and individual traders, trade against each other by sending competing bids and offers into the trading platform. Participants interact inside the trading platform and get the best offers for their trades available at that time. All trading orders are matched between counterparties in real time. We act as an agent for the trades executed on the GAIN GTX platform and, therefore, do not assume any market or credit risk. We generate revenue by charging a commission on trades executed on the platform.
For professional traders who meet certain qualifications but do not have a credit line with a prime broker, our GTX Direct offering allows access to the liquidity of the GAIN GTX marketplace. Through GTX Direct, we agree to act as counterparty to trades executed through the GAIN GTX trading platform on our clientsâ€™ behalf and earn a commission for each trade.
GAIN GTX is powered by software and services that we license from Forexster Limited, or Forexster. Pursuant to our agreements with Forexster, we have obtained, subject to certain excluded customers and geographic regions, exclusive rights to use the Forexster software in the field of forex trading and non-exclusive rights to use such trading services in the field of precious metals trading.
Our institutional customer base includes financial institutions, hedge fund managers, Commodity trading advisors (â€śCTAsâ€ť), high frequency traders, broker/dealers and high net worth individuals who are looking for competitive pricing from diverse and deep liquidity sources.
Sales and Marketing
We have a direct sales team of six employees who are dedicated to building relationships with potential institutional customers and expanding our GAIN GTX business. Since its inception in 2010, our institutional business has quickly expanded to include customers throughout the United States, Europe and Asia.
GAIN GTX competes with other firms offering electronic trading platforms, such as ICAP through its EBS offering; Reuters; FX Connect and Currenex, both owned by State Street Bank; BGC partners through its eSpeed offering; FX Alliance; Knight Capital through its Hotspot offering; 360T Trading Networks; Integral Development Corp. and others.
Our Broker-Dealer Business
We offer our customers the ability to trade exchange-traded products through our wholly-owned subsidiary, GAIN Securities, through which we generated less than 1.0% of our consolidated net revenues for the year ended December 31, 2011. A broker dealer registered with the SEC and a member of the Financial Industry Regulatory Authority, Inc., or FINRA, GAIN Securities offers direct access to listed U.S. equity securities, including stocks, exchange traded funds, or ETFs, options, mutual funds and bonds.
We rely on a combination of trademark, copyright, trade secret and unfair competition laws in the United States and other jurisdictions to protect our proprietary technology, intellectual property rights and our brands (e.g., Forex.com, GAIN Capital and GAIN GTX). We also enter into confidentiality and invention assignment agreements with our employees and consultants, and confidentiality agreements with other third parties. We rigorously control access to our proprietary technology. Currently, we do not have any pending or issued patents.
We use the following service marks that have been registered with the U.S. Patent and Trademark Office: GAIN Capital (registered service mark), FOREX.com GAIN Capital Group (registered service mark), Trade Real-Time (registered service mark), ForexPro (registered service mark), ForexPremier (registered service mark), Forex Insider (registered service mark), ForexTrader (registered service mark), FOREX.com (registered service mark), ForexPlus (registered service mark) and Itâ€™s Your World. Trade It. (registered service mark).
Mark E. Galant
53 1999 Since October 2008, Mr. Galant has served as Chief Executive Officer and Chairman of the Board of Directors of Tydall Trading LLC, a privately held high-frequency algorithmic trading firm. From October 1999 to June 2007, Mr. Galant, founder of GAIN, served as our Chief Executive Officer. From 1994 to 1999, Mr. Galant served as President of FNX Limited, an international provider of trading and risk-management systems. From 1991 to 1994, Mr. Galant served as Global Head of Foreign Exchange Options Trading at Credit Suisse. In May 2008, Mr. Galant founded the Galant Center for Entrepreneurship with the McIntire School of Commerce at the University of Virginia. Mr. Galant currently serves as a member of the Board of Directors of Trader Tools, Inc. and Faros Trading, LLC. Mr. Galant received a BS in Finance from the University of Virginia and an MBA from Harvard Business School.
Christopher S. Sugden
Nominating and Corporate Governance Committee
42 2006 Since 2009, Mr. Sugden has served as Managing Partner and Chairman of the Investment Committee of Edison Ventureâ€™s growth capital fund, which is one of our largest stockholders. From April 2002 to May 2007, Mr. Sugden held various positions with Edison Ventures, including Partner and Principal. From January 1999 to December 2001, Mr. Sugden served as Executive Vice President and Chief Financial Officer of Princeton eCom, a privately held financial services software company. Mr. Sugden currently serves as a member of the Board of Directors of Billtrust, Inc., Business Financial Services, Inc., Folio Dynamix, Inc., PHX, Inc., Operative Media, Inc., Trader Tools, Inc., SciVantage, Inc. and Softgate Systems. A certified public accountant, Mr. Sugden received a BA in Accounting, with Honors, from Michigan State University.
Susanne D. Lyons
Chairperson of Compensation Committee
Nominating and Corporate Governance
55 2009 Ms. Lyons retired in September 2007. From June 2004 to September 2007, Ms. Lyons served as Executive Vice President and Chief Marketing Officer of Visa, USA. From 2003 to 2004, Ms. Lyons served as Managing Director of Russell Reynolds Associates, an executive search firm. From 1992 to 2001, Ms. Lyons served in various senior capacities at Charles Schwab & Co., including president of retail client services and Chief Marketing Officer. Prior to 1992, Ms. Lyons served in various capacities at Fidelity Investments. Ms. Lyons has served as a member of the Board of Directors of Cnet, and currently serves on the Board of the United States Olympic Committee and the not-for-profit WildCare. Ms. Lyons received a BA from Vassar College and an MBA from Boston University.
Chairman of Audit Committee
53 2008 Since June 2009, Mr. Schenk has served as Chief Executive Officer of First NY Securities, LLC, a principal trading firm. From June 2008 to March 2009, Mr. Schenk served as Chief Executive Officer of Pali Capital, Inc., a financial services firm. From January 2000 until December 2007, Mr. Schenk served as Chief Financial Officer and Executive Vice President of Jefferies Group, Inc., a full-service investment bank and institutional securities firm. Mr. Schenk also served as Senior Vice President, Corporate Services, of Jefferies from September 1997 through December 1999. From January 1996 through September 1997, Mr. Schenk served as Chief Financial Officer and Treasurer of Tel-Save Holdings, Inc. (now Talk America Holdings, Inc.). From September 1993 to January 1996, Mr. Schenk served as Vice President, Capital Markets Group, with Jefferies. Mr. Schenk received a BS in Accounting from the University of Detroit.
Christopher W. Calhoun
Chairman of Risk Committee
41 2010 From April 2009 to October 2010, Mr. Calhoun served as our part-time Senior Advisor and our Corporate Secretary from June 2007 to October 2010. From June 2008 to April 2009, Mr. Calhoun served as our Managing Director. From December 2005 to July 2008, Mr. Calhoun served as our Chief Operating Officer. From November 2000 to December 2005, Mr. Calhoun served in various positions with us, including Vice President of Operations and Vice President of Business Technology. From March 1992 to March 2000, Mr. Calhoun served in a number of executive level roles, including Chief Operating Officer, of FNX Limited, an international provider of trading and risk-management systems. Mr. Calhoun currently serves on the Board Of Directors of SciVantage, Inc. Mr. Calhoun is registered with the CFTC and NFA as an associated person. Mr. Calhoun received a BS in Finance and an MBA from La Salle University.
MANAGEMENT DISCUSSION FROM LATEST 10K
As a global provider of online trading services, our results of operations are impacted by a number of external market factors, including market volatility and transaction volumes, competition in the forex market, the regulatory environment in the various jurisdictions and markets in which we operate and the financial condition of the retail and institutional customers to whom we provide our services. These factors are not the only factors that impacted our results of operations for the most recent fiscal period, and additional or other factors may impact, or have different degrees of impact, on our results of operations in future periods.
During the past few years, there has been significant disruption and volatility in the global financial markets. Our revenue and operating results may vary significantly from period to period due primarily to movements and trends in the worldâ€™s currency markets and to fluctuations in trading levels. As a general rule, our business typically benefits from volatility in the markets that we serve, as periods of increased volatility often coincide with higher levels of trading by our clients and a higher volume of transactions. However, periods of extreme volatility may result in significant market dislocations that can also lead clients to reduce their trading activity. In addition, volatility that results in trading within a relatively narrow band of currency prices may lead to less profitable trading activity. Also, market volatility can adversely affect our ability to profitably manage our net exposure, which represents the unhedged portion of the trading positions we enter into with our customers.
Market volatility is driven by a range of external factors, some of which are market specific and some of which are correlated to general macroeconomic conditions. Weakness in equity markets, which occurred in much of 2011 and several of the previous years, can result in reduced trading activity in the forex market. The European sovereign debt crisis, which arose in the second quarter of 2010 and continued throughout 2011, created economic uncertainty, adversely affecting the equities and other securities markets for much of this period, leading investors to, at times, reduce their forex trading activity, and also resulted in anomalous and challenging market conditions over several significant periods during 2011.
The forex market has been accessible to retail investors for a significantly shorter period than many other securities markets, such as equities, and is a rapidly evolving industry characterized by intense competition. Entering new markets often requires us to narrow our spreads in order to attract customers and compete with other companies who have established customer bases in such markets. In addition, in existing markets, on occasion we make short-term decisions to be more aggressive regarding the spreads we offer our customers, or we may decide to offer additional services at reduced rates, or free of charge, in order to attract customers and take market share from our competitors.
In recent years, the financial markets have experienced the beginning of a major global regulatory overhaul, as regulators and legislators in the U.S. and abroad have proposed and, in some instances, adopted, a wide range of regulatory changes that have had a significant effect on the manner in which we operate our business. In particular, as a result of the Dodd-Frank Actâ€™s requirement that essentially all transactions in commodities be executed on an exchange, after July 15, 2011, we were no longer permitted to offer leveraged spot metal transactions in the United States. For the period from January 1, 2011 through July 15, 2011, our leveraged spot metals business with U.S. customers generated approximately $20.7 million in revenue. In addition, reductions in permitted leverage ratios in Japan have, we believe, been a negative influence on trading volumes by customers in such country.
Part of our growth strategy is to enter new markets, and as we do so we will become subject to regulation in those markets. Complying with different regulatory regimes in multiple markets is expensive, and in many markets the regulatory environment is unclear and evolving. Changes in regulatory requirements and changes in the interpretation of existing regulatory requirements may force us to alter our business practices.
In the year ended December 31, 2011, we experienced periods of low and high volatility in reaction to various market conditions. For example, early in the twelve month period forex volatility was somewhat muted, while the natural disaster in Japan and economic issues in Europe resulted in elevated forex volatility levels and an increase in our customer trading activity in March. After relatively quiet markets in April, volatility returned in May due in part to the debt crises in Europe and inflation fears, causing increased interest in certain â€śsafe havenâ€ť currencies and commodities. In the third quarter of 2011, similar periods of volatility occurred due to the change in the credit rating of the United States and continued concerns over the debt crises in Europe. The year concluded with a steep drop-off in market volatility, heightened market uncertainty and tight trading ranges in major currencies.
Key Income Statement Line Items and Key Operating Metrics
The following section briefly describes the key components of our revenues and expenses, our use of non-GAAP financial metrics, and key operating metrics we use to evaluate the performance of our business.
We generate revenue from trading revenue, other revenue and interest income.
Trading revenue is our largest source of revenue and is generated in our retail forex business. Trading revenue represented 96.9% of our total net revenue for the year ended December 31, 2011, and 99.1% of our total net revenue for the year ended December 31, 2010.
We generate trading revenue as follows:
for trades that are naturally hedged against an offsetting trade from another customer, we receive the entire retail bid/offer spread we offer our customers on the two offsetting transactions;
for trades that are hedged with one of our wholesale forex trading partners, we receive the difference between the retail bid/offer spread we offer our customers and the wholesale bid/offer spread we receive from the wholesale forex trading partners; and
with respect to the remaining customer trades, which we refer to as our net exposure, we receive the net gains or losses generated through changes in the market value of the currencies held in our net exposure.
For the year ended December 31, 2011, approximately 97.1% of our average daily retail trading volume was either naturally hedged or hedged by us with one of our wholesale forex trading partners, and the remaining 2.9% of our average daily retail trading volume consisted of our net exposure, compared to average daily retail trading volume hedged of 98.0% and 98.6% in 2010 and 2009, respectively.
We manage our net exposure by applying position and exposure limits established under our risk-management policies and by continuous, active monitoring by our traders. Based on our risk management policies and procedures, over time a portion of our net exposure may be hedged with our wholesale forex trading partners.
Although we do not actively initiate proprietary directional market positions in anticipation of future movements in the relative prices of the products we offer, through our net exposure we are likely to have open positions in various currencies at any given time. In the event of unfavorable market movements, we may take a loss on such positions.
Other revenue is comprised of revenue from our GAIN GTX institutional business; account management, transaction and performance fees related to customers who have assigned trading authority to our subsidiary Gain Capital Asset Management, or GCAM; inactivity and training fees charged to customer accounts; and other miscellaneous items.
We generate revenue in our GAIN GTX institutional forex trading business by earning a commission on each transaction, which is recorded under other revenue. We act as an agent for the trades executed on the GAIN GTX platform and, therefore, do not assume any market or credit risk. Commission revenue received in our GAIN GTX institutional forex trading business generally generates a lower trading revenue per million traded than that which we have historically experienced in our retail forex trading business. We launched our specialty GTX execution desk in late 2011 to facilitate the execution of more complex transactions.
For the year ended December 31, 2011, other revenue was $6.5 million, which included GAIN GTX revenue of $4.4 million, compared to $3.4 million for the year ended December 31, 2010, which included GAIN GTX revenue of $2.0 million.
Net Interest Expense
Net interest expense consists primarily of the revenue generated by our cash and customer cash held by us at banks, in money market funds and on deposit as collateral with our wholesale forex trading partners, less interest paid to customers on their net account value and interest expense on our term loan. A customerâ€™s net account value equals cash on deposit plus the marking to market of open positions as of the measurement date.
Our cash and customer cash is generally invested in money market funds, which primarily invest in short-term U.S. government securities. Such deposits and investments earned interest at an average effective rate of approximately 0.1% for the year ended December 31, 2011 and 2010. Interest paid to customers varies among customer accounts primarily due to the net value of a customer account. From time to time, we also make available interest promotions pursuant to which we may pay certain customers higher levels of interest than that which is paid to other customers. Interest income and interest expense are recorded when earned and incurred, respectively. Net interest expense was $0.9 million for the year ended December 31, 2011, compared to $1.7 million for the year ended 2010.
Our expenses are principally comprised of employee compensation and benefits, selling and marketing, trading expenses and commissions, purchased intangible amortization and other expenses.
Employee Compensation and Benefits
Employee compensation and benefits includes salaries, bonuses, stock-based compensation, contributions to benefit programs and other related employee costs.
Selling and Marketing
Our marketing strategy employs a combination of direct online marketing and focused branding programs, with the goal of raising awareness of our retail forex trading Internet website, FOREX.com, and attracting customers in a cost-efficient manner. As part of our strategy to attract new accounts and client assets, we continue to invest in new international marketing programs in support of our global expansion efforts. A portion of selling and marketing expense is fixed at the beginning of each year. In the fourth quarter of 2011, in light of the challenging market conditions, we slightly decreased our spending on advertising. However, we continue to believe that robust advertising and marketing efforts are an essential part of our long term strategy to maintain the prominence of our Forex.com brand and to increase our customer base and market share. For the year ended December 31, 2011, selling and marketing expense was $36.2 million, compared to $37.7 million for the year ended December 31, 2010.
Trading Expense and Commissions
Trading expense and commissions consists primarily of compensation paid to our white label partners and introducing brokers. We generally provide white label partners with the platform, systems and back-office services necessary for them to offer forex trading services to their customers. Introducing brokers identify and direct potential forex trading customers to us. White label partners and introducing brokers generally handle marketing and the other expenses associated with attracting customers. Accordingly, we do not incur any incremental sales and marketing expense in connection with trading revenue generated by customers provided through our white label partners and introducing brokers. We do, however, pay a portion of this trading revenue to our white label partners and introducing broker partners and record this payment under trading expense and commissions. This expense is largely variable and changes principally based on the level of customer trading volume directed to us from our white label partners and introducing brokers, the specific terms of our agreements with the white label partners and introducing brokers, which vary on a partner-by-partner and regional basis, and the relative percentage of trading volume generated from particular relationships in any given period. The majority of our white label and introducing broker partners are paid based on the trading volume generated by the customers they introduce, directly or indirectly, to us. As such, during periods in which their customersâ€™ trading activity is not profitable for us, if the associated trading volume remains high, we may be required to make larger payments to these partners despite the fact that we are generating lower revenue from their customers. This situation occurred in 2011, in particular in the fourth quarter of the year, which resulted in an increase in trading expense despite a decrease in trading revenue generated by our white label and introducing broker clients. Our indirect business accounted for 34.6%, 42.5% and 38.9% of retail trading volume in the years ended December 31, 2009, 2010 and 2011, respectively.
Purchased Intangible Amortization
Purchased intangible amortization consists of amortization related to intangible assets we acquired in 2011 and 2010 in connection with our acquisition of customer accounts in several transactions we executed during these periods. The principal intangible assets acquired were customer assets and a non-compete agreement. These intangible assets have useful lives ranging from one year to six years. The acquisition of such intangible assets gives rise to contingent liabilities, which are adjusted to their fair value on a quarterly basis with such adjustments flowing through purchased intangible amortization expense.
Other expenses include professional fees, product development, software and maintenance, bank fees, depreciation and amortization, communications and data processing, occupancy and equipment, bad debt provision and other miscellaneous expenses, as described below under â€śResults of Operations.â€ť
Non-GAAP Financial Metrics
We use adjusted net income, adjusted earnings per common share and adjusted effective tax rate, each of which is a non-GAAP financial metric, to evaluate our business. We believe our reporting of adjusted net income and adjusted earnings per share assists investors in evaluating our operating performance. We also believe adjusted net income and adjusted earnings per common share allow investors to appropriately compare our results for periods before and after our IPO, because these metrics eliminate the effect of the embedded derivative in our preferred stock, which was extinguished at the time of our IPO, as discussed in more detail below. Additionally, we believe adjusted effective tax rate assists investors in evaluating our tax rate applicable to our operating performance by removing the impact of the embedded derivative liability. However, adjusted net income, adjusted earnings per common share and adjusted effective tax rate are not measures of financial performance calculated in accordance with GAAP and such measures should be considered in addition to, but not as a substitute for, other measures of our financial performance reported in accordance with GAAP, such as net income and earnings per common share. Below is a discussion and reconciliation of these non-GAAP financial metrics.
Adjusted Net Income
Adjusted net income is a non-GAAP financial measure and represents our net income/(loss) excluding (i) for periods prior to 2011 (x) the change in fair value of the embedded derivative in our preferred stock and (y) the after-tax impact of amortization of purchased intangibles; and (ii) for 2011 and future periods, the after tax impact of amortization of purchased intangibles. As discussed below, the embedded derivative in our preferred stock was extinguished at the time of our IPO. Accordingly, beginning in 2011, we no longer include an adjustment for changes in fair value of the embedded derivative and adjusted net income represents our net income excluding only the after-tax impact of amortization of purchased intangibles. This non-GAAP financial measure has certain limitations, including that it does not have a standardized meaning and, therefore, our definition may be different from similar non-GAAP financial measures used by other companies or analysts. Therefore, it may be more difficult to compare our financial performance to that of other companies.
Our previously outstanding Convertible, Redeemable Preferred Stock Series A, Series B, Series C, Series D, and Series E contained a redemption feature that allowed the holders of our preferred stock at any time on or after March 31, 2011 to require us to repurchase such securities. We had determined that this redemption feature effectively provided such holders with an embedded option derivative meeting the definition of an â€śembedded derivativeâ€ť pursuant to FASB ASC 815, Derivatives and Hedging. Consequently, the embedded derivative was required to be bifurcated and accounted for separately. As discussed above, this redemption feature and related accounting treatment is no longer required to be recognized following conversion of all of our then outstanding preferred stock into common stock in connection with our IPO. Historically, in accordance with FASB ASC 815, we adjusted the carrying value of the embedded derivative to the fair value of our company at each reporting date, based upon the Black-Scholes options pricing model, and reported the preferred stock embedded derivative liability on the Consolidated Financial Statements, with changes in fair value recorded in our Consolidated Statements of Operations and Comprehensive Income. Historically, this impacted our net income, but did not affect our cash flow generation or operating performance. The embedded derivative caused our earnings to fluctuate, but in our view was not indicative of our historical or expected future operating performance.
Adjusted Earnings Per Share
Adjusted earnings per share is a non-GAAP financial measure and represents our net income/(loss) per share excluding (i) for periods prior to 2011 (x) the change in fair value of the embedded derivative in our preferred stock and (y) the after-tax impact of amortization of purchased intangibles; and (ii) for 2011 and future periods, the after tax impact of amortization of purchased intangibles. As noted above, the embedded derivative in our preferred stock was extinguished at the time of our IPO. Accordingly, beginning in 2011, we no longer include an adjustment for changes in fair value of the embedded derivative and adjusted earnings per share represents our earnings per share excluding only the after-tax impact of amortization of purchased intangibles. This non-GAAP financial measure has certain limitations, including that it does not have a standardized meaning and, therefore, our definition may be different from similar non-GAAP financial measures used by other companies and/or analysts. Thus, it may be more difficult to compare our financial performance to that of other companies.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
We are a global provider of trading services and solutions, specializing in global over-the-counter, or OTC, markets, including spot foreign exchange, or forex, and precious metals, as well as â€ścontracts-for-difference â€ť, or CFDs, which are investment products with returns linked to the performance of an underlying commodity, index or security. We have customers in more than 140 countries worldwide and conduct business from our offices in New York, Bedminster, New Jersey, London, Tokyo, Sydney, Beijing, Hong Kong, Seoul and Singapore.
Our retail trading business, which has historically made up the majority of our business, allows customers to trade through our FOREX.com brand. We also offer retail customers the ability to trade exchange-traded products through our wholly-owned subsidiary, GAIN Securities. Our institutional trading business, GAIN GTX, which we launched in March 2010, serves institutional market participants, including hedge funds, banks and high-frequency trading firms. Our institutional trading business also includes our specialty execution desk, which we launched in September 2011 to facilitate the execution of more complex transactions.
We have invested considerable resources in developing our retail and institutional trading platforms and tools to allow our customers to trade and manage their accounts. While our retail and institutional trading businesses use separate platforms, we are able to leverage our combined scale and trading volume in our relationships with our wholesale trading partners, bank liquidity providers, and other service providers. In addition, we believe the two platforms complement each other, which allows us to cross-sell our services and to leverage our facilities and the technology we develop. Our customers can trade through web-based, downloadable and mobile trading platforms and have access to innovative trading tools to assist them with research, automated trading and account management.
As part of our strategy to diversify our product portfolio and add new revenue sources, we announced in June an agreement to acquire Open E Cry, or OEC, an online futures broker, from optionsXpress, a subsidiary of The Charles Schwab Corporation, for $12 million. As of June 30, 2012, OEC held $95.9 million in customer assets, with 8,101 open accounts. OECâ€™s revenue was $13.6 million for the year ended December 31, 2011. The transaction is expected to close in during the third quarter of 2012.
Our principal operating expenses are comprised of employee compensation and benefits, selling and marketing, trading expenses and commissions and other operating expenses.
Employee Compensation and Benefits
Employee compensation and benefits includes salaries, bonuses, stock-based compensation, contributions to benefit programs and other related employee costs.
Selling and Marketing
Our marketing strategy employs a combination of direct online marketing and focused branding programs, with the goals of raising awareness of our retail offering, FOREX.com, and our GAIN GTX institutional offering, and attracting customers in a cost-efficient manner. We generally adjust our level of advertising spending in relation to overall market activity and other market conditions in an effort to maximize the efficiency of our advertising. Changes in selling and marketing costs may also reflect the introduction of specific marketing campaigns to support product and service launches throughout the year.
Trading Expense and Commissions
Trading expense and commissions consists primarily of compensation paid to our white label partners, introducing brokers and specialty execution desk employees. We generally provide white label partners with the platform, systems and back-office services necessary for them to offer forex trading services to their customers. Introducing brokers identify and direct potential forex trading customers to us. White label partners and introducing brokers generally handle marketing and the other expenses associated with attracting customers. Accordingly, we do not incur any incremental sales and marketing expense in connection with trading revenue generated by customers provided through our white label partners and introducing brokers. We do, however, pay a portion of this trading revenue to our white label partners and introducing broker partners and record this payment under trading expense and commissions. This expense is largely variable and changes are principally based on the level of customer trading volume directed to us from our white label partners and introducing brokers, the specific terms of our agreements with the white label partners and introducing brokers, which vary on a partner-by-partner and regional basis, and the relative percentage of trading volume generated from particular relationships in any given period. The majority of our white label and introducing broker partners are paid based on the trading volume generated by the customers they introduce, directly or indirectly, to us. As such, since in certain periods higher levels of trading volume may not necessarily correlate with higher trading revenue, trading expense and commissions may increase during such periods without a commensurate increase in related trading revenue. This situation occurred in the first three months of 2012, which resulted in an increase in trading expense for the six months ended June 30, 2012 despite a decrease in trading revenue generated by customers introduced to us by white label partners and introducing brokers. Customers introduced by our white label partners and introducing brokers accounted for 36.9% and 37.4% of retail trading volume in the three and six months ended June 30, 2012, respectively. Customers introduced by our white label partners and introducing brokers accounted for 34.4% and 33.3% of retail trading volume in the three and six months ended June 30, 2011, respectively.
Other Operating and Non-Operating Expenses
Other operating expenses include professional fees, product development, software and maintenance, bank fees, communications and data processing, occupancy and equipment, bad debt provision and other miscellaneous expenses.
Non-operating expenses include restructuring charges, depreciation and amortization and purchased intangible amortization. Purchased intangible amortization is a non-operating expense, which consists of amortization related to intangible assets we acquired in 2011 and 2010 in connection with our acquisition of customer accounts in several transactions we executed during these periods. The principal intangible assets acquired were customer assets and a non-compete agreement. These intangible assets have useful lives ranging from one year to six years.
Non-GAAP Financial Measures
We use adjusted net income and adjusted earnings per common share, both of which are non-GAAP financial measures, to evaluate our business. Adjusted net income represents our net income excluding the after-tax impact of amortization of purchased intangibles. Adjusted earnings per share represents our net income per share excluding the after-tax impact of amortization of purchased intangibles. These non-GAAP financial measures have certain limitations, including that they do not have standardized meanings and, therefore, our definitions may be different from similar non-GAAP financial measures used by other companies and/or analysts. Thus, it may be more difficult to compare our financial performance to that of other companies.
However, we believe our reporting of adjusted net income and adjusted earnings per share assists investors in evaluating our operating performance because these measures exclude certain non-operating expenses and non-recurring items. However, because such measures are not measures of financial performance calculated in accordance with GAAP, such measures should be considered in addition to, but not as a substitute for, other measures of our financial performance reported in accordance with GAAP, such as net income and earnings per common share. Below is a reconciliation of these non-GAAP financial measures to the closest comparable GAAP financial measures.
Traded Retail Accounts
Traded retail accounts represent customers who executed at least one trade during the relevant period. We believe traded retail accounts is an important operating metric because it correlates to our trading volume and revenue. The number of our traded retail accounts in a given fiscal period is affected by the structure of our arrangements with our partners. For example, as part of our growth strategy in the Asia Pacific region, we have entered into omnibus agreements with various partners in the region. Regardless of the number of individual accounts, whether open and/or funded, that are introduced to us by each of these partners, because of the omnibus nature of our agreements, we recognize only one open and funded account in connection with each such partner relationship. For the six months ended June 30, 2012, we had 8 omnibus relationships in the Asia Pacific region which accounted for 3.0% of our total retail volume during the period.
Retail Trading Revenue Per Million Traded
Retail trading revenue per million traded is the revenue we realize from our forex and CFD trading activities per one million of U.S. dollar-equivalent trading volume, and is calculated as retail trading revenue divided by the result obtained from dividing the U.S. dollar-equivalent of retail trading volume by one million. The level of retail trading revenue per million traded that we experience in a given fiscal period is affected by a number of factors, including the volatility and trading ranges of the currencies we offer, changes in the mix of our customersâ€™ trading volume, which generally relates to the nature of customer positions relative to changes in the market prices of the currencies or other products they are trading, and the relative levels of trading spreads on the products we offer, which may be affected by changes in the geographic mix of our business, competition and other factors.
Funded Retail Accounts
Funded retail accounts represents retail customers who maintain cash balances with us. We believe the number of funded retail accounts is an important indicator of our ability to attract new retail customers that can potentially lead to trading volume and revenue in the future; however, it does not represent actual trades executed. In addition, as noted above with respect to Traded Retail Accounts , the structure of our arrangements with our partners can affect the number of funded retail accounts in a given fiscal period because, for example, where we have an omnibus agreement in place with a partner we recognize only one funded retail account in connection with that agreement regardless of the number of individual funded retail accounts introduced to us by such partner.
Client assets represents amounts due to clients, including customer deposits and unrealized gains or losses arising from open positions. We believe that increases in client assets are positively correlated with our customersâ€™ ability to engage in additional trading activity.
Foreign exchange contracts generally involve the exchange of two currencies at market rates on a specified date; spot contracts usually require the exchange of currencies to occur within two business days of the contract date. Customer transactions and related revenue and expenses are recorded on a trade-date basis. Gains or losses are realized when customer transactions are liquidated. Unrealized gains or losses on cash positions revalued at prevailing foreign currency exchange rates (the difference between contract price and market price) at the date of the balance sheet are included in Receivables from banks and brokers , Payables to customers and Payables to brokers, dealers, FCMs and other regulated entities on the Condensed Consolidated Balance Sheet. Changes in net unrealized gains or losses are recorded in Trading revenue on the Condensed Consolidated Statements of Operations and Comprehensive Income.
We prepare and file our income taxes as a consolidated legal entity. We account for income taxes in accordance with Financial Accounting Standards Board Accounting Standards Codification, or ASC, 740-10, Income Taxes . Income tax expenses are provided using the asset and liability method, under which deferred tax assets and liabilities are determined based upon the temporary differences between the consolidated financial statements and the income tax basis, using currently enacted tax rates. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in our Consolidated Statements of Operations and Comprehensive Income in the period of enactment. We routinely evaluate all deferred tax assets to determine the likelihood of their realization.
We use estimates in determining income tax positions under ASC 740-10-25, Income Taxes . Although we believe that our tax estimates are reasonable, the ultimate tax determination involves significant judgment and is subject to audit by tax authorities in the ordinary course of business.
Impairment of Long-Lived Assets
In accordance with ASC 360-10, Property, Plant and Equipment , we periodically evaluate the carrying value of long-lived assets when events and circumstances warrant such review. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flow from such an asset is separately identifiable and is less than the carrying value. In that event, a loss is recognized in the amount by which the carrying value exceeds the fair market value of the long-lived asset.
Goodwill and Intangible Assets
ASC 350-30, General Intangibles , requires a purchased intangible asset other than goodwill to be amortized over its useful life unless the useful life is determined to be indefinite. If the asset is determined to have a finite life in the future, we will amortize the carrying value over the remaining useful life at that time. In accordance with ASC 350-30, our URLs (foreignexchange.com and forex.com) are indefinite life intangible assets and are, therefore, not amortized. We compare the recorded value of the indefinite life intangible assets and goodwill to their fair value on an annual basis and whenever circumstances arise that indicate that an impairment may have occurred.
Allowance for Doubtful Accounts
Our allowance for doubtful accounts is based on our estimates of the uncollectibility of accounts receivable. The allowance for doubtful accounts, which is netted against Other assets on our Condensed Consolidated Balance Sheet, totaled approximately $0.2 million at June 30, 2012 and $0.1 million at December 31, 2011, respectively. We record an increase in the allowance for doubtful accounts when the prospect of collecting a specific account balance becomes doubtful. Management specifically analyzes accounts receivable and historical bad debt experience when evaluating the adequacy of the allowance for doubtful accounts. Should any of these factors change, the estimates made by management may also change, which could affect the level of our future provision for doubtful accounts.
For example, if the financial condition of our customers were to deteriorate, adversely affecting their ability to make payments, an additional provision for doubtful accounts may be required, and such provision may be material.
We make significant estimates in determining our quarterly and annual accrued non-share based compensation. A significant portion of our employee incentive compensation programs are discretionary. Each quarter and year-end we determine the amount of discretionary cash bonus pools. We also review compensation throughout the year to determine how overall performance compares to managementâ€™s expectations. We take these and other factors, including historical performance and our performance relative to budget, into account in reviewing accrued discretionary cash compensation estimates on a quarterly basis and adjusting accrual rates as appropriate. Changes to these factors could cause a material increase or decrease in the amount of compensation expense that we report in a particular period.